Eurosif-CORRUPTION-REPORT-June2010 by Eurosif Aisbl

Corruption Ensuring that employees know how to handle at-risk situations Awareness-raising and training programmes aim at improving the employees’ understanding of the company’s principles with regards to corruption. It helps them avoid any misconduct and promote the company’s principles of integrity.

Transparency Any company willing to strengthen its anti-corruption culture must be transparent. Being transparent about the implementation of preventive strategies lies within the set of predominant obligations of Corporate Social Responsibility. Transparency benefits all stakeholders: from investors to civil society.

Best practices:

The company is transparent on its objectives in terms of corruption prevention and the reporting of its policies. ● The number and nature of incidents indicated through the company’s whistle blowing system are disclosed. In addition, the company communicates concrete elements on the handling of these reported incidents (assistance, internal investigations, disciplinary measures etc.). ● The company reports on what corrective measures have been implemented following a sentencing. ● The company discloses all payments and taxes paid to host governments on a country-by-country basis.

Legislative and Voluntary framework MAJOR ANTI-CORRUPTION CONVENTIONS 1996

Inter-American Convention Against Corruption

1997

OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions

1999

The Council of Europe Criminal and Civil Law Conventions on Corruption

2000

UN Convention Against Transnational Organised Crime

2003

African Union Convention on Preventing and Combating Corruption UN Convention Against Corruption

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The Code of Conduct is part of induction training for all new employees, and experienced employees must test their knowledge of integrity issues on a regular basis (every three years). ● At-risk employees (consultants, sales agents, procurement staff, etc.) receive specific training on anti-corruption, such as situational training, which places the company’s principles into practice. ● An integrity component is included in the remuneration “scorecard” of managers. ●

Voluntary Initiatives

Major National Laws

Partnership against Corruption Initiative (PACI): launched in 2004

Foreign Corrupt Practices Act (US): 1998 extension

Implementing adequate control systems Employees have resources at their disposal enabling them to denounce any corrupt behaviour they have witnessed. It is imperative that this information is processed confidentially and the bonafide whistleblowers are protected from any discrimination. Companies should verify how well their policies are followed by regularly carrying out internal audits in order to ensure their systems are helping to prevent corruption.

UK Bribery Bill, passed in April 2010

Extractive Industries Transparency Initiative (EITI), launched in 2002

Wolfsberg Group, founded in 2000

Recommendations for investors:

Best practices:

• Ask for more transparency and disclosure on the issue of corruption • Push for an international level playing field and effective enforcement • Engage with companies and establish dialogue • Consider companies’ exposure to corruption risks in their investment policies • Use voting power and collaborate with other shareholders • Urge for corrective measures following condemnations

The whistle blowing system is managed by a third party, increasing the employees’ confidence in the reporting mechanism. ● The whistle blowing system is open to all third parties including transaction intermediaries, such as consultants, but also suppliers and business partners. ● The company’s internal controls are regularly subject to evaluation by an external organisation. ●

Eurosif wishes to acknowledge the support and direction provided by the Corruption Sector Report Steering Committee: CM-CIC Asset Management ECPI Fundación Ecología y Desarrollo Henderson Global Investors This sector report has been compiled by:

The Aspen Institute Business & Society Program, “Overcoming Short-termism: A Call for a More Responsible Approach to Investment and Business Management”, www.aspeninstitute.org

La Ruche • 84 quai de Jemmapes • 75010 Paris, France Tel: +33 1 40 20 43 38 contact@eurosif.org • www.eurosif.org

Les Mercuriales • 40, rue Jean Jaurès 93170 Bagnolet, France • Tel: +33 1 55 82 32 40 contact@vigeo.com • www.vigeo.com June 2010

Designer: Catsaï - www.catsai.net / The views in this document do not necessarily represent the views of all Eurosif member affiliates. This publication should not be taken as financial advice or seen as an endorsement of any particular company, organisation or individual.

Theme Report - 4th in a series his Eurosif thematic report has been compiled with research conducted by Vigeo. It emphasises the detrimental impacts of corruption on business performance, sustainable development and the various risks faced by companies that fail to address this issue. It also describes the most influential legislation, commonly affected sectors, and best practices to adopt for better corruption prevention.

CORRUPTION OVERVIEW Conflicts of interest are also considered as corruption in the sense that they may alter a company’s decisions as well as affect the integrity of its executives and employees, for private gain.

Over recent years, corruption has become one of the major concerns of large international companies, NGOs, and civil society organisations. The topic has become increasingly material for investors due to the adverse effects of legal proceedings and other corruption risks.

