FCPA Compliance and Ethics Blog

July 6, 2010

TOP 3 FCPA HITS OF 2010-THE GUN STING CASE

As we enter the second half of 2010 it is time to review what we believe to be three of the more significant Foreign Corrupt Practices Act (FCPA) matters which came to significant public attention in the first half of this year. We will review the (Ding Dong) Avon Calling matter revolving around its China operations; the case of the HP German subsidiary (allegedly) paying bribes to obtain a contract in Russia and today we begin with the Gun Sting case.

On January 18, 2010, on the floor of the largest annual national gun industry trade show in Las Vegas, 21 people from military and law-enforcement supply companies were arrested, with an additional defendant being later arrested in Miami. The breadth and scope was unprecedented. Assistant Attorney General for the Criminal Division of the US Department of Justice (DOJ), Lanny Breuer, who led the arrest team, described the undercover operation as a “two-and-a-half-year operation”. The arrests represented the largest single investigation and prosecution against individuals in the history of the DOJ’s enforcement of the FCPA.

As explained in an early indictment, one FBI special agent posed “as a representative of the Minister of Defense of a country in Africa (Country A),” [later identified as Gabon] and another FBI special agent posed “as a procurement officer for Country A’s Ministry of Defense who purportedly reported directly to the Minister of Defense”. Undercover criminal enforcement techniques such as wire taps, video-tapes of the defendants (allegedly) conspiring and a cooperating defendant were all used in the lengthy enforcement action. In a later indictment, and seemingly unrelated to the Africa part of this undercover sting operation, allegations were included that corrupt payments were made to the Republic of Georgia to induce its government to purchase arms.

The FCPA Professor has written extensively on the legal issues involved in this massive case, which include entrapment and whether there must actually be a foreign governmental official involved, rather than someone posing as such, for the FCPA to apply. Chris Matthews, writing in MainJustice.com, has written extensively regarding the court proceedings in Washington DC on this matter. Both of these blogs provide excellent overviews of the Gun Sting matter and we recommend both postings to you.

But what does all of this mean for the Chief Compliance Officer (CCO) sitting in his office in the US? It should mean quite a bit. There are several lessons from which you can learn and immediately implement in your FCPA compliance program if you have not previously done so.

1. High Risk Country. The undercover FBI agent was represented to be a sales agent who the defendants believed represented the Minister of Defense for Gabon. Any agent or transaction involving an agent in West Africa should receive heightened scrutiny as it is a high risk country. Any transaction involving an agent, a 20% commission or anything that remotely seems unusual should require Compliance Department involvement at some level. Procedures should be put in place to routinely Red Flag any such transactions for further review.

2. Agent Due Diligence. As the Sales Agent was an FBI agent posing as a corrupt foreign governmental official, it would appear that little-to-none due diligence was performed on the proposed agent. Such an approach (clearly) invites FCPA liability. All agents should receive the highest level of investigation, internal evaluation, contractual obligation and post-contract signing by management going forward. If your choices are close the deal without performing adequate due diligence OR walking away from the deal because of adequate due diligence, it is far better to complete the process than to close the business transaction without adequate risk analysis through the due diligence process. As noted with Number 1 above, any transaction in West Africa should have heightened scrutiny and any agent from this area of the world should be subjected to the current ‘best practices’ of agent due diligence, review and management.

3. Commission Amount. In this case, an agent, who for doing very little or nothing, was to receive a commission of 20% which is clearly above the standard and should have raised a Red Flag. Further, it was made clear that at least part of the commission would be paid as a bribe. Any commission should be reviewed by not only the Legal or Compliance Departments in a company but also by internal audit to assure that it is not out of line with other commissions paid. If required external forensic auditors should be brought into to review the proposed transaction.

The Gun Sting case and its aftermath may well be with us for sometime. All we can say, with any certainty, is that more will be revealed.

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

May 18, 2010

FCPA Red Flags, Hewlett-Packard and Big Papi

As most readers of this blog know, the author is an avid baseball fan. So it was not without some small interest when a term most often associated with the Foreign Corrupt Practices Act (FCPA) compliance world was used on ESPN’s Baseball Tonight to describe a hitter’s batting characteristics. Recently, commentator and former big league manager, Buck Showalter discussed the current batting slump of Big Papi, David Ortiz, by noting that his inability to hit the off-speed was a Red Flag for what is really ailing him, decreased bat speed. Showalter explained that the reason Big Papi’s failure to hit a curve ball was a Red Flag which indicates a bigger problem; Ortiz has to amp up to hit a fastball so much now that he is susceptible to being quite easily fooled by an off-speed pitch.

