Lessons from GSK in China – Internal Controls, Auditing and Monitoring

One of the great things about writing your own blog is that sometimes you can get going on a subject and just explore it. While I think I might sometimes get carried away when I delve into a topic, I certainly learn much while doing so. This week appears to be such a situation where in studying and researching the GlaxoSmithKline PLC (GSK); I find that the case has much more to inform the compliance practitioner. So I am going to try and tie together some of the major lessons learned from the GSK Chinese enforcement action for the remainder of the week and present to you how such lessons might assist you in designing, implementing or upgrading a best practices compliance program. Today I want to look at internal controls, auditing and monitoring.

One of the questions that GSK will have to face during the next few years of bribery and corruption investigations is how an allegedly massive bribery and corruption scheme occurred in its Chinese operations? The numbers went upwards of $500MM, which coincidentally was the amount of the fine levied by the Chinese court on GSK. It is not as if the Chinese medical market is not well known for its propensity towards corruption, as prosecutions of the Foreign Corrupt Practices Act (FCPA) are littered with the names of US companies which came to corruption grief in China. GSK itself seemed to be aware of the corruption risks in China. In a Reuters article, entitled “How GlaxoSmithKline missed red flags in China”, Ben Hirschler reported that the company had “more compliance officers in China than in any country bar the United States”. Further, the company conducted “up to 20 internal audits in China a year, including an extensive 4-month probe earlier in 2013.” GSK even had PricewaterhouseCoopers (PwC) as its outside auditor in China. Nevertheless, he noted, “GSK bosses were blindsided by police allegations of massive corruption involving travel agencies used to funnel bribes to doctors and officials.”

Internal Controls

Where were the appropriate internal controls? You might think that a company as large as GSK and one that had gone through the ringer of a prior Department of Justice (DOJ) investigation resulting in charges for off-label marketing and an attendant Corporate Integrity Agreement (CIA) might have such controls in place. It was not as if the types of bribery schemes in China were not well known. In an article in the Financial Times (FT), entitled “Bribery built into the fabric of Chinese healthcare system”, reporters Jamil Anderlini and Tom Mitchell wrote about the ‘nuts and bolts’ of how bribery occurs in the health care industry in China. The authors quoted Shaun Rein, a Shanghai-based consultant and author of “The End of Cheap China”, for the following “This is a systemic problem and foreign pharmaceutical companies are in a conundrum. If they want to grow in China they have to give bribes. It’s not a choice because officials in health ministry, hospital administrators and doctors demand it.”

Their article discussed the two primary methods of paying bribes in China: the direct incentives and indirect incentives method. Anderlini and Mitchell reported, “The 2012 annual reports of half a dozen listed Chinese pharmaceutical companies reveal the companies paid out enormous sums in “sales expenses”, including travel costs and fees for sales meetings, marketing “business development” and “other expenses”. Most of the largest expenses were “travel costs or meeting fees and the expenses of the companies’ sales teams were, in every case, several multiples of the net profits each company earned last year.””

It would be reasonable to expect that internal controls over gifts would be designed to ensure that all gifts satisfy the required criteria, as defined and interpreted in Company policies. It should fall to a Compliance Officer to finalize and approve a definition of permissible and non-permissible gifts, travel and entertainment and internal controls will follow from such definition or criteria set by the company. These criteria would include the amount of the spend, localized down into increased risk such the higher risk recognized in China. Within this context, noted internal controls expert Henry Mixon has suggested the following specific controls. (1) Is the correct level of person approving the payment / reimbursement? (2) Are there specific controls (and signoffs) that the gift had proper business purpose? (3) Are the controls regarding gifts sufficiently preventative, rather than relying on detect controls? (4) If controls are not followed, is that failure detected?

Auditing Lessons Learned

Following Mixon’s point 4 above, what can or should be a company’s response if one country’s gifts, travel and entertainment expenses were kept ‘off the books’? This is where internal audit or outside auditors are critical. Hirschler quoted an un-named source for the following, ““You’d look at invoices and expenses, and it would all look legitimate,” said a senior executive at one top accountancy firm. The problem with fraud – if it is good fraud – is it is well hidden, and when there is collusion high up then it is very difficult to detect.”” Jeremy Gordon, director of China Business Services was quoted as saying “There is a disconnect between the global decision makers and the guys running things on the ground. It’s about initially identifying red flags and then searching for specifics.”

