Lessons From Avon's China Bribery Scandal

Even for a company that made US$606.3 million in profit last year, blowing US$95 million on something that it should not have needed to spend on at all is infuriating.

 
So it is with beauty products global enterprise Avon. Its net earnings last year could have been 15.6% higher, in theory, had it not paid “professional and related fees” for an internal inquiry seeking to discover whether some of its executives paid bribes to government officials in China and other emerging markets.
 
It had previously paid US$59 million on the same probe in 2009, putting the total cost of the inquiry so far at US$154 million. The outside lawyers the company hired are still running up the tab, and the company may have to pay much more in government fines and court action by disgruntled shareholders and other parties..
 
Avon’s suspected breaches of the U.S. Foreign Corrupt Practices Act (FCPA) have already spawned five legal suits against the company, "alleging breach of fiduciary duty, and, in certain complaints, abuse of control, waste of corporate assets, unjust enrichment and/or proxy disclosure violations,” according to the company's May 3 filing with the U.S. Securities and Exchange Commission.
 
In an earlier filing, Avon warned: “Any determination that our operations or activities . . . are not in compliance with existing laws or regulations could result in the imposition of substantial fines, civil and criminal penalties, interruptions of business, modification of business practices and compliance programs, equitable remedies, including disgorgement, injunctive relief and other sanctions.”
 
A Big Mess
The investigation may be coming to a head. Last week, the company said it had fired four unnamed executives in China (newspaper reports identified one of them as CFO Jimmy Beh). Ben Gallina, Avon’s Senior Vice President for operations in Western Europe, Middle East & Africa, Asia Pacific and China, has been placed on administrative leave. “Additional personnel actions may be taken in the future,” says Avon.
 
It’s a big mess and one that may snare other multinationals in China and other emerging markets. As law firm Orrick, Herrington & Sutcliffe wrote in CFO Innovation in January this year: “There has been an increasing focus on anti-corruption in Asia particularly due to the UK’s Bribery Act . . . and more high-profile US Foreign Corrupt Practices Act (FCPA) investigations being conducted in 2010.”
 
The Bribery Act will enter into force on 1 July 2011. The FCPA has been on the books since 1977, but enforcement has been lackadaisical until recently. The number of FCPA cases filed by the U.S. Department of Justice has surged in the past five years, reaching more than 60 – exceeding the total number of cases in the previous 28 years.
 
The penalties can sometimes be dramatic, such as the US$1.6 billion in fines, penalties, and profit disgorgement that Siemens paid in 2008 for FCPA and bribery violations,” notes Jeffrey Cramer, Managing Director at risk management company Kroll.
 
CFOs and other executives in China and elsewhere in Asia are understandably unsettled. Practices that had seemed standard operating procedure in the recent past, and winked at, if not actively abetted by headquarters, are now punishable by termination. Some analysts speculate that the firing of Beh and others is designed to pave the way for Avon to strike a deal with the U.S. Department of Justice  and avoid criminal prosecution.
 
Avon’s Story
How did Avon, which relies on China for 2% of its revenues, come to this pass? The company was reportedly told by an employee in 2008 about improprieties in connection with Avon’s travel spending for government officials in China. The company’s audit committee started an investigation in June that year.
 
“We voluntarily contacted the United States Securities and Exchange Commission and the United States Department of Justice to advise both agencies of our internal investigation,” Avon says in its filings. “We are continuing to cooperate with both agencies and inquiries by them, including but not limited to, signing tolling agreements, translating and producing documents and assisting with interviews.”
 
In a sign of how seriously it was taking the allegations, Avon engaged top-notch lawyer Claudius Sokenu and his law firm, Arnold & Porter LLP, which explains in part why the company has spent US$154 million so far. The probe has also been widened beyond China to include “compliance reviews regarding the FCPA and related U.S. and foreign laws in additional countries.”
 
