AVON PRODUCTS BRIBERY SCANDAL IN CHINA

Presented toDr. Mark Panos

Towson University

Prepared by Kia Allen & Marie Claire Llareus

Towson University StudentsEnglish 317.20

May 8, 2012

TABLE OF CONTENTS

TRANSMITTAL LETTER……………………………………………………………………….ii

ABSTRACT……………………………………………………………………………………...iii

EXECUTIVE SUMMARY……………………………………………………………………….v

INTRODUCTION………………………………………………………………………………...1

BACKGROUND………………………………………………………………………………….1

CASE STUDY…………………………………………………………………………………….2

Ethical Issue……………………………………………………………………………….2

Avon vs. the U.S. Securities and Exchange Commission…………………………………3

Monetary Effects…………………………………………………………………………..4

RELEVANT LAW………………………………………………………………………………..5

The Foreign Corrupt Practices Act………………………………………………………..5

Liability……………………………………………………………………………………5

The OECD Anti-Bribery Convention……………………………………………………..6

PROPOSAL……………………………………………………………………………………….6

The FCPA Definition of “Foreign Official”………………………………………………6

OECD Enlargement and Enhanced Engagement in the Fight against Foreign Bribery…..8

Global Awareness of Foreign Bribery…………………………………………………….8

FEASIBILITY STUDY…………………………………………………………………………...9

CONCLUSION & RECOMMENDATIONS……………………………………………………..9

REFERENCES…………………………………………………………………………………..11

LOGICAL FALLACIES…………………………………………………………………………iv

Statements………………………………………………………………………………....v

Logical Fallacy Chart…………………………………………………………………......vi

APPENDIX……………………………………………………………………………………...vii

Appendix A……………………………………………………………………………...viii

Appendix B……………………………………………………………………………….ix

COURT DOCUMENTS…………………………………………………………………………..x

Class Action Complaint…………………………………………………………………..xi

Amended Complaint for Violations of the Federal Securities Law……………………..xii

Allen & Llareus Solutions317 West Aspen Road kallen10@students.towson.eduTowson, MD 21252 mllare1@students.towson.edu

May 8, 2012

Dr. Mark Panos8000 York RoadTowson, MD 21252

Dear Dr. Panos:

The attached report, in which you requested a case study on an unethical issue in the workplace, thoroughly describes the current bribery investigation on Avon Products. We believe you will find this study to be quite interesting and useful in evaluating policies and procedures within a company.

This study was designed to examine the impact of corruption in three areas:

Current laws enforced at Avon and potential future laws Direct effects on levels of management Monetary changes within the company

Secondary research provided a substantial amount of information regarding the case study. These sources included company financial reports, court documents, electronic databases, and online resources.

We would be pleased to further discuss this report and its conclusions with you at your request, along with any questions you may have. We thank you for your interest in reviewing our report and hope that you ultimately coincide with our suggestions.

Sincerely,

Kia Allen Marie Claire Llareus

Abstract

Avon Products is an American personal care company that continues to reach high success

globally, catering to women and their beauty needs. In 2008, Avon encountered a bribery

scandal in which a whistleblower reported to Avon chief executive officer Andrea Jung that the

company’s China unit was bribing government officials and misallocating funds equaling up to

several hundred thousands of dollars. The U.S. Securities and Exchange Commission (SEC)

immediately began to investigate the unethical act and suspect Avon to be in violation of the

Foreign Corrupt Practices Act (FCPA). While the court has not yet decided on a verdict, the

company’s financial statements are being closely examined along with different levels of

management associated with the case.

EXECUTIVE SUMMARY

Beginning in June 2008, Avon Products Inc. has been under investigation for bribery allegations in its China operations. The U.S. Securities and Exchange Commission (SEC) has been the main investigator on the case. The scandal includes related financial findings dating back to a 2005 draft internal report displaying a number of questionable payments. As a result, Avon Products has faced an array of changes.

Our conclusion that Avon Products Inc. is in violation of the Foreign Corrupt Practices Act (FCPA) and did not establish the proper policies and procedures to adhere the acts provisions is based on findings from online articles and electronic databases. In addition, the company’s financial reports along with court documents were reviewed.

