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. Here, I provide my
suggestions on how to risk rank and the manage distributors. In related posts, David will contribute his thoughts on a different approach and Bill will lay out his ideas on the topic. In an upcoming post, 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.
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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.
Visit the FCPA Compliance and Ethics Blog,
hosted by Thomas Fox, for more commentary on FCPA compliance, indemnities and
other forms of risk management for a worldwide energy practice, tax issues
faced by multi-national US companies, insurance coverage issues and protection
of trade secrets.
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© Thomas R. Fox, 2013
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