Cutting Out The Middleman?

Thursday, January 1, 2004 - 01:00

This article was taken from Control Risks Group's annual report RiskMap, which forecasts global opportunities and hot spots around the world. For more information on RiskMap, e-mail Leah.Robilotto@control-risks.com.

Three International Corruption Cases

In southern Africa...

The first case involves international engineering companies in the southern African state of Lesotho, and their alleged use of intermediaries to bribe Masupha Sole, the former chief executive of the Lesotho Highlands Water Project (LWHP). Sole is now in prison serving an 18-year sentence for corruption.

In September 2002, the Lesotho High Court convicted a Canadian company on two charges of bribery, and later sentenced it to a fine of $2.25m. The case revolved around its employment of a commercial representative, who had paid bribes to Mr. Sole via his Swiss bank accounts. The company appealed, arguing that it had no knowledge of the commercial representative's relationship with Mr. Sole. In August 2003, the Appeals Court dismissed one charge and reduced the fine, but upheld the main charge. Meanwhile, the Lesotho High Court had in June 2003 convicted a German company on similar charges of bribery via an intermediary. The Lesotho authorities have also initiated proceedings against companies from France and Switzerland, and may initiate proceedings against companies from Italy and the UK.

Kazakhstan...

The second case involves similar issues. In April 2003, a New York grand jury charged a U.S. lawyer with conspiracy, violations of the Foreign Corrupt Practices Act (FCPA), mail and wire fraud, money laundering and subscribing to false tax returns. The case concerns U.S. oil companies' purchase of Kazakh oil rights in the 1990s. The U.S. lawyer who served as a special adviser to Kazakh President Nursultan Nazarbayev, is accused of transferring around $78m to Kazakh officials as bribes in connection with the sale of rights to oil fields and pipelines. The money was transferred via Swiss bank accounts and - as with the Lesotho case - the Swiss authorities are cooperating with the U.S. investigation. The large amounts of money involved mean that the case could be the largest-ever FCPA violation. It has yet to come to trial.

and Iran

The third case involves a Norwegian company. In September 2003, Norway's National Authority for Investigation and Prosecution of Economic Crime (Oekokrim) launched an investigation into the company's business dealings with Iran. In 2002, the Norwegian company had agreed to pay $15.2m to a small consultancy registered in the Turks and Caicos Islands in return for advice on 'financial, industrial and social issues' in Iran. The money was to be paid via a Swiss bank account. By the time that the Norwegian company cancelled the contract in early September, it had already paid $5.2m, prompting suspicions that the consultant was being used as a conduit to pay bribes in Iran.

Public controversy over these payments led to the successive resignations ofthe company's head of international exploration, its chairman and its chief executive. In late September, the U.S. Securities and Exchange Commission (SEC) announced that it was holding its own enquiry into the company's contract with the consultant. The Norwegian company comes within the SEC's jurisdiction because of its listing on the New York Stock Exchange. Its share price fell significantly in the week after news of the police investigation became public.

Deniability And Liability

These three cases have several features in common. First, they run counter to the outdated conventional wisdom that suggests that companies have limited responsibility for what commercial intermediaries do - or are suspected of doing - on their behalf. If these intermediaries pay bribes, their employers can deny that they knew what was going on.

The issue of deniability was particularly significant in Lesotho. The Canadian company claimed that it had 'no knowledge or suspicion' of the payments made by its representative to Mr. Sole. It added that the company 'could not have anticipated them, had no motive for them, and received no benefit.' Both the High Court and the Appeals Court rejected this claim. The Crown acknowledged that its case was built on circumstantial evidence, but argued that this evidence was compelling. Among other points, it highlighted the secretive nature of the agreement with the representative, and challenged the company's need for a representative at a time when it was already well established in Lesotho. The representative had regularly passed on a set percentage of his fees within days of their arrival in his Swiss account; when Sole, the recipient of the bribes, finally lost his appeal against dismissal, the company reduced payments to the representative by this same percentage.

Secondly, the three cases reflect an emerging trend in international law enforcement. The U.S. has set the lead by prosecuting its own companies for foreign bribes, even when this is arguably against the national economic interest. Lesotho is an unusual example of a poorly resourced African state prosecuting an international company; it could not have succeeded without the help of the Swiss authorities. The investigations of the Norwegian authorities fall under new legislation conforming with the Organization for Economic Co-operation and Development (OECD) 1997 convention against transnational bribery. International corruption cases are difficult and expensive to investigate, but further high-profile prosecutions can be expected in 2004.

The third issue concerns reputation. In the Canadian company's case, the fine that it has to pay will be painful enough. However, the company's greatest concern will be the impact on its ability to win new international contracts, particularly those that depend on funding from the World Bank and other development banks. The Norwegian company suffered a fall in its share price and lost three senior employees at an early stage in the police investigation, before any offence had been proved. In law, individuals and companies are innocent until proven guilty. In the world of reputation, suspicion can be enough to inflict significant commercial damage.

What Is To Be Done?

It may be unrealistic to cut out intermediaries completely, but it is clear that the formal and informal rules of international business are changing decisively. Working within the new - and still emerging - rules will demand judgment and skill.

At a minimum, international companies are expected to conduct careful due diligence enquiries into the background, status and current reputation of their commercial representatives. Their relationship with such representatives is expected to be transparent and carefully documented. Employers will need to make absolutely clear that agents must not pay bribes on their behalf. Perhaps most importantly, company fees are expected to be commensurate with the services provided.

This last point will be one of the most problematic, particularly in sectors such as the arms industry, where it has been customary to pay by commission. At the very least, companies will need to be able to establish that their payments are in line with industry norms. These norms are themselves liable to change: percentage-based commissions are harder to justify in the case of projects worth tens or hundreds of millions of dollars.

Joint-venture partnerships will be another difficult area. If the foreign partner has majority control, it will be in a position to impress its own standards on the venture. This will be more difficult if the external party has no more than a minority shareholding. Companies will need to review whether they are willing to enter joint ventures if they cannot be assured of high ethical standards.

Under the new rules of international business, legal compliance is only the starting point. Companies will need to be sensitive to the reputational impact of everything that they do - regardless of whether there is a risk of prosecution for malpractice.

The use of commercial intermediaries - representatives, consultants and joint venture partners - is often an essential part of doing business in emerging markets. But these intermediaries are frequently associated with allegations of corruption and graft. Control Risks Group Director (Analysis) John Bray reviews three recent corruption cases and assesses the implications for international best practice.