Latin American Corruption and Corporate Fraud

A few years ago, when many international companies began business units in Argentina, a renowned American corporation acquired an Argentine company that manufactured metal structures. The operation seemed like a gold mine because of the high profit margins. There was just a minor detail, which wouldn’t have been relevant had it not been a Latin American country: public works contributed to about 60 percent of the company’s gross income.

The agreement between the corporation and the company included installing the former owner, an Argentine native, as president of the metal structure company. The company’s owner was famous for his ability to establish good business relations with people in the government. But he had also lived and studied in the United States, which helped to create trust and forge a close relationship with the representatives of the American corporation.

The corporation completely trusted the new president. It didn’t place any limitations on him and didn’t modify its rules for control and auditing to fit the new situation. The agreement only established that U.S. headquarters’ representatives would conduct simple quarterly on-site audits with just the president. They didn’t ask him any tough questions, and all seemed in order. The profit margins remained high and the headquarters’ bosses were happy, so the corporation didn’t place any further controls on the company. That was a big mistake.

When revenues unexpectedly shrunk, the company discovered that the president had embezzled more than US$3 million and had bribed federal officials so he could acquire lucrative public works contracts. And in the process, the U.S.-based corporation had unwittingly violated the U.S. Foreign Corrupt Practices Act (FCPA).

DEEPLY ROOTED PROBLEM? 

Some say corruption in Latin America is an endemic, deeply rooted, idiosyncratic cultural phenomenon. At least that’s the stereotype. The huge number of corruption cases could be enough evidence to support this point of view.

Transparency International’s Corruption Perception Index, the compilation of experts’ opinions gathered through various opinion surveys around the world, reports perceptions on public corruption in 163 countries. This index ranks nations in a scale from 0 to 10 with 0 the highest level of perceived corruption and 10 the lowest.

[Graphs referenced below are no longer available. — Ed.]

Graph A and Graph B show the evolution of this index for Latin America. Graph A includes details for some countries of the region, and Graph B compares the index against those of other regions of the world.

Graph A indicates that most of the Latin America countries share similar levels of perceived corruption with almost the same evolution. An important exception is Chile’s highest rank. Also notice that Colombia improved from a score of 2.6 to almost 4. Argentina reached its lowest level in 2003-2004; it’s slowly recovering from this drop but hasn’t yet reached the high scores it had in 2000-2001.

Graph B reveals that after a recovery of the level of perceived corruption in the late 1990s, Latin America has once again fallen to lower levels than Asia’s, which shows a recurring trend: less perception of corruption in Asia, more in Latin America.

Though many consider corruption as some sort of permanent cultural stigma, I would rather believe that it can be mitigated through conscientious efforts. Corruption strengthens via a series of practices, habits, and beliefs that can be modified. The problem of corruption in the last few years has been changing from an intractable conundrum into a problem to be solved.

Corruption has become an urgent concern not only for the judiciary system of each Latin American country but also for many local political institutions. In past years, institutions specialized in fighting corruption were created in many countries. Specific legislation, such as Ley Federal de Transparencia y Acceso a la Información (Federal Law in Transparency and Information Access) in México, and an anti-corruption law recently approved in Brazil, are good signals. However these acts are in their beginning stages, and enforcement isn’t adequate yet.

The recent incorporation of Chile into the Organization for Economic Co-operation and Development brought new regulations against fraud including establishment of required fraud prevention committees for all businesses. In Bolivia, legislators are negotiating to pass the “Marcelo Quiroga Santa Cruz” bill, which will fight strongly against corruption in the future and investigate past suspicious cases including fortunes of dubious origin. The bill, introduced in 2007, was deadlocked in the Senate, but a version should be approved.

In most cases, international organizations have aided the search for solutions. Transparency International has 12 offices in several Latin American countries and is a regular consultant of anti-corruption plans in those countries. OAS (Organization of American States) is also fighting corruption in Latin America. The Centro Interamericano de Información Jurídica en Materia de Lucha Contra la Corrupción (American Center of Legal Information in the Field of Anti-Corruption) is a good source for national plans, legislation, papers, and institutions fighting corruption.

