These are all important questions and, if not properly considered, could result in the failure of the business venture and a wasted opportunity. However, some of the issues that are not always at the forefront of the minds of decision makers are exactly with whom the company will be doing business and what they will be doing on your behalf. These are important considerations that introduce another and broad element of risk.
When expanding into different markets, determining companies and individuals to do business with is one of the most critical decisions an organization will make. These relationships often carry measurable financial and immeasurable business and reputational risks. Without sufficient and appropriate due diligence into these relationships, a company may unwittingly be exposed to a variety of potential risks. They may include, for example, money laundering, fraud, bribery and corruption, organized crime, industrial espionage and terrorism. Exposure to these types of risks can result in significant business loss as well as adverse media coverage, damaged reputation, regulatory sanctions and criminal liability.
In particular, international anti-bribery and corruption laws, such as the US Foreign Corrupt Practices Act (FCPA) and the new UK Bribery Act 2010 (Bribery Act) and Canada’s own Corruption of Foreign Public Officials Act (CFPOA), have been receiving increased attention lately. A key element to ensuring compliance with these regulations is understanding who you are doing business with and whether they may be considered a foreign public official 1or have any other relationships that may put your organization at risk. An easy way to reduce the risk of non-compliance with these regulations as well as manage the risks discussed above is a robust integrity due diligence program.
The Ministry of Justice in the UK released a document in September 2010 that outlines six principles to be considered when developing procedures for bribery prevention.2 Principle 3 speaks to due diligence: “The commercial organization has due diligence policies and procedures which cover all parties to a business relationship, including the organization’s supply chain, agents and intermediaries, all forms of joint venture and similar relationships and all markets in which the commercial organization does business.” This guidance is fairly broad. As discussed below, the extent of required due diligence will most likely be determined after certain preliminary information is pulled together. The extent of the research and review for each potential business partner may well differ. The goal is to obtain sufficient information to ensure that the relationship being established is transparent and the company is comfortable being associated with the prospective agent or partner and having them act, in some way, on the company’s behalf.
Another source for guidance is the Organisation for Economic Co-Operation and Development’s (OECD’s) publication entitled Good Practice Guidance on Internal Controls, Ethics and Compliance, which has various suggestions on procedures that could be implemented to prevent bribery, including: “Appropriate due diligence procedures for all agents and business partners.” We would caution, however, that while the risk of bribery and potential violations of the FCPA, the Bribery Act and the CFPOA are a prominent concern, there are many risks involved in doing business in a foreign jurisdiction and the level of due diligence should be carefully tailored to the risks and the proposed relationship.
Thirty eight countries around the world have adopted the OECD’s convention on anti-bribery and corruption. Local implementation of the convention, such as Canada’s CFPOA, the US FCPA and, more recently, the UK’s Bribery Act, make bribery and corruption a criminal offence. The application of these laws has a significant impact for global organizations, including extraterritorial jurisdiction in some circumstances. For example, investigations under the FCPA have resulted in multi-million dollar fines and penalties for organizations involved in improper activities outside of the US; individuals involved in bribery schemes have faced extradition, prosecution and imprisonment.
The FCPA applies not only to all US companies and individuals who are US citizens, nationals or residents of the US, but also to the following:
- Any corporation with securities registered in the US or that is required to file with the Securities and Exchange Commission
- Any officer, director, employee or agent of such company
- Foreign companies or persons that cause an act in furtherance of a corrupt payment to take place in the US.
In addition to prohibiting bribery, the FCPA requires foreign companies listed on US stock exchanges to maintain accurate books and records and to devise and maintain an adequate system of internal accounting controls so that bribes cannot be concealed or disguised.
The Bribery Act is possibly even further reaching than the FCPA; it applies to international individuals and organizations that carry on “a business, or part of a business, in any part of the United Kingdom,” which is potentially very broad. The Bribery Act extends to bribery in the private (not just public) sector, it criminalizes failure to prevent bribery and provides for no exceptions for “facilitation payments.” The primary defence for organizations is to demonstrate that they have adequate procedures in place to prevent bribery. Any company conducting business in the UK should have a robust compliance program in place in order to comply with the legislation.
Let’s look at an example: a company has decided to expand to Asia and wishes to open a manufacturing plant to service the Asian market. Management has evaluated the business relationships they require and have decided they need the following in their new market:
- A vice president of marketing for sales to the Asian market
- A sales team for the Asian market
- Importers and distributors to serve the various countries
- Local buyers to purchase the raw materials needed
- Suppliers for the various materials needed.
The questions now are: does management know the risks specific to the jurisdiction and industry, who does management select as employees and business partners for these roles, and how does management know the new team selected is going to represent the business in the manner intended by the Canadian head office? Management may already have some awareness that bribery, corruption and other unacceptable behaviour exists in this new market, but what are the unique country risks and how do they choose a sales force, distributors and senior management who are less likely to exhibit such behaviour in the name of the company?
Unfortunately, ignorance is an inadequate defence and is likely insufficient under the FCPA, Bribery Act or CFPOA. Failing to perform an appropriate level of due diligence on individuals and companies puts the company at significant risk. The behaviour and local practices of agents and other local business partners acting on behalf of the company can become the responsibility of the company as a whole. Bribes and other forms of corruption or misconduct, whether known or not by senior management, will often impact the company in a number of ways. The existence of a robust compliance program that includes due diligence procedures on new markets, employees and business partners is integral to defending any allegations should that undesirable situation arise.
