Risk Alert: Bribery Red Flags and Schemes
Andriy V. Kirmach
No one doubts that Ukraine has a corruption problem. The Ukrainian President reported that the country suffered budgetary losses of over USD 2.5 billion in 2012 because of corruption. According to the 2012 Corruption Perception Index published by Transparency International — Ukraine shares 144th place out of 174 countries together with Bangladesh, Cameroon, Republic of Congo, Syria and the South African Republic.
Nevertheless, Ukraine remains a developing country with a huge market where big profits can be generated. This is the reason why many international corporations do business here regardless of the risk. Although in light of recent anticorruption efforts worldwide, these risks have become unreasonably high. Many governments have passed new legislation that significantly increases the liability for corruption, including bribery of foreign officials. Enforcement authorities have increased the prosecution of corruption-related offences which have resulted in huge penalties for many world-known companies and jail time for individuals.
With the recent enactment of the UK Bribery Act (2010) and On Principles of Prevention and Combating Corruption Act of Ukraine of 7 April 2011 (the Anti-Corruption Act) as well as the aggressive enforcement of the US Foreign Corrupt Practices Act (FCPA) (1977), business was finally forced to take affirmative measures aimed at corruption prevention. Therefore, revealing bribery schemes and identifying corruption red flags became of crucial importance for every multinational company in Ukraine.
Bureaucracy equals corruption
In Ukraine, many business areas remain highly regulated or controlled by a massive state bureaucracy. For instance, every import shipment should be accompanied, depending on the product, with five to a dozen different certificates that evidence the product registration in Ukraine, hygienic safety, compliance with certain standards or technical regulations, and the like. Practically every business industry has separate regulations that require obtaining numerous licences, certificates and permits, e.g., for construction or agriculture, provision of telecommunication or healthcare services, even retail sales.
These regulatory approvals and associated bureaucracy create an area where virtually every company faces a bribery risk. This is primarily because the rules and procedures for the issuance of various regulatory documents originate from Soviet times where the bureaucracy was unbearable. Even after twenty years, the underlying legislation on permits and approvals contains so many inconsistencies and nuances that it becomes a real challenge to understand them, and not to mention, to carry them out. Such legislative ambiguity and complexity of procedures give significant discretionary powers to government authorities, which could easily delay or reject the application for a certificate or permit. Moreover, the process of getting regulatory approvals remains cumbersome and time consuming to this day because of the inefficient management of the administrative services system. Thus, many companies seek various opportunities to overcome government bureaucracy and to receive permits and approvals that are necessary for daily business.
These circumstances triggered the creation of a new service market of intermediary consultants and agents that help obtain various permits for business. Such consultants often provide quasi-legitimate services: collect application documents, fill in various forms, verify compliance of the application package with relevant legislation, etc. However, in many cases these consultants simply share their fees with government officials who agree to informally review the application package before filing, or accept/process the application on an expedited basis, or issue a permit without real examination of the case. This is how intermediary agents “guarantee” the success of their services. Though such guaranteed success also exposes a company that used the services of a tainted intermediary consultant or agent to bribery allegations. Enforcement authorities often reasonably argue that the company management knew or should have known that certain fees were funnelled to government officials through an intermediary consultant, thereby posing a risk of UK Bribery Act or FCPA violation.
Moreover, the Anti-Corruption Act specifically provides that legal acts adopted or official decisions made as the result of corrupt conduct may be cancelled on this basis by a competent authority or court. In practice this means that once the corrupt conduct is revealed, all certificates, permits and approvals could be challenged and cancelled, including material licences for certain types of commercial activity or registration certificates essential for importing goods into Ukraine.
Procurement of bribes
Even if a company was careful enough to procure all necessary permit documents for its products or operations without paying any illicit payments directly or indirectly, there are other risks of bribery ahead. After the regulatory compliance area, the second biggest group of bribery transactions relates to actual sales of products or services.
Public procurement tenders are commonly known as high risk sales. Many international corporations intentionally do not participate in tenders where public funds are awarded because government officials who run public tenders often require a kick-back payment that could range from 20% to 70% of the contract value from the tender winner. Ineffective public procurement legislation allows government officials to discretionally draft special tender conditions that allow only one product or company to win. Alternatively, government officials may insist that companies use designated distributors that have a longstanding history of successful participation in tenders. As a matter of practice, such successful distributors are often owned by relatives or other affiliates of the government officials responsible for the tender result. In addition to the obvious conflict of interests, these designated distributors also generate inflated prices that provide excessive profits for further distribution to government officials involved in the decision-making process.
Thus, even if a company does not directly participate in a public procurement tender, it may be still exposed to bribery allegations and liability. Under the UK Bribery Act or FCPA use of specific tender companies or payment of separate consultant fees to a third company at the direction of a government official would obviously be a red flag. Moreover, such direct or indirect bribery eventually increases the sales results of the manufacturing corporation and thus, the enforcement authorities may argue that the manufacturer benefited from the improper activity of the distributor who participated in the tender.