The Global Competitiveness Report 2009-2010 issued by the World Economic Forum strongly emphasises the impact of corruption on companies. The study identifies corruption as one of the top three most problematic factors (on a list of fifteen) for business practices in 51 of the 133 analysed countries (38%). Another study, released in 2007, revealed that half of international business managers estimate that corruption increases project costs by at least 10% (in some cases by more than 25%).2

Corruption is defined by Transparency International (TI) as “the abuse of entrusted power for private gain.” Among the many corrupt practices that prevail, bribery is the most commonly used term to define an act of corruption. Forms of corruption within the private sector include, among others, corporate fraud, account manipulation, embezzlement, facilitation of payments and money laundering.

CORRUPTION: IMPACTS ON COMPANIES AND INVESTORS Corruption perceptions index 2009

Companies that practice corruption are focused on short-term returns and often do not realise the long term risks. In addition to direct financial costs and lost business opportunities, corruption practices cause substantial damages to branding, staff morale and external business and government relations. Likewise, the enforcement of antibribery rules in some jurisdictions has resulted in stiff prison sentences

and penalties amounting to millions of euros. The various corruptionrelated risks that are described in this report may significantly impact companies’ material and immaterial assets. A Transparency International map on corruption perceptions index (shown above) ranks 180 countries and territories on their perceived level of public-sector corruption; higher rankings indicate a lower presence of corruption.

nations, etc.)”. Transparency International & Social Accountability International, “Business Principles for Countering Corruption”, 2004. 2 Control Risks and Simmons & Simmons, 2007.

Bribery is defined by Transparency International as “the offering, promising, giving, accepting or soliciting of an advantage as an inducement for an action which is illegal, unethical or a breach of trust. Inducements can take the form of gifts, loans, fees, rewards or other advantages (taxes, services, do-

Identifying potential red flags ●

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corporation Siemens is another notorious example of the market risks linked to court decisions. As a consequence of Siemens’ sentencing, the company agreed to a four-year debarment for its Russian subsidiary and a voluntary two-year shutout from bidding on the World Bank's projects for Siemens AG and all of its consolidated subsidiaries and affiliates.7

Foreign Direct Investments in weak governance zones are among the strongest factors that can undermine corporate integrity. All world regions have recently received record amounts of foreign investment, which in Africa and Latin America were driven mainly by booming demand for natural resources and other commodities.3

Legal risks and fees This is the most material risk for companies due to its direct association with administrative and financial sanctions. In the United States, legislative reinforcements have led to an increase in sanctions inflicted on companies found guilty of corrupt acts. The costs of noncompliance to anti-corruption laws are now reaching higher levels. During the past twelve months, Halliburton and Siemens paid fines amounting to €440 million8 and €1.2 billion9 respectively for corruption cases. These costs exclude the additional burden of fees related to operational disruptions, investigations, and the review of internal control systems.

Cross-border Mergers & Acquisitions also constitute at-risk situations: By 2007, transnational corporations (TNCs) were estimated to control some 790,000 foreign affiliates around the world. In 2006, the 100 largest TNCs from developing countries controlled more than €4.3 billion of foreign assets, led mainly by investors from China, South Korea, Brazil and Mexico. Outsourcing and recourse to overseas intermediaries: Corporate integrity is also at stake when cross-border business takes the form of outsourcing and trade rather than foreign ownership. Producers in many key industries, including chemicals, pharmaceuticals, electric machinery and medical components, source more than 30% of their inputs from outside their countries.4

Reputation risk The reputation risk does not necessarily affect the financial health of all companies because reputation might be damaged very differently depending on the industry and business nature (Business to Business or Business to Consumer). However, being active in the prevention of corruption may reduce reputational risk and preserve a company’s license to operate, which is vital in many sectors.

Relationships with public officials: Private-to-public corruption is often categorised as either administrative corruption or political corruption. Administrative corruption may be defined as the abuse of power by public officials during their interactions with citizens or organisations, while political corruption consists of the illegitimate private gain by government officials due to their abuse of legislative power and distortion of public policies. In some developing countries, corrupt politicians and government officials receive bribes believed to total around €15 to €30 billion annually. In countries such as Egypt, India, Morocco, Nigeria and Pakistan, more than 60% of the business executives polled in a TI survey reported having been solicited for bribe payments.

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SECTORS: THE MANY FACES OF CORRUPTION The most vulnerable sectors are considered to be at-risk based on their location, the nature of their operations and the type of their financial transactions. Despite sector driven initiatives, companies operating in extractive industries (oil, gas, coal, etc.), and more generally, companies that have relations with public officials, typically utilities (power generation, water), waste and tobacco have the highest exposure to allegations of corruption.

