Arnold Spencer
Akin Gump Strauss Hauer & Feld
Dallas
The Mexican constitutional reforms and related privatization of portions of the oil and gas industry are historic. The end of state-owned monopoly control will create great opportunities for foreign and domestic companies alike. And great opportunities attract visionaries and scoundrels alike.
US-based companies with visions of participating in the Mexican industries are well-advised to beware of the scoundrels. They should take thoughtful, risk-based steps to avoid the persistent corruption that has weakened the Mexican economy and communities for generations.
Corruption a problem
Corruption has been, and continues to be, a problem for Mexico. Transparency International, a nonprofit, anticorruption watchdog, ranked Mexico 103rd among 175 countries in its 2014 Corruption Perceptions Index, which assesses perceptions of corruption in countries' public sectors. Mexico's score was 35 on a scale with 0 as "highly corrupt" and 100 as "very clean." At that ranking, Mexico was tied with Bolivia, Moldova, and Niger.
Because of systemic corruption, international companies operating in Mexico constantly face requests and demands to make different, off-the-book payments to government officials. Local police officers and customs officials frequently demand a "mordida" or a "refresco," a small bribe payment as a taste or a bite. International reports cite corruption in every branch of the government.
The Mexican hydrocarbon industry is no exception. Energy has been identified as one of the most corrupt business sectors of the Mexican economy. State-owned Petroleos Mexicanos (Pemex) was recently described by Fortune as "laden with bureaucracy, teeming with superfluous workers, and, by its own executives' admission, thwarted by corruption."
In this unique stage of reform, the peso equivalent of hundreds of billions of dollars will be transferred from government control to private industry, and discretionary decisions will be made by government officials throughout the process.
US-based companies engaging in business in Mexico are subject to both Mexican and US anticorruption laws. While there are technical exceptions, generally it is a violation of both countries' laws to offer a bribe (including a gift, a meal, or any other object of value) to a government official. This is of particular concern to any foreign company engaging in the hydrocarbon market, as government officials are involved at every stage of Mexican exploration, production, transport, refining, and distribution of petroleum.
More problematic for US companies looking to participate in the Mexican hydrocarbon business, the Foreign Corrupt Practices Act (FCPA) holds a US company responsible not only for its own actions but also for the actions of third-party contractors working on its behalf. Specifically, under the FCPA, companies are responsible for the actions of their consultants, joint-venture partners, and subcontractors. If a consultant pays a bribe in order to obtain business for its client, both the consultant and the client can be prosecuted.
This is not a hypothetical situation. More than 100 companies in the US have publicly disclosed that they are currently under federal investigation for possible violations of the FCPA. Several of the largest investigations involve allegedly corrupt payments to Mexican officials.
Minimizing risk
Most FCPA violations arise from either rogue employees or failures to conduct thorough, risk-based due diligence. Companies attempting to minimize damage from FCPA violations should scrutinize their employment policies and due diligence procedures used in evaluating third-party contractors.
To minimize the chance of damage to reputation and security from rogue employees, companies should examine each step of the employment life-cycle for opportunities to emphasize compliance: upon hiring, during employment, and at termination.
In hiring new employees, companies benefit from stressing the importance of compliance. Both the new hires and the existing staff engaged in hiring are the priority of compliance. During employment, companies should maintain a vigilant training program, reengaging every employee in compliance.
The most successful compliance programs recognize that different jobs involve different responsibilities and tailor compliance training accordingly. Executives negotiating key contracts with Pemex counterparts in Mexico City face different pressures to engage in corruption than do geologists arguing about exploration decisions in the Chicontepec basin, who in turn face pressures very different from those on a truck driver pulled over by the Policia Federal de Caminos.
Furthermore, the most successful compliance programs are those with annual training. Compliance is not a vaccination that an employee gets once to become forever resistant to corruption. Compliance requires vigilance and will wither if not periodically bolstered.
Employee departure creates an additional opportunity to emphasize compliance with anticorruption laws. If an employee is retiring on amicable terms, a line in the announcement emphasizing compliance is appropriate and meaningful. In contrast, dismissal of an employee for corruption-related acts creates an opportunity to reemphasize the company's core culture and values. Even if the communication is not specifically tied to the employee's dismissal, both the act of termination and the communication should unambiguously reflect the company's refusal to sanction or tolerate any acts of corruption.
Third parties
Under the FCPA, frighteningly, a company can be held responsible for any corrupt transactions that a third party conducts on the company's behalf. For example, several recent FCPA prosecutions have been based upon third-party agents-consultants, distributors, sales agents-who ignored company policy and good sense and who submitted bogus receipts in order to generate funds for payments to employees of the state-owned companies.
Andrew Ceresney, director of the enforcement division of the Securities and Exchange Commission, reiterated this position in March when he told a conference, "Compliance programs must thoroughly vet [companies'] third-party agents to include an understanding of the business rationale for contracting with the agent. Appropriate expense controls must also be in place to ensure that payments to third parties are legitimate business expenses and not being used to funnel bribes to foreign officials."
