When Corporate Governance Fails - A look into decades of bribery by Rolls Royce

When Corporate Governance Fails
A look into decades of bribery by Rolls-Royce
ESCP Europe: MBA in International Management
Semester 2: London Campus
Ethics & CSR
Group 2
Amina Ndichi
Anna Kouzovleva
Maurizio Fanelli
Nitin Gupta
Oliver Madden

Agenda
INTRODUCTION
TIMELINE
BRIBERY DEFINED & COUNTRY LEGAL
INFRINGEMENTS
CORPORATE GOVERNANCE
WHAT WENT WRONG
MANAGING RISKS
STAKEHOLDERS
WHAT SHOULD ROLLS ROYCE HAVE DONE
DIFFERENTLY

Too Big To Fail - Deferred prosecution agreement (DPA) issues
Anti-corruption campaigners think that the deal showed the British government was not serious
about tackling bribery  despite years of rhetoric promising to make the UK a hostile
environment for the corrupt.
Do DPAs allow corrupt companies to “buy” their way out of prosecution? Are some companies
simply too big to be prosecuted?
The terms of the UK DPA which include a 50% discount in fine, a five year payment plan and a
lack of transparency about how the full benefit received by rolls from the contracts was
calculated, are overly generous and unmerited.
Susan Hawley, the policy director of Corruption Watch, described the settlement as “proof the UK is not willing to
prosecute a large, politically connected company”.

Agenda
INTRODUCTION
TIMELINE
CORPORATE GOVERNANCE
WHAT WENT WRONG
MANAGING RISKS
STAKEHOLDERS
WHAT SHOULD ROLLS ROYCE HAVE DONE
DIFFERENTLY
BRIBERY DEFINED & COUNTRY LEGAL
INFRINGEMENTS

Timeline - How the scandal unfolded
January 2013
RR announces that Lord Gold,
former Head of Law Firm
Herbert Smith, has been
appointed to review
compliance procedures
December 2013
Britain’s Serious Fraud
Office launches a formal
inquiry into allegations of
bribery and corruption
against RR
December 2012
RR says it has handed details
‘relating to concerns about bribery
and corruption’ to the UK Serious
Fraud Office relating to activity in
China and Indonesia
March 2014
RR’s annual report
discloses the US
Department of Justice
is also investigating
bribery allegations
Source: Financial Times
February 2015
RR is accused of
involvement in the
bribery scheme at
Brazilian oil producer
Petrobras
January 2017
RR agrees a deal with UK, US and
Brazilian authorities under which it will
pay £671m, including the largest ever
British fine imposed on a company for a
criminal conduct

Bribery Act 2010 (*)
1 Offences of bribing another person
A person (“P”) is guilty of an offence if […] offers, promises or
gives a financial or other advantage to another person, and
intends the advantage to induce a person to perform improperly
a relevant function or activity […]
The following functions and activities fall within this subsection:
any function of a public nature, any activity connected with a
business […]
7 Failure of commercial organisations to prevent bribery
A relevant commercial organisation (“C”) is guilty of an offence
under this section if a person (“A”) associated with C bribes
another person intending to obtain or retain business for C, or to
obtain or retain an advantage in the conduct of business for C.
What is bribery
INDIVIDUAL LIABILITY + COMPANY LIABILITY
Source: legislation.gov.uk (*) Remark: there are currently no known outstanding effects for the Bribery Act 2010

In 2009, Rolls-Royce paid £3m to rent a Dubai warehouse for 8 months to store products destined for the Indian market.
The only problem was that no Rolls-Royce stock ever passed through the warehouse doors!
The typical bribery scheme adopted by Rolls-Royce

Coordinated Global Resolution with US, UK and Brazil
Source: Serious Fraud Office, Ministério Público Federal, The US Department of Justice
On 17th January 2017, it was announced that Rolls-Royce simultaneously reached:
 an Agreement with US Department of Justice (US$170m)
 a Leniency Agreement with Brazil’s Ministério Público Federal (US$25m)
 a Deferred Prosecution Agreement with Britain’s Serious Fraud Office (US$605m)
In total, these agreements resulted in the payment of US$800m (approximately £671 million at the exchange rate
of that time) by Rolls-Royce.

