In our last column, we discussed the importance of prudently selecting third party consultants, contractors and joint venture partners when looking to expand your business in foreign markets. In other words, know your business partner. When looking to expand your business overseas it is equally important to ensure you have adequate internal controls. In other words, make sure your own house is in order.

The importance of internal controls is highlighted by the so-called “accounting provisions” of the Foreign Corrupt Practices Act (FCPA). Those provisions, which require accurate record keeping and sound systems of internal controls, apply to a large number of businesses—companies with securities registered with the Securities and Exchange Commission (SEC) and companies that must file reports with the SEC. Moreover, the FCPA accounting provisions apply to all dealings undertaken by the business, regardless of whether the business actually engaged in foreign operations or whether the transaction is legal. 

When expanding a business into overseas markets, failure to focus on FCPA reporting requirements can lead to harsh consequences. For example, the SEC filed a civil suit against IBM last year, alleging that the company’s internal controls were inadequate and violated the FCPA. Although IBM actually had internal compliance programs designed to prevent bribery, the SEC alleged that those controls did not prevent foreign operations from using local business partners (in this case, travel agencies) as conduits for improper payments to government officials in South Korea and China. To resolve the case, IBM paid more than $7 million.

In another recent case with similar allegations, the U.S. government also sued London-based Diageo, claiming that the company failed to implement internal controls sufficient to prevent corrupt payments to foreign officials in India, Thailand and South Korea. The SEC alleged that Diageo’s loose or non-existent controls resulted in inflated invoices and other deceptive practices that shielded the actual nature of payments to third parties. Although the alleged wrongdoing stemmed from three new subsidiary acquisitions, the SEC alleged that Diageo knew that the acquired companies had weak controls but failed to correct those deficiencies. As part of its agreed resolution with the SEC, Diageo paid more than $16 million.

These cases make clear that companies doing business overseas must ensure that their internal controls and record keeping systems are designed to monitor all accounting information related to foreign transactions. The compliance team should have sophisticated training targeted at identifying masked accounting entries. Improper kickbacks and bribes are rarely characterized as such in the general ledger.

Although the implementation of better internal controls comes with a cost, recent government enforcement actions demonstrate that ignoring the problem can be even more costly. An ounce of prevention is truly worth a pound of cure.