Diversified industrials – addressing risks through fully fledged compliance

Diversifying your business makes immediate sense. Take a quick example: in a corporate entity reliant on one product, the business’s fortune is tied to the volatility of that singular output. Diversification reduces that reliance on a narrow economic base.

For corporates with entrepreneurial instincts, diversification of your business spells opportunity. For diversified industrials, the frequent and/or significant pursuit or disposal of entities in infrastructure, chemicals, heavy machinery, engineering, and construction, to alter their corporate structure, is business as usual. However, diversity in your industry is not a risk-averse pursuit either, and proper integration is crucial.

In June 2017, we made a change. We adopted a sector-based approach to our clients. Revamping our industry sector groups, we wanted to bring the whole of the firm – for example, the corporate transactional lawyer in London to the projects guru in Tokyo to the regulatory translator in Washington to the compliance experts writing this piece – to the whole of our clients. In the reshuffle, we refocused our attention to one of our clients’ more complex sectors: diversified industrials. This international industry reflects the interests of clients in transportation, logistics, manufacturing, chemicals, engineering, and construction. The list is not exhaustive, but we quickly saw a trend this sector experienced.

Of the U.S. Foreign Corrupt Practices Act (FCPA) Top 10 in December 2019, at least five (if not more) of the largest FCPA cases based on penalties and disgorgement involve diversified industrial (DI) groups. If we were to include a more unusual top 12, entries 11 and 12 would also fall into the DI category. Health care, not immune from regulatory and investigatory enforcement, only features once on this same list. So why are these DI entities in the crosshairs?

DIs are exponentially exposed

For a DI, no part of the planet is untouched from its portfolio. And it is in developing markets, where corruption risk is a constant, that DIs often seek business opportunities. With our lens on Asia-Pacific, Transparency International’s annual snapshot of the corruption landscape highlights a region making little progress in the fight against corruption. In sub-Saharan Africa, the average corruption score is even more bleak. Overlay a DI of your choice’s operations with this CPI index, and then compare this to the enforcement activity, and a correlation emerges.

DIs are not isolated in experiencing jurisdictional risk, but their risk is amplified by “new technology.” The possibilities of malfeasance through technology can be found in cyber-fraud, hacking, or the disconnect between marrying/inputting into technology and manual records on the ground. The potential for misconduct outruns the capacity of compliance systems to monitor and intervene. Without a traditional linear business model – by way of providing one product, providing one service – it can be hard to capture at different business levels, in different jurisdictions, across different product lines the most apt surveillance and monitoring system to detect misconduct within DIs.

DIs will traditionally have a wide range of business offerings across different supply chains that leak into different markets. At least one or two of these production or supply markets will likely be in nations with a less-than-perfect compliance record. DIs’ management is no less complicated. In a recent piece for our regulatory and investigation periodical, SEA View, we cited the example of Japanese trading houses and the challenges they face with international and internal investigations. We witness a “central brain” in Tokyo who are removed from the group’s investment entities; subsidiaries where “secondees” and individuals are often placed keeping the topco exposed. At this subsidiary level, it is unclear how reporting should take place, and there can be amorphous management structures. By their very nature DIs are amalgamations. Products of an aggressive M&A strategy to fill strategic “gaps” in their profile, DI structures and acquisitions cannot merely rely on a topco transplant.

Such acquisitions require integration of management and employee groups sensitive to existing and cultural frameworks. Without “local” sensitivity, compliance will always be the “other.” So what can DIs do?

A post-acquisition checklist

For DIs to effectively “attack” the challenges above, we recommend:

• Post-acquisition investment that…
  
  We recommend a continuing engagement with acquired entities, beyond closing to prioritize structural investment in compliance, reporting lines, and proper management. This is to make compliance efforts consistent across the organization and to sustain the reasons that prompted the acquisition.
  
  
• …conceptualizes accessible “core” compliance messages and systems… 
  
  Seek to simplify, not necessarily expand, your compliance message. This should be in local languages as well as in English.
  
  
• …while still allowing flexibility to adapt for specific businesses and markets.
  
  Recognize that a one-size-fits-all compliance approach is not sensitive to the diverse business models or jurisdiction that even one business may operate in. Therefore, create compliance cross-structures – where companies within different parts of the group, particularly across different geographies, share similar risks, build compliance “bridges” laterally within the group or groups. These should be updated and compliance efforts should be rewarded rather than vilified.

Fully fledged compliance

In doing so, the most sustainable profits will be achieved through creating a truly centralized and independent compliance function, with independence and access to the board. This should be staffed by people familiar with, or willing to understand, the specific business. Compliance should be armed with tools and technologies. It should spend days in different parts of the business as part of forming a dynamic risk assessment of the business’s exposure to risk. This should feed up and into regional compliance and be tuned into the local cultural, linguistic, and operational sensitivities.

DIs’ inherent diversity across different product lines can even be a compliance strength, if coupled with our recommendations. If the business – from the junior factory worker to the mid-level executive to the board member – is aware of the risks or primed to spot these, malfeasance can be prevented. Either through educating the DIs’ specific and different business lines in the compliance risks or by making “better” business choices in who contractual arrangements are made with. Diversifcation need not be a disaster if compliance is given a clear business rationale.