Third Party Due Diligence - Know Your Third Party - EY India

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Third party due diligence, forensic data analytics and frequent compliance audits form the basis of a strong monitoring system. For more details, visit http://bit.ly/1RQuEGB.

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Third-party due diligence Key components of an effective risk-based compliance program

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The economic crisis vigorous governmental enforcement activity and the increased focus on enterprise risk are causing global corporations and their audit committees to take a closer look at how they manage and conduct their due diligence around vendor distributor joint venture and customer organizations — defned broadly as third parties. Those with existing due diligence programs are fnding they have not kept up with the increased global risks of third-party vendors — particularly in the areas of anti- bribery and corruption — leaving many companies to wonder what constitutes a reasonable due diligence program and how much research and documentation are enough. We help companies facing this issue and assist them in building compliance programs that aim to address vendor corruption risk. In this paper we share some of the leading practices for building an effective vendor due diligence program and suggest steps that companies could consider to improve their current processes and technologies to address the global regulatory environment. While the discipline around supply chain and vendor management is relatively mature third-party risk from a regulatory management perspective is in its infancy with little guidance available and no standards established. Perhaps this is because most third-party management programs were developed decades ago when the focus of the due diligence tasks were around “operational” and “fnancial” criteria and were typically only done once during the on-boarding process. Operational and fnancial criteria often included verifying that the third-party was in good corporate standing reviewing audited fnancial statements to ensure fnancial stability and perhaps calling upon a few references. Documentation rarely included due diligence activities related to adverse media searches criminal history government sanctions or queries to identify politically exposed individuals. From a regulatory perspective neither the U.S. Department of Justice DOJ nor the U.S. Securities and Exchange Commission SEC provide specifc guidance on the components of an effective third-party due diligence program. However the U.S. Sentencing Commission voted unanimously on April 7 2010 to modify the Federal Sentencing Guidelines for organizations including the provisions that set forth the attributes of an effective compliance and ethics program. The guidelines provide some high-level components that should be integrated into your third-party due diligence and compliance programs. These components which took effect November 1 2010 suggest that management should: 1 Establish standards and procedures to prevent and detect criminal conduct. 2 Be knowledgeable about the content and operation of the program and exercise reasonable oversight with respect to the implementation and effectiveness of the compliance program. 3 Make reasonable efforts not to include within the substantial authority personnel of the organization any individual whom the organization knew or should have known through the exercise of due diligence or has engaged in illegal activities or other conduct inconsistent with an effective compliance and ethics program. 4 Take steps to communicate the program’s standards and procedures throughout the organization and provide training tailored for various audiences. 5 Take reasonable steps to ensure that the program is followed including monitoring and auditing to detect criminal conduct periodically evaluating the program’s effectiveness and publicizing a system that allows reporting potential and actual criminal conduct without fear of retaliation. 6 Consistently promote and enforce the program with appropriate incentives for proper performance and appropriate disciplinary measures for those who engage in criminal conduct or fail to take reasonable steps to prevent or detect it. 7 Take reasonable steps to respond appropriately to criminal conduct when detected and prevent further similar criminal conduct including making any necessary changes to the program. “Third-party due diligence must be robust thorough impeccably documented and preserved.” — Former U.S. Department of Justice Fraud Section Deputy Chief Mark Mendelsohn 2005–2010 FCPA Conference November 2009 Third-party due diligence 2

