Corruption in defence procurement: “Blacklisting” must remain an option - Broadsword by Ajai Shukla - Strategy. Economics. Defence.

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Monday 27 July 2015

Corruption in defence procurement: “Blacklisting” must remain an option

By Ajai Shukla
Business Standard, 28th July 15

The debate over whether it is wise to blacklist global arms corporations found guilty of bribery and corruption is gathering steam as the defence ministry finalises its forthcoming defence procurement policy of 2015 (DPP-2015).

The National Democratic Alliance (NDA) government has always believed that the blacklisting of arms vendors who violated the DPP has become a stumbling block in defence procurement. Fifteen companies are already blacklisted and another 23 are under defence ministry scrutiny; the government cannot procure equipment of spares from them, narrowing its procurement options.

On August 23, 2014 former defence minister, Arun Jaitley, said corporate wrongdoing should be punished without blocking acquisitions and the flow of spares.

“We have to balance between two competing public interests. One public interest is that contracts are meant to be abided with and not violated, even by our suppliers. The other competing interest is the larger public interest in terms of our national security and defence preparedness. It is an issue that we are fully seized of and we are in the process of finding an answer to this, and you will hear about this from us very soon”, he promised.

Jaitley was referring to the Italian defence conglomerate, Finmeccanica, which the defence ministry had banned since February 2013, along with its subsidiaries, many of which are key defence suppliers to India. These include marine systems vendor, Whitehead Alenia Sistemi Subacquel (WASS); radar and communications specialist Selex Electronics Systems (ES); aerospace giant, Alenia Aeromacchi; armaments major, Otomelara; and helicopter maker, AgustaWestland. The United Progressive Alliance (UPA) defence minister, AK Antony proscribed Finmeccanica after its chairman was arrested in Italy on charges of bribing Indian officials to win a contract for twelve AgustaWestland AW-101 helicopters to ferry Indian VVIPs. The Italian court has since dismissed the case, but a Central Bureau of Investigation probe continues.

On August 26, Jaitley diluted the ban on Finmeccanica, allowing India’s military to go ahead with contracts already signed with its subsidiaries and to buy spares and upgrades for equipment earlier procured. However, Finmeccanica group companies remained proscribed from new tenders, and those where it was participating, but a winner had not been announced.

Manohar Parrikar, who succeeded Jaitley as as defence minister last November, shared Jaitley’s distaste for blacklisting. On December 12, Parrikar declared that companies that violated procurement norms should face “heavy financial penalties”, not blacklisting. Citing Finmeccanica, Parrikar asked: “Should we rule ourselves out of dealing with all of its 39 subsidiaries? There has to be a clear policy on that.”

Voicing his own views, Parrikar proposed: “How much you (the vendor) violated, pay the Indian government 4-5 times that, only then will you be permitted to participate in defence tenders.”

Calling this just “loud thinking”, Parrikar promised a formal policy on representatives and blacklisting by January 2015. The wait for this continues, with government legal experts and bureaucrats unwilling to renounce a key lever in their enforcement toolbox.

With the ministry publicly advocating out-of-court settlements rather than prosecuting of defaulters, the private industry has pressed home the advantage. On Wednesday, the Confederation of Indian Industries (CII), which represents big private sector corporations, issued a briefing paper that proposed the adoption of US-style “deferred prosecution agreements” (DPAs). In a DPA, the government grants amnesty to a defaulting company in exchange for its cooperation in investigating violations, hefty cash fines and an explicit or implicit acceptance of guilt.

Enumerating the disadvantages of blacklisting, the CII says it could result in vendors deciding “the risk of conducting business in India is too high”; dilution of competition in defence procurement that is already a field with limited players; and, in some cases, denying the military equipment that might be available only from a blacklisted company.

The CII paper also warns against the “Arthur Andersen effect” of blacklisting and vigorously prosecuting an erring vendor. This refers to the collapse of the American accounting firm in 2002 after its prosecution for falsifying the accounts of Enron. That led to the loss of about 28,000 jobs, many of them of innocents.

“[Blacklisting] has usually not served its desired purpose. The inquiry is often delayed and moves in circles… (and) the matter is stuck in the Indian legal system. On the other hand, the automatic blacklisting of companies limits the government’s options of negotiating a better deal from multiple supplier sources”, argues the CII paper.

It is true that none of the companies that the defence ministry has blacklisted over the years have been successfully prosecuted and penalised for wrongdoing. However, defence industry experts overwhelmingly agree that this is not for lack of guilt, but rather because of the weaknesses and complexity of India’s criminal prosecution system.

The DPA that the CII recommends traces its roots back to 1992, when the US Department of Justice (DoJ) agreed not to prosecute investment banker, Salomon Brothers in view of its “unprecedented cooperation” with an on-going investigation. Later, the US formalised guidelines for DPAs in the US Attorney’s Manual and other official procedures.

Legal expert, Percival Billimoria, says the US DoJ offers a DPA when it believes the benefits of voluntary disclosure and large restitution payments outweigh the benefits and uncertainties of prosecuting the offending company. A DPA usually includes an acknowledgment by the offending company of the offences it has committed; an obligation to cooperate fully with the prosecuting/investigating agency; details of the consequences of breaching the DPA; an acknowledgment that a repeat offence would lead to prosecution; an agreement to institute internal compliance mechanisms to prevent further breaches of law and ethics; and an enumeration of penalties/fines imposed.

The CII states that $24.8 billion in fines were imposed in the US during 2010-2014, of which $3.87 billion were for violations of anti-corruption laws.

While there are clear advantages to offering a DPA in certain cases, a growing school of thought warns against allowing companies to buy their way out of trouble as a matter of course. The DPA model, in fact, is facing growing criticism within the US, since it makes adjudicating guilt the preserve of prosecutors, not courts of law.

Legal experts like Sherbir Panag, who heads the criminal compliance practice of MzM Legal, point out that the multi-million dollar fines imposed by the US DoJ and Securities Exchange Commission (SEC) --- Siemens alone paid $800 million in one case --- in no way indicate that criminal misconduct has reduced or compliance has become more robust. Reduction in the commission of offences and behaviour alteration requires strong deterrence induced by prosecution of individuals and companies. That is not achieved if liability reduction paperwork replaces prosecution substantially.

“The corporations that bear the fines start accepting them as an opportunity cost of doing business, unless sanctions and penalties proportionate to the offences committed are imposed”, says Panag.

Furthermore, a DPA only becomes attractive to a company if it is backed by a strong investigative and prosecuting mechanism, which India clearly lacks.

“The US has a focused and centralised agencies, centred on the DoJ and the SEC. In contrast, India has a plethora of agencies, mostly working at cross-purposes: the defence ministry that orders investigation and imposes the administrative sanctions; the Central Bureau of Investigation; and numerous agencies investigating economic offences. Besides having to coordinate these, major substantive and procedural law reforms would be needed to allow DPAs”, points out Panag.

As the defence ministry grapples with these shortcomings, it is evident that the airy imposition of monetary fines cannot credibly replace criminal investigation and prosecution. Blacklisting must remain in the sanctions/penal toolbox of the defence ministry, along with the possibility of negotiated resolutions through DPAs. To be credible, both must be backed up with vigorous investigation/prosecution mechanisms and a tailored legislative framework.

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