CASE 3.9

Walmart de Mexico

Sam Walton was born on March 29, 1918, in Kingfisher, Oklahoma, a small town 50 miles northwest of Oklahoma City. Sams father, a farmer, struggled to support his family during the Great Depression. The Walton family hopscotched around the country before finally settling in Missouri where Sam graduated from high school. After obtaining a degree in economics from the University of Missouri, Sam went to work as a management trainee with J.C. Penney Company at a monthly salary of $75. Following the outbreak of World War II, Sam enlisted in the U.S. Army and served until 1945.

Upon returning to civilian life, Sam Walton borrowed money from his father-in-law to purchase a small retail store in northern Arkansas. Walton purchased additional stores in Arkansas, Kansas, and Missouri over the following years. In 1962, Walton opened the first store branded as a Wal-Mart in Rogers, Arkansas, 10 miles from Bentonville, which would become the companys corporate headquarters. Walmart expanded its operations across the continental United States over the next three decades. In 1992, the year Sam Walton died, Walmart surpassed Sears to become the largest retailer in the United States.

By 2012, Walmart employed over two million people, making it the worlds largest private employer. In that same year, four members of Sam Waltons family ranked among the top 10 of the Forbes 400, the 400 wealthiest individuals in the United States.1 Those individuals, with a collective wealth of more than $100 billion, included his three surviving children and the widow of his son, John Walton, a former Green Beret who was awarded the Silver Star for heroism during the Vietnam War.

The Lowest Prices Anytime, Anywhere!

Walmarts incredible growth was due to the hypercompetitive business model developed by Sam Walton. The central tenet of Waltons business plan was the motto that he adopted for his company, The Lowest Prices Anytime, Anywhere! Walton reasoned that if he undercut the prices charged by his competitors, his company would generate sufficient sales volume to realize significant economies of scale. The most important of those economies of scale would be purchasing merchandise in bulk quantities at discounted wholesale prices that were not available to other retailers.

Waltons simple business plan worked to perfection as Walmart routinely dominated the geographical markets that it entered. The ultimate result of Walmarts alleged predatory business model was to drive large numbers of small retailers, including pharmacies, groceries, and general merchandise stores, out of business. In an op-ed piece written for the New York Times, Robert Reich, former Secretary of the U.S. Department of Labor, observed that Walmart Turns main streets into ghost towns by sucking business away from small retailers.2

In the early 1990s, Walmart became an international company when it opened retail outlets in Mexico and Canada. After replicating its successful business model in those countries, Walmart extended its operations outside of North America. Within two decades, approximately one-fourth of the companys sales were produced by its 6,000 retail stores in more than two dozen countries scattered around the globe.

To date, Mexico has easily been Walmarts most successful international venture. Walmart quickly seized control of the retail industry in that country by taking away large chunks of a market share previously held by domestic retailers that had operated in the country for decades. By 2012, Walmarts Mexican subsidiary, Walmart de Mexico, was Mexicos largest retailer and that nations largest private employer.

Bribery Allegations

In April 2012, an article published by the New York Times, Vast Mexico Bribery Case Hushed Up by Wal-Mart After Top-Level Struggle, reported that Walmart had routinely bribed government officials to obtain building permits and other business licenses required by Mexican law. A former Walmart de Mexico officer testified that the bribes allowed the Mexican subsidiary to build hundreds of new stores so fast that competitors would not have time to react.3 The Pulitzer Prize-winning article in the New York Times, which was the culmination of an 18-month long investigation, insisted that the bribes violated the Foreign Corrupt Practices Act of 1977 (FCPA). The article also accused Walmarts senior management of concealing those bribes from U.S. law enforcement authorities.

