CONTENTS BOARD COMPOSITION Board Composition & Performance
May/June 2017 • Volume 25, Number 3
BOARD COMPOSITION
CONTENTS BOARD COMPOSITION
Board Composition & Performance: What Shareholders Want to Know By Julie Daum
Board Composition & Performance: What Shareholders Want to Know
1
By Julie Daum
CODES OF CONDUCT
Investor attention to board performance and governance continues to escalate, and, increasingly, it’s large institutional investors— so-called “passive” investors—who are making known their expectations in areas such as board composition, disclosure, and shareholder engagement. Long-term investors have shifted their posture to taking positions on good governance, and are increasingly demonstrating common ground with activists on governance topics. Board composition is a particular area of focus, as traditional institutional investors have become more explicit in demanding that boards demonstrate that they are being thoughtful about who is sitting around the board table and that directors are contributing. They are looking more closely at disclosures related to board refreshment, board performance, and assessment practices, in some cases establishing voting policies on governance. Continued on page 2 © 2017 Spencer Stuart. Julie Daum is a partner and copractice leader of the “Board & CEO” Practice at Spencer Stuart, a Chicago-based consulting firm. This article is based on the annual U.S. Spencer Stuart Board Index.
Ninth Circuit: Ethics Policy Violations Aren’t Securities Fraud
6
By Heidi Brooks Bradley
D&O INSURANCE
D&O Insurance & Insolvency: Navigating the Intersection
9
By Marshall S. Huebner and Benjamin M. Schak
ANTI-CORRUPTION
Corruption at Eletrobras: ‘Did You Mean Petrobras???’ By Mark Jenkins
20
ANTI-CORRUPTION Corruption at Eletrobras: ‘Did You Mean Petrobras???’ By Mark Jenkins I typically get a bit excited about movie sequels despite their historically bad reputations. I have enjoyed a few: The Empire Strikes Back, Aliens, Star Trek II—Wrath of Khan, Godfather II, and the highly anticipated sequel to Ridley Scott’s Blade Runner. What about corruption scandals? Do they have sequels? Of course they do!
government buildings called Posto da Torre or Tower Gas Station. The premises of the gas station housed a money transfer service that was allegedly used to transfer bribe payments from Petrobras to Petrobras executives’ offshore accounts.1
In the last four years, Brazilian federal prosecutors have had their courtroom dockets full of bribery and kickback cases related to Petrobras, the Brazilian state-controlled oil company. The Brazilian federal police nicknamed the Petrobas investigation, “Operation Lava Jato” or “Operation Car Wash.”
According to the US Department of Justice (DOJ), the Petrobras scheme of bribes and kickbacks came in part through a system put in place by Odebrecht and its subsidiary Braskem, a Brazilian construction company. Odebrecht created a division called the “Division of Structured Operations” (DSO), which operated solely to collect and disburse funds to pay bribes. Off-book transactions and secret encrypted email communications were used to conceal the activity from outsiders. The generation of funds to pay the bribes came from intercompany overhead charges, retainers for the purchase of company assets, and self-insurance charges.2
The Original Scheme
Now we have a second scandal: Eletrobras, the Brazilian state-controlled power company that produces electricity through electric, hydro and nuclear power plants. It has been quietly involved in the follow-up investigations with code names such as “operation radioactivity” and “operation electroshock.” It has promises of similar notoriety to Petrobras, but has not received as much media attention.
To best understand the Eletrobras scandal, it’s important to get a grasp on the Petrobras scandal. They are interrelated and overlap.
According to the DOJ, Odebrecht alone paid bribes in Brazil of at least $349 million to obtain $1.9 billion in such benefits as the awarding of contracts and favorable legislation. Outside of Brazil, Odebrecht paid bribes of $439 million to foreign government officials in at least 11 other countries in Latin America and Africa to obtain $1.4 billion in benefits. Odebrecht has pled guilty and has agreed to pay a total of at least $2.6 billion and up to $4.5 billion dollars in fines depending on its ability to pay. Braskem has pled guilty and has agreed to pay a total criminal penalty of $632 million and $325 million in disgorgement of profits.3
The name “Operation Car Wash” originated from a gas station two miles west of Brasilia’s
Eletrobras
Mark Jenkins is senior managing director of Glass Ratner Advisory & Capital Group LLC, based in Atlanta, GA.