Indictment: 12 counts of conspiracy to corrupt, false accounting and failure to prevent bribery
Criminal conduct time span: 1989-2013
Business units involved: Civil Aerospace, Defence Aerospace, (former) Energy
Aim of the criminal conduct: sale of aero engines, energy systems and related services
Jurisdictions involved: Indonesia, Thailand, India, Russia, Nigeria, China and Malaysia
Source: Serious Fraud Office
4-year investigation by Serious Fraud Office (SFO)
SFO entered into a Deferred Prosecution Agreement (DPA) with Rolls-Royce:
- the agreement is part of a coordinated Global Resolution with US and Brazilian authorities
- the indictment is suspended
- Rolls-Royce has to pay £497m (+ interest + £13m of SFO’s cost) for the settlement
- Rolls-Royce has to pursue the programme of corporate reform and compliance put in place by new
management
- Rolls-Royce has to cooperate with future prosecutions of individuals
- the investigation into bribery and corruption continues into the conduct of individuals
The UK scenario

Indictment: use of intermediaries to bribe foreign officials at a state-owned petroleum corporation
(Petrobras) that awarded multiple contracts to Rolls-Royce
Business units involved: Civil Aerospace, Defence Aerospace, (former) Energy
Aim of the criminal conduct: government contracts for aero engines, energy systems and related services
Jurisdictions involved: Brazil
Source: Ministério Público Federal, The US Department of Justice
Investigation by Força-tarefa Lava Jato
Brazil’s Ministério Público Federal (MPF) entered into a Leniency Agreement with Rolls-Royce:
- Rolls-Royce has to pay R$81m to Petrobras (approximately US$25m)
- Because the conduct underlying the MPF resolution overlaps with the conduct underlying the US Justice
Department’s resolution, the US J. Department credites US$25m against the total fine in the US
- Rolls-Royce has to cooperate with further investigations
- Rolls-Royce has to improve its internal integrity practices and its compliance programs in accordance with
the Brazilian Law Decreto 8.420/2015
The Brazilian scenario

Indictment: conspiring to violate the anti-bribery provisions of the The Foreign Corrupt Practices Act of 1977
Aim of the criminal conduct: $35m in bribes through third parties to foreign officials in various countries in
exchange for those officials’ assistance in providing confidential information and awarding contracts to Rolls-
Royce
Jurisdictions involved: Angola, Azerbaijan, Brazil , Iraq, Kazakhstan, and Thailand
Source: The US Department of Justice
Investigation by US Justice Department, FBI’s Criminal Investigative Division, U.S. Postal Inspection Service’s
Criminal Investigations Group
The US Department of Justice entered into a Deferred Prosecution Agreement (DPA) with Rolls-Royce:
- To pay a criminal penalty of $195.5m (minus a $25.5m credit from overlapping fines in Brazil)
- Rolls-Royce admitted that it conspired to violate the Foreign Corrupt Practices Act (FCPA)
- Rolls-Royce has to cooperate with ongoing investigations, including those of individuals
- Rolls-Royce has also taken significant remedial measures, including:
- terminating business relationships with employees and intermediaries implicated
- enhancing compliance procedures to review and approve intermediaries
- implementing new and enhanced internal controls to address and mitigate corruption and
compliance risks
The US scenario

Sir John denied any wrongdoing and was not charged (yet).
The investigation into bribery and corruption continues (still ongoing) into the conduct of individuals.
From Corporate to Individual responsibility
Former CEO Sir John Rose and dozens of former Rolls-Royce executives were interviewed “under
caution” by SFO after Rolls-Royce reached a deal to pay £671m in fines.

UK Corporate governance in application to Rolls Royce
‘Comply or Explain Rule’  Companies discloses their
compliance and explain where the code is not followed
‘Principles-Based Approach’  General guidelines of best
practices, instead of set up rules.
Corporate governance is the system by which companies
are directed and controlled. Boards of directors are
responsible for the governance of their companies. The
shareholders’ role in governance:
- appoint the directors and the auditors
- verify that an appropriate governance structure is in
place
Key Roles of the Board
Set the company’s strategic aims
Supervise the management of the business
Report to shareholders on their stewardship.
Establishing the culture, values and ethics of the company. It
is important that the board sets the correct ‘tone from the top’.
Directors must ensure that good standards of behaviour
permeate throughout all levels of the organisation. This will
help prevent misconduct, unethical practices and support the
delivery of long-term success.
‘Chairman’  A Chief Executive should not go on to be
Chairman of the same company. The board should consult
major shareholders in case of inevitability of this scenario, and
explain in the annual report.
UK CORPORATE GOVERNANCE CODE RELEVANT RULES AND SPECIFICITIES

