Foreign Corrupt Practices Act Presents New Risk for Franchisors

The FCPA has two provisions: anti-bribery rules and standards for proper bookkeeping, records, and internal controls. The anti-bribery provisions prohibit U.S. companies and their personnel, U.S. citizens, and other persons while in the United States from corruptly paying, offering to pay, promising to pay, or authorizing the payment of money, a gift, or anything of value to a foreign official in order to obtain or retain business. Foreign companies with shares listed on a U.S. stock exchange or otherwise required to file reports with the SEC also are covered.

“The terms 'money, a gift, or anything of value' are very broad,” said Spearing. In a paper that accompanied the presentation, the authors listed cash or cash equivalent, gifts, services, charitable donations, political contributions, loans, travel expenses, sporting events, or entertainment outings as potential violations. “Also, you don't have to give the money in order to be in violation of the Act. If you even authorize it, you could be found guilty,” she added.

The law goes even further by explicitly making covered companies responsible for corruption by third parties they have engaged. As described in the paper, businesses are held up to a tough standard of knowledge about their business partners:

Due to the knowledge standard, not only may a company be held responsible for the illegal actions of others if it authorizes such actions, it can also be held responsible if it is reasonably aware that an illegal bribe could take place. Thus, 'companies and their employees may not consciously disregard or deliberately ignore suspicious facts before entering into or during a third-party contract.' [Robert W. Tarun, The Foreign Corrupt Practices Act Handbook, 93 (2010)] As a result, even if a third party is not an agent of the company, the company may be held liable if it is doing business with the third party, and is aware of or otherwise involved with the violations of the FCPA by that party.

And third parties “are often the crux of these cases, such as when an agent or intermediary pays a bribe for an introduction to a foreign official,” Spearing said.

Yet franchisors clearly need to work with third parties, such as agents and master franchisees, said Yaffe. “Franchisors need agents and partners overseas who know the customs and practices of the foreign local market,” said Yaffe. “But with those partners comes risks ' especially if franchisors turn a blind eye to what is going on.”

Making matters more complicated, the definition of “government official” has been interpreted broadly by the SEC and DOJ. For example, in countries with state-owned or state-controlled businesses, franchisors might not realize that their business partner is considered to be a government official under the FCPA. “The U.S. enforcement agencies deem such personnel as 'foreign officials' regardless of rank or title or how the personnel are classified under local foreign law,” the authors wrote in their paper.

Finally, the accounting provisions of the FCPA act almost like add-on penalties when violations are found, according to Spearing. “These are 'gimmes' for enforcement because when bribery occurs, there's almost always inaccurate bookkeeping [to hide it],” she said. “Bribes are often called 'fees.' The SEC does not even have to prove intent on the accounting violations.”

Risk Factors and Red Flags

Given that franchisors need to work with agents and third parties, how can they reduce the likelihood of incurring FCPA violations? Yaffe said that it's a difficult balancing act. For example, a franchisor operating in countries or regions that have a reputation for high levels of bribery of public officials and kickbacks in public procurement would be expected to conduct extensive due diligence on any partners or agents and to work closely with them to ensure FCPA compliance. But the more oversight a franchisor exercises, the more it is vulnerable to the claim that it should have known about a violation.

Franchisors should start by being aware of “red flags” ' that is, the business activities in which problems are most likely to occur. “Real estate purchases are a big area for bribery,” Yaffe said. “Look at a real estate deal. Are you paying more than the fair market value? Who is the broker on that sale, and what are his connections?”

Wal-Mart might be ensnared in just such a violation in Mexico, as the DOJ said earlier this year that it is investigating allegations that its subsidiary in Mexico might have paid more than $24 million in bribes for construction permits, licenses, and inspection certificates.

Another red flag might be a master licensee that has not been able to secure several prime locations for expansion, but which suddenly is able to obtain the best sites. A franchisor should investigate the situation, even though the master licensee will surely argue that it is operating as an independent contractor and should not face extra scrutiny.

Franchisors also should demand detailed invoices from their agents that include expenses and the names of people they are entertaining, Yaffe said. “Watch out for lavish gifts, travel, and hospitality for government officials paid by your agents,” he said. Even legal entertainment or travel can slide into bribery, such as has been alleged in some FCPA enforcement actions when businesses were cited for paying per diems to foreign officials or paying for expenses beyond the business-related parts of the trip. “You can bring officials to the United States to see how a franchise is operating, but you can't then pay to extend their trip with a junket to Las Vegas,” he said.

