Herbalife’s FCPA Settlement: Lessons Learned (Part III of III)
Herbalife’s FCPA settlement is another one for books – the wreckage left includes two criminal indictments for Chinese officials who may never be apprehended, along with $123 million in penalties. When going through the wreckage, there are serious issues of corporate failures at senior levels of the company along with pervasive and systemic misconduct in China.
What is surprising is the obvious red flags of expense reports and reimbursement documentation. It is not worth listing the numerous indicators of bribery, but it is clear that the head-in-the-sand problem does not adequately capture the complicity of senior management and oversight functions in the ongoing bribery activities.
Taking a step back, let’s look at some of the important lessons learned.
Board and Internal Audit Failure: Despite questions from two board members in reviewing the Internal Audit reports showing large and obvious fraudulent expenditures and documentation, Internal Audit failed to acknowledge any issue and denied any possible wrongdoing. Evidently, the two board members were satisfied by that ridiculous and unbelievable answer. Both the board and the Internal Auditor failed to ask for additional investigation and follow up. The amount of money spent on so-called meals and entertainment were ridiculous on their face – the board members and internal Audit failed to follow up to resolve red flags. In this situation, their excuses and rationalizations ring hollow.
Chinese “Gift-Giving Culture”: It goes without saying that China is a hotbed for abuse of entertainment, gifts, meals expenditures. Through the last 20 years, FCPA enforcement actions on corrupt practices surrounding gifts, meals and entertainment expenses have focused on China. If your company operates in China and regularly interacts with government officials, strict controls, monitoring and review are essential to avoiding FCPA risks.
Numerous companies have a mix of government and private interactions in China. The interactions with government officials often involve officials who are critical to the business operations. There is significant demand from government officials for generous entertainment and gifts. A company operating in this environment has to draw a strict line early and stick to the limitations, notwithstanding the obvious negative impact on its business. If the company makes it clear from the beginning that it will not tolerate such improper payments, the company will eventually gain breathing room as its reputation is accepted by Chinese officials. It is easy in theory and difficult in practice, especially when the company experiences real financial damage from such an attitude. In the long-run, however, avoiding this trap pays off.
Gifts, Meals, Entertainment Policies and Procedures: Global companies have to design and implement carefully-constructed controls for gifts, meals and entertainment expenses. Even with the best controls, employees will figure ways in which to circumvent the controls. Herbalife’s controls included pre-approval requirements, which were routinely ignored, and a strict limitation of six events each year for a government official. This latter control was flouted at the direction and approval of a Herbalife senior executive who instructed a China executive to make false entries of names of government officials because no one would check the identities to ensure an accurate listing of attendees.
Absence of Audit and Compliance Oversight: With the ongoing expenditures of millions of dollars in gifts, meals and entertainment needed to expand Herbalife’s China business, Herbalife had no meaningful oversight from Internal Audit and Compliance functions. Herbalife’s culture was not committed to any notion of compliance. Even when detected by Internal Audit, there was no effort made to investigate and restrict China from continuing its criminal conduct. Business was too important in China and Herbalife had no intention of halting its ongoing activities.
Herbalife’s 1 remediation included the hiring of a dedicated Chief Compliance Officer. It is surprising that a public company with global operations failed to maintain any compliance function. Going forward, even with a new dedicated CCO, Herbalife faces numerous high-risk activities and will require regular reviews and compliance audits, as well as monitoring of compliance data.