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Revved up by Sarbanes-Oxley and M&A due diligence, regulators are coming down hard on corrupt practices involving the foreign subsidiaries of U.S. multinationals.
David M. Katz, CFO.com | US
November 8, 2004
Presentations in hand, six members of a U.S. architecture firm flew to London this year to meet with a high Russian provincial official. About three months earlier, the politician had asked the firm to submit a proposal to develop a waterfront area in the province. But when the architects arrived, the official declared that well before he had even met the Americans, he had promised the right to develop the property to a Russian concern.
Of course, the official assured the architects, they could contact the Russian developer and buy the rights to the property — the implication being that the politician would pocket a share himself. Had the Americans taken the bait, that would have been "the beginning of a long process of being shaken down," according to former congressman Sam Gejdenson, who heads an international-business consultancy that has worked with the architecture firm.
By many accounts, that experience is common in the former Soviet Union. During Peter Sprung's tenure as a senior legal advisor to the U.S. Ambassador to the Republic of Georgia from 1999 to 2000, irate representatives of U.S.-based multinational companies often asked the embassy to intervene with the local government to stop the bribery. The executives would not only complain that they were being shaken down, said Sprung, now director of litigation and fraud-investigation services at BDO Seidman in New York, but also that "their competitors were less scrupulous than they were."
Indeed, the lack of a level playing field has long been a complaint of U.S.-based companies doing business in many regions where bribery is rampant. Currently, experts rate Bangladesh, Haiti, Nigeria, Chad, Myanmar, Azerbaijan, and Paraguay at the bottom, according to Transparency International's recently published 2004 Corruption Perceptions Index. Each of those countries received a rating of less than 2 out of 10. Georgia received a rating of 2.0; Russia received a rating of 2.8.
Despite stepped-up anti-corruption regulation in the United States and attempts to persuade other countries to enforce such rules abroad, however, large deals are falling through if they lack the requisite "sweeteners." Between May 1, 2003, and April 30 of this year, for instance, the competition for 47 contracts worth $18 billion "may have been affected by bribery by foreign firms of foreign officials," according to a report issued in July by the Department of Commerce. U.S. firms lost at least eight of the contracts, worth $3 billion. During the same period a year earlier, added the Commerce Department, 40 contracts worth $23 billion may have been affected.
Meanwhile — swayed by a potent cocktail of regulatory, disclosure, and compliance ingredients — U.S companies are finding themselves under increasing pressure to uncover bribes paid by their foreign subsidiaries.
Tougher Regulation at Home Than Abroad
Indeed, the regulatory gap between the United States and the rest of the world seems to be widening. All 35 countries that signed provisions of the Organization of Economic Cooperation and Development's 1997 convention now have laws that make it a crime to bribe foreign officials. And yet "there has been little enforcement of new laws by national governments, other than the United States," wrote Fritz Heimann, chairman of the U.S. branch of Transparency International, a nongovernmental organization that aims to combat global corruption. "There is insufficient awareness in the business community that foreign bribery has become a crime, and relatively few non-U.S. companies have adopted anti-bribery compliance programs."
Companies in the United States, on the other hand, have more and more reasons to do so. Since 1977, to be sure, the Foreign Corrupt Practices Act (FCPA) has barred public corporations and other equities issuers from bribing foreign government officials to acquire or retain business. But regulators are now pursuing such cases more aggressively and assessing larger penalties when they find wrongdoing. That's particularly true on the mergers and acquisitions front, where a number of recent cases — including a $16.4 million judgment against ABB Inc. — have upped the ante on due diligence for corruption-related liabilities.
Further, new sentencing guidelines enacted on November 1 have strengthened the criteria for regulatory compliance programs, including those aimed at preventing foreign bribes (see "Curbing Corruption," at the end of this article). And the USA Patriot Act, which lists bribery of foreign officials as a triggering offense in money-laundering cases, adds the possibilities of new penalties for under-the-table payouts.
But perhaps more than any other factor, the Sarbanes-Oxley Act of 2002 has raised the stakes for noncompliance with the FCPA. Now that CEOs and CFOs must personally sign off on the accuracy of their companies' financials and on the effectiveness of their internal controls, those executives are likely to be more wary than ever of letting a bribe slide through.
