Companies operating internationally often engage numerous – sometimes even thousands – of third parties around the world to help facilitate their business. Alongside the growth of such relationships, the risks posed by them have taken on new significance with the rising tide of anti-corruption and anti-bribery enforcement actions throughout the world. 

As a direct consequence, the importance of third-party due diligence cannot be understated. Indeed, the level and thoroughness of third-party due diligence that a corporation undertakes is a factor that the United States Department of Justice and the Securities and Exchange Commission expressly consider when they are deciding whether to prosecute and enforce alleged violations of the Foreign Corrupt Practices Act. 

Therefore, ensuring that you complete proper due diligence can make the difference between a third-party relationship that truly adds value to a company and having to tackle expensive, time-consuming and, in the worst case, disastrous problems that may arise in the wake of actions a third party may take on behalf of your company.

The DOJ and SEC have stated that the degree of diligence “may vary based on industry, country, size and nature of the transaction, and historical relationship with the third-party.”[1] But, practically speaking, what does risk-based due diligence mean? And how can a corporation engage in risk-based due diligence in a comprehensive but cost-efficient manner?

In this article, we define key factors around risk-based due diligence and then provide a basic scorecard to guide you to a general understanding of the levels of risk posed by third parties who may be providing services for your company in your international operations.

KEY FACTORS IN RISK-BASED DUE DILIGENCE

Understanding the basics

Risk-based due diligence is the process by which a corporation determines what level of due diligence to complete based upon the level of risk posed by a third party. 

Third parties include, among others, sales agents, distributors, suppliers, resellers, consultants, service providers, customs brokers, lobbyists and joint venture partners.

Key issues to consider in assessing risk include high-risk locations and industries. A third party that conducts business in a high-risk location or industry, or both, should raise a red flag. 

A useful tool in identifying high-risk locations or industries is the Corruption Perceptions Index (CPI), created by the global organization Transparency International. The CPI measures the perceived levels of public sector corruption in 176 countries and territories worldwide. 

Region-specific: Even in countries that are low-risk based on CPI, particular regions may suffer from higher levels of corruption than other regions.

  • Certain industries historically tied to corruption are regarded as high-risk industries.
  • When these two factors overlap, so that a third party is both in a high-risk location and a high-risk industry,the risk of corruption is exponentially greater. 

Government interactions

Because interactions with government officials remain at the heart of anti-corruption compliance, the level and type of interactions in which the third party will engage with the government are also key considerations. 

High-risk interactions often involve, among others:

  • Engaging directly with government officials to secure government contracts and other forms of authorization
  • Engaging with government officials to secure sales to governmental customers
  • Engaging with state-owned enterprises (SOE).

Particularly risky is a close relationship between a third party and a government or political official linked to the transaction at issue. Key considerations:

  • Why was a particular third party selected? 
  • What other types of interactions, outside of those directly related to the transaction, does the third party have with the government official in question?

Categorizing the third party

Certain basic characteristics of third parties are key to categorizing the levels of due diligence that are required, including the third party’s:

  • Scale of operations
  • Level of expertise within the relevant industry

Terms of the relationship

Particular topics arising during contract negotiations with a third party are also useful indicators in determining the level of due diligence warranted, including:

  • The form of payment the third party requests
  • Types of discounts the third party requests
  • Transparency regarding expenses and accounting
  • Compliance with FCPA and local anti-bribery laws 

A SAMPLE SCORECARD FOR COMPARING THIRD PARTIES

Once you have addressed these basic issues, how do you categorize third parties to determine which ones need closer scrutiny? 

Although far from exhaustive, below is a scorecard providing sample markers against which to compare third parties. Most third parties likely will not fit neatly into any one category when all factors are considered, but patterns can be drawn from such factors.

THIRD-PARY SCORECARD

Click here to view table.

COMPLETING APPROPRIATE DUE DILIGENCE

Based on the level of risk associated with the third party at issue, a corporation should conduct an appropriate level of due diligence. While, generally speaking, a high level of due diligence is necessary for high-risk third parties and a lower level of due diligence is likely sufficient for lower-risk third parties, the appropriate level of due diligence will vary based on the circumstances surrounding a particular third party. 

Following are some potential methods for carrying out due diligence at various levels:

  • Low-level diligence: Third-party questionnaire and related follow-up; review summary financial statements and other background documents; conduct general online research and review publicly available information.
  • Medium-level diligence: In addition to the aforementioned, perform a background check of the third party, including a more extensive review of publicly available information (e.g., government database search); interview the third party’s senior management; conduct a more extensive review of relevant documents and financial records.
  • High-level diligence: In addition to all the aforementioned, conduct interviews of employees beyond senior management – e.g., personnel in the field who would be involved in the engagement; review facilities; comprehensively review relevant documents and financial records; conduct a background investigation that includes inquiries beyond publicly available information (e.g., interview industry sources).

A PRACTICAL, REASONABLE APPROACH

By engaging in risk-based due diligence methodically, a company can introduce practicality and reasonableness to the often daunting task of examining its current and prospective relationships with third parties. 

Moreover, conducting such due diligence can sufficiently limit risk for the company and comply with government expectations, while maintaining the value that third-party relationships are intended to bring to the company’s business.