16 Feb 2017

On 17 January 2017 the Serious Fraud Office announced the conclusion of the first milestone in its four year investigation into criminal conduct within the Rolls-Royce Group. It announced it had agreed a Deferred Prosecution Agreement (DPA) for total payments of nearly £500 million. The investigation that led to the agreement covered conduct over nearly 30 years, in seven countries and involving three business sectors. The saga is not yet over, as SFO is continuing to investigate individuals, and Rolls Royce has been in discussions with the US and Brazilian authorities around settlement of actions by them, but the DPA is a major step towards final conclusion.

Background

The business

The allegations arose in relation to three business streams within the Rolls-Royce Group:

  • The civil aerospace business (Civil): Civil generates around half of the Group's revenue and makes engines for the commercial large aircraft and corporate jet markets
  • The defence aerospace business (Defence): Defence generates around one-fifth of the Group's revenue and manufactures engines for the military transport market
  • The former energy business (Energy): Energy (which the Group sold in late 2014) generated less than 10% of the Group revenue and made gas turbines and compressors to power offshore platforms, transport gas and oil through pipelines and generate electricity.
The issue

In brief, the investigation concerned:

  • Four counts relating to agreements to make corrupt payments to agents in connection with the sale of aero engines for civil aircraft in Indonesia and Thailand between 1989 and 2006
  • One count relating to concealment or obfuscation of the use of intermediaries to facilitate defence business in India at a time when use of intermediaries was restricted, between 2005 and 2009
  • One count of making a corrupt payment to recover a list of intermediaries that had been taken from the company in India in 2006/7
  • One count relating to an agreement to make corrupt payments to agents in connection with the supply of gas compression equipment in Russia between the start of 2008 and the end of 2009
  • Two counts of failing to prevent bribery in the Energy business in Nigeria and Indonesia from the date the Bribery Act took effect and May 2013, and in July 2013
  • Three counts of similar failures in relation to the Civil business in Indonesia, China and Malaysia up to December 2013.

So, of the 12 counts, nearly half related to allegations of failure to prevent bribery, once the Bribery Act had taken effect.

Rolls Royce's policies

The company had policies around use of intermediaries, and retained both advisers, who were paid on commission linked to the company obtaining specific contracts, and consultants, who were paid fixed amounts not dependent on any particular contract. The Marketing Services department within the RR headquarters was responsible for oversight of the approval and appointment of intermediaries.

In 1996 the company's first published Code of Conduct banned bribes, and stated that intermediaries should be paid at a rate consistent with the value of the services they provided. In 1999 its first written policy on the use of intermediaries was published, but this did not include any process for due diligence. It merely required the approval of, first, a senior employee if a proposed payment exceeded 5% of the contract price and, later of the CEO. In 2003, Marketing Services issued guidance notes on the intermediary policy and in 2007 a Global Code of Business Ethics included a section on bribery and corruption, which was supported by a revised intermediary policy which by now required additional approval for fixed fee arrangements exceeding £150,000 and introducing a TRACE due diligence process for advisers while maintaining an internal due diligence process for consultants.

The company had a contracts review sub-committee, which operated from at least 1997 to 2008 and which met annually to consider all material contracts. 

First signs of trouble

Following a compliance review by a big 4 accountancy firm in 2009, the company issued a new policy on intermediaries. The review had concluded, among other things, that accountability and responsibility for intermediaries was unclear, and that there was no evidence that enhanced due diligence ever took place. It also found the Marketing Services department lacked resource, did not perform compliance functions and that some business units did not understand this aspect of the Marketing Services role. The 2009 upgraded policy (which among other things banned commissions exceeding 10% of the contract price) was further embellished in 2010. This transferred overall responsibility for the process to the company's compliance function and set requirements for each intermediary of business case, proper identification and risk assessment, with due diligence defined according to the risk rating. As time went on, the Head of the Audit Committee, another NED, the CFO, general counsel and an external audit representative attended these meetings, which happened at the time of the end of year audit. In 2008, the committee was discontinued, and the company established an Ethics Committee which oversaw the Compliance Function and reported to the Audit Committee.

