Knowledge and the FCPA: Being Alert, Aware, and Responsive to Red Flags

In essence, this means that a company, or one of its executives, could face criminal liability under the FCPA if signs of potential bribery, or “red flags,” are reasonably evident in a transaction and nothing is done to resolve the red flags. If the company, for example, learns at some point in the future that a bribe was paid, liability could arise even if no one at the company actually knew or intended for a bribe to be paid. Merely failing to address the red flags may facilitate allegations by U.S. authorities that the company or one of its executives violated the FCPA. What types of red flags could indicate potential bribery? Consider when one company seeks to acquire another company that does business globally, including in countries viewed as high-risk from a corruption standpoint. U.S. authorities have opined that merely doing business in a corrupt country should be considered a red flag.  Moreover, in the Bourke case, prosecutors persuaded a U.S. federal judge that it was appropriate to enter into evidence the fact that Bourke’s conduct took place in Azerbaijan, a country known for corrupt business practices. The court stated that the evidence demonstrated “that Bourke was aware of how pervasive corruption was in Azerbaijan generally.” While prosecutors introduced evidence that Bourke actually knew about the bribery of Azeri government officials involved in the proposed privatization of the Azeri national oil company, the court also permitted the jury to make a finding of “constructive knowledge.” The court determined that “a rational juror could conclude that Bourke deliberately avoided confirming his suspicions that [his business partners] may be paying bribes.” With that background, assume that the target does significant business in a high-risk country through a distributor that sells primarily to customers that are government-controlled. Assume further that the distributor is responsible for obtaining key government approvals to sell the target’s products. In a pre- acquisition review, your company learns that the target never performed any anti-corruption due diligence on the distributor and, despite having compliance audit rights in its contracts with the distributor, the target never exercised such rights or conducted any form of compliance review. Before you determine what your company should do, consider the following recent FCPA matter resolutions.

Ignoring Red Flags Becomes Basis For $384M in Criminal Fines and Disgorgement of Profits for Alcoa, Based on the Actions of a Single Consultant/Distributor

On January 9, 2014, Alcoa World Alumina LLC, a majority-owned U.S.- based subsidiary of Alcoa, Inc. (“Alcoa”) pleaded guilty to violating the anti-bribery provisions of the FCPA and agreed to pay a criminal fine of $209M and forfeit $14M to settle charges by the Department of Justice (“DOJ”). Alcoa, Inc. itself agreed to pay $161M in disgorgement to settle civil charges levied by the Securities and Exchange Commission (“SEC”). The charges resulted from alleged corrupt schemes used by Alcoa subsidiaries to funnel money to foreign officials in Bahrain through a consultant/distributor in order to obtain business with a government-controlled aluminum smelter. This case is notable because it is one of the first criminal FCPA enforcement actions against a company built on a “constructive knowledge theory,” described as “conscious disregard” by one of the executives of red flags evidencing corruption-related misconduct. The language of the plea agreement indicates that the government interpreted the direct delivery of alumina by an Alcoa subsidiary to the Bahraini end users, despite the existence of a distributorship agreement with the consultant, as a red flag. When an Alcoa executive was asked by the legal department about the purpose of a distribution agreement with the consultant’s entities, he responded that it was “something that the Bahrain Government wants and that Alcoa shouldn’t get too involved with how the Distributor and the Government interact.” Based on the distribution agreement, the consultant had the right to mark up prices on alumina from Alcoa to the end user. The Alcoa subsidiary also sought and received approval to extend credit lines to the consultant’s entities even though the consultant refused to provide financial statements to Alcoa’s credit department. Allegedly, the credit lines were “significantly greater than those granted by Alcoa to any other third party.” The government claimed that by doing so, Alcoa “enabled the purported distribution scheme,” and that the red flags should have put Alcoa on notice that the distribution agreement was a sham. However, Alcoa failed to follow up on the red flags and entered into more distribution agreements. Both the SEC and DOJ asserted that Alcoa “consciously disregarded” the fact that the consultant’s role in Alcoa’s supply chain may have been to generate funds to pay bribes to Bahraini officials. In each instance in which the government alleged that Alcoa’s subsidiary “consciously disregarded” red flags, there was evidence of legitimate commercial and legal arrangements. Nonetheless, where bribes have been paid over an extended period, the government’s review of the transactional history can be shaped by the evidence of bribery, leading investigators to, in some instances, interpret certain key events, statements, and documents to confirm their perception.