GOVERNMENTS’ STRONG INFLUENCE 

National and local Latin American governments strongly influence and regulate currency exchange policies, subsidies, and incentives to companies, all of which create too many opportunities for corrupt practices.

Latin America economies are more dependent, in varying degrees, on fluctuations in international prices of commodities than countries in other regions. Major fluctuations in commodities’ pricing generate major discretionary governmental policy changes, which can affect an entire industry and create stronger motivations for corruption.

Governments’ impunity in many Latin American countries means they can easily launder money, which helps create a vicious cycle: impunity allows money laundering, and the gained purchasing power increases the capacity to buy people and therefore more impunity. This is reinforced by tolerance for tax havens and the lack of international cooperation agreements against them.

Other conditions that can contribute to corruption include political decisions that allow transfer of income from one sector of the economy to another; and weak treatment and application of rules and laws regarding taxes, public works, and service hiring.

Here are just a few additional factors of which to be aware when searching for Latin American corruption:

Administrative Disorder

Lack of efficient public administration might act as a sort of “passive corruption” – limited or incomplete records make it impossible to carry out controls and follow cash flows. U.S.-based companies shouldn’t rely on government records on their business interactions, but they should keep their own.

Discretionary Power of Some Authorities

Local government officials often have unlimited power of decision on economic matters of companies located in the country. For example, they might decide on the supply or pricing of highly demanded goods and services, which would result in the state’s monopoly.

During the 1990s, Latin American economies underwent a series of changes and transformations; some of them were developed within the framework of the International Monetary Funds’ Enhanced Structural Adjustment Facility.

After the 1980s Latin American debt crisis, many countries in the region needed to eliminate large deficits and regain the ability to pay. The Argentina government, for example, privatized several public enterprises (steel, railroads, production and distribution of natural gas, a commercial airline, and other services), which reduced the level of public spending, paid defaulted debt, and reduced some fraud risks.

Many other countries in the region also transferred public enterprises to the private sector, which lessened governmental discretion. However, public works still represent an important part of countries’ Gross Domestic Product.

Poor Development of a Tax Culture

Latin American citizens don’t consider paying taxes mandatory. On the other hand, governments often don’t have strict controls on taxes or tax laws, which allow managers to follow the unethical demands of the shareholders and find ways of increasing profit margins. I’m not saying that no one in Latin American countries pays taxes, but governments in other parts of the world (especially the United States) are more stringent in enforcing tax laws.

Though corruption does exist in most levels of administration of almost every country of the region, it’s still possible to separate it from cultural norms, link it to criminal economic and political practices, and tackle it head on. We can go beyond theoretical discussions and consider corruption a consequence of these practices and not just cultural features, which opens us up to concrete crime-fighting options.

NEW EMPHASIS ON FCPA 

In the last few years, the U.S. government has placed renewed emphasis on its Foreign Corruption Practices Act (FCPA) for companies with their main headquarters in the United States. (See sidebar article on page 54.)

In January 2009, the former director of worldwide factory sales for Control Companies Inc., pleaded guilty to three counts of violating the FCPA in connection with an alleged scheme of improper payments to Brazilian foreign officials. Control Companies is a California-based corporation that manufactures and sells industrial service valves for use in nuclear, oil and gas, and power generation facilities.

Another recent case in Brazil involves Nature’s Sunshine Products Inc., of Provo, Utah, a manufacturer and marketer of encapsulated herbs and vitamins, which settled SEC charges relating to alleged violations of the FCPA. The SEC’s complaint alleges that in 2000 and 2001, former employees in the company’s Brazilian subsidiary made undocumented cash payments to customs brokers, some of which were later paid to Brazilian customs officials to allow unregistered products to be imported and sold in Brazil. The SEC filed a settled enforcement action against two officers of Nature’s Sunshine Products Inc. – CEO Douglas Faggioli and CFO Craig Huff – saying they violated the books and records and internal controls provisions. It was the first time the SEC used “control person” liability in an FCPA case.