Fees are another area in which the line between legal and illegal is finely drawn. Franchisors can legally pay a licensing or permitting fee, a customs fee, or even make routine, nominal payments to facilitate a payment or currency exchange, said Yaffe. When those fees are excessive and when the fees go directly to a government official, they could be deemed as FCPA violations. “These are real problems that occur every day, such as when a franchisor has items held up in customs,” Yaffe said.

How the McDonald's Compliance System Works

With franchises in nearly every country in the world, McDonald's has grappled with FCPA compliance in many environments, and it's a serious matter, said DiLorenzo, who is Senior Counsel for Global Compliance and Privacy. “Our goal is to have high-level oversight within our company and to hold people accountable,” she said. “Compliance reports directly to the board, as well as to the legal department. And we have very strong whistle-blower protections that protect any report made in good faith.”

The McDonald's compliance program starts at the corporate level with an enterprise-wide risk assessment that is constantly updated. “We're growing rapidly in China and Russia, and corruption is at every level [in those countries],” she said, “so we know we have to be extra-vigilant.”

The company includes anti-corruption language in its contracts, and it provides mandatory anti-corruption training in every country in which it operates in the home country's language, said DiLorenzo. “We distribute hard copies of our anti-corruption policies to all managers, and we communicate to all of our licensees, too.” The policy not only prohibits bribes and gifts to government officials, but it also goes a step further by prohibiting similar forms of commercial bribery, as well as kickbacks.

Every agent who works with McDonald's undergoes careful due diligence before contracts are signed, and the level of scrutiny rises with the size of the contract. McDonald's uses third parties to conduct much of the due diligence, and it has them pay extra attention to any person who has at least a 10% ownership stake in the agent company. Casting a wide net because of the broad interpretation of the FCPA, McDonald's seeks information about service providers for its franchises such as architects, permit expediters, real estate brokers, tax consultants, lobbyists, and attorneys. Also, for each contract, McDonald's keeps information such as the party's experience and capabilities, reason for selection, and expectations for interaction with government officials.

Conclusion: Enforcement Is Here to Stay

Penalties for FCPA violations are severe. For individuals and businesses, civil penalties for violations of the anti-bribery provisions are up to $10,000 per count, and criminal penalties are up to $250,000 per count and five years in jail for individuals, and $2 million per count for businesses. For books and records violations, individuals can be penalized up to $100,000 per count, and businesses can be penalized up to $500,000 per count. Criminal penalties for individuals are up to $5 million per count and 20 years in prison, and up to $25 million per count for businesses. Further penalties can include disgorgement of profits (which can be hundreds of millions of dollars), barring individuals from serving as officers in companies, and barring companies from contracting with the federal government. Past penalties have been up to about 2% of a company's annual sales.

Compared with a decade ago, more settlements are being reached, and more penalties are being paid. In 2011, 15 companies settled FCPA actions by paying a total of $508.6 million in fines. In 2010, 23 companies settled FCPA actions by paying $1.8 billion in fines.

Joint ventures, a popular arrangement for franchisors, have generated an increasing number of enforcement actions in recent years. Seven such actions were brought under the FCPA in 2010, as compared with a total of 10 in the prior five years. In each of the 2010 cases, the joint venture partner was alleged to have paid bribes to win business.

“Enforcement is here to stay,” Spearing predicted. “This is not a cyclical area, like the focus on health care fraud was a few years ago.”

Kevin Adler is associate editor of FBLA. He can be contacted at [email protected].

No U.S. franchisor has faced an action brought against it under the Foreign Corrupt Practices Act (“FCPA”), a 35-year-old law that prohibits U.S. firms and individuals from bribing foreign government officials. But Eric L. Yaffe, principal with Gray Plant Mooty, predicted that “it's just a matter of time” before a franchisor is accused of a violation, given the rapid expansion of international franchising operations and the very aggressive enforcement of the FCPA that began about a decade ago.

That blunt assessment was the motivation for a session about the FCPA at the International Franchise Association's 45th Annual Legal Symposium in Washington, DC, in May. Yaffe was joined by Sarah M. DiLorenzo, senior counsel for McDonald's Corporation, and Mary C. Spearing, partner, Baker Botts, L.L.P., for a discussion of the FCPA and anti-corruption laws in Canada and the UK.