Failure to Recognize Red Flags Evidencing Potential Corrupt Practices at a Subsidiary Can Be the Basis for an FCPA Enforcement Action

On December 30, 2013, Archer Daniels Midland Company (“ADM”) reached a settlement with the DOJ and SEC of allegations under the FCPA relating to conduct by ACTI Ukraine, ADM’s indirect majority-owned Ukrainian subsidiary, and ACTI Hamburg, ADM’s majority-owned German subsidiary. According to the case resolution documents, from 2002-2008, ACTI Hamburg and ACTI Ukraine engaged in multiple fraudulent schemes and paid third- party agents to channel bribes to Ukrainian government officials to obtain VAT refunds owed to ACTI Ukraine by the Ukrainian government. According to the documents, ACTI Hamburg and ACTI Ukraine paid vendors roughly $22M, nearly all of which was remitted to Ukrainian government officials. In exchange, ACTI Ukraine received over $100M in VAT refunds, to which ACTI Ukraine was legally entitled. The SEC and DOJ alleged that the VAT refunds obtained by ADM’s subsidiaries through improper payments gave ACTI Ukraine an undue business advantage, resulting in a benefit to ACTI Hamburg and ACTI Ukraine of roughly $41M. The SEC charged ADM with violations of the FCPA books and records and internal control provisions and ordered it to pay $36.5M in disgorgement and prejudgment interest. In a parallel DOJ action, ACTI Ukraine pleaded guilty to one count of conspiracy to violate the FCPA anti-bribery provisions and agreed to pay a criminal fine of $17.8M. In addition, ADM entered into a non- prosecution agreement with the DOJ, apparently for ADM’s knowing failure to implement and maintain adequate controls over its subsidiaries’ use of third parties. In contrast to the Alcoa case, ACTI Hamburg and ACTI Ukraine were allegedly aware of the misconduct. But there is no clear evidence that ADM, the parent company, was aware of the conduct of its subsidiaries. In holding ADM directly accountable through a non-prosecution agreement, the DOJ seemingly relied on a “constructive knowledge” theory. According to the non- prosecution agreement, “an ADM executive in the tax department sent an email to the head of the international tax organization” and stated that in order to recover $100M of the VAT refunds a Ukrainian subsidiary paid 30 percent to local charities. While it is clear that ADM’s executives were aware of some concerns related to legal procedures for obtaining a VAT refund, the case indicates how aggressively the DOJ will act to hold companies accountable where there is a failure to recognize and respond to red flags.

Prosecution of Weatherford for Internal Controls Violations is Equivalent to the DOJ Pursuing a Constructive Knowledge Theory for Bribery

On November 26, 2013, Weatherford International (“Weatherford”), a Swiss oil services company that trades its shares on the New York Stock Exchange, and its Bermudian subsidiary, Weatherford Services Limited, reached a settlement with the DOJ and the SEC for FCPA violations in Africa, the Middle East, and Europe. Weatherford allegedly obtained a dominant position and earned profits of $54.4M by bribing foreign officials. Weatherford and its subsidiaries agreed to pay $152M in fines and $65.6M in disgorgement, prejudgment interest, and civil penalties. In this matter, the DOJ appeared to use the criminal prosecution of internal controls violations as an alternative to a “constructive knowledge” theory. The DOJ charged Weatherford International under the accounting provisions of the FCPA for the “knowing failure to implement internal accounting controls.” The deferred prosecution agreement, however, does not recite evidence of Weatherford’s knowledge of corrupt misconduct by its subsidiaries. Instead, in the case of the joint venture established by one of its subsidiaries in Africa, the DOJ stated that Weatherford did not conduct “any meaningful due diligence of either joint venture partner” even though the joint ventures were controlled by foreign officials and their relatives, nor did it investigate why the local entities were partners in the joint venture despite the fact that they “did not contribute capital, expertise or labor to the joint venture.” The DOJ’s position is that Weatherford created “a permissive and uncontrolled environment” in which employees of certain of its subsidiaries “were able to engage in various corrupt conduct.” It appears from the deferred prosecution agreement that the bases for establishing criminal liability under the internal controls provisions consisted of Weatherford’s failure to conduct compliance due diligence on third parties and business transactions, failure to investigate allegations of illegal conduct, and failure to implement its policies at its subsidiaries and newly-established joint ventures. In other words, Weatherford failed to have an effective anti-corruption program, which led to a criminal violation of the accounting provisions of the FCPA.

Pre–Acquisition Due Diligence and Post-Acquisition Integration as Effective Safeguards

Returning to the original hypothetical acquisition of the target operating in a high-risk jurisdiction (mentioned at the outset of this article) and using third parties to interact with government-controlled end-users, what can companies do to protect themselves from FCPA liability? Appropriate due diligence of the target followed by prompt and comprehensive remediation and integration to ensure compliance with company compliance policies and procedures are critical tools to minimize the risk of criminal liability for post-acquisition improprieties. A failure to conduct such due diligence, in light of the cases described above, could expose your company to FCPA liability if it turns out that the target company has been paying bribes through its distributors or other third parties in the high-risk market.