Crude Allegations: Corruption in the Energy Trading Sector

by King & Spalding
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The world-wide energy trading sector, where traders match physical supply and demand of energy by purchasing, reselling, and moving commodities (crude oil and refined products, natural gas, coal, and even electricity) across the globe, is a high-risk area for corruption. Corruption in the industry can take various forms, from bribery of public officials to energy market manipulation. This state of affairs is attributable to many factors, among them the financial magnitude and complexity of most trades, the steady rise in oil prices over the past decade, and the inherent challenges posed by operating in jurisdictions with varying degrees of law and order. As trading companies have emerged from relative obscurity to become formidable players in global energy markets, a series of high-profile allegations of corruption involving energy traders has led to increased awareness of potential misconduct in the energy sector by both global financial regulators and parties engaged in international arbitration proceedings.

The controversy surrounding the United Nations' Oil-For-Food Program in Iraq is a vivid illustration of the corruption pitfalls associated with energy trading activities. The Oil-For-Food Program provided a mechanism for Iraq to sell oil on the world market in exchange for food, medicine, and other humanitarian needs for Iraqi citizens following the imposition of international economic sanctions in the wake of the first Gulf War. As the program wound down in 2003, corruption allegations surfaced in connection with energy traders indirectly paying an estimated USD$1.8 billion in kickbacks to agents of the Iraqi regime in exchange for oil contracts. The subsequent investigation into the program—"conceivably the largest international anti-corruption investigation ever"—involved thousands of companies worldwide and implicated titans of the oil and gas industry like Oscar Wyatt. Other more recent examples of corruption allegations in the energy sector abound. On August 15, 2013, Indonesia's anti-corruption agency arrested and charged the head of the country's oil and gas regulatory authority with accepting a USD$700,000 cash bribe from representatives of an oil trading company. [1] In January 2013, Canadian anti-corruption authorities imposed a record fine exceeding CAD$10 million on Griffiths Energy International for paying a CAD$2 million bribe in order to secure lucrative oil contracts in Chad, the largest fine Canadian authorities have secured in a foreign corruption case. [2]

In light of the serious consequences for industry players who fail to identify and address corruption risks, trading companies and individuals must take appropriate steps not only to ensure compliance with the anti-corruption statutes enforced by regulators across the globe, but also become familiar with the specific issues involved in alleging and proving corrupt conduct before an arbitral tribunal. [3]

FCPA Risks

Perhaps the most recognizable anti-corruption statute is the United States' Foreign Corrupt Practices Act (FCPA), which bans bribery of foreign officials and imposes accounting and record-keeping requirements. [4] The FCPA's anti-bribery provisions prohibit payments by corporations and individuals for the purpose of "(i) influencing any act or decision of [a] foreign official in his official capacity, (ii) inducing such foreign official to do or omit any act in violation of the lawful duty of such official, or (iii) securing any improper advantage . . . to obtain or retain business for or with . . . any person." [5] The U.S. Department of Justice and the U.S. Securities and Exchange Commission investigate FCPA cases and often conduct criminal and civil enforcement proceedings in parallel against the same party. The consequences for violations are severe—a corporation faces not only the prospect of multi-million dollar penalties and public reputational damage, but also the immense burden of an internal investigation and likely overhaul of the company's control functions.

While participants in the energy trading sector must be vigilant with respect to many categories of FCPA risk, there are two risk areas that demand particular attention. The first is the broad definition of "foreign official" under the statute. Recent FCPA guidance issued by the U.S. enforcement authorities states that foreign officials include "officers or employees of a department, agency, or instrumentality of a foreign government" and "[w]hether a particular entity constitutes an 'instrumentality' under the FCPA requires a fact-specific analysis of an entity's ownership, control, status, and function." [6] Given this expansive interpretation of "foreign official," industry players must account for the risk that payments to individuals affiliated with state-owned companies that might not seem to U.S. persons or to the people working in the company itself to be "foreign officials" may nonetheless be improper.

The second key FCPA risk area for participants in the energy trading sector is the potential to incur liability for the corrupt conduct of others, including intermediaries and joint venture partners involved in energy transactions. For example, if a party under contract with a trading company engages in conduct that violates the FCPA and the trading company is aware of a high probability of the third party's misconduct, the company may be held directly liable for corrupt payments made by the third party. Actual knowledge of the third party's misconduct is not required; rather, the question is whether the trading company knew, or should have known, about the violations. Accordingly, trading companies must perform a comprehensive, risk-based due diligence assessment of third party partners and the "degree of scrutiny should increase as red flags surface." [7]

Corruption Allegations in Arbitration Proceedings

Apart from regulator inquiries, allegations of corruption have also surfaced in the context of energy sector arbitrations between private parties or investor-State arbitrations. Although the vast majority of energy trading arbitration cases are confidential, some awards involving corruption allegations have become public. Most of these cases relate to the payment of commissions (often by intermediaries) to secure or renew supply contracts at advantageous conditions or to facilitate the clearance or shipment of hydrocarbons. [8]

Since arbitration is a private dispute resolution mechanism, alleging and proving corrupt conduct before an arbitral tribunal raises specific issues. One critical aspect is the onerous burden of proof incumbent on the party alleging that corrupt conduct occurred. Unlike U.S. enforcement agencies probing potential FCPA violations, parties to an arbitration generally lack the power and resources to investigate indicia of corruption in energy trading transactions. At the same time, arbitrators themselves possess limited capabilities to investigate or compel the disclosure of facts underlying corruption allegations. Consequently, procuring evidence to substantiate claims of corruption in international arbitration proceedings can be a Sisyphean task for the party attempting to do so.

