Chapter 4. Corruption risks in the regulation and management of operations

Bid rigging

Bid rigging (OECD, 2009) (or collusive bidding) occurs when “businesses, that would otherwise be expected to compete, secretly conspire to raise prices or lower the quality of goods or services acquired through a bidding process”. Bid rigging schemes in procurement processes include cases in which co-operating companies agree not to compete or to submit deliberately inflated or defective bids to ensure the selection of the designated winner. In exchange, the winner might pay to the losing bidders a share of the premium of the contract obtained as a result of the collusion, hire them as subcontractors, or allow them to win in following bids or other high priced contracts. The last case is referred to as bid rotation schemes.

Inflated bids resulting from these collusive behaviours generate a windfall with which to bribe cooperating companies or public officials. Bribery payments are often disguised as commissions or mark-up on sales.

Other bid rigging schemes include “lowballing” practices that consist of a collusive arrangement between a bidder and the public official responsible for awarding the contract. In a lowballing scheme, the bidder agrees with the public official to submit the lowest bid with the understanding that once the contract is awarded, the price will increase (World Bank, 2007). The modifications and amendments can also be agreed following the award of the contract. Such was the case in the example of a contract for the distribution of natural gas, which stipulated the specific number of domestic users to benefit from the service, a provision that was modified two years after the signing of the contract, without any explanation.1

Undue favouritism of suppliers

Direct negotiation with suppliers for the procurement of equipment, goods and services may be prone to corruption (for example, bribery, conflicts of interest and favouritism) when the company favours one supplier against competitors on non-market grounds; or for reasons other than longstanding connections due to trust; or as a result of political capture when the company is being urged to select local suppliers with close political ties and affiliations.2 Companies may also be exposed to those risks in contract renegotiation or extension.

Favouritism, cronyism, kickbacks and bribery associated with the misuse of local content requirements

Local content requirements may be misused when contracts to supply extractive industries are awarded to shell or front companies, resulting in cost inflation and delays in project execution. In such cases, there is only a semblance of compliance with local content requirements since typically the front company does not have the capacity to actually implement the contract and will most likely further subcontract to a competent foreign operational entity. Alternatively, local content requirements may be used to favour local companies with political ties and connections and/or to channel and disguise kickback schemes involving the prime contractor and public officials. Companies may be “advised” that awards to certain local firms, connected with public officials, could have a favourable impact on their business (World Bank, 2007). There can also be a risk that local companies bribe or offer kickbacks to public officials to be included in the list of pre‐qualified suppliers (Martini, 2014).

Bribery associated with mispricing practices in the procurement of infrastructure services

Foreign companies may be exposed to specific corruption risks in the context of the procurement of infrastructure services. Transportation infrastructure for extractives, including pipelines, storage or transfer terminals, and port jetties is often characterised by natural, absolute or quasi-monopolies. Empirical evidence based on concrete experience, shared by participants in the Working Group on Corruption Risks, show that corruption may occur when granting or controlling access to infrastructure services. At the initial stage, a company may be prompted to make payments to public officials when negotiating and entering into an agreement with government. The lack of competition also favours opacity and discretion in defining the terms and conditions of access, including the appropriate level of fees and charges to be applied which may be inflated for bribery purposes. At a later stage, the company may be further solicited for bribery payments by public administrators in charge of controlling access to infrastructure (World Bank, 2007).

Patronage and clientelism in the procurement of intellectual services

Extractive companies may be exposed to risks of patronage and clientelism in the procurement of intellectual services when they are urged to hire local consultants based on political affiliations rather than on commercial grounds (price, skills and competencies).3

Shell and front companies

Special-purpose vehicles, such as shell or front companies, may be used to circumvent local content requirements, particularly in countries where local content rules do not clearly define what “local” or “indigenous” actually means. These companies may be hired or purposefully created by foreign companies to participate in the bidding process though these local partners might not have the capacity to deliver on the awarded contract.

Shell and front companies may be further used to disguise kickback schemes between the primary contractor and public or state-owned enterprise officials. As already described in the previous chapter, these types of vehicles may prove particularly efficient to conceal and launder the proceeds of corruption due to the opacity typically surrounding beneficial ownership (World Bank, 2007).

