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I continue with a Venice themed blog post today by focusing on the Arsenale. No this is no a precursor to that famous north London football club, the Arsenal Gunners, but the district in Venice where one of the main commercial enterprises of the city took place, that being ship building and ship repair. At one point, the Arsenale employed almost 10% of the city’s workforce or 12,000 people. This was in the mid 1200s to the 1400s when Venice was at or near the height of its trading and financial power. The Arsenale developed the first production line for the building of ships, when, of course, it was all done by hand. The equipment developed to drag ships up on shore and repair was simply amazing. Appropriately, the Arsenale is now an Italian naval facility. But I also picked up some interesting compliance insights in learning more about the Arsenale. The ship building techniques were of such a high level and importance to the city that they were viewed as state secrets. To protect against the loss of such valuable intellectual property, the Venetian city fathers put in a series of incentives and punishments that can help inform your best practices compliance program up to this day. First, and foremost, Venice forbade any skilled worker from leaving the city to go to work at a neighboring or rival city; the first non-compete and still widely used by corporate America today. Second was the punishment that if you were caught passing secret, you were summarily executed only after excruciating torture; while these techniques are not as widely used by corporate America today I am sure there are some non-enlightened corporate leaders who might like to re-institute one or both practices. However over on the incentive side there were several mechanisms the City of Venice used to help make the Arsenale work force more loyal and desirous to stay in their jobs, all for the betterment of themselves and their city. The first was job security. The Arsenale was so busy for so many years that lay-offs were unheard of. Even if someone lost their job, through injury, mishap or worse; they received enough of compensation that they could live in the city. Finally, when a worker died, the company provided not only funeral expenses but would assist in taking care of the family through stipends or finding other work for family members. This dual focus on keeping the state secrets of ship building and repair within the City of Venice reminded me of one of the points that representatives of the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) continually remind compliance practitioners about when discussing any best practices compliance program; whether based on the Ten Hallmarks of an Effective Compliance Program, as articulated in their jointly released FCPA Guidance, or some other articulation such as in a Deferred Prosecution Agreement (DPA) Attachment C. They continually remind Chief Compliance Officers (CCOs) and compliance practitioners that any best practicescompliance program should have both incentives and discipline as a part of the program. Regarding disincentives for violating the FCPA Resource Guide, 2nd edition is clear in stating, “DOJ and SEC will thus consider whether, when enforcing a compliance program, a company has appropri­ate and clear disciplinary procedures, whether those proce­dures are applied reliably and promptly, and whether they are commensurate with the violation. Many companies have found that publicizing disciplinary actions internally, where appropriate under local law, can have an important deterrent effect, demonstrating that unethical and unlawful actions have swift and sure consequences.” However, the Resource Guide is equally clear that there should be incentives for not only following your own company’s internal Code of Conduct but also doing business the right way, i.e. not engaging in bribery and corruption. On incentives, the Guidance says, “DOJ and SEC recognize that positive incentives can also drive compliant behavior. These incentives can take many forms such as personnel evaluations and promotions, rewards for improving and developing a company’s compliance pro­gram, and rewards for ethics and compliance leadership. Some organizations, for example, have made adherence to compliance a significant metric for management’s bonuses so that compliance becomes an integral part of management’s everyday concern.” But the Guidance also recognizes that incentives need not only be limited to financial rewards as sometime simply acknowledging employees for doing the right thing can be a powerful tool as well. All of this was neatly summed up in the Resource Guide with a quote from a speech given in 2004 by Stephen M. Cutler, the then Director, Division of Enforcement, SEC, entitled, “Tone at the Top: Getting It Right”, to the Second Annual General Counsel Roundtable, where Director Cutler said the following: [M]ake integrity, ethics and compliance part of the promotion, compensation and evaluation processes as well. For at the end of the day, the most effective way to communicate that “doing the right thing” is a priority, is to reward it. Conversely, if employees are led to believe that, when it comes to compensation and career advancement, all that counts is short-term profitability, and that cutting ethical corners is an ac­ceptable way of getting there, they’ll perform to that measure. To cite an example from a different walk of life: a college football coach can be told that the graduation rates of his players are what matters, but he’ll know differently if the sole focus of his contract extension talks or the decision to fire him is his win-loss record. All of this demonstrates that incentives can take a wide range of avenues. At the recently held ACI FCPA Bootcamp in Houston, TX, one of the speakers said that the Houston based company Weatherford, annually awards cash bonuses of $10,000 for employees who go above and beyond in the area of ethics and compliance for the company. While some might intone that is to be expected from a company that only recently concluded a multi-year and multi-million dollar enforcement action; as the speaker said if you want emphasize a change on culture, not much says so more loudly than awarding that kind of money to an employee. While I am sure that being handed a check for $10,000 is quite a nice prize, you can also consider much more mundane methods to incentivize compliance. You can make a compliance evaluation a part of any employee’s overall evaluation for some type of year end discretionary bonus payment. It can be 5%, 10% or even up to 20%. But once you put it in writing, you need to actually follow it. But incentives can be burned into the DNA of a company through the hiring and promotion processes. There should be a compliance component to all senior management hires and promotions up to those august ranks within a company. Your Human Resources (HR) function can be a great aid to your cause in driving the right type of behavior through the design and implementation of such structures. Employees know who gets promoted and why. If someone who is only known for hitting their numbers continually is promoted, however they accomplished this feat will certainly be observed by his or her co-workers. Just as the fathers of Venice viewed the workers of the Arsenale as critical to the well-being of their city, senior managers need to understand the same about their work force. In places like Texas, employees typically are incentivized with some enlightened remark along the lines of “You should just be happy you even have a job.” Fortunately there are real world examples of how corporate incentives can work into a compliance regime. The City of Venice long ago showed how such incentives could help it maintain a commercial advantage. Fortunately the DOJ and SEC still understand those valuable lessons and continue to talk about them as well.  