There are legitimate reasons to hold medical conferences, such as to make physicians aware of products and the latest advances in medicine, however, this legitimate purpose can easily be corrupted. Hirschler quoted Paul Gillis, author of the China Accounting Blog, for the following “Travel agencies are used like ATMs in China to distribute out illegal payments. Any company that does not have their internal audit department all over travel agency spending is negligent.” Based on this, GSK’s auditors should have looked more closely on marketing expenses and more particularly, the monies spent on travel agencies. Hirschler wrote, “They [un-named auditing experts] say that one red flag was the number of checks being written to travel agencies for sending doctors to medical conferences, although this may have been blurred by the fact that CME accounts for a huge part of drug industry marketing.”

Another issue for auditing is materiality. If GSK’s internal auditors had not been trained that there is no materiality standard under the FCPA, they may have simply skipped past a large number of payments made that were under a company’s governance procedure for elevated review of expenses. Further, if more than one auditor was involved with more than one travel agency, they may not have been able to connect the dots regarding the totality of payments made to one travel agency.

Ongoing Monitoring

A final lesson learned for today is monitoring. As Stephen Martin often says, many compliance practitioners confuse auditing with monitoring. Monitoring is a commitment to reviewing and detecting compliance programs in real time and then reacting quickly to remediate them. A primary goal of monitoring is to identify and address gaps in your program on a regular and consistent basis. Auditing is a more limited review that targets a specific business component, region, or market sector during a particular timeframe in order to uncover and/or evaluate certain risks.

Here I want to focus on two types of ongoing monitoring. The first is relationship monitoring, performed by companies such Boston-based Catelas, through software products. It was reported in a Wall Street Journal (WSJ) article, entitled “Glaxo Probes Tactics Used to Market Botox in China”, that internal GSK emails showed the company’s China sales staff were instructed by local managers to use their personal email addresses to discuss marketing strategies related to Botox. The Catelas software imports and analyzes communications data, like email, IM, telephony and SMTP log files from systems such as Microsoft Exchange Servers and Lotus Notes. The software then leverages social network analysis and behavioral science algorithms to analyze this communications data. These interactions are used to uncover and display the networks that exist within companies and between the employees of companies. Additionally, relationships between employees and external parties such as private webmail users, competitors and other parties can be uncovered.

The second type of monitoring is transaction monitoring. Generally speaking, transaction monitoring involves review of large amounts of data. The analysis can be compared against an established norm which is derived either against a businesses’ own standard or an accepted industry standard. If a payment, distribution or other financial payment made is outside an established norm, thus creating a red flag that can be tagged for further investigation.

GSK’s failure in these three areas now seems self-evident. However, the company’s foibles can be useful for the compliance practitioner in assessing where their company might be in these same areas. Moreover, as within any anti-corruption enforcement action, you can bet your bottom dollar that the regulators will be assessing best practices going forward based upon some or all of GSK’s miss-steps going forward.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2014

The Weatherford FCPA Settlement, Part III

Yesterday, I reviewed the conduct which Weatherford International Limited (Weatherford) engaged in over a period from 2002-2011 in connection with its Foreign Corrupt Practices Act (FCPA) investigation, noted the deficiencies in its compliance program and its internal controls and even how the company intentionally impeded the investigations of both the Department of Justice (DOJ) and Securities and Exchange Commission (SEC). Today, I want to look at how the company changed course in mid-stream during the investigation, brought in a top-notch and well respected lawyer as its Chief Compliance Officer (CCO), created a best-in-class compliance program; all of which saved the company millions of dollars in potential fines and penalties.

1. I.                    DOJ Fine Calculation

To resolve the criminal aspects of this case, Weatherford agreed to pay an $87.2 million criminal penalty as part of a Deferred Prosecution Agreement (DPA) with the DOJ. There was also another $65.6 million paid to the SEC. However the figure paid to the DOJ was at the very bottom range of a potential criminal penalty. The range listed in the DPA was from $87.2 to $174.3 million. In coming up with this range under the Federal Sentencing Guidelines, it is significant for the actions that Weatherford did not receive credit for during the pendency of the investigation. The company did not receive a credit for self-reporting. The company only received a -2 for its cooperation because prior to 2008 the company engaged in activities to impede the regulators’ investigation.

So the fine range could have been more favorable to the company. But the key is that Weatherford received the low end of the range. How did they do this?

A.     New Sheriff in Town

One of the key things Weatherford did was bring in Billy Jacobson as its CCO and give him a seat at the table of the company’s Executive Board. He was a Federal Prosecutor in the Fraud Section, Criminal Division, US Department of Justice. He also served as an Assistant Chief for FCPA Enforcement Department so we can assume he understood the FCPA and how prosecutors think through issues. (Jacobson also worked as a State Prosecutor in New York City, with my former This Week in FCPA co-host Howard Sklar, so shout out to Howard.) Jacobson was not hired directly from the DOJ but after he had left the DOJ and had gone into private practice. There is nothing that shows credibility like bringing in a respected subject matter expert and giving that person the tools and resources to turn things around.