In the FCPA compliance world a Red Flag can also be equally indicative of a larger problem. As reported in The Russia Monitor on May 4, 2010, high-level executives at a Hewlett-Packard (HP) subsidiary made payments, through agents, to the Russian Prosecutor General’s office in order to obtain the contract to supply computers to that office. There was a complicated financing scheme used to route payments to offshore accounts beneficially owned or controlled by unnamed Russian officials; funneling the suspected bribes through a network of shell companies and accounts in places including Britain, Austria, Switzerland, the British Virgin Islands, Belize, New Zealand, Latvia, Lithuania, and the US states of Delaware and Wyoming. The bribes were paid through three German agents, who submitted fake invoices for non-existent sales and then paid the money on as bribes to unnamed Russian governmental officials.

On April 15, 2010, the WSJ reported that three middlemen are alleged to have paid invoices; using funds provided by HP for equipment never purchased, to shell companies with bank accounts in Latvia, Lithuania, Austria, Switzerland and Belize. In return, the suspected middlemen allegedly received commissions totaling US$700,000, according to court documents. German authorities reported the investigation, which started in 2007, when a German tax auditor discovered bank records showing that between 2004 and 2006, a HP subsidiary paid €22 million into the account of ProSoft Krippner GmbH, a small computer-hardware company in Leipzig. The records indicated the payment was made for services performed in Moscow. It was the size of the payment to ProSoft that caught the tax auditor’s attention and he red-flagged the matter for transfer to a special prosecution team in Dresden who handle major corruption cases.

To top it all off, at least one witness has said that the above transaction was internally approved by HP through its then existing contract approval process. In the April 15, 2010, WSJ article, Mr. Dieter Brunner, a bookkeeper who is a witness in the probe, said in an interview that he was surprised when, as a temporary employee of HP, he first saw an invoice from an agent in 2004. “It didn’t make sense,” because there was no apparent reason for HP to pay such big sums to accounts controlled by small-businesses such as ProSoft Krippner, Mr. Brunner said. Mr. Brunner then proceeded to say he processed the transactions anyway because he was the most junior employee handling the file, “I assumed the deal was OK, because senior officials also signed off on the paperwork”.

Just how many Red Flags are raised by the above?

  • Offshore Companies

In a white paper entitled “Grey Practices in the Russian Business EnvironmentControl Risks reviewed what it viewed as some of the more routine “day-to-day schemes that erode the integrity of transactions” in Russia. One of the main tactics utilized to disguise the principal who receives a bribe is through the use of offshore companies, usually located in ‘exotic’ locations as per the countries listed in the diagram above, to take advantage of weak disclosure requirements to conceal beneficial ownership. Any monies paid by HP to an agent, which were then sent to an offshore company, should have been flagged for further inquiry.

  • Small Sized Agents

As noted, by the temporary HP employee Dieter Brunner, one of the facts that “didn’t make sense” was a large payment to a small-sized business. One of the Red Flags that arises during due diligence on business partners is the size of the company in relationship to the work or services it performs. If a one-man company is receiving a multi-million dollar (or Euro) payment, it should be flagged for further inquiry.

  • Faked Invoices for Goods/Services

One of the tests of revenue recognition for hardware and software is whether the goods and services relating thereto are actually delivered. If the middlemen above did not receive the equipment they allegedly purchased, this should have been picked up by an internal company audit or even simple inventory control and flagged for further inquiry.

The above presented Red Flags may not be the only ones found in this series of transactions engaged in by HP. Indeed the overall body of Red Flags is significantly larger than only the three discussed herein. The point in all of this discussion is that the FCPA mandates due diligence before a transaction in a high risk country occurs, due diligence before agents are engaged and then more due diligence thereafter to continue to monitor such transactions. If facts or circumstances arise which cannot be immediately explained, then the matter should be referred to Legal or Compliance for additional investigation. How many additional Red Flags can you spot in this HP transaction? More importantly, if a commentator Baseball Tonight can spot a Red Flag I hope that any US company, subject to the FCPA, has a compliance program in place to spot them as well.

For prior posts on HP and its current FCPA issues, see here and 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

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