Tag Archives: Bribery & Corruption

Bribery & Deferred Prosecution

Between January and February 2015, a prominent trade organization focusing on American attorneys conducted a survey of 243 Chief Legal Officers of global companies to assess the corporate counsel’s opinion regarding the greatest threats to their organization’s growth. Respondents were asked to rank their top three concerns. Not surprisingly, economic uncertainty was at the top of the list with 57% of the respondents ranking it in their top three. The unexpected finding was that 53% of the respondents named regulatory compliance and enforcement as a top concern as well.

When asked to specify which laws caused them the most concern 28% identified the Foreign Corrupt Practices Act and 15% identified the UK Bribery Act. This means 43% of the respondents named anti-bribery laws as one of their top three concerns, more than any other law or regulation identified. When asked about the resources spent on regulatory compliance and enforcement, the response was also surprising as only 38% of the corporate counsel who identified regulatory compliance and enforcement as a threat, are expending resources to address the threat. As a follow up to the 2015 survey, the same organization conducted a second survey in early 2017 to gain further insight into corporate counsels’ ability to address regulatory and compliance threats. This time 256 respondents were surveyed, 62% of whom stated that their organization is designing or building some type of robust internal compliance program. Although this is movement in the right direction, over a third of the organizations surveyed still may not be prepared to detect or deter bribery and corruption. Most significantly, they will not be prepared to meet government expectations if a violation occurs and self-reporting is required. Lastly, 54% of the respondents stated that they are building or expanding their in-house systems to address this threat. Many believe that compliance technology is the appropriate answer as regulators prefer technical solutions to these problems, because they are viewed to be sophisticated and ‘state of the art’.

This research should be of special interest to all CFEs because we work so frequently with corporate counsels, but indeed, to assurance professionals in general who like fraud examiners are on the front line in the fight against corruption.

The Foreign Corrupt Practices Act (FCPA) was enacted in 1977 but aggressive enforcement did not really pick up until around 2005 when there were twelve enforcement actions.  The purpose of the FCPA was to prevent the bribery of foreign government officials when negotiating overseas contracts. The FCPA imposes heavy fines and penalties for both organizations and individuals. The two major provisions address: 1) bribery violations and 2) improper books and records and/or having inadequate internal controls. Methods of enforcement and interpretation of the law in the US have continued to evolve over the years.

The FCPA created questions of definition and interpretation, i.e., Who is a “foreign official?” What is the difference between a “facilitation” payment and a bribe? Who is considered a third party? How does the government define adequate internal controls to detect and deter bribery and corruption?

The enactment of the United Kingdom (UK) Bribery Act in July 2010 was the first attempt at an anti-bribery law to address some of these issues. The UK Bribery Act introduced the concept of adequate procedures, that if followed could allow affirmative defense for an organization if investigated for bribery. The UK Bribery Act recommended several internal controls for combating bribery and introduced the incentive of a more favorable result for those who could document compliance. These controls include:

• Established anti-bribery procedures
• Top level commitment to prevent bribery
• Periodic and documented risk assessments
• Proportionate due diligence
• Communication of bribery prevention policies and procedures
• Monitoring of anti-bribery procedures

The concept of an affirmative defense for adequate procedures creates quite a contrast to FCPA which only offers affirmative defense for payments of bona fide expenses or small gifts within the legal limits of the foreign countries involved.

The UK Bribery Act equated all facilitation and influence payments to bribery. Finally, the UK Bribery Act dealt with the problem of defining a foreign official by making it illegal to bribe anyone regardless of government affiliation. Several countries such as Russia, Canada and Brazil have enacted or updated their anti-bribery regulations to parallel the guidelines presented in the UK Bribery Act. The key to the effectiveness of all these acts remains enforcement.

In November 2012 the US Department of Justice and the Securities Exchange Commission released “A Resource Guide to the Foreign Corrupt Practices Act.” The guide book introduced several hallmarks of an effective compliance program. The Resource Guide provided companies with the tools to demonstrate a proactive approach to deter bribery and corruption. Companies in compliance may receive some consideration during the fines and penalty stage.