But more than simply bringing in a new sheriff, Weatherford turned this talk into action by substantially increasing its cooperation with the government, thoroughly investigating all issues, turning over the results to the DOJ and SEC and providing literally millions of pages of documents to the regulators. The company also cleaned house by terminating officers and employees who were responsible for the illegal conduct.

B.     Increase in Compliance Function

In addition to establishing Jacobson in the high level CCO position, the company significantly increased the size of its compliance department by hiring 38 compliance professionals and conducted 30 anti-corruption compliance reviews in the countries in which Weatherford operates. This included the hiring of outside consultants to assess and review the company’s compliance program and beefing up due diligence on all third parties, including those in the sales and supply chain, joint venture (JV) partners and merger or acquisition (M&A) candidates. The company also agreed to continue to enhance its internal controls and books and records to prevent and/or detect future suspect conduct.

If you have ever heard any of the current Weatherford compliance professionals speak at FCPA conferences, you can appreciate that they are first rate; that they know their stuff and the company supports their efforts on an ongoing basis.

C.     Best in Class Compliance Program

During the pendency of the investigation, Weatherford moved to create a best practices compliance program. They appear to have done so and agreed in the DPA to continue to maintain such a compliance program. Under Schedule C to the DPA, it set out the compliance program which the company had implemented and continued to keep in place, at least during the length of the DPA. It included the following components.

1. High level commitment from company officials and senior management to do business in compliance with the FCPA.
2. A substantive written anti-corruption compliance code of conduct.
3. Written policies and procedures to implement this code of conduct.
4. A robust system of internal controls, including accounting and financial controls.
5. Risk assessments and risk reviews of its ongoing business.
6. No less than annual assessments of its overall compliance program.
7. Appropriate oversight and responsibility of a Chief Compliance Officer.
8. Effective training for all employees and relevant third parties.
9. An effective compliance function which can provide guidance to company employees.
10. A robust internal reporting system.
11. Effective investigations of any reported compliance issue.
12. Appropriate incentives for employees to do business ethically and in compliance.
13. Enforced discipline for any employee who violates the company’s compliance program.
14. Suitable due diligence and management of third parties and business partners.
15. A correct level of pre-acquisition due diligence for any merger or acquisition candidate, including a risk assessment and reporting to the DOJ if the company uncovers and FCPA-violative conduct during this pre-acquisition phase.
16. As soon as practicable, Weatherford will integrate any newly acquired entity into its compliance regime, including training of all relevant new employees, a FCPA forensic audit and reporting of any ongoing violations.
17. Ongoing monitoring, testing and auditing of the company’s compliance function, taking into account any “relevant developments in the field and the evolving international and industry standards.”

D.    Monitor

Weatherford also agreed to an external monitor. However, the term of the monitor is not the entire length of the three-year DPA; the term of the monitor is only 18 months. The monitor’s primary function is to assess the company’s compliance with the terms of the DPA and report the results to the DOJ at least twice during the terms of the monitorship. After this 18 month term the DOJ will allow the company to self-report to the regulators. It should be noted that the term of the external monitor can be extended by the DOJ.

II.                Conclusion

It certainly has been a long, strange journey for Weatherford. I should note that I have not discussed at all the Oil-For-Food aspect of this settlement, which was an additional $100MM penalty to the company. However, with regard to the FCPA aspects of the matter, there are some very solid and telling lessons to be drawn from this case. First and foremost is that cooperation is always the key. But more than simply cooperating in the investigation is that a company should take a pro-active approach to putting a best-in-class compliance program in place during, rather than after the investigation concludes. Also, a company cannot simply ‘talk-the-talk’ but must come through and do the work to gain the credit. The bribery schemes that the company had engaged in and the systemic failures of its compliance program and internal controls, should serve as a good set of examples for the compliance practitioner to use in assessing a compliance program.

The settlement also sends a clear message from both the DOJ and SEC on not only what type of conduct will be rewarded under the US Sentencing Guidelines, but what they expect as a compliance program. One does not have read tea leaves or attempt to divine what might be an appropriate commitment to compliance to see what the regulators expect these day.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2013

Financial Controls in a Best Practices Compliance Program

Financial controls are rarely given top billing in an anti-corruption compliance program under the Foreign Corrupt Practices Act (FCPA) or UK Bribery Act. However, it turns out that financial controls are essential to the long term success of not only a compliance program but also to the great health and success of a company. This was the message delivered by Stephen Arbogast, Executive Professor at the University of Houston, Bauer College of Business, Department of Finance, in a presentation to the Greater Houston Business and Ethics Roundtable (GBHER). Arbogast worked at Exxon Chemical and ExxonMobil Chemical Company from 1997-2004. In his academic career he has focused on International Finance, Project Finance and Business Ethics.