NON-EXECUTIVE DIRECTORS EXECUTIVE DIRECTORS
Board Responsibilities
 Delegated responsibility for the in depth review and oversight
of particular risks to certain board committees
 Managing risk and reviewing and assessing Rolls-Royce’s
internal control and risk management
 Interests of Rolls-Royce as a whole ( shareholders,
employees, customers and suppliers, and its social,
environmental and legal responsibilities)
Jointly responsible for Rolls Royce’s direction
- Running the company
- Day-to-day business delegated
through Chief Executive Officer
- Assess management performance
against goals and reporting
- Check accuracy of financial
information and control system
- Exec. Director remuneration
effectiveness
- Appointing, removing Exec. Directors
CHAIRMAN
REMUNERATION
COMMITTEE
SAFETY AND ETHICS
COMMITTEE
SCIENCE AND
TECHNOLOGY
COMMITTEE
NOMINATIONS AND
GOVERNANCE
COMMITTEE
AUDIT COMMITTEE
CEO
EXEC LEAD TEAM
BOARD
DEPARTMENTS
Ex: Marketing
Rolls Royce corporate governance structure
Degree of autonomy
in regions
Global Code of Business
Ethics – only as of 2004
2008

ETHICS COMMITTEE AND FAILURE TO PREVENT MISCONDUCT
 Ethics Committee
Objective: assists the board in fulfilling its oversight responsibilities in
respect of product safety, HS&E (occupational health and safety,
process safety, maintenance of facilities, asset integrity, personnel
security, the environment and sustainability), ethics and compliance.
Responsibilities
 Keeping under review the frameworks for the effective governance
of Safety and Ethics and the Company’s Safety and Ethics culture.
 Overseeing and reviewing annually key policies including: anti-
bribery and corruption and export controls policies;
Authority
 Authorized by the board to investigate any matter within its terms
of reference
 Authorized to seek information from any Director or employee, and
from any adviser, agent or representative of Rolls-Royce, for the
purpose of fulfilling its duties
“Rolls’s management knew about corruption in 2010 and did not
notify the Serious Fraud Office (SFO)”
Sir Ralph Robins
- Appointed Chief Executive in 1991
- Appointed Chairman in 1992
SAFETY AND ETHICS
COMMITTEE
ISSUES
Marketing was informing CEO of additional payment for securing
contracts, no one was raising it to Ethics Committee and the
Committee was not monitoring this department close enough
Regions had a degree of autonomy and executives in London were at
times bypassed
Chairman appointment
Breach of the “Comply and Explain Rule”
Opaque management reporting structure
No due diligence in place

•Adoption of code of
conduct
•Marketing services
dept. was responsible
for overseeing the
appointment of
intermediaries by the
company.
•The marketing
services dept. was
also responsible for
administering the use
of intermediaries.
•No clear process for
due diligence.
•Approval required
when the proposed
payment exceeded 5%
of the contract price.
•Additional approval
process also to
require approval from
Rolls Royce’s CEO.
•Marketing
Services dept. was to
be responsible for any
necessary due
diligence.
•Issuing of the Global
Code of Business
Ethics containing a
specific section on
bribery and
corruption.
•Revised intermediary
policy extending the
approval process and
distinguishing
between advisers and
consultant.
•External due
diligence process.
•Anti-Bribery and
Corruption
Compliance Review
 new policy on
intermediaries issued
by Marketing
Services:
accountability and
responsibility for
intermediaries was
unclear, and that
enhanced due
diligence was not
seen, even in areas of
high risk.
•Transfer of the
responsibility for the
process to Rolls-
Royce’s compliance
function.,
•Due diligence and
approval processes be
defined by the risk
rating for each
intermediary.
•Rolls-Royce
established a new
Compliance team +a
Committee for
approval of High Risk
Intermediaries.
1996 1996 2003 2007 2009 2010
Marketing services responsible for the assessment of risk related to intermediaries

