Last Friday the SEC announced  that Cardinal Health Inc. agreed to pay $8.8 million to resolve a Foreign Corrupt Practices Act enforcement action.
The action is based on a Cardinal entity (acquired in 2010 and sold in 2018) maintaining and operating marketing accounts for certain customers in China.
In summary fashion, the SEC order states:
“These proceedings arise out of Cardinal’s violations of the internal accounting controls and recordkeeping provisions of the FCPA through the operations of its former subsidiary in China.
In November 2010, Cardinal entered the Chinese market by acquiring the Chinese subsidiaries of an established pharmaceutical distribution company. Cardinal rebranded the acquired entities as “Cardinal China” after the acquisition. Prior to the acquisition, the pharmaceutical distribution company had longstanding distribution agreements with a number of global manufacturers of prescription medications, medical devices, and consumer health products.
In addition to its role as a distributor for the products sold by its business partners, Cardinal China also operated and maintained on its own books, financial accounts that certain distribution customers used to fund their operations and marketing efforts in China. These accounts largely consisted of excess distribution margin that Cardinal China generated from distributing customers’ products, and Cardinal China was obligated to return these funds to the customers in accordance with its contractual agreements. Cardinal China authorized and made payments from these marketing accounts as directed by the employees of its distribution customers.
After it was acquired by Cardinal, Cardinal China terminated most of the marketing accounts due in part to known FCPA-related compliance risks associated with channeling the marketing expenses of third parties through its own books and records. But despite these risks, until 2016, Cardinal China maintained and operated marketing accounts for a European supplier of non-prescription, over-the-counter dermocosmetic products for which Cardinal China served as the exclusive product distributor inChina.
In addition to maintaining and operating marketing accounts for the dermocosmetic company, Cardinal China also formally employed approximately 2,400 employees for the dermocosmetic company pursuant to an administrative and HR services agreement. The 2,400 employees reported to the dermocosmetic company, and while Cardinal China administratively managed the employees pursuant to its contractual agreement, it did not supervise their day-to-day activities. Most of these employees were beauty assistants and supervisors, who worked in retail stores and interacted with individual consumers. The remaining approximately 100 employees were sales, marketing, management, and back office employees. The sales and marketing employees were responsible for marketing and selling the dermocosmetic company’s products in China, and regularly drew down funds from the marketing accounts to pay third parties for marketing-related expenses.
Although Cardinal determined that other marketing accounts should be terminated because of their significant FCPA-related compliance risks, Cardinal inaccurately assessed the risks of the arrangements with the dermocosmetic company as minimal. Cardinal thus did not apply its full internal accounting controls to these accounts, or to the conduct of the marketing employees Cardinal China employed for the company. Cardinal China regularly authorized and made payments from the marketing accounts at the direction of the dermocosmetic company without controls sufficient to provide reasonable assurance that the transactions were executed in accordance with management’s general or specific authorization, and failed accurately to record on its books and records payments made from the accounts.
In 2016, Cardinal China learned that the marketing employees and the dermocosmetic company had hidden the purpose of certain purported marketing payments, which were redirected to healthcare professionals who provided marketing services to the dermocosmetic company, and to other employees of state-owned retail entities who had influence over purchasing decisions related to the dermocosmetic company’s products. Upon learning of the misconduct, Cardinal and Cardinal China took action to cease these payments in 2016.
Cardinal benefitted from its arrangement with the dermocosmetic company. As the company’s exclusive distributor in China, Cardinal China directly profited from the distribution, administrative, and HR services it provided to the dermocosmetic company, and Cardinal was unjustly enriched by approximately $5,400,000 between March 1, 2013, and December 31, 2016, as a result of its deficient internal accounting controls relating to the marketing accounts.”
The order states:
“Cardinal China did not subject the marketing employees, who it employed on behalf of the dermocosmetic company, to its full internal accounting controls, such as providing FCPA and anti-bribery training, or providing any oversight of their interactions with third parties in China. In addition, as Cardinal China knew from its business arrangement with the dermocosmetic company, a large portion of the marketing employees conducted some of their business using e-mail accounts and computer systems that belonged to the dermocosmetic company and were inaccessible to Cardinal’s and Cardinal China’s compliance personnel, and Cardinal China had no ability to review the full scope of the marketing employees’ activities.
From at least March 2013 through December 2016, Cardinal failed to apply sufficient internal accounting controls to the marketing employees and the marketing accounts. For example, Cardinal China executed payments requested by the marketing employees without requiring sufficient supporting documentation to verify the purpose of the transactions. Over the four-year period from 2013 through 2016, Cardinal China authorized and paid more than $250 million from the marketing accounts, but had insufficient policies and procedures in place concerning the payments.
Without the authorization of Cardinal’s management, Cardinal China, at the request of the marketing employees, regularly made payments from the marketing accounts that were improperly redirected to government-employed healthcare providers and employees of Chinese state-owned retailers to promote the sale of the dermocosmetic company’s products.
The improper payments took varied forms, including cash, luxury goods, gift cards, and travel.
Due to Cardinal’s insufficient internal accounting controls, the marketing employees were able to easily disguise these payments by channeling funds through complicit third-party vendors and by characterizing transactions with healthcare providers as payments to printing companies for “production fees,” and they were also reimbursed for high-value gifts based on falsified or incomplete documentation.”
