Last week’s announcement by the Securities and Exchange Commission (SEC) of the resolution of its outstanding Foreign Corrupt Practices Act (FCPA) enforcement action with Halliburton Company continues to resonate and provide lessons for the compliance practitioner. [Full disclosure – I am a Halliburton shareholder] I wanted to continue to explore the enforcement action around the issue of internal controls, their effectiveness (or lack thereof) and management over-ride of internal controls.
In a Cease and Desist Order which also covered former employee Jeannot Lorenz, the SEC spelled out a bribery scheme facilitated by both a failure and over-ride of company internal controls. The matter involved Halliburton’s work in Angola with the national oil company Sonangol, which had a local content requirement. The nefarious acts giving rise to the FCPA violation involved a third-party agent for Halliburton’s contracts with the state-owned enterprise.
According the SEC Press Release, this matter initially began in 2008 when officials at Sonangol, Angola’s state oil company, informed Halliburton management it had to partner with more local Angolan-owned businesses to satisfy local content regulations. The company was successful in meeting the requirement for the 2008 contracting period.
However, when a new round of oil company projects came up for bid in 2009, Sonangol indicated, “Halliburton needed to partner with more local Angolan-owned businesses in order to satisfy content requirements.” The prior work Halliburton had on local content was deemed insufficient and “Sonangol remained extremely dissatisfied” with the company’s efforts. Sonangol backed up this dissatisfaction with a potential threat to veto further work by Halliburton for Sonangol. It was under this backdrop that the local business team moved forward with a lengthy effort to retain a local Angolan company (Angolan agent) owned by a former Halliburton employee who was a friend and neighbor of the Sonangol official who would ultimately approve the award of the business to Halliburton.
In each of these attempts, the company bumped up against its own internal controls around third parties, both on the sales side and through the supply chain. The first attempt to hire the Angolan agent was as a third-party sales agent, which under Halliburton parlance is called a “commercial agent”. In this initial attempt, the internal control held as the business folks abandoned their efforts to contract with the Angolan agent.
The first attempt to hire the Angolan agent was rejected because the local Business Development (BD) team wanted to pay a percentage fee based, in part, upon work previously secured under the 2008 contract and not new work going forward. Additional fees would be paid on new business secured under the 2009 contract. This payment scheme for the Angolan agent was rejected as the company generally paid commercial agents for work they helped obtain and not work secured in the past. Further, the company was not seeking to increase its commercial agents during this time frame (Halliburton had entered into a Deferred Prosecution Agreement (DPA) for FCPA violations in December 2008 for the actions of its subsidiary KBR in Nigeria).
Finally, “As outlined by Halliburton’s legal department, to retain the local Angolan company as a commercial agent, it would be required to undergo a lengthy due diligence and review process that included retaining outside U.S. legal counsel experienced in FCPA compliance to conduct interviews. Halliburton’s in-house counsel noted that “[t]his is undoubtedly a tortuous, painful administrative process, but given our company’s recent US Department of Justice/SEC settlement, the board of directors has mandated this high level of review.”” In other words, the internal controls held and were not circumvented or over-ridden.
The Angolan agent was then moved from commercial agent status to that of a supplier so the approval process would be easier. The proposed reason for this switch in designations was that the Angolan agent would provide “real estate maintenance, travel and ground transportation services” to the company in Angola. However, the internal controls process around using a supplier also had rigor as they required a competitive bidding process which would take several months to complete. Over-riding this internal control, the local business team was able to contract with the Angolan agent for these services in September 2009 and increase the contract price, all without the Angolan agent going through the procurement internal controls.
A second internal control which was over-ridden was the procurement requirement that the supplier procurement process begin with “an assessment of the critically or risk of a material or services”; not with a particular supplier and certainly not without “competitive bids or providing an adequate single source justification.” However, as the Order noted, the process was taken backwards, with the Angolan agent selected and then “backed into a list of services it could provide.” Finally, there was a separate internal control that required “contracts over $10,000 in countries with a high risk of corruption, such as Angola, to be reviewed and approved by a Tender Review Committee.” Inexplicably this internal control was also circumvented or over-ridden.
Yet this arrangement was not deemed sufficient local content by Sonangol officials. After all of this and further negotiations, Halliburton entered into another agreement with the Angolan agent, where the company would lease commercial and residential real estate and then sublease the properties back to Halliburton at a substantial markup, and also provide real estate transaction management consulting services (the “Real Estate” contract).
This Real Estate contract also had to go through an internal control process. Initially, there were questions by the company about the Real Estate contract as a single source for the procurement function, the upfront payment terms to the Angolan agent, the high costs, and the rationale for entering into subleases for properties that would cost less if leased directly from the landlord. Indeed, “One Finance & Accounting reviewer at headquarters noted that he could not think of any legitimate reason to pay the local Angolan company over $13 million under the Real Estate Transaction Management Agreement and that it would not have cost that much to run Halliburton’s entire real estate department in Angola.”
Halliburton internal controls required that when a single source was used by the company it had to be justified. This justification would require a showing of preference for quality, technical, execution or other reasons, none of which were demonstrated by the Angolan agent. Finally, if such a single source was used, the reasons had to be documented or in Halliburton’s internal controls language “identified and justified”. None were documented by the company.
Finally, as the internal controls were either circumvented or over-ridden; “As a consequence, internal audit was kept in the dark about the transactions and its late 2010 yearly review did not examine them.” This was yet another internal control failure but was built on the previous failures noted above.
So how many internal controls failures can you spot? Whatever the number, the lesson for the compliance practitioner is that you must do more than have internal controls. They must be followed and be effective. If you are doing business in high risk regions, you have to test the controls and then back up your testing by seeing if payments are being made in those regions. Perhaps the best concept would simply be Reaganian, trust but verify.
Internal controls must be effective and a CCO must test and verify that effectiveness.Click to tweet
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© Thomas R. Fox, 2017