FCPA Compliance and Ethics Blog

February 12, 2013

The HP Acquisition of Autonomy – Lessons Learned for Doing Compliance ‘By the Book’

Doing something ‘by the book’ means more than following a process. It means following that process during high stress times. One of the things that I think gets missed when discussing compliance programs is the need for rigor in the process. By this not only do I mean that your process needs to be robust but that you need to follow that process even in very extraordinary circumstances. Further, if you deviate from your compliance process you should document the reason for doing so. During a compliance emergency is not the time to depart from your well-thought out process that you use at all other times. One of the things that appear to have gotten Wal-Mart into trouble over its Mexican subsidiary’s actions is that when allegations of bribery and corruption bubbled up to its corporate office, the standard investigation protocol was over-ridden and a completely new and different investigation protocol was put into place. A protocol which had the persons accused of bribery and corruption investigating themselves. Can you guess what the result was?

Similarly, the ongoing news about the Hewlett-Packard Co’s (HP) acquisition of Autonomy Corp., (Autonomy) and its attendant fall-out can provide similar lessons for the compliance professional. As reported by Ben Worthen and Justin Scheck in the Wall Street Journal (WSJ) article entitled “Inside H-P’s Missed Chance To Avoid a Disastrous Deal”, HP did not follow its own internal protocol for acquisitions during the time that led up to its purchase of the British company Autonomy. Additionally, HP’s actions and decisions before and after the acquisition probably steered the deal in to, at a minimum, a very difficult path to success.

New Leadership

In 2010, HP made the decision to bring in someone, who was little known in Silicon Valley, to run the company, that person being Leo Apotheker, who had headed the German company, SAP. However, little noted at the time was the change in the Board of Directors, where “H-P simultaneously got a new board chairman, also a software specialist: Ray Lane, a venture capitalist and former president of Oracle Corp. Soon after, four H-P board members didn’t stand for re-election, and five new members arrived.” In other words, a majority of the top leadership positions in the company changed in a very short time.

Apotheker immediately made clear his desire to purchase one or more software companies. However, the Board of Director’s “finance committee scotched one, and negotiations to buy the other fell apart over price. A frustrated Mr. Apotheker told Mr. Lane, “I’m running out of software companies,” said a person familiar with the conversation.” This led HP to take a look at Autonomy.

Board Protocol

Another change for HP in the pre-acquisition process regarding the Autonomy deal related to Board of Director oversight. It came about because Apotheker had two major initiatives early in his tenure. One was to divest the company of its PC-manufacturing business. The second was to purchase Autonomy. These initiatives were considered so large and complex that the Board of Directors split itself into two separate groups to evaluate each proposal. So only half the Board was looking into the details of the Autonomy deal. Further, “H-P’s normal procedures require the board’s finance committee to review and approve deal proposals before they reach the full board. That didn’t happen with the proposal to acquire Autonomy, said people familiar with how the board proceeded.” While the split of the Board of Directors provided some ease of coordinating some logistical issues such as scheduling meetings, it provided Apotheker, with “more opportunities to lobby for a deal, said people familiar with the board’s activities.”

Red Flag Raised (or not)

One of the things that HP’s Board of Directors were surprised about during the due diligence process was “how little detail about the target firm’s finances became available. Autonomy allowed a review of financial statements and about 25 sales contracts. H-P also wanted the “working papers,” or original financial material, underlying Autonomy’s audits. Autonomy declined to provide them, citing U.K. corporate-takeover rules that require companies to disclose the same documents to all potential suitors.” While understanding that it is never the case that an acquiring company gets to review everything that it wants to during due diligence, reviewing only 25 sales contracts for a company that you are about to spend over $8 bn on does seem a bit of an under-representation of financial data to review. Moreover, some of the members of the HP due-diligence team “said they were reassured, to some extent, by Autonomy’s being a public company that had been audited for years.” Autonomy’s UK audit firm was Deloitte.

But even Deloitte raised red flags with HP, however weakly. At one point, people from HP and KPMG, HPs audit team in the acquisition of Autonomy, spoke by telephone with the Deloitte team. Someone at Deloitte “mentioned that about a year earlier, an Autonomy finance executive had alleged improper accounting at Autonomy, according to people familiar with the call. Three of these people  said Deloitte mentioned the issue briefly and added that a review had found the allegation to be baseless. The H-P team didn’t investigate further, one of the people said, and didn’t share the information with either Mr. Apotheker or H-P’s board.” The articles claims that “Neither Mr. Apotheker nor the directors ever heard such an allegation during negotiations, according to several people either close to the CEO or knowledgeable about the board. Said one: “There were zero red flags raised about this company during the whole process.””

Loss of Steam

The WSJ article referred to the lack of enthusiasm that some members of senior management at HP had over the Autonomy transaction. For instance, “Chief Financial Officer Cathie Lesjak said an acquisition would batter H-P’s balance sheet, using up its cash and incurring debt, said people familiar with the conversations.” Pretty profound when you think about it now. But beyond simply the Autonomy debacle, the Board of Directors was becoming equally uneasy with Apotheker’s desire to cut the heart out of the company by getting rid of the PC-manufacturing business. So just after the Autonomy purchase, the Chairman of the Board Mr. Lane “spoke to senior H-P executives and found a near-universal view that their CEO wasn’t right for the job. In late September, 35 days after the agreement to buy Autonomy and 11 months into Mr. Apotheker’s tenure, the board dismissed him.”

This meant that the person who had shepherded the deal through the company was gone. Apotheker had not only pushed for the deal but said he had plans on how to integrate Autonomy into HP and make it work. He was quoted in the WSJ article as saying, “”We had concrete and ambitious plans on how to integrate and leverage the Autonomy acquisition,” Mr. Apotheker said. “But I was gone by the time the deal closed.”” This led to claims by the head of Autonomy, Mike Lynch to claim that the intention for HP to integrate and sell Autonomy software after the transaction never came to pass. “Within weeks, Mr. Lynch told the new H-P CEO, Ms. Whitman, in an email that when he discussed with H-P’s server unit the idea of selling Autonomy software along with H-P hardware, he received a “very negative response.””

The End

Whitman and other HP executives went to the UK to try and figure out what went wrong with the transaction, the integration or both, and two weeks later Lynch was fired by HP. Within weeks of the Lynch firing, HP said that “the company heard an allegation from an Autonomy executive that Autonomy manipulated its numbers. That set in train the process that led to H-P’s November write-down and allegation of improper accounting by the software firm.” Now the US Department of Justice (DOJ), the Securities and Exchange Commission (SEC) and the UK Serious Fraud Office (SFO) are all investigating the allegations that Autonomy manipulated its books and records.

Lessons Learned

I understand that you never have enough time to perform all the pre-acquisition due diligence that you might like to, whether it is financial or compliance. However, several clear lessons standout for the compliance practitioner from this matter. The first, and foremost, is to establish your pre-acquisition protocol, not during the time you are acquiring a company but before so. If you normally require approval from the full Board of Directors keep that requirement in place and do not cut your approval to one-half because you have two large matters to digest. Second, if a red flag is raised, you should clear it, not the person or entity that brings you the information. The third is to have a post-acquisition plan in place and, to the extent you can do so under the circumstances presented, follow it.

