Last month, Stryker Corporation joined a rather ignominious list of recidivists under Foreign Corrupt Practices Act (FCPA) enforcement annuls. The company had previously sustained a FCPA enforcement action back in 2013, paying a penalty to the Securities and Exchange Commission (SEC) of $3.2 million, together with disgorgement and interest of $9.7 million for a total fine and penalty to the SEC of $12.9. The first FCPA enforcement action involved conduct in multiple countries from 2003 to 2008 and was settled via a Cease and Desist Order (prior Order).
In this second penalty in 2018, the company paid a fine of $7.8 million to the SEC. It was settled via a Cease and Desist Order (Order). It involved conduct from 2010 to 2017, each means that the FCPA violative conduct occurred after Stryker had settled its initial FCPA enforcement action. The bribery schemes involved in this second SEC fine were in several countries including India, Kuwait and China. Each of these bribery schemes provides multiple lessons to be learned by the compliance professional.
Over the next two blog posts, I will discuss this second enforcement action as it has several unique aspects which I wish to drill down in some detail. Stryker’s sales models was the traditional distributor model in China and Kuwait and the dealer model in India. Every Chief Compliance Officer (CCO) which uses these models should study this Stryker enforcement action in some detail. However even if your organization does not use these sales models, it is important that a compliance practitioner understand the risks of these sales models so that if your organization considers using them, you can not only point out the risks but also have a risk management strategy in place.
The largest portion of the Order dealt with the company’s operations in India. The business model Stryker used was dealers and although it does not explicitly state, it appears the dealers were close to a distributorship sales model. The dealers purchased Stryker products at a discount and then sold the products at an uplift over their costs. However in a twist from the standard distributor model, the dealers were not free to negotiate their sales prices with customers: hospitals, doctors and health care providers (HCPs) but rather “Stryker India authorized these dealer transactions only after Stryker India’s management negotiated and approved the price that the hospitals would pay to the dealers. Thus, in determining the price charged to dealers, Stryker India’s management and the dealers specifically negotiated the profit margin such dealers would stand to earn based on the difference between what hospitals paid the dealers and what the dealers paid Stryker India.”
This Stryker policy of negotiating the cost structure would seem to have been a risk management strategy but the purchasers of Stryker products from the dealers would then request and receive from the deals an inflated invoice, with a price at an uplift above the agreed upon pricing. These inflated costs were passed on to the HCP’s patients, customers and their insurers. The HCP would pay the agreed upon price structure and pocket the uplift paid by the patients, customers and their insurers. It is not clear from the Order if this uplift was pocketed by individuals as bribes or simply fraudulent over-charging by the HCPs.
After complaints were made to Stryker’s India subsidiary (Stryker India), the company initiated an investigation of certain dealers. The internal investigation “uncovered evidence of such overbilling by one dealer when it conducted audits of three dealers in 2012. Yet Stryker failed to devise and maintain a system of internal accounting controls sufficient to detect, address, and prevent this widespread practice at the dealer level, which violated Stryker’s own policies governing the activities of Stryker India’s dealers.”
Even worse for Stryker, in 2015, it “performed audits of other dealers in India. The audits revealed that the practice of Stryker India’s dealers inflating invoices for the sale of Stryker orthopedic products to certain private hospitals – an improper practice identified three years earlier in connection with the 2012 audits – had become more widespread. Certain private hospitals in India (mostly large, corporate hospitals) routinely asked dealers to mark up the cost of the orthopedic products above the price that those hospitals had directly negotiated with Stryker India and actually paid to Stryker India’s dealers. In doing so, dealers allowed these private hospitals to gain a windfall from passing on the higher (invoiced) prices to their patients or their insurance companies.”
Here the company had a traditional distributor model which sold Stryker products to state-owned hospitals. The bribery scheme was more straight-forward, as “From 2015 through 2017, the Kuwait Distributor made over $32,000 in improper “per diem” payments to Kuwaiti HCPs to attend Stryker events, when Stryker had directly paid the costs for lodging, meals, and local transportation for these individuals. Stryker had in place certain internal accounting controls relating to third parties that limited transactions to those that complied with their contractual undertakings to adhere to Stryker’s anti-corruption policies and procedures.”
During this time period Stryker attempted to audit its third-party distributor and the distributor denied the attempted audit. The Order stated, “When Stryker sought to exercise its audit rights under its distribution agreement with the Kuwait Distributor to review records to determine whether improper payments had been made to any government official, the Kuwait Distributor denied access.” Stryker had not before attempted to audit or otherwise review the Kuwait Distributor’s records to determine whether it was complying with Stryker’s policies even though Stryker had previously received a complaint from a former employee of the Kuwait Distributor alleging that the “Kuwait Distributor paid bribes in connection with the sale of Stryker products.” The Order went on to state, “Stryker failed to sufficiently implement policies to test or otherwise assess whether the Kuwait Distributor would allow the company to exercise its audit right to review records”.
Once again, the sales model for Stryker in China was through the distributor model. There was one state-owned distributor who would then distribute the company’s products through sub-distributors. The Order noted, “From 2015 through 2017, at least 21 sub-distributors of Stryker’s Sonopet products in China were not vetted, approved, and trained by Stryker in accordance with its internal accounting controls. During that time, the sale of some Sonopet products to hospitals involved third, fourth, and even fifth tier sub-distributors, none of which were subjected to due diligence approval or training.” Moreover, “Stryker China employees worked directly with these unauthorized sub-distributors, and at other times installation records were falsified to hide the involvement of the unauthorized sub-distributors in the sale of Sonopet products.”
Stryker had a third-party management system which consisted of the five-steps of risk management: (1) business justification, (2) questionnaire, (3) due diligence, (4) compliance terms and conditions and (5) management after contract execution. There was no evidence presented in the Order that, of the 21 unauthorized distributors identified, the company followed this process.
Tomorrow I will consider the specific FCPA violations, the actions Stryker took in response to these findings and the lessons to be learned for the compliance practitioner.
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© Thomas R. Fox, 2018