List of local suppliers

National laws and regulations may require principal contractors to select suppliers from a list pre-established by the government. This may expose the contractor to risks of corruption if the criteria required to qualify for the government-sponsored suppliers’ register are lower than the company’s standards on anti-corruption and due diligence.4

Opacity and discretion in the procurement of goods and services

Insufficient clarity and transparency of procurement rules may leave room for the abuse of power in decision making. For example, inadequate, vague or deliberately exclusive pre-qualification criteria may grant excessive discretion to evaluators in bid evaluation systems, particularly for non-price evaluation criteria (e.g. evaluation systems based on the conversion of evaluation criteria into notional points).5

Similarly, corruption may be facilitated when the legislation does not clearly specify the roles and responsibilities of the different actors, or when it does not spell out information disclosure requirements on private stakes and conflicts of interest for public or state-owned enterprise officials involved in the sector.6 Potential conflicts of interest for state-owned companies may arise in state owned companies where the distinction between the roles of administrator and regulator of the sector are not clearly established. It is reported for example that in an oil‐producing country, subsidiaries of the national oil company participate in bidding processes that the state company is responsible for overseeing (Global Witness, 2012).

Another corruption risk arises in the lack of independent monitoring and oversight of bidding processes, particularly where there are decentralised responsibilities. Limited reporting by state companies and government agencies to the legislature may also contribute to further weakening the integrity of procurement processes.

In some cases, the lack of open, publicly advertised and competitive bidding, the limited participation of international bidders or the excessively bureaucratic nature of the bidding process may limit competition, deter potential bidders from competing, and lead to the suboptimal allocation of contracts to firms with limited demonstrated capacity.

More specifically, risk factors associated with the procurement of infrastructure include the lack of transparency of rules governing access to infrastructure (e.g. non-official and non-public tariffs) as well as of administration of access.

Lack of or inadequate due diligence procedures governing the relationship with suppliers

For the private sector, opportunities for corruption may arise from inadequate segregation of roles and duties within the qualification process, including in the assignment of the contract, monitoring of its performance inadequate rules for the selection of the contractors (e.g. no separate treatment in bids of the technical offer and the economic offer); and insufficient auditing and monitoring of the suppliers’ contract performance may exacerbate the risks.7

Corruption associated with enforcement of local content requirements

Corruption related to the violation of customs clearance rules

Corruption related to the violation of customs clearance rules may serve the following purposes: accelerating the customs clearance process, skipping inspection or influencing the inspection’s findings, ignoring errors in documentation and non-compliance with customs regulations, reducing customs duties or resolving a customs dispute. Kickbacks for customs officials may also be designed to circumvent export or import bans or restrictions, or absolve non-compliance with specific product transformation requirements before export.

Thirteen cases in the Trace database refer to corruption related to violation of customs procedures. In three of the cases, improper payments were made to customs authorities to allow shipments to pass through customs in spite of small paperwork errors, to avoid causing significant delays in the importation of necessary supplies by the companies. In one case a company bribed a customs official to block the employees of a competitor company from entering the country. Payments were then made to facilitate the company’s own employees to enter the country and obtain work visas. In the other cases, bribery payments were made in exchange for favourable resolution of a customs dispute, avoidance or reduction of customs duties and penalties, circumvention of customs regulations with regard to special import permits or permit extensions (e.g. for temporary import permits).

Corruption related to the violation of labour and immigration rules

Similarly, corruption related to the violation of labour and immigration rules may be intended to accelerate immigration visa and work permit processing and approval or to settle disputes. The Trace database reports three cases in which improper payments were made to immigration officials to facilitate immigration visa and work permit issuance. In two cases at least, the bribery resulted in abuse of discretionary power, attempted extortion and embezzlement by immigration officials.

In one particular case, a settlement agreement was signed between a company and the country’s tax authorities. The company paid fees and penalties for violation of labour and immigration rules, subsequently embezzled by public officials.

Another case involved insider trading practices as the immigration official started investigating the company’s competitors, purportedly on his own initiative, providing the company with confidential information and making it difficult for the competitors to gain entry.

Corruption related to the violation of environmental regulations

Corruption related to the violation of environmental regulations may be intended to bypass existing legislation, to accelerate administrative procedures to get the necessary operational permits (e.g. environmental assessment, etc.) or to avoid penalties or secure the favourable resolution of disputes. It may take the form of bribery, trading in influence by the company or extortion by public officials.13

The literature cites an ongoing case of opposing indigenous communities and a foreign oil company accused of polluting local waterways severely affecting the indigenous peoples living in the region. Trading in influence by the company and the suspected bribery of a judge from the host country in exchange for false testimony were reported.