As part of the plea-bargains agreed to in Operation Car Wash during 2014 and 2015, several construction company executives admitted
Similar to Petrobras, Eletrobras involves federal prosecutors arresting high-level executives, construction companies involved in scandal, and a civil class action lawsuit for securities violations.
Petrobras
The Corporate Governance Advisor
20
May/June 2017
to bribing Brazilian state-controlled companies in other sectors. During testimony in 2015, Dalton Avancini, CEO of Camargo Correa SA, stated that [Petrobras] bribes were paid to Eletrobras executives by Camargo Correa SA on a hydro dam project called Belo Monte and a nuclear reactor construction project called Angra 3.4 Two months later Ricardo Pessoa, owner of UTC, another construction company, also testified that his firm paid bribes to Eletrobras officials for the Angra 3 project.
Also stated in the 2015 financial statements was a comment, which had been included in the last several years’ financial statements: As a result of our management’s evaluation of the effectiveness of our disclosure, controls and procedures in 2015, our management determined that these controls and procedures were not effective due to material weaknesses in our internal controls over financial reporting.6
On May 14, 2015, Eletrobras issued a disclosure to the US Securities and Exchange Commission (SEC) stating it would not be able to file its financial statements with the SEC in part due to the internal investigation of the bribery allegations. In July 2015, Brazilian law enforcement arrested Othon Luiz Pinheiro da Silva, CEO of Eletronuclear, a subsidiary of Eletrobras, for 24 instances of rigging bids for the Angra 3 project in return for R$4.5 million (USD $1,137,600) in bribes. On August 15, 2015, the City of Providence, Rhode Island, brought a class action lawsuit against Eletrobras for violating the Securities Exchange Act of 1934 for concealing the Eletrobras corruption issues, and misleading investors.
Compliance Takeaways As a multinational company or even a business entity that is contemplating entering international trade, how do you avoid scandals such as those described ? How could a robust compliance program uncover widespread corruption involving several levels of management going all the way to the top? For the numerous entities and subsidiaries involved in the investigations, it is difficult to determine what compliance programs were in place, if any, and when the compliance programs began. Eletrobras stated they had a compliance program, however, as mentioned previously, Eletrobras management stated that their internal controls had not been adequate in 2014 and 2015.
In May 2016, the New York Stock Exchange suspended trading of Eletrobras securities and began delisting procedures due to the failure of Eletrobras to file its 2014 financial statements. The acting Eletrobras CEO, Pedro Figueredo who had taken over for Pinheiro after his arrest the prior year, was suspended in July 2016 from Eletrobras. He was being investigated by Brazilian police for collusion with Pinheiro in the bribery scheme and interfering with the investigation. In October 2016, Eletrobras released their 2014 and 2015 financial statements with the following message:
Compliance Must Haves Companies that have United States and foreign regulatory mandates such as Sarbanes Oxley, DOJ, SEC, and Brazil’s Clean Company Act should have the minimum requirements in place (see Exhibit 1, first column). An effective compliance program must go beyond what is standard and have top level commitment, compliance testing, and a risk-based compliance program (see Exhibit 1, second column). The third column represents seasoned multinationals that understand corruption risks and thrive on the additional scrutiny by law enforcement globally. Their compliance programs factor in corruption risk as part of their overall strategy. They continually monitor high-risk transactions
… our 2014 and 2015 consolidated financial statements reflect the conclusions of the Investigations which resulted, respectively, in the expensing of costs of R$195.127 million (approximately USD 73.4 million) and R$15.996 million (approximately USD 4.04M) that had been improperly capitalized to our assets.5
Volume 25, Number 3
21
The Corporate Governance Advisor
Exhibit 1. Compliance Programs
Compliance Programs Best Pracces
Must Haves
Effective Compliance Program
Robust Compliance Program
Code of Conduct
Commitment from Sr. Management/ Communicated to All
Ethical risks are factored into growth strategy.
Written Anti-Corrupon Compliance Program
Tailored to Real Risks
Regular tesng of compliance policies and procedures.
