Ed. Note-David Simon is a partner at Foley and Lardner and Bill Athanas is a partner at Waller Lansden Dortch & Davis, LLP. Both have practices which include FCPA compliance. After my recent post on distributors under the FCPA, David and I had a dialogue on how distributors should be reviewed and analyzed under the FCPA. Bill also had some thoughts on the subject. I asked them if they would contribute guest posts with their ideas.
As this is the first time that I have had a dialogue with two other FCPA practitioners based on a post, this week we will have 3 days of discussion and dialogue on distributors. Today, I provide my suggestions on how to risk rank and the manage distributors. Tomorrow, Daivd will contribute his thoughts on a different approach. On Wednesday, Bill will lay out his ideas on the topic. Finally on Thursday I will try to wrap up and weave together our three articles. I hope that you will find this series instructive and useful. I know I certainly have in my dialogues with these two other excellent FCPA compliance practitioners.
In today’s post, I advocate that distributors should be treated as any other third party representative in the sales chain; IE., agents and resellers.
In 2012, there were three enforcement actions which I believe made clear that there were no distinctions between agents and distributors. They were, the Smith & Nephew, Inc., (S&N) Deferred Prosecution Agreement (DPA) for criminal FCPA violations, the Oracle SEC Complaint for books and records violations and the Eli Lilly and Company (Lilly) SEC Compliant for books and records violations.
These enforcement actions involved three separate bribery schemes which I believe call for three different but overlapping responses. In the case with Lilly, the SEC Complaint noted the following “Lilly-Brazil’s pricing committee approved the discounts without further inquiry. The policies and procedures in place to flag unusual distributor discounts were deficient.” Lastly, as stated by Matt Ellis, the enforcement action “noted that the company relied on representations of the sales and marketing manager without adequate verification and analysis of the surrounding circumstances of the transactions.”
The Lilly enforcement action also makes clear the need for internal audit to follow up with ongoing monitoring and auditing. Internal audit can be used to help determine the reasonableness of a commission rate outside the accepted corporate norm. As stated by Jon Rydberg, of Orchid Advisors, in an article entitled “Eli Lilly’s Remedial Efforts for FCPA Compliance – After the Fact”, the company should be “implementing compliance monitoring and corporate auditing specifically tailored to anti-corruption” for the distributor sales model.
The Oracle enforcement action demonstrates that Oracle needed to institute the proper controls to prevent its employees at Oracle India from creating and misusing the parked funds in the distributor’s account. The Company needed to audit and compare the distributor’s margin against the end user price to ensure excess margins were not being built into the pricing structure. Oracle should have sought to either (1) seek transparency in its dealing with the distributor or (2) audit third party payments made by the distributors on Oracle’s behalf, both of which would have enabled the Company to check that payments were made to appropriate recipients.
What are some of the factors that demonstrate the distributors used by S&N were fraudulent and did not have a legitimate business purpose? It was clear that S&N did not perform sufficient due diligence on these distributors nor did they document any. I would note that the distributor was domiciled in a location separate and apart, the UK, from the sole location it was designed to deliver products or services into, Greece. This clearly demonstrated that the entities were used for a purpose that the company wished to hide from Greek authorities. While it is true that a distributor might sell products into a country different than its domicile, if the products are going into a single country, this should have raised several Red Flags.
However, the biggest indicium of corruption was the amount of the commission paid. The traditional sales model for a distributor has been to purchase a product, take the title, and therefore the risk, and then sell it to an end user. Based upon this sales model, there has been a commission structure more generous than those usually accorded a reseller or sales agent, who is usually only a negotiator between the Original Equipment Manufacturer (OEM) and the end user. This difference in taking title, and risk of loss, have led to a cost structure which has provided a deeper discount of pricing for distributors than commission rates paid to resellers or sales agents. The sales structure used by S&N had pricing discounts of between 26-40% off the list price. Further, this money was used precisely to pay bribes to Greek Doctors to use S&N products.
These three enforcement actions make clear that distributors will be treated like any other representative in the sales chain. This means that distributors need to go through the same rigorous due diligence and review, contracts and management going forward as agents or resellers.