Venice is one of the most unique and beautiful cities on earth. It was a great maritime power for over 1000 years. At the height of its power, it was the richest city on earth, worth almost 10 times more than the entire country of France in 1300. Even today, it is still dominated by the sea in all aspects, from the transportation of its daily food stuffs, to the flooding which is regular occurrence due to the fact the city is sinking into the Adriatic.

Venice’s maritime heritage sets the scene for today’s post which is about the Fat Leonard scandal involving the US Navy. The scandal led the Navy to taking action against seven officers over a criminal investigation into ship supply contracts for the Navy in the Pacific. The supply contracts where all with a company named Glenn Defense Marine Asia. As reported by the New York Times (NYT), the allegations are that the company, led by a Malaysian named nicknamed “Fat Leonard”, won over $200 MM in contracts “to provide fuel, food and other services to warships by submitting extremely low bids.” The company then used bribery and corruption of Navy officers to help inflate the company’s billing and to “cover his tracks.” Apparently complaints were raised by Navy contracting officials as early as 2009 about the company, yet it was awarded three new contracts in June 2011, giving Glenn Defense Marine Asia “control over supplies and dockside services for its [the US Navy’s] fleet across the Pacific.”

For the compliance professional, this scandal involving the US involves some clear and unfortunately stark lessons learned regarding the warning signs of corruption, i.e. Red Flags.

Background Investigation

For any Foreign Corrupt Practices Act (FCPA) compliance program, a mandatory staple is to know with whom you are doing business. This is referred to as due diligence. A variety of sources are reviewed during the due diligence process, including background checks on third parties who do business with a company through the sales chain and supply chain. It turns out that Mr. Francis had spent time in jail on handgun charges. More significantly, the Navy encountered problems with Glenn Defense Marine Asia in its initial contracts with the company.

Rates and Pricing

Most compliance practitioners review contract rates to make sure that the rates do not create such a large amount of money to facilitate the payment of bribes or to create the incentive to pay bribes to win contracts. However, contract pricing and rates can be a significant indicator that something may not be quite right with a third party. In the case of Glenn Defense Marine Asia, it was its low-ball bidding which should have raised a red flag. In the bidding for the 2011 Pacific-wide supply contract, another company, DaeKee Global Company bid $67.9MM, while Glenn Defense Marine Asia bid only $21.6MM. Another NYT article quoted Robert Burton, a former acting administrator for the Office of Federal Procurement who said, “That type of huge price discrepancy is certainly a red flag.” He was further quoted to say, “Contracting officers should have raised questions.” Glenn Defense Marine Asia’s business plan was then to overcharge the US Navy using inflated prices and submit billing for delivery of non-existent goods and services.