Compliance Officer
Specialized Training for Risky Employees
Ethics/Whistleblower Hotline
Call Volume Appropriate Hotline/Experienced Investigators and Legal
Encouragement of employees and vendors to come forward. Investigations fully integrate with compliance program.
Due Diligence Procedures
Risk-Based Level of Due Diligence
On high-risk third parties, independent local country investigations. Will “walk away” if corruption red flags are present.
Written Assessment of Internal Controls/Accurate Books and Records
Testing — Data Analycs
Regular fraud and corruption risk assessments, continuous monitoring of risky transactions.
and incentivize their employees to conduct business ethically.
•
Obtain at least three bids with the same bid specifications sent to each bidder for construction projects over a certain dollar amount.
•
Segregation of duties: The person sending out the bid information, such as an engineer, is not the same person that should receive and analyze bid packages. A third employee with no interests as to the outcome should choose the winner based on quality and price.
•
Quality and due diligence investigations should be conducted on bidding companies to determine the appropriateness of the bidder, potential conflicts of interests, history of corruption, and bid history results.
•
Market and comparison analysis should be conducted on purchased equipment and
Internal Controls/Due Diligence Anti-corruption policies are only as effective as the internal control and compliance procedures that test whether the policies are being followed by employees. Following are a few examples of internal control and compliance procedures that can assist you in validating that your organization has “above board” transactions:
Construction Bid Review International construction projects in highrisk countries involving foreign governments should be considered high priority for review. For public bid government projects, determine whether bid procedures were followed:
The Corporate Governance Advisor
22
Ethical behavior is rewarded, remedial action taken on corrupt activity.
May/June 2017
Of special note, accepting at face value information provided by a third party without verifying the accuracy is not real due diligence. This would be considered “papering the file” and will not be accepted by regulatory agencies when an investigation commences and therefore should not be accepted by compliance professionals.
services of the winning bidder to identify potential overcharges.
•
Conduct change order analysis frequency and amounts post bid.
High Risk Transactions There are certain transactions that have a great susceptibility for corruption. Exhibit 2, show below, shows several typical high-risk transactions and potential guidance on how to review them:
The Unaoil scandal (Unaoil, a Monacobased consulting company,had internal emails go public showing that it may have been an intermediary for bribes involving numerous corporations) validates the argument that compliance cannot be a “check the box exercise.7
Anti-Corruption Due Diligence with Third Parties For high-risk third parties, which includes agents (in high corruption risk countries) that are providing introductions to government entities, there should be a higher level of due diligence. As noted in Exhibit 3 on the next page, this should include the following:
Independent Transactional Testing Along with the internal review processes mentioned previously, data analytics testing will assist with ensuring your anti-corruption program is operating effectively:
Exhibit 2. Transactions at High Risk for Corruption ● Travel approvals should be measured, monitored and scrutinized ● Web approval systems controlled date and number entries, accessible to legal and investigative depts can eliminate corrupt txns
●Above a nominal amount, strict processes that include sr mgr approval outside the country requesting the gift. ●The donation/gift should be legal and not be related to project approvals
Charitable / Political Donations / Gifts
Gov. Officials site visits
Expense reimbursement
Additional training
● Analyze sales reps’ (interfacing with gov. agencies in high risk places) reimbursement vouchers. ● Review high $, qty in total compared to other sales reps, high risk categories such as “misc”, “other”, “gifts”, “entertainment”
Volume 25, Number 3
●For employees involved in high risk transactions, such as sales reps. and approvers of their disbursements reimbursements, provide periodic add’l scenario based anti-corruption training. ● Let them know their txns are being reviewed in detail
23
The Corporate Governance Advisor
Exhibit 3. Anti-Corruption Due Diligence with Third Parties
Request
Invesgate
Document
•Request references, ownership interests (over 10%), financial statements, location and addresses of entity and key owners/employees.
•Use experienced investigators with local resources to corroborate informaon provided, review local criminal and civil litigation records.
•Note reacon to request for informaon.
•Run name match on sanctions lists, Politically Exposed People (“PEP”) lists and international terrorist watch lists.