CONTROVERSIAL SECTORS IN EUROPE Share of companies subject to Sectors - Europe allegations

Corporate Risks5

What is at stake for investors?

Examples of affected industries

Operational and Financial risk An investigation for corruption can be a major burden for a company, requiring the allocation of substantial resources and means. The presence of investigators at the workplace, researching and analysing a company’s documents, disrupts business. Top managers and board members may step down or be fired if they are found responsible, creating disruptions at the highest levels.

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Impacts on earnings: In light of the magnitude of fines received by Siemens (€1.2 billion) and Halliburton (€440 million), or the contingency provision set aside by Technip (€279 million) in anticipation of a settlement, investors cannot afford to ignore this issue.

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Impacts on share prices: Fines represent the ex-ante implications of legal proceedings but markets may anticipate court decisions and significantly influence share prices. This has been shown by cases such as BAE Systems (the share price slumped nearly 8% after news that the US Department of Justice had launched a corruption probe)10 German truck maker MAN11 (-3%) or AVON (-8%).12

3 United Nations Conference on Trade and Development (UNCTAD), "World Investment Report 2008: Transnational Corporations and the Infrastructure Challenge” Geneva, 2008. 4 World Trade Organisation (WTO), “World Trade Report 2008: Trade in Globalizing World”, 2008. 5 Vigeo comments on 4 categories of intangible assets that may be positively or negatively affected depending on how companies handle relevant CSR objectives: Reputation, Human Capital, Operational Efficiency, and Legal Security. Vigeo believes that changes in these immaterial assets may over the medium to long term impact positively or negatively a company’s economic and financial performances

Reuters, « Italie-La police suspend pour un an une licence de Total », 16 February 2009. The World Bank, Press Release n° 2010/001/EXT/FR, 2 July 2009. Bloomberg, “KBR, Halliburton Agree to $579 Million Fine for Nigeria Bribes,” 12 February 2009. 9 Bloomberg, “Siemens to Pay $1.6 Billion to Settle Bribery cases”, 16 December 2008. 10 http://www.guardian.co.uk/business/2007/jun/26/marketforces.baesystemsbusiness. 11 http://www.reuters.com/article/idUSLC80616720090512. 12 http://www.marketwatch.com/story/avon-shares-drop-amid-internal-ethics-probe-2010-04-13. 7 8

Pharmaceuticals and healthcare: corruption to bypass competition? In an environment of fierce competition, characterised by the decline of new drugs discovery, the near extinction of blockbuster patents and the increased regulation of sales and marketing channels, pharmaceutical firms are under pressure to change their business model. While emerging economies represent new business opportunities, corporations may be tempted to bypass the rules of the market in order to preserve their future margins. Corruption can appear in several forms in this sector, such as: bribes to public authorities in order to receive marketing approval, incentives to doctors for prescribing certain treatments, conflicts of interest regarding researchers conducting clinical trials, and pricing schemes to defraud government health systems. In the USA, on October 19, 2009, AstraZeneca and three other pharmaceuticals companies paid €93 million to the state of Missouri to resolve allegations that they had underpaid their rebate obligations to the Medicaid programme by improperly classifying drugs.

According to a 2010 Vigeo study, 13% of European companies (out of 506) were subject to allegations or condemnations between April 2007 and August 2009. The most frequent cases of corruption concerned briberies or payments made to public officials. In Europe, Energy and Pharmaceuticals rank among the most controversial sectors.

Human capital risk When employees and managers are accused of corruption, the risk for a deteriorating corporate culture environment increases. If the management’s involvement is confirmed by a judicial decision, this could result in employees losing their trust in management and losing faith in the company’s values. In addition, companies facing recurrent allegations or sentencing may send a negative message to potential job seekers.

Other operational risks may be linked to a company’s access to markets and call for tenders. In 2009, the operating license of the French oil group Total was suspended for one year by the Italian authorities due to an investigation related to corruption.6 The case of the German

place Siemens under surveillance and to evaluate its efforts in terms of anti-corruption measures before making a final decision on how to handle this investment.13

Impacts on cost of capital: The cost of capital of a company may also be at stake if investors decide to divest their shares. For example, the Norwegian Public Pension Fund, which owns shares in Siemens amounting to 6.3 billion Norwegian kroner, decided to

Energy (oil & gas)

38%

Pharmaceuticals & Biotechnologies

38%

Aerospace & Defence

30%

Aerospace and defence: classified bribes? The intense competition and considerable amounts of money in the aerospace industry and the frequent interaction with various governments, especially in politically sensitive regions, significantly expose aerospace companies to potentially corruptive situations. The increase in military revenues largely depends on national governments’ decisions to invest in defence. Thus, lobbying is recognised as a central strategy in the aerospace industry and conflicts of interest may arise. In February 2010, the highly political BAE case ended with the company paying €290 million to the US Department of Justice (DoJ) and €35 million to the British Serious Fraud Office (SFO) to settle the case.14 The DoJ and the SFO had been investigating the case for eight years and their sanctions highlight the gap that can exist in the implementation of national laws.