The presenters began by summarizing the key provisions of the FCPA, and then they turned to its application in a franchising context. They observed that the Securities and Exchange Commission (“SEC”), which has civil jurisdiction over public companies, and the Department of Justice (“DOJ”), which has civil and criminal jurisdiction over all companies, have worked in tandem on numerous high-profile settlements in the last few years. The SEC and DOJ also have made it clear that they are going after individuals, as well as businesses, observed Spearing. “This was spurred by criticism from Congress, which said that financial settlements with companies, but without criminal charges, was treating the violations as merely a cost of doing business,” she said.

The FCPA has two provisions: anti-bribery rules and standards for proper bookkeeping, records, and internal controls. The anti-bribery provisions prohibit U.S. companies and their personnel, U.S. citizens, and other persons while in the United States from corruptly paying, offering to pay, promising to pay, or authorizing the payment of money, a gift, or anything of value to a foreign official in order to obtain or retain business. Foreign companies with shares listed on a U.S. stock exchange or otherwise required to file reports with the SEC also are covered.

“The terms 'money, a gift, or anything of value' are very broad,” said Spearing. In a paper that accompanied the presentation, the authors listed cash or cash equivalent, gifts, services, charitable donations, political contributions, loans, travel expenses, sporting events, or entertainment outings as potential violations. “Also, you don't have to give the money in order to be in violation of the Act. If you even authorize it, you could be found guilty,” she added.

The law goes even further by explicitly making covered companies responsible for corruption by third parties they have engaged. As described in the paper, businesses are held up to a tough standard of knowledge about their business partners:

Due to the knowledge standard, not only may a company be held responsible for the illegal actions of others if it authorizes such actions, it can also be held responsible if it is reasonably aware that an illegal bribe could take place. Thus, 'companies and their employees may not consciously disregard or deliberately ignore suspicious facts before entering into or during a third-party contract.' [Robert W. Tarun, The Foreign Corrupt Practices Act Handbook, 93 (2010)] As a result, even if a third party is not an agent of the company, the company may be held liable if it is doing business with the third party, and is aware of or otherwise involved with the violations of the FCPA by that party.

And third parties “are often the crux of these cases, such as when an agent or intermediary pays a bribe for an introduction to a foreign official,” Spearing said.

Yet franchisors clearly need to work with third parties, such as agents and master franchisees, said Yaffe. “Franchisors need agents and partners overseas who know the customs and practices of the foreign local market,” said Yaffe. “But with those partners comes risks ' especially if franchisors turn a blind eye to what is going on.”

Making matters more complicated, the definition of “government official” has been interpreted broadly by the SEC and DOJ. For example, in countries with state-owned or state-controlled businesses, franchisors might not realize that their business partner is considered to be a government official under the FCPA. “The U.S. enforcement agencies deem such personnel as 'foreign officials' regardless of rank or title or how the personnel are classified under local foreign law,” the authors wrote in their paper.

Finally, the accounting provisions of the FCPA act almost like add-on penalties when violations are found, according to Spearing. “These are 'gimmes' for enforcement because when bribery occurs, there's almost always inaccurate bookkeeping [to hide it],” she said. “Bribes are often called 'fees.' The SEC does not even have to prove intent on the accounting violations.”

Risk Factors and Red Flags

Given that franchisors need to work with agents and third parties, how can they reduce the likelihood of incurring FCPA violations? Yaffe said that it's a difficult balancing act. For example, a franchisor operating in countries or regions that have a reputation for high levels of bribery of public officials and kickbacks in public procurement would be expected to conduct extensive due diligence on any partners or agents and to work closely with them to ensure FCPA compliance. But the more oversight a franchisor exercises, the more it is vulnerable to the claim that it should have known about a violation.

Franchisors should start by being aware of “red flags” ' that is, the business activities in which problems are most likely to occur. “Real estate purchases are a big area for bribery,” Yaffe said. “Look at a real estate deal. Are you paying more than the fair market value? Who is the broker on that sale, and what are his connections?”

Wal-Mart might be ensnared in just such a violation in Mexico, as the DOJ said earlier this year that it is investigating allegations that its subsidiary in Mexico might have paid more than $24 million in bribes for construction permits, licenses, and inspection certificates.