The recent firing of the four executives – in addition to the China CFO, the China general manager, China head of corporate affairs and head of global internal audit and security were also told to go – may be only the tip of the iceberg.
 
Quoting an unnamed source in Avon, the Wall Street Journal reports that the investigators have also discovered millions of dollars in questionable payments to officials in Brazil, Mexico, Argentina, India and Japan.
 
That is not farfetched, given the wide scpe of the internal investigation and compliance reviews.  According to Avon, the investigators have been asked to focus on "reviewing certain expenses and books and records processes, including, but not limited to, travel, entertainment, gifts, use of third party vendors and consultants and related due diligence, joint ventures and acquisitions, and payments to third-party agents and others, in connection with our business dealings, directly or indirectly, with foreign governments and their employees.”
 
What Companies Can Do
The beauty company is now in full damage control. “We continue to enhance our ethics and compliance program, including our policies and procedures, FCPA compliance-related training, FCPA third party due diligence program and other compliance-related resources,” Avon stressed in its filings.
 
These are useful initiatives that other organizations may wish to emulate and extend to also cover the UK Bribery Act. This legislation, seen in some ways as even more draconian than the FCPA, applies even to an organisation that is not incorporated or formed in the United Kingdom and to a person who is neither a UK national or resident, provided the organisation carries on a business in the UK or part of a business in the UK.
 
Part of the training programme should include the provisions in both laws, particularly what is permissible and what is not with regards to payments. In the FCPA, for example, “facilitation payments for routine governmental actions” are permissible. The statute lists the following examples:
 
  • obtaining permits, licenses, or other official documents
  • processing governmental papers, such as visas and work orders
  • providing police protection, mail pick-up and delivery
  • providing phone service, power and water supply, loading and unloading cargo, or protecting perishable products
  • scheduling inspections associated with contract performance or transit of goods across country
 
Under the FCPA, “routine governmental action” does not include any decision by a foreign official to award new business or to continue business with a particular party.
 
Case Studies
In “The Bribery Act 2010 – Guidance” issued by the UK Ministry of Justice in advance of the UK Bribery Act coming into force, some important points were made in hypothetical case studies to help companies navigate bribery waters. They include:
 
  • Communicate the company’s commitment to transparency and zero tolerance of bribery in pursuit of business objectives to employees, consultants and external contacts, such as sectoral bodies and local chambers of commerce. If the company operates in a foreign country through an agent company, the company’s policy of not making facility payments must also be made clear.

 

  • Ensure that the executives and employees of an agent company are trained on the provisions of the Bribery Act and local laws

 

  • Draw up key points guidance on preventing bribery for sales staff and others involved in bidding for business and when engaging consultants

 

  • Provide a confidential means for staff and external business contacts to air any suspicions of the use of bribery on the company’s behalf

 

  • Identify someone of a suitable level of seniority to be a point person for queries and issues relating to bribery risks
 
“Combating the risks of bribery is largely about common sense, not burdensome procedures,” Kenneth Clarke, the UK’s Secretary of State for Justice wrote in the preface to the guidance. “Rest assured – no one wants to stop firms getting to know their clients by taking them to events like Wimbledon or the Grand Prix.”
 
The key determinant is proportionality. Flying a Chinese official first-class to London for Wimbledon matches and giving him the chance to visit his son who is studying in a British university on a scholarship provided by the company will probably count as bribery by “a reasonable person in the U.K.” – which is one test the law sets out in determining whether or not bribery has occurred.
 
As the U.S. and UK continue their crusade against corruption in business, it's a lesson Avon and other companies should continue to learn. 
 
About the Author
Cesar Bacani is Editor-in-Chief of CFO Innovation.  
 
Read more on

Suggested Articles

Some of you might have already been aware of the news that Questex—with the aim to focus on event business—will shut down permanently all media brands in Asia…

Some advice for transitioning into an advisory role

Global risks are intensifying but the collective will to tackle them appears to be lacking. Check out this report for areas of concern