All three of the above suggestions would seem to be the perfect description of ‘by the book’. My father was in the US Navy during World War II and Korea. He is also an engineer. Those two backgrounds would seem to make him as strong a candidate for as ‘by the book’ as possible. But he was also a believer in information, analysis and documentation. The reason, he believed that if you did not study it, you could not document it; if you did not document it, you could not analyze it; and if you did not analyze it, you could not improve it. So document, document and then document everything you do from the compliance perspective and use that information to create a better book, but only if the information and your analysis thereof warrants it.

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

February 8, 2013

How Does Your Organization Treat Whistleblowers?

As almost everyone knows, Lance Armstrong spoke for the first time about his performance enhancing drug (PED) use recently on Oprah. On the first night he admitted for the first time that he used PEDs during his seven wins at the Tour De France. The title of my colleague Doug Cornelius’ piece in Compliance Building really said it all in his article “Lance Armstrong – A Lying Liar Just Like Madoff”. Cornelius said “What caught my attention about the Armstrong interview was the window into the mind of a pathological liar. Armstrong had been telling the lie over and over and over. He lied to the public. He lied to the press. He lied to cancer survivors. He lied under oath.”

One of the areas which came up for me was how the people who blew the whistle on Armstrong’s use of PEDs before his admission were treated and how Armstrong subsequently treated them. Armstrong admitted that he was a ‘bully’ to those who said, hinted, or even implied that he had taken PEDs. He attacked ex-teammates; wives of ex-teammates and even a masseur who saw him take such substances. He put on an aggressive PR campaign for the better part of the past decade, to which the wife of ex-Tour De France winner Greg LeMond said “I can’t describe to you the level of fear that he brings to a family.”

While I would hope that most American and European companies have moved past the situation where whistleblowers are ostracized or worse threatened, one can certainly remember the GlaxoSmithKline (GSK) whistleblower Cheryl Eckard. A 2010 article in the Guardian by Graeme Wearden, entitled “GlaxoSmithKline whistleblower awarded $96m payout”, he reported that Eckard was fired by the company “after repeatedly complaining to GSK’s management that some drugs made at Cidra were being produced in a non-sterile environment, that the factory’s water system was contaminated with micro-organisms, and that other medicines were being made in the wrong doses.” She later was awarded $96MM as her share of the settlement of a Federal Claims Act whistleblower lawsuit. Eckard was quoted as saying, “It’s difficult to survive this financially, emotionally, you lose all your friends, because all your friends are people you have at work. You really do have to understand that it’s a very difficult process but very well worth it.”

More recently there was the example of NCR Corp., as reported in the Wall Street Journal (WSJ) by Christopher M. Matthews and Samuel Rubenfeld, in an article entitled “NCR Investigates Alleged FCPA Violations”, who stated that NCR spokesperson Lou Casale said “While NCR has certain concerns about the veracity and accuracy of the allegations, NCR takes allegations of this sort very seriously and promptly began an internal investigation that is ongoing,” regarding whistleblowers claims of Foreign Corrupt Practices Act (FCPA) violations. In a later WSJ article by Matthews, entitled “NCR Discloses SEC Subpoena Related to Whistleblower, he reported that NCR also said “NCR has certain concerns about the motivation of the purported whistleblower and the accuracy of the allegations it received, some of which appear to be untrue.”

Lastly, is the situation of two whistleblowers from the British company EADS. As reported by Carola Hoyos in a Financial Times (FT) article, entitled “Emails tell of fears over EADS payments”, Hoyos told the story of two men who notified company officials of allegations of bribery and corruption at the company and who suffered for their actions. The first, Mike Paterson, the then financial controller for an EADS subsidiary GPT, internally reported “unexplained payments to the Cayman Island bank accounts for Simec International and Duranton International, which totaled £11.5M between 2007 and 2009.” Hoyos reported that Paterson was so marginalized in his job that he was basically twiddling his thumbs all day at work.

The second whistleblower was Ian Foxley, a retired British lieutenant-colonel, who had joined the company in the spring of 2010 stationed in Saudi Arabia, to oversee a £2M contract between the British Ministry of Defence (MOD) and the Saudi Arabian National Guard. In December 2010, Foxley discovered some of the concerns which Mike Paterson had raised. According to Hoyos, “The morning after he discovered Mr. Paterson’s concerns he assessed the emails that Mr. Paterson had told him he had written over the previous three years.” This led Foxley to flee Saudi Arabia with documents of these suspicious payments, which he has turned over to the Institute of Chartered Accountants and the UK Serious Fraud Office (SFO).

What does the response of any of these three companies say about the way that it treats whistleblowers? Is it significantly different from the bullying Armstrong admitted he engaged in during his campaign to stop anyone who claimed that he was doping? While I doubt that companies will ever come to embrace whistleblowers, the US Department of Justice’s (DOJ’s) recent FCPA Guidance stated that “An effective compliance program should include a mechanism for an organization’s employees and others to report suspected or actual misconduct or violations of the company’s policies on a confidential basis and without fear of retaliation.” However, by marginalizing, attacking or even making a whistleblower fear for their life, such actions can drive a whistleblower to go the DOJ, Securities and Exchange Commission (SEC) or SFO. The Guidance recognized that “Assistance and information from a whistleblower who knows of possible securities law violations can be among the most powerful weapons in the law enforcement arsenal.”

So what is the compliance professional to make of the Armstrong confession and how can it be used for a compliance program? A recent White Paper, entitled “Blowing the Whistle on Workplace Misconduct”, released by the Ethics Resource Center (ERC) detailed several findings that the ERC had determined through surveys, interviews and dialogues. One of the key findings in this White Paper was that that a culture of ethics within a company does matter. Such a culture should start with a strong commitment to ethics at the top, however it is also clear that this message must be reinforced throughout all levels of management, and that employees must understand that their company has the expectation that ethical standards are vital in the business’ day-to-day operations. If employees have this understanding, they are more likely to conduct themselves with integrity and report misconduct by others when they believe senior management has a genuine and long-term commitment to ethical behavior. Additionally, those employees who report misconduct are often motivated by the belief that their reports will be properly investigated. Conversely, most employees are less concerned with the particular outcome than in knowing that their report was seriously considered.

This is the ‘Fair Process Doctrine’. This Doctrine generally recognizes that there are fair procedures, not arbitrary ones, in a process involving rights. Considerable research has shown that people are more willing to accept negative, unfavorable, and non-preferred outcomes when they are arrived at by processes and procedures that are perceived as fair. Adhering to the Fair Process Doctrine in two areas of your Compliance Program is critical for you, as a compliance specialist or for your Compliance Department, to have credibility with the rest of the workforce.

In this area is that of internal company investigations, if your employees do not believe that the investigation is fair and impartial, then it is not fair and impartial. Furthermore, those involved must have confidence that any internal investigation is treated seriously and objectively. One of the key reasons that employees will go outside of a company’s internal hotline process is because they do not believe that the process will be fair.