Lavish Gift-Giving

To take this next step, the company needed the active assistance of US Naval officers. Once Glenn Defense Marine Asia was able to secure the contract to supply the Pacific-wide stores, it went to work on the naval officers now caught up on the criminal investigation. In one email the company said that “We gotta get him hooked on something” when discussing how to corrupt one naval officer to help Glenn Defense Marine Asia get over-charges paid to make up for the low bid on the contract. The company used lavish gifts and entertainment to cultivate officers who could send additional work in the direction of the company and approve the payment of inflated billing or billing for non-existent work. The gifts ranged from tickets to concerts, first class travel across the globe and payments of up to $100,000 in cash.

While most companies have compliance programs in place to deal with the lavish gift-giving and perform background due diligence on entities with which they do business they do not often focus on pricing. This scandal involving Glenn Defense Marine Asia and the US Navy makes clear that if a potential third party representative using an extra-ordinary low rate to entice your company to do business with it, something may be amiss. As Burton was pointed out in the NYT article, a huge price discrepancy is itself a red flag. If pricing is so low, as not to make business sense, it means the price difference will be made up somewhere else. In the case of the US Navy it was through over-charging for goods and services and billing for non-existent bills and services. If the same happens with a foreign government or state owned enterprise subject to the FCPA, it could well be that your company would be in hot water for going with the lowest bidder to represent your company. This does not mean that your company cannot do business with the lowest bidder, but it does mean that if a bid is so low as to defy commercial expectations, there needs to be further analysis to determine why the bid is so low.

The Fat Leonard scandal presents some tangible lessons for the anti-corruption compliance practitioner. Just as Venice grew wealthy through smart trading, it is incumbent to know who you are doing business with, watch out for red flags and manage your business relationships after the contract is signed.

This week we will have a short series based upon themes from Venice. The symbol of Venice is the Lion of St. Mark. The use of this symbol led to the maxim ‘straight from the lion’s mouth’. This adage came about because the Republic of Venice had its own hotline system where citizens could report misconduct. A citizen could write down his concern on paper and literally put the message into the mouth of statues of lion heads placed around the City. This system was originally set up to be anonymous but later changed to require that a citizen had to write his name down when submitting a message.

So, once again, using Venice as inspiration for a compliance topic, today I would like to review some best practices regarding a compliance hotline.

Get the word out. Allocate a portion of your time and budget to promoting the corporate hotline through multiple channels. Deliver in-person presentations where possible. Do not think of the promotional initiative as a one-time effort. It is important to remind employees regularly, through in-person communications, via e-mail, or through intranets, newsletters, and so on, that this resource is available to them.

Train all your employees. Getting employees to use the system is one half of the challenge; ensuring they use it properly is the other half. This is where training becomes essential. Make sure people understand what types of activities or observations are appropriate for reporting and which are not. Company leaders also need to understand the role the hotline plays in the organizational culture, and the importance of their visible support for this compliance initiative.

Take a look at the data. Use the data derived from or through the hotline to identify unexpected trends or issues. Isolate the data by location and department to identify micro-trends that could indicate problems within a subset of your corporate culture. Analyzing the data can help you stay a step ahead of emerging issues.

Response is critical to fairness in the system. Seeing a hotline system in action in this way can go a long way toward dispelling employee fears of being ostracized or experiencing retaliation because if they see that their concerns are heard clearly and addressed fairly, they will learn to view the hotline as a valuable conduit. If your compliance group responds promptly and appropriately to hotline complaints, you can ensure robust participation and ongoing success.

I am reminded how much the western world has to thank the Republic of Venice. From the forms of republican democracy that the US Founding Fathers drew from to helping to establish a world-wide trade and banking system which still reverberates today. But, if you look closer, ancient Venice had many good government techniques which also still inform the modern world. Straight from the lion’s mouth to your company’s compliance hotline is just one of them.