Analysis of the data revealed effects on the company in three areas:

Laws & Regulations. Avon Products is expected to abide by the FCPA along with other regulations the company itself has enforced. The Compliance Committee and senior management are assigned to oversee that these regulations are enforced and associates comply accordingly. In 2010, Avon established the Global Ethics and Compliance Council which was designed to further evaluate day-to-day operations.

Employment. Due to the type of ethical issue being faced in this case, several people were involved and therefore, either terminated from their positions or demoted. CEO Andrea Jung for example, was demoted and placed as executive chairman. Although Jung was demoted during the investigation, she was demoted due to Avon’s financial performance, not bribery allegations. Also, in May 2008, 4 executives were fired after being suspended the previous year.

Finances. The company has faced descriptive changes within their financial statements. Since 2009, Avon has incurred costs at roughly $250 million on the internal investigation of possible FCPA violations. Avon’s sales revenue even dropped by 4% and net profits dropped by 15%.

On the basis of these findings, it is recommended that Avon Products Inc. establish more reasonable policies and procedures that have an extensive assurance on the business. It is also recommended that the company make due diligence steps proposed by author Charles H. Calhoun. This includes performing a risk evaluation on locations known for unethical business practices, assessing internal controls to be assured that they are sufficient, and many more.

INTRODUCTION

Corruption within the workplace is a very common issue today but, in many cases it fails to

surface. This study was designed to analyze the direct and indirect impacts of bribery within

Avon Products Inc., in which employees were misallocating funds in order to obtain specific

governmental permission. Within this report, you will find highlights of the company’s history,

a clear description of the case study and ethical issue, laws pertaining to the case study, and a

proposal to finding a solution. Specifically, we will attempt to answer the following questions:

How effective is current law in specifying what is considered bribery?

How has the investigation affected Avon Products monetary accounts?

What can be done to improve current law and reduce the number of foreign bribery

cases?

BACKGROUND

Avon stands as the world’s largest direct seller and one of many leading beauty companies.

Since David H. McConnell founded Avon in 1886, the company has been extremely successful.

With more than $11 billion in annual revenue, Avon meets the needs of women globally. Its

product line includes a wide range of beauty, fashion, and house products. By having growing

markets in more than 100 countries, Avon strives “to be the company that best understands and

satisfies the product, service and self-fulfillment needs of women” (Avon, 2012).

According to Avon’s company website, “ethics and compliance are core priorities at Avon”

(Avon, 2012). Ironically, Avon initially established the Compliance Committee to ensure the

effectiveness of ethical enhancements and the compliance of the law in day-to-day operations,

but is yet facing foreign bribery violations. Under the committee, senior management would

oversee the procedures of associates and enforce the policies.

“The bribery investigation and potential disclosure violation could be a distraction for

management and could lead to fines and other regulatory actions against the company,” S&P

said in a statement (Rubenfeld, 2012).

As the case unfolds more and more, there will be further information available and eventually a

verdict for the case.

CASE STUDY

Ethical Issue

The ethical issue that will be addressed in this case study is bribery. Bribery is the offering or

taking of something of value to influence persons or gain an unfair advantage. It is a form of

corruption that sometimes occurs in dealings of international business. Bribery is a serious issue

because it “raises moral and political concerns, undermines good governance and economic

development, and distorts international competitive conditions” (OECD, 1997).

It would seem that bribery is accepted in some countries more than others. But, according to the

Encyclopedia of Business Ethics and Society, it is all a matter of cultural relativism. In our

country, the exchange of gifts between business associates is considered unethical and, in some

cases, illegal. In other countries, business gift giving is a culturally expected part of doing

business and business relationship building. In China, for example, relationship-based business

is highly valued. An article by China Briefing states, “Treating government officials to business

dinners and entertainment… is a common way for businesses to manage their guanxi1 with local

authorities.”

United States corporations are expected to uphold home ethical standards when conducting

business in other countries. However, some corporations unwisely follow the ancient adage of

“when in Rome, do as the Romans do.”

Avon vs. the U.S. Securities and Exchange Commission

In June 2008, an investigation began regarding allegations of bribery in Avon’s China division.

Avon employees paid some hundreds of thousands of dollars to Chinese government officials

and third-party consultant agencies in order to obtain governmental permission to conduct direct

sales in China. The bribery allegations consisted of improper expenses for items like travel and

entertainment. Eventually, the allegations extended to other countries such as Brazil, Mexico,

Argentina, India, and Japan. Federal prosecutors found the questionable payments in a

September 2005 draft internal report by the company. It raised concern over Avon’s compliance

with U.S. anti-bribery laws that bar U.S. companies from paying bribes to foreign officials.