In addition, the party alleging bribery or corruption must prove its allegations by clear and convincing evidence. General allegations based on rumors or speculation, or allegations of endemic corruption in a particular area, are insufficient to satisfy this burden of proof. For example, faced with substantial allegations of corruption, the Himpurna Tribunal nonetheless observed that "such grave accusations must be proven. There is in fact no evidence of corruption in this case. Rumours or innuendo will not do." [9] The Himpurna case involved an electricity sale agreement in Indonesia. Similarly, the EDF (Services) Tribunal held that "corruption must be proven and is notoriously difficult to prove since, typically, there is little or no physical evidence. The seriousness of the accusation of corruption in the present case, considering that it involves officials at the highest level of [a national government], demands clear and convincing evidence." [10]

Practitioners recently have proposed changes to address concerns about the difficulty of proving corruption allegations in international arbitration proceedings. One proposal would require a party that denies plausible evidence of corruption to present evidence disproving the allegations. Another proposal would allow arbitral tribunals to rely on reasonable inferences when assessing allegations of corruption. These proposals, if adopted by arbitral tribunals, would significantly enhance the likelihood of successful corruption claims.

Another important issue to consider with respect to corruption claims in arbitration proceedings is the possibility that the allegations will be publicly disclosed. Arbitral tribunals are under an obligation to investigate and rule upon allegations of corruption when parties to an arbitration expressly premise their claims or defenses on such allegations. Arbitral practice suggests that tribunals faced with prima facie evidence of corruption can investigate the issue sua sponte and draw appropriate conclusions without acting outside the scope of their mandate (ultra petita). The arbitrators' general duty to maintain the confidentiality of the arbitral proceedings prohibits them from disclosing suspicion or evidence of corrupt activities by the parties, unless they are subject to specific reporting obligations because of their nationality, residence or activities. However, some practitioners have suggested that arbitrators may disclose corrupt activities even if they are not under a legal obligation to do so, if the public interest or the proper administration of justice requires such disclosure. Although this does not necessarily reflect mainstream arbitral practice, parties to energy trading disputes should be aware of the possibility of such disclosure.

Conclusion

The risk of corruption in the global energy trading sector can create problems for companies in both the regulatory and arbitration contexts. Companies engaged in energy trading can mitigate risks by conducting comprehensive due diligence analyses of entities eligible to receive payments from the company—whether putative foreign officials or third parties. In addition, trading companies should strengthen internal controls in order to monitor outgoing payments and ensure that every payment is properly documented with respect to a specifically designated purpose. Regarding allegations of corruption in international arbitration proceedings, trading companies must familiarize themselves with the burden of proof required for corruption allegations and be mindful of the possibility of public disclosure of such allegations.
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[1] The New York Times, Oil Regulator in Indonesia Arrested in Bribery Investigation, August 14, 2013.
[2] Globe and Mail, In wake of scandal, Griffiths Energy plans IPO in London, February 4, 2013.
[3] Participants in the energy trading sector must be aware of numerous regulatory regimes, including enforcement initiatives related to competition law and trade sanctions. The focus of this short article is anti-bribery.
[4] Trading companies and individuals must also be familiar with the bribery prohibitions contained in the U.K. Bribery Act 2010 and other domestic legislation enacted by OECD member states criminalizing bribery of foreign public officials.
[5] 15 U.S.C. § 78dd-3(a)(1)(A)-(B) (2006).
[6] DOJ and SEC Resource Guide to the U.S. Foreign Corrupt Practices Act, at 20 (Nov. 14, 2012).
[7] DOJ and SEC Resource Guide to the U.S. Foreign Corrupt Practices Act, at 60 (Nov. 14, 2012).
[8] See, for example, ICC Case No. 7664 (1996), ¶ 66; ICC Case No. 4145 (1983, 1984, 1986); Deutsche Schachtbau-und Tiefbohrgesellscaft mbh v Ras Al Khaimah National Oil Company [1987] 2 Lloyd's Rep. 246 at 254. See also, Lemenda Trading Co. Ltd v African Middle East Petroleum Co. Ltd [1988] 1 QB 448.
[9] Himpurna California Energy v. PLN, Final Award May 4, 1999, ¶ 118.
[10] EDF (Services) Limited v. Romania, Award October 8, 2008, ¶ 221.

 Louis-Alexis Bret
 New York
 +1 212 556 2283
 lbret@kslaw.com

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 Kyle Sheahen
 New York
 +1 212 556 2234
 ksheahen@kslaw.com

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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