Yesterday, I wrote about the Cardinal Health, Inc. Foreign Corrupt Practices Act (FCPA) resolution with the Securities and Exchange Commission (SEC). One of the areas that many compliance practitioners confuse is evaluating the risk of business venture partners in the same manner they evaluate the risk of third parties, typically on the sales side. They then assess and manage business ventures risks exactly they would as with third parties. However, business ventures, whether Joint Ventures (JVs), partnerships, franchises, team agreements, strategic alliances or one of the myriad types of business relationships a US company can form outside the US, are different than the usual risk presented by third parties under compliance requirements such as those mandated by the FCPA. Business ventures are different and must be, assessed, evaluated and managed differently.

These problems continue to exist in places like China and India where there have been a number of FCPA enforcement actions involving US companies which enter these markets via a JV. They have some sort of arms-length business relationship with a Chinese or Indian company; then they move to a JV relationship; and as the final step they end up buying out the foreign partner so that they bring the JV into the company. By the time of the full merger into the US organization, the corruption is so established and ingrained that it continues. Then it is no longer them doing bribery and corruption; it is now you doing the bribery and corruption.

Consider the business risk for JVs. It begins with the business reason for setting up the JV. The US company wants a connected, well-placed partner who can gain them influence in the foreign market. That foreign partner may be a government official, employee of a state-owned enterprise, or a state-owned enterprise itself. Mike Volkov has said, “by definition the JV relationship you are creating has risks in terms of why you are even doing business with them or even bringing them to the joint venture”. The next problem is in JV governance.

The first problem was why the JV was created but the next is how it will be created? Will it be 50/50 ownership between the US and foreign partner or something else? If it is 50/50 how will you split the Board or other governing body? How will you resolve final disputes? All of these questions should be considered from the compliance perspective.

Next, what are the incentives of all the parties and what are the roles that everybody is going to take on regarding the business operation? Volkov has further noted, “if you have a 50/50 joint venture then you would have a situation where the joint venture itself retains third-parties or distributors.” Whose third-party risk management program will be followed? What if red flags arise, who and, more importantly, how will they clear them going forward?

Next is the JV going to use lobbyists and consultants to facilitate the JV operations? The foreign partner may want to hire third parties with no US partner input. The bottom line is that this is an incredibly high risk which requires more than just third-party risk management strategies because you need to get into the guts of the business; how it was created, how it operates and then how is it going to operate.

A different situation comes into play with franchisors and international franchising. Here the issue may be one of control and you must look at the nature of the relationship between the parties in a franchise relationship. Most franchise agreements raise significant FCPA risks. They are outside the classic agent/distributor situation, subsequently a business needs to take a hard look at the nature of the business venture or how it is operating, why the people have gotten together, next look at the intricacies of the business and, finally, apply a risk analysis to the entire transaction.

In addition to the “following the money” issues present in every business relationship, the franchisee may also hire its own third-parties, have its own interactions with foreign government regulators and, of course, have its own compliance program in place. Yet how many international franchisors have thought through all of these compliance requirements? Regarding franchising, it is both structure and oversight that are required. A company must use its full compliance tool kit in managing the relationship. Sitting back, putting compliance requirements in a franchise agreement will simply not suffice. There must be active management of the compliance risk going forward on an ongoing basis.

Another business venture which requires a different approach from traditional third parties is  distributors. Here most of their attention is on the pre-contract phase of the risk management process, with most of the efforts spent on due diligence and less on managing the relationship after the contract is signed. However, many facets of a corporate relationship with a distributor are closer to those of other business venture partners.

One of the issues in any compliance program is the compensation paid to a business venture partner as FCPA exposure arises when companies pay money – either directly or indirectly – to fund bribe payments. In the traditional intermediary scenario, the company funnels money to a business venture partner who then passes on some or all of it to the bribe recipient. Often, the payment is disguised as compensation to the intermediary, and some portion is redirected for corrupt purposes.

When companies grant distributors uncommonly steep discounts, bribes can result either: 1) because the distributor is instructed by the company to use the excess amounts to fund corrupt payments; or 2) because the distributor pays bribes on its own, without the express direction or implicit suggestion from the company to do so, to gain some business advantage. The 2012 FCPA Guidance notes that common red flags associated with third-parties include “unreasonably large discounts to third-party distributors.” The distributor enforcement cases offer lessons to combat this scenario, which is where legitimate companies require assistance.

The bottom line is that many compliance practitioners have not thought through the specific risks of business ventures such as JVs, franchises, strategic alliances, teaming partner or others as opposed to sales agents or representatives on the sales side of the business. I hope that this will help facilitate a discussion that maybe people will begin to think about more of the issues, more of the risk parameters and perhaps put a better risk management strategy in place

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© Thomas R. Fox, 2020