As reported in the December 25, 2015 New York Times (NYT) article, “U.S. Foreign Arms Deals Increased Nearly $10 Billion in 2014,” “foreign arms sales by the United States jumped by almost $10 billion in 2014, about 35 percent, even as the global weapons market remained flat and competition among suppliers increased.” Among the countries referenced in the export growth were Qatar and Saudi Arabia.
This development should come as no surprise, especially as U.S. and traditional NATO spending has been on the wane. As referenced in an article by Howard Weissman, Counsel at Baker & McKenzie, “A recent report on U.S. military spending issued by the Council on Foreign Relations noted that in calendar year 2013, U.S. military spending declined from $671 billion to $619 billion (in constant 2011 dollars), the largest decline since 1991. In addition, “the report predicted a likely further decline in 2014 because of reduced U.S. operations in the Middle East and sequestration.” With those levels of decline, it is no wonder that major defense contractors, as well as small- to medium-sized enterprises, are looking overseas for growth.
Overlay these patterns with recent reports issued by Transparency International, including Middle East and North Africa Government Defense Anti-Corruption Index (link here for maps), and you can see a sea of red representing critical corruption risk. As the TI paper well states, in the Middle East, for example, “while defence spending is on the rise, there remains a lack of clear, transparent strategic planning to ensure that governments are investing wisely in national security priorities that serve the interests of their country.”
In such regions, as the Report continues, there is “little if any oversight,” and “in other states there are signs of well-equipped security structures which lack public legitimacy, creating internal risks to stability.” Those are all conditions ripe for corruption risk, as procurement officials look for contracts that nurture bribery, as opposed to the promotion of internal and external security. In addition, as the NYT article describes, “some arms producers have adopted measures like flexible financing, counter-trade guarantees and co-production and co-assembly to try to secure sales.”
It was those last two which caught my attention.
During my career working in the defense industry, I saw a rise in overseas manufacturing entities promoting themselves as co-production partners. In some cases, the advantages for the manufacturer was that such a partnership would allow, under local regulations, for the procurement to proceed without a tender. In other words, no public bid. In some cases, the production facilities were either owned or co-owned by members of the military or other public officials. There was little to no transparency pertaining to beneficial ownership. In many instances, the facilities were improperly equipped, and personnel were inadequately trained and staffed. I remember one meeting where the local representatives stated that they were simply satisfied to put a label on a product and call it “co-production.” All to avoid the public tender process.
Another category for such arrangements are “offsets,” which can, as described in a Financial Times article, ”increase the chance that a country buys equipment it does not need or decides to sign a contract that does not offer the best in quality and value.” There is a very robust debate right now about the danger offsets present in terms of corruption risk, including Transparency International Reports.
All of these teaming agreements, as Mr. Weissman well states, have “greatly increased the FCPA risk” which defense companies now confront. While a number of larger defense companies have addressed and acknowledged the increased peril, including disclosing offset agreements in public filings, the risks to smaller and medium-sized enterprises are substantial. Small- to medium-sized contractors, which might not have the benefit of experience or the compliance and due-diligence resources to address these risks, might easily find themselves attracted to these frontier markets, where lucrative business opportunities and corruption risk abound, and simply “roll the FCPA dice.”
In addition, these teaming agreements, be they offsets or co-production, which might sound “too good to be true,” might be just that: an in-country vehicle to transfer procurement funds to corrupt public officials. Thus, organizations would be well advised to challenge their business teams who promote such ventures, and to exert additional due diligence in such markets. There is no substitute for knowing your customer, to which we can add, know your partner, even if all they want to do is to affix a label to your product.