This fairness has several components. One would be the use of outside counsel, rather than in-house counsel, to handle the investigation. Moreover, if company uses a regular firm, it may be that other outside counsel should be brought in, particularly if regular outside counsel has created or implemented key components which are being investigated. Further, if the company’s regular outside counsel has a large amount of business with the company, then that law firm may have a very vested interest in maintaining the status quo. Lastly, the investigation may require a level of specialization which in-house or regular outside counsel does not possess.

Phrasing it in another way, Mike Volkov, writing in his blog Corruption, Crime and Compliance, in an article entitled “How to Prevent Whistleblower Complaints”, had these suggestions: (1) Listen to the Whistleblower – In dealing with a whistleblower, it is critical to listen to the whistleblowers concerns. (2) Do Not Overpromise – At the conclusion of an initial meeting with a whistleblower, the company representative should inform the whistleblower that the company will review the allegations, conduct a “preliminary” investigation and report back to the whistleblower during, or at the conclusion of, any investigation. (3) Conduct a Fair Investigation – Depending on the nature of the allegations, a follow up inquiry should be conducted. The steps taken in the investigation should be documented.

I would add that after your investigation is complete, the Fair Process Doctrine demands that any discipline must not only be administered fairly but it must be administered uniformly across the company for the violation of any compliance policy. Simply put if you are going to fire employees in South America for lying on their expense reports, you have to fire them in North America for the same offense. It cannot matter that the North American employee is a friend of yours or worse yet a ‘high producer’. Failure to administer discipline uniformly will destroy any vestige of credibility that you may have developed.

Lance Armstrong has and will continue to provide the ethics and compliance practitioner with many lessons. You can use his treatment of whistleblowers as an opportunity to review how your company treats such persons who make notifications of unethical or illegal conduct. With the increasing number of financial incentives available to persons to blow the whistle to government agencies, such as the SEC under the Dodd-Frank Act, it also makes very good business sense to do so.

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

February 1, 2013

Amnesty for Armstrong? Lessons for the Compliance Practitioner

The Lance Armstrong saga continues to provide many lessons for the compliance practitioner. A recent article on ESPN.com, entitled “Lance calls for amnesty program”, reported that Armstrong has come out in favor of those who openly speak about the doping culture of cycling, of course most notably him. The article stated “Now that doping has become such a big problem, Armstrong said a truth and reconciliation program is the “only way” to rid cycling of performance-enhancing drugs, and the sport’s governing body should have no role in the process.” In an interview given to Cyclingnews, it was reported that Armstrong said that the “best way forward is a truth and reconciliation process offering amnesty to riders and officials who detail doping in the sport.”

When asked which anti-doping agency should give this amnesty and which one should take such testimony Armstrong answered that “the program should be run by the World Anti-Doping Agency and not the U.S. Anti-Doping Agency (USADA), the body that produced a scathing report detailing systematic doping by Armstrong and his teams. The USADA report led to Armstrong being stripped of his seven Tour titles and banned from elite sport for life.” Not too surprising that Armstrong does not want to get anywhere near USADA given the report they released on him last summer. Armstrong stated that complete amnesty must be given “otherwise no one will show up.” Any chance that ‘no one’ he refers to would be himself?

While Armstrong’s idea of a ‘Truth and Reconciliation’ program may seem, well shall we say, a tad self-serving, the use of a suspended or lessened sentence has been successfully used to elicit testimony in the cycling world.According to the New York Times, USADA had “the ability to offer other cyclists reduced suspensions if they provided information about Armstrong’s doping. Similar to how prosecutors try to persuade lower-level drug dealers to share information about their superiors, the anti-doping agency sat down one by one with cyclists from Armstrong’s teams. Ultimately, 11 agreed to cooperate.” So I guess people will show up if you offer them some type of amnesty, just not the top banana.

What is the compliance angle to amnesty programs? Siemens used an amnesty program to help it investigate its worldwide bribery scheme. In November 2007, Siemens began an amnesty program relating to possible violations of anti-public-corruption laws in order to expedite the independent investigation and facilitate clarification. According to an article in the FCPA Blog, entitled “Siemens’ Employees Come In From The Cold”, Siemens began this amnesty program because its “internal investigation reportedly had stalled because of stonewalling by managers in various countries.”

In the first three months 66 employees came forward in connection with the amnesty program. In addition, a large number of employees received information about the program. “The amnesty program has been very successful” Peter Y. Solmssen, member of the Managing Board and General Counsel of Siemens AG said. He went on to say “We’re pleased that so many employees have made use of the program and are thereby expediting clarification.” By mid-January, 2008, Siemens’ counsel, Debevoise & Plimpton, said that “[s]ince November 28, 2007, we have obtained significant new information and developed very substantial leads from participants in Siemens’ amnesty program, as well as other sources, regarding topics relevant to our investigation.” Siemens itself said that information provided by the employees who ‘came in from the cold’ through this amnesty program gave it new leads to pursue in its internal investigation. At the end of the day, the Department of Justice (DOJ) lauded Siemens amnesty program, which it characterized as “innovative” in helping to further Siemens internal investigation.

Further, The Wall Street Journal (WSJ) reported in March 2008, in an article entitled “Siemens Amnesty Plan Assists Bribery Probe”, that the amnesty program “was offered to all employees except 300 of Siemens’s top executives and expired at the end of February [2008], prompted about 110 employees to offer information about alleged wrongdoing.” Under the amnesty program, the company did not make claims for damages or unilaterally terminate employee relationships. However, Siemens reserved the right to impose lesser disciplinary measures.

So what about Armstrong and his ‘Truth and Reconciliation’ idea? In the ESPN.com article, he intones that he is really the victim here. First of all, he feels that he is really the fall guy for the sport of cycling, because you know, everybody was doing it. He just did it better. He also said it was unfair that those who testified against him had received “minor off-seasons sanctions versus the death penalty” for himself. He was quoted as saying, “What is relevant is that everyone is treated equally and fairly. We all made the mess, let’s all fix the mess, and let’s all be punished equally.” That certainly sounds like someone who is repentant, doesn’t it?

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

December 30, 2012

The Lilly FCPA Enforcement Action Part I – Key Lessons Learned on Sportsmanlike Conduct

Patriots PictureAs you see from today’s picture I am enthusiastically wearing a New England Patriots (classic) shirt. You may ask yourself why am I wearing this shirt? The reason is because of a rather rash wager I made with Jay Rosen, Vice President of Merrill Brink, earlier this month on the Patriots/Texans football game. (I also made the same wager with Matt Kelly, Editor of Compliance Week, who says he will use the photo for marketing Compliance Week 2013, good luck with that!) I can’t quite seem to remember the final score but I do recall that it was what we in Texas might call a full ‘butt-whoopin’. Up until that game, the Patriots were 19-1 at home in the month of December over the past ten years, after beating the Texans, they became 20-1. The key lesson I learned from this experience is to evaluate your risk and then manage that risk accordingly.