Please refer to Appendix A for a timeline of events.

Currently, the U.S. Securities and Exchange Commission are investigating the case along with

the Federal Bureau of Investigation (FBI) and the Southern District of New York’s Complex

Frauds Unit in Manhattan. Throughout the investigation, the mentioned prosecutors have

evaluated personnel from different levels of management. As a result, they have either been

terminated from their positions or demoted. Charles Cramb, now former vice chairman at Avon,

was demoted to chief finance and strategy officer. China’s Avon President S.K. Kao was

1 ‘Guanxi’ is a Mandarin Chinese word for “relationships.” It describes the system of social networks that facilitate business dealings in China.

terminated along with Jimmy Beh, China CFO; C.Q. Sun, head of corporate affairs at China; and

Ian Rossetter, head of global internal audit and security in New York. Even CEO Andrea Jung

was demoted during the investigation but, was demoted due to Avon’s financial performance and

not based on bribery allegations. Please refer to Appendix B for a diagram of significant figures

in the case.

Monetary Effects

The Avon bribery scandal has caused drastic changes in the company’s monetary accounts. By

combining investigation costs, drops in earnings, and losses in revenue, Avon has incurred costs

totaling to almost $250 million since 2009, displayed in Figure 1. The company’s sales revenue

dropped by 4 percent and net profits dropped by 15 percent (Anderson, 2012).

Figure 1

2009

2010

2011

0 10 20 30 40 50 60 70 80 90 100

Investigation Costs

Costs (million)

Year

Since 2012, Avon has reported that the company’s stock is down by 7 percent since their last

quarterly earnings report. In addition, sales have dropped 40 percent since last year.

RELEVANT LAW

$59

$95

$93.3

The Foreign Corrupt Practices Act

The United States was the first country in the world to make the bribing of foreign officials

illegal. The Foreign Corrupt Practices Act (FCPA) was enacted in1977, prohibiting individuals

and corporations from bribing or paying foreign officials with the intention of obtaining business

contracts. The FCPA applies to all United States publicly traded companies filing with the U.S.

Securities and Exchange Commission (SEC). It mandates that these companies maintain records

and file financial statements that accurately reflect their transactions. The FCPA divides

enforcement authority between the SEC and the Department of Justice. One of the unintended

consequences of the FCPA is that it puts United States corporations at a disadvantage to

competitors from other countries that do not have comparable legislation. Nonetheless, federal

prosecutors have been aggressively pursuing violations of the FCPA in recent years.

Liability

Both corporations and individuals may be held liable for violating the FCPA. An article from

the Wall Street Journal states “executives can be liable in overseas bribery cases even if they

didn’t authorize illegal payments or try to hide evidence of bribes.” The article is referring to a

legal concept known as “willful blindness.” Under “willful blindness,” a person can be found

guilty of simply taking steps to avoid learning of wrongdoing.

The Foreign Business Bribery Prohibition Act of 2011 is a bill currently pending in Congress. In

December, the bill was referred to the Subcommittee on Courts, Commercial and Administrative

Law. The bill was created to amend the Foreign Corrupt Practices Act of 1977, to make “a

foreign concern liable for up to treble damages to any issuer, domestic concern, or U.S. person as

a result of violating certain anti-bribery prohibitions” (Thomas, 2011).

The OECD Anti-Bribery Convention

Internationally, legislation similar to the FCPA has been developed to help combat bribery of

foreign officials. In 1997, the Organization for Economic Cooperation and Development

(OECD) adopted the Convention on Combating Bribery of Foreign Public Officials in

International Business Transactions (Anti-Bribery Convention). Thirty-nine countries are parties

to the convention and have made the bribery of foreign officials a criminal offence. In addition,

the countries have agreed to put in place measures reinforcing their efforts to prevent, detect, and

investigate foreign bribery. China is not currently a member party to the OECD Anti-Bribery

Convention.

PROPOSAL

To reduce the probability of recurrence of this type of problem, we propose the following:

1. Clarify the FCPA’s definition of “foreign official”;

2.[1.] Enlarge and enhance OECD engagement in the fight against foreign bribery and;

3.[2.] Raise global awareness of foreign bribery.

