Firms Vulnerable In Corrupt Practices Crackdown

By | January 19, 2011

Authorities have been escalating their campaign against corruption in the last few years, resulting in a sharp spike in enforcement actions in the United States and the enactment of a new anti-bribery law in the United Kingdom.

For years, the United States has led the way in the fight against corruption with the Federal Corrupt Practices Act, which prohibits companies with U.S. operations from engaging in corrupt practices overseas.

Although the law has been in effect since 1977, it is in the last few years that enforcement activity has skyrocketed. This comes at a time when other countries are also cracking down on corruption.

The U.K.’s Bribery Act, for instance, goes into effect in April 2011 and prohibits companies with U.K. operations from engaging in bribery. Germany and other members of the Organization for Economic Cooperation and Development also have increased investigations and are collaborating more with the United States.

As corporate business practices come under increasing scrutiny, U.S. companies that do business outside the country are more vulnerable than ever. The risk goes beyond their own internal operations.

Many companies that have solid policies in place for their own operations are vulnerable when it comes to their supply chains and past activities of entities that have been acquired in a merger or buyout.

Losses associated with this risk can be substantial. Businesses face the prospect of hefty defense costs as well as the possibility of fines and penalties if convicted. Individuals, including chief executives, chief financial officers and other executives can be charged with violations of the law and be sentenced to serve jail time. An investigation and negative publicity also can result in significant damage to a company’s reputation.

Multinationals are facing an evolving legal climate in the U.S. and Western Europe that has become increasingly intolerant of practices that are still commonplace in certain parts of the world.

Without a well thought out plan to manage this risk, companies are at risk of a serious loss that is largely uninsurable.

Increased FCPA Enforcement Activity

Every year, businesses pay billions of dollars in bribes in an effort to get favorable treatment, secure new business or even just to get necessary paperwork expedited. While these kinds of practices are still a part of the business culture in many developing countries, the U.S. and Western Europe have been cracking down on such corruption.

Until 1977 when the FCPA was passed, no government had made it a crime to bribe officials of a foreign country and many governments even allowed companies to count bribes being paid to foreign officials as ordinary business expenses that the company could deduct for tax purposes, according to a report “Restoring Balance” by the U.S. Chamber of Commerce’s Institute for Legal Reform.

Under the FCPA, however, companies are prohibited from bribing foreign officials and prohibited from hiding illegal payments through misleading or inaccurate accounting practices. Companies are also required under the FCPA to implement stringent internal accounting controls.

Although it has been around now for more than 30 years, there has been a marked increase in the enforcement of the FCPA in the last decade by both the Department of Justice and the Securities and Exchange Commission, according to the Institute for Legal Reform’s “Restoring Balance” report. In the last five years, the report says, there has been nothing short of a boom in enforcement.

More enforcement actions are being brought, fines and penalties have risen dramatically and the government has shown an increased willingness to seek jail terms for individual defendants, according to the report.

The size of FCPA settlements also has increased dramatically. Five of the top 10 settlements occurred in 2010 and the remaining five have all occurred since 2007.

In one high-profile case, German engineering company Siemens agreed to pay a total of $1.6 billion in penalties and disgorgement of profits, the highest FCPA settlement in history, according to PricewaterhouseCoopers in its “Corruption Crackdown” report. Of the $1.6 billion, about $800 million was paid to German authorities and about $800 million to the U.S. Justice Department and the Securities and Exchange Commission.

In that case, Siemens was accused of violating the FCPA by engaging in a widespread and systematic practice of paying bribes to foreign government officials to obtain business.

Defense costs alone for an FCPA case such as the one against Siemens can run into the hundreds of millions of dollars. The fines and penalties can be millions more.

Executives may have coverage for the directors & officers’ exposure related to a corruption investigation, but there is no insurance for the organization. There also could be some coverage for individuals named in a government investigation, but again, there is no coverage for corporate entities.

Anti Bribery Act in the U.K.

The fight against corruption also will gain traction in the United Kingdom, where the new Bribery Act goes into effect next year. The scope of the Bribery Act, like the FCPA, will be very broad and will apply to companies that carry on some or part of their business in the United Kingdom. Activities conducted anywhere in the world by a company that does business in the United Kingdom will be subject to its anti-bribery provisions.

