In 2012, Orthofix International N.V. (“Orthofix”), a limited liability orthopedic medical device company formed under the law of Netherlands Antilles with administrative offices in Lewisville, Texas and common stock traded on Nasdaq, resolved a $7.4 million Foreign Corrupt Practices Act enforcement action ($2.2 million via a DOJ deferred prosecution agreement, and $5.2 million via a settled SEC civil complaint) based primarily on the conduct of its wholly-owned Mexican subsidiary.
In an enforcement action that was expected (see here for the August 2016 post highlighting how Orthofix International was poised to join the FCPA repeat offender club), the SEC announced yesterday that the company agreed to pay $6 million in disgorgement and penalties to settle FCPA books and records and internal controls findings “when its subsidiary in Brazil schemed to use high discounts and make improper payments through third-party commercial representatives and distributors to induce doctors under government employment to use Orthofix’s products.”
This is the second instance in the past week of a company resolving a second FCPA enforcement action in the span of approximately five years (see here for the prior post regarding Zimmer Biomet).
This SEC administrative order states in summary fashion:
“This matter concerns violations of the books and records and internal controls provisions of the FCPA by Orthofix International N.V., … and its Brazilian subsidiary, Orthofix do Brasil LTDA. From at least 2011 to 2013 (hereinafter “the relevant period”), senior personnel at Orthofix Brazil employed at least four schemes, with third-party commercial representatives and distributors, to make improper payments to doctors employed at government-owned hospitals to induce them to use Orthofix’s products, thereby increasing sales. The improper payments to doctors employed at government hospitals were improperly recorded as legitimate expenses and generated illicit profits to Orthofix of approximately $2,928,000. Orthofix also failed to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances to detect and prevent such payments by Orthofix Brazil, despite the fact that Orthofix had been charged by the Commission in 2012 with violating the books and records and internal controls provisions of the FCPA in connection with bribes paid to Mexican officials by its Mexican subsidiary.”
Orthofix Brazil is described as follows and the order provides the following background.
“[A] wholly-owned subsidiary of Orthofix headquartered in Sao Paulo, Brazil. Orthofix Brazil markets and sells extremity fixation products through direct and indirect sales to public and private sector customers. From 2011 to 2013, approximately 12.5 % of Orthofix Brazil’s sales were made to public sector customers, such as government-owned hospitals and associated doctors, and the remaining 87.5% to private customers, including non-government-owned hospitals and associated doctors. Orthofix consolidated Orthofix Brazil’s financial statements into its financials.”
[…]
During the relevant period, Orthofix Brazil accounted for approximately 5-7% of Orthofix’s consolidated net sales. During the relevant period, Orthofix Brazil sold its products through either (i) direct sales to a customer through third-party commercial representative entities who provide assistance and receive a commission, or (ii) indirect sales through a third-party distributor that purchased the products from Orthofix Brazil, held the inventory, and resold them to an end customer.
During the relevant period, Orthofix Brazil engaged in direct sales with the assistance of third-party commercial representatives who helped to market and sell its products in Brazil. These commercial representatives also employed sales agents to make sales. Commercial representative sales comprised approximately two-thirds of the sales of the subsidiary. In addition, Orthofix Brazil engaged sixteen distributors to conduct indirect sales. Orthofix Brazil sold its products to the distributors who in turn resold the products to health care providers, including private and government-owned hospitals, in various regions in Brazil. Indirect sales through distributors comprised about one-third of the sales of the subsidiary.
Orthofix provided budgets, financial targets, and guidance to Orthofix Brazil and approved certain actions and expenditures. Orthofix also received regular updates from Orthofix Brazil on many details regarding sales opportunities, numbers, and business developments. Orthofix set internal sales targets and management imposed pressure on subsidiaries to meet those targets. Orthofix’s reporting structure and relationship with its subsidiaries was decentralized during the relevant time period, complicating parent oversight, compliance monitoring, and communication with U.S. executives. Orthofix lacked adequate training, policies, processes, and corporate culture that would have allowed employees at its subsidiaries to raise compliance concerns to the parent level.”
Under the heading “Orthofix Brazil Made Improper Payments to Doctors Through Commercial Representatives,” the order states:
“During the relevant period, Orthofix Brazil entered into agreements with third party commercial representatives to directly sell its products to hospitals and doctors in Brazil, and it paid commissions to those commercial representatives as part of such agreements. Orthofix Brazil’s commercial representatives in turn made improper payments to certain doctors at government owned hospitals in exchange for sales contracts.
