Earlier this week, Jim McGrath, writing in his Internal Investigations Blog, posted a blog entitled “Human Trafficking Concerns for 7-Eleven in Wake of Payroll Scam”. In this post McGrath reviewed the seizure of “fourteen 7-Eleven stores on Long Island and in Virginia while arresting nine owners and managers and seizing property – including five homes – after one of the largest criminal immigrant employment investigations ever conducted by the Justice and Homeland Security Departments.” He also reported that there is an ongoing investigation of “40 other 7-Eleven franchises in New York City.”
The allegations of human trafficking are bad enough. McGrath wrote that “the defendants found more than 50 illegal immigrants and gave them identities stolen from American citizens, including children and dead people. These employees then worked for as much as 100 hours a week, but were paid for a fraction of that time, and were forced to live in substandard housing owned by the operators of the convenience stores.” He also noted that while the stores may have been owned by franchisees, the parent company was also involved because it not only failed to detect the scheme but “processed the payroll and sent the wages to the employers for distribution.” I would also suspect the part of the franchisees’ fee back to the franchisor was based upon revenues so any reduction in cost could also inure back up the chain.
McGrath’s article got me to thinking about franchisor liability under the Foreign Corrupt Practices Act (FCPA). It has been a successful model in the US and now many corporations are looking at overseas expansion opportunities. Franchise law has become well developed across the US, with many states developing laws to protect the rights and obligations of both parties in a franchise agreement. According to an International Franchise Association survey of nearly 1,600 franchise systems in 2008 stated “nearly two-thirds (61 percent) of respondents currently franchise or operate in non-U.S. markets and three-fourths (74 percent) plan to begin international expansion efforts or accelerate their current ventures immediately.”
There are no reported FCPA enforcement actions regarding franchisors. However, the factors in a franchise relationship would appear to lead to clear FCPA responsibility of the franchisor for its overseas franchisee’s actions. Additionally, court interpretation of the FCPA has held that it is applicable where conduct, violative of the Act, is used “to obtain or retain business or secure an improper business advantage” which can cover almost any kind of advantage, including indirect monetary advantage even as nebulous as reputational advantage. As almost everyone knows, the FCPA prohibits payments to foreign officials to obtain or retain business or secure an improper business advantage. Nevertheless many US companies view franchisees as different from other types of more direct sales representatives, such as company sales representatives, agents, resellers or even joint venture partners, for the purposes of FCPA liability.
I believe that such an analysis is misguided as the Department of Justice (DOJ) takes the position that a US company’s FCPA responsibilities extend to the conduct of a wide range of third parties, including the aforementioned company sales representatives, agents, resellers, joint venture partners and distributors. It does not take too great a leap of imagination to see that a franchise relationship could be contained within this interpretation. It does not take too many legal steps to see that a franchisee’s actions can impute FCPA liability to a US franchisor.
There are other factors, unique to the franchise relationship, which would point towards FCPA liability of the US franchisor. A US franchisor’s intent and the degree of control it exercises over its overseas franchisees’ operations are factors the DOJ/Securities and Exchange Commission (SEC) might consider in determining whether to pursue an FCPA case against a franchisor for bribes made by one of its foreign franchisees. It is always in the financial interest of a US franchisor for its franchisees to be successful businesses. Additionally, most US franchisors require its overseas franchisee’s to use the same company name for branding. Of course, not only the initial franchise fee but the franchisee’s monthly royalty payment roll up into the books and records of a franchisor so that might well catch the attention of the SEC if there is a FCPA books and records violation.
Victor Vital and Jessica Parker-Battle, writing in the Franchise Law Journal, Winter 2012 Issue, in an article entitled “Implications of the Foreign Corrupt Practices Act for International Franchising”, believe that a franchisor may not have direct involvement in conduct prohibited by the FCPA, there may not be the requisite corrupt intent required under the statute. However, I believe unless a franchisor has an adequate compliance program in place, a franchisor may well find itself in the shoes of Frederick Bourke and sustain a finding of conscious indifference.
How would all of this play out for a franchisor? As a franchisor moves into foreign markets there could well be the temptation to “grease the skids” and make payments or offer gifts to government officials, or their family members, to get the permits or permissions necessary to open and operate. In many countries, bribery is a common way of getting business done, and there can be tremendous pressure from local agents or franchisee candidates to follow regional customs and use bribes to become or remain competitive. Even if it is not the US franchisor’s own employees which engage in the FCPA violations, the US franchisor will still face the risk of an enforcement action if the franchisee’s employees engage in such conduct.
Most franchisors have thorough financial vetting requirements before allowing any person or business to become a franchisee. However, how many of these same businesses perform FCPA compliance due diligence on their prospective overseas franchises? How many US franchisors have FCPA compliance training programs? How many evaluate, on an ongoing basis, the FCPA compliance and program of their overseas franchisees? How many US franchisors have a compliance hotline or other reporting mechanism for any compliance violations made against their franchisees?
Vital and Parker-Battle suggest that franchisors conduct thorough research in both the foreign market they hope to enter and on their potential franchisees. The franchise agreement itself should have strong FCPA anti-corruption/anti-bribery language and any franchisee, and its key employees, should receive FCPA training. The franchisor also needs to have a compliance subject matter expert (SME) available for franchisees and they also suggest that the franchisor provide an anonymous reporting hotline for FCPA violations. They end some of their suggested practices for the franchisor with the following, “it would be prudent to pay particular attention and monitor those countries in areas where bribery or gifts are encouraged in business relations. In sum, franchisors must be diligent when entering a foreign market and make sure to use best practices routinely and consistently.”
This last point, about ongoing monitoring, ties into McGrath’s article on the problems which 7-Eleven may now face. It would appear that the franchisor/parent corporation did no ongoing monitoring of its franchisees on the employment status of the franchisees’ employees. One thing that the FCPA Guidance makes clear is that statements and hypothesis must be tested by reviewing the underlying data or transaction. As a compliance practitioner, you cannot take things at face value. Further, as the FCPA Guidance also made clear, everything starts with a risk assessment. So if you are a US franchisor, looking to expand overseas, one of the first things you should do is to perform a FCPA risk assessment and then use that risk assessment to implement a full FCPA compliance program within your company going forward. If you are a US franchisor which has international franchises but you have not previously reviewed your FCPA requirements, you should do so as soon as possible. If not, your FCPA exposure may be unlimited….