Earlier this month, the Securities and Exchange Commission (SEC) announced the settlement of the Eli Lilly and Company’s (Lilly) violations of the Foreign Corrupt Practices Act (FCPA). The enforcement action details a number of bribery schemes that Lilly had engaged in for many years in multiple countries. Indeed Lilly used four different styles of bribery schemes in four separate countries; all of which violated the FCPA. In China, corrupt payments were falsely called reimbursement of expenses; in Brazil, money that was characterized as a discount for distributor was used to pay a bribe; in Poland, charitable donations were falsely labeled and used to induce a Polish government official to approve the purchase of Lilly products; and, finally, Lilly’s subsidiary in Russia, paid bribes to Offshore Agents who were domiciled outside Russia and who performed no services for which they were compensated.

I think the most noteworthy information found in this enforcement action is that it provides significant guidance to the compliance practitioner on not only the different types of bribery schemes used, but more importantly, by reading into the types of conduct the DOJ and SEC finds violates the FCPA, it is valuable as a lesson on how to structure tools to manage FCPA risks going forward. In this post I will detail the bribery schemes that Lilly engaged in and in Part II, I will discuss how the Lilly enforcement action should inform your FCPA compliance program.

I.                   China – Use of False Expense Reports to Cover Improper Gifts and Cash Payments

In China, Lilly employees used the classic system of submitting inflated expense reports and using the excess reimbursements to pay bribes. More ominously, not only did the sales representatives engage in this tactic but their supervisors did and also instructed subordinates to do so as well. The list of gifts that were provided to Chinese government officials was as wide ranging as it was creative. There were gifts consisting of specialty foods, wines and a jade bracelet. There were paid trips to bath houses, karaoke bars and spas. There was money paid to purchase “door prizes and publication fees to government employed physicians.” It was even noted that bribes were paid consisting of cigarettes. In the SEC complaint it stated that “Although the dollar amount of each gift was generally small, the improper payments were wide-spread across the [China] subsidiary.”

II.                Brazil – Use of Distributor Discounts to Fund Bribes

In Brazil, Lilly sold drugs to distributors who then resold the products to both public and private entities. It was the classic distributor model where Lilly sold the drugs to the distributors at a discount and then the distributors would resell the products “at a higher price and then took their discount as compensation.” There was a fairly standard discount given to the distributors which generally ranged “between 6.5% and 15%, with the majority of distributors in Brazil receiving a 10% discount.”

However in early 2007, at the request of a Lilly sales manager, the company awarded an unusually high discount of between 17% and 19% to a distributor for the sale of a Lilly drug to the government of one of the states of Brazil. The distributor used approximately 6% of this additional discount to create a fund to pay Brazilian government representatives to purchase the Lilly drugs from him. Further, the Lilly sales manager who requested this unusual discount was aware of the bribery scheme. Moreover, this increase in the discount was approved by the company with no further inquiry as to the reason for the request or to substantiate the basis for such an unusually high discount. If there were any internal controls they were not followed.

III.             Poland – Use of Charitable Donations to Obtain Sales of Drugs

In Poland we see our old friend the Chudow Castle Foundation (Foundation). You may remember this charity as it was the subject of a prior SEC enforcement action involving Schering-Plough Corporation. The thing that got both Lilly and Schering-Plough into trouble was that the Foundation was controlled by the Director of the Silesian Health Fund (Director) and with this position he was able to exercise “considerable influence over the pharmaceutical products local hospitals and other health care providers in the region purchased.”

Just how did this bribery scheme camouflaged as a charitable donation work? Initially it started while Lilly was in negotiations with the Director for the purchase of one of Lilly’s cancer drugs for public hospitals and other health care providers in the region. The Director actually made a request for a donation directly to representatives of Lilly. Thereafter, the Foundation itself made “subsequent requests” for donations.

In addition to this obvious red flag, Lilly did no due diligence on the Foundation and falsely described the nature of the payments not once but three separate times with three separate descriptions. Lilly turned some of the monies over not to the Foundation, but to the Director for use at his “discretion”. Interestingly, the donations were not only made at or near the time of a contract execution, with one donation being made two days after the Director authorized the purchase of the drugs from Lilly.  Internally Lilly even discussed the size of a donation, calling it a “rebate” and said “it will depend on the purchases of medicines.”

IV.              Russia – Use of Offshore Agents Who Performed No Services

As with Brazil, Lilly used a distributor sales model in Russia. However, there was a further twist which got Lilly into FCPA hot water. Lilly would enter into an agreement with a third party other than the distributor who was selected by the government official making decisions on the purchase of Lilly products. The other third parties were usually not domiciled in Russia, nor did they have bank accounts in Russia. In other words, they were Offshore Agents who were paid a flat fee or percentage of the total sales with no discernible work or services performed.

There was little to no due diligence performed on these Offshore Agents. In one instance, detailed in the SEC Complaint, Lilly ran a Dun and Bradstreet report on a third party agent, coupled with an internet search on a third party domiciled in Cyprus. There was no determination of the beneficial ownership of this Offshore Agent nor was there any determination of the business services which this Offshore Agent would provide, subsequently this . This Offshore Agent was paid approximately $3.8MM. An additional  Offshore Agent, again in Cyprus, which Lilly conducted little to no due diligence on, received a $5.2MM commission. Under another such agreement, yet another Cypriot Offshore Agent received a commission rate of 30% of the total sale.

What about the services that these Offshore Agents provided to Lilly? First and foremost, they all had their own special “Marketing Agreement” which was actually a template contract prepared by Lilly. The services allegedly provided by these Offshore Agents included “immediate customs clearance” or “immediate delivery” of the product. There were other equally broad and vague descriptions such as “promotion of the products” and “marketing research”. But not only was there little if no actual evidence that these Offshore Agents provided such services; Lilly, or its regular in-country distributors, actually performed these services.

Unlike their experience in Poland, officials from Lilly simply inquired directly from government officials with whom it was negotiating if it could “donate or otherwise support various initiatives that were affiliated with public or private institutions headed by the government officials or otherwise important to the government officials.” As noted in the SEC Complaint, Lilly had neither the internal controls in place nor performed any vetting to determine whether it “was offering something of value to a government official for the purpose of influencing or inducing him or her to assist Lilly-Vostok in obtaining or retaining business.”

In my next post I will discuss how the compliance practitioner can use the information and facts presented in the Lilly enforcement action as teaching points to evaluate and enhance a company’s compliance program.

Although I rarely agree with Peggy Noone, I always read her Saturday column in the Wall Street Journal (WSJ) and would like to end my blogging year with the closing paragraph, which I quote in full, from her article entitled “About Those 2012 Political Predictions”:

Lesson? For writers it’s always the same. Do your best, call it as you see it, keep the past in mind but keep your eyes open for the new things of the future. And say what you’re saying with as much verve as you can. Life shouldn’t be tepid and dull. It’s interesting—try to reflect the aliveness in your work. If you’re right about something, good. If you’re wrong, try to see what you misjudged and figure out why. And, always, “Wait ’til next year.”

A safe and Happy New Year to all.

