Yesterday I began a (now) three-part series on the Foreign Corrupt Practices Act (FCPA) enforcement actions involving PTC Inc. (PTC), Parametric Technology (Shanghai) Software Co. Ltd. and Parametric Technology (Hong Kong) Limited. PTC was previously known as Parametric Technology Corporation, and the two other companies were wholly owned subsidiaries (collectively PTC-China).
Today I want to consider some of the lessons to be learned from these enforcement actions. The Chinese subsidiaries settled with the Department of Justice (DOJ) via a Non-Prosecution Agreement (NPA) and PTC settled with the Securities and Exchange Commission (SEC) via an agreed Cease and Desist Order (Order), through a SEC Administrative Proceeding. These two settlement mechanisms mean there was no judicial involvement as nothing was filed in federal court.
Funding the Bribery Schemes
The bribery schemes utilized by the Chinese subsidiaries provide some excellent lessons for any compliance practitioner. The foremost thing to understand is that any bribery scheme is fraud and that means the perpetrators are going to try and hide it. No current bribery scheme is done in the open, even if top management is in on the act, as with Jack Stanley at KBR in the Nigerian bribery scheme. Someone, somewhere is going to try and hide what he or she is doing. That is why there are three parts to any best practices compliance program: prevent, detect and remediate. Just as the employees out in the field have a legal obligation not to violate the FCPA, a corporation sitting back home in America has the obligation to work to detect any bribery its employees might be engaging in.
The Chinese subsidiaries used at least three separate schemes to finance the bribe payments. The first was through an inflated commission scheme where the commission rate for their third party business partners, who facilitated the transactions, was between 15% to 30%. The problem was that the commission rate was not fixed until at or near the time the transaction was completed. Although PTC-China reported up the chain to the US parent, there was nothing in the record that would suggest PTC did anything other than approve the commission rate.
A second bribe funding mechanism was through fraudulent billing of third party business partners. Here the scheme was more sophisticated as the Chinese state-owned entity representative would sign off that the third party business partner had delivered certain services and then the PTC-China would make payment to these corrupt third party business partners. Of course there was no independent verification these services were actually delivered by the third party business representative.
Finally, abandoning all pretense of a valid transaction, PTC-China moved to a model called “Completely Outsourced Deals or CODs” where the monies used to pay bribes or later the illegal gifts, travel and entertainment were disguised as COD expenses related to success fees or subcontracting payment for business partners. It was through the use of these CODs that PTC-China was able to bury the $1MM+ they spent on gifts, travel and entertainment.
The inflated commission or “success fee” paid to third party business representatives coupled with the fraudulent accounting scheme, exemplified by the CODs, were then used to fund the illegal gifts, travel and entertainment. As was stated in the NPA, “If the business partner was to provide subcontracted services such as information technology services, those services might either be included in the total commission or itemized separately using a line item”; both mechanisms were used to fund and pay bribes.
Gifts, Travel and Entertainment Under the FCPA
Bribing Chinese government officials and representatives of state-owned enterprises is a well known bribery scheme. The number of cases prosecuted for such actions is long in both time and the number of companies. The problem is that payment for such travel, lodging and expenses may run afoul of the prohibition against corrupt payments (or promises of them) made to obtain or retain business. The FCPA allows payments to foreign officials for expenses related directly to “the promotion, demonstration, or explanation of products or services” that are “reasonable and bona fide” 15 U.S.C. §§ 78dd-1(c)(2)(A) and 78dd-2(c)(2)(A).
This affirmative defense, however, is notoriously hard to use because the travel and entertainment must be both reasonable and bona fide. Whatever you might think those two terms might mean; they cannot be defined as sightseeing tours across the US. In the NPA it specified, “Generally, the trips included one or two days of business activities at PTC headquarters in order to justify the trips, proceeded or followed by several days of sightseeing that lacked any business purpose and that was in fact the primary reason for the trip.”
There were a wide variety of illegal gifts provided by PTC-China as well. Gift giving is well known in China and certainly appropriate in some circumstances. Indeed PTC seemed to appreciate this as it had written policies and procedures requiring the following: “$50 monetary limits on the provision of gifts and business entertainment to government officials; requiring PTC-China sales staff to obtain preapprovals for business expenses over $500; and requiring that PTC-China sales staff document the date, place, attendees, and purpose of business entertainment and the recipient.” The problem, as noted in the SEC Order, was “These gifts were improperly recorded as legitimate business expenses.”
Tomorrow, I will review the accounting records violations, including both the internal controls and the books and records failures. I will also have some thoughts on the internal investigation and your conduct with the DOJ after you have self-disclosed a potential FCPA violation. Finally, I will consider the Deferred Prosecution Agreement (DPA) the SEC executed with former PTC-China employee, Yu Kai Yuan, in conjunction with settlement.
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