The guide’s hallmarks include:

• Establish a code of conduct that specifically addresses the risk of bribery and corruption.
• Set the tone by designating a Chief Compliance Officer to oversee all anti-bribery and corruption activities.
• Training all employees to be thoroughly prepared to address bribery and corruption risk.
• Perform risk assessments of potential bribery and corruption pitfalls by geography and industry.
• Review the anti-corruption program annually to assess the effectiveness of policies procedures and controls.
• Perform audits and monitor foreign business operations to assure compliance with the code of conduct.
• Ensure that proper legal contractual terms exist within agreements with third parties that address compliance with anti-bribery and corruption laws and regulations.
• Investigate and respond appropriately to all allegations of bribery and corruption.
• Take proper disciplinary action for violations of anti-bribery and corruption laws and regulations.
• Perform adequate due diligence that addresses the risk of bribery and corruption of all third parties prior to entering a business relationship.

The SEC and DOJ entered into the first ever Non-Prosecution Agreement (NPA) for Foreign Corrupt Practices violations in 2013. This decision was a harbinger from the DOJ and SEC with regard to future enforcement actions. The NPA highlighted the “extensive remedial measurements and cooperation efforts” that the defendant company demonstrated during the investigation. The corporation paid only $882,000 in fines because they were able to “demonstrate a strong tone from the top and a robust anti-corruption program”.

Under a Deferred Prosecution Agreement (DPA) the DOJ files a court document charging the organization while simultaneously requesting that prosecution be deferred to allow the company to demonstrate good conduct going forward. The DPA is an agreement by the organization to: cooperate with the government, accept the factual findings of the investigation, and admit culpability if so warranted. Additionally, companies may be directed to participate in compliance and remediation efforts, e.g., a court-appointed monitor.

If the company completes the term of the DPA, the DOJ will dismiss the charges without imposing fines and penalties. Under the Non-Prosecution Agreement, the DOJ maintains the right to file charges against the organization later should the organization fail to comply. The NPA is not filed with the courts but is maintained by both the DOJ and the company and is posted on the DOJ website. Like the DPA, the organization agrees to monetary penalties, ongoing cooperation, admission to relevant facts, as well as compliance and remediation of policies, procedures and controls. If the company complies with the agreement, the DOJ will drop all charges.

The key differences between a deferred prosecution case and one not featuring deferred prosecution is the initial response of the defendant company to the discovery of improper payments. In a deferred prosecution case the response usually features prompt self-reporting, full cooperation with the government and the quality of the serious remedial steps taken, including termination of implicated personnel and the modification of company behavior in the country where the violations occurred. Additionally, deferred prosecution defendants frequently discover the improper payments while in the process of enhancing their anti-bribery and corruption controls.

Originally allegations of FCPA violations were received through a company’s internal whistleblower hotline. That trend changed with the enactment of the Sarbanes Oxley Act in 2002 and the Dodd-Frank Act in 2012. These laws created other means and mechanisms for reporting suspicions of illegal activity and provided protections from retaliation against whistleblowers. The Dodd-Frank Act also has monetary incentives of 10% to 30% of the amounts recovered by the government to encourage whistleblowers to come forward. Companies considering whether to disclose potential anti-corruption problems to the SEC must now consider the possibility that a potential whistleblower may report it first to the government thus creating greater liability for the organization.

In conclusion, according to recent reporting by the ACFE, corporate compliance programs continue to mature, and are now accepted as a cost of conducting business in a global marketplace. The US government continues to clarify its expectations about corporate responsibility at home and abroad and works with international partners and their compliance programs. Increased cooperation between the public and private sectors to address these issues will assist in leveling the playing field in the global marketplace. Non-government and civil society organizations, i.e. World Bank and Transparency International play a key role in this effort. These organizations set standards, apply pressure on foreign governments to enact stricter anti-bribery and corruption laws, and enforce those laws. Coordination and cooperation among government, business and civil entities like the ACFE, reduce the incidences of bribery and corruption and increase opportunities for companies to compete fairly and ethically in the global marketplace.

Living Underground

tax-hellRegister Today for Investigating on the InternetMay 18-19 2016 RVACFES Seminar!

The first signs that the tide may be turning in the world-wide battle against corruption appear to be upon us.  Issues surrounding the growing international Panama Red movement and the scandal of secret money have thrown a spotlight on what’s called the underground economy.