What happened?

The fact patterns behind each count are complex, but the key elements are summarised below. The Statement of Fact is hard to understand, also, because the names of individuals have been removed, so as not to prejudice criminal proceedings, with reference only to "employees" and "senior employees". The judge was, however, aware of the more detailed position of each individual involved.

Indonesia

Count 1 alleged that senior employees of Rolls Royce agreed to pay $2.25m and give a Silver Sprint to an intermediary (or a company the individual controlled), which may have been a reward for Rolls Royce being shown favour in respect of a contract for engines for 6 Airbuses when the intermediary acted as an agent of the President's office. The agreement with the intermediary, which was owned by a close relative of the Indonesian President, provided for a commission of 5% on the price of new engines and spares.  Rolls Royce's "regional intermediary" would receive 2% of the value of the business one via this intermediary, and additional commission for introducing another intermediary, who was a former commander of the Indonesian Air Force. The first intermediary received a payment of 25% of the commission expected on an anticipated deal. At that time it had not signed a contract, and the payment was to be recovered from other commissions due if the deal did not materialise. The payment was authorised and was intended to secure the intermediary's commitment to a deal on the Airbus engines. Further payments were made two years later, when Rolls Royce believed the deal was imminent. At this stage, the car was also delivered, with an internal memorandum noting the intermediary could be obstructive to future military business, and that, although the car had not been promised, a memo said that "in one way or another, we are going to have to deliver, and recover the costs as best we can". 5 years later an internal memo sent to a senior Rolls Royce employee noted the commissions that had been paid, while no engine deliveries had taken place. Eventually, the deal was done, but with fewer aircraft than anticipated.

Count 8 also related to Indonesia, and was the first of the "failure to prevent bribery" allegations. In 2007, Rolls Royce had appointed an intermediary to pay commission to a member of a competitor consortium on a bid to ensure the competitor submitted an uncompetitive bid in the Energy sector. There was also an inference the intermediary agreed to pay individuals within the state-owned company which was the customer. The intermediary received regular commission payments, so the Bribery Act allegations relate to those made after July 2011. The payments had continued even after Rolls Royce internal compliance had raised queries and concerns that had gone unanswered.

Count 10 was a further "failure to prevent bribery" allegation, this time in the Civil sector. Rolls Royce had appointed an intermediary in respect of contracts relating to airline engines and care packages. Despite some employees being aware of evidence that the intermediary had bribed state officials, Rolls Royce did not terminate its relationship with the intermediary until March 2012, a month in which it had already paid over $1m in commission. The intermediary relationship had come about because of a need to "screen off" intermediary relationships that were a liability – and the intermediary referred to in count 1 fell into this bucket. So a new intermediary was appointed, but this intermediary had been the managing director of a "liability" intermediary, and the Rolls Royce regional intermediary had strongly suggested a relationship with him should be continued.  There was clear evidence from 2009 of the bribes being paid, and evidence that at least one Rolls Royce employee had expressed concern that they were unethical. In 2010, Rolls Royce reclassified the intermediary as "high risk", and held a meeting with it to discuss its probity. The draft report of the meeting was altered before it was finalised, and employees who had known about the previous payments sought to explain them. Rolls Royce's legal and compliance functions continued to raise queries, and were told there was a risk of a key deal falling through if the intermediary was not used. A compliance employee raised further queries when the contract was renewed. Finally in February 2012, the SFO contacted Rolls Royce, asking for information in relation to allegations of corruption a former employee had made. Following further investigations, and significant opposition to Compliance requests, the relationship was terminated, but there was only belated recognition of the need to stop payments. 

