Jon Umarov, an Associate at The Volkov Law Group, has written today’s blog entry. Jon is from Uzbekistan and is very familiar with business practices in Russia and the Commonwealth of Independent States.  His bio is available here. Jon can be reached at [email protected].    

Cisco’s 2009 audits concerning its operations in Russia revealed that its interactions with the state-owned company, Svyazinvest and local resellers, could not be “verified.”  An interesting phraseology to say the least, Cisco’s counsel should be applauded for creativity.

Navigating the corruption risks in Russia is more than a challenge, it is a guaranteed headache.  Why do I say that?  According to a recent Reuters report, Cisco discovered that its audit was conducted without key documents or fabricated documents.

Cisco relied on third parties to resell its products to the telecommunications company.  Svyazinvest is now part of Rostelecom – a company controlled by the Russian government.

DOJ and SEC requested Cisco to conduct an internal investigation into allegations of possible FCPA violations in Russia and other Commonwealth of Independent States (CIS), after a whistleblower contacted the SEC.  Cisco’s quarterly report stated that the investigation concerned resellers of its products.  The company is cooperating with DOJ and SEC and sharing the investigation results.

According to the audit results, sales to Svyazinvest went through a company named Compulink.  Out of $23 million in sales bookings for Cisco’s telecom equipment, only $5 million seemed to be legitimate.  The rest of the sales bookings could not be verified due to the local partner’s refusal to provide documentation.

The reseller that Cisco used for these sales was Step Logic Companies.  Two other companies that were used for sales were AKOM and Stins Coman.  $3.1 million went through these two companies and the documents were either “mischaracterized,” or “falsified” in Stins Coman’s case.

Although the audit reports do not suggest that Cisco violated the FCPA, the case shows the importance of conducting a thorough due diligence effort on local third parties.  One of the objectives of the audit was to verify the legitimate purpose behind the 68% discount provided to Svyazinvest by the resellers.  High discounts provided through third parties (e.g., resellers, distributors) are treated as red flags under the FCPA and were specifically cited by DOJ and the SEC, in its November 2012 Guidance.

In order to trigger liability under the FCPA, the 68% discount provided to Svyazinvest must have been offered with “corrupt intent” and must satisfy the requisite knowledge required under the FCPA.  This requirement can be satisfied if it is proven that Cisco purposefully avoided the actual knowledge that local resellers corruptly provided the discount to Svyazinvest in order to obtain new business.

Another red flag is raised by the fact that some of the documents provided by the resellers were “falsified” and in other instances no documentation was provided for sales bookings.  Transactions supported by improper documentation or no documentation may, at a minimum, lead to internal controls violations, and more significantly, may reflect bribery.  To prove an internal controls violation, the government need not prove that bribery in fact took place.  The government simply needs to prove that Cisco failed to “devise and maintain a system of internal accounting controls” to provide a reasonable assurance that the sales bookings were executed in accordance with Cisco management’s authorization.