As a result of the act and the scandals that spawned it, experts say, boards of directors are also worrying about how well their companies comply with the FCPA. "The Sarbanes-Oxley Act has increased our company's efforts dramatically to document our processes and document our internal controls on a companywide basis more than ever before," says Warren Malmquist, director of audit services for the Coors Brewing Co. In the run-up to producing the company's income statement, his department expends "considerable effort" in testing the validity of payments made by foreign subsidiaries, he adds.
Encouraging U.S. Companies to Come Clean
Until a few years ago, however, some companies weren't in the habit of informing regulators when they unearthed corruption in their overseas units, according to Kathryn Atkinson, a partner in the Washington, D.C., law firm Miller and Chevalier. "Traditionally," says Atkinson, "the concept was that you don't have to turn yourself in on a potential claim."
Under the FCPA, of course, it's illegal for U.S.-based parent companies and their employees to direct or take part in foreign bribes or to create slush funds out of which to pay them. A U.S. citizen working for a foreign subsidiary can also be held culpable under the act — but the foreign units of U.S.-based parent companies are beyond the jurisdiction of the Securities and Exchange Commission and the Department of Justice. In the past, since it would have been unlikely that bribes by a subsidiary were large enough to show up on a financial statement, observes Atkinson, subsidiary bribe payments were often made in secret.
Things started to change in October 2001, when the SEC settled an enforcement action against Gisela de Leon-Meredith that had nothing to do with bribery. The commission alleged that Meredith, while controller of the Chestnut Hill Farms subsidiary of Seaboard Corp., caused inaccuracies in Seaboard's books and covered up her actions. However, the SEC merely slapped Meredith with a cease-and-desist order and took no action against the company. In a statement at the time, the SEC credited Seaboard's cooperation — specifically, coming forward with details of its internal investigation, not invoking attorney-client privilege, and promptly notifying the commission of the company's restatement plans — as the reason for the lenient treatment.
More broadly, the SEC spelled out its criteria for giving companies credit for self-policing, self-reporting, remediation, and cooperation. Among other things, the agency said it would look at how a company uncovered the information, whether its audit committee was informed, and how committed the company was to digging out the truth. Many more companies began to self-report bribery and other abuses, maintains Paul Berger, the SEC's associate director of enforcement, as a result of the Seaboard statement. Another reason, he adds, is that investigative programs at the SEC and at the Justice Department "really got fired up."
In addition, "Sarbanes-Oxley created more pressure to comply with federal securities laws" such as the FCPA, according to Berger, who says that the commission has lately added many more bribery probes to its investigative portfolio.
Much of the pressure stems from Sarbanes-Oxley Section 302, which requires CEOs and CFOs to sign off personally on the accuracy of their company's financials. Through that requirement, the act supplies a "design to change the tone at the top," says Berger. That blueprint pushes senior management to gather information about possible violations from line employees, he adds, noting that the act's whistle-blower protections encourage employees to report bribes upward within the organization.
The effects of Sarbanes-Oxley Section 404, which compels top executives to certify their companies' internal controls over financial reporting, might be even more basic. For instance, Audit Standard 2 of the Public Company Accounting Oversight Board, which was issued in connection with Section 404, states that a company's internal controls must provide "reasonable assurance" that payments and receipts are being authorized by management and the board.
The audit standard thus provides a "direct connection between Sarbanes-Oxley and the FCPA," said Jonny Frank, head of the fraud risks and controls practice at PricewaterhouseCoopers. That's because a bribe payment (governed under the FCPA) also represents a breach of a company's controls over unauthorized payments (under Sarbanes-Oxley), he suggests.
The bottom line, says Atkinson, is that "if someone has been able to pay a bribe, your internal controls system has failed."
Mergers, Acquisitions, and Brown Bags
If someone has paid a bribe, that could also spell the end of a merger or an acquisition — not to mention the possibility of hefty fines and investigations for the companies involved. "U.S. companies buying businesses that include overseas operations are much more careful about uncovering potential FCPA issues during due diligence," according to Dick Cassin, an attorney in the Hong Kong office of Heller, Ehrman, White, & McAuliffe. "An acquiring company risks prosecution if it buys a business that has unresolved FCPA problems."
That risk was obviously on the minds of managers at Lockheed-Martin when they scuttled a merger agreement with The Titan Corp. in June. The deal, reportedly valued at $1.8 billion, fell through following Titan's announcement that its own internal review and a review of the company by Lockheed revealed "allegations that improper payments were made, or items of value were provided, involving international consultants for Titan or its subsidiaries to foreign officials." (Under the FCPA, it's illegal for a U.S.-based company to pay an intermediary when it knows that the payment will go to a public official for the purpose of acquiring or retaining business.)
