Energy Reform in Mexico Puts Spotlight on Corruption Risks

For the first time in 75 years, Mexico has opened up its energy market to the private sector and to foreign companies. U.S. oil and gas companies looking to enter this new market, however, will need to take steps to reduce their corruption and bribery risks even before signing the first contract.

Mexico’s Congress passed long-awaited comprehensive energy reform last December and amended Mexico’s constitution to end the country’s state-owned energy monopoly held since 1938 by oil company Pemex. The reforms required the passage of secondary laws necessary for their implementation, which President Enrique Pena Nieto signed last month.

Passage of the legislation means that private companies—both foreign and domestic—will soon be allowed to invest in all energy activities in the country. “But those opportunities come with a high degree of corruption risk, because Mexico is an emerging market,” Joan Meyer, a partner with law firm Baker & McKenzie, says.

Under the new system, Mexico’s National Hydrocarbons Commission (CNH) may designate specific production activities to state-run entities, such as Pemex, or enter into contractual arrangements with private parties to carry out specified exploration and production activities in a stated territory. Unlike with state-run entities, contractual arrangements with private parties will be awarded through a public bidding process overseen by CNH.

Although Pemex will continue to remain an important player in Mexico’s energy sector, central authority has moved into the hands of regulators, explains Fernando Cano-Lasa, formerly in-house counsel for Pemex, and now of counsel at law firm Squire Patton Boggs. “Regulators now have full autonomy to make decisions in regards to the industry,” he says. “They can now act, and are required to act, in the benefit of the industry, and not for the benefit of a certain company or entity.”

That’s good news for U.S. oil and gas companies that want to do business in Mexico, but they will have to be on high alert for bribery and corruption. Any business that regularly interacts with foreign government officials is susceptible to bribery and corruption risks. Those risks are exponentially greater, though, when entering an unfamiliar market. Add to that Mexico’s long history of corruption, and the risk of a Foreign Corrupt Practices Act violation in the energy sector is even more elevated.

Southern Exposure

Corruption watchdog Transparency International puts Mexico among the most corrupt economies in the world, scoring the country 34 out of a possible 100 in its 2013 Corruption Perceptions Index. Mexico ranks 106th out of 175 countries in the Index.

“Regulators now have full autonomy to make decisions in regards to the industry. They can now act, and are required to act, in the benefit of the industry, and not for the benefit of a certain company or entity.”
Fernando Cano-Lasa, Of Counsel, Squire Patton Boggs

As reflected by a handful of criminal enforcement actions in recent years, Mexico’s energy market, in particular, is no stranger to anti-corruption enforcement by U.S. enforcement authorities. According to analysis conducted by the Mintz Group, out of 17 Mexican companies across eight sectors that faced an enforcement action for violations of the FCPA since the law was enacted, ten were in the energy sector.

In one of the larger settlements, energy company ABB paid $60 million in 2010 to the Department of Justice and Securities and Exchange Commission for paying bribes from 1997 to 2004 to officials at Comisión Federal de Electricidad, a Mexican state-owned utility company, in exchange for contracts. Other energy companies that have settled FCPA charges from actions in Mexico include Pride International, Siemens, and Paradigm Group.

Bribery and corruption risks in Mexico have not been limited to just the energy sector. According to the Mintz Group analysis, non-energy companies that have faced an FCPA enforcement action in Mexico include Tyson Foods, BizJet International, Orthofix, Bridgestone, Lindsey Manufacturing, and more.

In a more recent example, Hewlett-Packard reached a $108 million settlement with the SEC in April 2014 to resolve charges that H-P’s subsidiaries in three different countries, including Mexico, made improper payments to government officials to obtain or retain lucrative public contracts in violation of the FCPA. Mexico paid a consultant to help the company win a public IT contract worth approximately $6 million. At least $125,000 was funneled to a government official at the state-owned petroleum company with whom the consultant had connections.

The poster child of them all, though—Walmart—highlights just how expensive an FCPA investigation can run. To date, the retail giant has spent in excess of $400 million in total costs for fiscal years 2013 and 2014 for compliance enhancements and investigation costs related to possible FCPA violations resulting from allegations that executives at Walmart’s Mexico unit bribed Mexican officials to open stores in prime locations.

Due Diligencia

Any company wanting to do business in Mexico will need to enlist the help of third parties to help facilitate the process, advises anti-corruption experts. But even that heightens FCPA risks.

Thus, companies should undertake a comprehensive risk assessment before entering Mexico, particularly as it applies to the energy market, by being able to answer the following questions:

Who will be your third-party business partners in Mexico? 

What expertise and services will those third parties be providing? 

Who on the ground will have contact with foreign government officials or state-owned entities? 

Perform adequate due diligence on any potential local hires, business partners, agents, and third parties before engaging them, or entering into any contracts. “Due diligence is a vital component of any compliance program as these new opportunities open in Mexico,” Meyer says.