Thailand

The Thai allegations related to three separate orders. On Count 2, it was alleged that Rolls Royce agreed to pay nearly $19 million to the regional intermediary and another intermediary, with the intention that a proportion of the payment would go to state agents and Thai Airways employees with the result that they would act in the company's favour in respect of a purchase of engines by Thai Airways. Various memoranda recorded the arrangements, using words like "demand", "success fee" and "additional requests". One particular memorandum stated that $8m was the extent of the demands, arranged for it to be paid to an intermediary, and the employee who drafted the memo recommended that all copies should be destroyed and only the original note retained. The intermediary was receiving increasing sums of money as contracts were awarded in addition to the fixed sum and, at one point, an internal memo encouraged prompt payment of some outstanding commission "as a prompt payment could have an influence…." on the thinking of a senior Thai official. Various other payments were made both to that intermediary and the regional intermediary to placate unhappy contacts who felt short-changed. Counts 3 and 4 involved the same intermediaries, in relation to different orders, mainly following those that Count 2 related to. Further notes were discovered attempting to justify why certain payments were made. One note referred to "managing the political process". The evidence relating to Count 4 also indicated significant pressure from the Regional Intermediary to increase commission to levels above Rolls Royce's policy limits, and showed clear concern by some Rolls Royce staff about the amounts in question.

India

Counts 5 and 6 related to false accounting and conspiracy to corrupt. In relation to count 5, the Indian authorities had restricted the use of intermediaries in connection with government contracts, saying that if they were used, the principal must register all intermediaries together with details of all their arrangements with them, including commissions paid. The terms of some contracts contained undertakings by Rolls Royce that they had not used intermediaries. However, Rolls Royce continued to use one intermediary, and created contractual documents saying the intermediary was being paid for general consultancy services rather than as commissions due on the relevant contracts (which was in fact the case). In relation to count 6, Rolls Royce paid the same intermediary to retrieve a list of intermediaries the Indian tax authorities had obtained – again using a contract that did not properly record the reason for the payments. There was also an inference that the retrieval of the list and the prevention of further investigations involved a payment to a tax official. Discussions within Rolls Royce headquarters once the tax authorities had started to make requests made it clear some employees were suspicious of the actual purpose of the contacts and the possibility Rolls Royce had breached its undertakings. Even after the investigation was "resolved", and the company said it would stick strictly to regulatory requirements, further contracts again indicated the payment of commission while not evidencing it as such on the company books.

Russia

Count 7 related to a contract to support Gazprom with gas compression equipment. A Gazprom official had requested payment in exchange for influence in the relevant Rolls Royce company's favour. The company provided a Russian intermediary with commission, and the inference is that some of this was destined for the Russian official. One email from a Rolls Royce employee referred to the fact that "I do not want to see any of this stuff appearing in an email in future…".

Nigeria

Count 9 was the second "failure to prevent bribery" allegation. It related to Rolls Royce's failure to prevent a company with which it worked in Nigeria from paying bribes to Nigerian officials in a bid to help the company win two key tenders. Ultimately, it withdrew from the first for reasons unrelated to the bribes, and then from the second after concerns were raised internally about the receipt of confidential competitor information. Rolls Royce had initially classed the company as a customer, which allowed it to earn mark-ups on business far greater than the amounts it would have been allowed to earn on commission under Rolls Royce's policies, and subsequently the two entities entered into a distribution agreement. There were several emails that made the purpose and nature of the payments the Nigerian company made clear. There was evidence that Rolls Royce had carried out some due diligence on the Nigerian company, but it was ineffective and did not detect the corrupt relationship between it and the public entity which oversaw the bidding process. A review by external consultants had suggested the company was a suitable agent, or at least more suitable than other local companies. However, a number of other concerns were raised internally, culminating in the meeting of the Rolls Royce Higher Risk Committee. It was clear from the meeting minutes that the discussions were insufficient, and ultimately the company was approved as a distributor. 

