An Ounce of Prevention: Assessing Corruption Risk in International Dealings
Article – April 2016
Corporate / Investigation / Forensic Investigation
Access to overseas opportunities is increasing among middle market companies. Be it production facilities, new vendors or new customer relationships, overseas ventures carry new and different risks that must be understood and managed. One of the greatest potential risks is corruption. As a result, companies considering an overseas move should undertake corruption due diligence to understand and remediate those risks.
As appeared in Middle Market Growth // Weekly, April 28, 2016. Learn more at acg.org.
The world has become a smaller place. Through improved technology, communications and transportation, it is now easier than ever for a small- or medium-sized businesses to realize the benefits of a production facility in Thailand or sales to customers in China. While such ventures can be extremely rewarding, they also carry new risks that must be understood and managed. Among the most potentially severe of those risks is corruption. As a result, companies considering an overseas move should undertake corruption due diligence to understand and remediate those risks.
What Is Corruption Risk?
Corruption risk is the risk that your company, or someone representing your company, is offering something of value (e.g., cash, gifts, liquor, travel, cars, donations, jobs, the list goes on and on…) in order to obtain or retain business. In most countries around the world, commercial bribery and bribery of government officials is illegal, though the laws may not be widely enforced.
US citizens and companies are also subject to the US Foreign Corrupt Practices Act (FCPA), which makes it a criminal offense to give (or even just offer to give) something of value to a foreign government official in order to obtain or retain business. The definition of a foreign official includes employees of state-owned enterprises like national oil companies or even physicians in a national healthcare system. The FCPA frequently makes headlines for hundred million dollar fines against big corporations. But the FCPA can, and does, result in prosecutions of individuals who may end up in federal prison.
What Is Corruption Due Diligence?
Most people are familiar with financial due diligence related to a merger or acquisition. Much like a financial audit, financial due diligence seeks to confirm the accuracy of information in the acquisition target’s books and records so the buyer understands what is being purchased.
Using similar information, corruption due diligence informs the buyer of the corruption risk that may be attached to the purchase of, or other transaction with, a foreign business partner. In addition to being a sound business practice (understanding what you’re buying), US regulators expect that buyers are undertaking procedures to understand and mitigate corruption risks prior to a transaction.
The procedures undertaken must be tailored to each assignment, but generally include questions such as:
- Where does the target have operations and customers? Are they in places with a high corruption risk?
- Does the target have customers that are state owned or government entities?
- Does the target utilize sales agents or consultants? If so, what do they do and how are they compensated?
- Is the target in a heavily regulated industry? What types of interactions does the target have with government officials?
- What type of controls does the target have around gifts, meals and entertainment for customers? How does the target manage petty cash?
- Does the target have anti-corruption policies and procedures in place? If so, are they effective? Do they mitigate the risks associated with the target’s business?
Will the discovery of a potentially corrupt transaction kill a deal? Not necessarily, as long as the buyer takes appropriate steps to remediate the improper activity and prevent similar transgressions from recurring. The buyer will need to consider the benefits of the transaction if the improper activities are terminated. Will a customer stop buying your goods or services when they stop receiving bribes?
More generally, the buyer will need to address the risks identified during due diligence when/if the transaction is consummated. For example:
- Tell employees not to pay bribes. While it sounds simple, many companies never expressly communicate to their employees that business will be conducted legally and ethically.
- Monitor disbursements and understand the business purpose for each.
- Review expense reports and require complete supporting documentation. Pre-approve any expense related to government officials to ensure reasonableness.
- Ensure sales agents are properly monitored. Demand detailed reports of their activities and interactions with government officials. Resistance to providing this information is a red flag.
For small- and medium-sized businesses, many risks can be mitigated through robust monitoring by finance or accounting personnel with sufficient knowledge of the potential risks to identify and stop a problematic payment before it is made.
An Ounce of Prevention Is Worth a Pound of Cure
Before undertaking an international expansion, be sure to understand the corruption risks that may accompany your opportunity. A relatively small investment in robust corruption due diligence (compared to the overall transaction costs) will likely pay for itself through the establishment of risk-based, mitigating controls and the avoidance of expensive problems down the road.
Corruption Perceptions Index 2015 map courtesy of Transparency International.