Who are the third-party agents? Historically, most FCPA enforcement actions involve third-party transactions at some level, and most transactions that third parties engage in on behalf of a company are or should be predictable. Companies entering Mexico will be confronted with corrupt proposals. They need to know the companies with which they will be dealing through intermediaries. Due diligence should focus broadly on understanding whom the third party is paying, what business role or value the third party adds, and where the money goes that flows to the company.
So how does a company thoroughly vet its third party agents? At the earliest stages of reaching out to third-party consultants or contractors, companies should conduct due diligence regarding the potential agents. Researching the reputation and qualifications of third parties seems obvious in retrospect but is frequently overlooked in the rush to move business ventures forward. Every year, companies pay large sums as a result of enforcement actions involving actions by third-party vendors, when simple internet investigations would have revealed serious questions about the vendors' reputations or qualifications. Companies should systemically evaluate the consultants and contractors with whom they intend to do business and confirm legitimate, verifiable credentials. Companies that fail to engage in this type of due diligence, assuming that corruption is a way of life in Mexico, are taking on substantial business and reputational risks.
Why are payments made to the third parties? Supervisors should know, and as importantly, be able to explain, the business reasons that the company is making payments to third-party agents. Of course, companies cannot micromanage every payment, but the government expects companies to focus on high-risk transactions. Certain expenditures immediately raise alarm: unusually large payments; payments in round-figure amounts; and vague explanations or undocumented payments.
One of the most common schemes that corrupt agents use is seeking reimbursement for projects which bear no relation to the business plan: for example, an exploration and production company paying for an agricultural viability study. E&P companies typically do not consider opportunities in beet farming. Yet FCPA practitioners often see this sort of unrelated business venture buried in third party agents' billings. And more often than not, these payments are for bribes, not beet farming.
As importantly, federal prosecutors have indicated that they are not focusing on low-risk transactions. Third-party payments for a cup of coffee or cab fare are unlikely to influence government officials. Likewise, enforcement officials have recognized that small gifts may be appropriate in business relationships as an appropriate display of respect. If these transactions are in good faith and not intended corruptly then the transactions are typically open and transparent and are properly reported on the company's books and records. In contrast, large sums of cash are almost exclusively designed to influence business decisions and not designed to show respect. Accordingly, the cash is typically concealed-both as it is being transferred through covert accounts or unmarked bags and as it is recorded on the company's books and records.
Third-party payments
Sound compliance programs incorporate routine evaluations of the amounts being paid and the services being performed. It is a red flag when a third party submits for reimbursement an expense that cannot be explained or when the explanation of the expense is disproportionate to the value of the service. Again, risk-based principles can be applied. Small payments that are undocumented are not typically the bases for allegations of bribery. In contrast, large payments for unnecessary or unexplained services are frequently the foundation of corruption schemes.
Increasingly, sophisticated companies are negotiating for third-party audit rights as part of their ongoing due diligence of consultants, joint-venture partners, and other contractors. By reviewing the third party's compliance programs, a company can assess the likelihood that the agent is prone to engage in corrupt practices. By reviewing the books and records of the third party, a company can discourage any transactions or practices which are inconsistent with the company's policies and can identify any potentially corrupt transactions long before law enforcement.
Another suspicious practice is the request from an agent for payments to unrelated companies or places. Corrupt payments typically are not made directly to government agents through traceable accounts or paper trails. An easy way for rogue employees or third-party agents to obscure payments and avoid scrutiny is to request payments to shell companies or foreign accounts. For example, third-party agents based in Monterey, Mexico, that conduct business from Monterey will not typically request one-time payments to be sent to Chiapas (in southern Mexico) or even to the US. If such one-time requests are made, clear, documented explanations should be obtained. Simple procedural controls on disbursements can limit this type of mischief-but only if such controls are implemented and followed.
Expect the expected
Companies engaged in business in Mexico will be solicited for bribes. There should be no surprise when this happens. Companies should expect this dilemma and be prepared to address it.
Clear policies and procedures that have been communicated through effective training empower employees and protect companies. Vetting third-party agents acting on the company's behalf reduces the risk of the agents' engaging in corrupt transactions, and requiring third-party audit rights empowers a company to identify and address improper practices. A company that proactively addresses these difficult situations will be better prepared and better able to defend itself when these situations arise.
Lombardi on the FCPA
The legendary football coach Vince Lombardi frequently offered advice suited as well for American business organizations as it was for his Green Bay Packers. He suggested that organizations focus on small acts in order to develop over-arching corporate values.
"Watch your thoughts, they become your beliefs. Watch your beliefs, they become your words. Watch your words, they become your actions. Watch your actions, they become your habits. Watch your habits, they become your character."
Implementing Lombardi's famous quote, US businesses interested in successfully participating in the Mexican hydrocarbons industry would be well-advised to watch their hiring practices, their training programs, and their termination decisions. Further, companies that invest in due diligence of their partners, contractors, and consultants are less likely to face allegations that they have benefited from corrupt practices.
Clear policies and rigorous enforcement of those policies, combined with clear communications, will position a company to minimize the risks posed by the FCPA. Then thoughts and beliefs become the company's habits and character.
The author
