The Justice Department’s recent enforcement action against Smith & Nephew underscored an important point – companies can be responsible for FCPA violations committed by distributors of the company’s products.  FCPA compliance professionals already knew that the FCPA can apply to distributors.

Reams of paper have been used to explain due diligence procedures for third party agents.  These same procedures should be applied to distributors and include: (1) a basic open source intelligence check on the distributor; (2) completion of a questionnaire by the distributor; (3) interview of the distributor; (4) execution of a written distribution agreement which contains anti-corruption compliance representations and warranties, audit rights and participation in company anti-corruption training programs.

This list is more a wish list than anything else.  Why?  In many cases, the relationship between a company and its distributors is far different than the relationship between a company and its agents and consultants.  A company has far less leverage with its distributors – often the distributors are responsible for distributing many products, including competitors’ products.  As a result, they are often unwilling to agree to some of the requirements for an anti-corruption program.

Companies have little leverage to insist that its distributors agree to provide audit rights and participation in anti-corruption training.  It is understandable – no distributor wants to cede these rights to multiple companies and have to incur the costs of compliance.  Most distributors are comfortable agreeing to anti-corruption representation and warranties.  They have little incentive to agree to much more. 

A company has to be careful in negotiating with distributors and seeking agreement to anti-corruption controls.  Its leverage can vary depending on the distributor.  In the event that the distributor rejects many of the anti-corruption requests, the company should document its requests, and the distributors’ response to ensure that the company can document its efforts to seek compliance. 

Distributors are a more significant corruption risk than agents.  Companies have less control over distributors than agents.  Distributors purchase a product from a company and have the ability to set the retail price of the product.  They have greater flexibility to build in a margin to cover any improper payments. 

In contrast, companies set the retail price for the product to be sold with the assistance of an agent.  When using an agent, the company should have greater control over the agent’s activities and ability to restrain an agent from making any improper payments to foreign officials.     

Some industries rely heavily on distributors.  For example, the health care industry uses vast networks of distributors and sub-distributors in foreign countries.  As a result, compliance is a big challenge for health care companies and others that rely on distributors to sell their products in international markets.