The long-awaited December 2008 settlement with Siemens AG resulted in more than US$1.6 billion in combined penalties (in addition to a previous settlement with German regulators), which far exceeded all previous FCPA-related sanctions. This settlement confirms the U.S. government’s expansive jurisdictional view as to the applicability of the FCPA and clearly indicates that foreign regulatory investigations and prosecutions can serve as the basis for investigations by U.S. regulators.

Siemens and three of its subsidiaries – Siemens Argentina, Siemens Venezuela, and Siemens Bangladesh – incurred total fines of US$800 million paid to U.S. authorities. (The judgment also stated that Siemens will pay an additional fine of approximately $569 million to the Munich, Germany, Office of the Prosecutor General, to which the company had previously paid an approximately $285 million fine in October 2007, totaling US$1.6 billion.) (Source: www.ethicsworld.org)

According to the Dec. 16, 2008, article in The New York Times, “Siemens to Pay $1.34 Billion in Fines,” (the headline should have read “$1.6 Billion”) by Eric Lichtblau and Carter Dougherty, officials said that Siemens, beginning in the mid-1990s, used bribes and kickbacks to foreign officials to secure government contracts for projects like a national identity card in Argentina, and mass transit work in Venezuela, among many others.

The United States claimed partial jurisdiction in the case because Siemens, once it was listed on the New York Stock Exchange in 2001, was subject to American financial laws and regulations including FCPA.

Helmerich & Payne (H&P), an Oklahoma-based oil and gas drilling company, has agreed to settle FCPA bribery and books and records charges in connection with improper payments made to government officials in Argentina and Venezuela. From 2003 through 2008, subsidiaries of the company, H&P Argentina and H&P Venezuela, made some 50 improper payments totaling approximately US$185,000 to foreign customs authorities in connection with the international passage of drilling equipment parts into and out of drilling sites. The payments were made to evade higher duties and taxes on the goods, which saved the company more than US$320,000. (Source: www.ethicsworld.org)

These are just a few of the companies that have violated the FCPA and paid the price. All U.S.-based companies that have Latin American subsidiaries must:

1. Ensure that all transactions, agreements, payments, and disbursements among U.S. and Latin American parties are approved in writing.

2. Conduct a FCPA risk assessment especially if a foreign government is a direct customer.

3. Establish an FCPA compliance policy.

4. Communicate that compliance policy to all employees and ensure they understand the importance of FCPA compliance.

5. Incorporate FCPA requirements into internal controls.

6. Keep accurate and detailed accounting books and records for later audits.

EMBEZZLING, BRIBING CORPORATION PRESIDENT 

Let’s get back to our opening case. The U.S.-based corporation had completely trusted the former owner, now new president, of the Argentine metal structure company they had bought. As long as profits were growing, they placed no controls on this Argentine national.

But then revenues unexpectedly shrunk. The president said the company had lost some contracts. Sales continued to deteriorate so the big bosses demanded a deeper explanation. The head office finally decided to fly in members of the audit committee who interviewed several employees.

Based on these interviews, the audit committee determined that the revenue drop resulted from the loss of a key public works contract. The U.S. managers hired an independent external auditor who would be in charge of a thorough investigation with no restrictions.

The independent auditor instantly discovered that the company had bribed an official in federal government to acquire the contracts, and when that “inside man” left his position those contracts didn’t renew. The company never noticed the crimes because its president had unrestricted authority and could assign company assets with virtually no supervision or control.

When an employee would suspect irregularities, managers would consider it a common practice and they wouldn’t report it. The company acquisition was just a formal change for them; the president continued managing business as if he were the actual owner of the firm. Internal auditors reported to the president, and they didn’t question his decisions. Employees didn’t have an anonymous hotline or website, so their complaints never reached the auditors.

Obviously, we now can understand the need for immediately hiring independent auditing services, especially when the person in charge of the company manages to dodge internal controls. Moreover, external investigators have a broader perspective on fraud and are acquainted with the tools to detect it or set up the necessary measures to prevent it. Various international consulting companies equipped with fraud-fighting tools, among them forensic accounting and computer forensics, have been expanding their reach in Latin America during the past few years.

