Uncovering Foreign Corruption Risk Before It Covers You

Thursday, May 1, 2008 - 01:00

Through the centuries of international business, bribing government officials to influence or secure a positive result has been a common and accepted way of conducting business. Until recently, bribes were even tax deductible in France and Germany. Today we enounter a very different story.

The U.S. Foreign Corrupt Practices Act ("FCPA") is just one of many laws now proliferating around the globe aimed at eliminating corruption in business transactions involving foreign government entities. It is based on the Organization for Economic Co-operation and Development ("OECD") Convention, which has been adopted by the United Nations and most of its member nations. This agreement requires signatory countries to pass compliant anti-corruption laws and to report annually on their efforts to improve governance issues. (See www.uhyadvisors-us.com/uhy/ Default.aspx?tabid=391 for information on international conventions.)

Anti-corruption is a major initiative of the World Trade Organization, and the World Bank is aggressively stamping out corruption from its programs. The WTO recognized the magnitude of the issue, estimating that more than $1 billion of corruption occurs every year. In addition, the EU, African Union, ASEAN, OAS, CARICOM and many other international organizations are forcing their members to adopt anti-corruption laws. Countries around the globe now clearly realize that to secure their share of the rapidly growing world trade market and to foster economic growth, bribery and government corruption must be mollified. There are simply too many competitors in other countries that are willing to safely and more honestly host lucrative business opportunities. While he was United Nations Secretary-General, Kofi Annan warned the world about the ill effects of corruption in his statement on the adoption by the General Assembly of the United Nations Convention Against Corruption.

Corruption hurts the poor disproportionately by diverting funds intended for development, undermining a government's ability to provide basic services, feeding inequality and injustice, and discouraging foreign investment and aid.

Corruption Is Now A Life And Death Matter In Some Parts Of The World

It is naive to think that the current efforts will reverse thousands of years of behavior and tradition anytime soon. Nonetheless, the international cooperation requirements in the U.N.'s version have increased global prosecutions. Government officials have been jailed and in China, recently, even executed for taking bribes in many countries. Local bribe payers are being interrogated to dilvulge individuals and companies responsible for facilitating bribe payments. That information is then used for both in-country investigations and prosecutions, and is referred to the foreign jurisdiction, most notably the U.S. and EU, for further prosecution in the responsible company's home country. Companies are settling with the governments and still paying millions of dollars in fines, disgorgement of all related profits and other penalties.

The largest settled case to date involves Baker-Hughes, which paid a fine and disgorgement of profits in excess of $44 million. In addition, estimates are that they paid an additional $50 million in legal and accounting fees related to bribery. Baker-Hughes is now under the scrutiny of an internal watchdog as part of the settlement with the Department of Justice and SEC. It is anticipated that the penalties, fines, disgorgement of profits, investigative costs and business losses suffered by Siemens in its on-going international action will dwarf these numbers.

What Circumstances Drive Corruption Risk For Your Company?

Virtually every company conducts some business internationally. And as the world grows flatter, that trend will continue. So how does savvy management know whether their risks of running afoul of the FCPA are high or low? There are four principal factors that drive risk in this area:

1. In what countries do you do business?

2. How do you conduct business within each of those foreign locations and what is the level of involvement with government officials?

3. How much of your company's gross revenues are dependant on your business with foreign governments or quasi-government entities?

4. How do you connect into foreign markets?

Country Risk

Transparency International ( www.transparency.org ) compiles an annual Corruption Perception Index ("CPI") on virtually all countries. This rating is widely used to determine the extent to which corruption is prevalent in a country. The lower the rating the greater the likelihood that doing business in or with that country requires the bribery of government officials. For example under the 2007 CPI:

• New Zealand, Denmark and Finland are rated the least corrupt countries in the world with a rating of 9.4.

• The United States is ranked 20th and rated at 7.2.

• China, Mexico, Brazil and India are all ranked at number 72 and rated 3.5, which is significantly below average.

• Myanmar and Somalia are the most corrupt according to TI, both rated 1.4.

If one is doing any business with government or quasi-government entities in Myanmar, or in any other country rated below or significantly below average, an evaluation of that business activity is probably warranted.