Extractive industries: the “resource curse” paradox The “resource curse” is a notion that describes the paradox between the high revenues generated by the extraction of oil, gas, and minerals vs. the poverty and lack of basic infrastructure from which the civil societies of some natural resource-rich countries suffer. If the taxes, royalties, or production entitlements paid to host governments were disclosed on a country-by-country basis, it would make host governments accountable towards their citizens. In reality, the argument of commercial sensitivity is used by most companies to justify their accounting opacity. A few countries, such as Norway and Canada, require disclosure by companies of the payments they make to foreign governments for oil, gas, and minerals. In February 2009, the oilfield services company Halliburton and its one-time KBR subsidiary paid a combined €440 million to settle bribery charges in connection with their dealings with Nigerian officials.

Construction: building beyond awareness? Corruption in the construction sector can result in unnecessary, unsuitable, or dangerous projects, which are often subject to severe delays. Construction is highly exposed to corruption for two main reasons. First, it is a capital intensive industry which requires large up-front investments to start and run projects. Second, it has strong ties with the public sector (e.g. for building permits, delimitation of living spaces, bid processes, etc.). In its 2008 Bribe Payers Index (survey of 2,742 senior business

Norwegian Ministry of Finance, “Siemens under observation in corruption case”, 13 March 2009.

http://www.ft.com/cms/s/0/8134d35a-126a-11df-8d73-00144feab49a.html, 5 February 2010.

involved in corruption. Typically, a financial institution could be used as a vehicle for corruption by a corporate customer that places funds in a bank, often in offshore locations, to pay bribes. On March 2009, the Britain's Serious Fraud Office (SFO) announced it was investigating an alleged 56 million pound (€65 million) fraud in the corporate banking department of Allied Irish Banks. The SFO said Allied Irish Banks (AIB) had provided loans to companies controlled by an unnamed individual who was the main suspect in the probe. The loans were used for the purchase of investment properties in the UK by these companies between 2003 and 2007.

executives in 26 countries), Transparency International revealed that the Public Works Contract & Construction industry was the most likely to pay bribes to public officials.15 Finance: a black box? As most forms of corruption usually involve a financial transaction between one person or institution and another, many corrupt dealings eventually involve banks or other financial intermediaries. Although often unknowingly, financial intermediaries’ remain highly exposed to and potentially directly

PREVENTING CORRUPTION: BEST PRACTICES Engaging employees and managers to behave honestly

Best practices: A Code of Conduct, available in local languages, that addresses and defines the forms of corruption existing in the sector. ● A clear commitment from top management against any forms of corruption. ● A decentralised network of compliance officers to ensure the correct implementation of the Code of Conduct. ● Collaboration with external stakeholders and/or initiatives in the fight against corruption. ●

Generally, responsibilities pertaining to the management of a company’s business principles belong to the Board of Directors and to Senior Management. Some companies are transparent about the organisational support standing behind their commitment, thus choosing to communicate the name of the department or of the person responsible for this role. The involvement of companies with external or sector driven initiatives reinforces the legitimacy and success of a company’s commitment to transparency.

Implementing a company’s principles into practice The most advanced anti-corruption programmes combine awareness-raising and training programmes, advice services (e.g. helpline), risk analysis tools, adequate internal and external control procedures and whistle blowing systems.

The analysis of the relevance of corporate policies is based on three elements: the visibility of the policy, the content of the commitment, and the level of corporate support, or ownership (see “Leadership policies” chart).

By evaluating the tangibility and adequacy of processes and resources (human, financial, organisational etc.) that have been put in place by the organisation to prevent corruption (see “Implementation” chart), the coherence of these policies may be measured.

Leadership (policies) - Average scores

Implementation - Average scores

Source: Vigeo, “What measures are listed companies taking in the fight against corruption: A comparative analysis of North-American and European strategies for the prevention of corruption between 2007 and 2009”, February 2010. The figures presented in the charts are average scores, on a scale of 1 to 100, obtained from 772 European and North American companies listed on the Dow Jones Stoxx Global 1800 Index.

http://www.transparency.org/policy_research/surveys_indices/bpi.