The Ukrainian Anti-Corruption Act also specifies adverse consequences for tainted tender results. Under the law, the contracts or other similar documents executed on the basis of corrupt action are deemed to be null and void. This means that business opportunities gained because of illicit arrangements would be automatically negated once the corrupt offence is revealed and no separate process is necessary for invalidation of the tainted contract. Moreover, the Anti-Corruption Act provides that incomes or other benefits resulting from corrupt practices or businesses should be confiscated by the state.
International contracts risk
In addition to the typical bribery risks and arrangements discussed above, there is also another group of risks which are not that obvious to understand. It is a rather common scheme in Ukraine and other CIS countries, where companies are advised by a distributor or buyer to use certain sales structures. Although such structures appear to be legitimate on the surface, closer examination of them may lead to the conclusion that significant bribery risks are generated by such sales structures. For instance, a customer from Ukraine agrees to buy certain products ex works offshore and suggests that the invoice be paid by its offshore parent or affiliate in Cyprus or Switzerland. Alternatively, the customer performs direct payment to the offshore manufacturer, but requests that the product delivery is made not to the buyer’s office in Ukraine, but to a warehouse in a neighbouring country, e.g., Moldova, Poland or in one of the Baltic States. Product manufacturers have reasonable grounds to pursue such sales structures as they allow companies to minimise logistics expenses and avoid concerns about customs clearance or necessary certification of the product in Ukraine.
However, from an anti-bribery standpoint, such sales structures need to be classified as red flags that require thorough review. This is because such schemes allow distributors or customers to manipulate customs clearance, inflate resale prices or perform other improper actions that allow the minimizing of customs fees and state duties. Such actions often require the making of improper payments to customs officials or other government officials and such payment may be eventually attributed to the product manufacturer. In several recent FCPA enforcement actions, the prosecution successfully argued that in these circumstances the customer or distributor acted for the benefit or on behalf of the product manufacturer, facilitating the import of its products to one of the countries of the CIS. Although under the Ukrainian Anti-Corruption Act the schemes described would not cause a risk unless the product manufacturer explicitly knew that improper payments were made for customs clearance of product certification, the contracts of indirect sales or shipment structures would likely expose the company to the risk of FCPA or UK Bribery Act liability.
Detection and mitigation plan
The increasing enforcement of international and local anti-corruption statutes against international companies worldwide requires that businesses reconsider the usual ways of doing business. The risk of penalties and other enforcement actions for bribery violations already amounts to the value of benefits gained by the illicit conduct and it could quite possibly be even higher than the benefits received. Thus, it is obviously high time for companies to revise their operations in Ukraine by eliminating improper business arrangements if any exist. Therefore, we recommend that companies implement a three step action plan:
Step 1: Assess Risks and Detect Red Flags. Undertake a careful examination of a company’s specific industry, business practices and market environment which would allow the identification of areas of highest corruption risks. It seems prudent to review obtained regulatory documents and verify that they were obtained in compliance with the law and, if intermediary consultants were used, that their actions would not qualify as a corrupt conduct that may be attributable to the company. For obvious reasons, companies also need to strengthen due diligence review of business partners and establish robust third party vetting procedures that would allow the detection of tainted distributors and agents. Depending on the risks identified, each company also needs to elaborate meaningful procedures that would eliminate or mitigate the risk of corrupt practices or violation of global anti-corruption statute requirement.
Step 2: Implement Procedures and Mitigate Corruption Schemes. Draft or review anti-corruption procedures which should be clear, effective and workable and ensure that their enforcement must be unflinching. None perhaps is more important than a due diligence policy that enables thorough review of partners and agents hired to assist with various business activities. Many anti-bribery experts agree that in the current anti-corruption enforcement environment the use of intermediary agents, consultants and even distributors should be minimised. Where it is impossible to eliminate intermediaries, companies are required to invest significant cost and effort into proper training and control over such intermediaries.
If companies identify corrupt arrangements during the risk assessment, it is essential to work out a separate mitigation plan that eliminates the risk of liability or other adverse effects. It is also necessary to consider the merits of possible local or international reporting of revealed corrupt actions to prosecution authorities.
Step 3: Train Employees and Ensure Top Commitment. This step allows the institution of strong and effective commitment towards the company’s values, policies and procedures. The regular training of personnel and business partners allows the dissemination of ethical business values. In order to be able to spot bribery red flags and schemes, employees should be aware of those risks and understand the possible arrangements and corporate liability. Thus, proper training will ensure a day-to-day anti-bribery effort which will increase the chances of catching improper conduct and eliminating or mitigating risks at an early stage.
Finally, a top level anti-corruption commitment from management is essential to change the business culture in Ukrainian subsidiaries of multinational corporations by promoting compliance and corporate integrity.