Apparently, even the SEC's professed taste for voluntary reporting doesn't guarantee leniency when it comes to foreign bribes connected to mergers and acquisitions. Despite praising "the full cooperation" of ABB Ltd. for bringing bribery violations at its foreign subsidiaries to the attention of the SEC and the Justice Department, in July the commission fined the Swiss-based company $10.5 million and required it to disgorge an additional $5.9 million.
In its complaint, the SEC charged that the U.S. and foreign units of ABB, a global provider of power technologies that became a reporting company in the United States in 2001, paid $1.1 billion in bribes to officials in Nigeria, Angola, and Kazakhstan between 1998 and 2003. The commission also alleged that ABB improperly booked the payments and lacked the internal controls to prevent them; in one instance, ABB's country manager for Angola doled out $21,600 in a brown paper bag to five officials of the state-owned oil company.
ABB, which neither admitted nor denied the SEC allegations, apparently had a strong motivation for reaching a settlement. Within a week, ABB announced that it had closed the sale of two subsidiaries, including one of the units charged with FCPA violations, to a consortium of private-equity investors; the closing had been contingent on regulatory approval. Another benefit was that ABB was able to satisfy the $10.5 million civil penalty by paying that amount in fines, which had been levied against two of its subsidiaries in a parallel criminal proceeding by the Justice Department.
The ABB case, say a number of observers, is a sign of tougher regulatory enforcement as well as a benchmark of how merging or divesting companies can deal with foreign bribery liabilities. Demanding that companies cough up ill-gotten gains represents a new approach by the SEC, which hasn't sought disgorgement in such cases until now, according to Berger. "If you're making a payment to obtain business, and you get that business," he added, "that money should be given back."
Spurred by new federal sentencing guidelines, regulators and internal-controls experts are paying increased heed to tough anti-bribery corporate compliance programs that can help corporations avert whopping fines and other penalties.
The new guidelines took effect November 1, "ushering in a new era of corporate compliance," according to a release issued by the U.S. Sentencing Commission. "Establishing an effective compliance and ethics program is essential for an organization seeking to mitigate its punishment (including fines and terms of probation) for a criminal offense." Punishments imposed under the Foreign Corrupt Practices Act (FCPA) for overseas bribery, as well as environmental, workplace, and other laws governing corporations, have long been subject to the commission's strictures.
In light of the new sentencing guidelines, the presence of a strong and growing compliance function could thus provide companies with a defense in foreign-bribe cases. "The compliance department is a measure of management's effort to prevent violations, said Charles Grice, director of anti-money-laundering and financial services for Kroll Inc. "If it's weak, it looks as if it was intentionally created that way."
The new guidelines require companies to identify their vulnerability to internal crime, to train management and employees in legal standards, and to provide their compliance officers with sufficient resources to do the job. The board of directors is responsible for the oversight and management of the company's compliance and ethics programs. One effect of the guidelines, says Warren Malmquist, director of audit services at Coors Brewing Co., is that senior managers and boards are paying more attention to beefing up compliance with the anti-bribery laws.
At Coors, that will mean increased reporting by internal audit to the audit committee, according to Malmquist. Previously, internal auditors would report to the committee only if they discovered compliance violations; now they must report in detail on the overall effectiveness of the company's compliance programs as well as on specific violations. Coors has never had an FCPA violation, notes Malmquist.
To prevent such offenses, investigators say, companies need to respond quickly to certain warning signs. One area that could give rise to problems is the payment of signing bonuses to foreign government officials, a traditional practice in the oil industry, according to Peter Sprung, director of litigation and fraud-investigation services at BDO Seidman. "You need to look at the facts and circumstances," he said. "If the government official is telling you to pay it into a personal bank account offshore, that's the time you should be scratching your head."
Similarly, corporate officials should be on the lookout for large travel and entertainment expenses booked by foreign employees, according to Sprung, especially if the payments are going into offshore accounts and take "more than a couple of sentences to explain."
A key part of any anti-bribery compliance program, many experts agree, should be the tracking of company payments to third-party agents or consultants. "Are you in a country where there's a $10,000 [annual] per capita income, and you're paying $500,000 to agents? That raises red flags," said Paul Berger, associate director of enforcement at the Securities and Exchange Commission. "That's the kind of circumstantial evidence we look for. What payments were made, to whom, and to what purpose?"