The IBM Case: FCPA Compliance Programs And Internal Controls

There was Congressional testimony last fall to consider possible modifications to the Foreign Corrupt Practices Act. In part the testimony focused on the issue of FCPA compliance procedures as a defense for a business organization. Under current practice those procedures are not a defense but mitigation. In contrast, under the new UK Bribery Act compliance procedures can be a defense. Precisely what will be required is yet to be decided however.

The SEC's recent action against International Business Machine or IBM highlights the relation between FCPA compliance procedures and internal controls. In its complaint the SEC notes that the company has anti-bribery and FCPA procedures. IBM's internal controls however were inadequate, according to the SEC. This resulted in violations. Improper payments were made to South Korean officials, Improper travel and entertainment was paid for Chinese officials. All the payments were by subsidiaries for which IBM was held responsible. SEC v. IBM, Case No. 1;11-cv-00563 (D.D.C. Filed March 18, 2011).

The complaint centers on the activities of IBM-Korea, LG-IBM and IBM-China and payments made to employees at South Korean government entities and Chinese government officials to obtain or retain business. IBM-Korea is a wholly owned indirect subsidiary of IBM International Group B.V. which is owned by IBM. LG-IBM is a joint venture between IBM-Korea and LG Electronics, Inc. which is 51% owned by the IBM subsidiary. IBM-China is owned by IBM/Hong Kong which is ultimately owned by IBM. The actions detailed in the complaint involve only these subsidiaries, not IBM.

In Korea the violations are based on the alleged improper payments by either IBM-Korea or LG-IBM. The complaint states that from 1998 through 2002 these two subsidiaries made improper payments to South Korean government officials who worked for sixteen government entities. IBM-Korea is alleged to have made payments over the four year period totaling $135,558 while LG-IBM's payments totaled $71,599.

Typical of these allegations are the ones made regarding SKGE -1 or South Korean Government Enterprise No. 1. According to the complaint, in mid-December 1998 officials from IBM-Korea met with representatives of SKGE-1. At the meeting IBM-Korea "gave him [SKGE-1] a shopping bag containing a large IBM-Korea envelope filled with KRW 20 million ($19,093)." This happened repeatedly during the time period.

The summary section of the complaint states that IBM had "corporate policies prohibiting bribery and procedures relating to compliance with the FCPA; however, deficient internal controls allowed employees of IBM's subsidiaries and joint venture to use local business partners and travel agencies as conduits for bribes or other improper payments to South Korean and Chinese government officials over long periods of time." The complaint does not provide any detail or specify how the internal controls were deficient with respect to the claimed improper payments in Korea.

The conduct alleged in China differs. There the SEC complaint states that from 2004 through 2009 IBM-China employees created slush funds at local travel agencies in China. Those funds were used to pay for overseas and other travel expenses incurred by government officials. The complaint goes on to specify that in at least 114 instances the internal controls of the company failed to detect improper payments. This occurred because: "(1) IBM-China employees and its local travel agency worked together to create fake invoices . . . (2) trips were not connected to any DTRs [Delegation Trip Requests]; (3) trips involved unapproved sightseeing itineraries . . . (4) trips had little or no business content; (5) trips involved one or more deviations from the approved . . [itinerary]; and (6) trips where per diem payments and gifts were provided to Chinese government officials."

To resolve the case IBM consented to the entry of a permanent injunction prohibiting future violations of the books and records and internal control provisions of the FCPA, Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). The company also agreed to pay disgorgement of $5.3 million along with prejudgment interest and a $2 million civil penalty. There is no indication in the papers as to how the disgorgement or penalty were calculated. There is no reference to cooperation by the company.

For more cutting edge commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.

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