The regulatory challenges of crossing new frontiers
One result from the latest EIU Global Fraud Survey—that the greatest fraud risk to companies lies with employees and agents—reinforces a truth well-known to practitioners: it’s usually an inside job.
But there is a double risk from employees committing crimes that seek perceived easy routes to business success, such as paying bribes, colluding with competitors and cutting corners on compliance: not only does the company suffer the economic consequences of their behavior but it also opens itself to increasingly robust treatment from regulators. These risks have been heightened by the current economic climate.
Many companies operating in the currently flat markets of the developed world are seeking growth elsewhere, sometimes simply to survive. That is likely to require developing new product lines or entering new geographical markets – which generally means operating outside existing comfort zones. The quick route is to use acquisitions, joint ventures, or distribution agreements but, as with all short cuts, these can be risky. Acquisitions or partnerships can infect a business if they have questionable business practices or lax standards. These may even be perceived to be tolerated in the target’s or partner’s sector or country of operation, but they can leave the unaware open to economic damage and increasingly harsh treatment from regulators.
This risk is heightened when the move is into an emerging market, where growth rates are higher but governance, compliance and transparency are often less mature than in developed countries and where regulation is sporadic and inconsistent, even arbitrary. Too often, corporate attention focuses on market and credit risk in emerging markets: operational risk is neglected until it turns around and bites you.
The bite is as likely to come from regulatory enforcement at home as in the place where the offense occurs. Stung by criticism that their laxity contributed to the financial crisis, regulators are acting with renewed vigor, authority, and political backing – and in some cases new legal powers.
Certain longstanding prosecutorial backwaters have bubbled into life. The most obvious is corruption: as the Economist Intelligence Unit’s introduction highlights, there have been more prosecutions under the United States Foreign Corrupt Practices Act (FCPA) in the past five years than in the previous 30 and the UK has passed a new Bribery Act. Corruption is not the only area of increased regulatory activity: last year fines – in one case of more than half a billion dollars – were levied against several major banks for financial sanctions compliance failures that might once have been seen as little more than clerical errors.1 Meanwhile, European Union competition investigators have conducted dawn raids to gather documents and the resultant suits have led to fines of hundreds of millions of euros.
Another feature of the new regulatory landscape is the rise of extraterritoriality: the application of laws from one country to actions in another. The FCPA always applied to overseas actions, as does the new UK Bribery Act. So, typically, do competition legislation and trade sanction-related laws.
The exposure is not only to the actions of a company’s own employees: regulators have gotten wise to the practice of “outsourcing” wrong-doing to a local partner or agent. The UK Bribery Act makes quite explicit a corporation’s liability to third party acts that benefit the company, but it has been implicit in most such national legislation already. The onus is now clearly on the company to police the actions of affiliates, partners, and agents, and to have a clear record of doing so, in order to protect its own integrity. This applies not just to the prevention of corruption but to many other aspects of international trade and business regulation.
The SEC cracks down harder on pay to play
Banks have long had “Know Your Customer” rules; now the United States Securities and Exchange Commission (SEC) is telling investment managers to “Know Your Placement Agent” as part of its efforts to crack down on “pay to play” – the practice of making political donations or payments in return for government business.
For investment managers seeking government work, federal, state, and local pension fund investments hold out enticing prospects. These total more than $2.6 trillion, or one-third of all US pension assets. On June 30 of this year, the SEC adopted rules to restrict investment managers from making political contributions if they are trying to win government business. They also require placement agents – third parties hired by investment managers to solicit government business – to register with the SEC.
The SEC first addressed pay to play in 1999, but recent events show that those rules did not go far enough.
* In March 2009, the SEC charged New York State’s former Deputy Comptroller with attempting to extract illegal kickbacks from placement agents trying to obtain business from the New York State Common Retirement Fund.1 The SEC and New York’s Attorney General also charged private equity firm Quadrangle Capital Partners with trying to win a $100 million investment from the fund by paying more than $1million to a top political adviser and fundraiser of the State Comptroller, who oversaw the fund.2 In April 2010, Quadrangle agreed to pay a $12 million fine to settle the charges and pledged to support regulators’ efforts to ensure that investment managers are selected “based solely on merit.”3
* In 2009, a private investment advisor to New Mexico’s State Investment Council admitted that, due to pressure from unnamed, politically-connected individuals, he had recommended investments which were not necessarily in the state’s best interest. A grand jury is investigating.4
* In May 2010, the California Attorney General sued a placement agent, representing leading private equity firm Apollo Global Management, for “attempting to bribe” a senior investment officer at the California Public Employee Retirement System (CalPERS), the nation’s largest public pension fund. The agent had allegedly sought to persuade CalPERS to buy a 10% interest in Apollo.5 Apollo was not charged and said it was “deeply troubled” by the allegations.6
Foreign Corrupt Practices Act
The energy industry has long been fertile ground for corruption and bribery and, therefore, ripe for Foreign Corrupt Practices Act (FCPA) enforcement activity. By its very nature, the international energy business, including the oil and gas sector, requires a high degree of government involvement and cooperation, particularly when entering markets overseas, constructing facilities in new territories, applying for permits from foreign agencies, or reaching distribution agreements with countries. Such cooperation can be achieved in many ways, and some firms resort to methods with FCPA implications.
The most recent example of an energy company undergoing an FCPA investigation and prosecution ended in a December 2008 settlement between Siemens AG, the United States Department of Justice (DOJ), and the Securities and Exchange Commission (SEC). The case provides lessons for every international energy firm on how to remain FCPA compliant as it develops business and establishes a presence overseas.
Cooperation with Government investigations: Siemens’ approach to the FCPA investigation has been universally recognized as the “right way” and can serve as a model for those facing similar actions. Siemens retained a multi-national team of accountants and lawyers to establish the facts and circumstances surrounding all of the allegations. The company was also reportedly timely and forthcoming with all of the DOJ’s requests for documents and information. The settlement agreement calls Siemens’ level of cooperation “exceptional.” This behavior is said to be why the company secured the terms it did. Approaching an FCPA investigation cooperativly, rather than contentiously, is the single greatest lesson coming from the case.
Due diligence failures: Siemens’ failure to perform meaningful due diligence on some third-party consultants led to many of its FCPA-related problems. Numerous “red flags” relating to their hiring and use went mostly undetected because of a failure to centralize the due diligence and third-party retention processes. For example, Siemens engaged certain consultants with no relevant experience in their contracted tasks and many received unusually high fees relative to the going rate for such work. In addition, the company used third parties concurrently employed by the governments with which it was seeking a business relationship. Engagement of a third party should always be preceded by a level of due diligence which will yield full knowledge of its proposed activities, remuneration, and expertise to carry out its mission.
Management’s role in compliance: Siemens was harshly taken to task for management’s apparent failure to ensure FCPA compliance in parts of its overseas business. The SEC complaint criticized Siemens’ FCPA compliance program, saying bribe payments and inadequate controls were “accepted by senior management.” The DOJ admonished Siemens’ senior leadership for failing to instill ethics into its business by, for example, not making a clear statement of company policy to employees on the payment of bribes. In essence, the government was condemning a failure of corporate leadership to create a “tone at the top” consistent with effective compliance. Management buy-in involves more than just promulgation of FCPA related rules: senior executives must be actively engaged to ensure not merely conformity with the letter of the law, but also an ethos of compliance.
See, also, Foreign corrupt practices? It's negotiable.
No comments:
Post a Comment