•Document findings and red flags •Be prepared to “walk away” based on red flags found. •If a third party is approved as a vendor, include in your contract (consult experienced aorney) •A “right to audit” clause (exercised periodically and without advanced notice) •Anti-corruption language requiring current and future anti-corruption law certification of all employees/owners. •Termination of contract clause if corrupon has occurred involving third party
•Third parties that refuse to provide informaon or are surprised/offended could be indicave of inexperience or a red flag of potential corruption.
•
•Search for negave media on third party.
of specific digits with the same significance. For example, if you observe multiple amounts just below approval thresholds such as $24,999, $249, and $24, the second digit, “4,” has an occurrence greater than is natural according to Benford’s law. Such behavior may be indicative of an attempt to circumvent approval processes for purposes of making corrupt payments.
Conduct prioritized data analytics testing based on high-risk divisions, vendors/agents (based on type and monetary amounts paid), or locations. ❍
Test project purchase order and invoice data including quantity, pricing, and descriptions while comparing to other arms-length transactions with review by third-party objective experts. For example: ❏
❏
❏
Look for low digit or consecutive invoice numbers (indicating that you might be the only customer for a vendor or potential shell company).
❍
Identify potential duplicate invoices by examining those with the same date and amount for invoice numbers such as “1a” or “2b.”
•
Using Benford’s law,8 test invoice amounts for unnatural frequencies
The Corporate Governance Advisor
24
Compare project vendor addresses with those of other vendors, employees, and related parties to identify potential conflicts of interests.
Based on investigation of data analytics testing results, eliminate false positives and perform “on the ground gum shoe” investigating. For example, if you find two bidders that are consistently winning bids, visit the location. In parts of Latin America,
May/June 2017
Make sure before entering into international, high-risk transactions that you have a robust and risk-based anti-corruption compliance program with sufficient internal controls in place so your organization can avoid the “film noir” atmosphere encountered by these Brazilian business entities.
different addresses and vendor names can lead you to the same location. Site visits can also provide you with information on whether the vendor can actually provide the service or manufacture the product. A residential address that is billing for large power generators may be either a distributor or a false vendor. In addition, check whether the product or service was actually delivered or provided.
Notes 1. https://www.wsj.com/articles/brazil-carwash-shrugsoff-notoriety-tied-to-petrobras-scandal-1434930402, last accessed March 26, 2017.
Post-Script
2. US v. Odebrecht S.A., Cr. No. 16-643 RJD)(T. 18, U.S.C., § 371 and § 3551 et seq)
As of the date of publication, it is unknown what the conclusions will be of the ongoing investigations by Brazilian authorities of Eletrobras. There is a continuing Eletrobras internal investigation, and it is unknown what will transpire, if anything, regarding the pending class action lawsuit.
3. https://www.justice.gov/opa/press-release/file/919901/ download, last accessed March 26, 2017. 4. Development of the Angra 3, the third nuclear reactor in Brazil, originated in the mid 1980s but was shelved until 2008. 5. h t t p : / / g l o b a l d o c u m e n t s . m o r n i n g s t a r. c o m / DocumentLibrary/Document/1dad90e9cc4d796b38601ce 60b994674.msdoc/original/d173088d20f.htm#toc173088_4, last accessed March 26, 2017.
In the meantime, the Petrobras scandal does not seem to be going away. In February 2017, Panamanian investigators raided Mossack Fonseca law firm offices, the law firm that was the integral player in the “Panama Papers” scandal. Ten months before the raid, documents were leaked implicating companies and individuals using the law firm as a safe haven for tax evasion. Now there are allegations by Panamanian and Brazilian authorities related to Odebrecht bribe payments being connected to Fonseca.
Volume 25, Number 3
6. Id. 7. See “The Unaoil Corruption Scandal: Where Was the Due Diligence?” Dun & Bradstreet, April 21, 2016, http:// www.dnb.com/perspectives/corporate-compliance/unaoilcorruption-scandal.html, last accessed March 26, 2017. 8. https://en.wikipedia.org/wiki/Benford’s_law, last accessed March 26, 2017. Benford’s law, also called the first-digit law, is an observation about the frequency distribution of leading digits in many real-life sets of numerical data. The law states that in many naturally occurring collections of numbers, the leading significant digit is likely to be small.
