Don't let U.S. focus crimp oversight abroad: with increased SEC and DOJ scrutiny on U.S. companies' business practices in foreign countries, a myopic focus on U.S. policies and procedures can detract from oversight of FCPA violations.

In the wake of the Sarbanes-Oxley Act of 2002, companies have invested significant time and money to ensure compliance with U.S. laws and regulations. However, these laws and regulations are the Achilles' heel of many U.S. companies with foreign operations. A myopic focus on home office policies and procedures can detract from oversight of overseas operations. In particular, significant risks exist when companies neglect to monitor for violations of the Foreign Corrupt Practices Act (FCPA).

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While the FCPA has been in place since the 1970s, there has been a recent spike in investigations by both the U.S. Securities and Exchange Commission (SEC) and the Department of Justice (DOJ). This current trend is the result of companies moving more aggressively into emerging markets like India and China, where anti-bribery laws tend to be somewhat lax.

Provisions of Sarbanes-Oxley itself are another reason why scrutiny of FCPA violations has increased. Not only is there overall concern with corporate governance, prompting regulators to increase their watchfulness, but an important Sarbanes-Oxley provision encourages companies to set up whistleblower programs to facilitate the reporting of fraud and other illegal activity. Whistleblower programs have been proven to increase the reporting of suspicious activity.

And, because FCPA violations such as bribes and money laundering are often associated with terrorism, the DOJ has stepped up its vigilance.

Penalties for violating the FCPA can be harsh. Companies that pay off foreign officials are liable for up to $2 million, or twice the gross gain or loss derived from the bribe. Individuals can be fined up to $250,000, or twice the gross gain or loss derived, and can incur a prison sentence of up to five years. Companies found guilty of improper and misleading record-keeping can pay up to $2.5 million in fines. The repercussions for individuals are even more severe; these include a maximum $1 million fine and up to 10 years in prison.

Pitfalls of Emerging Markets

Many companies fail to evaluate the risks before entering a new market. Often, poorly trained employees assume a "when-in-Rome" attitude, not realizing that the local way of doing business may be a direct violation of U.S. laws and regulations. It does not help that U.S. companies that abide by these laws and regulations tend to face an uneven playing field, sometimes losing out to competitors from countries that do not adhere to such practices. Even when companies do have similar legislation, it is not necessarily enforced with the same vigor as in the U.S.

Prior to beginning business in a new country, it is important to thoroughly research the business environment. The global organization, Transparency International (www.transparency.org), compiles a "corruption index" every year to help companies understand the potential risks arising in certain countries (see Table on page 26).

When trying to penetrate a new market, businesses will often hire agents or consultants to assist with activities such as obtaining licenses. These individuals know the local business community and have access to the right government officials; when they offer legitimate assistance, they are a real asset. However, agents can pose risks because while some act properly, others do not. Often, relatives of foreign officials who have decision-making authority may set up consulting firms to facilitate transactions for foreign businesses. Paying individuals in such positions of influence can be considered a violation of the FCPA.

It is critical for companies to conduct a full background investigation of any agent or consultant they hire. Some federal agencies like the Department of Commerce and the Department of State will even assist with that process (they keep lists of individuals who have had previous FCPA violations). Such due diligence has an additional benefit: it creates a document trail that may be important if, despite its best efforts, a company is subject to an investigation. The company will then be able to show that it acted in good faith and tried to detect and deter FCPA violations.

Nevertheless, a background investigation is not always enough. Even after agents receive the green light, companies must continually monitor agent and employee activity. For example, if a company is paying an agent a flat fee for services and reimbursing expenses, the agent must show how that money is being used. Also, agents' contracts should clearly state that any violation of the FCPA is unacceptable--because ultimately, the company can be held liable for that agent's actions.

The FCPA does acknowledge the complexities of conducting business in emerging markets. It includes exceptions that allow certain payments to help ease the transition into a country. These payments must be aimed at facilitating government procedures, as opposed to sidestepping them. For example, a company can hire an agency to facilitate the processing of employee passports and other paperwork. Similarly, many companies hire local representatives to help move equipment through customs quickly. This is normally considered legitimate, as long as the agency is not linked to government officials who oversee the process. The FCPA also allows companies to hire police protection to keep their employees safe.

Monitoring Behavior

To identify violations before the SEC does, companies should be aware of the following red flags:

* Payments going offshore or to unusual addresses. People involved in illegal activity want to put money in places where their government cannot get at it. For example, in Russia, payments may be going to the Cayman Islands. The Office of Foreign Assets Control www.ustreas.gov/ofac) and the Financial Crimes Enforcement Network (www.fincen.gov) both offer lists of known money laundering havens.

* Frequent cash disbursements. Distribution of large cash sums is often an indication that bribes are being doled out.

