2016 was an usually tough year for U.S. advertising agency executives. The list of things keeping them awake at night include shrinking margins, restless clients and a changing marketplace that seems to be moving away from historically reliable sources of revenue. Arguably, the biggest cause of those restless nights were the ripple effects of the bombshell 2016 Report published by the Association of National Advertisers (ANA). The Report included the results of an eight-month investigation that found certain agencies had exploited clients through nontransparent, and potentially fraudulent business practices.
The research was performed on behalf of ANA by K2 Intelligence, an experienced corporate investigation firm. Among the conclusions reached in the initial draft of the Report:
Volume based "cash rebates" received by agencies from media entities and "other non-transparent practices" are common in the media buying process; Contracts for rebates and other non-transparent business practices were negotiated and signed by high-level ad agency executives; On certain transactions, paid rebates to ad agencies accounted for up to 20% of aggregate media spending; Certain agencies and media companies contrived pretextual research “services” with little or no value to be “performed” on behalf of media companies to compensate the agency for media buys on behalf of its clients; and Certain agencies steered commercial production and post-production work to their in-house production teams or their affiliated companies through the use of allegedly illegal price-fixing and bid-rigging strategies.
U.S. agencies, for the most part, have denied negotiating and accepting credits and other consideration from media based on the agency’s media buys. However, certain agencies readily acknowledge this practice routinely occurs outside the U.S. There are also reported cases of agencies’ overseas global holding companies receiving media rebates as a result of their U.S. subsidiaries’ media spend. Audits of an agency may not even disclose the benefits ultimately received by an agency’s parent holding company.
The most serious ripple effect of the ANA Report is the continuing U.S. Justice Department’s investigation into whether agencies engaged in illegal price fixing and bid-rigging to steer work to their own or affiliated production companies instead of more price-competitive independent companies. The U.S. Justice Department investigation is being led by Rebecca Meiklejohn, an experienced investigative attorney who helped send several ad agency executives to jail in 2002 for antitrust violations and tax fraud arising out of illegal bid-rigging practices.
Ms. Meiklejohn has reportedly sought and received information from people involved in the K2 International investigation. The draft ANA Report stated certain agencies used a variety of illegal practices to steer “post-production projects to affiliated companies within the same Agency Holding Companies”. The draft Report also noted how independent production firms routinely retained by agencies, were requested by those agencies to submit “check bids” on production and non-production work. These firms were asked to submit a bid on a job the agency or its affiliate had also bid on. The agency would inform the firms of the actual price to be included in their bids. If the firm submitted a lower bid, the agency would ask for it to be resubmitted at the previously requested higher price. These predestined “check bids” were then used to justify the awarding of the work to the agency. Thus, the bidding paper trail required under the typical advertiser/agency services agreement was created. Why would independent production firms agree to engage in such self-defeating chicanery? Because the same agencies often retain these firms for other work neither the agencies nor their affiliates perform.
The Justice Department investigation continues. Subsidiaries of some of the largest advertising companies, including Omnicom Group Inc., WPP PLC, Interpublic Group and Publicis Groupe SA have been contacted and are reportedly cooperating with the investigation.
What can advertising executives (and execs from other products and services companies) do to help avoid a similar Justice Department investigation:
Implementation, Communication and Enforcement of Corporate Policies Prohibiting Retention of Credits, Rebates and Other Forms of Consideration From Media Companies and other Vendors, and Establishing Commercially Reasonable Bidding Procedures. Create appropriate internal processes to ensure: (i) credits or other consideration received based on client-based spending is credited to the appropriate client’s account, and (ii) appropriate bidding procedures are implemented. Properly train management and staff on the new procedures.
Understand the Agreement between your Firm and the Client. What are the purchasing requirements your firm must comply with before outsourcing work to a contractor on behalf of the client? Are you also required to comply with the client’s purchasing guidelines? What are the client’s audit rights to examine your firm’s purchasing and bidding processes? Active participation, cooperation and buy-in among your CFO, attorney and business managers are crucial. Re-examine your Conflict of Interest Policy. Does it address conduct that could compromise the best interests of the firm’s clients? Require Competitive Bidding for all Ancillary Work the Client Expects to be Performed in the Most Cost-Effective Manner. Ensure identical information is provided to all bidders. Disclose to client any bidders that are affiliates or have pre-existing commercial relationships with your company. No check bids! Ensure Different Departments Approve Contracts and Invoices. Helps serve as a check and balance on the contracting, billing and payment processes.
Executives implementing these measures may not necessarily avoid being targeted for investigation, but they will likely fare better than their peers too busy to worry about such operational matters. And they should sleep a little better in 2017!