In 2010, Deloitte published the guidance below addressing the regulatory risks associated with lodging companies seeking to expand internationally. The material is as relevant today as it was then and worth reviewing for any hotel owner or operator.
As U.S. based hotel franchise, management and investment companies recover from the recent economic recession and seek growth in international markets, operators should be aware of certain regulatory risks associated with international expansion. Of particular concern in the lodging industry should be compliance with the Foreign Corrupt Practices Act (“FCPA”). This publication brieﬂy summarizes the provisions of the FCPA, its potential impact on the lodging industry, and certain actions that lodging companies may consider in mitigating the risk of corruption within their organization.
The FCPA environment
The FCPA is a U.S. statute initially enacted in 1977. The FCPA has two main provisions – an anti-bribery and a books and records provision. The anti-bribery provision states that a company cannot corruptly make an offer, promise, or payment of ‘anything of value’ to a ‘foreign government ofﬁcial’ for the ‘purpose of inﬂuencing his or her ofﬁcial actions’ for the advantage of the company. The FCPA deﬁnes a foreign government ofﬁcial very broadly to include not only government ofﬁcials, but also employees of state owned enterprises, politicians, party ofﬁcials, and candidates. It is important to note that the actions of the company’s agents, consultants, or representatives, acting on behalf of the company, can be attributed to the company. The anti-bribery provisions apply to U.S. companies and citizens, foreign companies that issue stock in the U.S. and are traded on public exchanges, or any person’s acts while working in the U.S. The books and records provision requires companies who ﬁle reports with the Securities and Exchange Commission (“SEC”) to maintain accurate books and records and also to maintain an adequate system of internal controls.
Throughout the last few years, there has been an increase in the level of activity regarding FCPA matters, including prosecution of individuals, multi-jurisdictional investigations, large FCPA settlements, and additional regulator resources focusing on investigations, particularly within the Department of Justice and the SEC. In May of 2009, Mary Shapiro, SEC Chairman, stated that “FCPA violations have been and will continue to be dealt with severely by the SEC and other law enforcement agencies. Any company that seeks to put greed ahead of the law by making illegal payments to win business should be aware that we are working vigorously across border to detect and punish such illicit conduct”. The SEC has established a new unit of enforcement which will focus on new and proactive approaches to identifying violations of the FCPA. This may result in more investigations and conducting industry wide assessments.
This regulatory environment should be top of mind for lodging companies – particularly as many companies in the industry expand into Asia and other emerging markets. According to Lodging Econometrics, China continues to lead the Asia Paciﬁc region in terms of new hotel development. Over 600 new hotels encompassing over 150,000 rooms are set to open in China in the next two years. Many new hotel projects are also slated for India and the rest of the Asia/Paciﬁc market. Unfortunately, there is a relatively higher risk of corruption in these countries, and lodging companies should be aware of these circumstances as they expand their footprint into the region. For example, Transparency International, a nonproﬁt organization whose mission is to identify and reduce global corruption, has developed a “Corruption Perception Index” to assess the perceived level of corruption in each of the 180 countries that it surveys. In 2009, China ranked number 79 and India number 80 out of 180 countries in terms of the perceived level of corruption (country no. 180 having the highest perceived level of corruption). These survey results demonstrate the heightened level of corruption risk when doing business in this region.
(Ethics Suite note: in 2016, China and India were ranked 79 of 176)
Lodging companies may be prone to a wide range of potential corruption schemes. This may include payments to government ofﬁcials – whether directly or indirectly (via agents or consultants) to secure or expedite the acquisition, development, or construction of the hotel property. The construction and development of the property generally includes the need to obtain licenses and/ or permits from various government agencies. For example, a hotel developer will likely need to obtain operating and occupancy permits; ﬁre, safety, and health permits; construction and environmental permits; and liquor licenses from various government agencies. There is a potential risk that bribe payments may be made to government agencies in order to expedite or overlook certain criteria for obtaining such permits or licenses. Hotel developers may also seek local partners, including joint venture partners, to assist them in their hotel development. Lodging companies should perform due diligence in order to understand the relationship their partners have with local government ofﬁcials, as well as whether there are integrity concerns with their partners’ prior business dealings.