The underground economy is a group of clandestine transactions that create financial value, but are conducted with the intention of escaping something — primarily taxes, but also revelation of bribes, government regulations, exchange controls, or criminal prosecution.  The ACFE has been telling us for years that the underground economy exists for four primary reasons:

— to escape taxation;
— to escape regulation;
— to escape prohibition;
— to further corruption.

Because all of these activities are illegal and the individuals involved in them want to escape detection, the underground economy operates on secret money. Economists have attempted to determine the exact size of the international underground economy, but have, thus far, met with limited success because the main premise of the underground economy is that income is not reported. In the early 2000’s, India, the United States, Canada, Russia, Nigeria, and Italy were believed to have the largest underground economies in the world. According to estimates, the underground economy in the United States has grown significantly, totaling as much as $2.25 trillion annually. Today, most observers in the United States estimate that ten percent of the actual Gross Domestic Product can be attributed to criminal activity.

The underground economy in the United States (as it does to the tax collection efforts in other developed economies) is undermining the effectiveness of the Internal Revenue Service, which is highly dependent on employee’s withholding taxes. If the IRS could collect all of the taxes that it says it is owed from the underground economy, then the current budget deficit would decrease overnight. The IRS has estimated that its tax gap, the estimated amount of taxes owed minus the amount collected, is around $600 billion in any given year. The gap number measures only a portion of the underground economy. Because the number is extrapolated from audited returns, it makes no allowance for criminal enterprises that report no income, and it even fails to capture some typical varieties of non-reporting. This gives just some idea how much the underground economy is costing the U.S. economy alone.

In response to these issues, the IRS developed the Criminal Investigative Unit. This unit serves the American public by investigating potential criminal violations of the Internal Revenue Code and related financial crimes in a manner that fosters confidence in the tax system and compliance with the law. The enforcement efforts of this unit include tax violations, money laundering, currency crimes, and asset forfeiture.

The Criminal Investigation Program Strategy falls into three interdependent categories: Legal Source Tax Crimes, Illegal Source Financial Crimes, and Narcotics-Related Financial Crimes. The Legal Source Tax Crimes Program Strategy addresses tax investigations involving taxpayers in legal occupations and legal industries. The Illegal Source Financial Crimes Program Strategy recognizes that illegal source proceeds, which are part of the untaxed underground economy, are a threat to the voluntary tax compliance system, and that failure to investigate these cases would erode public confidence in the tax system. The primary objective of the Narcotics-Related Financial Crimes Program Strategy is to reduce the profit and financial gains of narcotics trafficking and money laundering organizations that compromise a significant portion of the untaxed underground economy.

The foremost reason for the existence of the underground economy is to escape taxation, which in some countries can be more than half of a person’s yearly income. Swiss bankers have a saying, “There would be no tax havens without tax hells.” As the rate of taxation increases, so does the cost of honesty. The higher the tax burden, the more incentive people have to attempt evading those taxations. Because it’s illegal, tax evasion always involves financial secrecy. And tax evasion, as the Panama Paper’s illustrate, transcends national boundaries due to the investigative and jurisdictional limits set by each country for revenue authorities. While there is a great deal of cooperation between international governments in matters of tax evasion, there are many loopholes that make overseas transactions appealing and profitable to the secrecy seeker.

The second factor that motivates the underground economy is the desire to escape regulation. Government-imposed regulations are often perceived as hindrances to the efficient flow of business. Regulations might affect prices, wages, returns on capital, exchange rates, and so forth. As with taxes, each time a new regulation is enacted, an economic incentive is created to find a way to evade it. In many countries, parallel financial markets, also known as curb markets, are the result of stringent financial controls. These controls also give rise to parallel foreign exchange markets involving currency smuggling and transfer pricing. All of this economic activity is conducted in secrecy and is neither taxed nor reported in official statistics.

Prohibition is defined as the forbidding by law of certain activities. Avoidance of prohibitions is the third reason underground economies exist. Prohibition is usually associated with criminal activities such as narcotics smuggling and sales, prostitution, gambling, and usury (i.e., the lending of money at excessive interest rates). Most of these transactions are made with cash and are therefore extremely difficult to detect and trace.

