I have not written much in honor of the centennial of the First World War (WWI). However this week I will to remedy this oversight by focusing on the Battle of the Somme, leading up to the first day of the long battle, which began on July 1, 1916. I cannot say precisely why this one battle has long held such fascination for me. Perhaps because I first read a detailed account of it in John Keegan’s seminal work The Face of Battle back in 1976. I subsequently read other, more detailed works on the battle.
In many ways the Battle of the Somme was a defining moment in British history. Perhaps only Waterloo (defeat of Napoleon) was as important and certainly only Hastings (1066 and all that) was more important. In raw numbers, no other battle in British history comes close to the horrific slaughter of British manhood, with 20,000 killed and another 40,000 wounded on the opening day of the campaign. The campaign lasted five months and cost the British nearly 420,000 casualties. Many authors have struggled to explain the battle and its costs. As a reader, I have struggled to understand the same issues as a reader. Yet there are lessons to be learned from the battle and its aftermath, which I will use as an introduction to my blog posts this week.
Last week the Securities and Exchange Commission (SEC) announced a resolution of an outstanding Foreign Corrupt Practices Act (FCPA) action involving the company Analogic Corporation (Analogic) and Lars Frost (Frost), a former Chief Financial Officer (CFO) of its wholly-owned Danish subsidiary BK Medical ApS (BK Medical). Separately BK Medical settled its outstanding FCPA enforcement action with the Department Of Justice (DOJ) via a Non-Prosecution Agreement (NPA). BK Medical agreed to pay a fine of $3,402,000. In a settlement with the SEC, Analogic agreed to pay $7.7 million in disgorgement and $3.8 million in prejudgment interest. Frost agreed to a fine of $20,000.
Analogic is a medical device manufacturer headquartered in Massachusetts, primarily manufacturing ultrasound equipment. Its sales method into Russia, as well as other countries, was through its Danish subsidiary BK Medical and then through distributors. It was through this mechanism that the bribery and corruption was facilitated. And what a bribery scheme it was.
As stated in the SEC Order, “From at least 2001 through early 2011, BK Medical participated in hundreds of highly suspicious transactions at its distributors’ direction which posed a significant risk of bribery or other improper conduct. The suspicious transactions involved BK Medical’s distributor in Russia, as well as, to a lesser extent, its distributors in Ghana, Israel, Kazakhstan, Ukraine, and Vietnam. The transactions routinely involved fictitious invoices issued by BK Medical at inflated prices, overpayments to BK Medical from the distributors against the inflated invoices, and subsequent payments by BK Medical out of the distributors’ excess funds to unknown third parties all over the world for unknown reasons. In short, for at least nine years, BK Medical acted as a conduit for its distributors to funnel money to parties, and for reasons, unknown to BK Medical. Approximately $20 million flowed through BK Medical from these distributors, with over $16 million from BK Medical’s Russian distributor.”
Down in his CFO office at BK Medical, Frost “personally authorized approximately 150 conduit payments to unknown third parties during his tenure at BK Medical despite knowing that the payments violated BK Medical’s internal accounting controls. Frost also submitted numerous false quarterly sub-certifications to Analogic.”
False Contracts and Bogus Invoices
The SEC Order gave exacting detail on how the illegal payments were created and funded. “The first step involved the creation of one or more fictitious documents reflecting an inflated purchase price for the product or products BK Medical was selling to the Russian distributor.” From there, “the Russian distributor would request that BK Medical create a fictitious, second invoice at an inflated price. The Russian distributor would send BK Medical a template invoice with the inflated price, which was regularly well in excess of 100% of the original, agreed-upon price. BK Medical’s distributor sales staff understood the inflated price to reflect the price the ultimate end user would pay to the distributor.”
BK Medical would then “cut and paste BK Medical’s logo onto the template invoice and complete other pertinent fields, such as an invoice number. These steps were taken outside BK Medical’s standard invoice-generation system, in violation of BK Medical’s internal accounting controls. The fictitious, second invoice would subsequently accompany the ultrasound products when they were shipped to Russia. An invoice prepared by BK Medical’s standard invoice generation system reflecting the agreed-upon, actual price would also be sent to the Russian distributor”.
Next the Russian distributor would send BK Medical a bogus contract at this higher price that the Danish-subsidiary would approve it. The Russian distributor would then pay against the bogus contract and invoice. BK Medical would book the true or original contract price and credit the excess amount to the Russian distributor.
As set out in the NPA’s, in addition to these fake contracts, with their attendant payments, the Russian distributor “would send BK Medical an invoice that purported to be from the third-party entity that was to receive a payment from BK Medical. These invoices referred to services being rendered to BK Medical as, among other things, “marketing,” “logistic service,” and “commission.” BK Medical employees have confirmed that none of these entities actually rendered any services to BK Medical and that they understood this fact at the time these invoices were received by BK Medical.”
Payments Based on False Documents
Of course this excess amount had to be sent somewhere for a bribe to be paid and sent somewhere the payments were. The SEC Order stated, “Then, at some point weeks or months later, the Russian distributor would direct BK Medical to make a wire payment out of the excess funds to a third party that was otherwise unknown to BK Medical. BK Medical complied with the directives, despite not knowing the purpose of the payments or the nature of the payees.” The payees were largely shell companies located in the usual locations for suspicious payments: Belize, the British Virgin Islands, Cyprus and the Seychelles and made payable “to specific individuals in Russia.”
All of these payments were made outside of and in violation of Analogic’s internal controls. Over a 10-year period, these payments totaled approximately $16.1 million and BK Medical recorded over $21.6 in profits from these transactions. There were other countries where this or a similar distributor-based bribery funding mechanism was used. These countries were “Ghana, Israel, Kazakhstan, Ukraine, and Vietnam” to the tune of some $3.8 million.
As blatant as all of the above was in terms of an overt bribery program, it did not pass unnoticed. As early as 2004, BK Medical’s Vice President (VP) of Sales asked the purpose of the payments. He was told “Russian market conditions.” Moreover, in 2008, Analogic recognized the potential for FCPA violations by BK Medical. The parent corporation provided training to BK Medical but it stopped there and did not inquire further into the Russian agent. So red flags were identified and raised yet there was no follow up action by the corporate parent.
Tomorrow, I will consider more lessons from the Battle of the Somme and how a company, which engages in such a blatant bribery program, can achieve the rather stunning result that Analogic sustained.
How did Analogic obtain such a favorable FCPA settlement result in view of their subsidiary’s bribery program?Click to tweet
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© Thomas R. Fox, 2016