Type Of Business Risk

While conducting business in a high-risk country is certainly a red flag, in most cases that is just the beginning. One could be conducting high-risk business in a relatively non-corrupt country or very low-risk business in a moderately rated country. Bribery occurs with some frequency in the U.S., Europe and other comparatively "safe" countries.

A company can transact business in numerous ways, with a wide range of risks that the company is unknowingly paying bribes in violation of these laws. In order of low to high risk, some methods of doing business overseas are:

1. Source and buy foreign goods in the U.S. from U.S. importer.

2. Source and import using your own freight forwarder.

3. Outsource work to foreign firms.

4. Manufacture overseas and import only into U.S.

5. Provide services in foreign countries either directly or through agents.

6. Sell or market products or services into foreign countries.

7. Maintain sales or marketing offices overseas.

8. Sell to state-owned businesses.

9. Sell to government agencies.

Each of these strategies has nuances and differences that could increase or decrease the risk. The first scenario is not without risk, it is normally just the least risky. The second can be more risky, for example, if the freight forwarder is a state-owned entity. The greater your involvement in a foreign country, the greater the risk. The greater your involvement with the government or its instrumentalities, the higher the risk.

Exposure Risk

The more business you conduct in one of the higher risk countries the greater the exposure and risk of violations. Assuming at this point that your company could potentially be paying bribes to obtain or retain business, exposure comes in several forms:

• Would disgorgement of all "tainted" gross profits earned from that country be material to your business?

• Is the business generated from that locale worth the millions of dollars in potential fines and penalties?

• If you stopped all bribery and lost much of this business, would that be material?

• Does it make more sense to stop doing very high risk business in the country or to investigate and correct any problems or determine with certainty that there are none?

• How material a risk would be posed by the reputational damage associated with public disclosure of paying bribes?

Representation Risk

How is your business represented in a foreign jurisdiction? How much control do you have over your own foreign operations? The more disconnected your foreign representative is, the higher your risk of violating these anti-bribery laws. Whether you knew of a bribe payment or not, you are liable for the acts of your downstream agents. For example, Textron was liable for the acts of a Jordanian company, acting on behalf of a Lebanese company, who was hired by a French subsidiary of U.S.-based Textron.

Effective compliance programs including well-defined and communicated policies, effective training, appropriate internal controls and periodic reviews are critical to avoiding or reducing liability in this area. Some examples of ways companies connect overseas, in order of increasing risk, are the following:

1. Purchase from U.S. company that has imported the goods into the U.S.

2. Fully trained, wholly owned subsidiary or division with effective internal controls that are verified in place.

3. Fully trained joint venture ("JV"), with anti-bribery language in the contract, clean periodic background checks on JV partner, and effective internal controls.

4. Fully trained independent agent, with background check and anti-bribery language in written contract including right to audit, and regular audits.

5. Untrained subsidiary, JV or agent with anti-bribery language in the contract and clean background check.

6. Untrained subsidiary, JV or agent with anti-bribery language in the contract but no background check.

7. Untrained subsidiary, JV or agent without anti-bribery language in the contract and no background check.

8. Untrained subsidiary or JV without a written contract and no background check.

9. Untrained independent agents without written contracts or clean background check.

What Are The First Steps You Should Take?

Evaluating these factors is a starting point for determining whether your potential risk is significant. Each incremental factor is cumulative and can increase the aggregate risk of an otherwise deemed low-risk involvement in international business. Identifying and mitigating risk and reducing exposure is often relatively inexpensive. Investigating high-risk business ventures to uncover any potential problems is also very advisable in light of the ever-increasing diligence and depth of focus by countries, competitors and U.S. officials. Before doing either, a company has to understand where its risks actually are. You can begin understanding your level of risk by using UHY Advisors' FCPA Risk Assessment tool found at http://uhy-us.com/FCPA/Calc. Once you complete the assessment, there are additional recommended steps on that web page designed to help mitigate your risk, lest you wind up on the front page of the business section.

Jeff Harfenist is a Managing Director of UHY Advisors FLVS. Chris Lozier is a Senior Manager for Enterprise Risk Advisory Services for UHY Advisors. FLVS.UHY is one of the leading business advisory, consulting and accounting networks, with teams operating across 198 offices in 66 countries .

Please email the authors at jharfenist@uhy-us.com or clozier@uhy-us.com with questions about this article.