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One may also look to the Organisation for Economic Co-operation and Development OECD for its February 18 2010 adoption of “Good Practice Guidance on Internal Controls Ethics and Compliance.” This Good Practice Guidance was adopted by the OECD Council as an integral part of the “Recommendation of the Council for Further Combating Bribery of Foreign Public Offcials in International Business Transactions” dated November 26 2009. The guidance provides for the following leading practices for ensuring effective internal controls ethics and compliance programs or measures for the purpose of preventing and detecting foreign bribery. As it relates to third-party due diligence the guidance includes the following points: • Strong explicit and visible support and commitment from senior management • Ethics and compliance programs or measures designed to prevent and detect foreign bribery applicable where appropriate and subject to contractual arrangements to third parties such as agents and other intermediaries consultants representatives distributors contractors and suppliers consortia and joint venture partners hereinafter “business partners” including among other things the following essential elements: • Properly documented risk-based due diligence pertaining to the hiring as well as the appropriate and regular oversight of business partners • Informing business partners of the company’s commitment to abiding by laws on the prohibitions against foreign bribery and of the company’s ethics and compliance program or measures for preventing and detecting such bribery • Seeking a reciprocal commitment from business partners • Effective measures for: • Providing guidance and advice to directors offcers employees and where appropriate business partners on complying with the company’s ethics and compliance program or measures including when they need urgent advice on diffcult situations in foreign jurisdictions. • Internal and where possible confdential reporting by and protection of directors offcers employees and where appropriate business partners not willing to violate professional standards or ethics under instructions or pressure from hierarchical superiors as well as for directors offcers employees and where appropriate business partners willing to report breaches of the law or professional standards or ethics occurring within the company in good faith and on reasonable grounds. • Undertaking appropriate action in response to such reports. • Periodic reviews of the ethics and compliance programs or measures designed to evaluate and improve their effectiveness in preventing and detecting foreign bribery taking into account relevant developments in the feld and evolving international and industry standards Finally the UK Bribery Act effective July 1 2011 mentions due diligence as one of its six principles for anti-bribery compliance and stresses the importance that companies should focus their third- party due diligence resources using a “risk- based” approach. The Act creates four offenses one of which is failing to prevent bribery which covers the activities of any person or third-party acting on behalf of a business for example employees agents or subsidiaries. “… due diligence procedures should be proportionate to the identifed risk. ‘Due diligence’ … should be conducted using a risk- based approach.” — Bribery Act 2010 Guidance UK Ministry of Justice Key components of an effective risk-based compliance program 3

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Key components of an effective program Taking the existing guidance into consideration four key principles become apparent which serve as a strong frame of reference for incorporating the multiple guidelines and legal rulings previously discussed into an effective global due diligence program. These guidelines are consistency management oversight objectivity and reasonableness. Consistency — Automating the process and developing standard templates for vetting third parties especially overseas will help drive consistency across the company. A robust platform allows a company to effectively and effciently manage a decentralized program. The goals that companies should be to have one system that everyone uses on a consistent basis. Management oversight — It is important that management’s intent and actions provide for a robust third-party due diligence process. Is management doing the best they can based on their perceived risk and limited resources or are they choosing to look the other way Objectivity — Are the due diligence procedures objective and performed separately from the requestor which could contain inherent conficts of interest Each due diligence investigation should be independently performed with its own case fle notifcations investigative fndings remediation actions education and representations between the company and its agent partner distributor third parties and others. Having a defned case management work fow integrating people process and technology can be particularly useful to ensure an objective process. Evaluating your program Questions to ask Consider your current anti-corruption vendor on-boarding process and ask tough questions about consistency management oversight objectivity and reasonableness. Consistency. Is the process followed consistently Can you audit or tie back vendor request forms to each vendor in the vendor master Is there training around the process Is it globally deployed Is the process repeatable — i.e. would you arrive at the same conclusion if you were to run a selection of new vendor setup forms through the same process Are the rules and contract language around FCPA and anti-corruption consistent from country to country Management oversight. When was the last global training program on anti- corruption due diligence or compliance When did you last update your new vendor setup form or procedures Does your company use software tools for case management to manage and document the vendor setup process What database and due diligence steps does accounts payable take to categorize new vendor submissions received from the requestor Is the right person making the decision Once accepted is it rechecked annually or on an ongoing basis During the escalation process who is responsible for making the tough calls How robust is the vendor “vetting report” Does it incorporate public database checks include the offcers of a company and search for “politically exposed persons” adverse media country-specifc sanctions and more Who is made aware of a new vendor once approved — is it communicated to the corporate offce and centrally managed or is it handled and decided by the local offce Objectivity. Given so many decision-makers at the country or subsidiary level can the current process stand up to independence scrutiny from an outside or DOJ perspective For example can the accounts payable clerk processing the original new vendor setup form be forced to designate a form as “low risk” from the requestor in order to avoid additional scrutiny from upper management Reasonableness. Is the process reasonable Does the process generate too much paperwork that may not get reviewed or too little paperwork where rogue third parties or necessary contract terms might be missed Does the process incorporate leading practices including the criteria set forth in the U.S. Sentencing Guidelines and OECD “Put simply the prospect of signifcant prison sentences for individuals should make clear to every corporate executive every board member and every sales agent that we will hold you personally accountable for FCPA violations.” — Assistant Attorney General for the Criminal Division Lanny Breuer Feb. 2010 Third-party due diligence 4

