On 11 July 11 the UK’s Serious Fraud Office announced that it had secured its second deferred prosecution agreement. A partner at the global law firm of Morgan Lewis examines it and its implications for US financial corporations.

The first DPA came in November 2015 when Standard Bank agreed to pay financial penalties of US$25.2 million. The second concerns an as-yet-unidentified British company (referred to as 'XYZ Limited' for the purposes of the case) that secured a number of contracts in various parts of the world through bribery. The bribery was said by the judge to be “part of XYZ’s established business conduct” and that within XYZ it was “an accepted way of doing business.” The bribery took place over a period of eight years and subterfuge and deception were employed to keep the truth secret from auditors and XYZ’s parent company in the USA.

Under the financial settlement approved by a court, XYZ agreed to pay a financial penalty of £352,000 and also to disgorge profits of £6.2 million.

One of the most significant features of the financial settlement is that XYZ’s American parent (dubbed 'ABC Companies LLC' for the purposes of the case) has been made responsible for paying almost all of the penalty. This is particularly striking considering that, as the judge observed, ABC was entirely unaware of XYZ’s behavior, was to be regarded as 'innocent' and conducted itself in an 'exemplary' manner after having become aware of what occurred. Moreover, ABC had been a concerned and well-intentioned parent since it first acquired XYZ in February 2000. It had provided support for marketing, product development, long-term strategic planning and annual budgeting. It provided supply-chain and global purchasing resources and cost-saving services. It created and implemented a group-wide health and safety programme and a group-wide compliance programme.

Despite all that, ABC was left in a position of having to make a direct payment of just under £2 million (by way of returned dividends) and also having to provide support of almost £4.2 million to give XYZ the financial wherewithal to pay the balance of the penalty.

The financial cost to the 'innocent' US parent of its subsidiary’s unseen criminality was, therefore, very high. Given the fact that the judge put ABC beyond reproach, it is instructive to trace the steps that brought it such huge, and underserved, expense.

History of the case

XYZ is a small-to-medium entity incorporated in the UK. ABC had no group-wide compliance policy at the time it acquired it. Between June 2004 and 2012, a small group of senior managers at XYZ were involved, through the use of agents, in systematic bribery to secure contracts. In total, investigators found 28 contracts to be tainted and these contracts had produced revenues of £17¼ million for XYZ — 15% of its income over the relevant period.

The payments that the firm made to agents for the provision of bribes, which had nothing to do with those agents' contractual entitlements, were described in internal documents as special commissions, fixed commissions or additional commissions. Thus did the small group of senior managers responsible for the bribes conceal their true nature.

In late 2011, ABC sought to make XYZ conform to its global compliance programme. The activity created by the introduction of that programme aroused ABC's suspicions about some of XYZ’s foreign contracts. By August 2012, senior managers at XYZ became concerned about these discoveries and decided to dismiss the employees who had been responsible for the misconduct. On 4 September, external counsel were instructed to investigate contracts signed after 1 January 2006. On 2 October, the company’s lawyers told the SFO that an unnamed client might be "making a self-report." That report duly appeared on 31 January.

[NB The SFO uses the term 'self-reporting' when a company finds that fraud or bribery on the part of its staff or under its leadership has taken place and reports its own potential guilt to the SFO. The company is not, however, obliged to do so by law and the term does not appear in any statute.]

Using the information it had received, the SFO conducted its own criminal investigation. Simultaneously, the XYZ internal investigation began to cast its net much wider, resulting in two further reports to the SFO in 2013 and 2014.

The SFO took the view that, when taken together, the level of co-operation that XYZ offered and the support that ABC provided was of a quality and degree that allowed it to invitate the group to take part in discussions about a deferred prosecution agreement. Those negotiations came to a successfully conclusion and the court approved the terms of the DPA on 11 July this year.

Why did the parent company have to pay?

The XYZ case was considerably more complex than the Standard Bank DPA, which concerned a single (albeit high-value) instance of bribery that local bank officials carried out in Tanzania. Standard Bank was, and is, a substantial international bank with all the financial and other resources that that brings. XYZ, in contrast, committed many offences of bribery in a number of countries over a period of eight years, events which resulted in part from a culture among senior managers of conducting business illegally. By way of additional contrast to Standard Bank, XYZ is an impecunious and relatively small business unable to meet any significant financial penalty without losing the ability to trade.

