multiple rows of cardboard boxes on warehouse shelves

Moving Beyond Routine Contract Provisions

If companies are to maintain a commitment to risk mitigation, they must keep an eye on (and extend its oversight to) distributors – as well as sub-distributors and sub-sub-distributors. This will mean leveraging distributor relationships and using a variety of tools and strategies to conduct compliance and financial audits. Limiting oversight to strictly formal audits is an unnecessary restriction on the company’s ability to mitigate risks.

Whether you are in the high-tech industry and managing your channel partners (i.e., third-party distribution network), the pharmaceutical and medical device industry managing a complex network of distributors and sub-distributors or any other industry relying on third-party distributors, chief compliance officers face a number of challenges managing and mitigating risks.

To state the obvious, a company relying on distributors has, by definition, less control over the conduct of its distributors (and sub-distributors) than its own sales employees. A company has to manage its relationship with distributors primarily through its contracts and informal understandings and communications. Such relationships can range from informal, without a contract, to a complex set of contracts and formalized understandings.

There are two common types of distributors. From the pure business standpoint, most distributors maintain a buy-sell relationship wherein they purchase products from the company and resell the items at a price set by the distributor. The “buy-sell” distributors are sometimes characterized as company “customers,” but in fact, they are really acting as intermediaries in the sale of company products to sub-distributors and final customers/users. A less common model is for companies to supply a distributor on “consignment,” meaning the distributor does not pay a company for its product until the distributor sells the product.

When assessing bribery risks, it is important to focus on potential sources of funds for distributors to use to pay bribes. First and most significant is the margin that distributors earn. The distributor sets the price, subject to competitive forces, and seeks to maximize its profits. Second, some companies provide their distributors with financial and marketing benefits, including rebate programs and marketing/promotion funds. The level of risk requires companies to monitor these programs, audit the use of funds and make sure that distributors are not siphoning off money to fund bribery schemes.

In the high-tech industry in particular, companies provide significant marketing support to promote business development. Distributors use these funds for a variety of promotional programs, some of which operate close to the line between legitimate marketing and corrupt activities. As a consequence, high-tech companies have to audit and monitor their distributors, requiring documentation and proof of legitimate marketing activities.

To address distributor risks, companies rely on a mix of mitigation strategies, including comprehensive written representations and warranties, training, annual certifications, monitoring of activities and audit programs.

Companies have to move beyond “standard” contract provisions that have become “routine” over the last few years. Of course, a company has to secure appropriate compliance representations and warranties, as well as audit and termination provisions. As risk assessments and third-party strategies evolve, companies should look to tailoring additional provisions to the “specific” risk for a distributor.

Additional provisions have to be crafted for distributors’ relationships with sub-distributors – and sub-sub-distributors. Assuming that the company is only in privity with the distributor, the company has to leverage its relationship with the distributor to impose requirements on the distributor to exercise oversight responsibility of the sub- and sub-sub-distributors in its distribution chain. In this area, companies should consider requiring distributors to seek company approval of a sub-distributor before engaging the sub-distributor to sell the company’s products.

Many companies have secured appropriate audit provisions from their distributors. Companies have to exercise these audit clauses to maintain their credibility and commitment to risk mitigation, and should include distributors in the development of its annual audit plan. The key here is to conduct compliance and financial audits using a range of tools and strategies. A company that limits its audits to only formal, financial audits is unnecessarily restricting its audit capabilities to mitigate risks.

New and cutting-edge monitoring strategies are being developed to ensure that companies focus on high-risk distributors and flag those for follow-up inquiries and audits. With the advent of third-party management technologies, companies can free up resources to develop monitoring tools to capture and mitigate high-risk distributors.

This article was republished with permission from Michael Volkov’s blog, Corruption, Crime & Compliance.


Michael Volkov

Michael Volkov

Michael-Volkov-leclairryanMichael Volkov is the CEO of The Volkov Law Group LLC, where he provides compliance, internal investigation and white collar defense services.  He can be reached at mvolkov@volkovlaw.com.  His practice focuses on white collar defense, corporate compliance, internal investigations, and regulatory enforcement matters. He is a former federal prosecutor with almost 30 years of experience in a variety of government positions and private practice.

Michael maintains a well-known blog: Corruption Crime & Compliance which is frequently cited by anti-corruption professionals and professionals in the compliance industry.Michael has extensive experience representing clients on matters involving the Foreign Corrupt Practices Act, the UK Bribery Act, money laundering, Office of Foreign Asset Control (OFAC), export controls, sanctions and International Traffic in Arms, False Claims Act, Congressional investigations, online gambling and regulatory enforcement issues.

Michael has assisted clients with design and implementation of compliance programs to reduce risk and respond to global and US enforcement programs.

Michael has built a strong reputation for his practical and comprehensive compliance strategies.Michael served for more than 17 years as a federal prosecutor in the U.S. Attorney’s Office in the District of Columbia; for 5 years as the Chief Crime and Terrorism Counsel for the Senate Judiciary Committee, and Chief Crime, Terrorism and Homeland Security Counsel for the Senate and House Judiciary Committees; and as a Trial Attorney in the Antitrust Division of the U.S. Department of Justice.

Michael also has extensive trial experience and has been lead attorney in more than 75 jury trials, including some lasting more than six months. His clients have included corporations, officers, directors and professionals in, internal investigations and criminal and civil trials. He has handled a number of high-profile criminal cases involving a wide‐range of issues, including the FCPA and compliance matters, environmental crimes, and antitrust cartel investigations in countries all around the world.

Representative Engagements

  • Successfully represented three officers of a multinational company in two separate criminal antitrust investigations involving a criminal antitrust investigation in the District of Columbia and the Southern District of New York.
  • Defended pharmaceutical company before the Food and Drug Administration and Senate Finance Committee relating to application for approval of generic drug.
  • Conducted internal investigation which exonerated company against allegations of false statements in submissions to the FDA and against improper conduct alleged by Senate Finance Committee.
  • Represented company before the US State Department on alleged violations of ITAR which lead to voluntary disclosure and imposition of no civil or criminal penalties.
  • Advised several multinational companies on compliance with anti‐corruption laws, and design and implementation of anti‐corruption and anti‐money laundering compliance programs.
  • Advised hospitals, pharmaceutical companies and medical device companies on compliance issues relating to Stark law and Anti‐Kickback law and regulations.
  • Conducted due diligence investigations for large multinational companies for anti‐corruption compliance of: potential third party agents, joint venture partners and acquisition targets in Europe, Africa, Asia and Latin America.
  • Represented individual in white collar fraud case in Alexandria, Virginia and secured dismissal of criminal charges and expungement of criminal record.
  • Represented company before Congress and Executive Branch in effort to modify Justice Department regulations concerning use of federal funds.
  • Advised and assisted World Bank in review of global corruption policies, enforcement programs and corruption investigations and prosecutions.

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