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, 2012

November 21, 2012

Why Perform Due Diligence?: “That’s PR Speak for fraud”

Yesterday brought some very interesting news from both ‘across the pond’ and here in the US. From the UK, there was the news of the arrests of former News Corp head honchos Rebekah Brooks, who ran Murdoch’s newspaper holdings in Britain, Andy Coulson, former editor of the now defunct News of the World. Dominic Rushe, writing in the Guardian, quoted the FCPA Professor who said it “would be hard for the Department of Justice [DOJ] and the Securities and Exchange Commission [SEC] to ignore. We have been hearing allegations for a year and a half now, now we clearly have charges against high ranking officials at a foreign subsidiary.” More ominously, Rushe cited to a report from The Daily Beast that the “Daily Beast alleged that the Murdoch tabloids the Sun and the New York Post may have made payments to a US official on American soil in order to obtain a photo of a captive Saddam Hussein, the deposed Iraqi leader, in his underwear.” Rushe did note that “News Corporation has denied the claims.” But we will leave a more detailed discussion of the events for a later post.

The second piece of news was almost as breath-taking. As reported in the Wall Street Journal (WSJ), Hewlett-Packard (HP) wrote down $8.8bn of its $11bn purchase value of the UK Company Autonomy. HP said “that an internal investigation had revealed “serious accounting improprieties” and “outright misrepresentations” in connection with U.K. software maker Autonomy.” Further, according to HP Chief Executive Officer (CEO) Meg Whitman, “”There appears to have been a willful sustained effort” to inflate Autonomy’s revenue and profitability. This was designed to be hidden.” Speaking more bluntly (as always) Francine McKenna, in her post entitled “Hewlett-Packard’s Autonomy Allegations: A Material Writedown Puts All Four Audit Firms On The Spot”, in forbes.com said “That’s PR-speak for fraud.”

Not to be outdone, the WSJ reported that “Michael Lynch, Autonomy’s founder and former CEO, fired back hours later, denying improper accounting and accusing H-P of trying to hide its mismanagement. “We completely reject the allegations,” said Mr. Lynch, who left H-P earlier this year. “As soon as there is some flesh put on the bones we will show they are not true.”” In other words, Lynch accused HP of mismanaging his former company and destroying its value in less than 12 months. It should also be noted that the Autonomy acquisition was pushed through by the former CEO of HP, Leo Apotheker; not the current CEO.

I thought about the HP story in the context of the section in the recently released DOJ/SEC A resource Guide to the U.S. Foreign Corrupt Practices Act (FCPA) on successor liability and why a company needs to perform pre-acquisition due diligence:

First, due diligence helps an acquiring company to accurately value the target company. Contracts obtained through bribes may be legally unenforceable, business obtained illegally may be lost when bribe payments are stopped, there may be liability for prior illegal conduct, and the prior corrupt acts may harm the acquiring company’s reputation and future business prospects. Identifying these issues before an acquisition allows companies to better evaluate any potential post-acquisition liability and thus properly assess the target’s value.

 It should be noted that Autonomy’s outside auditor before the deal, Deloitte UK, gave the company a clean bill of health. Further, HP had its own outside auditor, KPMG, brought in at the pre-acquisition stage to conduct due diligence work, which was essentially to check Deloitte’s audit work of Autonomy. In other words, two of the world’s top auditing firms passed muster over Autonomy’s books and records and gave the entity’s financial statements a passing grade.

Once, when asked why men play football, Jet coach Herm Edwards emphatically said “You play to win the game.” I think people need to realize that compliance due diligence under the FCPA can also be used to help company’s do more than uncover potential FCPA issues but also help correctly assess the value of target companies. It might help prevent multi-billion dollar write downs. Unless of course the target company has engaged in an on-running, long term fraud…

Happy Thanksgiving to all…

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I will be discussing the recently released FCPA Guidance next Tuesday afternoon in a webinar, hosted by World Compliance. The event will be held at 2 PM CST. Details and registration can be found here. I hope that you can attend.

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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, 2012

March 12, 2012

Wynn Casinos and Charitable Donations under the FCPA

The recent events surrounding Wynn Casinos and its now former director, Kazuo Okada, have almost been breath-taking in their family feud nature. Indeed in an article in the March 2, 2012 edition of the Wall Street Journal (WSJ), entitled “The Family Feud That Could Cost Combatants Billions”, reporter John Bussey called it the “slug-it-out-divorce” by Steve Wynn from his former partner, Okada. Wynn provided the opening salvo in this battle of titans by summarily booting Okada off the Wynn Casino Board of Directors and “forcibly cashed out” his stake in the company, all for alleged violations of the Foreign Corrupt Practices Act (FCPA).

However, Okada appears to have fired back a FCPA-based salvo of his own. In the same edition of the WSJ, another article reported on Wynn Casinos and another potential FCPA violation. It involved a gift of $135 Million by Wynn Casinos to a foundation which supports the University of Macau. The article on this donation was entitled “Macau School Ties Roil Wynn Resorts” and was co-authored by Kate O’Keefe and Alexandra Berzon. They reported that Okada had gone to a Nevada state court to request an order that Wynn Casinos “give him access to documents tied to the donations.” One of the reasons Okada detailed in his court request was to determine if the gift by Wynn Casinos to the University of Macau was “an appropriate use of corporate funds.”

I would also ask whether the gift was proper under the FCPA. There is not much definitive guidance for charitable donations under the FCPA. I have summarized the available information as follows.

I.                   Opinion Releases

There have been four Opinion Releases in the area of charitable donations under the FCPA. In each Opinion Release, the Department of Justice (DOJ) indicated that it would not initiate prosecutions based upon the fact scenarios presented to it.

A. 95-01

This request was from a US based energy company that planned to operate a plant in

South Asia, in an area where was no medical facility. The energy company planned to donate $10 million for equipment and other costs to a medical complex that was under construction nearby. The donation would be made through a US charitable organization and a South Asian LLC.

The energy company stated it would do three things with respect to this donation.

  1. Before releasing funds, the energy company said it would require certifications from the officers of all entities involved that none of the funds would be used in violation of the FCPA.
  2. It would ensure that none of the persons employed by the charity or the LLC were affiliated with the foreign government.
  3. The energy company would require audited financial reports detailing the disposition of the funds.

B.   97-02

This request was from a US based utility company that planned to operate a plant in

Asia, in an area where there was no primary-level school. The utility company planned to donate $100,000 for construction and other costs to a government entity that proposed to build an elementary school nearby. Before releasing funds, the utility company said it would require certain guarantees from the government entity regarding the project, including that the funds would be used exclusively for the school.

C.   06-01

This request was from a Delaware company doing business in Africa. The company desired to initiate a pilot project under which it would contribute $25,000 to the Ministry of Finance in the country to improve local enforcement of anti-counterfeiting laws. The contribution would fund incentive awards to local customs officials, which is needed because this African country is a major transit point for illicit trade and the local customs officials have no incentive to prevent the contraband.