The FCPA Definition of “Foreign Official”

We believe a large part of why international bribery occurs is due to uncertainty regarding the

FCPA definition of “foreign official”. In the Journal of Business Ethics, Longenecker describes

FCPA provisions as “so vague that business executives, fearing its sanctions, have become

unnecessarily cautious in their international operations.”

The Institute for Legal Reform published a paper, titled Restoring Balance: Proposed

Amendments to the Foreign Corrupt Practices Act, by Andrew Weissmann and Alixandra Smith.

According to the publication, clarifying the definition of “foreign official” will improve the

FCPA. The statute defines a “foreign official” as:

“any officer or employee of a foreign government or any department, agency, or

instrumentality thereof, or of a public international organization, or any person acting in

an official capacity for or on behalf of any such government or department, agency, or

instrumentality, or for or on behalf of any such public international organization.”

However, the FCPA does not provide any definition of the word “instrumentality.” Without a

clear understanding of what companies are considered “instrumentalities,” other companies are

left with no way of knowing whether the FCPA applies to a particular transaction or business.

Weissmann and Smith wrote that the government’s interpretation of “instrumentality” is meant

to encompass companies that are partially owned or controlled by a foreign government. They

add that the uncertainty is particularly discerning in China, where “most if not all companies are

either partially or entirely owned or controlled by the state.”

To clarify who is considered a “foreign official,” Weissmann and Smith suggest modifying the

FCPA to provide a clear definition of “instrumentality.” Such a definition would indicate:

the percentage ownership by a foreign government that will qualify a corporation as an “instrumentality”

whether ownership by a foreign official necessarily qualifies a company as an instrumentality and, if so, whether the foreign official must be of a particular rank or the ownership must reach a certain percentage threshold

to what extent “control” by a foreign government or official will qualify a company as an “instrumentality”

Perhaps Avon executives were dealing with an “instrumentality,” and were therefore uncertain as

to who is considered a “foreign official.” We believe answering the above questions about the

definition of “instrumentality” would reduce uncertainty, and in effect, decrease the likelihood of

FCPA violations.

OECD Enlargement and Enhanced Engagement in the Fight against Foreign Bribery

The OECD should invite non-member countries that are not yet parties to the Anti-Bribery

Convention to open discussions for membership of the organization. Encouraging these non-

members to participate in the fight against bribery may lead to enhanced engagement and

enlargement of the organization. The discussion would cover how the non-members can meet

OECD anti-bribery standards. For example, non-members would be informed about compliance

with the Anti-Bribery Convention and the legal framework for combating bribery. If all

countries become parties to the Anti-Bribery Convention, the U.S. disadvantage would be

eliminated because all competitors would then play by the same rules.

Global Awareness of Foreign Bribery

The OECD launched an Initiative to Raise Global Awareness of Foreign Bribery, however we

believe further awareness is needed. In addition to raising awareness, the OECD Initiative aims

to illustrate the negative impact of foreign bribery and increase interest in anti-bribery measures

for every country. The more people know about this crime, the less likely companies are to offer

bribes, the less likely public officials are to receive or solicit them, and the more likely law

enforcement authorities are to investigate foreign bribery allegations.

FEASIBILITY STUDY

We believe our proposal should be implemented because it will help to prevent bribery in

international business. Modifying the FCPA to include a clear definition of “instrumentality” is

an easy way to reduce uncertainty of United States companies conducting business

internationally. Encouraging OECD membership will support the international fight against

foreign bribery. Promoting efforts to raise awareness and increase knowledge of the issue will

reduce the occurrence of foreign bribery.

CONCLUSION & RECOMMENDATIONS

Analysis of the statements, journal articles, and relevant law leads to the following conclusions

and recommendations regarding Avon Products Inc. We believe Avon is guilty of bribing

foreign officials in China, and therefore, has violated the Foreign Corrupt Practices Act (FCPA).

Avon failed to establish policies and procedures that provided reasonable assurance that the

business was adhering to FCPA provisions.