Since some of the potential areas of concern of corruption surround hotel development and construction, lodging franchisors may be at risk of unknowingly lending money to their franchisees which in turn is used to fund bribery payments. For example, loans are generally given to franchisees to either develop new or renovate existing properties. Budgets are generally prepared that detail out the use of the funds –such as for new construction, new room additions, renovations, or new branding style. As stated above, this development generally would require the need to obtain various permits and licenses. There is a risk that these funds may be used by the franchisee to fund bribes to government ofﬁcials for the obtaining of permits and licenses. In this scenario, both the franchisee and the franchisor would beneﬁt from the results of any corrupt payment.
Other potential schemes impacting the lodging industry may include payments to tax inspectors or real estate assessors to achieve favorable tax treatment or avoid penalties or even advertising of the hotel property on state-owned or operated television or radio stations.
In addition to direct cash payments, bribery can take many forms, such as providing gifts of jewelry, donations to an ofﬁcial’s favorite charity, “comp” stays at hotel properties, or reimbursement for non-business related travel and entertainment.
(Ethics Suite note: loyalty program points and benefits, memberships to hotel health and/or golf facilities, and offsite entertainment should also be considered.)
To deal with these risks, lodging companies should develop an anti-corruption compliance program that is structured to prevent, deter and detect potential violations of the FCPA. Although the programs and controls will vary in their complexity and degree of rigor, the program should include the seven hallmark elements established by the Federal Sentencing Guidelines. This includes prevention and detection procedures, high level oversight, due care, training and monitoring, consistent enforcement and response and prevention, and the tone of the top.
An effective program should address the risk of corruption in a comprehensive and integrated way. This generally begins with the development of a risk assessment. One way to perform this risk assessment is to survey the legal, accounting, ﬁnance, sales/marketing and M&A personnel as well as franchisees to gauge their understanding and awareness of potential corruption risk areas. These areas may include business and government relationships, government “touch points”, employee conduct, record keeping and controls, use of agents and other third parties, and joint ventures. This information will also assist management in assessing the company’s knowledge regarding FCPA and compliance activities. Based on the results of these surveys, lodging companies will be able to perform a more focused risk assessment – tailored to their business. This will help in the development of speciﬁc anti-corruption policies and procedures. For example, policies may need to be revised or updated to address the identiﬁcation of new franchisee relationships, the process for entering into management agreements, and disbursements for charitable or political contributions, and gifts and entertainment to foreign ofﬁcials.
Lodging companies may also consider performing background checks on franchise owners, joint venture partners, developers, suppliers, agents, distributors, and other intermediaries to help identify integrity concerns or potential conﬂicts of interest. These checks could alert lodging companies about the relationships these individuals have to government ofﬁcials and whether the individual or company is involved in other nefarious areas such as organized crime, terrorist groups, money laundering, as well as bribery and corruption, in business practice. This information may also identify whether the company or vendor included on certain domestic and international sanction and embargo lists.
Lodging companies may also consider developing and delivering focused anti-corruption trainings as part of their compliance program. These trainings may be developed in local languages and be speciﬁcally structured to the respective audience or function – such as executive management, regional management, sales teams, franchise owners, franchise administration, internal audit, and construction agents. Trainings may also include real life or hypothetical case studies to give the participants a real life feel for the FCPA and anti-corruption matters. Companies may also consider obtaining compliance certiﬁcations from employees, franchisees, and other agents, including developers regarding their compliance with the FCPA.
A successful anti-corruption compliance program must also include investigative protocol when allegations of violations arise. This protocol may include the need to retain outside counsel and forensic investigators to perform swift and appropriate independent investigations.
In summary, lodging companies should be aware of the corruption risks as they expand their global footprint into the emerging markets and should continuously assess whether their anti-corruption policies and procedures are effective in helping stop corruption from “checking-in”.
Anthony J. Campanelli, Partner – Deloitte Financial Advisory Services LLP
Christopher Georgiou, Partner – Deloitte Financial Advisory Services LLP