China

Count 11 was a further count of failure to prevent bribery in relation to Civil business in China. Rolls Royce failed to prevent its employees from providing $5m cash credit to China Eastern Airlines (CES) at the request of a board member, in return for him favouring the company in the purchase of a number of engines and associated care agreements. The intention was to use some of the money for employees to attend an MBA course in New York, with lavish accommodation and leisure activities. The request also included a payment into a pilots' healthcare fund. In the run up to the signing of the agreement, Rolls Royce compliance employees became aware of what they were supposed to be funding and raised significant concerns. A US law firm was engaged to advice on potential liability under the US FCPA, and advised the risk was significant. Rolls Royce decided to convert the credit to cash, using a side letter, and the cash could be used to pay the "study" amounts. Rolls Royce compliance advised that this would only increase the risk. The discussions continued, and the company took further legal advice, which was not to proceed as planned, and not to provide the same benefits in another way or through a disguised account. When further details of the proposed "study" became available, the Rolls Royce compliance employee clearly catalogued the elements that were not acceptable. CES was informed of what Rolls Royce would pay for and was not happy. It summoned a Rolls Royce employee to a meeting, the upshot of which was a further attempt to structure the payments. Compliance continued to resist, ultimately apologising for the "relationship death spiral" this had become but asking how the customer had come to have these expectations in the first place. Eventually, Rolls Royce offered the amount in case, despite this being the least preferred option of its legal team. Thereafter compliance appear to have been largely excluded from the facts of the payments, and the company tried to distance itself from the study trip.

Malaysia

Count 12 was also a failure to prevent bribery charge, again in relation to Civil. This time it was alleged Rolls Royce failed to prevent its employees from providing an Air Asia Group (AAG) executive with credits worth $3.2m to pay for the maintenance of a private jet, despite suspecting the executive intended to perform a relevant function improperly. The executive had asked for the payment in return for showing favour towards Rolls Royce in the purchase of its products and services. Immediately after the executive had made the request, and been "offended" at the price quoted, the compliance department explained the company could not give him a preferential rate just because of past business with the executive's employer. Eventually, it was suggested that maybe a discount could be offered with funds transferred to an AAG subsidiary. The executive at first appeared to agree and then demanded a 50% buy-in fee discount and ultimately to "hide" the deal within care package charges for the subsidiary company. Rolls Royce developed a plan to provide $2m credits to the subsidiary for it to spend as it wished. It put the proposal, but none of the background, to the compliance team. Legal and compliance agreed the proposal. But the shape of the deal changed, and the subsidiary's senior employee reacted badly to the altered proposal and when a Rolls Royce employee raised the issue of debt payment. The Rolls Royce employee emailed a superior to note the request for a cash payment that was off the record and not visible to the group. He said it was not ABC compliant and that he would rather not be on the account. When the subsidiary employee emailed Rolls Royce to complain about the Rolls Royce employee, the employee again explained that the payment being sought was unlawful cash payment for the AAG executive's private jet. The Rolls Royce employee was removed from the account for two months. Finally, the agreement was approved again by compliance, who agreed to use of credits on the basis the relevant documents were delivered "in the normal manner",.The documents were unclear as to how the credits would be used, but there was expectation within Rolls Royce that the value of the notes would be applied to the vehicle through which the jet was owned. This happened, and they were redeemed within the Rolls Royce Civil business unit, which used the funds to cover the cost of the jet entering the corporate care programme.

How the investigation started

In 2012, SFO asked the Rolls Royce group for information resulting from internet postings that raised concerns about its Civil business in China and Indonesia. This request led to significant investigations by the Group, and reports to SFO relating to these issues and also other issues in Civil and Defence.

The huge investigation which resulted from the request, from the perspective of both Rolls Royce and the SFO, has led to the review of over 30 million documents. Sir Brian Leveson was at pains to comment throughout his judgement that SFO received an "extraordinary" level of co-operation from Rolls Royce, and that its proactive method of co-operating meant SFO received some information which may not otherwise have come to light. It also provided information that may have been subject to privilege, and without requiring SFO to resort to compulsory powers to acquire it. The previous DPAs were granted, at least in part, because the companies involved took a pro-active approach to self-reporting to SFO before SFO was aware of the concerns. It is because of the help Rolls Royce gave that it was suggested, and the judge agreed, to treat it the same way as a self-report in considering whether to accede to the DPA request.