25
The Corporate Governance Advisor
BOARD COMPOSITION
CONTENTS BOARD COMPOSITION
Board Composition & Performance: What Shareholders Want to Know By Julie Daum
Board Composition & Performance: What Shareholders Want to Know
1
By Julie Daum
CODES OF CONDUCT
Investor attention to board performance and governance continues to escalate, and, increasingly, it’s large institutional investors— so-called “passive” investors—who are making known their expectations in areas such as board composition, disclosure, and shareholder engagement. Long-term investors have shifted their posture to taking positions on good governance, and are increasingly demonstrating common ground with activists on governance topics. Board composition is a particular area of focus, as traditional institutional investors have become more explicit in demanding that boards demonstrate that they are being thoughtful about who is sitting around the board table and that directors are contributing. They are looking more closely at disclosures related to board refreshment, board performance, and assessment practices, in some cases establishing voting policies on governance. Continued on page 2 © 2017 Spencer Stuart. Julie Daum is a partner and copractice leader of the “Board & CEO” Practice at Spencer Stuart, a Chicago-based consulting firm. This article is based on the annual U.S. Spencer Stuart Board Index.
Ninth Circuit: Ethics Policy Violations Aren’t Securities Fraud
6
By Heidi Brooks Bradley
D&O INSURANCE
D&O Insurance & Insolvency: Navigating the Intersection
9
By Marshall S. Huebner and Benjamin M. Schak
ANTI-CORRUPTION
Corruption at Eletrobras: ‘Did You Mean Petrobras???’ By Mark Jenkins
20
ANTI-CORRUPTION Corruption at Eletrobras: ‘Did You Mean Petrobras???’ By Mark Jenkins I typically get a bit excited about movie sequels despite their historically bad reputations. I have enjoyed a few: The Empire Strikes Back, Aliens, Star Trek II—Wrath of Khan, Godfather II, and the highly anticipated sequel to Ridley Scott’s Blade Runner. What about corruption scandals? Do they have sequels? Of course they do!
government buildings called Posto da Torre or Tower Gas Station. The premises of the gas station housed a money transfer service that was allegedly used to transfer bribe payments from Petrobras to Petrobras executives’ offshore accounts.1
In the last four years, Brazilian federal prosecutors have had their courtroom dockets full of bribery and kickback cases related to Petrobras, the Brazilian state-controlled oil company. The Brazilian federal police nicknamed the Petrobas investigation, “Operation Lava Jato” or “Operation Car Wash.”
According to the US Department of Justice (DOJ), the Petrobras scheme of bribes and kickbacks came in part through a system put in place by Odebrecht and its subsidiary Braskem, a Brazilian construction company. Odebrecht created a division called the “Division of Structured Operations” (DSO), which operated solely to collect and disburse funds to pay bribes. Off-book transactions and secret encrypted email communications were used to conceal the activity from outsiders. The generation of funds to pay the bribes came from intercompany overhead charges, retainers for the purchase of company assets, and self-insurance charges.2
The Original Scheme
Now we have a second scandal: Eletrobras, the Brazilian state-controlled power company that produces electricity through electric, hydro and nuclear power plants. It has been quietly involved in the follow-up investigations with code names such as “operation radioactivity” and “operation electroshock.” It has promises of similar notoriety to Petrobras, but has not received as much media attention.
To best understand the Eletrobras scandal, it’s important to get a grasp on the Petrobras scandal. They are interrelated and overlap.
According to the DOJ, Odebrecht alone paid bribes in Brazil of at least $349 million to obtain $1.9 billion in such benefits as the awarding of contracts and favorable legislation. Outside of Brazil, Odebrecht paid bribes of $439 million to foreign government officials in at least 11 other countries in Latin America and Africa to obtain $1.4 billion in benefits. Odebrecht has pled guilty and has agreed to pay a total of at least $2.6 billion and up to $4.5 billion dollars in fines depending on its ability to pay. Braskem has pled guilty and has agreed to pay a total criminal penalty of $632 million and $325 million in disgorgement of profits.3
The name “Operation Car Wash” originated from a gas station two miles west of Brasilia’s
Eletrobras
Mark Jenkins is senior managing director of Glass Ratner Advisory & Capital Group LLC, based in Atlanta, GA.
