Ed. Note-we continue our series on the risk analysis and assessment of distributors under the FCPA and management of that risk. Today, David Simon contributes a guest post where he articulates another approach to the risk analysis of distributors. 

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Tom and I have been engaged in an interesting discussion (interesting to us, as FCPA geeks, anyway) about the FCPA risk posed by distributors and the most appropriate compliance response to that risk.  Tom correctly focuses on the risk posed by distributors and recommends that companies apply “Full Monty” third-party due diligence procedures to distributors to minimize that risk.  Based some work counseling mid-sized companies with limited compliance resources, I have focused on the practical challenges that approach presents, and have proposed an analytical framework for conducting a risk-based approach to assessing FCPA exposure, which can be used to sensibly and reasonably allocate compliance resources.

It seems that everyone agrees on a couple of key points.  First, it is clear that distributors do pose FCPA risk.  Indeed, the majority of enforcement actions over the past several years have involved at least some alleged violations by third parties, including some involving distributors.  Second, there is no question that a company will be held responsible for improper payments made by a distributor if the company actually knows about or participates in the improper payments.

My focus is on FCPA liability for acts of distributors that is premised on “willful blindness.”  A significant benefit from third-party due diligence is protection against a “willful blindness” FCPA charge if a distributor makes an improper payment on the company’s behalf.

Here’s the problem:  Some companies employ vast distributor networks, sometimes including hundreds, if not thousands, of distributors around the world.  Many distributors are more like customers than agents – they merely purchase a product and resell it to others, often in conjunction with other products purchased from other manufacturers.  Is it really practical and  necessary to conduct full FCPA due diligence on every one of those distributors?  Do the U.S. companies in these situations even have the leverage to insist on FCPA representations and warranties in the written agreements, to demand audit rights, and to require certifications by and training of these distributors?  The question thus arises whether U.S. companies are faced with a difficult choice either to accept substantial FCPA risk or to devote disproportionate resources to running an FCPA compliance program that fully vets all distributors.

I think the answer to this question is “no,” and that there is a practical way to minimize the FCPA risk associated with a global distributor network without devoting an unreasonable and disproportionate amount of resources to compliance.  The key, in my view, is to employ a risk-based approach to distributor compliance, focusing on those relationships that pose the greatest FCPA risk.  The U.S. government has endorsed the use of a risk-based approach to FCPA compliance – and the agencies emphasized this point in the recent FCPA Resource Guide — and I see no reason why those principles should not apply equally in this context.

The first step in a risk-based approach is to identify those parts of the distribution network that pose the greatest FCPA risk.  Companies should look at the countries of operation, including their respective reputations for corruption, the end-user base (are there government contacts or state-owned enterprise customers?), the level of government regulation and the amount of interaction with the government, the industry, and other factors that would help assess FCPA risk generally.  Those parts of the world and parts of the company’s operation that pose the greatest risk should get the greatest attention.  Distributors in Norway who sell to private commercial customers will require less scrutiny than those in India who bid on government contracts.

But companies following a risk-based approach should take this risk analysis a step further and focus on the nature of their relationships with their distributors.  The goal should be to determine which distributors are the most likely to qualify as agents, for whose acts the company is likely to be held responsible.  Think about this as a continuum of risk.  On the low-risk end are distributors that are nothing more than re-sellers with little actual affiliation with the supplier company.  On the high-risk end are distributors who are very closely tied to the supplier company, who effectively represent the company in the market and end up looking more like a quasi-subsidiary than a customer.

In order to determine where a distributor falls on this continuum of risk basic principles of agency law are instructive.    The Restatement (Third) of Agency defines agency as “the fiduciary relationship that arises when one person (a ‘principal’) manifests assent to another person (an ‘agent’) that the agent shall act on the principal’s behalf and subject to the principal’s control, and the agent manifests assent or otherwise consents so to act.”  It is this relationship that gives rise to potential FCPA liability for the actions of distributors.

As with liability for a principal in any agency relationship, whether a distributor qualifies as an agent for FCPA purposes should turn on the amount of control a principal exerts over the distributor and whether the distributor is seen to be acting under the authority of the principal.  Factors to consider include:

• The volume of sales made to the distributor;

• The percentage of total sales of the distributor’s total business the principal’s product represents;

• Whether the distributor represents the principal in the market, including whether it can (and does) use the company trademarks and logos in its business; and

• Whether the principal company is involved in the running of the distributor’s business (such as by training the distributor’s sales agents, imposing performance goals and objectives, or providing reimbursement for sales activity).

Once a company segregates out the high-risk distributors that likely qualify as agents and potentially subject the company to FCPA liability from those that are mere resellers and pose less FCPA risk, FCPA compliance procedures can be tailored appropriately.  For those distributors that qualify as “agents” and also pose FCPA risk, full FCPA due diligence, certifications, training and contract language are imperative.  For those that do not, more limited compliance measures that reflect the risk-adjusted potential liability are perfectly appropriate.