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The Road to Excess

Joint ventures are an effective vehicle for bribing foreign officials. But with investors starting to notice, so may the authorities.

1Nov

The turmoil that has swept Asia, has descended upon Russia, and now threatens Latin America raises a question about U.S. joint ventures there. Can these ventures withstand the kind of upheaval that has toppled the Suharto Suharto regime in Indonesia and may threaten ruling cliques in other markets? Like the Suharto clan, they, too, are often U.S. companies' partners.


For one thing, the backlash against crony capitalism could finally lead other countries to embrace a U.S. law against bribery, which would help U.S. authorities' efforts to crack down. Whether or not that happens, investors are increasingly wary of the potential instability of corrupt regimes.


Freeport-McMoRan's experience in Indonesia is perhaps the best example of a U.S. company doing business with such a regime. Less than a year before Indonesia's former president Suharto resigned in the face of nationwide turmoil, in February 1998, Freeport's chairman and CEO, James Moffett, capped a three-decade-long relationship with the dictator by forming a joint venture with Suharto's family. Freeport's complex deal gave a Suharto-controlled group, PT Nusantara Ampera Bakti, a 4.7 percent stake in Freeport's famed Grasberg mine, which contains the world's largest copper and gold reserves and is located on the Indonesian island of Irian Jaya. In return for its stake, the Suharto group paid $315 million, according to documents filed with the Securities and Exchange Commission, $254 million of which Nusantara borrowed from commercial banks. Under the agreement, if Nusantara can't repay the interest on the loans from dividends it receives as a shareholder, Freeport will make up the difference.


Sure enough, Nusantara's interest arrears amounted to $7.6 million at the end of last year. That represents 3 percent of the $245 million in net income that Freeport's publicly traded subsidiary, Freeport-McMoRan Copper & Gold, earned in 1997.


While Freeport declined to comment on the arrangement, it was nothing out of the ordinary. Other prominent companies that entered into joint ventures with Suharto family members on what are — at the very least — favorable financial terms include Merrill Lynch, Lucent, and General Electric.


Granted, these companies' arrangements with the Suharto family don't necessarily violate a U.S. law designed to prohibit payments by U.S. companies to foreign officials in return for business, according to experts. The law, known as the Foreign Corrupt Practices Act (FCPA), was passed in 1977, after post-Watergate investigations revealed a slush fund operated by Lockheed for such purposes. Says a corporate attorney specializing in defending bribery allegations, who is currently working on an Indonesian case he would not disclose: "You can do business with the Suhartos all day long, as long as it is legitimate business. The mere fact that they don't put in an equity contribution doesn't automatically mean it's a bribe."


But what does the partner offer? "If you want to do business in Indonesia, you need to have the logistics running smoothly," he suggests. "An American company couldn't walk into the country and understand all the elements required to get up and running in a timely manner. The local partner can do that."


But there is a fine line between local knowledge and undue influence. "The issue is, what is it in tangible form that the joint partner brings to the table in return for the equity that the partner receives?" explains Frank Vogl, vice chairman of Transparency International, an anticorruption lobbying group. "If the only thing that person brings to the table is connections and access, then I'm not sure what the difference is between that and the outright payment of bribes." Typically, bribes are paid through middlemen, and the joint venture setup provides a perfect vehicle for them.



Too Connected

In fact, corporate investigators involved in due diligence investigations of potential foreign partners say that such partners have been chosen precisely for their connections. Henry Lew, Asian project manager at Parvus International, a corporate investigative firm in Silver Spring, Maryland, says that there's a contradiction at work. "While you want to be involved with a well-connected firm, you don't want it to be a firm that's obviously well connected in the wrong way and actively trading on that." In reality, however, until now clients have been more likely to back out on deals in which the foreign partner didn't have the connections claimed, instead of when the person had too many ties to those in power. Lew says he has investigated no cases in Asia in which U.S. companies turned down a deal because the potential foreign partner was found to be "too well connected."


At the moment, however, the prohibition against bribing foreign officials as a way of gaining business abroad is unique to the United States. U.S. companies have long complained that the law therefore puts them at a competitive disadvantage. While U.S. businesses' hands are tied, foreign competitors are free to pay the bribes necessary to win contracts in countries where bribery is an accepted fact of life.