As part of the plea-bargains agreed to in Operation Car Wash during 2014 and 2015, several construction company executives admitted
Similar to Petrobras, Eletrobras involves federal prosecutors arresting high-level executives, construction companies involved in scandal, and a civil class action lawsuit for securities violations.
Petrobras
The Corporate Governance Advisor
20
May/June 2017
to bribing Brazilian state-controlled companies in other sectors. During testimony in 2015, Dalton Avancini, CEO of Camargo Correa SA, stated that [Petrobras] bribes were paid to Eletrobras executives by Camargo Correa SA on a hydro dam project called Belo Monte and a nuclear reactor construction project called Angra 3.4 Two months later Ricardo Pessoa, owner of UTC, another construction company, also testified that his firm paid bribes to Eletrobras officials for the Angra 3 project.
Also stated in the 2015 financial statements was a comment, which had been included in the last several years’ financial statements: As a result of our management’s evaluation of the effectiveness of our disclosure, controls and procedures in 2015, our management determined that these controls and procedures were not effective due to material weaknesses in our internal controls over financial reporting.6
On May 14, 2015, Eletrobras issued a disclosure to the US Securities and Exchange Commission (SEC) stating it would not be able to file its financial statements with the SEC in part due to the internal investigation of the bribery allegations. In July 2015, Brazilian law enforcement arrested Othon Luiz Pinheiro da Silva, CEO of Eletronuclear, a subsidiary of Eletrobras, for 24 instances of rigging bids for the Angra 3 project in return for R$4.5 million (USD $1,137,600) in bribes. On August 15, 2015, the City of Providence, Rhode Island, brought a class action lawsuit against Eletrobras for violating the Securities Exchange Act of 1934 for concealing the Eletrobras corruption issues, and misleading investors.
Compliance Takeaways As a multinational company or even a business entity that is contemplating entering international trade, how do you avoid scandals such as those described ? How could a robust compliance program uncover widespread corruption involving several levels of management going all the way to the top? For the numerous entities and subsidiaries involved in the investigations, it is difficult to determine what compliance programs were in place, if any, and when the compliance programs began. Eletrobras stated they had a compliance program, however, as mentioned previously, Eletrobras management stated that their internal controls had not been adequate in 2014 and 2015.
In May 2016, the New York Stock Exchange suspended trading of Eletrobras securities and began delisting procedures due to the failure of Eletrobras to file its 2014 financial statements. The acting Eletrobras CEO, Pedro Figueredo who had taken over for Pinheiro after his arrest the prior year, was suspended in July 2016 from Eletrobras. He was being investigated by Brazilian police for collusion with Pinheiro in the bribery scheme and interfering with the investigation. In October 2016, Eletrobras released their 2014 and 2015 financial statements with the following message:
Compliance Must Haves Companies that have United States and foreign regulatory mandates such as Sarbanes Oxley, DOJ, SEC, and Brazil’s Clean Company Act should have the minimum requirements in place (see Exhibit 1, first column). An effective compliance program must go beyond what is standard and have top level commitment, compliance testing, and a risk-based compliance program (see Exhibit 1, second column). The third column represents seasoned multinationals that understand corruption risks and thrive on the additional scrutiny by law enforcement globally. Their compliance programs factor in corruption risk as part of their overall strategy. They continually monitor high-risk transactions
… our 2014 and 2015 consolidated financial statements reflect the conclusions of the Investigations which resulted, respectively, in the expensing of costs of R$195.127 million (approximately USD 73.4 million) and R$15.996 million (approximately USD 4.04M) that had been improperly capitalized to our assets.5
Volume 25, Number 3
21
The Corporate Governance Advisor
Exhibit 1. Compliance Programs
Compliance Programs Best Pracces
Must Haves
Effective Compliance Program
Robust Compliance Program
Code of Conduct
Commitment from Sr. Management/ Communicated to All
Ethical risks are factored into growth strategy.
Written Anti-Corrupon Compliance Program
Tailored to Real Risks
Regular tesng of compliance policies and procedures.
