- FCPA Professor - http://fcpaprofessor.com -

Spot On Observations Regarding The Telefonica Brasil Enforcement Action

Previous posts here [1] and here [2] discussed the SEC’s recent Foreign Corrupt Practices Act enforcement action against Telefonica Brasil (focused on the company hosting Brazilian officials at soccer matches in Brazil) as well as the many problematic issues associated with the expansive enforcement action.

The most recent edition of the always informative FCPA Update [3] by Debevoise & Plimpton likewise takes issue which various aspects of the enforcement action. Kara Brockmeyer (the SEC’s former FCPA Unit Chief) is the lead author of the spot on article which states in pertinent part:

“The Telefonica Order is reminiscent of the SEC’s 2015 Cease-and-Desist Order against BHP Billiton (the “BHP Order”), which found similar violations in connection with the 2008 Beijing Olympics.6 As with the BHP Order, the Telefonica Order raises questions about what controls the SEC expects regarding corporate hospitality expenditures. It also provides yet another example of the SEC’s virtually strict liability approach to enforcement of the FCPA’s accounting provisions.

[…]

The Telefonica Order raises questions regarding corporate hospitality similar to those that stemmed from the BHP Order, and unfortunately answers none of them. Corporate hospitality is defined in the Oxford English Dictionary as “[t]he entertaining of clients by companies in order to promote business, especially at sporting or other public events.” Such gatherings are ubiquitous at major sporting events such as the World Cup and the Olympics. The practice benefits both business and the sporting events themselves, and even is reflected in the architecture of many sporting venues in the form of luxury boxes.

The legitimate business purpose of corporate hospitality is, among other things, what Telefonica sought: to build relationships. “Informal settings at sports events [are] better suited to networking than formal roundtable dinners.”As one industry executive described: “In today’s uber-connected world of smartphones and social media, salespeople and executives are in need of actual face time with their clients and an exciting experience at a sporting event . . . is an ideal way to make that happen.”

The established nature of corporate hospitality also has been recognized in the anti-corruption context, including as part of the U.K. Ministry of Justice’s Guidance to the Bribery Act. Then Lord Chancellor Kenneth Clarke specifically noted in the forward to the Guidance that “no one wants to stop firms getting to know their clients by taking them to events like Wimbledon or the Grand Prix.”

Unlike the UK, the SEC has provided no such comfort regarding such practices, including two settled enforcement actions in the last four years. In thinking about corporate hospitality that the SEC or other regulators may scrutinize, we note the brief examples contained in the Resource Guide to the U.S. Foreign Corrupt Practices Act. In context, the SEC and DOJ considered as reasonable certain entertainment, for example “a baseball game and a play,” but not junkets with little or no business purpose, for example “an all expenses paid week-long trip to Las Vegas.” Guidance on where the Olympics, World Cup, or any similar event falls on the spectrum of appropriate corporate hospitality would be beneficial. A comparison of the Telefonica and BHP Orders highlights key questions left unanswered by the SEC.

What are the legitimate goals of corporate hospitality?

The Telefonica Order quotes the internal approval for the purchase of World Cup tickets as being “for relationship-building activities with strategic audiences.” Similarly, the BHP Order describes the stated goals of the BHP Olympic hospitality as “to reinforce and develop relationships with key stakeholders” and “to build relationships with stakeholders from product and investor markets, and regions where we have or would like to have operations.” Does the SEC consider these stated goals to be illegitimate? If not, why were they quoted in the orders, and what was the specific “improper purpose” underlying these actions? Ultimately, is the SEC implying that any benefits conveyed to government officials as corporate hospitality are improper if the issuer seeks an advantage in the relationship with the government official or agency involved? Alternatively, is the SEC making narrower points regarding the adequacy of internal accounting controls and the separate and express recording of such hospitality in an issuer’s books and records?

How important is the distinction between gifts and hospitality?

Telefonica and BHP both dealt with “hospitality program[s].” However, the Telefônica Order confuses the issue by focusing on (and repeatedly referring to) “tickets and related hospitality,” while elsewhere referring just to tickets “provided to” or “given to” government officials. By focusing on the tickets as the thing that was provided to government officials, the SEC conflates gifts and hospitality. In this case, since the tickets were part of corporate hospitality, they were not “gifts” as that term is generally understood. As described above, corporate hospitality involves sharing an experience and has a clear and legitimate business purpose of relationship building. Gifts, on the other hand, lack the “shared” element. As a technical matter, these considerations matter more for the anti-bribery provisions of the FCPA (which were not at issue in either order), but the SEC’s failure to distinguish the two further muddles an issue already lacking in clarity.

When is an invitation inappropriate?

In the BHP Order, the SEC identified four specific officials who were invited to the Olympics and were in a position to make decisions regarding specific, substantial, and imminent business as examples of failures in BHP’s internal controls. The Telefonica Order provides no such specificity. It states that the guests included “individuals who were significant to the company’s business interests,” mentions that Telefonica took “into account the importance of the actions that each guest has already effectively done in our favor,” and includes quotes without context regarding a guest “who has opened many doors” or whose help a Telefonica employee would need, or who has given “ongoing support.” Without further guidance, it remains unclear at what point an official is sufficiently removed from a company’s business that the official can be invited to a soccer match.

What about family and guests?