The judge looked at whether it is in the interests of justice to agree a DPA. He started with the relatively simple fact pattern of the Standard Bank case: there was one failure, in relation to which there was no suggestion the UK bank was complicit in the corruption involved. Then, in the case of XYZ Ltd, there was systematic offer and payment of bribes to secure contracts overseas. Now, Rolls Royce presented even more extensive systemic bribery, and several aggravating features, not least the spread of offences, the persistent conduct over 24 years, the amounts involved, the evidence of careful planning, and the conduct involving senior employees. On the face of it, there had to be very strong public interest factors, and availability of appropriate measures outside of a prosecution, to make a DPA appropriate. 

The court looked at the countervailing considerations, and considered:

  • From the moment the SFO started to ask questions, Rolls Royce could not have co-operated more
  • There had been no prior conduct to implicate Rolls Royce in corruption allegations, although the existence of the Brazilian and US authorities
  • Corporate compliance, and the fact that, since the events that led to the investigation, the company has appointed an external expert to review its procedures and act as a quasi-monitor of it, and has taken significant steps to enhance its ethics and compliance procedures. The independence of the compliance function and an improved due diligence process for intermediaries were also noted. The company also reviewed 250 intermediary relationships, and, as a result, suspended 88. Finally, it has taken disciplinary action against 38 employees. The judge said he accepted that Rolls Royce could not have done more to address the issues that were exposed
  • Change in culture and personnel, and the fact that the judge was informed that no current member of the Board was involved in any of the conduct described in the Statement of Facts
  • The impact of prosecution. A prosecution would have affected the ability of the company to trade in many jurisdictions which have public sector procurement rules that would have debarred the company following conviction. It could have affected up to 30% of its business, and short-term debarment could easily lead to long term exclusion from contracts. In turn this could have very negative share price impact, potentially going to viability. Additionally, there could be significant third party impacts, including an adverse effect on the UK defence industry and consequential effects on the supply chain, leading to possible significant redundancies and weakening of the company's financial covenant for pensions. The judge was keen to point out the decision on whether to allow a DPA should not be, and was not, affected by the national economic interest or any suggestion that because Rolls Royce is Rolls Royce it is exempt from prosecution
  • The costs to SFO and the calls on the court of proceeding to prosecution
  • That a DPA would be likely to incentivise self-reporting from organisations in a similar position to Rolls Royce.

The judge commented that his reaction was that if this did not lead to a prosecution, then it was difficult to see when any company would be prosecuted. He noted particularly that the purpose of the procurement rules is to discourage corruption and so this should not be circumvented. However, he accepted Rolls Royce is no longer the company that it once was. Finally, he noted that as a company, Rolls Royce could only ever be fined, and that the DPA would be approached on the basis that a comparable sanction to what a court would have imposed on prosecution should follow. On the whole, then, he decided it was in the interests of justice to proceed with a DPA subject of course to its terms being fair, reasonable and proportionate.

The terms of the DPA

So the terms of the DPA were decided. They are:

  • Co-operation with authorities in all matters relating to the conduct arising out of the circumstances of the draft indictment
  • Disgorgement of profit of over £258m
  • Payment of a financial penalty of over £239m
  • Payment of SFO's costs (nearly £13m)
  • Completing, at its own expense, a compliance programme following the recommendations of Lord Gold (estimated to cost around £15m).

The court noted that these costs, together with the US, Brazilian and other related costs, would exceed half a billion pounds sterling. The US DPA additionally required payment of nearly $170m, and the Brazilian leniency agreement around $25.5m.

The judgment contains interesting details on how the judge set the penalty amounts, especially in terms of the culpability ratio. There was a discussion on how to apply the multipliers in respect of each count, how to view the totality of the offences, and the extent to which mitigation could reduce the figure. After all that, and prior to any discount, the penalty amount was over £478m.

The judge then turned to the matter of the discount. He noted that, in the XYZ case, the discount was set at 50%, not least to encourage others on how to conduct themselves when confronting criminality. Noting Rolls Royce's willingness to co-operate, and its identification of other conduct which might be capable of resolution using a DPA, the judge felt a 50% discount was appropriate here also.