Compliance Officer
Specialized Training for Risky Employees
Ethics/Whistleblower Hotline
Call Volume Appropriate Hotline/Experienced Investigators and Legal
Encouragement of employees and vendors to come forward. Investigations fully integrate with compliance program.
Due Diligence Procedures
Risk-Based Level of Due Diligence
On high-risk third parties, independent local country investigations. Will “walk away” if corruption red flags are present.
Written Assessment of Internal Controls/Accurate Books and Records
Testing — Data Analycs
Regular fraud and corruption risk assessments, continuous monitoring of risky transactions.
and incentivize their employees to conduct business ethically.
•
Obtain at least three bids with the same bid specifications sent to each bidder for construction projects over a certain dollar amount.
•
Segregation of duties: The person sending out the bid information, such as an engineer, is not the same person that should receive and analyze bid packages. A third employee with no interests as to the outcome should choose the winner based on quality and price.
•
Quality and due diligence investigations should be conducted on bidding companies to determine the appropriateness of the bidder, potential conflicts of interests, history of corruption, and bid history results.
•
Market and comparison analysis should be conducted on purchased equipment and
Internal Controls/Due Diligence Anti-corruption policies are only as effective as the internal control and compliance procedures that test whether the policies are being followed by employees. Following are a few examples of internal control and compliance procedures that can assist you in validating that your organization has “above board” transactions:
Construction Bid Review International construction projects in highrisk countries involving foreign governments should be considered high priority for review. For public bid government projects, determine whether bid procedures were followed:
The Corporate Governance Advisor
22
Ethical behavior is rewarded, remedial action taken on corrupt activity.
May/June 2017
Of special note, accepting at face value information provided by a third party without verifying the accuracy is not real due diligence. This would be considered “papering the file” and will not be accepted by regulatory agencies when an investigation commences and therefore should not be accepted by compliance professionals.
services of the winning bidder to identify potential overcharges.
•
Conduct change order analysis frequency and amounts post bid.
High Risk Transactions There are certain transactions that have a great susceptibility for corruption. Exhibit 2, show below, shows several typical high-risk transactions and potential guidance on how to review them:
The Unaoil scandal (Unaoil, a Monacobased consulting company,had internal emails go public showing that it may have been an intermediary for bribes involving numerous corporations) validates the argument that compliance cannot be a “check the box exercise.7
Anti-Corruption Due Diligence with Third Parties For high-risk third parties, which includes agents (in high corruption risk countries) that are providing introductions to government entities, there should be a higher level of due diligence. As noted in Exhibit 3 on the next page, this should include the following:
Independent Transactional Testing Along with the internal review processes mentioned previously, data analytics testing will assist with ensuring your anti-corruption program is operating effectively:
Exhibit 2. Transactions at High Risk for Corruption ● Travel approvals should be measured, monitored and scrutinized ● Web approval systems controlled date and number entries, accessible to legal and investigative depts can eliminate corrupt txns
●Above a nominal amount, strict processes that include sr mgr approval outside the country requesting the gift. ●The donation/gift should be legal and not be related to project approvals
Charitable / Political Donations / Gifts
Gov. Officials site visits
Expense reimbursement
Additional training
● Analyze sales reps’ (interfacing with gov. agencies in high risk places) reimbursement vouchers. ● Review high $, qty in total compared to other sales reps, high risk categories such as “misc”, “other”, “gifts”, “entertainment”
Volume 25, Number 3
●For employees involved in high risk transactions, such as sales reps. and approvers of their disbursements reimbursements, provide periodic add’l scenario based anti-corruption training. ● Let them know their txns are being reviewed in detail
23
The Corporate Governance Advisor
Exhibit 3. Anti-Corruption Due Diligence with Third Parties
Request
Invesgate
Document
•Request references, ownership interests (over 10%), financial statements, location and addresses of entity and key owners/employees.
•Use experienced investigators with local resources to corroborate informaon provided, review local criminal and civil litigation records.
•Note reacon to request for informaon.
•Run name match on sanctions lists, Politically Exposed People (“PEP”) lists and international terrorist watch lists.