Walmarts senior executives learned of the bribes being paid by their companys Mexican subsidiary in late 2005 and immediately launched an investigation. Wal- Mart dispatched investigators to Mexico City, and within days they unearthed evidence of widespread bribery. . . . They also found documents showing that Wal-Mart de Mexicos top executives not only knew about the payments but had taken steps to conceal them from Wal-Marts headquarters in Bentonville, Ark.4

Following the discovery of the bribes, Walmarts senior executives disagreed on how to address the problem. The New York Times article reported that Walmarts management ultimately decided to resolve the matter quietly and internally. That goal was achieved by placing the Walmart de Mexico executive who had allegedly authorized the bribes in charge of the ongoing investigation of them. The investigation ended shortly thereafter. The subsequent internal report noted that There is no clear evidence or clear indication of bribes paid to Mexican government authorities with the purpose of wrongfully securing any licenses or permits.5

The former FBI agent who served as Walmarts director of corporate investigations found the internal report inadequate. The report was nonetheless accepted by Wal- Marts leaders as the last word on the matter.6 Walmarts senior executives informed the U.S. Department of Justice that their company may have violated the FCPA only after they had learned of the ongoing investigation by the New York Times.

The author of the New York Times article charged that Walmarts relentless pursuit of growth had compromised its commitment to the highest moral and ethical standards.7 A follow-up article in the New York Times in December 2012, How Wal-Mart Used Payoffs to Get Its Way in Mexico, described the methods used by

Walmart de Mexico to gain an unfair advantage over its competitors. That article also dismissed the suggestion that Walmart was a victim of a corrupt business culture in Mexico that obligated companies to bribe governmental officials.

The Times investigation reveals that Wal-Mart de Mexico was not the reluctant victim of a corrupt culture that insisted on bribes as the cost of doing business. Nor did it pay bribes merely to speed up routine approvals. Rather, Wal-Mart de Mexico was an aggressive and creative corrupter, offering large payoffs to get what the law other-wise prohibited. It used bribes to subvert democratic governancepublic votes, open debates, transparent procedures. It used bribes to circumvent regulatory safeguards that protect Mexican citizens from unsafe construction. It used bribes to outflank rivals. 8

After reporting the potential FCPA violations to the U.S. Department of Justice in December 2011, Walmart instructed its audit committee to use all resources necessary to aggressively investigate the companys FCPA compliance not only in Mexico but worldwide. The audit committee hired KPMG and a major law firm to assist in the forensic investigation.10 Walmarts board also created a network of international FCPA compliance directors that would report to a Bentonville-based Global FCPA Compliance Officer. In an April 2012 press release that addressed the bribery allegations made by the New York Times, Walmart officials declared that We will not tolerate non-compliance with the FCPA anywhere or at any level of the company.11

Since 2012, Walmart officials have discussed the status of the ongoing internal and external FCPA investigations in their companys periodic registration statements filed with the SEC. Those disclosures have consistently warned the investing and lending community that it is probable that Walmart will eventually incur a loss stemming from the alleged FCPA violations but that the amount of the loss can- not be reasonably estimated. Nevertheless, company management reports that the expected loss is unlikely to have a material adverse effect on Walmarts operations. The company also regularly discloses the cumulative cost that it has incurred in connection with its internal FCPA investigation. By early 2016, that figure had topped $600 million. Finally, the companys interim reports on the FCPA matter reveal that potential FCPA violations have been uncovered within the companys operations in countries other than Mexico, including Brazil, China, and India.

There has been widespread speculation in the business press concerning the ultimate outcome of the joint SEC and U.S. Department of Justice investigation of Walmarts alleged FCPA violations. Much of that speculation has focused on the magnitude of the monetary fines the federal agencies might levy on Walmart. Many observers believe that those fines could surpass the $450 million in FCPA-related fines imposed on the German engineering and electronics firm Siemens AG in 2008.

The FCPA: From Watergate to Walmartgate

Walmarts widely publicized FCPA problems refocused attention on the origins and nature of that federal statute. The FCPA was a by-product of the scandal-ridden Watergate era of the 1970s. During the Watergate investigations, the Office of the Special Prosecutor uncovered large bribes, kickbacks, and other payments made by U.S. corporations to officials of foreign governments to initiate or maintain business relationships.

Widespread public disapproval compelled Congress to pass the FCPA, which criminalizes most such payments.12 The FCPA also requires U.S. companies to maintain internal control systems that provide reasonable assurance of discovering improper foreign payments. In a 1997 Accounting and Auditing Enforcement Release, the Securities and Exchange Commission (SEC) highlighted the importance and need for the accounting and internal control requirements embedded in the FCPA.

