Philips Settles FCPA Case With SEC

Manufacturing giant Philips has agreed to pay $62 million to settle FCPA charges with the Securities and Exchange Commission, for a rather ho-hum corruption scheme in China that compliance officers have seen many times before.

The case is still interesting, however, because this is Philips’ second FCPA settlement in 10 years. That raises the question of what heightened punishments the company might receive as a recidivist offender. Moreover, this latest settlement does not involve the Justice Department. So when might those folks enter the chat, and what will they say? Hmmm. 

For now, let’s start with the ho-hum corruption scheme. As described in the SEC’s settlement order, it happened in China in the 2010s and took two forms. Sometimes local employees, along with distributors and dealers working for Philips, collaborated with public health officials in China to fix bids on government contracts. Other times, distributors asked for “discounts” to their government clients, which Philips China approved with little or no documentation — and as we’ve seen innumerable times before, those discounts then became bribes that went to government officials. 

For example, in 2017 Philips was bidding on a $4.6 million contract for healthcare imaging equipment. To goose the company’s chances, a Philips China district sales manager for Hainan Province delivered approximately $14,500 to the home of a director of the hospital’s radiology department, in return for the director’s assistance in the procurement process. The sales team discussed the specifications to be included in the bid with the relevant hospital director, and its distributor prepared an accompanying bid with another manufacturer’s products.

Meanwhile, the discounts requested by distributors were governed by weak approval processes and incomplete documentation. Nor did Philips China enforce due diligence and training procedures for its distributors, or conduct adequate testing in high-risk areas of sales to identify control failures.

Compliance Points to Ponder

We’ve talked many times before about the perils of incomplete documentation from distributors seeking discounts. My standard refrain is that policies and procedures need to impose a high standard of documentation, so that when distributors say they need a discount to match prices from competition, they’re forced to submit proof that you can then keep on file.

The SEC’s order against Philips, however, includes a sentence that suggests another way to approach this headache:

During the relevant period, Philips China’s use of special price discounts with distributors created the risk that excessive distributor margins could be used to fund improper payments to employees of government-owned hospitals.

Distributor margins: that is, the spread between what they pay your company for goods (essentially, the wholesale price), and what they charge end-use customers (the retail price). The wider that spread, the greater the chance that some of those monies are being diverted into someone’s back pocket.

Well, distributor margins are something you can monitor. You can track them over time, to see whether one distributor is suddenly asking for much greater discounts. You can compare one distributor against others, to see whether he is far outside his peers. You can study whether the distributor asks for larger discounts only with certain customers, or only when working with certain sales executives at your company. 

Those are all ways you might use data analytics — because you have, or at least should have, all this data already — to assess the corruption risk within your extended enterprise. Then you can tailor your approval processes as necessary, so that distributors with higher corruption risk need to supply more documentation. 

We should also note that the Philips people involved in these China shenanigans included sales executives, distributors, and technical employees within Philips who supported the sales teams (“inside sales engineers,” such folks are often called) . That’s yet another reminder about proper training for employees, because inside sales engineers perform a very different role than direct sales employees; they might never even meet the customer. 

So as always, think about who might interact with a potentially corrupt transaction, and how they’d interact with that deal. Then tailor your training appropriately. That’s true for accounting people who might log the transaction, engineers who might alter technical documentation or deliverables at a sales executive’s request, and other employees too. Think creatively, since the fraudsters already are.

FCPA Recidivism

As we said, this is Philips’ second encounter with the FCPA. The company previously settled charges with the FCPA in 2013, for similar offenses that happened in Poland in the early 2000s. In that case, Philips paid $4.5 million in disgorgement and interest. 

Here, Philips had roughly $41 million in ill-gotten gains, and that $62 million penalty breaks down as $47 million in disgorgement and interest plus a $15 million penalty. 

What we don’t have, however, is any statement from the Justice Department about whether it too might sanction Philips for its misconduct. The company did say in an SEC filing earlier this year that it was in talks with both the Justice Department and the SEC about this misconduct, and now obviously the SEC’s interest in the matter is closed. So what happens with potential criminal charges? 

One clue: when Philips gave that update to investors in February, it also said it had set aside $65 million to cover potential settlement costs. Well, that’s the amount that Philips just agreed to pay the SEC — which means that the company either has no money to pay any potential future settlement with the Justice Department for the same misconduct; or doesn’t expect it will need to pay any settlement. 

Is the Justice Department going to take no action here? That strikes me as rather contradictory to its supposed determination to crack down on recidivist offenders. Sure, in the grand scheme of things, Philips’ FCPA violations weren’t anywhere near some of the abuses we’ve seen at other companies; but repeat offenses are still repeat offenses. So what’s going on? 

I suppose we’ll find out eventually.