The final reason for the perpetuation of the underground economy is corruption. Corrupt activities include bribes on public procurement contracts, customs clearance, traffic violations, zoning ordinances and building permits, investment licenses, import and foreign exchange permits, allegations of consumption, investment, and infrastructure goods that are in short supply. As the current revolt of the Mexican people against corruption illustrates, bribery is commonplace in many countries and is pervasive among public officials. Despite official laws banning bribery, the practice is sometimes an intrinsic part of a country’s cultural, political, and economic system. In these places, it is tolerated or simply overlooked.

One of the most important services fraud examiners can render to their clients and to the general public is to increase awareness of the pernicious effect on economic freedom and liberty of the underground economy phenomena, not just in the developed countries in which we primarily practice, but world-wide.

War Stories

war-stories_2Register Today for Investigating on the Internet May 18-19 2016 RVACFES Seminar!

I like to collect war stories from fellow fraud examiners and auditors.  This one is a story a long time member of our Chapter and a personal friend shared with me not too long ago over lunch.  It has to do with a case he investigated during the mid-nineties.  One of his client companies at the time was the wholly owned subsidiary of a prominent medical equipment wholesaler which sold primarily to local pharmacies.  It seems the subsidiary maintained a large sales force, the superstar of which was a sales manager I’ll call Drew Paul.  Paul’s division brought in over 50% of the subsidiary’s revenue and, even in a sales force of above average performers, Paul stood out.

Our Chapter member got involved with the subsidiary when a member of the parent’s audit committee requested a routine fraud vulnerability study of all the parent’s principal subs.  Paul’s sub was the second our Chapter member evaluated.  As part of the general review’s kick-off process, my friend met with the human resources head to obtain an organization chart and to familiarize himself with the sub and its operations.  Review of the data supplied by HR revealed high turnover in the sales division, turnover that was predominantly related to one sales manager, Drew Paul. He also discovered that the HR department didn’t routinely conduct exit interviews when employees left either the sales division or the company. Our member was immediately concerned because the lack of such a routine personnel procedure was unusual in a sub of such a progressive company.  Our member then scheduled a follow up meeting with the HR head which yielded some interesting observations. The HR head noted that Paul Drew didn’t seem to care about HR policies. His attitude seemed to stem from his assertion that the sales team was the “bread and butter” and that the rest of the company was dependent on it. The HR head had the impression that the sub’s CEO seemed to agree, not requiring the sales division to adhere to company policy and procedure. At our friend’s request, the HR head handed over copies of the sales senior management team’s personnel files for his review. The HR head also mentioned, as an aside, that, in her opinion, Paul’s income would not begin to support the level of his apparent lifestyle. Our member additionally found that the HR head had issued a warning letter to Paul for violating company policy by recruiting entry-level data clerks to collect checks from the subs retail pharmacy customers without HR’ s knowledge.

Given these red flags, and with the parent’s permission, our Chapter member decided to start the sales vulnerability assessment portion of the general assessment immediately. He met with the sub’s CEO and quietly put a small upper management team together to begin the review.  The first week of the assessment was spent reading company/division policies and procedures; reviewing the sales department’s structure, authority matrix, sales process, and analysis of the past two years’ sales, as well as the portion of the market (sales territories) allotted to each of the managers; and the access level controls on the sales module of the general ledger system. The review team planned the engagement to cover both compliance and substantive testing of the entire sales process. Two deficiencies came out clearly during the initial review testing: There were loose controls around issuing promotional and bonus products to pharmacies, and there were few controls on sales returns. Bonus and promotional products were used by the wholesaler to reward pharmacies that met or exceeded their sales targets, launch a new product, or successfully push a slow-moving product.

Our friend reviewed the list of past employees who were terminated or had resigned from the sales force in the last year. His eyes fell on Billy Preston who had been terminated at the end of the second quarter.  After consulting with the parent’s corporate legal counsel and obtaining consent from the audit committee, our member invited Preston to lunch the next week. Preston conveyed some astonishing things about Paul and even provided a copy of a check from a pharmacy written out to Paul (while collecting checks for the subsidiary from the pharmacy, Preston was handed the check made out to Paul). When Preston confronted Paul about the suspicious check, Paul terminated Preston on behavioral grounds and threatened to withhold severance pay if he went to HR. Considering Paul’s intimidating stature and apparent influence with the CEO and within the company generally, Preston decided to just leave the company quietly and begin looking for another job.