The independent auditors discovered the president had made withdrawals without proper justification and invoiced expenses to a mystery company, which had grown exponentially in the past few months. Employees explained that the president had approved these expenses, but the independent auditors never found these written authorizations because the authorization policy had never been enforced. Later, the president confessed to the bribes but didn’t explain the destination of the funds paid to that mysterious company.

During a second stage of the investigation, the auditing committee found those irregularities were just the tip of the iceberg. Irregular payments, nonexistent invoices, fake receipts, and expenses on “business facilitations,” were only a few of the darker discoveries. The company had no idea it was violating the FCPA, but it acted quickly to fix the situation and avoided any penalties.

The investigation’s final results concluded that the president – the former owner of the company – had taken advantage of his unlimited power, lack of internal controls, and the commonly accepted use of bribes to embezzle more than US$3 million. The independent auditors finally discovered that the president’s wife “owned” the mysterious company that had received the undue payments.

The corporation sued the former president, using the forensic audit report and computer forensics – such as imaged e-mails and electronic documents – as expert opinion evidence. The lawsuit lasted more than three years. Finally, the judge approved the seizure of the goods, and the company recovered 60 percent of the fraud losses.

LESSONS LEARNED 

We can learn some simple lessons from this investigation. It’s not necessary to install complex control systems, innovative re-organizations, or the latest technology to help prevent this type of corruption. (Though all companies would benefit from those activities.) We only need to consider a few important steps to ensure the safe control of branches or subsidiaries located in distant locations.

• Task division: The president’s unlimited power led to a centralization of tasks, which isn’t safe in any context. The special talents of a company president, CEO, CFO, or any other key member might be invaluable, but this shouldn’t allow him or her to have absolute control, authorization, and records of all operations. (In this case, the president wasn’t in charge of the records, but he established the rules on how to keep them.)
• Control system: “If it’s not broken, don’t fix it” doesn’t apply here. If the company had set up a functional system from the start, it might have prevented the president from committing his crimes or they might have been discovered earlier. The company’s No. 1 priority should be to devise an efficient way of controlling its cash flow. An adequate system would include transaction level controls over authorizations, verifications, and reconciliations, and ongoing monitoring by external auditors. 
• FCPA: Managers and employees of U.S.-based companies should be in compliance with this act and understand its violations. In this case, the accounting department, to comply with the FCPA, should have scrutinized the governmental public works contracts and observed the provisions about record keeping.
• External Audit: Any external auditor should have fraud examination and/or forensic accountancy skills so he or she will not only search for fraud but be able to strongly recommend prevention and detection tools. This is crucial in Latin American subsidiaries owned by U.S. companies but managed by natives. And internal audits, which should be as autonomous as possible, should also report directly to the board or headquarters’ audit committee to guarantee full independence.
• Contract review and approval policy: Companies should assemble a standard operating procedures manual on contract review and approval. This manual, which should include all issues that might arise related to commercial agreements, must be given to all personnel. Periodic compliance monitoring reviews also are strongly recommended.
• Continuous staff training on FCPA’s scope and requirements: Any entity doing business in Latin America must have ongoing employee one-on-one training, workshops, and e-learning on FCPA to prevent breaches of the act.

I could add many other recommendations. However, the key point is that if your company has subsidiaries in Latin America, or is participating in any business in the region, it must closely monitor those entities regardless of each business unit’s profitability.

Learn the Latin American business culture before venturing into the area so you’ll know the common pitfalls and ingrained corruption schemes. (Obviously, this is good advice when your company expands into any area of the world.) You never want to leave new assets unsupervised and controlled almost exclusively by local managers. If you do, you will pay for your inattention.

Diego Cano, MBA, CFE, is managing director-forensic and litigation consulting for FTI Consulting in Buenos Aires, Argentina.

Anti-bribery Provisions of the U.S. Foreign Corruption Practice Act 

The FCPA makes it unlawful to bribe foreign government officials to obtain or retain business. With respect to the basic prohibition, there are five elements which must be met to constitute a violation of the Act:

A. Who: The FCPA potentially applies to any individual, firm, officer, director, employee, or agent of a firm and any stockholder acting on behalf of a firm. Individuals and firms may also be penalized if they order, authorize, or assist someone else to violate the antibribery provisions or if they conspire to violate those provisions.

