FCPA Contractual Provisions in Alliance and Joint Venture Agreements

As was recently shown by the RAE Systems, Inc., enforcement action, foreign Joint Ventures are still the bane for many companies under the Foreign Corrupt Practices Act (FCPA). Similarly Alliance or Consortium Agreements can place a US company at risk for the actions of others which may violate the FCPA. This post will set forth some of the risk management techniques that companies can use to assist in controlling this FCPA exposure through the utilization of contractual clauses.

As a starting point, we believe that it is important to have compliance terms and conditions, these reasons can include some of the following: (1) To set expectations between the parties; (2) To demonstrate the seriousness of the issue to the non-US party; and (3) To provide a financial incentive to do business in compliant manner.

The ensuing provisions are those we believe that you should include in your Joint Venture, Alliance or Consortium Agreements, as a minimum. They include:

1. Prohibit Bribery and all forms of corruption. Many foreign Joint Venture and Alliance Partners may not understand that the FCPA applies to them if they partner in a business relationship with a US company. Further, they do not understand that they may be governmental officials under the FCPA. This all must be spelled out for them so you should have language regarding the following:

• Prohibition of all forms of bribery and corruption, but you should be careful to make note that FCPA is broader than simple bribery; it includes hospitality/gifts/entertainment/travel as well.
• Affirmation of FCPA compliance, this should be in writing and it should also require that the non-US party understand or have familiarity with the FCPA, as well as that they will comply with the tenets of the FCPA.
• Agreement to comply with local laws and customs regarding anti-bribery and anti-corruption in the jurisdiction where it is located and/or does business.

2.   Right to Cancel and Recoupment rights. These should include the following:

• Right to cancel the contract if there is a compliance violation or breach of contract because that allows you maximum flexibility.
• Withhold any payments due.
• Allow for disgorgement of any monies previously paid under the agreement.
• Take any other action you think necessary or appropriate.

3.   Duties

• Spell out exact duties and deliverables of the Joint Venture, Alliance or Consortium.
• Agent has continuing duty to adhere to training and due diligence
• Duty to report changes in ownership structure of any non-US partner. This includes changes in corporate structure and/or corporate leadership. There must be immediate notification to the US company and it is particularly important when government changes.

4.  Audit Rights – recognizing that our colleague Howard Sklar is not a big fan of audit rights; we nevertheless believe that they are an important tool in your FCPA risk management profile. Therefore we would suggest that they be included in any Joint Venture, Alliance or Consortium Agreement that you may enter into. In addition to putting your non-US partner on notice that you are not simply willing to look the other way once the agreement is signed, it is an active acknowledgement that there will be ongoing transactional due diligence during the term of the relevant contract. If any illegal payments are made or discovered the US company should retain full access to the audit trail which it can then turn over to the proper authorities. Additionally, the Joint Venture, Alliance or Consortium should have the right to audit any agent it may hire for its own use.

At this point we should note that we are in absolute agreement with Howard Sklar on the following point; if you have audit rights you better exercise them. The same calculus is true for termination rights. If you have a good faith belief that your non-US partner has violated the FCPA, you better exercise your right to terminate. If you do not do so, your US company will probably be in more hot water with the Department of Justice (DOJ).

5.  Prohibited Parties – the Joint Venture, Alliance or Consortium will not deal with US designated Prohibited Countries or Prohibited Parties. At this point the list includes Cuba, North Korea, Iran, Sudan, Syria and Myanmar (formerly Burma).

Lastly one area which is continuing to be problematic is that of how to make payments. Some of the tools we would suggest are the following:

• Always try to make payments via wire transfer.
• No large upfront payments unless designated for legitimate start-up expenses.
• Pay only to the named company, not unknown third parties.
• Payment in local currency, however  you can pay in USD. The key is consistency in how you are paying and your documentation.
• Pay where the agent’s country of residence or where the work is done.
• Agent must be able to justify the payment requested.

All of the above steps should be taken only after extensive due diligence has been completed. After the contract is signed your company will have to work just as hard to keep the compliance program for any Joint Venture, Alliance or Consortium robust and meaningful. However, with these terms and conditions in place, you will have a chance to maintain your FCPA obligations and to manage the risk that is involved when working jointly with non-US companies.

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, 2011

RAE Non-Prosecution Agreement (Part III): The Tangible Benefits of Full Cooperation in a FCPA Investigation

In our prior two postings we reviewed the Non-Prosecution Agreement (NPA or Agreement) entered into by RAE Systems, Inc., and the US Department of Justice (DOJ). In Part I, we reviewed the facts which led to the violations of the Foreign Corrupt Practices Act (FCPA); in Part II, we discussed the Corporate Compliance Program which RAE agreed to implement; and in this final article, we will discuss the Corporate Compliance Reporting that RAE agreed to in its NPA. We will then conclude with some of the lessons which we believe can be learned from this NPA and the implication of these lessons for the FCPA practitioner. 