Another case points to extortion practices exerted on a company by public officials from the ministry of energy in relation to authorising the implementation of a power plant. The refusal of the company to pay bribes has led to attempts by public officials to sabotage the project, as reported in the complaint filed by the company.14 In another country, public officials allegedly imposed arbitrary fines on companies in order to generate additional revenue regardless of whether environmental regulations were breached or not.15

Finally, corruption may occur during the assessment of environmental liabilities arising in operations at a given site. The high level of discretion exercised by public officials in charge of identifying these environmental liabilities will determine the costs of the investment or operation. In particular, collusion with representatives from the operating companies may prompt those public officials to underestimate environmental liabilities and costs associated with the operations.16

Corruption related to the granting of administrative authorisations to operate

Given the complexity of extractive projects, there are several instances in which companies must obtain authorisations to perform their operations. In addition to work permits and customs clearance, health and environmental permits, security, quality control and assurance of operations (plants, storage, drilling), and local community development are also needed, and corruption (bribery, trading in influence and extortion) may be intended to speed up or circumvent procedures for the issuance of the necessary authorisations.17

Further gate-keeping and corruption may arise in the exercise of periodic controls to confirm the validity of the authorisation granted. These controls can be performed directly by a public official or through authorised third parties (specialised companies/consultants). Corruption may serve to keep inspectors from reporting violations and to avoid penalties or receive favourable treatment in dispute resolution. In some jurisdictions, mining companies may face difficulties in ensuring inspections of their sites and facilities by public officials, and as mandated by law, without providing significant benefits in the form of transport, accommodation and hospitality due to government resource and capacity constraints, especially in remote areas. Although this type of logistical assistance does not by itself substantiate corruption, it might offer opportunities for corruption in exchange for a favourable inspection report.

Risks associated with the design and enforcement of local content rules

Ill-designed local content rules setting unrealistic targets or vaguely defined roles and responsibilities or evaluation criteria for waiver applications may urge companies to use corrupt practices to circumvent those rules or get favourable treatment. Such rules may also foster political discretion and lack of transparency in their interpretation and enforcement with risks of favouritism and conflicts of interest.

Corruption may also be encouraged by lax or lower standards of government-sponsored supplier registers, compared with operators’ international standards.

For the private sector, corruption risks may include the lack of, or inadequate harmonisation between control standards required by the company and local content requirements provided by the government,18 together with unclear or inappropriate internal procedures for effective implementation and compliance with local content requirements.19

Risks associated with administrative authorisation and clearance procedures

Corruption in authorisation and clearance procedures may be encouraged by ill‐designed, lax or unclear procedures that leave too much scope for interpretation by public officials in charge of enforcement. In one case cited in the Trace Compendium database, the company alleged that procedures associated with obtaining labour and immigration authorisations for short-term workers were not clearly established in the country’s legislation, leaving companies vulnerable to the abuse of power on the part of public officials.

With respect to the regulatory process itself, an insufficient separation between the functions of inspection and assessment, authorisation, and monitoring and control may increase chances of corruption.

Inspections carried out prior to authorisation (e.g. environmental, health and safety inspections, customs inspections) may suffer from inconsistencies, arbitrariness and lack of transparency which increase opportunities for corruption.20 Corruption risks may also arise from excessive bureaucracy, which causes unreasonable processing and approval delays for import permits, visas, work permits, etc. Finally, the lack of safeguards (anti‐corruption compliance training, regular rotation, etc.) for officials exposed to corruption (e.g. inspectors, customs or immigration officials) is of particular concern.

Fraud and document falsification in record-keeping or audit reporting

Corruption and bribery may be facilitated by fraud and document falsification in the context of audit reporting. The Trace Compendium database reports a case of corruption in the context of an agreement between a foreign company and a state-owned enterprise under which the company assumed all operational and financial control over the project and was to pay a tariff to the state-owned enterprise in order to use its pipeline to deliver the recovered oil. The state-owned enterprise would then reimburse the company for certain costs incurred in the oil and gas recovery process. Reimbursement was made on the basis of the submission of monthly invoices by the company documenting the volume of oil delivered through the pipeline, the pipeline fee and a calculation of the company’s reimbursable monthly operating costs. Independent auditors were annually mandated by the state-owned enterprise to determine whether costs were properly claimed. The auditors’ report would then be reviewed, discussed and conclusions agreed among the auditors, the company and the state-owned enterprise. It is alleged that during these review sessions, the company made improper payments in order to receive favourable audit reports, increase the costs recoverable under the contract, and reduce the company’s tax obligations.

