Guarding Against Corruption In Emerging Markets

By: Kimberly Reed Issue: Global Trade Section: Jewel Of Collaboration

Why the U.S. is Made for Trade

Guarding Against Corruption

As American businesses routinely expand into emerging markets abroad through mergers, acquisitions, joint ventures, partnerships and greenfield investments, they invariably face traditions and cultures of corruption that are unfamiliar and highly frustrating to those accustomed to doing business under strict rule of law. For American companies and entrepreneurs, demands for bribes or other corrupt practices present a catch-22 -- if they succumb to the demands, they place themselves at risk for hefty fines and criminal penalties under the Foreign Corrupt Practices Act (FCPA) and other U.S. anti-corruption laws, as well as loss of financing and insurance, debarment from public contracts, and reputational damage. However, if they do not play along with demands of government officials in the foreign country, they could find themselves at distinct and perhaps fatal disadvantages in that market. How can U.S. businesses successfully navigate these dichotomies in such markets?

What kinds of corruption are illegal for US businesses?

“Corruption” is usually defined as the abuse of entrusted power for personal benefit or the benefit of those connected or related to the person in power. It is important to distinguish between two kinds of corruption: (1) “grease,” or facilitation, payments, which are bribes paid in order to motivate an official to accelerate a routine government action that s/he is required to perform, e.g., hasten a registration, ruling or approval that would eventually be granted anyway, or process a visa request; and (2) payments made to influence an official to do something that s/he is prohibited by law from doing (such as awarding a project without a required bidding process), or to obtain an improper advantage (such as bribing a judge to obtain a favorable ruling).

This distinction is very important because the FCPA allows (1) under certain circumstances, but prohibits (2) Virtually all emerging markets have specific laws against such illegal payments to officials, though these laws are frequently and even flagrantly ignored.

Where is corruption worst?

Despite the fact that corruption clearly discourages foreign investment and trade in a country, inhibits economic growth, warps meritocratic employment and promotion systems, causes domestic populations and companies to lose confidence in free markets, and undermines fragile democracies, countries classified as “emerging markets” have approached corruption with varying levels of seriousness.

According to Transparency International (TI), public officials in today’s emerging economic giants, Russia, India and China, are perceived to routinely demand and accept illegal bribes (as well as grease payments), with China ranking 72nd among 180 countries on the 2008 TI Corruption Perception Index, India ranking 85th, and Russia a dismal 147th. Other emerging markets showing poor scores are Vietnam (121st), Ukraine (134th), and Kazakhstan (145th), while faring considerably better are Singapore (4th), Hong Kong (12th), Chile and Uruguay (tied for 23rd), Slovenia (26th) and Estonia (27th). (By way of comparison, Denmark ranked first, Germany was 14th, the UK 16th, and the U.S. 18th).

Handshake and teamworkin Africa, Central and South America, and the giants of the East (Russia, China, India). In many of these countries, public officials are paid very low wages, and are therefore tempted to take bribes to supplement their incomes. For example, in Russia and many former Soviet states, it is virtually impossible for a traffic policeman to support his family on his meager official salary, so the populace has resigned itself to a police force that demands bribes to ignore violations of law (some of which are completely imaginary). This is true of low-level government officials in many countries as well.

However, wherever bribery exists at low levels of the bureaucracy, it is virtually certain to exist at high levels also, so that it is not unusual for a company seeking to begin operations in such a country to have bribes demanded at many different levels for each registration or approval necessary for their corporate, real estate, labor, import/export, and other necessary components of business.

TI also publishes a Bribe Perception Survey, which measures the likelihood of companies in 19 specific sectors to engage in bribery. In 2008, the Survey found that companies in the fields of public works contracts and construction; real estate and property development; oil and gas; heavy manufacturing; and mining bribed government officials most often, while those in information technology, fisheries, and banking and finance did so the least frequently. A separate ranking found that, again, companies in public works contracts and construction; real estate and property development; oil and gas; and mining were the most likely to attempt to wield undue influence on government rules, regulations and decision-making through private payments to public officials. TI noted that “[t]he banking and finance sector is seen to perform considerably worse in terms of state capture than in willingness to bribe public officials, meaning that its companies may exert considerable undue influence on regulators, a significant finding in light of the ongoing global financial crisis.”

How to guard against corruption in your expanding international organization

Of course, governments must play a key role in ensuring that corruption is eradicated in their countries. However, it is incumbent on U.S. businesses to ensure that they are compliant with U.S. laws such as the FCPA when they are operating abroad. Indeed, it is important to note that the FCPA can hold a company, its executives and directors responsible for bribes or other illegal behavior committed abroad by their employees, business partners, intermediaries or other agents even if they did not have direct knowledge of the illegal acts but “consciously disregarded” evidence of such acts.

Pay-Off This broad potential liability mandates that companies engage in aggressive risk management and compliance programs all the way down the corporate chain, including subsidiaries, joint ventures, intermediaries and agents. It is necessary to involve in this process legal counsel with excellent working knowledge not only of U.S. anti-corruption laws but also of doing business in the relevant country or region.