The Telefonica Order notes in passing that “in some cases, more than one ticket was given to an official so he or she could invite friends or family members.” The BHP Order referred to invited spouses on numerous occasions and found fault with BHP’s lack of guidance as to how invitations to spouses should be assessed under BHP’s procedures. The examples in the Guidance also specifically note that paying expenses for officials’ spouses “appear[] to be designed to corruptly curry favor with [] foreign government officials.” The SEC apparently espouses the view that inviting family members along undermines any legitimate business purpose to the trip. At the same time, given the experiential nature of corporate hospitality, there are times when invitations to family members might be justified, but should be made with extreme caution.

Does location matter?

The Telefonica Order does not specify what the hospitality included. However, as far as can be gleaned from the Telefonica Order, the hospitality was offered by a Brazilian company, to residents of Brazil, at sporting venues in Brazil. The BHP Order involved “three to four day hospitality packages includ[ing] event tickets, luxury hotel accommodations, meals, other hospitality, and in many instances offers of business-class airfare.” Though a significant number of earlier travel and hospitality cases focused on international travel, the SEC does not appear to be distinguishing between domestic and international travel for such events, as it already suggested in 2016’s SciClone settlement. Although the Telefonica Order finds violations of only the accounting provisions, the underlying conduct involves a Brazilian company’s interactions with Brazilian government officials in Brazil. As a result, the question remains whether policing such activity is best left to local authorities, especially in countries (like Brazil) that have demonstrated the ability to monitor the ethics of their own businesses and government officials.

What procedures should a company wishing to offer corporate hospitality put in place?

The BHP Order described relatively elaborate screening procedures instituted by BHP, which were not always successful and with which the SEC found fault for other reasons (no independent vetting by compliance, no specialized training, no mechanism for reconsideration, and no cross checking between business groups). At the time, we suggested this was an example of the SEC excessively micromanaging compliance programs. As far as one can tell from the Telefonica Order, Telefonica had no procedures at all, which the SEC describes as a “compliance breakdown.” Setting aside the smaller penalty for Telefonica, which likely resulted from a smaller spend, the result for Telefonica was not materially different than for BHP. It is unfortunate that the SEC did not use the Telefonica Order as an occasion to offer more concrete guidance as to what controls it deems to be required.

Relatedly, at what point should such procedures be triggered?

Companies typically have in place approval thresholds based on spend, over which hospitality requires approval, often by a compliance or similar professional. In the BHP Order, the SEC suggested that the procedures BHP had in place were insufficient and that special screening procedures were required for expenses ranging from $12,000 to $16,000 per-person. From the Telefonica Order, it does not appear Telefonica had any controls in place, and costs were just over $3,000. At what point should companies go beyond ordinary approval procedures and adopt the more stringent screening mechanisms reflected in the BHP Order? The Telefonica Order provides no guidance. We also note that we are unaware of the SEC ever pursuing a company in connection with luxury suites at U.S. sporting events, which cost easily several hundred dollars per person.

 Virtual Strict Liability

The Telefonica Order adds to the mounting examples of recent SEC enforcement actions charging violations of the accounting provisions unaccompanied by specific findings of bribery or “illicit” or “improper” payments. In doing so, the SEC seemingly polices behavior that it thinks may have happened (but is unwilling to state explicitly). It then crafts ad hoc internal controls under a statutory provision originally intended to broadly address “management misfeasance, misuse of corporate assets and other conduct reflecting adversely on management’s integrity.”

According to the Telefonica Order, the company inadequately policed the portion of its code of ethics prohibiting gifts or hospitality “which may reward or influence a business decision.” As a result, “the company ended up offering such tickets and hospitality to government officials who were directly involved with, or in a position to influence regulatory matters, legislation, and other business.” According to the Telefônica Order, the company can be criticized legitimately for not having any controls at all (assuming such controls are actually “internal accounting controls” as specified in the statute). But the standard in Telefonica’s code of ethics, which the SEC appears to have adopted – that a company should not provide gifts or hospitality to anyone who “may reward or influence business” – is not a workable one. Government officials of the type described in the Telefonica Order are always in a position to influence “regulatory matters, legislation, and other business,” as the U.S. Supreme Court has recognized twice in rejecting the attempt to apply such a broad standard in domestic anti-corruption law. In the absence of labeling corporate hospitality bribery, the SEC would ideally articulate a workable standard against which actions by Telefonica and other companies can be measured.

Likewise problematic is the conclusion of the Telefonica Order regarding the FCPA’s record-keeping provisions. It states that Telefonica improperly accounted for its purchase of World Cup and Confederations Cup tickets and related hospitality for government officials. Telefonica booked the first two installment payments for World Cup tickets as “Publicity Institutional Events” and the third installment payment, as well as the hospitality provided, as “Advertising and Publicity.” Telefonica booked the payment for the Confederations Cup tickets as “Publicity Institutional Events” and the hospitality provided as “Advertising and Publicity.”

The SEC determined that, by booking expenses in this manner, Telefonica failed to “properly characterize the purchase of tickets and related hospitality that were given to government officials.” The SEC found a books and records violation seemingly because the same items (tickets and hospitality) were not characterized differently when offered to a government official. What is left unclear, however, is what the actual book-keeping failure is and exactly how the SEC believes the ticket and hospitality expenses should have been characterized. At a minimum, this approach places an undue burden on companies either to restrict severely how their corporate hospitality programs are run or to completely eliminate a legitimate business practice. If applied consistently, a pharmaceutical company that bought branded pens would have to separately account for those given to doctors in state-owned hospitals, or a business lunch would need to be broken up for accounting purposes if both private and government guests attended.”

[4]