The Corporate Compliance Reporting requirements are found at Appendix C of the NPA. In this, RAE agreed to report, at no less than annual intervals, on the remediation efforts to which it agreed to and the implementation of a Corporate Compliance Program. RAE is required to provide a “complete description of its remediation efforts” and any proposals “reasonably designed to improve the policies and procedures of RAE for ensuring compliance with the FCPA and other applicable anticorruption laws…” If the DOJ has any comments to the initial two reports, RAE is to incorporate them into any subsequent reports. Additionally, if RAE discovers credible evidence of a FCPA violation, it is required to report this “promptly” to the DOJ. 

The RAE Agreement, in conjunction with the Deferred Prosecution Agreements and the NPA for Noble Corp., released in November 2010 regarding Panalpina and related settlements, provide excellent guidance for the FCPA Practitioner. Each Agreement sets forth a complete description of the DOJ’s most current thoughts on what constitutes the most recent best practices of a FCPA compliance program and in addition to this general guidance, the RAE Agreement provides specific guidance on joint ventures. More than going through the motions of performing due diligence on a prospective joint venture partner, a company must remedy any deficiencies found in the process should the transaction go forward. 

Yet, as significant as the information noted above may be, I believe that the most significant lessons are learned from the RAE Agreement Non-Prosecution Agreement is what did not occur. Even though RAE failed to follow the 2004 FCPA compliance best practices when it failed to engage in due diligence on the Fushun joint venture acquisition and even though RAE failed to take effective remedial measures with the KHL joint venture after it became a corporate subsidiary and after RAE had actual knowledge of FCPA violations; RAE did not sustain a criminal charge against it. In its Letter Agreement to the NPA, the DOJ noted “…non-prosecution agreement based, in part, on the following factors: (a) RAE Systems’s timely, voluntary, and complete disclosure of the facts described in Appendix A; (b) RAE Systems’s thorough, real-time cooperation with the Department and the U.S. Securities and Exchange Commission (“SEC”); (c) the extensive remedial efforts already undertaken and to be undertaken by RAE Systems; and (d) RAE Systems’s commitment to submit periodic monitoring reports to the Department.” 

Representatives from both the DOJ and SEC have been preaching the virtues and tangible benefits of self-disclosure and thorough cooperation with their respective agencies in any FCPA investigation or enforcement action. This RAE matter would appear to provide specific evidence of the benefits of such corporate conduct. The NPA reports that RAE had actual knowledge of FCPA violations yet no criminal charges were filed. Further, no ongoing external Corporate Monitor was required. Clearly RAE engaged in actions during the pendency of the investigation which persuaded the DOJ not to bring criminal charges. 

Any company facing a FCPA enforcement action should study this matter quite closely and, to the extent possible, determine the steps that RAE engaged in or performed. The RAE enforcement action together with the Noble enforcement action which resulted also in a Non-Prosecution Agreement, were also reached with no external Corporate Monitor. No criminal penalties and no External Monitor are important examples of the tangible benefits for working closely with the DOJ in any FCPA enforcement matter. 

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, 2010

RAE and Settlement of FCPA Violations in China

As reported on Friday, December 10, 2010 in the FCPA Blog and by others, RAE Systems, Inc., (RAE) a California-based gas detection company settled Foreign Corrupt Practices Act (FCPA) charges on this date with the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) for $2.9 million. The DOJ’s letter to the RAE CEO and its legal counsel, dated December 10, 2010, declined to prosecute the company and its subsidiaries for its admitted “knowing” of violations of the internal controls and books and records provisions of the FCPA. The DOJ entered into this Non-Prosecution Agreement (NPA) based upon four listed factors, which were detailed as follows: (1) timely and voluntary disclosure; (2) the company’s thorough and “real-time” cooperation with the DOJ and SEC; (3) extensive remedial efforts undertaken by the company; and (4) RAE’s commitment to periodic monitoring and submission of these monitoring reports to the DOJ. We will review this enforcement action and NPA over several blog postings. Today we will discuss the facts underlying the allegations and findings of bribery and corruption. 

I.                   The Joint Ventures and Due Diligence 

a. KLH 

The DOJ Statement of Facts, attached to the NPA as Appendix A, reports that RAE sold its products into China primarily through “two second tier subsidiaries” which were organized as joint ventures with local Chinese entities. One of these joint ventures, RAE-KLH, Limited (KLH) was originally owned 64% by RAE. This interest in KLH was initially purchased by RAE in 2004. Later, in 2006, RAE increased its ownership interest to 96%. Prior to its initial purchase of a stake in KLH, RAE conducted due diligence on the Chinese entity. This report made what the DOJ called “troubling findings” by noting: 

As the important clients are those related to the government, it is very important for the company to keep very good relationship [sic] with those government people. In normal practice, KLH will determine its internal product price, the salesmen can negotiate the price with the client based on that and can take away the difference between the internal product price and the final sales price as commission. It is the salesmen, not the company, who will decide the [sic] whether and how much amount of the commission they should give to the clients. The salesmen didn’t get the commission in cash directly, but instead they get the cash by provide [sic] different acceptable invoices. These invoices will then be used as original supporting documents for accounting records. They are recorded as different expenses in the financial statements. To some extent, the financial statements have been distorted by these commissions [sic]. 