Apparently, Paul was using bonus and promotional products for personal gain. The value of bonus and promotional products given out to pharmacy customers amounted to 9 percent and 12 percent of total sales respectively. The lack of strictly defined policies and guidelines for the use of promotional and bonus products at the parent and sub left the distribution of them to the discretion of managers. Unfortunately, it also made it possible for Paul and (it later developed) a corrupt distribution manager at the parent working together to exploit the internal control deficiency. The bonus and promotional products program was transparent only to the two managers but not to the individual pharmacies. Keeping pharmacies in the dark about the details of how much they should be getting in bonus and promotional products if they reached sales targets, the two managers could favor the pharmacies of their choice.  With this additional information, our member further analyzed how a small number of pharmacies were favored with extra bonus and promotional items compared to other pharmacies, though the other pharmacies were giving the same amount of business to the parent. Not surprisingly, sales returns were also higher for the pharmacies receiving the extra bonus and promotional items than the average sales returns of all the other pharmacies put together. By colluding with pharmacies, Paul pushed sales at month end and arranged with the pharmacies to return their purchases by the first week of the next month so the pharmacy would not be overburdened with stock. By doing this, Paul received more commission from the parent, which was, at the time, based on gross sales and not on net sales (gross sales minus sales returns).

Our member wrote a confidential report and delivered his findings to the audit committee of the parent. After a thorough review, the audit committee chairman summoned Paul. As part of the review, Paul’s bank statements were legally obtained. The chairman asked Paul to explain why his bank records showed deposits from seven out of the 35 pharmacies he was handling. After initial denials, Paul admitted to accepting kickbacks in the amount of $175,00 by favoring certain pharmacies. He also came clean on the sales-returns routing that was conveniently altered so that certain of his sales team members would receive higher commissions than those to which they were entitled. Paul also revealed the names of several employees in his department who were helping him in the scheme. The parent decided not to press charges against Paul and the others because they agreed to repay monies received as kickbacks from the pharmacies.

For our member the takeaways are that CFE’s should tell their clients not to lose control of their subs.  Policies, procedures, and guidelines should be established in all sub departments, especially in those areas where more discretionary powers are involved. Keep the whistle blowing process transparent, approachable, and user-friendly. There also should be a mechanism in place to protect whistle blowers like Billy Preston. Management should engage CFE’s to perform regular fraud risk assessments, especially of semi-independent subsidiaries.  Finally, high turnover in a department should always be perceived as a red flag. Exit interviews should be thoroughly conducted to get to the root of a problem which can often turn out to be fraud related.

Facilitation or Bribe?

LondonBridge2During our recent live training event on November 12th , Tom Gober, our speaker, alluded to the importance of the U.S. Foreign Corrupt Practices Act as a piece of US government regulation of which it behooves all fraud examiners to be aware. Tom’s reference got me to thinking about the confusion that still persists regarding certain provisions of the Act among corporate players (as reported in the financial trade press following several recent high profile prosecutions). Enacted to great fanfare in 1977, the purpose of the FCPA was to prevent the bribery by the agents of US corporations of foreign government officials when those agents were negotiating overseas contracts. The FCPA imposes heavy fines and penalties for both organizations and individuals. The two major provisions address: 1) bribery violations and 2) improper corporate books and records as well as maintenance of inadequate internal controls. Understandably, methods of enforcement and interpretation of the law in the US have continued to evolve to the present day.

From the first, the FCPA spawned questions of definition and interpretation for those trying to comply, i.e., who is a “foreign official?” What is the difference between a “facilitation” payment and a bribe? Who is considered a third party? How does the government define “adequate” internal controls to detect and deter bribery and corruption?

The United Kingdom enacted its UK Bribery Act in July 2010 which really represented the first real attempt at an anti-bribery law to address some of these issues. The UK Bribery Act introduced the concept of “adequate procedures”, that if followed could allow affirmative defense for an organization under investigation for bribery. The UK Bribery Act recommended several internal controls for combating bribery and offered the incentive of a more favorable result for those who could document compliance. Among the controls:

• Establish anti-bribery procedures;
• A top corporate level commitment to prevent bribery;
• Periodic and documented risk assessments;
• Proportionate due diligence;
• Communication of bribery prevention policies and procedures to all involved parties in corporate transactions;
• Monitoring of anti-bribery procedures.

