Case Study: Och-Ziff’s African Bribery

Och-Ziff African Bribery

By: Sherri Lee 

The Och-Ziff African bribery case, which was settled in the summer of 2016, provides important illustrations for understanding ethics in finance, especially in hedge fund management. The following is a description of the key parties, the financial instruments involved, the sequence of events, transactions, and ethical violations, followed by policy recommendations

THE PLAYERS

  • Och-Ziff Capital Management Group LLC (Och-Ziff). A large-scale American alternative investment and hedge fund manager founded in 1994. Och-Ziff went public in 2007, with 505 total employees by 2017 (Bloomberg, 2017). It has offices in New York, London, Hong Kong, Mumbai and Beijing. Its clients include pension funds, private banks, corporations and other institutions, mutual funds, foundations and endowments, and family offices and individuals. It managed assets for over 1,400 investors, receiving management fees in return (Reuters, 2017). In 2015, Och-Ziff had $48 billion in assets under management (Stevenson, 2016).
  • Daniel Och. The founder, chairman, and Chief Executive Officer (CEO) of Och-Ziff Capital Management Group. He is a U.S. citizen aged 55, residing in Scarsdale, New York (SEC, 2016).
  • Joel M. Frank. The Chief Financial Officer (CFO) of Och-Ziff Capital Management Group. He is a U.S. citizen aged 61, residing in downtown New York City (SEC, 2016).
  • The Securities and Exchange Commission (SEC). An independent agency of the United States federal government, with the mission to protect investors, facilitate capital formation, and maintain fair, orderly, and efficient markets. It is the primary overseer and regulator of U.S. securities markets, with the authority to bring civil enforcement actions against individuals and companies for violation of securities laws (SEC, 2013). 
  • Libyan Investment Authority (LIA). A sovereign wealth fund established in 2006 by the Libyan government, aiming to diversify the nation’s economic development (LIA).

THE INSTRUMENTS

  • Hedge fund. An investment fund available only to accredited individuals or institutional investors, i.e. individuals with significant assets or institutions. Hedge funds invest in a wide variety of assets and are administered usually by investment management firms in the form of limited partnerships or limited liability companies. The characteristics of hedge funds include (1) flexibility in investment as they operate with little to no regulation from the SEC; and (2) the purpose of generating a higher return for a given level of risk than normal investments (SEC, 2012). As for fee structure, typical hedge funds charge an asset management fee of 1–2% of the assets. In addition, 20% of the profit of a hedge fund is deducted as a “performance fee.” Such fees drive hedge fund managers to strive for higher returns, usually by taking greater risks (SEC).   

THE TRANSACTIONS

The bribery charges involve the CEO and CFO of Och-Ziff, Daniel Och and Joel M. Frank. The SEC accused them of knowing involvement in several suspicious transactions and investments in which two senior employees of Och-Ziff paid bribes to high-ranking government officials in numerous African countries including Chad, the Democratic Republic of the Congo (DRC), Libya, and Niger (Stevenson, 2016).

According to the facts established by the SEC and admitted by the accused parties, the transactions conferring the corrupt payments occurred from 2007 to 2011 in the following order.

  • In 2007, Och-Ziff used an agent to pay a bribe of $3 million to high ranking Libyan government officials to secure $300 million of LIA funds for Och-Ziff (SEC, 2016).
  • In 2007, an Och-Ziff employee paid $400,000 from investor funds to its Libyan agent, the agent would then use those funds to pay bribes to benefit a Libyan property development project in which $40 million of Och-Ziff funds had been invested (SEC, 2016).
  • In 2007 and 2008, Och-Ziff gave a loan of more than $86 million (more than $10 million from investor funds) to one of its South African partners, an African mining-focused fund. Och-Ziff’s employees deliberately ignored the fact millions would go to the bribery of foreign government officials, illicit payments to middlemen, the personal benefit of business partners, and expenditures irrelevant to investment (SEC, 2016).
  • In 2008, Och-Ziff gave a loan of about $124 million from investor funds to an entity affiliated with an infamous Israeli businessman, Dan Gertler (Geiger, Robinson, Weinberg and Hurtado, 2016), who had close connections with DRC government officials at the highest levels and became Och-Ziff’s partner in the DRC to purchase mining assets there. Gertler used a substantial amount of the money to bribe high-ranking DRC officials with the aim of securing mining assets for both himself and Och-Ziff (SEC, 2016).
  • In 2010 and 2011, Och-Ziff took out $130 million from investor funds and then loaned the funds to another entity also controlled by Gertler. Och-Ziff allowed him to take $84.1 million without any restrictions or supervision. Och and Frank knew he would use the money to bribe important DRC officials, and were aware of the corruption allegations against Gertler (SEC, 2016).
  • In 2011, Och-Ziff created another Africa-focused fund in a London-based oil exploration company. The fund purchased shares from Och-Ziff’s South African partner, who then paid more than $1 million to a consultant. The latter used the funds to bribe Guinean government officials. Both Och-Ziff and its two employees were willfully blind as to the high probability the consultant would use the funds for bribery (SEC, 2016).