The company said that along with the contribution, it would execute an agreement with the Ministry to encourage exchange of information and establish procedures and criteria for incentive awards. The company said that if the program is successful, the awards would continue to be funded as needed, and the company will seek the participation of its competitors in this program.

The company would implement at least five safeguards to ensure the funds would be used as intended, including:

  1. Payments to a valid government account, subject to internal audits.
  2. Payments only upon the confirmation that goods seized were in fact counterfeit.
  3. The Ministry would identify award candidates without input from the company and would provide evidence that funds were used properly.
  4. The company would monitor the program’s effectiveness.
  5. Records will be required to be kept and be available for inspection for a period of time.

D.   10-02

A US Company desired to move from a charitable entity model to a for profit model in the area of micro-financing. To do so it was required to make a large cash donation to a charity in the country in question. The company engaged in three rounds of due diligence in which it determined that the most favorable candidate had a government official on its Board of Directors but that under the laws of the country in question, the government official could not receive compensation to sit as a Board member. After initially listing the 3 levels of due diligence in which the company had engaged prior to finalizing its choice of local entity to receive the donation in question; the DOJ noted that the donation ‘requested’ of the US Company would be subject to the following controls:

  1. Payments of the donations would be staggered over a period of eight quarters rather than in one lump sum.
  2. Ongoing monitoring and auditing of the funds use for a period of five years.
  3. The donations would be specifically utilized for the building of infrastructure.
  4. The funds could not be transferred to either the charities parent or any other affiliated entity.
  5. The funds would not be paid to the parent of the organization receiving the grant and there was an absolute prohibition on compensating Board Members.
  6. The proposed grant agreement under which the funds would be donated had significant anti-corruption provisions which included a requirement that the local organization receiving the funds adopt an anti-corruption policy and that company making the donation shall receive full access to the local organization’s books and records.
  7. Right to terminate the agreement and recall the funds if evidence was found that “reasonably suggests” a breach of compliance provisions.

II.                Sole Enforcement Action

There appears to be only one FCPA enforcement action based entirely upon charitable giving. It is the case of Schering-Plough Poland which paid a $500,000 civil penalty assessed by the Securities and Exchange Commission (SEC) in 2008. (For a copy of the SEC Compliant, click here.) As reported in the FCPA Blog, the Company’s Polish subsidiary made improper payments to a charitable organization named the Chudow Castle Foundation, which was headed by an individual who was the Director of the Silesian Health Fund during the time period in question. Schering-Plough is a pharmaceutical company and the Director of the Health Fund provided money for the purchase of products manufactured by Schering-Plough as well as influencing medical institutions, such as hospitals, in their purchase of pharmaceutical products through the allocation of health fund resources. In addition to the above, the SEC found that Schering-Plough did not accurately record these charitable donations on the company’s books and records.

III.              Mendelsohn Guidance

The FCPA Blog reported, in a posting entitled “When is Charity a Bribe?”, that when asked about the guidelines regarding requests for charitable giving and the FCPA, then Deputy Chief of the Criminal Division’s Fraud Section at the DOJ Mark Mendelsohn, said that any such request must be evaluated on its own merits. He advocated a “common sense” approach in identifying and clearing Red Flags. Some of the areas of inquiry would include answers to the following questions.

  1. Is there a nexus between the charity and any government entity from which the company is seeking a decision?
  2. If the governmental decision-maker holds a position at the charity, that’s a red flag.
  3. Is the donation consistent with the company’s overall pattern of charitable contributions?
  4. If one donation or a series of them is more than the company has made to any other charity in the past five years, that’s a red flag too.
  5. Who made the request for the donation and how was that request made?

So what of Wynn Casinos and its $135 Million donation? Did Wynn perform the types of analysis suggested by the Opinion Releases? The WSJ article reports that the Chairman of Wynn’s Committee “told analysts last month that the donation was vetted in advance by outside experts,” relative to the FCPA. The donation is apparently not for construction or other infrastructure projects but “the gift will support academic activities.” The WSJ article also reports that the Board of the University foundation includes “current and former government officials” and “a member of the committee to elect Macau’s chief executive”, who is the chancellor of the university. Lastly the article reports that the Securities and Exchange Commission (SEC) has “begun an inquiry into the donation.”

We may reasonably conclude from both of these WSJ articles that Wynn Casinos will be in for a long, long road of FCPA investigations.

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, 2012

January 23, 2012

General Petraeus and Four Tasks to Inform Your Compliance Program

Most senior corporate officers are firmly behind their company’s compliance programs, whether based upon the Foreign Corrupt Practices Act (FCPA); the UK Bribery Act or some other anti-corruption or anti-bribery regime. They often ask me what specifically they can do to assist in moving their company’s compliance program forward. I thought about this question while reading a book review by Max Boot, in the January 21-22 edition of the Wall Street Journal (WSJ), of “All In: The Education of General David Petraeus” authored by Paula Broadwell, with Vernon Loeb. The book itself is an account of General Petraeus’s life story coupled “with an insider’s look at the general’s year in command in Afghanistan.”

From the perspective of the compliance practitioner, the thing that I found of interest was the discussion of four tasks that General Petraeus believes that leaders must perform. After listing these four tasks out, the authors go on to demonstrate  how General Petraeus applied this approach to such basic tasks as crafting rules on the use of force designed to strike a balance between being aggressive without causing unnecessary civilian casualties. The four tasks are:

  1. A leader must get “the big ideas right”;
  2. A leader must communicate those “big ideas”;
  3. A leader must oversee “the implementation of those big ideas”; and
  4. A leader must capture “best practices and lessons” and cycle them “back through the system to help refine the big ideas.”

So how can your senior management use General Petraeus’ four tasks to move towards a best practices compliance program?

Get the Big Ideas Right

The Big Idea here is compliance is good business. One only needs to look at the current debate to amend the FCPA to understand that it can be simple. At the House Judiciary Committee hearing last June, Department of Justice (DOJ) representative Greg Andres said it is quite easy to avoid FCPA liability; simply do not engage in bribery. That is certainly a big idea and one that senior management can lead the way.

Communicate the Big Ideas

Once senior management is committed to a big idea, such as the company will not engage in bribery or other forms of corruption to do business, senior management must communicate this message. Here a variety of forms of communications can be used; email, video messages, presenting at annual sales and leadership conferences or any other medium. Remember you, as the compliance officer, are only limited by your imagination on how to communicate this idea.

Oversee Implementation of the Big Ideas

Here General Petraeus suggests that senior management must take an active involvement in any program implementation or significant enhancement. This does not mean that senior management could or even should be down into the details of compliance program implementation or enhancement. However, it does mean that senior management needs to stay abreast of progress and assist, if required, to untangle strategic bottlenecks within the company.

Capture Best Practices and Lessons and Cycle Back

This fourth task is one that has clearly been discussed by Lanny Breuer and other DOJ representatives at compliance conferences over the past 2+ years. In any minimum best practices compliance program, there should be an annual assessment. The lessons learned from this annual assessment should be cycled back through your compliance program to allow continual refinement of the big idea that your company will not engage in corruption or bribery to obtain business.