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The supplier vetting activities Approve Total supplier universe Develop supplier category and geographic filtering criteria Develop detailed filtering criteria on supplier relationship and nature of contract Develop supplier vetting protocols to effectively document legal regulatory and reputational risks Develop decision criteria for acceptance denial or specific contract modifications based on risk profile 80000 third parties 10000 moderate risk 1000 high risk 250 negative hits 150 denied Denied Approve with restrictions Geographic filtering will include Transparency International’s Global Corruption Perception’s Index among other criteria. Filtering criteria example: of thousands. Filtering them down to a management population is a critical frst step before deciding which due diligence procedures to conduct as demonstrated by the diagram above. As it relates to actually conducting regulatory related due diligence activities for those higher risk third parties we see the process broken down into three general levels of investigation: Level I: open source background checks Level I analysis includes a comprehensive check of available sanctions and embargo and watch lists. It also includes internet and media search inquires. These searches use open source databases and public information to search a wide range of business journals websites industry publications and mainstream media. When these processes are streamlined through the use of case management software online databases and internet searching a Level I analysis can be accomplished by an investigator in three to fve hours and given its streamlined repeatable nature it is ideal for centralization and perhaps even outsourcing. Reasonableness — Given limited company resources taking a risk-based tiered approach to third-party due diligence helps management to allocate resources accordingly. Reasonableness addresses the question “How much is enough” In your efforts to avoid doing business with the wrong people a prudent and well thought-out process is important. A thoughtful and reasonable compliance program that is risk based is the best preventive strategy for making sure that compliance is both practical and defensible. Taking a risk-based approach The four components described above are predicated on a critical frst step: a credible risk-based assessment of a company’s third parties. Many corporate compliance departments we observe conduct their due diligence programs based on deploying multiple levels of investigation based on the perceived or known risks. Many global corporations have vendor masters and third-party databases spanning in the tens of thousands even the hundreds Level II: enhanced due diligence Based on the Level I analysis Level II analysis involves additional public database searches with a specifc focus on localized public records databases such as court flings. A Level II analysis may also incorporate phone interviews reference checks and research into potentially vulnerable corporate relationships with a deeper dive into public records and media searches. A Level II analysis often requires local country presence to gain access to local records and contacts and typically requires signifcantly more hours between 20 to 40 hours of local in-country investigator time to research and report. Level III: deep dive As the risk level dictates a Level III analysis may be further warranted. This may include on-site inspections interviewing associates in political business and social circles to uncover reputation reviewing corporate civil and criminal documents and validating fnancial records. Key components of an effective risk-based compliance program 5