Under the heading “Cardinal Did Not Properly Evaluate Red Flags and Failed to Resolve Known Internal Control Deficiencies,” the order states:
“At the time that it operated the marketing accounts on behalf of the dermocosmetic company, Cardinal and Cardinal China were aware of the compliance risks posed by marketing accounts in China.
Shortly after it acquired Cardinal China in November 2010, Cardinal determined that Cardinal China’s practice of administering marketing accounts for its suppliers created excessive FCPA-compliance risks because the accounts could be used by suppliers to facilitate surreptitious payments to government officials without Cardinal China’s knowledge. By July 2011, Cardinal directed Cardinal China to wind down all of its pharmaceutical marketing accounts due to these risks. Nevertheless, Cardinal China continued to administer marketing accounts for certain large suppliers for several years.
After it was acquired by Cardinal, on at least two occasions, Cardinal China abruptly terminated third-party marketing accounts amid allegations that they had been used to facilitate improper payments:
Cardinal China terminated a marketing account it administered for an Italian pharmaceutical manufacturer after receiving an internal report in 2012 that Chinese authorities had fined the Chinese subsidiary of the Italian pharmaceutical manufacturer for violating China’s Pharmaceutical Administration Law by providing certain benefits to hospitals.
Cardinal China terminated a marketing account it administered for a U.K.- based pharmaceutical manufacturer after Cardinal’s CEO received an internal report in 2013 alleging that Cardinal China employees were using the account to bribe employees of China’s Center for Disease Control.
Despite these events, Cardinal failed to assess whether Cardinal China followed its instruction to wind down the pharmaceutical marketing accounts, or implement stricter controls to reduce the compliance risks for the marketing accounts that it administered for the dermocosmetic company.
In December 2012, Cardinal received a report from a Cardinal China employee raising questions about the legality of the marketing accounts and the marketing employees. The report recommended that Cardinal China hire an external auditor to assess its business arrangement with the dermocosmetic company. In response to the 2012 report, neither Cardinal 6 nor Cardinal China took sufficient steps to enhance their compliance practices concerning the marketing accounts or the marketing employees.
In September 2014, Cardinal China was fined by the Shanghai Administration of Industry and Commerce (“AIC”) for providing luxury dermocosmetic products to employees of a Chinese retailer equal to a percentage of the retailer’s sales of the dermocosmetic company’s products. The AIC found that Cardinal China had provided a “secret commission” to employees of the retailer in violation of Chinese unfair competition law. Cardinal China had engaged in the practice at the request of the dermocosmetic company, and the products were funded by the marketing accounts that Cardinal China administered on behalf of the dermocosmetic company. Cardinal and Cardinal China, again, failed to sufficiently enhance the supervision of the marketing employees and oversight of the marketing accounts.
In July 2015, after discovering that the marketing employees had recently used the marketing accounts to purchase smart phones for undisclosed reasons, Cardinal China’s Vice President of Compliance emailed a colleague, copying Cardinal China’s President, acknowledging that the dermocosmetic company was unlikely to allow Cardinal China to implement its standard compliance protocols to the marketing employees, and observing that this gap in controls had created an “enormous compliance risk” for Cardinal China. Another Cardinal China employee highlighted that, “This is a big exposure indeed as we have no control [over] how [the marketing employees] may be gifting and spending on entertaining.” Neither Cardinal nor Cardinal China took steps to enhance the controls associated with the marketing account or marketing employees until 2016.”
Based on the above, the SEC found that Cardinal Health violated the FCPA’s books and records and internal controls provisions. According to the SEC, “Cardinal China directly profited from the distribution, administrative and HR services it provided to the dermocosmetic company, and Cardinal was unjustly enriched by approximately $5.4 million between March 1, 2013 and December 31, 2016.”
Without admitting or denying the SEC’s findings, Cardinal Health agreed to pay approximately $8.8 million ($5.4 million in disgorgement, $916,887 in prejudgment interest and a civil penalty of $2.5 million).
Under the heading “Cardinal’s Self-Disclosure, Cooperation, and Remedial Efforts,” the order states:
“In May to June 2016, Cardinal China compliance conducted an audit of the marketing account’s expenses, which identified evidence that payments from the marketing accounts did not comply with Cardinal China’s compliance policy requirements. Also, in June 2016, Cardinal executives in the United States received an internal report stating that the marketing employees were using the marketing accounts to channel payments to government officials in China.
In December 2016, Cardinal voluntarily disclosed the results of its investigation to the Commission staff and subsequently cooperated with its investigation.
Cardinal China also undertook significant remedial measures, including terminating the marketing accounts and its employment contracts with the marketing employees, adding anti-bribery representations and obligations to the relevant contracts, and strictly limiting the use of the remaining balance of the dermocosmetic company’s funds to low-risk expenses, such as salary payments, with robust controls and monitoring from Cardinal China’s legal and compliance personnel.”
In the SEC’s release, Anita Bandy (Associate Director of the Division of Enforcement) stated:
“Cardinal’s foreign subsidiary hired thousands of employees and maintained financial accounts on behalf of a supplier without implementing anti-bribery controls surrounding these high-risk business practices. The FCPA is designed to prohibit such conduct, which undermined the integrity of Cardinal’s books and records and heightened the risk that improper payments would go undetected.”
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