Under the Bribery Act, offenses fall into four key categories: bribery, receiving a bribe, bribing a foreign public official and failing to prevent bribery.

The law creates a strict liability offense for companies and other commercial organizations that fail to prevent bribery. The law also calls corporate hospitality into question.

Risk Management

With the crackdown on corruption and bribery moving into high gear, multinationals need to make sure that operations here and abroad are meeting the standards imposed by the U.S. and U.K. laws.

A company that has operations in multiple countries and regions throughout the world will have to understand the business practices and the culture prevalent in each of those countries. While the U.S. and U.K. have made it clear they take a dim view of corrupt practices, it is not uncommon in countries such as Russia and China to give bribes or gifts to officials.

In fact, bribery is so common in Russia that it has been estimated at close to $300 billion a year, equivalent to about 20 percent of the country’s GDP, according to Russian government studies and U.S. State Department statistics.

In China, the situation can be further complicated because senior corporate executives are often relatives of senior government officials and the distinction between the government and private sector can often be unclear.

Multinationals operating in these countries can face some difficult situations as they attempt to compete for business and maintain cordial relationships with foreign governments while also abiding by corruption laws.

Even if a company’s own policies are clear cut and well understood, an organization’s supply chain represents a significant vulnerability. Under the FCPA and the Bribery Act, companies are accountable not only for their own practices, but for the actions of their suppliers as well.

Another Achilles heel has to do with the past practices of acquired companies. When a company acquires a business, it also acquires its liabilities and the corrupt practices of a buyout target become the liabilities of the new owners.

In addition to these problems, questions also have been raised about the treatment of facilitation payments and corporate hospitality under the Bribery Act. In some cases, it is not entirely clear when a practice might become unacceptable. The U.K. Serious Fraud Office, for instance, has said it will take a close look at corporate hospitality and that lavish hospitality could pose a problem. But there could be questions about what constitutes lavish hospitality.

To minimize the risk of any violation of corruption laws, multinationals first need to make sure they understand the standards imposed by these laws and establish an unambiguous FCPA policy statement that outlines expectations and procedures.

Given the magnitude of potential losses, senior executives must be involved and must sign off on company policies just as they do with other critical compliance issues such as Sarbanes Oxley. A compliance program has to be seen by prosecutors and employees as driven from the top of the organization.

Companies also should consider appointing a senior executive as the FCPA compliance officer. Businesses also need to provide employees with training to help them understand the risks and the potential pitfalls.

To reduce the risk of problems with suppliers and vendors, businesses should insist that those companies have an FCPA compliance program that is in line with the organization’s internal policies and procedures. Managers then should audit their suppliers from time to time to be sure that they are fulfilling their responsibilities under those policies. Documentation of these reviews is critical as it can later serve as part of a defense if necessary.

When it comes to mergers and acquisitions, it is important for companies to conduct a thorough due diligence with regard to FCPA procedures, compliance and books and records. Anything that could pose a problem should be considered carefully and included in the documentation related to the deal. If a violation does occur, the company must alert the board and conduct a thorough investigation. Care must be taken to preserve all documents related to the incident. Do not destroy documents.

If a violation did occur, prosecutors are likely to look more favorably on a company that has demonstrated a strong compliance initiative, self-reports an incident and moves swiftly to correct an identified problem.

With the increased enforcement activity in the United States and the passage of a new law in the United Kingdom, multinationals need to understand that the legal environment is changing. Officials are less willing to turn a blind eye and are more willing to take aggressive action in their crackdown on corruption.

As businesses become increasingly global, the potential for risk also increases. By establishing a sound compliance program, requiring suppliers to comply with the organization’s procedures and taking care with due diligence on acquisitions, multinationals minimize the risk of a corruption law violation.

Ellis is a senior vice president of Chubb & Son and Worldwide Manager, Chubb Multinational Solutions.

About Kathleen Ellis

Ellis is a senior vice president of Chubb & Son and manager of Multinational Risk Group - Global Accounts. More from Kathleen Ellis

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