Why do due diligence? The “knowing” standard of the US Foreign Corrupt Practices Act (FCPA) makes a company equally liable whether an improper payment is made to a “Foreign Official”¹ directly or through a third-party, such as an agent, distributor, reseller, or sub-contractor. To minimize their exposure to potential sanction under anti-bribery and corruption regulations such as the FCPA, companies need to apply appropriate due diligence, taking a proportionate and risk-based approach.
Potential due diligence efforts include direct requests for details on the background, expertise, and business experience, of relevant individuals. It is also important to know whether you are dealing with a Politically Exposed Person (PEP) or a State Owned Enterprise (SOE).
A ‘Level 1’ screen using the Thomson Reuters Accelus World-Check or similar database² is a good way to establish exactly who you are dealing with. Transacting with a PEP or SOE poses a higher risk and may require further risk mitigation procedures. This does not imply that you cannot do business with PEPs or SOEs. However, if you do no due diligence and an issue arises, the appropriate regulatory bodies will not be kind or sympathetic. Not doing due diligence can be a costly exercise Due diligence may take time and this implies that business often cannot transact immediately. Due care must nevertheless be applied consistently. Any consideration of the cost of doing due diligence should include an analysis of the return on investment of avoiding a FCPA investigation.
Investigations are lengthy and costs run into hundreds of millions of dollars. In each of these cases, the actions of third parties were what got the companies into hot water with the FCPA.
In a speech delivered in February of 2018, the FBI stated that more than 90% of all FCPA matters involve Third Parties!
The risk of FCPA violations or investigations is not reducing, it is in fact increasing and due diligence on third-party agents³ is something our clients view as a minimum first step, especially when dealing with business partners outside the US.
Step One: Risk Assessment
To initiate “appropriate due diligence” a company must first-rate the compliance risk of the third-party. The risk rating will inform the level of due diligence required. Both the Consultative Guidance to the United Kingdom Bribery Act and the Panalpina settlements list the risk rating as a key component of a best practices anti-corruption and anti-bribery compliance program.
A company need not engage in full due diligence for all third parties. However, it must implement and follow a system to rate each third party for FCPA compliance risk and evaluate and manage that relationship accordingly. Several methods could be used to assess risk in third parties. The approach suggested by the UK’s Financial Services Authority (FSA) in its settlement of the enforcement action against the insurance giant AON refers “to an internationally accepted corruption perceptions index.” Country-Check is an objective country risk ranking index that is widely used in assessing country-specific corruption risk. The approach suggested by the US Department of Justice (DOJ), in Release Opinion 08-02, groups third parties into High Risk, Medium Risk and Low Risk categories. Based upon the assessed risk, an appropriate level of due diligence would then be required.
Using suppliers as an example, the categories suggested are as follows: » High Risk Suppliers; » Low Risk Suppliers; » Nominal Risk Suppliers; and » Suppliers of General Goods and Products.
A. High-Risk Suppliers
A High-Risk Supplier is defined as a supplier that presents a higher level of compliance risk because of the presence of one or more of the following factors: • It is based in or supplies goods/services from a high risk country; • It has a reputation in the business community for questionable business practices or ethics; or • It has been convicted of, or is alleged to have been involved in, illegal conduct and has failed to undertake effective remedial actions.
B. Low-Risk Suppliers A Low-Risk Supplier is defined as an individual or private entity located in a Low-Risk Country which:
• Supplies goods or services in a low-risk country;
• Is based in a low risk country where the goods or services are delivered and has no involvement with any foreign government, government entity, or Government Official; or
• Is subject to the FCPA and/or Sarbanes-Oxley compliance.
C. Minimum Risk Suppliers
A Minimum Risk Supplier is an individual or entity that provides goods or services that are nonspecific to a particular job or assignment and the value of each transaction is USD $10,000 or less. These types of vendors include office and industrial suppliers, equipment leasing companies and such entities, which may supply routinely used services.