A compliance program must fit a company’s needs and circumstances, such as the size of the company and foreign operation, the type of management structure, and the extent of the company’s reliance on intermediaries and agents. In creating compliance programs, however, the following should be kept in mind:

Clear and detailed company ethics policies and procedures (often termed “codes of corporate conduct”) must be adopted, and should include not merely platitudes about operating ethically, but also specific examples of acceptable and unacceptable conduct. Each employee should be required to sign an acknowledgement of having read the code. In addition to a code for the entire company (translated into local languages as necessary), it is often deemed necessary and desirable to have additional “chapters” written for operations in other countries that address particular situations common in those countries or warnings about specific corrupt agencies or processes and how to handle them. Although codes of conduct are often met with skepticism by employees, the presence of such a code and a demonstrated commitment to its enforcement does make a difference in conduct and helps prove to a court of law or the U.S. Justice Department that the company takes this subject seriously and took steps to prevent corrupt practices.

Regular education and training must be implemented to ensure that changes in the law and in local practice are covered, that new employees are brought up to speed, and that employees have an opportunity to share experiences. Employees in a foreign country, along with agents and intermediaries of the company there, should be required to attend periodic seminars wherein the code and specific examples are discussed. This is particularly important in high-risk countries such as Russia, China, India, Nigeria, Vietnam and others. Management must be highly engaged and committed to anti-corruption measures and must communicate this value effectively and often to all employees and agents, especially those in foreign countries. Strict punishments must be enforced for any non-compliance and for executives and managers who turn a blind eye to violations or risky behavior.

Clear and well-publicized policies on confidentiality and non-retaliation are crucial. All employees should know who the corporate compliance chief is and should feel free to consult that person with any questions or concerns; indeed, whistle-blowing should be encouraged with respect to bribery and corruption, given the very high stakes. Issue 5 Guarding Against Corruption In Emerging Markets pic003 It is key that corporate compliance officers have open access to senior management and influence over conduct policies and procedures. However, it is also necessary that the compliance officer be someone that employees feel comfortable approaching with sensitive information. In this regard, periodic “360 degree” anonymous reviews of the compliance officer should be done to ensure that s/he is trusted and viewed as effective by individuals in the organization.

In addition to direct discussions with the compliance officer, employees should have access to suggestion boxes and/or “help lines” to report questionable conduct or offer suggestions anonymously.

Internal accounting and audit professionals should receive ongoing training in early detection of suspicious payments or expenses. Companies should enact clear accounting policies that prohibit off-the-books accounts and payments. Use of “Big Four” accounting and audit firms in foreign countries is very useful in this regard, as they are highly experienced in the local market’s potential for hiding bribes and other corrupt payments (such as hidden commissions and “bonuses” paid to local intermediaries or excessive hospitality or gifts). It should be noted that the FCPA requires compliance with various accounting and record-keeping provisions.

Acknowledge that gift-giving is an important part of some local cultures and is necessary for relationship building in some parts of the world. Corporate in-house and local legal counsel should speak frankly and extensively with each other in order to ascertain what the company can and cannot do, thus enabling it to follow local customs on gift-giving while also complying with U.S. and local law. American lawyers experienced with the FCPA can clearly explain what types of “grease” payments are allowable under U.S. law – in many cases, these kinds of payments will constitute the majority of bribes needed to do business effectively abroad.

When choosing intermediaries, joint venture partners, agents or suppliers (together “Partners”) in a foreign country, it is key to involve legal counsel and other professionals who can legally investigate the reputation and experience of the Partner-candidates. Require references from each potential Partner, and follow up with all such references, asking specific questions that address honesty and integrity. Document fully all findings and decisions with regard to chosen Partners. Be wary of any requests they make for urgent or cash payments, vague explanations of how an approval or business relationship will be accomplished, or other potential red flags. Additionally, maintain a system of ongoing monitoring of foreign Partners.

When starting business in a new country, be proactive by setting up meetings with the local U.S. Embassy’s Economics and Commerce Officers and the local branch of the U.S. Chamber of Commerce (if there is one) to learn where the potential corruption trouble spots are and how U.S. companies have best dealt with local corruption. Then, meet with local governmental officials (see #7 on gift-giving to local officials, which may be appropriate at this meeting) and explain your company’s business and how it will contribute to the local economy, and ask them how best to comply with local laws and to American anti-bribery and anti-corruption laws (which may have to be explained). In many cases, a commitment to a community project or to corporate social responsibility programs that will benefit local people can go a long way to demonstrating to local officials that a U.S. company will be a good corporate citizen so long as it finds the business environment favorable.

When performing due diligence on potential joint venture partners or acquisitions in a foreign country, engage legal counsel and accountants who are highly experienced in the local market. A lawyer who has practiced in the country will know what to look for. For example, when performing due diligence in Russia, we commonly look for and inquire about “gray tax schemes”; vaguely described monthly or quarterly payments (or missing funds) that might be bribes to ministry officials; lack of corporate approvals or decisions for corporate actions such as stock issuance or other capitalizations; loans to directors or employees; unpaid or miscalculated taxes, and many other features that are common to Russian businesses. Representations, warranties and covenants are highly important in acquisition and joint venture agreements, but cannot replace careful and thorough due diligence.

Even if all of these strategies are implemented, there is no guarantee that your company’s employees or representatives will not be approached for a bribe or that a corrupt official will not try to ensnare you into a scheme of some sort. However, accepting that corruption is almost a “normal” way of doing business in some emerging markets, and not naively turning a blind eye to it, is the first step toward protecting your business.

Taking proactive steps to increase internal transparency, train employees and representatives in acceptable and unacceptable business behavior, diligently investigate all business partners, and enact the practices detailed above, are excellent defenses, and will help to demonstrate to U.S. law enforcement as well as governmental officials and potential partners and customers in emerging markets that your company takes seriously its responsibility to do “clean business.”

Kimberly Reed is a International Business Lawyer and Consultant in Washington, DC and Moscow, Russia.