* Over-utilized accounts. Accounts that cover payments for intangible services are often used to veil illegal payoffs. For example, if the legal accounts or consulting accounts appear over-utilized, it is possible that illegal payoffs are being made. Companies should pay particular attention to activity in these accounts and demand supporting documentation for services rendered.

* Lack of proper approval process. Wire transfers typically require the sign-off of two high-ranking officials. However, employees involved in bribery or money laundering will often verbally approve wire transfers because they do not want their signature on such transactions. Look for instances where managers have opted to override these internal controls.

* Deals with complex legal structures. When there are several layers of lawyers involved in a transaction, it's easy to lose track of payment flows. Funds that are ostensibly used to cover business meetings necessary for hashing out the details of a complex contract might instead be used for bribes. These types of expenditures should be examined closely, particularly when multiple firms are involved.

* Unusually high or low profit margins on projects. Profit margins cannot always be taken at face value. For example, profit margins might be high because no work is being performed. Very often, this red flag is ignored; so consider whether foreign operations are losing or making too much money.

* Payments in round dollar amounts. The Bank Secrecy Act requires financial institutions to report suspicious cash transactions. There is also a dollar threshold of $10,000, above which the filing of a Currency Transaction Report or a Suspicious Activity Report is required. Thus, companies involved in money-laundering will often transfer funds in amounts just below the $10,000 reporting threshold, but often still in round numbers. If a company observes a series of transactions in round dollar amounts below the reporting threshold, this is a pattern that is consistent with money laundering activity and should be investigated.

Education and Communication

While it helps to know how to spot violations, knowing how to prevent them is even more important. The companies that are most successful in deterring FCPA violations usually do the following:

* Educate employees about laws, regulations and internal policies. Employees being sent to manage foreign operations need to fully understand the provisions of the FCPA. Best-practice companies develop detailed training with interactive case material. They often require that employees sign an annual FCPA statement stating that they understand the Act. This also documents that the company has been proactive in communicating that it will not tolerate improper business practices.

* Provide mechanisms to report violations. A comprehensive whistleblower and complaint-handling process ensures that employees have a confidential means of notifying the home office of improper behavior.

* Monitor for compliance. Auditors, compliance officers or ethics officers should have some formal involvement in overseeing foreign operations.

* Respond quickly and appropriately to reported violations. The worst thing an organization can do is to have suspicions raised and not properly respond to allegations. Not only is this a guaranteed way of running afoul of the regulators, it also sends a message down through the ranks that the company is not serious about punishing improper behavior.

At the first report of suspicious activity, the organization should conduct a prompt and thorough investigation. It may need to disclose certain information to the SEC, terminate employees, or even walk away from a lucrative contract. Finally, the results of any investigation should be used to develop strategies for deterring future violations.

Extending the Tone from the Top Beyond the Borders

The due diligence required to comply with the FCPA may mean that, in some cases, U.S. companies in emerging markets will not be as competitive as businesses from other nations. If a government investigation does occur, a strong FCPA program will reduce the risk of criminal prosecution or civil sanctions because regulators will consider whether the business fostered an anti-bribery culture or one where violations could thrive.

In the U.S., Sarbanes-Oxley has placed companies on notice that intentional misrepresentation of their financial statements will not be tolerated. Thus, companies must remember that the importance of ethical and legal behavior does not stop when a company extends its operations overseas.

There is a common misperception that when "no one is watching," U.S. law does not apply. As the FCPA demonstrates, nothing could be further from the truth. Companies that believe otherwise, do so at their own peril.

William Olsen is a Principal in the Forensic Accounting and Investigations practice of Grant Thornton. He is based in McLean, Va., and can be reached at [e-mail].

RELATED ARTICLE: takeaways

* While the Foreign Corrupt Practices Act (FCPA) has been in place since the 1970s, there has been a recent spike in investigations by regulators as companies move aggressively into markets like China and India.

* Many companies fail to evaluate risks before entering new markets, and employees fail to realize local business practices may violate U.S. laws and regulations.

* Companies that pay off foreign officials are liable for up to $2 million, or twice the gross gain or loss derived from the bribe; individuals can be fined up to $250,000, or twice the gross gain or loss derived, and incur a prison sentence of up to five years.

RELATED ARTICLE: Transparency International Corruption Index

LOW-SCORING COUNTRIES

 1) Finland
 2) Iceland
 3) New Zealand
 4) Denmark
 5) Singapore
 6) Sweden
 7) Switzerland
 8) Norway
 9) Australia
10) Netherlands

HIGH-SCORING COUNTRIES

 1) Haiti
 2) Myanmar
 3) Iraq
 4) Guinea
 5) Sudan
 6) Congo, Democratic Republic
 7) Chad
 8) Bangladesh
 9) Uzbekistan
10) Equatorial Guinea