Avon Products Inc. (Avon) and a group of its shareholders reached a $62 million settlement last month in a derivative class action law suit alleging securities fraud. The plaintiffs claimed that Avon and its officers had concealed that the company had given bribes to Chinese government officials by various means, including gifting Gucci bags and improper travel expense payments. This settlement follows the December 2014 payment of a total of $135 million in fines to both the U.S. Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) for violating the Foreign Corrupt Practices Act (FCPA).

Background

The class action claimed that Avon artificially inflated the price of its shares by intentionally misleading shareholders about the company’s compliance with the FCPA. In particular, the plaintiffs alleged that the former CEO and former Chief Financial Strategy Officer knew that Chinese officials were being bribed years before the company publically disclosed in 2008 that it was investigating possible FCPA violations. The pleadings also alleged that Avon embraced a corporate culture that was “actively hostile” to effective oversight and hid its dependence on corrupt activities to boost sales revenues.

Significance

Class Action Liability Separate From Enforcement Actions

Increasingly, public companies not only have to pay hefty criminal and civil fines to enforcement agencies after years of costly internal and authorities-driven investigations, but then must also deal with derivative class action law suits brought by plaintiffs’ law firms specializing in such actions. The amounts claimed in derivative law suits are often in excess of the fines imposed by the law enforcement authorities.

On the enforcement front, Avon had to contend with the criminal and civil aspects of the FCPA violations for over eight years before convincing the authorities that $135 million in criminal and civil penalties and a deferred prosecution agreement should result in the conclusion of the FCPA investigations into Avon’s China operations. Of that amount, $68 million was paid to settle the DOJ’s criminal investigation and $67 million settled the SEC’s civil investigation. As part of the settlement, Avon was also required to retain an independent monitor to review its FCPA compliance program for a period of 18 months, followed by an additional 18 months of self-reporting on its ongoing compliance efforts.

Avon then entered into yet another round of settlement negotiations in response to a claim by some of its shareholders’ lawyers. Avon decided to settle that class action for $62 million, despite the fact that the court granted its first motion to dismiss on the grounds that the plaintiffs had failed to demonstrate that Avon made any false statements regarding the use of bribes. Avon brought another motion to dismiss the plaintiffs’ amended complaint, which apparently also had a considerable chance of success according to the statements made to the judge by the shareholders’ lawyers in explaining the fairness of the settlement for the plaintiffs. Despite the frailties in the shareholder class action, Avon thought it best to reach an agreement to settle. In many cases, the serious disruption to the management of the company of a class action law suit, even one that has significant weaknesses, justifies a settlement.

Robust and Effective Internal Controls

Dealing with criminal and civil enforcement proceedings for several years, followed by having to defend derivative class action law suits, can be a severe distraction for a company and its management. Companies can avoid this disruption by implementing anti-corruption compliance programs, including strict management oversight of overseas operations.

However, having an anti-corruption compliance program on paper is not enough; the program must be robust and effectively implemented to adequately mitigate risks – particularly in high risk countries such as China. As we have noted previously, companies operating in China face high anti-corruption risks, and the slightest indication of wrongdoing should necessarily lead to a thorough investigation. In some cases, enforcement authorities will consider involving independent counsel with experience in conducting such investigations followed by the immediate implementation of remedial measures to be the only appropriate response.

When Avon first learned about potential FCPA problems in China through an internal audit report, it consulted an outside law firm but did not carry out a thorough investigation. Instead, it simply directed that internal control measures be instituted at the subsidiary. However, no such measures were taken, and there was no follow-up on the compliance initiatives. Avon began a full-blown internal investigation a few years later only after the CEO received a whistleblower letter. However, by this time, much of the damage had been done.

An appropriate early response commensurate with the level of risk of non-compliance is critical. Failure to conduct a thorough internal or independent investigation using outside experts when  the various risk factors warrant one heightens the risk of scrutiny by enforcement authorities and derivative class actions further down the road. Companies should consider risk factors such as the previous history of anti-corruption violations at the company, the geographic and political profile of the country, the nature of the industry, interaction with government officials, use of agents and consultants, methods of compensation for employees, agents and consultants, and effectiveness of the compliance program in responding to any indications of wrong-doing by company officials.

Conclusion

To minimize compliance costs, companies often choose to not respond appropriately, only to discover later that the enforcement authorities believe that the violation could have been uncovered if the company had undertaken a timely, thorough and independent investigation. The consequences of seeking to minimize disruption and costs in the first instance can result in more time-intensive and expensive steps being necessary later, including cooperating with enforcement authorities in conducting a more thorough internal investigation, responding to subpoenas and search warrants, paying hefty fines, and responding to class action law suits seeking enormous amounts for damages claimed to have been inflicted on a certain group of shareholders. The old proverb “a stitch in time saves nine” should be heeded by compliance officers seeking to galvanize internal corporate response to possible anti-corruption violations.