International - Written by on Friday, July 29, 2011 0:30 - 1 Comment

The post closing hangover – Diageo US$16.4M bill for FCPA violations after rapid expansion

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What lies beneath?

Cash service fees, market scheme settlement, deposit[s] with Delhi Excise, incentives, special incentives, promotions, Promotions-Outlet, Secondary or Trade Incentives, commissions, business promotion expenses, miscellaneous expenses, expenses incurred on your behalf, factory expenses, travelling expenses, telephone expenses, scheme or special scheme payments, selling commission, special rebates, incentive for reaching sales targets, special rebates, trade incentives, DIF – selling commission, Outside Services, Corporate Social Responsibility, Corporate Communications, EA [External Affairs] Project, Stakeholder Engagement, Entertainment – Customer, rice cake payments and Mokjuksaupbi payments.

These were the descriptions contained in Diageo PLC’s books and records, a company headquartered in London UK, which in a US SEC Order this week were stated to mask illicit payments to government officials in violation of the US Foreign & Corrupt Practices Act.

Mergers & Acquisitions

In the SEC order it stated “Diageo’s history of rapid multinational expansion through mergers and acquisitions contributed to defects in its FCPA compliance programs”…and that “at the time of these acquisitions, Diageo recognized that its new subsidiaries had weak compliance policies, procedures, and controls. Nevertheless, Diageo failed to make sufficient improvements to these programs until mid-2008”

The payments were made in India, Korea and Thailand.

We are often asked – what do such an illicit payments look like?  The answer is not what you’d necessarily think – some being very modest.

What were they?

India – extra sales, goodwill, approvals and customs issues

An estimated $792,310 in improper cash payments through its third-party distributors to several hundred employees of government liquor stores (in other words less than US$1000 each) and an estimated $186,299 (representing 23% of the payments) as compensation for the distributors in advancing the funds to increase government sales orders of its products, and to secure favorable product placement and promotion within the stores.

An estimated $530,955, (with plans to reimburse an additional $79,364) in improper cash payments made by third-party sales promoters to government employees designed to: (i) foster the promotion of Diageo products in government stores; (ii) obtain initial listings and annual label registrations for Diageo brands, price revision approvals, and favorable factory inspection reports; (iii) secure the release of seized shipments of Diageo products; and (iv) promote good will through the distribution of Diwali and New Year’s holiday gifts.

An estimated $98,310 in cash payments made by its third-party promoters and distributors to government officials for the purpose of securing label registrations for Diageo products.

An estimated $78,622 in extra commissions to its distributors to reimburse them for payments made to Excise officials to secure import permits and other administrative approvals.

Thailand – lobbying

In Thailand Diageo retained the services of a Thai government and foreign political party official to lobby other Thai officials to adopt Diageo’s position in several multi-million dollar tax and customs disputes. Diageo paid approximately $12,000 per month for 49 months, for a total of $599,322 making the payments through 49 direct payments to a political consulting firm for which the Thai Official acted as a principal.

South Korea – tax advisory, a jolly to Prague & Budapest & rice cake & Mokjuksaupbi payments

Following resolution of tax disputes in Korea (including the receipt of a US$50 million tax rebate) a Diageo manager paid an apparent reward of 100 million KRW ($86,339) to a Korean Customs Service official who had “played a key role in the transfer pricing negotiations” paying at least part using a cash kickback scheme.

At the same time Diageo paid $109,253 in travel and entertainment costs for Korean customs and other government officials. This included the travel costs for customs and other official who traveled to Scotland with Diageo Korea employees to inspect Diageo’s Windsor Scotch production facilities as part of the transfer pricing negotiations.

During the course of this apparently legitimate trip, Diageo Korea’s CFO and the Manager took the South Korean officials on a purely recreational side-trip to Prague and Budapest.

Rice cake payments were customary and traditional presents that Diageo provided to scores of military officers – many of whom were responsible for procuring liquor – several times each year during holidays and vacations. Over four years Diageo made approximately 400 rice cake payments, totaling at least $64,184, in the form of cash or gift certificates.  These ranged in value between $100 and $300 per recipient.

In October 2004, a senior officer within Diageo’s global compliance department explicitly approved the practice of making rice cake payments after a Diageo Korea employee explained that the company would face a competitive disadvantage if it refrained.

Over the same four-year period Diageo also spent approximately $165,287 on hundreds of non-traditional, non-seasonal gifts and entertainment for the military. Of these so-called “Mokjuksaupbi” payments approximately $106,051 were for the purpose of influencing specific purchasing decisions. In one example in 2003 approval was sought for $2,600 to entertain army personnel “for their cooperation” in connection with the re-selection of Windsor Scotch.

The Bribery Act

If this conduct took place today the UK Bribery Act would be in play.  The Diageo story contains a number of elements which should be a warning to business.

A speedy expansion through M&A and numerous violations some of which appear relatively minor but which when added together and thrown in with some serious tax savings (for example the US$50 million rebate) and seen in the context of the revenue benefits (which the SEC cited as over 11 million US$ in “ill gotten gains” ) take on an entirely different complexion.

On top in last years Diageo Annual report Diageo stated that the Korean authorities had secured convictions for improper payments to a Korean customs official against two former Diageo Korea employees, and that a former and two current Diageo Korea employees had been convicted on various counts of tax evasion.  This further highlights the risk in local jurisdictions as well as under the FCPA and the Bribery Act if illicit payments are made.

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Emerging Markets Insights
Jul 31, 2011 22:35

FCPA compliance continues to challenge western multinationals operating in emerging markets. Diageo is the first in a string of such cases. Your audience may be interested in our recent post entitled, Expect Costlier Penalties for Violating the FCPA

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