But that could soon change. European companies now contend they'd rather not have to pay the extra freight, which studies estimate runs to some $11 billion annually. After years of lobbying, Transparency International and the U.S. government have convinced other member countries of the Organization for Economic Cooperation and Development (OECD) to endorse antibribery statutes similar to the U.S. law. Last December, OECD members agreed to implement a treaty by the end of this year, and national parliaments are scrambling to ratify it. This would turn the treaty into law.



Discounting Corruption

Enforcement is another matter, simply because it's difficult for authorities, much less shareholders, to determine that such payments are being made. Yet in Indonesia, as elsewhere, pervasive corruption has led to bad deals that the market, in effect, is starting to police. "There is a reason kickbacks and bribes have been paid; it's to sweeten the deal because it may not be as attractive as it appears on paper," says Stephen Vickers, a managing director with Kroll Associates (Asia) Ltd., a corporate-intelligence firm in Hong Kong.


Freeport's experience may again be instructive. Around the time it entered into a joint venture with the Suharto family in 1997, Freeport was also awarded the rights to help develop what appeared to be a huge gold deposit discovered by Bre-X Minerals Ltd., a Canadian mining concern, in Busang, on the island of Borneo.


But due diligence uncovered a massive hoax — at a cost of $2 million to the company. Since that embarrassment and the Indonesian economic crisis, Freeport's shares have traded at a huge discount to other mining companies, despite the fact that its lowest-cost copper mine and largest gold deposits have made it one of the world's most profitable mining companies. Barrick Gold, a Canadian company that Freeport beat out for the Bre-X mine, is trading at 13 times cash flow, while Freeport trades at only 3.5 times.



What's a Bribe Anyway?

A U.S. law against foreign bribery has few teeth. It remains difficult to prove that U.S. companies are breaking the law prohibiting bribery of foreign officials. "Joint ventures are a very gray and difficult area," says Frank Vogl, vice chairman of Transparency International, an anticorruption lobbying group. "When the Foreign Corrupt Practices Act [FCPA] was written, the focus was very much on trade and international procurement. Today, there needs to be far more focus on investment, and the game there may be somewhat different."


The U.S. Justice Department's deputy chief of enforcement, Peter Clark, admits that joint ventures present "complications" for law enforcement officials.


The issue often boils down to whether or not the U.S. partner knew, or should have known, about any illegal activity undertaken by its partner.


"The key thing is, what is your state of knowledge?" explains Fritz Heimann, Transparency International's U.S. chairman. If the U.S. partner actively participates in the management of the joint venture, it is difficult to claim that it didn't know its foreign partner was paying bribes, he says. "If you're on the board of directors, you have a duty to find out what's going on in the country. But if you have an investment relationship and have a foreign partner running the business, that's a different situation."


In any case, chances of prosecution are slim. In the FCPA's two decades of existence, the Justice Department has prosecuted only two dozen cases. Clark says there have been a half dozen or more cases that could not be prosecuted under the act because of restrictions on the use of evidence gathered overseas. In return for help in gathering evidence, says Clark, the United States often agrees to foreign governments' demands that it use the information only to prosecute crimes they also are pursuing. Even in the best situations, an investigation takes three times as long as a domestic case because of the hurdles in the way of evidence gathering.


Tim Dickinson, partner in the Washington, D.C., law firm of Dickinson Landmeier LLP, says the Justice Department won't bring a case to court unless it has a "smoking gun." That's especially hard to find in a corruption case. For diversified global companies, a joint venture in a small Asian company represents such a tiny fraction of its operations that the details needn't be publicly disclosed under U.S. securities laws or accounting rules.


Whistleblowers within the company or competitors that believe a company is being treated preferentially are usually the best means by which corrupt practices are brought to the attention of the government. For example, the SEC's case against Triton Energy was brought to light during a contract dispute with a Canadian company and through a wrongful termination suit by a disgruntled employee. But, typically, an investigation can't go too far without the foreign government's cooperation. "If they are involved in a bribe, they're not going to [help], and that's the end of it," says Dickinson.


Most corruption and bribery cases are settled long before they reach court, with a consent decree and a fine, and often with no public disclosure. "You never hear about them," adds Dickinson, who represents corporations in negotiations with the Justice Department. Clark would not discuss specific cases or even say how many are under investigation. But Dickinson estimates the department has at least 25 to 50 that are active. And he expects that number to double after the OECD convention leads to antibribery statutes in member countries.

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