Arbogast thesis was that while financial controls are generally viewed as a set of burdensome rules and procedures, which are designed to constrain how a person does business, the reality is that they are essential to the long term success of any organization. He cited general propositions for this thesis. The first is that financial controls promote a culture of honesty, so that employees do not cheat in doing business and do not steal from the company. The second is that having financial controls in places helps to ensure information and data integrity so that reporting up the chain provides accurate information about what is really happening, not what people want the higher-ups to believe. The third reason is that financial controls not only assist in effective risk management but also help to identify risks and develop procedures to manage those risks. Arbogast believes that such practices do not ensure a business will be successful but without them a business will fail, sooner or later. I would add that I cannot think of any FCPA enforcement action where there was not a failure or lack of financial controls in place.

While most compliance practitioners will certainly be familiar with financial controls in the detect prong of a compliance program, I came away from Arbogast’s presentation with a greater understanding of how financial controls help to prevent compliance violations. Arbogast explained that financial controls are a “structure of checks and balances” that can (1) compensate for human ethical weakness and (2) provide necessary support to individuals of integrity who are facing unethical behavior. More specifically, financial controls provide assistance to compliance regimes. In other words, they are designed to not only prevent cheating but promote doing business ethically.

Arbogast said that financial controls work by helping to set the expectations of the ethical behavior which is required of a company’s employees. It does so in a couple of ways. First it narrows the scope for unethical behavior, coupled with raising the risk of discovery and punishment. Having financial controls in place also acts to train employees in proper practice and procedures. And, finally, but certainly not least, is that financial controls help to protect employees who report unethical behavior. This final point is not to be discounted when considering the Dodd-Frank and Sarbanes-Oxley Whistleblower protections and the Dodd-Frank whistleblower bounty.

A large part of the reason that I found Arbogast’s talk so persuasive is that he made clear that financial controls are not about rules and regulations but they are really about a company’s culture. A commitment to financial controls is a commitment to doing business the right way. He said that the most effective controls are those embedded “in the line” which he defined as being used directly by line management and not simply the company’s finance or accounting group. In this manner, such financial controls became the responsibility of management and simply a corporate function such as Internal Audit. Further, if it is only Internal Audit which “owns” or uses financial controls, it becomes an “us against them” mentality.

Arbogast believes that, as with a safety first doctrine, successful management teams have determined that the “mindset underpinning good financial controls is also critical to good operations”. Some of these key management mindsets Arbogast identified were to “do it right the first time and do it right every time”. With everyone working under the same set of financial controls, it is the team or company which is emphasized; that everyone must buy in to be on the same page. Financial controls can also provide the information to allow continuous improvements through continuous feedback. Finally, Arbogast emphasized the importance of management having accurate data to be successful. He characterized this as “You are what the data says you are”. The rewards for using financial controls include accountability, data integrity and improvement of results.

Arbogast concluded by noting that company management often under-estimated the contributions that financial controls make to a long term strategy success. He listed six economic rationales for their incorporation into your company’s system. He divided them into “Preventative” and “Positive” Contributions.

Preventative Contributions included not only a check on employee behavior such as preventing theft from a company but also as a check on what he called the “management agency behavior” where a company’s management runs the business for the themselves and their personal benefit rather than for the stakeholder. Also included in the Preventative column are that financial controls help a company to avoid claims, judgments, lawsuits and monetary damages. I would add that financial controls certainly help to avoid FCPA liability because in addition to the actual fines and penalties assessed in a FCPA violation, the actual costs for such an investigation and resolution are usually estimated to be at a factor of 3 to 6 times the final financial penalty. Under this prong, Arbogast brought up a point not discussed often enough which is that by preventing claims or unethical behaviors which lead to FCPA violations, a company can avoid disrupting normal business and implementation strategy.

In the area of Positive Contributions, Arbogast said that financial controls help to preserve accurate information which allows management to better run a business. Put conversely, if such financial controls are not in place, employees will only report up the chain the information that they want management to know, which will present a false picture of the organization. Having the financial controls in place will establish accountability within the management team of the company. Lastly, financial controls help to create a culture of continuous improvement because they allow for a more meaningful assessment and amelioration of risk.

I found Arbogast’s presentation very useful for the compliance practitioner. He directly addresses how financial controls can help your anti-corruption compliance program to do business more ethically and in compliance with the relevant legislation. Moreover, I found that his overarching thesis that financial controls are really about a culture of doing business ethically and in compliance equally applies to compliance programs in general. This is a strong message that compliance practitioners can take to management; that there is an economic rationale for having a best practices compliance program going forward.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2013