D. Suppliers of General Goods and Services
A Supplier of General Goods and Products is an individual or entity that provides goods or services that are widely available to the general public and do not fall under the definition of Minimum Risk Supplier. These types of vendors include transportation, food services and educational services providers. This proposed rating is but one method to allow a company to assess its risks involving its Supply Chain vendors.
Step Two: Initial Enquiry
Once the risk assessment has been included, those third parties that flagged for further investigation should be subjected to a deeper level of inquiry. Information on what steps could be performed in this deeper level of enquiry can be found in the US Federal Sentencing Guidelines, the guidance offered by the DOJ Opinion Releases and the publicly released Plea Agreements and Deferred Prosecution Agreements (DPA) entered into by US companies who admit to violating the FCPA.
The review process should contain, at a minimum, enquiries into the following areas:
• Need for the relationship with a third-party: Clearly articulate the business case for the proposed relationship. This must be approved by management before it goes to legal or compliance for review.
• Credentials: List the critical reasons for selection of the proposed third-party. This should include a discussion of the business partner’s background and experience.
• Ownership Structure: Describe whether the proposed third-party is a government or state-owned entity, and the nature of its relationship(s) with local, regional and governmental bodies. Are any members of the business partner related to government officials?
• Financial Qualifications: Describe the financial stability of, and all capital to be provided by, the proposed third-party. Obtain financial records, audited for 3 to 5 years, if available.
• Personnel: Determine whether the third-party will be providing personnel, particularly whether any of the employees are government officials. Obtain the names and titles of those who will provide services to the US company.
• Physical Facilities: Describe what physical (not virtual) facilities are used by the third-party.
• Reputation: Describe the business reputation of the proposed third-party in its geographic and industry-sector markets. This due diligence should be recorded and maintained by the US company for review, if required, by a governmental agency.
Step Three: Background Checks
After this initial inquiry is concluded, the US company should move forward to perform a background check on the business partner by using the following resources:
• References: Obtain and contact a list of business references.
• Embassy Check: Obtain information regarding the intended business partner from the local US Embassy or a Commerce Department report such as an International Company Profile Report.
• Compliance Verification: Determine if the third-party, and those persons within the third party who will be providing services to the US company, have reviewed or received FCPA training.
• Foreign Country Check: Have an independent third-party, such as a law firm, investigate the business partner in its home country to determine compliance with its home country’s laws, licensing requirements and regulations.
• Cooperation and Attitude: One of the most important inquiries is not legal but based upon the response and cooperation of the third-party. Did the business partner object to any portion of the due diligence process? Did it object to the scope, coverage or purpose of the FCPA? In short, is the business partner a person or entity that the US company is willing to stand up with under the FCPA?
After a company completes these due diligence steps, there should be a thorough review by the company. This review should examine the adequacy of due diligence performed in connection with the selection of overseas partners, as well as the third-party’s selection of subcontractors and consultants which will be used for business development on behalf of the US company.
These steps do not include the use of, or continued management of, a third-party. These steps need to be taken by all US companies entering into, or already engaged in, a relationship with a third party as the FCPA applies to all US companies, whether public or private.
Step Four: Enhanced Due Diligence
If the information outlined above reveals a higher level of risk and further investigation is required, or there is a “hit”4 from a Level 1 Report, an IntegraScreen (IS) Report for Due Diligence (a Level 2 Report) may be required. An IntegraScreen Due Diligence Report (Level 2 Report) routinely provides a deeper level of information that is not included in a Level 1 Report, including:
• a full media profile;
• litigation and bankruptcy information; and
• full identification of beneficial ownership from primary sources such as a company registry
This is some of the information you may require in order to assess risk and make an informed decision. It is highly recommended that you perform Enhanced Due Diligence or an IS Level 2 Report enquiry where:
• you have instances where individuals have a common name;
• where you are unable to definitively identify an individual who is listed on a Level 1 Report, and there are ‘red flags’ raised that you cannot clear; or
• where you require an in-depth dossier on the background of a company and the individuals behind it.