FCPA CASE SPECIFICS

Below, Walmart explains its actions in regard to the Mexico FCPA investigation.
The Audit Committee of our Board of Directors, which is composed solely of independent directors, is conducting an internal investigation into, among other things, alleged violations of the Foreign Corrupt Practices Act and other alleged crimes or misconduct in connection with certain of our foreign subsidiaries, including Wal-Mart de México, S.A.B. de C.V., or Walmex, and whether we appropriately handled prior allegations of such violations and/or misconduct. We are also conducting a voluntary global review of our policies, practices and internal controls for FCPA compliance and strengthening our global anti-corruption compliance programs. Since the implementation of the global review and enhanced anti-corruption compliance programs, the audit committee and we have identified or been made aware of additional allegations regarding potential violations of the FCPA. Inquiries or investigations regarding allegations of potential FCPA violations have been commenced in a number of foreign markets in which we operate, including, but not limited to, Brazil, China, and India. In November 2011, we voluntarily disclosed our investigative activity to the U.S. Department of Justice and the SEC, and we have been informed by the DoJ and the SEC that we are the subject of their respective investigations into possible violations of the FCPA. A number of federal and local government agencies in Mexico have also initiated investigations of these matters. Furthermore, lawsuits relating to the matters under investigation have been filed by several of our shareholders against us, certain of our current and former directors and officers and certain of Walmex’s current and former officers.
We could be exposed to a variety of negative consequences as a result of these matters. One or more enforcement actions could be instituted in respect of the matters that are the subject of some or all of the on-going government investigations, and such actions, if brought, may result in judgments, settlements, fines, penalties, injunctions, cease and desist orders, debarment or other relief, criminal convictions and/or penalties. The existing and any additional shareholder lawsuits may result in judgments against us and our current and former directors and officers named in those proceedings. We cannot predict at this time the outcome or impact of the government investigations, the shareholder lawsuits, or our own internal investigations and review. Moreover, we expect to continue to incur costs (incremental to the $282 million of costs incurred in fiscal 2014) in conducting our on-going review and investigations and in responding to requests for information or subpoenas seeking documents, testimony, and other information in connection with the government investigations and in defending the existing and any additional shareholder lawsuits and any governmental proceedings that are instituted against us or any of our current or former officers. These matters may require the involvement of certain members of our senior management that could impinge on the time they have available to devote to other matters relating to our business. We also expect that there will be ongoing media and governmental interest, including additional news articles from media publications on these matters that could impact the perception of our role as a corporate citizen among certain audiences. Our process of assessing and responding to the governmental investigations and the shareholder lawsuits continues. While we believe that it is probable that we will incur a loss from these matters, given the on-going nature and complexity of the review, inquiries and investigations, we cannot reasonably estimate any loss or range of loss that may arise from these matters. Although we do not presently believe that these matters will have a material adverse affect on our business, given the inherent uncertainties in such situations, we can provide no assurance that these matters will not be material to our business in the future.
Source: Walmart.

Potential red flags include a third party that:

States or describes services for which it lacks the capacity to perform;

Is not being transparent in its interactions with government officials;

Demands methods of payment through companies that seem like sham companies or have dubious origins; or

Have relationships with government officials responsible for the contracting or regulatory process.

Under Mexico’s energy reform, all major agreements for upstream, midstream, and downstream activities will be made publicly available through the Ministry of Energy and CNH. Companies doing business in Mexico have a lot of public information available to them that, if they know where to look, can be used as an important tool to determine whether a particular request made for a payment is proper or not, Cano-Lasa says.

“From an FCPA point-of-view, the more that Mexico can make its process transparent, the more you reduce the risk of corruption,” says Rebekah Poston, former assistant U.S. attorney in Florida and now a partner with Squire Patton Boggs.

Audit activities and records related to any new contracts won in Mexico, particularly in the energy market, and be mindful of any excessive, or unusual, payment terms being required by third parties. “Pay special attention to how payments are being processed, or invoiced,” Meyer says.

Require companies or individuals working on the company’s behalf to certify compliance with the FCPA and other applicable anti-bribery laws on a periodic basis. “Monitor compliance with those policies,” Poston says.

Companies should provide anti-corruption training to any employees, consultants, agents, or other third parties acting on the company’s behalf who regularly interact with foreign government officials, and that training should be tailored to job function, Meyer advises. In addition, the company’s anti-corruption policies and training should be made available in both Spanish and English, she says.

Furthermore, employees should be trained on how to spot red flags, advises Meyer. This is particularly true of employees who interact with agents or business partners on a day-to-day basis, or who process or audit invoices locally, she says. All red flags should be promptly investigated and remediated.

Anti-Corruption Strides

On the surface, Mexico appears to be making strides with its anti-corruption efforts. In 2012, it passed the Federal Law Against Corruption in Public Procurement, which prohibits the offering of money or gifts by individuals or companies with respect to obtaining or maintaining a business advantage in the procurement of public contracts with the Mexican government.

Now that Mexico has reformed its energy market, the law holds even more relevance. “They have a law in place that applies perfectly to these energy reforms,” Poston says. “Now, let’s see if they use it.”

Mexican enforcement authorities, to date, have not brought any enforcement actions under the anti-corruption public procurement law, but some legal experts don’t believe that will be the case for long. “It is a relatively new law,” Meyer says. “It’s going to take awhile for these cases to develop, but I’m sure we’re going to see activity in the next few years.”