•Document findings and red flags •Be prepared to “walk away” based on red flags found. •If a third party is approved as a vendor, include in your contract (consult experienced aorney) •A “right to audit” clause (exercised periodically and without advanced notice) •Anti-corruption language requiring current and future anti-corruption law certification of all employees/owners. •Termination of contract clause if corrupon has occurred involving third party
•Third parties that refuse to provide informaon or are surprised/offended could be indicave of inexperience or a red flag of potential corruption.
•
•Search for negave media on third party.
of specific digits with the same significance. For example, if you observe multiple amounts just below approval thresholds such as $24,999, $249, and $24, the second digit, “4,” has an occurrence greater than is natural according to Benford’s law. Such behavior may be indicative of an attempt to circumvent approval processes for purposes of making corrupt payments.
Conduct prioritized data analytics testing based on high-risk divisions, vendors/agents (based on type and monetary amounts paid), or locations. ❍
Test project purchase order and invoice data including quantity, pricing, and descriptions while comparing to other arms-length transactions with review by third-party objective experts. For example: ❏
❏
❏
Look for low digit or consecutive invoice numbers (indicating that you might be the only customer for a vendor or potential shell company).
❍
Identify potential duplicate invoices by examining those with the same date and amount for invoice numbers such as “1a” or “2b.”
•
Using Benford’s law,8 test invoice amounts for unnatural frequencies
The Corporate Governance Advisor
24
Compare project vendor addresses with those of other vendors, employees, and related parties to identify potential conflicts of interests.
Based on investigation of data analytics testing results, eliminate false positives and perform “on the ground gum shoe” investigating. For example, if you find two bidders that are consistently winning bids, visit the location. In parts of Latin America,
May/June 2017
Make sure before entering into international, high-risk transactions that you have a robust and risk-based anti-corruption compliance program with sufficient internal controls in place so your organization can avoid the “film noir” atmosphere encountered by these Brazilian business entities.
different addresses and vendor names can lead you to the same location. Site visits can also provide you with information on whether the vendor can actually provide the service or manufacture the product. A residential address that is billing for large power generators may be either a distributor or a false vendor. In addition, check whether the product or service was actually delivered or provided.
Notes 1. https://www.wsj.com/articles/brazil-carwash-shrugsoff-notoriety-tied-to-petrobras-scandal-1434930402, last accessed March 26, 2017.
Post-Script
2. US v. Odebrecht S.A., Cr. No. 16-643 RJD)(T. 18, U.S.C., § 371 and § 3551 et seq)
As of the date of publication, it is unknown what the conclusions will be of the ongoing investigations by Brazilian authorities of Eletrobras. There is a continuing Eletrobras internal investigation, and it is unknown what will transpire, if anything, regarding the pending class action lawsuit.
3. https://www.justice.gov/opa/press-release/file/919901/ download, last accessed March 26, 2017. 4. Development of the Angra 3, the third nuclear reactor in Brazil, originated in the mid 1980s but was shelved until 2008. 5. h t t p : / / g l o b a l d o c u m e n t s . m o r n i n g s t a r. c o m / DocumentLibrary/Document/1dad90e9cc4d796b38601ce 60b994674.msdoc/original/d173088d20f.htm#toc173088_4, last accessed March 26, 2017.
In the meantime, the Petrobras scandal does not seem to be going away. In February 2017, Panamanian investigators raided Mossack Fonseca law firm offices, the law firm that was the integral player in the “Panama Papers” scandal. Ten months before the raid, documents were leaked implicating companies and individuals using the law firm as a safe haven for tax evasion. Now there are allegations by Panamanian and Brazilian authorities related to Odebrecht bribe payments being connected to Fonseca.
Volume 25, Number 3
6. Id. 7. See “The Unaoil Corruption Scandal: Where Was the Due Diligence?” Dun & Bradstreet, April 21, 2016, http:// www.dnb.com/perspectives/corporate-compliance/unaoilcorruption-scandal.html, last accessed March 26, 2017. 8. https://en.wikipedia.org/wiki/Benford’s_law, last accessed March 26, 2017. Benford’s law, also called the first-digit law, is an observation about the frequency distribution of leading digits in many real-life sets of numerical data. The law states that in many naturally occurring collections of numbers, the leading significant digit is likely to be small.
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The Corporate Governance Advisor