General Petraeus’ four tasks outline an excellent manner for senior management to organize its approach to anti-corruption and anti-bribery compliance programs. As a compliance officer, you can present this mechanism to senior management as an approach to think through and manage its role in your compliance program. It is well worth a look.

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, 2012

January 4, 2012

From Whistleblower to RICO Claimant

The holiday season is past and many of us have returned to work. However, if you are a Chief Compliance Officer (CCO) there is a gift that you may wish to give yourself, it is “The Whistleblower’s Handbook – A Step-by-Step Guide to Doing What’s Right and Protecting Yourself” authored by Stephen Martin Kohn, Executive Director of the National Whistleblowers Center. I do not suggest that CCO’s purchase this volume for their own protection, although the former Chief Executive Officer (CEO) of Olympus might have been able to use it before he was fired by the Olympus Board last October. No, I suggest that CCOs purchase this because many others in your company may well do so and it is the best single volume collection of all laws, rights and obligations related to whistle-blowing that I have come across.

I thought about Kohn’s book when I came across a couple of whistleblower related items last month. The first one was an article in the December 28, 2011 edition of the Wall Street Journal (WSJ), entitled “Internal BNY Mellon Documents Show Panicby Jean Eaglesham and Michael Siconolfi. In the article they report on some of the emails and other documentary evidence that whistleblower Grant Wilson was able to obtain during the two year period that he was operating “as a government informant” while employed by Bank of New York Mellon (BNY). The WSJ obtained this evidence through an open-records request. Wilson was part of a group which brought a series of whistleblower lawsuits against BNY, which have led to several states, and the Manhattan US attorney, filing civil suits against BNY. Eaglesham and Siconolfi also reported that “the bank’s [BNY] foreign-exchange traders grew concerned about a leaker” and in an earlier WSJ article, entitled “Secret Informant Surfaces in BNY Currency Probe”, reporter Carrick Mollenkamp stated “BNY Mellon sought to discover the insider’s identity and to fight the lawsuits.”

I quote that final line because of a December 15, 2011 Court of Appeals decision from the Seventh Circuit Court of Appeals, styled “DeGuelle v. Camilli et al”, which is a whistleblower retaliation claim. As reported by Richard Renner, in an article entitled “Major Victory for Whistleblowers in Seventh Circuit Says Retaliation is a RICO Violation, in the Whistleblowers Protection Blog, the Court of Appeals found valid a claim for damages under the Racketeer Influenced and Corrupt Organizations Act (RICO) for the retaliation against a whistleblower who provides information about corporate fraud to law enforcement officers under Sarbanes-Oxley Act (SOX).  SOX itself makes it a felony to retaliate against whistleblowers who bring forward such information.

The SOX provision in question states that Congress made it a crime to:

“knowingly, with intent to retaliate, take[] any action harmful to any person, including interference with the lawful employment or livelihood of any person, for providing to a law enforcement officer any truthful information relating to the commission or possible commission of any Federal offense[.]” 18 U.S.C. 1513(e).

The novelty and significance of the Seventh Circuit decision is that it held “When an employer retaliates against an employee, there is always an underlying motivation. In this case, for example, the motivation was to retaliate against DeGuelle for disclosing the tax scheme. Retaliatory acts are inherently connected to the underlying wrongdoing exposed by the whistleblower.”

This means that any company which terminates or in any other way retaliates against a whistleblower may have engaged in a violation of RICO, which itself is a criminal statute. This becomes relevant to Foreign Corrupt Practices Act (FCPA) whistleblowers through the Dodd-Frank Whistleblowers provision. In excerpts from the final Securities and Exchanges Commission (SEC) comments, they stated “Employees who report internally in this manner will have anti-retaliation employment protection to the extent provided for by Section 21F(h)(1)(A)(iii) of the Exchange Act, which incorporates the broad anti-retaliation protections of Sarbanes-Oxley Section 806, see 18 U.S.C. 1514A(b)(2).” In other words, if a person reports internally to a company or externally to the SEC of a FCPA violation and there is retaliation against that person, a RICO claim may arise.

Ladies and Gentlemen, this is scary stuff so your company had better be ready and have a robust investigative protocol in place when an internal report is made. And train, train, train and really, really, really mean it when your company says that it will not retaliate against an employee for making an allegation of a FCPA violation.

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, 2012

November 16, 2011

Transaction Monitoring: Fighting Corruption and Protecting National Security

In an article in the Tuesday Wall Street Journal (WSJ), entitled “More foreign banks probed for sanctions violations”, Brett Wolf reported that the New York County District Attorney’s Office will shortly announce additional enforcement actions against banks for sanctions violations regarding Iran and Syria. In a speech made on November 14, Manhattan District Attorney Cyrus Vance talked about payments made to persons associated with sanctioned countries as constituting a threat “to US national security.”

This reminded me of the ideas that my “This Week in FCPA” colleague Howard Sklar often speaks about; that being ‘compliance convergence.’ One of these areas where there is convergence with anti-corruption and anti-bribery compliance programs is anti-money laundering. While many persons discuss the techniques used in anti-money laundering as techniques which can or should be used in banking and other financial institutions’ compliance programs, there is one area which companies should adopt from anti-money laundering directly into their anti-corruption and anti-bribery compliance programs and that is transaction monitoring.

For some time now banks have been required to monitor transactions of Politically Exposed Persons (PEPs). Generally speaking this effort includes requiring banks to apply enhanced due diligence to bank accounts and transactions by PEPs; requiring financial institutions to assess and evaluate risk so that it can be more carefully managed; promoting transparency in all transactions and monitoring transactions which might be termed suspicious. This means more than single transaction monitoring and is a more sophisticated approach which allows cataloguing and cross-referencing transactions.

Banks begin with the need for enhanced due diligence that they can determine when dealing with a foreign governmental official. This due diligence must include procedures “reasonably designed to detect and report transactions that may involve the proceeds of foreign corruption.” Banks make some or all of the following list of inquiries: identify the stakeholder and any beneficial owners; from this identification, determine the PEP status; obtain employment information and evaluate for industry and sector risk of corruption; review the stakeholder’s country of residence and evaluate for level of corruption; check references; obtain information on immediate family members to determine PEP status; and make reasonable efforts to review public sources of information.

Although not couched in terms of the compliance lingo “Red Flag”, anti-money laundering requirements make clear that simply identifying a stakeholder as a PEP does not disqualify the candidate. It means that additional investigation must be performed. Therefore, if a PEP comes up in your Foreign Corrupt Practices Act (FCPA) compliance program due diligence investigation, as an owner of a Foreign Business Partner, additional investigation must be performed to determine the relationship of this governmental official; the transaction at issue;  and any potentials for conflicts-of-interest or self-dealing. The promotion of transparency requires actual knowledge of the parties who are involved in all transactions. In addition to identifying those owners and any beneficial parties as indicated above, care should be taken to identify any shell companies which a PEP might have ownership or interest in. This is a critical analysis which companies should take as part of their overall due diligence effort.