Under the FCPA, U.S. jurisdiction over corrupt payments to foreign officials depends upon whether the violator is an “issuer,” a “domestic concern,” or a foreign national or business.

An “issuer” is a corporation that has issued registered securities in the United States and must file periodic reports with the SEC. A “domestic concern” is any individual who is a citizen, national, or resident of the United States, or any corporation, partnership, association, joint-stock company, business trust, unincorporated organization, or sole proprietorship which has its principal place of business in the United States, or which is organized under the laws of a State of the United States, or a territory, possession, or commonwealth of the United States.

Issuers and domestic concerns may be held liable under the FCPA under either territorial or nationality jurisdiction principles. For acts taken within the territory of the United States, issuers and domestic concerns are liable if they take an act in furtherance of a corrupt payment to a foreign official using the U.S. mails or other means or instrumentalities of interstate commerce. Such means or instrumentalities include telephone calls, facsimile transmissions, wire transfers, and interstate or international travel. In addition, issuers and domestic concerns may be held liable for any act in furtherance of a corrupt payment taken outside the United States. Thus, a U.S. company or national may be held liable for a corrupt payment authorized by employees or agents operating entirely outside the United States, using money from foreign bank accounts, and without any involvement by personnel located within the United States.

Prior to 1998, foreign companies, with the exception of those who qualified as “issuers,” and foreign nationals were not covered by the FCPA. The 1998 amendments expanded the FCPA to assert territorial jurisdiction over foreign companies and nationals. A foreign company or person is now subject to the FCPA if it causes, directly or through agents, an act in furtherance of the corrupt payment to take place within the territory of the United States. There is, however, no requirement that such act make use of the U.S. mails or other means or instrumentalities of interstate commerce.

Finally, U.S. parent corporations may be held liable for the acts of foreign subsidiaries where they authorized, directed, or controlled the activity in question, as can U.S. citizens or residents, themselves “domestic concerns,” who were employed by or acting on behalf of such foreign-incorporated subsidiaries.

B. Corrupt intent: The person making or authorizing the payment must have a corrupt intent, and the payment must be intended to induce the recipient to misuse his official position to direct business wrongfully to the payer or to any other person. You should note that the FCPA does not require that a corrupt act succeed in its purpose. The offer or promise of a corrupt payment can constitute a violation of the statute. The FCPA prohibits any corrupt payment intended to influence any act or decision of a foreign official in his or her official capacity, to induce the official to do or omit to do any act in violation of his or her lawful duty, to obtain any improper advantage, or to induce a foreign official to use his or her influence improperly to affect or influence any act or decision.

C. Payment: The FCPA prohibits paying, offering, promising to pay (or authorizing to pay or offer) money or anything of value.

D. Recipient: The prohibition extends only to corrupt payments to a foreign official, a foreign political party or party official, or any candidate for foreign political office. A “foreign official” means any officer or employee of a foreign government, a public international organization, or any department or agency thereof, or any person acting in an official capacity. You should consider utilizing the Department of Justice’s Foreign Corrupt Practices Act Opinion Procedure for particular questions as to the definition of a “foreign official,” such as whether a member of a royal family, a member of a legislative body, or an official of a state-owned business enterprise would be considered a “foreign official.”

The FCPA applies to payments to any public official, regardless of rank or position. The FCPA focuses on the purpose of the payment instead of the particular duties of the official receiving the payment, offer, or promise of payment, and there are exceptions to the antibribery provision for “facilitating payments for routine governmental action” (see below).

E. Business Purpose Test: The FCPA prohibits payments made in order to assist the firm in obtaining or retaining business for or with, or directing business to, any person. The Department of Justice interprets “obtaining or retaining business” broadly, such that the term encompasses more than the mere award or renewal of a contract. It should be noted that the business to be obtained or retained does not need to be with a foreign government or foreign government instrumentality.

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