The concept of an affirmative defense for adequate procedures creates quite a contrast to the US FCPA which only offers affirmative defense for payments of bona fide expenses or small gifts within the legal limits of the foreign countries involved. The UK Bribery Act simply equates all facilitation and influence payments to bribery, thus eliminating much confusion. Finally, the UK Bribery Act dealt with the problem of defining a foreign official by making it illegal to bribe anyone regardless of government affiliation. Several countries such as Russia, Canada and Brazil have enacted or updated their anti-bribery regulations to parallel the guidelines presented in the UK Bribery Act. The key to their effectiveness remains enforcement.

Then, in 2010, the US Department of Justice and the Securities Exchange Commission released a guide book introducing several hallmarks of an effective FCPA compliance program. The publication of the guidebook is a development which, according to Tom Gober, many auditors and CFE’s remain unaware, even to this day. The Resource Guide provides our client companies with the tools to demonstrate a proactive approach to the deterrence of bribery and corruption. Companies found out of compliance may receive some consideration during the fines and penalty stage of their cases.

The guidebook recommends that companies doing business overseas:

• Establish a code of conduct that specifically addresses the risk of bribery and corruption;
• Set the tone by designating a Chief Compliance Officer to oversee all anti-bribery and anti-corruption activities;
• Train all employees to be thoroughly prepared to address bribery and corruption risk and document that the training took place;
• Perform fraud risk assessments of potential bribery and corruption pitfalls by country and industry;
• Review the anti-corruption program annually to assess the effectiveness of policies, procedures and controls;
• Perform audits (routine and surprise) and monitor foreign business operations to assure strict compliance with the published code of conduct;
• Ensure proper legal contractual terms exist within agreements with third parties that address compliance with anti-bribery and corruption laws and regulations;
• Investigate and respond promptly and appropriately to all allegations of bribery and corruption;
• Take proper disciplinary action for violations of anti-bribery and corruption laws and regulations;
• Perform adequate due diligence that addresses the risk of bribery and corruption performed by third parties prior to entering into any business relationship.

Fraud examiners should make their clients aware that a company which can provide evidence of compliance with these recommendations is afforded many advantages if they’re ever charged with a violation of the Act. Among them is a Deferred Prosecution Agreement (DPA). Under a Deferred Prosecution Agreement the Department of Justice files a court document charging the organization while simultaneously requesting prosecution be deferred in order to allow the company to demonstrate good conduct going forward. The DPA is an agreement by the organization to: cooperate with the government, accept the factual findings of the investigation, and admit culpability if so warranted. Additionally, companies may be directed to participate in compliance and remediation efforts, e.g., a court-appointed monitor. If the company completes the term of the DPA the DOJ will dismiss the charges without imposing fines and penalties!

The DOJ and the company may alternatively even enter into a Non-Prosecution Agreement. Under such an agreement the DOJ retains the right to file charges against the organization at a later time should the organization fail to comply. The NPA is not filed with the courts but is maintained by both the DOJ and the company and posted on the DOJ website. Similar to the DPA, the organization agrees to monetary penalties, ongoing cooperation, admission to relevant facts, as well as compliance and remediation of policies, procedures and controls. If the company complies with the agreement, the DOJ will, again, drop all charges.

The good news is that, since publication of the guidebook, corporate compliance programs have continued to mature, and are now generally accepted as just another cost of conducting business in a global marketplace. The US government is continuing to clarify expectations with regard to corporate responsibility at home and abroad, and working with international partners and their compliance programs. Increased cooperation between the public and private sectors to address these issues will assist in leveling the playing field in the global marketplace. Non-government and civil society organizations, i.e. World Bank and Transparency International are playing a key role in this effort. These organizations set standards, apply pressure on foreign governments to enact stricter anti-bribery and corruption laws, and enforce those laws. Coordination and cooperation among government, business and civil entities, reduce the incidence of bribery and corruption and increase opportunities for companies to compete fairly and ethically in the global marketplace. Hence, every fraud examiner and assurance professional should strongly support these efforts while strongly encouraging our clients to comply with the provisions of the 2010 guidebook.