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Consistency — Management oversight — Objectivity — Reasonableness Business unit risk profile Third party Extreme Moderate Low High Integrated due diligence program insourced or outsourced Vendors agents and consultants Resellers Customers Acquisition targets Robust open source databases Displays negative coverage Possibly displays negative coverage Political affiliations indentified Level I entity analysis No negative coverage Cleared Unrestricted business Restricted business Denied business Business unit Level II entity analysis Unclear Management decision Entity cannot be identified Localized targeted databases Special contract or or Level III entity analysis or or Ernst Young’s open source third-party due diligence methodology y _ Standardized business risk assessment documented. While the rules to getting to an “approval” are always unique to the business the key point of the analysis phase is to centralize and document the process. Depending on the business rules set a third-party may be approved with “unrestricted business” e.g. no issues semi-approved with either specifc contract language or other limiting conditions or denied entirely. Company management plays a key role in decision-making however its burden is reduced as its decisions follow a predictable rules-based methodology in a documented consistent format that reduces ambiguity and helps provide for more “fact-based” decision-making. Recommended next steps Here’s how you can get started on your own assessment. • Ask those tough questions about consistency management oversight objectivity and reasonableness • Evaluate the current process map in the context of Ernst Young’s methodology and conduct a gap analysis • Determine if your company’s best option is to insource or outsource key processes such as Level I and Level II analyses • Develop categorization and decision rules as part of the data-gathering process • Seek assistance from outside advisors and legal resources who are specialists in the areas of third-party due diligence and FCPA Conclusion Today’s global companies should evaluate their current third-party anti-corruption due diligence programs in the context of a risk-based framework that incorporates attributes of consistency management oversight objectivity and reasonableness. The economic crisis recent governmental enforcements and the increased focus on enterprise risk are causing global corporations and their audit committees to take a closer look at how they manage their vendor and customer compliance relations. While several corporations are still grappling with what processes represent an effective due diligence program incorporating the attributes above can go a long way in demonstrating an effective risk-based vetting program. Process examples By incorporating the attributes of consistency management oversight objectivity and reasonableness we have developed a third-party due diligence framework that seeks to provide adequate risk-based categorization appropriate levels of data analysis ongoing monitoring and effective communication. The framework starts with the business unit where adequate training and communication are essential. Business units interact with multiple parties so the framework must be fexible to accommodate vendors resellers customers and acquisition targets. Through standardization and a risk-based set of questions we have worked with companies to develop a standardized business risk assessment that categorizes each third-party into categories such as low moderate high or extreme risk groups. Based on the risk assessment categorization the analysis phase is represented by the integrated due diligence program as set forth in the next phase. Typically the majority of third parties regardless of the categorization are run through a battery of Level I public database checks as previously defned. This starts the case management fle for each third-party where all decisions tests and outputs are centralized and Third-party due diligence 6

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About the authors This paper was written by Steven Kuzma and Vince Walden. Steven is a partner and the leader of Ernst Young LLP’s Corporate Compliance team within its Fraud Investigation Dispute Services practice. He can be reached at steven.kuzmaey.com or + 1 404 817 4280. Vince is a partner in Ernst Young LLP’s Forensic Technology and Discovery Services team. He can be reached at vincent.waldeney.com or + 1 214 754 3941. Steven Kuzma Vince Walden “We recognize the issues of costs to companies to implement robust compliance programs to hire outside counsel to conduct in-depth internal investigations and to forego certain business opportunities that are tainted with corruption. Those costs are signifcant and we are very aware of that fact. The cost of not being FCPA compliant however can be far higher.” — Lanny Breuer Assistant Attorney General Nov. 17 2009 Key components of an effective risk-based compliance program 7

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Ernst Y oung Assurance | T ax | Transactions | Advisory About Ernst Y oung Ernst Y oung is a global leader in assurance tax transaction and advisory services. Worldwide our 141000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people our clients and our wider communities achieve their potential. Ernst Y oung refers to the global organization of member firms of Ernst Y oung Global Limited each of which is a separate legal entity. Ernst Y oung Global Limited a UK company limited by guarantee does not provide services to clients. For more information about our organization please visit www.ey.com. Ernst Y oung LLP is a client-serving member firm of Ernst Y oung Global and of Ernst Y oung Americas operating in the US. About Ernst Young’s Fraud Investigation Dispute Services Dealing with complex issues of fraud regulatory compliance and business disputes can detract from efforts to achieve your company’s potential. Better management of fraud risk and compliance exposure is a critical business priority — no matter the industry sector. With our more than 1000 fraud investigation and dispute professionals around the world we assemble the right multidisciplinary and culturally aligned team to work with you and your legal advisors. And we work to give you the beneft of our broad sector experience our deep subject matter knowledge and the latest insights from our work worldwide. It’s how Ernst Young makes a difference. © 2011 Ernst Y oung LLP . All Rights Reserved. SCORE No. WW0234 This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter reference should be made to the appropriate advisor.

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