Internal Controls: SEC v. Oracle

From the perspective of internal controls and global anti-bribery compliance, the recent complaint arising out of the SEC’s settlement with Oracle Corporation is instructive for attorneys, international lawyers, in-house counsel, accountants, and anyone providing advice to foreign and domestic publicly-held companies listed in the United States or with listed ADRs. Although allegations against Oracle did extend directly to violations of the anti-bribery provisions of the FCPA, the accounting and internal control provisions were specifically implicated.

The SEC alleged that Oracle’s wholly-owned subsidiary in India, Oracle India Private Limited (“Oracle Limited”), “parked” the proceeds of sales to the Indian government.  Transactions were structured so that funds were held by Oracle India’s distributors and, as a result, not reflected on the books of Oracle India.  Then, Oracle India employees would direct its distributor to disburse payments out of these side funds to “vendors”.  Several of the vendors were “storefronts” that did not provide any services.

Although Oracle India was heavily involved in working with the customers in selling the products and services and negotiating the final price, the actual purchase order was placed by customers with Oracle India’s distributor.  The distributor bought the product and services from Oracle India at a lower price and then resold the product and services at the negotiated price with the customer.  The difference in price was set aside in a side fund to pay third parties.  The record-keeping provisions were violated by failing to record and reflect the side funds.  They should have been recorded as a prepaid marketing expenses of Oracle India.

The SEC alleged that Oracle lacked the proper controls to prevent its Oracle India employees from creating and misusing the parked funds.  Moreover, though Oracle was aware that distributor discounts created a margin of cash from which distributors received payments for their services, it failed to audit or compare the distributor’s discount against the customer’s price to ensure that excessive discounts were not being built into the pricing structure.

The SEC also alleged that despite the existence of Oracle policies requiring approvals for payment of marketing expenses, “Oracle failed to seek transparency in or audit third party payments made by distributors on Oracle India’s behalf.  This would have enabled Oracle to check that payments were made to appropriate recipients.”

The resolution of the SEC’s allegations against Oracle demonstrates how loose practices of foreign subsidiaries can expose an issuer to liability regardless of lack of intent or knowledge on the part of their parent company  Nor do violations of the anti-bribery provisions need to be involved.  However, the specific facts of the SEC’s complaint against Oracle suggests a scenario whereby the side fund of the distributors could have been used as a vehicle to make improper inducements to foreign officials.

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