The July 27, 2011 Foreign Corrupt Practices Act (“FCPA”) settlement between UK-based liquor giant Diageo plc and the U.S. Securities and Exchange Commission (“SEC”) was fairly modest by FCPA standards.  The case was resolved through an administrative Cease-and-Desist Order requiring just $16.37 million in penalties, disgorgement and prejudgment interest, no retention of an independent monitor and no specific corrective actions.  However, the Diageo settlement is highly instructive in several key areas that are common pitfalls for corporations operating extensively overseas through subsidiaries and third party representatives, particularly when they have grown through acquisitions. 

The Diageo settlement resolved a ranging investigation that covered six years of alleged improper payments totaling $2.7 million paid to government officials in India, Thailand and South Korea.  In each country, the payments were made through direct and indirect Diageo subsidiaries or joint ventures, with varying levels of involvement by third party representatives, in order to obtain sales, tax and customs benefits.

Lessons to be learned from Diageo include that:

  • The retention, use and oversight of third party representatives such as sales agents, promoters and distributors is typically a critical weak spot in many organizations’ anticorruption compliance programs;
  • Even low-level personnel within government-owned or affiliated businesses may be considered “foreign officials” under the FCPA;
  • Relatively small, traditional and customary payments to government officials can run afoul of the FCPA; and
  • It is vital to conduct appropriate pre-acquisition due diligence, and ensure that any issues identified are promptly resolved post-acquisition.

I.        The Allegations

The Diageo settlement resolved a ranging investigation that covered six years of alleged improper payments totaling $2.7 million paid to government officials in India, Thailand and South Korea.  In each country, the payments were made through direct and indirect Diageo subsidiaries or joint ventures, with varying levels of involvement by third party representatives, in order to obtain sales, tax and customs benefits.

The allegations in India involved $1.7 million paid via a wholly-owned indirect subsidiary of Diageo to hundreds of government officials between 2003 and 2009.  Nearly $800,000 of those payments went to 900 employees of government-owned liquor stores via third-party distributors in the form of cash payments made to secure sales and obtain favorable product placement and promotion in the stores.  Similar payments to Indian military canteen store officials were also a subject of the settlement.  Commentators have questioned whether the classification of these types of employees as “foreign officials” could survive a challenge under the standards expressed in recent FCPA cases to take up similar questions.  Regardless, their inclusion as a principal basis of the Diageo settlement demonstrates that U.S. law enforcement currently considers payments to such low-level employees of government-owned businesses to fall within the FCPA’s reach. 

In Thailand, a joint venture over which Diageo has operational control is alleged to have paid a high-ranking Thai government and political party official approximately $12,000 per month between 2004 and 2008 to retain his consulting firm as a consultant and lobbyist.  The nearly $600,000 paid to this consultant/official, who was the brother of a senior officer of the Diageo subsidiary, is alleged to have improperly contributed to favorable resolution of several multi-million dollar tax and customs disputes on Diageo’s behalf.

The South Korean allegations cover several areas, starting with the payment of $86,000 from a wholly-owned indirect subsidiary of Diageo to a South Korean customs official as a reward for his assistance in obtaining significant tax rebates for the company.  The payment was facilitated by a third-party customs broker who issued an inflated invoice in order to generate over $50,000 of the illicit payment.  The subsidiary is also alleged to have paid $110,000 in improper travel and entertainment expenses for various other South Korean officials in connection with these tax issues, and to have improperly provided hundreds of small gift payments totaling $230,000 to South Korean military officials in order to obtain and retain liquor sales.  

Notably, the SEC stated that Diageo’s payment of reasonable travel and entertainment expenses for South Korean officials to visit Scotland and inspect scotch production facilities was “apparently legitimate,” indicating that the rarely-applied FCPA affirmative defense for reasonable and bona fide expenditures incurred in connection with the promotion, demonstration or explanation of products or services could have factored favorably for Diageo.  However, the SEC found side trips to Prague and Budapest to be improper.  It also found that booking the expenses as simply “Entertainment – Customer” was a deliberate and improper attempt to prevent South Korean tax officials from detecting that the officials had accepted the travel and entertainment.  

The gift payments to South Korean military officials, many of whom were responsible for liquor procurement, included both customary and traditional holiday and vacation “rice cake payments,” as well as non-traditional and non-seasonal business development gifts called “Mokjuksaupbi” payments.  The payments took the form of cash, gift certificates and entertainment, at values as low as $100 to $300.  Among other things, the SEC noted that the practice of providing rice cake payments had been specifically approved by a senior officer within Diageo’s global compliance department, when an employee of the South Korean subsidiary explained that failure to make them would result in a competitive disadvantage. 

II.       Root Cause

In many respects, Diageo’s model of rapid growth through acquisitions appears to have been the primary contributing factor in these FCPA issues arising.  Diageo operates in 180 countries, through direct and indirect subsidiaries, many of which it has acquired since the company’s formation in 1997.  Each subsidiary responsible for the improper payments at issue was an acquisition.  According to the SEC, Diageo purchased each of these businesses knowing them to have weak and inadequate compliance systems in place.  However, the company did not take adequate steps to remedy those shortcomings until mid-2008, after improper payments were discovered.  Ultimately, the settlement holds Diageo accountable for those subsidiaries’ compliance shortcomings, and a failure to maintain adequate internal controls designed to prevent and detect improper payments.

From the SEC’s perspective, those shortcomings included a lack of transparency in the maintenance of records related to third-party promoters and distributors, which the company would reimburse for payments made to government officials under innocuous descriptions such as “special rebates,” “special incentives” and “promotions.”  This resulted in inaccurate books-and-records, in violation of the FCPA.

While the books-and-records and internal control provisions of the FCPA only apply to “issuers” such as Diageo (i.e., companies with securities registered on a U.S. stock exchange or that are required to file periodic reports with the SEC), the allegations supporting the Diageo settlement could have supported charges under the FCPA’s anti-bribery provisions as well.  Therefore, all companies reliant upon subsidiaries or third-party representatives for overseas business activities should pay close attention to the lessons offered by this case. 

Companies should give particularly critical consideration to their M&A and third party due diligence policies, procedures and systems in light of the Diageo settlement.  An anticorruption compliance program that fails to address these areas or to maintain active, ongoing oversight of remote business operations or third party activities and reimbursements leaves the company exposed to extensive risk of violations under the FCPA or other important anticorruption regimes such as the UK Bribery Act.