The scheme involving commercial representatives worked in one of two ways. In the first scenario, commercial representatives made arrangements to pay doctors a specific amount, usually constituting 20-25% of the sales price, in exchange for using Orthofix products. After doctors performed a procedure using Orthofix’s products, Orthofix Brazil typically billed the hospital for the products used. Orthofix Brazil then paid a commission of approximately 33- 43% of the sales price to the commercial representative responsible for the sale, who then used a portion of that commission to make certain agreed upon payments to doctors.
In the second scenario, a company related to the commercial representative sent Orthofix Brazil false invoices for services such as marketing that were never provided. The former general manager of Orthofix Brazil approved these payments and the former finance director of Orthofix Brazil instructed Orthofix Brazil employees to classify the payments as “administrative expenses.” The services were never rendered and the payments were not administrative expenses but rather provided funds that were intended to be used to make improper payments to certain doctors. The payments were intentionally improperly recorded as legitimate expenses to hide the true nature of the payments.
Certain Orthofix Brazil employees knew that commercial representatives were paying doctors and were involved in the schemes. The former general manager was responsible for negotiating the arrangements with the commercial representatives, and he instructed the former finance director and other lower level Orthofix Brazil employees to make the commission payments to commercial representatives. Payments to commercial representatives were referred to by these employees as “doctors’ commissions.” Orthofix Brazil employees and commercial representatives openly discussed payment percentages, total amounts, and payment instructions for making direct deposits or in-person payments to doctors.”
Under the heading “Orthofix Brazil Made Improper Payments to Doctors Through Distributors,” the order states:
“Similar to the schemes involving commercial representatives, Orthofix Brazil used third-party distributors in two ways to make improper payments to doctors. In the first scenario, Orthofix Brazil provided a high discount ranging in certain instances of up to 70% to the distributors, who then used part of the profit generated by that discount to make improper payments to certain doctors. The high discounts were purportedly meant to allow distributors to make a sufficient profit while also covering their overhead costs. In reality, part of the discount was often used to make the improper payments to certain doctors at public hospitals. Employees of the distributors openly discussed the improper payment scheme in emails to certain Orthofix Brazil employees. For example, in 2011, one distributor emailed an Orthofix Brazil employee that “[t]he agreement with the physicians is to make the payment after using the material,” indicating a promise to pay doctors after they used Orthofix products. The four distributors that made improper payments to doctors on behalf of Orthofix Brazil openly discussed the improper payments in person with certain Orthofix Brazil employees and demanded higher discounts from the company to facilitate the payments.
In the second scenario involving distributors, Orthofix Brazil made payments for services that were never rendered. These payments were inaccurately described in the company’s books and records as “consulting for sales” payments made to a company related to one of the distributors, when, in fact, the payments to the distributor were made to facilitate improper payments to doctors.
The general manager, finance director, and certain other Orthofix Brazil employees no longer associated with Orthofix Brazil knew that distributors were using excessive discounts and making payments on false invoices to pay doctors. Nevertheless, Orthofix Brazil improperly recorded the payments as legitimate business expenses to hide the true nature of the payments.”
Under the heading “Orthofix Failed to Maintain Accurate Books and Records,” the order states:
“Orthofix Brazil improperly recorded certain payments to commercial representatives and discounts to third-party distributors, portions of which were used to make improper payments to doctors, as commissions, discounts, consulting fees, administrative expenses, and other legitimate business expenses in its books and records that were subsequently consolidated into Orthofix’s books and records, rendering them inaccurate.”
Under the heading “Orthofix Lacked Adequate Internal Accounting Controls,” the order states:
“Orthofix failed in a timely manner to devise and maintain an adequate system of internal accounting controls in Brazil, even after the company had been charged previously for internal controls failings in the Commission’s earlier case against it for improper payments in Mexico. The controls in place during the relevant period were minimal and clearly deficient.
The internal accounting controls were deficient with respect to the setting, approval, and payment of commissions and discounts. Orthofix had no policies or processes in place to standardize or centrally approve and monitor the commissions and discounts that Orthofix Brazil was providing to third parties, which allowed Orthofix Brazil to push through high commissions and discounts that ultimately were used to facilitate improper payments. The decentralized nature of Orthofix’s business in Brazil allowed Orthofix Brazil to easily evade the policies and controls that Orthofix did have in place when the conduct occurred. An indirect reporting structure created gaps in supervision that provided the opportunity to orchestrate and execute the bribery schemes without detection.