Another red flag might be a master licensee that has not been able to secure several prime locations for expansion, but which suddenly is able to obtain the best sites. A franchisor should investigate the situation, even though the master licensee will surely argue that it is operating as an independent contractor and should not face extra scrutiny.

Franchisors also should demand detailed invoices from their agents that include expenses and the names of people they are entertaining, Yaffe said. “Watch out for lavish gifts, travel, and hospitality for government officials paid by your agents,” he said. Even legal entertainment or travel can slide into bribery, such as has been alleged in some FCPA enforcement actions when businesses were cited for paying per diems to foreign officials or paying for expenses beyond the business-related parts of the trip. “You can bring officials to the United States to see how a franchise is operating, but you can't then pay to extend their trip with a junket to Las Vegas,” he said.

Fees are another area in which the line between legal and illegal is finely drawn. Franchisors can legally pay a licensing or permitting fee, a customs fee, or even make routine, nominal payments to facilitate a payment or currency exchange, said Yaffe. When those fees are excessive and when the fees go directly to a government official, they could be deemed as FCPA violations. “These are real problems that occur every day, such as when a franchisor has items held up in customs,” Yaffe said.

How the McDonald's Compliance System Works

With franchises in nearly every country in the world, McDonald's has grappled with FCPA compliance in many environments, and it's a serious matter, said DiLorenzo, who is Senior Counsel for Global Compliance and Privacy. “Our goal is to have high-level oversight within our company and to hold people accountable,” she said. “Compliance reports directly to the board, as well as to the legal department. And we have very strong whistle-blower protections that protect any report made in good faith.”

The McDonald's compliance program starts at the corporate level with an enterprise-wide risk assessment that is constantly updated. “We're growing rapidly in China and Russia, and corruption is at every level [in those countries],” she said, “so we know we have to be extra-vigilant.”

The company includes anti-corruption language in its contracts, and it provides mandatory anti-corruption training in every country in which it operates in the home country's language, said DiLorenzo. “We distribute hard copies of our anti-corruption policies to all managers, and we communicate to all of our licensees, too.” The policy not only prohibits bribes and gifts to government officials, but it also goes a step further by prohibiting similar forms of commercial bribery, as well as kickbacks.

Every agent who works with McDonald's undergoes careful due diligence before contracts are signed, and the level of scrutiny rises with the size of the contract. McDonald's uses third parties to conduct much of the due diligence, and it has them pay extra attention to any person who has at least a 10% ownership stake in the agent company. Casting a wide net because of the broad interpretation of the FCPA, McDonald's seeks information about service providers for its franchises such as architects, permit expediters, real estate brokers, tax consultants, lobbyists, and attorneys. Also, for each contract, McDonald's keeps information such as the party's experience and capabilities, reason for selection, and expectations for interaction with government officials.

Conclusion: Enforcement Is Here to Stay

Penalties for FCPA violations are severe. For individuals and businesses, civil penalties for violations of the anti-bribery provisions are up to $10,000 per count, and criminal penalties are up to $250,000 per count and five years in jail for individuals, and $2 million per count for businesses. For books and records violations, individuals can be penalized up to $100,000 per count, and businesses can be penalized up to $500,000 per count. Criminal penalties for individuals are up to $5 million per count and 20 years in prison, and up to $25 million per count for businesses. Further penalties can include disgorgement of profits (which can be hundreds of millions of dollars), barring individuals from serving as officers in companies, and barring companies from contracting with the federal government. Past penalties have been up to about 2% of a company's annual sales.

Compared with a decade ago, more settlements are being reached, and more penalties are being paid. In 2011, 15 companies settled FCPA actions by paying a total of $508.6 million in fines. In 2010, 23 companies settled FCPA actions by paying $1.8 billion in fines.

Joint ventures, a popular arrangement for franchisors, have generated an increasing number of enforcement actions in recent years. Seven such actions were brought under the FCPA in 2010, as compared with a total of 10 in the prior five years. In each of the 2010 cases, the joint venture partner was alleged to have paid bribes to win business.

“Enforcement is here to stay,” Spearing predicted. “This is not a cyclical area, like the focus on health care fraud was a few years ago.”

Kevin Adler is associate editor of FBLA. He can be contacted at [email protected].