Sir John Rose acting as CEO had to personally authorise all
commissions above more than 5 per cent the value of any
contract under company rules. He also had to authorise
any fixed payments above £150,000 from 2007. directly
implicated.
•It is argued that the board was mainly composed by non
executive directors who were not involved in day to day
operations and did not know about the briberies.
•The Ethics committee was only founded in 2008.
•The compliance procedures and due diligences
requirements were not clear and were supervised by
the marketing services department for a long time.
•RR has appointed Lord Gold to investigate and
conduct an independent review of its ethics and
compliance procedures and to act on an ongoing basis
as a “quasi-monitor” of its compliance programme.
•RR stated in its own investigation report in 2013 to
SFO that- they knew about the briberies in 2010 but
decided not to notify.  The leadership of the
company was changed and the company is now
operating under a new board and new procedures.
•The non executive directors were not prosecuted but
the employees directly implicated in the briberies of
the company were prosecuted and dismissed from the
company.Marketing
services
Ethics committee
The CEO of Rolls Royce had to authorize all “commissions” from 2003 onwards
Shift of responsibility of supervising the
intermediaries commissions

Improving the company’s internal compliance & ethics procedures
• Rolls-Royce terminated business relationships with multiple employees and third-party intermediaries who were implicated
in the corruption scheme.
• It enhanced compliance procedures to review and approve intermediaries
• It implemented new and enhanced internal controls to address and mitigate corruption and compliance risks.
• RR has engaged an outside advisor to serve as a compliance advisor responsible for reviewing the Company’s compliance
programs, making recommendations for improvement.
• Having the Board of Director’s Safety and Ethics Committee monitor the implementation of the recommendations
Measures Adopted by the Company to Manage the Risks Incurred Due to the Prosecution

• Rolls-Royce has changed business model and it has been made sure that both the customer base and general public
perceives it as if it is completely free from acts of bribery.
• It held the final payment to shareholders at the same level as in 2016 – 7.1p per share – in spite of the company’s financial
commitments and the investments .
• It is focussing on making Rolls more efficient and accelerating the pace at which it builds engines.
• It has backed the quality of the technology that the company is developing
• Rolls-Royce has ditched plans to close a precision machining facility in Derby, saving 150 jobs that were at risk, as well as
creating 200new positions by building a new testing facility for jet engines.
• It has cut hundreds of middle and senior managers and by the end of 2017 wants to have cut £200m of annual costs.
• It has kept open the option of sell off underperforming businesses – it is world leader in 80% of the segments it is doing
business in. But it does not mean that rest 20% of the business is available to sell.
Enhance the company’s image and maintain a good level of profitability
Measures Adopted by the Company to Manage the Risks Incurred Due to the Prosecution

Each stakeholder has a financial interest and reputation to maintain…
Creditors
Owners and
Shareholders
Employees
Customers
SuppliersGovernment

Source: Firm Competitiveness and Detection of Bribery, by George Serafeim (HBS) (2014)
…but bribery most strongly affects employee morale, financial performance
Bribery
Size of bribe
does not
matter
35% of
bribes under
$100k had
equal effect
as 16%
involving
amounts of
+$500k
Four Dimensions of
Competitiveness
External Business
Relations
Public Reputation
Regulator Interaction
Employee Morale
Three Factors Determine the Extent of Damage to a Firm
Who initiated the under-the-table payment?
Senior executive committing bribery has a 64.9 percent more significant
impact than those incidents in which the briber was more junior
How did the firm respond after bribery was discovered?
Dismissal of an employee that initiated bribery or cease of business
relations with an outside party that initiated bribery is significantly
associated with a lower likelihood of significant impact on a firm's
reputation
How was it detected?
Bribery cases detected by a firm's internal control systems (including tip-
offs and whistle-blowers) had a far less negative impact than those
detected by outside regulators
High-morale companies (+75% overall satisfaction) averaged 11% greater stock price improvement than low-
morale counterparts in 2011-2012

 Rotation or switching management and Board of Directors often  avoid
long tenures that can potentially cover up misconduct.
 More transparent management with open reports available to employees
and shareholders
 Outlined consequences for anyone that will breach the ethics and conduct
(if consequence is meant as a penalty, it becomes law)
 Ensure Ethics Committee is monitoring departments directly linked to
negotiation, sales and marketing.
What Rolls Royce could have done differently

When Corporate Governance Fails - A look into decades of bribery by Rolls Royce

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