One strategy is to carefully look into these potential employees and business partners by conducting background checks. For companies or individuals located in areas of the developed world, there can be a variety of information available on the internet. While this is a simple approach to getting a sense of who you are dealing with and may be sufficient in some circumstances, the challenge is knowing where to look and what to believe. External providers who routinely undertake such checks should know where to look and will have access to an array of sources, including subscription-based searches. With a little help, it is not difficult in some jurisdictions to gather enough baseline information through these and other approaches to make an informed decision as to whether or not a company wants to establish a business relationship with a third party. In establishing some relationships, a more proactive and detailed approach will be warranted and worth some incremental investment of time and resources.
For countries, companies or individuals located in the developing world, such as India, China and Russia or those in the Middle East, the process of due diligence isn’t as easy. Electronic databases are not as sophisticated, well populated or recent. In some countries, the government maintains control and influences these databases, rendering them inaccessible and sometimes less useful. The electronic information available can be much narrower and more time and patience is necessary to collect the information needed to make informed decisions. However, a capable external provider with international capabilities will have a network of sources they can use to get information. Often, this can include human source intelligence that can provide a unique perspective.
The level of due diligence conducted should be consistent with the level of risk to be managed. Agents often present a higher risk to an organization than, for example, employees working in a more controlled corporate environment or who are more in a junior administrative or operational role where there is less direct interaction with customers and suppliers.These two very different risk profiles warrant two different due diligence plans.
For the employee, the concern may be how they conduct themselves in a work environment. For example, is there an indication they have a history of questionable actions or do not have the qualifications they claim to have? For a lower level employee, a criminal and civil litigation check, a credit check and education and prior employment confirmations may provide the company with what is needed to make a suitable hiring decision.
For the prospective agent, the conduct that is of greatest concern is how this company or individual may act using the name of the company when nobody is watching. Agents often operate in an uncontrolled environment and their manner of doing business will be important to the success of the new operation. They often operate beyond the influence and impact of a company’s internal procedures, controls, compliance programs and direct supervision. Most agents and partners also control their record keeping and bank accounts, making knowledge and monitoring of their activities much more difficult.
In either situation, leveraging the experience and network of a capable professional services firm with knowledge of these matters can be valuable.
So how does a company collect enough information to allow it to assess the various risk profiles it is facing, particularly in jurisdictions that present more complex and difficult compliance and legal challenges than in North America? In the case of the “lower” risk subjects, phone calls and database searches, to the extent available, may provide a suitable level of information. With respect to an external agent or partner, the solution is to perform a more in-depth review that includes database searches as well as local on-the-ground searches and inquiries by individuals who know the information environment and the privacy rules that apply in a particular country. In-depth searches cannot be done from the other side of the world.
Guidance from the UK Ministry of Justice with respect to managing bribery risks suggests that there should be attempts to determine if the potential business partners or anyone they are affiliated with has a reputation for bribery, whether it is in the form of an allegation, investigation or conviction.
It is important to determine whether there is any association with the prospective agent or partner, personally or through business relationships with any “politically exposed persons.”3 Sometimes the mere existence of the opportunity is a red flag.
Practical questions should be asked: How does the company and/or individual carry on their business? How are they viewed in the public domain? Why does your subject have an exceptional level of success in an extremely competitive environment? The alignment of these questions to the information obtained will help to paint a picture of the prospective agent’s or partner’s reputation. It is this reputation that will need to be evaluated, because once the relationship with your company begins, their reputation becomes your reputation.
In many jurisdictions, it may be necessary to engage a network of sources and conduct informal discussions to gain an understanding of the subject. This can be vital to providing relevant and valuable information. However, a word of caution: sometimes who a company hires to perform its background search is as important as the agent, partner or company that is being searched. Capable external providers with international reach will have access to on-the-ground contacts in these countries. However, there are many unethical and sometimes illegal ways to gain information, particularly in nations with a reputation for corruption. Management should understand the method by which the contracted company will be gaining their information and that these risks are managed by stipulating the parameters of the work in writing.
It is important to understand that the due diligence process may also bring to light negative information. This does not necessarily mean that there should be no interaction with that entity, but rather that the organization should somehow eliminate its risk or at least put in place appropriate mitigating controls to reduce it to an acceptable level.
The exercise of conducting due diligence is by its very nature a judgmental process and it is impossible to know everything one would ideally like to know. However, companies can substantially reduce their risks by undertaking proper background checks that are commensurate with the risk presented by the prospective employee or business partner. The key is to consider up front what kind of information will be relevant and focus the searches on gaining as much information in those areas as possible.
1 As discussed in the article, this consideration is not relevant for the Bribery Act.
2 “Consultation on guidance about commercial organizations preventing bribery”, Ministry of Justice Consultation Paper CP11/10, September 14, 2010.
3 Politically Exposed Persons are defined as “individuals who are or have been entrusted with prominent public functions in a foreign country, for example Heads of State or of government, senior politicians, senior government, judicial or military officials, senior executives of state owned corporations, important political party officials… The definition is not intended to cover middle ranking or more junior individuals in the foregoing categories.” (Glossary on the Financial Action Task Force website accessed on March 14, 2011).
Stuart Horn is a Vice President of KPMG Forensic. He is a Chartered Accountant and Chartered Business Valuator. Stuart has performed numerous investigations over the past 7 years that have spanned across borders, from employee and management frauds to multimillion dollar misappropriation of assets. Stuart is the former Head of KPMG’s Corporate Intelligence practice in Canada, and has led integrity due diligence assignments on individuals and companies within North America and countries across the globe, including China, India, Russia and Saudi Arabia.
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