While many compliance programs do a good job of the above due diligence and attendant analysis; companies do not take the next step, that being transaction monitoring, and integrate it into their compliance function.

Generally the Treasury Department, or some other functional group in a company has a policy preventing payments to locations other than (1) where services are delivered or (2) the home country of the payee. However, this other functional department rarely works in concert with the Compliance or Legal Department, in terms of notifying other company groups of a suspicious payments or even providing documentation of such suspicious payments and storage of such information in a mutually accessible database. Contrasting this, situation most companies will have a policy regarding the retention and contracting with agents or other foreign business representatives or partners but how often are such policies found for vendors in the Supply Chain. The next step in this transaction monitoring process is monitor each transaction to determine if it is ‘suspicious’, that is the term generally recognized by banks in the anti-money laundering context. How many companies have systems in place to perform the same suspicious activity analysis in the normal course of transacting business? Further, there are software program and other tools which a company can utilize which will automate this monitoring process.

Wolf reported that Manhattan District Attorney Vance said that payments out of certain financial institutions had “stripped wire transfer payments of information that would have revealed that sanctioned parties were engaging in US dollar transactions.” How many companies could monitor that type of information for payments they may have made to vendors in the Supply Chain or agents in the Sales Chain for that matter? Near the end of his speech, Vance said that his office was “well positioned” to pursue such claims.

As banks and other financial institutions become more robust in their anti-money laundering programs, many nefarious individuals may move their activities to companies with less robust procedures and back-up systems to detect, record, store and share any such activity with the appropriate group within a company. This may well be the next US government target for inquiry.

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

November 10, 2011

Olympus Trifecta

Richard Cassin author of the FCPA Blog, among others, consistently writes about corruption as ripping apart the fabric of many countries. This makes anti-corruption and anti-bribery legislation not only appropriate but mandatory. Over the past few weeks, I believe that we have seen another reason and that is that shareholders may have some comfort that the companies in which they invest are valued fairly and will not implode. In the US, we had the last decade brought us the trifecta of Enron, World Com and Adelphia, where accounting frauds destroyed these companies. But Japan is experiencing something different with the still unfolding Olympus matter.

On Monday, the Wall Street Journal (WSJ), in an article entitled “Olympus Admits to Hiding Losses” reporters Kana Inagaki and Phred Dvorak, wrote about the scheme by which the Olympus Corp. hid years of investment losses by making wildly overpriced acquisitions and then writing off the investments losses by writing down the value of the acquisitions. Such a business strategy  is so well known in Japan that it even has a name, “tobashi.”

To recap this story, on October 14, 2011 the now-resigned Olympus Chairman, Tsuyoshi Kikukawa, dismissed the former head of the company, the Briton Michael C. Woodford, citing cultural differences in management styles. Mr. Woodford contended that he had been fired after raising questions about a series of acquisitions made by Olympus, that, he said, were inexplicably high prices paid for the acquired companies or involved exorbitant advisory fees paid to tiny entities which acted as agents of Olympus for the transactions in question. Indeed one of these commissions was a payment of $687 million, almost one-third of the amount of a transaction of just less than $2 billion. Of course the company claimed he was fired for the catch-all usual suspect reason, that being he was ‘not a team player.’

Later the WSJ reported that the three companies purchased by Olympus, whose purchases led to the unusually high commissions, had the following characteristics: “two of the acquired companies, medical-waste disposal company Altis Co. and food-container maker News Chef Inc., were founded in the early 1990s under different names, public company records show. The companies conducted no business for years.” The third company was founded “less than a year before Olympus bought a stake”. Olympus eventually acquired control of all three companies.  Within a year of acquiring control of these three companies, “Olympus wrote off three-fourths of its investments in the companies.”

In an article in Wednesday’s New York Times, entitled “Shares Dive as Olympus Scrambles for Answers”, Christine Hauer reported that “The developments cast a harsh light on Olympus’s auditors, KPMG until 2009, which have signed off on financial statements that may now be suspect.” While auditor negligence may well have been a factor, I will leave this area of comment to Francine McKenna and her blog site, retheauditors.com. If you do not read Francine of a regular basis, you should take this opportunity to begin doing so.

So what makes this new revelation so stunning? First, much like Harry Markopolis, who could not have predicted that Bernie Madoff was running a decades long Ponzi scheme, I could not have predicted that Olympus was defrauding its shareholders by hiding investment losses through acquisitions. And while fraud may well be a part of this story, I will leave that discussion to Tracy Coenen and her blog site, sequenceinc.com. As with Francine, if you do not read Tracy’s site on a regular basis now might be a propitious to start.

Remember the $687 million commission paid to an agent of Olympus? It is this part of the story that relates to Richard Cassin and all the others who tirelessly campaign against bribery and corruption in the corporate world. One of the bases for jurisdiction of the Foreign Corrupt Practices Act (FCPA) applies if a company with a US presence engages in bribery or corruption and the US banking system is involved. While at this point it is unknown if any of the monies paid for the companies acquired by Olympus to hide its investment losses came through the US banking system, if it did, the FCPA might well be invoked. To this end the New York Times reported that the US Securities and Exchange Commission (SEC) and FBI are investigating the matter.

Admittedly the FCPA is a supplier side law, which only punishes the bribe-payer. However, the same is not true of the UK Bribery Act, which makes illegal the payment or receipt of bribes. Clearly Olympus does business in the UK so the Bribery Act may also be invoked. Further, while the FCPA applies to ‘foreign governmental officials’, the UK Bribery Act applies to bribery between foreign officials and private citizens. If any of the monies paid as commissions was made to purchase the silence of the putative agents, then jurisdiction may lie. Lastly, the Board of Olympus should also note that the Bribery Act has a strict liability component for those who are actively involved in conduct which violates the Bribery Act.

So just who on Olympus could have been involved in any untoward conduct? Perhaps any person involved in properly not recording the company’s transactions so as to provide a fair and accurate representation of the financial health of the company? Any person involved in the transactions of purchasing the companies bought for the purposes of writing down their values? Maybe the agents who received the high commissions and, by the way, where did those exorbitant commissions go after they went into those Cayman Island bank accounts? How about any persons from the company’s purchased? Was this conduct systemic, as it engaged in for 15-20 years?

In my last post on Olympus (Olympus Redux) I wrote about the need to perform due diligence on transactional agents. While this need still exists, the use of transactions and transactional agents to hide investment losses may explain why it does not appear that such due diligence was done on the agents. Moreover, if such transactional agents are going to be used for fraudulent purposes, it really doesn’t matter what quality of due diligence is performed. Further, if the amount of the commission is exorbitant, as in one-third the value of a multi-billion dollar transaction, this in and of itself may be a Red Flag. This is the initial Red Flag that the now fired UK whistle blowing President reported to UK authorities. So now we have hit the trifecta for Olympus in the arena of corruption: (1) termination of the UK subsidiary President for reporting Red Flag conduct; (2) use of small agents who were paid huge commissions which were not deserved; and (3) failure to actively report years of investment losses by fraudulent transactions. I can only wonder what might be the next bombshell. I guess it will have to be called the quadruple.

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

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