The accounting provisions [of the FCPA] were enacted by Congress along with the anti-bribery provisions because Congress concluded that almost all bribery of foreign officials by American companies was covered up in the corporations books and that the requirement for accurate records and adequate internal controls would deter bribery.13

In the two decades following the passage of the FCPA, the SEC seldom charged U.S. companies with violating its provisions. In fact, in 1997 when the SEC filed FCPA- related charges against Triton Energy Ltd., an international oil and gas exploration company, more than 10 years had elapsed since the federal agencys prior FCPA case. At the time, the SEC conceded that the filing of the FCPA charges against Triton Energy was intended to send a message to U.S. companies that its not O.K. to pay bribes as long as you dont get caught.14 At the same time, an SEC spokesperson predicted that his agency would be filing considerably more FCPA charges in the future.15

The SEC was true to its word. By 2015, the SEC was investigating potential FCPA violations by 74 public companies. Those companies included such prominent firms as Bristol-Myers Squibb, Cisco Systems, Halliburton, United Technologies, and Wynn Resorts. The World Bank has reinforced the need for the SEC and other global law enforcement agencies to rein in corporate bribery since it estimates that more than $1 trillion in bribes are paid annually in the U.S. alone.16

The FCPA is not without its critics. Many corporate executives have complained that the federal statute places U.S. multinational companies at a significant competitive disadvantage to multinational firms based in countries that have do not have a comparable law. Those same executives also find the recent overzealousness in prosecuting alleged FCPA violators inappropriate. We are seeing companies getting scooped up in aggressive enforcement actions and investigations. A culture of overzealousness has grabbed the Justice Department. The last time I checked, we were not living in a police state.17 In response to that complaint, a representative of the U.S. Department of Justice observed, This is not the time for the United States to be condoning corruption. We are a world leader and we want to do everything to make sure that business is less corrupt, not more.18

To date, the FCPA has not had a significant impact on the auditors of SEC registrants. An audit firm has been named in only one FCPA complaint filed by the SEC. In that case, a representative of KPMGs Indonesian affiliate was charged with paying a bribe to a governmental official to reduce the tax bill of its client. The KPMG affiliate settled the charge by agreeing to a cease and desist order but was not fined.19 As the FCPA complaint against Walmart unfolded, a reporter for the Reuters international news service noted that it was unlikely that Ernst & Young, Walmarts longtime auditor, would become a target of that investigation.

In fact, the FCPA has created a new revenue stream for the major accounting firms that serve as the auditors of most SEC registrants. For example, Deloittes website lists Foreign Corrupt Practices Act Consulting as an ancillary service that it provides to public companies.

Our Foreign Corrupt Practices Act (FCPA) Consulting practice helps organizations navigate FCPA risk and respond to potential violations. Utilizing the network of Deloitte member firms and their affiliates including their forensic resources in the United States, Canada, Europe, Russia, Africa, Latin America, and Asia, we have worked on a variety of FCPA engagements including investigations, acquisition due diligence, and compliance program implementation and assessments in over fifty countries for some of the world's leading companies

1. Identify control activities that Walmart could have implemented for Walmart de Mexico and its other foreign subsidiaries to minimize the likelihood of illegal payments to government officials. Would these control activities have been cost-effective?

2. What responsibility, if any, does an accountant of a public company have when he or she discovers that the client has violated a law? How does the accountants position on the companys employment hierarchy affect that responsibility, if at all? What responsibility does an auditor of a public company have if he or she discovers illegal acts by the client? Does the auditors position on his or her firms employment hierarchy affect this responsibility?

3. Does an audit firm of an SEC registrant have a responsibility to apply audit procedures intended to determine whether the client has complied with the FCPA? Defend your answer.

4. If the citizens of certain foreign countries believe that the payment of bribes is an acceptable business practice, is it appropriate for U.S. companies to challenge that belief when doing business in those countries? Defend your answer.