When I say “teachable moment” I don’t mean that there are lessons here that everyone should know. I actually mean that I will literally be using this IBM situation as a case study in my FDI Law class. Why? It’s rather classic stuff, it’s an easy case, and it illustrates both how US anti-bribery laws work and common mistakes foreign investors make in China.
The International Business Machines Corporation, the computer services provider, agreed on Friday to pay $10 million to settle claims that it gave cash and gifts to Chinese and South Korean officials in connection with about $54 million in government contracts.
The applicable anti-corruption law in the United States is the Foreign Corrupt Practices Act, which makes certain kinds of bribery and related activities done overseas illegal. The FCPA covers a lot of territory, but it’s basically focused on improper accounting practices and bribery.
Why is accounting involved? Well, companies do two different things. First, they bribe government officials. Second, they cover it up, or attempt to do so. Enforcement of the FCPA would be a lot more difficult if it just made bribery illegal without going after the creative ways companies have used to hide these practices.
Moreover, enforcement has to deal with the usual excuse of “we (HQ) did not authorize that bribe, it was the employee acting on his own” — that excuse can work to separate the company from the act of bribery (sometimes), but if the company has an affirmative duty to keep adequate books and records that can be used to ferret out illegal activities, then the government can use that obligation as a secondary enforcement target.
Does that make sense?
In this case, the complaint against IBM was made by the Securities and Exchange Commission (SEC), which has authority to impose fines under the FCPA. The Department of Justice handles criminal matters — IBM’s activities did not rise to that level here.
“Deficient internal controls allowed employees of I.B.M.’s subsidiaries and joint venture to use local business partners and travel agencies as conduits for bribes or other improper payments to South Korean and Chinese government officials over long periods of time,” the S.E.C. said in the complaint.
“Internal controls” refers to that FCPA focus on accounting practices. In other words, the SEC is slapping IBM on the wrist, saying that they failed to adequately supervise their people, and not that IBM (as a single entity) knowingly permitted these illegal activities.
What were they doing over here in China?
[T]he SEC alleges that officials created a “slush fund” to pay for travel and entertainment expenses in order to help IBM win deals between 2004 and 2009. The SEC contends that the trips and entertainment expenses covered by the slush fund had little or nothing to do with business meetings or training.
Again, classic stuff. Officials from MIIT or MOFCOM want to go to Vegas for a few days? Their friends at some big IT companies can help. (Back in the day, also law firms, accounting agencies, and other service providers, but you didn’t hear that from me.)
This all makes me a bit nostalgic. The case relates to activities that took place between 1998 and 2009, so we’re talking about almost my entire time in China (so far). All that travel-related bribery was rampant at that time and only recently has been curtailed, with respect to American companies, due to stepped-up FCPA enforcement and, more importantly, a crackdown by Beijing on official travel.
So the SEC is saying that IBM’s internal controls were not adequate, which allowed these activities to persist for so long without, apparently, HQ catching on. No red flags went up because the IBM system was not designed to manage this kind of thing. No surprise here — what company in China doesn’t have a huge line item on its books designated “Entertainment Expenses”? The entire freakin’ tax system practically mandates that kind of structure.
The accounting provisions in the FCPA make more sense when you look at a case like this. If the FCPA was strictly an anti-bribery statute, then the choice is between a strict liability system (i.e. IBM is liable for all actions of its employees — no excuses) or one that includes a knowledge requirement (i.e. IBM only liable for acts it knew about).
With the accounting rules, the government can operate in that middle ground, penalizing firms for activities it allowed to happen, even if the government cannot prove actual knowledge.1
You can see how this case is a nice illustration of the FCPA and the relationship between bribery and accounting practices. It also contains a good example of what used to be a very common type of bribery. Sounds like classroom gold to me.
One last comment. The SEC filed this case in US federal court and IBM immediately settled. Here are the numbers:
Before the ink was even dry on the lawsuit filed by the SEC today, IBM did an 8K filing with the stock regulator, saying it had settled the matter. (That must be some sort of land speed record.)
“As part of the settlement, IBM has consented to the entry of a judgment relating to the books and records and internal control provisions of the securities laws,” the company said in the short filing. IBM has also agreed to pay a total of $10m. That figure includes $5.3m for the profits the company gained from all of the deals in South Korea and China where bribes were given, $2.7m in prejudgment interest on that $5.3m, and $2m to cover the civil penalty for breaking the FCPA.
So of the ten million bucks they will pay, eight million covers disgorgement (profits gained from the deals they won through bribery in South Korea) and related interest, while two million would correspond to a fine.
I don’t know about you, but bribery that took place in two different countries over the course of many years, including the delivery of bags of cash to South Korean officials, and all they have to do is pay two million bucks? By the way, under the terms of the settlement, IBM is not even admitting any wrongdoing.
Seems like IBM is getting a really good deal here — agreed?
- FYI, FCPA litigation over the years has focused, among other matters, on this issue of knowledge. But that’s for another post. [↩]