Furthermore, a lack of centralized global accounting and payment controls allowed Orthofix Brazil to record the improper payments as legitimate business expenses. Given the prior corruption and internal controls issues at its Mexican subsidiary, Orthofix was aware of deficiencies in its controls and the FCPA risks at its subsidiaries’ operations. Despite these red flags, Orthofix failed to establish better controls and supervision over its subsidiaries in high risk countries.”
Based on the above, the order finds that Orthofix violated the FCPA’s books and records and internal controls provisions and the company agreed to pay disgorgement of $2,928,000, prejudgment interest of $263,375, and a civil money penalty in the amount of $2,928,000.
The order contains a separate section titled “Cooperation and Remedial Action” which states:
“Orthofix disclosed the Brazil allegations as part of its ongoing self-reporting obligations undertaken as part of its earlier settlement with the Commission for its conduct related to Mexico discussed above. Orthofix cooperated with the investigation by, among other things: (i) conducting a thorough and timely internal investigation; (ii) voluntarily producing documents and other information in a timely manner, identifying significant documents and translating documents from Portuguese; (iii) compiling financial data and analysis; (iv) providing detailed witness interview downloads, Power-Point presentations summarizing its findings, and timelines; and (v) assisting us in our efforts to coordinate witness interviews with current and former Orthofix and Orthofix Brazil employees.
Although the Company took remedial steps following the resolution of the Promeca allegations in 2012, Orthofix did not start fully implementing sufficient remedial steps until after the discovery of the Brazil conduct in late 2013. Though delayed, these efforts have been significant. Orthofix and Orthofix Brazil now have terminated problematic representatives and distributors; developed and implemented new global accounting policies to provide further structure and guidance to foreign subsidiaries; established an internal audit function and expanded Orthofix’s compliance department; conducted extensive audits of third-party vendors used by subsidiaries; and revised existing trainings and implemented additional compliance training for employees.”
In the SEC’s release, Kara Brockmeyer (Chief of the SEC Enforcement Division’s FCPA Unit) stated:
“Orthofix did not have adequate internal controls across all its subsidiaries and failed to detect and prevent the improper payments in Brazil that were intended to boost sales.”
In the same release, the SEC announced that Orthofix also agreed to resolve a separate SEC enforcement action (including books and records and internal controls violations) for improperly booking revenue in which the company agreed to pay $8.25 million civil penalty. The SEC’s release states:
“Four then-executives at Orthofix also agreed to pay penalties to settle cases related to the accounting failures, which according to the SEC’s order involved Orthofix improperly recording certain revenue as soon as a product was shipped despite contingencies requiring certain events to occur in order to receive payment in the transaction. In other instances, Orthofix immediately recorded revenue when it had provided customers with significant extensions of time to make payments. The accounting failures caused the company to materially misstate certain financial statements from at least 2011 to the first quarter of 2013.”
In this Orthofix release, Brad Mason (President and CEO) states:
“We are very pleased to bring closure to these collective matters, which relate to activities that occurred largely between 2011 and 2013. We have instituted broad remedial measures designed to detect and prevent the issues that led to the matters being resolved, and these resolutions allow us to continue moving forward with the Company’s critical mission of serving patients, our physician customers, and shareholders.”
The release further states:
“The second resolution relates to an anti-bribery matter involving the Company’s Brazilian subsidiary. Orthofix self-reported the matter to the Department of Justice (DOJ) and SEC, conducted a diligent and thorough internal review with the assistance of outside counsel, and fully cooperated with the SEC and the DOJ. The Company instituted extensive remediation measures with respect to this matter, including terminating employees, as well as relationships with third-party representatives and distributors; conducting a global review of its anti-corruption and anti-bribery program; implementing regular audits of its third-party distributors and sales agents; developing and implementing new global accounting policies to provide further structure and guidance to foreign subsidiaries; establishing an internal audit function; expanding Orthofix’s Compliance department in both number and quality of personnel; and implementing enhanced anti-corruption compliance training for employees and certain third parties. As part of this SEC resolution, the Company agreed to retain an independent compliance consultant for one year to ensure the remediated compliance and ethics programs and internal controls and processes continue to function properly. Finally, after careful review by the DOJ, the Company was informed that the DOJ has decided to take no further action with respect to this matter.”
Yesterday’ Orthofix’s stock closed up .53%
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