In approving the terms of the DPA, the judge noted that the level of penalty that would usually follow such egregious criminality would have put XYZ out of business instantly.

The judge was of the view that causing XYZ to go into liquidation would achieve nothing, as no penalty could, in those circumstances, ever be paid. As such, he took the view that the public interest was best served by keeping the business alive so that there would remain a vehicle through which the penalty could be paid. That left the practical issue of who was actually going to provide the funds to meet the penalty. In the final analysis, the parent was the only option, undeserving though it may have been.

Penalty calculation

The standard calculation of a penalty in circumstances such as those in which XYZ found itself involves, firstly, identifying a starting sum, which is normally the profits flowing from the contracts obtained through bribery. This figure is then increased by identifying aggravating features and applying a multiplier reflecting those aggravating features. When that figure is reached, it is then reduced by identifying and giving credit for mitigating circumstances. In the XYZ/ABC case, this exercise produced a figure of almost £16.5 million. Having arrived at this stage, there is then a further discount to reflect—not mitigation, but cooperation.

It was at this point in the exercise that the judge did something that was truly remarkable. The jurisprudence and official guidance surrounding this part of the exercise states that the discount to be applied at this stage should be enough to put the company that signs the DPA into roughly the same position as it would have been in if it had been prosecuted and pleaded guilty. That would usually produce a discount of 50%, being the maximum available to a company pleading guilty. In this case, the judge subtracted a discount of approximately 17%, which would not have been available to a company being prosecuted, and which brought the final figure down to just over £6½ million.

That was divided into a financial penalty imposed directly upon XYZ Limited of £352,000 (the amount agreed to be the limit of XYZ’s ability to pay), with the balance being met both directly and through financial support from ABC.

The significance of the judgment

When assessing the impact of how the court approached both the mechanics of arriving at the final figure for the financial penalty, and the division of who would bear the burden of payment, it is important to have regard to the identity of the judge. The judge in this case was the same judge who approved the Standard Bank DPA, and it seems clear that he has taken on the mantle of shaping British law in this area. No British DPA can be struck without the express approval of a court.

The judge chosen to create this area of law is Sir Brian Leveson, President of the Queen’s Bench Division of the High Court, normally referred to as the most senior judge in the country. Directions or rulings from a judge of such seniority are held, quite rightly, in the highest regard carrt a great deal of weight in terms of precedent.

Before XYZ, people who advise corporations believed that when a company is thinking about "self-reporting" (with a view to securing a DPA) or doing nothing (and running the risk of prosecution) it should assume that the financial penalty for both courses of action would, if its misconduct were to come to the attention of the authorities, be the same. This judgment has put an end to that assumption and shows that there is now more to be gained by co-operation than was previously believed to be the case.

The judge expressed his approach in these terms: “A company’s shareholders, customers and employees are far better served by self-reporting and putting into place effective compliance structures. When it does so, that openness must be rewarded and be seen to be worthwhile.”

For a long time, the SFO has been pursuing a policy of encouraging 'self-reporting,' thereby “dangling the carrot” of a DPA in front of offending corporations. DPAs are unlikely to be available to companies that do not 'self-report.' For an equally long time, that metaphorical carrot has seemed more illusory than real. Now that Leveson has offered banks and other firms a real carrot, there is no doubt that people who advise corporations about the virtues and drawbacks of 'self-reporting' ought to adjust their thinking.

This is not, however, the only important issue to emerge from this DPA.

The fact that the SFO initiated proceedings against a subsidiary company is noteworthy. The SFO seems to like the idea of pursuing a small company that is part of a group, thereby bringing its larger and more powerful parent company into the frame. It worked effectively with XYZ, causing ABC to become the major contributor to the financial penalty. It worked with Sweett, where the SFO prosecuted a British company's offshore subsidiary. On 13 July, the SFO announced that it had begun proceedings for bribery against F H Bertling Ltd, a British subsidiary of the Bertling Group, a German logistics and shipping multi-national. The degree to which the parent becomes embroiled in that prosecution remains to be seen.

Lessons learned

We have therefore in this judgement two important lessons. Firstly, parent companies — even benign, concerned, and well-intentioned parent companies — ought to know in detail what their subsidiaries are doing. Secondly, co-operation brings its own reward and it seems that of all forms of cooperation, 'self-reporting' brings the highest.

* Kevin Robinson is available on +44 203 201 567 or at kevin.robinson@morganlewis.com