With the change of market regulations in China, the government influence will be less important, there is a challenge as to whether KLH could still keep these clients. Although KLH let the salesmen to deal with the kickback, still they are the employees of the company and they represent the company in the transaction. 

Nevertheless, internal RAE documents simply noted that RAE knew “how much [FCPA] risk we are taking.” 

All of these practices were continued after RAE obtained its ownership interest in KLH. Indeed a RAE employee who reviewed KLH after the joint venture became effective noted “If you want them to be aggressive and grow business per set goals, they will do”. This same RAE employee, commenting on the institution of a FCPA compliance program for the joint venture, stated: 

It will be a challenge to restructure because it changes the way they have been “successful” and rewarded in the past. As you know, KLH sales guy [sic] behave/get compensated as distributors and get “discretionary discount structure” (any residual = compensation to keep or to dispense as they see fit to close deal. To kill the sales model that has worked for them all these years is to kill the JV deal value or hurt sales momentum. 

So we need to tread carefully in designing something halfway that won’t choke the sales engine and cause a distraction for the sales guys. We knew this risk all along and have accepted it upon entering the JV deal. 

After these reports, RAE did provide FCPA training and did inform KLH employees not to pay bribes. However, RAE seemed to believe that “we told them about [about the FCPA]…and that’s all we can do.” As you might guess, based upon this non-action, these bribery practices continued unabated even after such conduct was reported again to RAE management. The DOJ noted that while RAE senior management did indicate such bribery payment should cease, the company made “no effective effort to actually stop the practice.” Most interestingly, the RAE Financial Controller in China was directed to perform an internal audit on these issues but “he never provided any findings.” 

So just what is “troubling” about this sales method? Initially, it appears that the sales person involved in each transaction sets the price, without corporate oversight. But for FCPA purposes the most troubling aspect is that the sales person involved would receive the difference in the internal product price and final sales price as a commission. To compound the problem there was apparently a double accounting of these amounts in the books and records which distorted the company’s financial statements. This structure allowed KLH employees to use this money “under table greasing to get deals regardless if profitable/collectible or not, kosher or not, etc.” 

The DOJ reported that as late as 2008, sales representatives of KLH used monies from this commission scheme for improper purposes. These purposes included the “corrupt giving of gifts and paying for entertainment, as well as direct and indirect payment, to customers”. 

            b. Fushun 

In December, 2006 RAE purchased a 70% interest in another Chinese company named Fushun. RAE also operated Fushun as a joint venture but included Fushun’s financial results in the consolidated financial statements that RAE filed with the SEC. For reasons not stated in theNPA, RAE did not conduct pre-acquisition due diligence on Fushun. However, sometime later, RAE obtained information that Fushun did engage in business practices improper under the FCPA and thereafter, failed to implement an effective system of internal controls at the joint venture. 

II.                The Payment Scheme(s) 

As noted above, the KLH sales force set pricing and was able to obtain the difference between the price book pricing and the as-purchased pricing. In addition to this source of cash, which could be used for bribery and corruption, both joint ventures had reimbursement schemes through which joint venture employees would submit alleged Chinese governmental tax documents which did not support the claimed reimbursement, yet RAE would pay out cash for reimbursement purposes. From such reimbursements, gifts were made to family members of Chinese governmental officials and two contracts for “consulting services” valued over $300,000 were used to funnel monies to Chinese governmental officials. The Fushun joint venture used this reimbursement scheme to provide gifts to officials of state owned enterprises which included “jade, fur coats, kitchen appliances, business suits and high-priced liquor.” 

From all of the above information, the DOJ was able to conclude that RAE knowingly failed to implement a system of effective internal accounting controls at both joint ventures which was sufficient to provide reasonable assurances that: (i) transactions were executed in accordance with management’s general or specific authorization; (ii) transactions were recorded as necessary to (a) permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and (b) maintain accountability for assets; (iii) access to assets were permitted only in accordance with management’s general or specific authorization; and (iv) the recorded accountability for assets was compared with the existing assets at reasonable intervals, and appropriate action taken with respect to any differences. 

Download the DOJ’sNon-Prosecution Agreement with RAE Systems Inc. here.

Download the SEC’s civil complaint against RAE Systems Inc. here.

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, 2010