Suspicious fluctuations in consultancy fees suggest the payment of bribes. In one case, the parent company’s management had an opportunity to discover the improper payments when a senior finance officer took note of an increase in contract labour costs, including consultancy fees in the country branch office. However, because the finance officer accepted the local controller’s explanation and did not make further inquiries, the issue was not investigated fully. As a result, the improper payments were not discovered until the following year; when, as part of the annual budgeting process, the company’s senior management made inquiries upon noticing narrower profit margins in the country branch office. Upon learning of the kickback scheme, the company’s senior management reported the issue to the parent company’s audit committee.

Corruption associated with illegal resource extraction

Informal small-scale and artisanal mining (ELLA, 2012)22 is particularly exposed to corruption risks, and these are often associated with and fuelled by conflicts, political instability and criminal activities such as drug smuggling. Corruption can take the form of exploitation or extortion, as well as fraud, bribery and theft. Some evidence has emerged about the mechanisms of money laundering associated with informal small-scale and artisanal mining involving international transactions as well as gold smuggling and tax fraud. For example, in one gold producing country, illegally extracted gold is laundered through the legal domestic gold sector of the neighbouring country (Global Witness, 2013). Another case shows how drug smugglers launder illegal money through fictitious transactions with local government officials in regions with informal mining activities. Drug smugglers import gold acquired abroad with the proceeds of drug smuggling and distribute it to local government officials. Government officials then send it to the Central Bank and report it as local production in order to receive the corresponding royalties, which are then divided between the local government officials and the drug smugglers (ELLA, 2012).

Bribery and diversion of public resources and assets, including through resource theft

Oil theft is a major concern in certain oil producing countries where it is practised on a large scale and severely erodes and drains revenues from oil. Even more challenging is that it is very often linked to other criminal activities. The diversion of public assets as a result of resource theft can range from small-scale pilfering and illegal local refining to large-scale illegal bunkering in the field or theft at export terminals (Katsouris and Sayne, 2013). Resource theft commonly arises through the bribery of public officials responsible for overseeing and monitoring production volumes. But it may also be orchestrated by elites benefitting from illicit oil exports.

Large-scale oil theft was often reported in the particular context of oil trading restrictions imposed by the UN Oil-for-Food Programme in Iraq. The Programme was initially established to enable Iraq to sell its oil for humanitarian purposes despite an extensive international sanctions regime. Oil thefts can also be used as a system for diverting resources for the benefit of local officials.

Extortion by means of threats on security or continuity of operations

Three cases in the Trace Compendium database relate to the payment of bribes connected to conflicts with local communities. Bribes were paid by a company in exchange for assistance in protecting and defending its operations, managing social unrest and maintaining a stable business environment.

Bribery can also happen in response to the threat of delays or halts in extractive operations or extortion demands in exchange for retaining business in the country. In one case involving extortion on the part of government officials, the company was forced to submit false paperwork and cash in order to retain business with the government and benefit from favourable tax treatment.

In a second case, threats and attempts of extortion were exerted on a subsidiary company following non-compliance with the country’s legislation. The company was required to obtain immigration documentation prior to an expatriate worker’s entry into the country. Immigration officers conducted audits after which they claimed that the company’s expatriates were working without proper immigration documentation. Following the threat of fines, jail and deportation of the expatriate workers unless the company paid cash fines, employees of the subsidiary sought and received authorisation from the parent company’s senior management to pay these officials in cash using their personal funds. The parent company then reimbursed these employees and reflected these payments as visa fines and as payroll advances on the employees’ upcoming bonus. Charges subsequently brought against the parent company did not concern the payment of bribes made in response to extortion demands but rather the inaccurate recording of payments in company’s records.

The database reports a third case in which threats were exerted by public officials from a state-owned enterprise (SOE) on a consultant hired by a foreign company to provide assistance with daily operations, including with the submission of invoices to the SOE. It is alleged that SOE employees threatened to stop or delay the company’s work if the consultant refused to take part in a kickback scheme, which consisted of the consultant overbilling his own services to the company and providing kickbacks to SOE employees. In return, the company would submit inflated invoices to the SOE justified as “lost rig time” in order to cover these additional consultancy costs.

