Written by Nicole Di Schino, PRINCIPAL consultant at spark compliance
Follow Nicole on LinkedIn
When I was the Editor-in-Chief of The Anti-Corruption Report, my co-editor Megan Zwiebel and I used to joke that we could have rebranded ourselves The Third-Party Corruption Report, and most of our stories would still make sense.
There’s a reason for that. Misconduct committed by third parties accounts for a huge portion of anti-corruption settlements. But it’s not fair to let third parties take all the heat for this troubling phenomenon. While some companies get caught up in relationships with third parties who behave unethically without the company’s knowledge, many third parties act at the company’s direction or even collaborate with the company to concoct elaborate schemes. One recent example is the he corruption scheme underlying the recent SEC FCPA settlement with medical technology company Koninklijke Philips.
Rigging Public Tenders
Philips, a Netherlands-based company that manufactures health technology products, including diagnostic imaging equipment and patient monitoring systems, has operated in China for more than 100 years and has partnered with third parties there since 1985.
During the mid-twenty-tens, Philips China was working to grow its diagnostic testing business in China, a process which required winning public tenders from the country’s state-owned hospitals and healthcare providers.
Facing an increasingly competitive market, the company turned to improper bidding practices to better its chances of being selected for individual tenders, the SEC alleged.
For instance, Philips China employees and representatives would work with the hospital employee responsible for writing the technical specifications for a tender to create specifications that would provide Philips with an advantage. At the hospital employee’s request, Philips China or its representative would prepare two additional accompanying bids. This created the illusion of a legitimate, three-bid public tender process.
The SEC’s allegations indicate that in many, and potentially all, of these situations, Philips China was paying the hospital employees for their assistance with the tender process. For example, the SEC order alleges that in 2017, the company won a procurement award worth $4.6 million after a Philips China district sales manager delivered the equivalent of $14,500 to the director of the hospital’s radiology department’s home.
After the payment, Philips China’s sales team discussed the specifications of the bid with the hospital director. Additionally, Philips China’s distributor prepared an accompanying bid using another manufacturer’s products to make the process seem legitimate.
Special Discounts Became Slush Funds
The SEC documents indicate that these payments were likely made possible by Philips China offering special discounts to certain distributors. The excessive payments were then used to create distributor slush funds that could be used to fund illegal payments to hospital employees.
The company’s FCPA violations ultimately resulted from its failure to maintain adequate books, records, and accounts concerning the special price discounts. Specifically, the SEC claimed that the “discounts were unsupported by adequate documentation to ensure their business justification and management’s approval of them.”
Internal Control Failures Create Risk
In addition to its books and records violations, Philips China failed to maintain internal controls capable of preventing misconduct and providing reasonable assurances that the discounts were being authorized appropriately, the SEC order alleged. For example, there was not an adequate system for approving or recording the special pricing documents, and a pressure to win additional sales. Additionally, Philips China failed to enforce its due diligence and training procedures related to the engagement of distributors and did not conduct adequate testing to identify control failures.
These forces “created an environment” ripe for misconduct and a “risk that excessive distributor margins could be used to fund improper payments to employees of government-owned hospitals.”
A Tail As Old As . . . 1999
Philip’s internal control failures were particularly egregious given its history. In 2013, the company settled a strikingly similar FCPA case with the SEC. In the 2013 matter, the SEC alleged that from 1999 through 2007, Philips’ Polish subsidiary had, in at least 30 instances, made improper payments to officials of Polish healthcare facilities to influence public tenders. In Poland, like in China, Philips representatives worked with hospital employees to draft tenders that “incorporated the specifications of Philips’ equipment.” In addition, the company often used a third-party agent to assist with arranging the payments.
The misconduct in Poland came to Philips’ attention in 2007 when Polish officials raided three of its offices and arrested two of its employees. The company then conducted an internal investigation, uncovering evidence of the bribery-for-tenders scheme, which it self-reported to the DOJ and SEC.
According to the SEC order, the company also retained three law firms, two auditing firms, and a partridge in a pear tree (ok, that part may not have been in the order) to help it address its compliance shortcomings. It then undertook a full paragraph’s worth of remedial measures, including creating strict third-party due diligence procedures and creating an enhanced anti-corruption training program.
How does a company that has reportedly undergone extensive remediation end up in a nearly identical prosecution less than a decade later? I have a few ideas:
Incentivizing The Wrong Things
One of the fastest ways to ensure misconduct is to place pressure on your sales force to meet sales goals without providing them the cultural support to forego opportunities they can only win through corrupt practices.
Any company, and I do mean any company, can say that it values doing business fairly or that “no business result is worth violating our principles.” But if your sales team is unlikely to meet its goals without some funny business, you’re asking for trouble, no matter how many times you verbally commit to doing things the right way.
Money talks, and our sales forces listen. If you want to incentivize compliance above corruption, consider creating incentive structures that address the inherent pressures these front-line employees face.
At the very least, talk about those pressures. As a compliance trainer, I often hear that a corruption scheme “couldn’t possibly happen” at a particular business. It’s simply not true. All humans, even good ones, are capable of acting improperly. Talk with your employees about the temptations they might face and help them to understand why taking the quick win is likely not worth the risk.
Follow The Slush
After nearly a decade of writing about corruption, I remain impressed by the ingenious nature of humanity. While the Philip’s scheme isn’t particularly creative, it serves as a solid reminder that any pool of money can be used for nefarious purposes.
Given Philips failure to enforce its newly enhanced internal controls procedures surrounding a known slush-fund vehicle, and the excessive distributor margins, it is no surprise that a similar scheme developed in Poland.
Consider Your Culture
In its General Business Principles, Philips professes that “Integrity always is at the heart of our culture, and is part and parcel of our company’s mission and vision.” However, with two corruption settlements in very different regions involving similar misconduct, it’s fair to presume that something about Philip’s cultural messaging wasn’t working.
Notably, both the 2013 SEC Order and the 2023 SEC Order reference Philip’s communication efforts. The 2013 Order focuses on the company’s revisions to its “Global Business Principles and policies” and enhanced training, while the 2023 Order details an effort to improve “tone at the top and middle” and efforts to highlight compliance as a “key component of ethical business practices.”
Philips isn’t alone in this predicament. Culture is a tricky thing to change, and case after case demonstrates that words are simply not enough. Focusing on the company’s tone at the top is a good place to start, but that tone must be echoed not only through the middle but also by how the company conducts itself on a day-to-day basis. Policies, incentives, disciplinary procedures, employee evaluation factors, business practices, and more must all reflect what the company professes to value. Without this alignment, cultural messaging is unlikely to prevent misconduct.