The difference in cost between a Level 1 and Level 2 report is immaterial if it allows you to assess risk appropriately. Practice Recommendation No matter how much information is gathered during the steps of the due diligence review, accurately assessing risk is difficult. WorldCheck has run Proof of Concepts (PoCs) at thousands of companies for over a decade. These have identified hundreds of examples where initial risk was deemed to be low/ minimal, but after executing a Level 1 Report through World-Check, the rating changed to extremely high risk for any number of reasons. Because of this reality, our practice recommendation is that Level 1 Reports should be executed on all third-party relationships. This can be considered a form of insurance and should be made part of the intake or on-boarding process.
This approach is the best and arguably only way to truly verify the key information provided, and know if there is a risk to your organization. Moreover, for instances that require more information, a Level 2 Report will supplement what was accomplished at Level 1.
A simple approach would be:
• Every third-party should go through due diligence, that includes screening or executing a Level 1 Report.
• Red flags and/or risk drivers indicate the need for Enhanced Due Diligence (EDD) or Level 2 Reports – but these are done on an as needed basis.
• If you analyze all the business intelligence and you still cannot get comfortable, and the residual risk is high, consider and have the courage to walk away. This document contains general information only and is based on the experiences and research of the author.
I welcome your comments and suggestions!
I, Jonathan Marks, am not, by means of this publication, rendering business, legal advice, or other professional advice or services and is not a substitute for such advice or services. Moreover, it should not be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult qualified professionals.
The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this document.
I acknowledges the work of Tom Fox, Esq. http://www.tfoxlaw.com
1 The FCPA proscribes only illicit payments made to a foreign official, foreign political party or official thereof, or a candidate for foreign political office. It was not intended to, and does not, address bribes or kickbacks paid to employees of private, nongovernmental entities. Nor does the FCPA proscribe payments (for example, discounts or donations) made directly to a government department or agency that are not for the personal use or benefit of a foreign official. The term “foreign official” was originally defined by the FCPA as “any officer or employee of a foreign government or any department, agency, or instrumentality thereof, or any person acting in an official capacity for or on behalf of any such government or department, agency, or instrumentality.” The 1998 Amendments, to conform the FCPA to the OECD Convention, added “public international organizations” to the definition of a foreign official.
The FCPA statute defines ‘foreign official’ as ‘any officer or employee of a foreign government or any department, agency or instrumentality thereof.’ However, the FCPA does not define ‘instrumentality’ of a foreign government. The US Department of Justice (DOJ) and the US Securities and Exchange Commission (SEC) have interpreted the term broadly, and have routinely concluded that state-owned enterprises may be considered ‘instrumentalities’ and, consequently, the employees of these entities may be ‘foreign officials’ under the FCPA. Upholding Esquenazi and Rodriguez’s convictions, the 11th Circuit affirmed the prevailing view of the regulators and confirmed that state-owned commercial entities may be ‘instrumentalities’ of a foreign government and that its employees may properly be considered ‘foreign officials’ following a consideration of a variety of factors. Read more – (http://www.nortonrosefulbright.com/knowledge/publications/124533/us-11th-circuit-decision-defines-foreign-official-under-the-foreign-corrupt-practices-act)
2 World-Check Screening is a comprehensive and widely adopted source of structured intelligence on heightened risk individuals and organizations; World-Check Risk Screening is a volume or batch screening solution for the monitoring of business relationships. It covers regulatory obligations such as Know Your Customer (KYC), Anti Money Laundering (AML), organized crime, sanctions, Countering the Financing of Terrorism (CFT) and aids the monitoring of Politically Exposed Persons (PEPs) and their associates. World-Check Risk Screening also helps organizations to avoid reputational damage, the consequence of which can be harder to measure compared to a fine issued upon a breach of compliance.
3 The third-party may include foreign sales representatives or any other intermediaries such as foreign distributors, consultants, independent contractors, foreign subsidiaries, or other legal entities, such as a joint venture.
4 World-Check Risk Screening uses industry standard matching technology and settings. When a name is run against the World-Check database, the name will match according to how close it is to the database profile. This includes any known aliases, a.k.a.s and alternative spellings, as well as close and partial matches.
Note: Minor modifications to the original article have been made.