What Enforcement Actions Based On Distributor Conduct Teach About Improving FCPA Compliance Programs

by Thomas Fox
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Ed. Note-today we have a guest post by our colleague, William C. Athanas, a partner in the law firm of Waller Lansden Dortch & Davis, LLP. In the prior two posts, David Simon and myself posited different approaches to analyzing the risks that distributors present under the FCPA. In this post, Bill suggests an approach for managing the risks that distributors present under the FCPA. 

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In a recent post, Distributors Under the FCPA, Tom Fox detailed three enforcement actions filed in 2012 which show that the actions of distributors can create FCPA liability for the companies that hire them.  The Smith & Nephew, Oracle and Lilly actions summarized in Tom’s post demonstrate the continuing viability of distributor conduct as the basis for FCPA enforcement actions by aligning with previous cases (such as GE InVision and AGA Medical) also grounded on that theory.  Together, those cases make plain that the government perceives no distinction between distributors and any other kind of intermediary used as a conduit for bribe payments.  Tom’s post offers a useful jumping-off point an equally significant and far less apparent lesson:  just because distributors’ actions can give rise to FCPA exposure does not mean that companies are best served by relying on traditional compliance measures to mitigate the risk they present.

FCPA exposure arises when companies pay money – either directly or indirectly – to fund bribe payments.  In the traditional intermediary scenario, the company funnels money to the agent or consultant, who then passes on some or all of it to the bribe recipient.  Often, the payment is disguised as compensation to the intermediary, and some portion is redirected for corrupt purposes.

But distributors are an atypical intermediary, at least where compensation is concerned.  Unlike the standard intermediary relationship, companies generally do not transfer funds to distributors as payment for services rendered.  Rather, as Fox explained in a prior post, What’s in a Name: Agents, Resellers and Distributors under the FCPA, distributors make money by buying goods for one price and selling them for a higher amount.  As a result, the greater the discount provided to the distributor, the more money available to pay bribes.

When companies grant distributors uncommonly steep discounts, bribes can result either: 1) because the distributor is instructed by the company to use the excess amounts to fund corrupt payments; or 2) because the distributor pays bribes on its own, without the express direction or implicit suggestion from the company to do so, in an effort to gain some business advantage.  (Note on this issue the reference in the Resource Guide to the U.S. Foreign Corrupt Practices Act  recently released by the DOJ and SEC, which notes that common red flags associated with third parties include “unreasonably large discounts to third-party distributors”).  The distributor enforcement cases offer lessons to combat the second scenario, which is where legitimate companies require assistance.

Assuming that the company’s desire is not to use its distributors as a conduit for paying bribes, how can it manage the FCPA risk that distributors present?  By installing a distributor discount policy and monitoring system tailored to the company’s operational structure.  In virtually every business, there exists a range of standard discounts granted to distributors.  Under the approach recommended here, discounts within that range may be granted without the need for further investigation, explanation or authorization (absent, of course, some glaring evidence that the distributor intends use even the standard cost/price delta to fund corrupt payments).

Where the distributor requests a discount above the standard range, however, the policy should require a legitimate justification.  Evaluating and endorsing that justification requires three steps:  (1) relevant information about the contemplated elevated discount must be captured and memorialized; (2) requests for elevated discounts should be evaluated in a streamlined fashion, with tiered levels of approval (higher discounts require higher ranking official approval); and (3) elevated discounts are then tracked, along with their requests and authorizations, in order to facilitate auditing, testing and benchmarking.  The basics concepts underlying each step are discussed below.

1.         Capturing and Memorializing Discount Authorization Requests

Through whatever means are most efficient, a discount authorization request (“DAR”) template should be prepared.  While remaining mindful of the need to strike a balance between the creation of unnecessary red tape and the need to mitigate risk, the DAR template should be designed to capture the particulars of a given request and allow for an informed decision about whether it should be granted.  Because the specifics of a particular DAR are critical to evaluating its legitimacy, it is expected that the employee submitting the DAR will provide details about how the request originated (e.g., whether as a request from the distributor or a contemplated offer by the company) as well as explain the legitimate justification for the elevated discount (e.g, volume-based incentive).  In addition, the DAR template should be designed so as to identify gaps in compliance that may otherwise go undetected (e.g., confirmation that the distributor has executed a certification of FCPA compliance).

2.         Evaluation and Authorization of DARs

Channels should be created to evaluate DARs submitted.  The precise structure of that system will depend on several factors, but ideally the goal should be to allow for tiered levels of approval.  Usually, three levels of approval are sufficient, but this can expanded or contracted as necessary.  Ultimately, the greater the discount contemplated, the more scrutiny the DAR should receive.  Factors to be considered in constructing the approval framework include the expected volume of DARs and the current organizational structure.  The goal is to ensure that all DARs are vetted in an appropriately thorough fashion without negatively impacting the company’s ability to function efficiently.

3.         Tracking of DARs

Once the information gathering, review and approval processes are formulated, there must be a system in place to track, record and evaluate information relating to DARs, both approved and denied.  This captured data can provide invaluable insight into FCPA compliance and beyond.  By tracking the total number of DARs, companies will find themselves better able to determine where and why discounts are increasing, whether the standard discount range should be raised or lowered, and gauge the level of commitment to FCPA compliance within the company (e.g., confirming the existence of a completed and approved DAR is an excellent objective measure for internal audit to perform as part of its evaluation of the company’s FCPA compliance measures).  This information, in turn, leaves these companies better equipped to respond to government inquiries down the road.

Rethinking approaches to evaluating distributor activities is but one of the ways that the increased number of enforcement actions and FCPA Guidance have provided insight into how the government interprets and enforces the FCPA.  This information, in turn, allows companies to get smarter about FCPA compliance.  With a manageable amount of forethought, companies who rely on distributors can create, install and maintain systems which allow them to spend fewer resources to more effectively prevent violations.  Moreover, these systems generate tangible proof of a company’s genuine commitment to FCPA compliance, which can be invaluable in responding to a government inquiry.

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Bill Athanas served as a member of the Justice Department’s Fraud Section and later as an Assistant U.S. Attorney in the Northern District of Alabama.  Currently, he is a partner based out of the Birmingham, Alabama office of Waller Lansden Dortch & Davis, LLP.  His practice focuses on white collar criminal defense, including providing FCPA advice and counsel to privately held and publicly traded companies operating in a wide range of industries and geographic regions. He can reached at Bill.Athanas@wallerlaw.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.

© Thomas Fox, Compliance Evangelist | Attorney Advertising

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