Judge's final observations

In closing, the judge observed that it was not possible to compare the UK fine with the US one, as the facts and the extent of criminality make it difficult to do so. He also stressed the DPA does not cover conduct that was not disclosed by Rolls Royce before the date on which the DPA took effect, although SFO has assured Rolls Royce it would not consider it in the interests of justice to investigate or prosecute any additional conduct pre-dating the DPA in relation to the ongoing investigations into Airbus and Unaoil.

What do we take from the DPA?

Reading the papers SFO has published relating to this DPA is not an easy task.  The judge's "summary" of the 12 counts levied against Rolls Royce runs to 162 paragraphs. Much of the detail is hard to understand for those not steeped in how the relevant sectors work. Also, the removal of reference to names, or any status other than "employee" or "senior employee" makes it hard to see precisely where fault lay. However, several points stand out:

  • The Rolls Royce headquarters ABC compliance procedures were weak, especially surrounding intermediaries. During the period in which the various offences took place, they were improved several times, and the lack of clarity on responsibilities often noted. But from the discussion on the matters which gave rise to each count of the allegations, there was little evidence that intermediary payments and contracts were reviewed in an organised fashion
  • In many cases, business relationships seemed to begin on an assumption that bribes would be paid, and the Rolls Royce employees dealing with the relevant contracts or intermediaries did little or nothing to correct this assumption. Then, when it became an issue, there was often pressure to find a way to make the payment, as otherwise a contract or good relationship would be lost
  • Several of the employees involved clearly knew what they were doing was wrong, as the quotes from some of the quoted emails suggest. Others either did not understand what a corrupt payment was, or affected not to, in order to try to convince the compliance and legal teams involved to agree to a solution
  • There were a number of instances in which employees seeking approval to contracts or payments did not provide the compliance team with the correct, or enough, information
  • With a few exceptions, there seemed to be a culture of not asking difficult questions.

It is surprising Rolls Royce did not have the internal procedures in place to see the totality of the problems that were occurring and start its own detailed investigation before prompted to do so by SFO.

It is interesting to see that the judge went to great lengths to assess whether a DPA was appropriate, and ultimately decided it was, despite the fact there had been no self-reporting to start the case off. SFO would obviously wish to encourage total co-operation once it starts an investigation, and to encourage those under investigation to volunteer evidence of further wrongdoing should they discover it. But against, that, as the judge said, it was on the face of it hard to see what would ever justify a full prosecution if this did not.

We have three precedents in terms of section 7 of the Bribery Act, all very different. The Standard Bank case was the first published case, and the first DPA. As the judge mentioned, this related specifically to one transaction, there was no suggestion anyone at Standard Bank knew about the corrupt payments, and it self-reported the problem almost before it was certain there was a problem. The other DPA, in the XYZ case, was based on a very different fact pattern, but it seemed a key in agreeing the DPA was the role and conduct of the company's new owners, who set about making the company compliant and took a significant financial impact of the breaches. Sandwiched between those was the Sweett case. Coming after Standard Bank, the distinction seemed stark – here was clear corruption, where the court saw through the use of an overseas company, saying it was effectively just a branch of the English company – and no self-reporting. It seemed reasonable that this should be a full prosecution, but nothing was published that gave any detail of whether a DPA was ever desired by Sweett or contemplated by SFO, although it appears SFO was unimpressed by the lack of cooperation it received. Looking at the Rolls Royce case in the light of these, it would seem that it is after all possible to get over the fact that an SFO enquiry is the start of an investigation, if, once contacted by SFO, the company goes out of its way to be helpful – and, of course, promptly puts its house in order for the future.

What next?

As the judge noted, this is not the end of the saga for Rolls Royce. There are outstanding prosecutions against individuals, the ongoing compliance with the DPA and the agreements reached with the US and Brazilian authorities, and the possibility of other issues being uncovered. Also, SFO has just announced an investigation into the activities of ABB Ltd's UK subsidiaries in relation to its Unaoil investigations, which it began in July 2016.

We will be watching this space for the results of the next investigation to reach resolution. 

This article was written for Financial Regulation International, an Informa Group