Bribe payments in connection with espionage in industrial operations

One case in the Trace Compendium database relates to the prosecution of a foreign mining company and four employees accused of paying bribes to executives from major local industries in exchange for confidential information on industrial activities and commercial trade secrets. Press reports suggest that political and commercial interests were at the centre of the case and that the arrest of the foreign company’s employees might be related to the decision by the foreign company to cancel an investment deal with one of the country’s state-owned enterprises. Before the case was investigated, the foreign company had been repeatedly accused of forming cartels with other foreign companies to manipulate prices and harm the country’s mining industry.

Risks associated with fraud and document falsification

For both the public and private sectors, risks associated with fraud and document falsification may result from the lack of, weak or inadequate internal control procedures and poor record-keeping and monitoring.

With specific regard to companies, the lack of robust internal financial controls exercised by the parent company may extend to its subsidiaries and offer room for corruption to thrive.

Risks associated with illegal resource extraction

First, corruption associated with illegal resource extraction may arise where regulation of the artisanal and small-scale informal mining sector is either missing, incomplete, too complex or weakly enforced. Opacity of the sector may also be reinforced due to the outdated registration of minerals, limited access to mining titles or the lack of a coherent framework for determining and monitoring the extent of the country’s subsoil wealth.

Moreover, in many cases mineral extraction does not require as much equipment and investment as required for oil and gas which facilitates its illegal extraction and export (OECD, 2012).

Finally, illegal resource extraction and corruption tend to thrive in contexts of conflict, political instability and criminal activity such as drug smuggling, which further challenges the state’s capacity for detection and prevention.

Risks associated with resource theft

Risks associated with resource theft include the lack of adequate control and metering capacity on oil production, storage and transportation on the part of both the government and the private sector23 as well as weaknesses and shortcomings in the inspection of oil volumes produced.

Risks associated with extortion practices

Abuse of power, particularly at the local level (local political elite or security forces), and insufficient control of the central government over local authorities may exacerbate corruption and extortion.

For the private sector, risks favourable to extortion include the lack of internal procedures to tackle extortion demands and prohibit facilitation payments, the failure to conduct due diligence into intermediaries’ and consultants’ backgrounds and to provide anti-corruption compliance training to intermediaries or consultants to avoid exposure and vulnerability to extortion themselves.

Corruption related to the acquisition or selling of concessions (“grabbing and flipping”)

In one case, assets in a concession were initially transferred at knockdown prices to a series of offshore companies owned by a personal friend of a high-level politician, and registered in jurisdictions where regulations allow beneficial owners to remain secret. The offshore companies in turn sold the same assets at market value to major multinational companies, striking immensely profitable deals. In another case, national authorities revoked a concession awarded to a private company where production was imminent and passed it on to a new joint venture. Through a series of complex transactions, a person with close ties to high-level politicians acquired the rights to the concession. Government officials received kickbacks in return for their sale of assets to the joint venture. The concession was then sold to another multinational company.

Corruption related to privatisation or acquisition of shares in a state-owned enterprise and the acquisition of shares in a private company

Lack of transparency in the process of privatisation or selling of shares

Opacities in the process of privatisation or selling of shares may result from the lack of the following elements: an open and transparent bidding process; transparent and appropriate evaluation methods to assess state-owned enterprise’s assets and determine the base price for the sale of shares or privatisation of the state-owned company;28 transparent rules and procedures for the hiring of external consultants, assessors and asset evaluators; harmonisation and enforcement of disclosure standards regarding contractual arrangements (McMillan, 2005); full disclosure of the form of payment, governance and ownership arrangements in the case of state equity participation in private companies (composition of board, audit practices, etc.) (IMF, 2007); and clear regulations allowing for the identification of the ultimate beneficial owners of the operations subject to privatisation or share acquisition.

Inadequate internal rules and procedures governing corporate mergers and acquisitions

For the private sector, risks associated with corruption in the acquisition of shares in a public or private company may include the lack of clear rules and constraints on payment (e.g. cross-border transfers, particularly when tax heavens are involved) (IMF, 2007); insufficient oversight of the parent company over the subsidiary’s merger and acquisition29 as well as inadequate segregation of roles and duties within the sale process (proposal, evaluation, negotiation, final authorisation).