The Organization for Economic Cooperation and Development (OECD) adopted the

Recommendation of the Council for Further Combating Bribery of Foreign Public Officials in

International Business Transactions. Within this recommendation, the OECD Council gives

“Good practice Guidance” to companies on establishing effective internal controls, ethics, and

compliance programs or measures for preventing and detecting foreign bribery. The guide states

that companies should develop these practices on the basis of foreign bribery risks facing the

company. To ensure the continued effectiveness of the company, “such circumstances and risks

should be regularly monitored, re-assessed, and adapted as necessary.”

We suggest that companies conducting business internationally create a strong FCPA

compliance program. A strong compliance program should be able to detect and deter improper

conduct. The following guidance principles were provided by the U.S. Chamber Institute for

Legal Reform. Six principles constitute a strong compliance program:

1. Risk Assessment – the regular and comprehensive assessment of bribery-related risks to an organization

2. Top-Level Commitment - a commitment to preventing bribery clearly communicated by top-level management

3. Due Diligence - due diligence policies and procedures covering all parties to a business relationship

4. Clear, Practical and Accessible Policies and Procedures - ensuring that policies and procedures are readily accessible and enforceable throughout the organization

5. Effective Implementation - ensuring that the policies and procedures are embedded throughout the organization

6. Monitoring and Review – mechanisms to ensure compliance with relevant policies and procedures, and implementation of improvements where appropriate

Companies that adhere to these principles will be less likely to encounter FCPA noncompliance.

References:

About Avon (2012). Avon Products, Inc. Web page. Retrieved 30 Apr. 2012 from, http://www.avoncompany.com/aboutavon/index.html

Anderson, Mae, and Michelle Chapman. "Avon Posts 4th-quarter Loss as Sales Slump, Costs Rise; Doesn't Expect 2012 Improvement." - Winnipeg Free Press. 14 Feb. 2012. Web. Retrieved 30 Apr. 2012 from http://www.winnipegfreepress.com/business/avon-posts-4th-qtr-loss-as-sales-slump-costs-rise-doesnt-expect-margins-to-improve-in-2012-139282148.html

Calhoun, Charles H. "Foreign Corrupt Practices Act of 1977." Encyclopedia of Business and Finance. Ed. Burton S. Kaliski. Vol. 1. New York: Macmillan Reference USA, 2001. 397-399. Gale Virtual Reference Library. Web. 16 Apr. 2012.

Davis, J. (2004). Bribery. In (Ed.), Encyclopedia of White-Collar & Corporate Crime (pp. 111-113). Thousand Oaks, CA: SAGE. Retrieved from http://www.sage-ereference.com/view/corporatecrime/n63.xml

Longenecker, Justin G., Joseph A. McKinney, and Carlos W. Moore. "The Ethical Issue of International Bribery: A Study of Attitudes among U.S. Business Professionals." Journal of Business Ethics 7.5 (1988): 341-46. Web.

"Magazine and Daily News Service." Avon Bribery Case May Face U.S. Grand Jury Investigation. Ed. Dezan Shira. China Briefing, 14 Feb. 2012. Web. 30 Apr. 2012. Retrieved from http://www.china-briefing.com/news/2012/02/14/avon-bribery-case-may-face-u-s-grand-jury-investigation.html

"Organization for Economic Cooperation and Development (OECD)." USDOJ: CRM: FRAUD: FCPA: International Agreements Relating to Bribery of Foreign Officials. Web. 06 May2012. Retrieved from http://www.justice.gov/criminal/fraud/fcpa/intlagree/

Rubenfeld, Samuel. "S&P Downgrades Avon Debt Over Bribery Probe, Weak Results."WSJ.com. The Wall Street Journal, 16 Mar. 2012. Web. 30 Apr. 2012. Retrieved from http://blogs.wsj.com/corruption-currents/2012/03/16/sp-downgrades-avon-debt-over-bribery-probe-weak-results/

Shichor, David. "Foreign Corrupt Practices Act." Encyclopedia of White-Collar & Corporate Crime. Ed. Thousand Oaks, CA: SAGE, 2004. 330-31. SAGE Reference Online. Web. 14 Apr. 2012.

Weissmann, Andrew, and Alixandra Smith. "Restoring Balance: Proposed Amendments to the Foreign Corrupt Practices Act." Homepage. U.S. Chamber Institute for Legal Reform, Oct. 2010. Web. 06 May 2012. Retrieved from http://www.instituteforlegalreform.com/doc/restoring-balance-proposed-amendments-to-the-foreign-corrupt-practices-act