Gertler strongly denied the allegations made against him in both (5) and (6) (Geiger, Robinson, Weinberg and Hurtado, 2016).

Och-Ziff used not its own capital, but funds which investors gave Och-Ziff for management to fund the above corrupt transactions. The SEC repeatedly insisted the CEO and CFO of Och-Ziff knew investor funds were being used to pay bribes (SEC, 2016).

As for Daniel Och, the SEC accused him of involvement in the corrupt transactions, as he had final decision-making power over all private investments by Och-Ziff. This authority meant he could decide whether to allow the above transactions. He also personally approved transactions (4) and (5) (SEC, 2016).

Joel M. Frank was in a similar position. He was responsible for controlling Och-Ziff’s internal accounting system, and he approved the expenditure of Och-Ziff funds in the above improper or corrupt transactions (SEC, 2016).

The SEC also stressed that although neither Och nor Frank had actual knowledge that bribes would be paid through the above transactions, they were still liable for the bribery because of their executive positions and the power and responsibility which came with the posts (SEC, 2016).

THE OUTCOMEOch-Ziff African Bribery

Och-Ziff pleaded guilty in a Federal District Court in Brooklyn to one count of conspiracy. Settlements were entered into to settle the civil as well as criminal charges against Och-Ziff, Daniel Och, and Joel M. Frank (Stevenson, 2016). They were all charged under the Foreign Corrupt Practices Act (FCPA) in the U.S. (SEC, 2016).

Och-Ziff paid a $413 million fine as part of a deferred-prosecution agreement. Apart from monetary compensation, the agreement requires Och-Ziff to hire an independent monitor, and the criminal charges will only be dismissed if the company complies with the terms of the agreement and does not violate any other laws over the course of three years, from 2017 to 2019 (SEC, 2016).

Daniel Och had to pay a $2.2 million fine as an admission for lack of control and oversight of his own company. He was also charged with four counts of bribery, which will be dismissed if Och-Ziff complies with the agreement terms (Stevenson, 2016).

Joel M. Frank also had to settle charges against him of allowing executives to ignore red flags (Stevenson, 2016).

ANALYSIS OF ETHICAL ISSUES

  • Violation of the core values of the company

Och-Ziff is a hedge fund that is supposed to adhere to federal law aimed at preventing bribery of foreign officials (Stevenson, 2016). Nevertheless, this case exposes a company deliberately involving itself in bribery of African officials for economic self-interest. Such action erodes public faith in hedge funds because Och-Ziff used its power not to regulate, but to corrupt for its own gain. The ethics of letting hedge funds escape standard SEC regulations set out for mutual funds should also be re-considered, following this scandal.

Apart from this, the company failed to act according to its core values of honesty and compliance. From the company website, it promises to “be truthful in all of their business dealings” and “to follow the letter and spirit of all applicable laws” (Och-Ziff, 2017). By knowingly entering into suspicious transactions and actively bribing African officials through an agent, Och-Ziff was dishonest in business dealings and broke the law. Och-Ziff’s actions do great violence to the idea of financial ethics, especially when these ethics are what the company praises itself for.

This act of Och-Ziff not only damages its own reputation, but also sets a bad example in the hedge fund industry. More importantly, as Och-Ziff is a leading hedge fund manager, ranked as the world’s 3rd hedge fund manager by Investopedia in 2015 (Seth, 2015), its conduct damages the image of the industry. Trust, once broken, is hard to regain.

In short, Och-Ziff’s dishonest behavior in dealing with investor funds is highly unethical and probably will have a lasting negative impact on investors’ impression of Och-Ziff and the entire hedge fund industry.

  • Duty of care of the executives to monitor the company’s day-to-day operation

This case reaffirms the duty of company executives to bear responsibility for the company’s day-to-day operations. An executive has the power to monitor the company and order a halt to suspicious transactions. Therefore, it is unjustifiable to free executives from liability when the company is found to be involved in serious misconduct like bribery. Even if direct, knowing involvement of the executives cannot be proved, they should not be allowed to shirk liability by simply claiming ignorance of the transactions in question, shifting the responsibility to the employees carrying out the transactions.

Similarly, in the present case, it has been established that Och and Frank were aware of the suspicious transactions with the various African governments but did not order a stop to the transactions. Although they may not have directly ordered the transactions, as the highest-ranking executives, they should be assumed to know about the company’s suspicious transactions. Unless they prove they had taken reasonable steps to investigate and bring the transactions to an end, Och and Frank should be held liable for not taking reasonable care to maintain the integrity of the company and for being willfully blind to the company’s potential misconduct.

This case is significant because the outcome ensures some protection of employees: employees will not bear all criminal and civil liability for the company’s business misconduct. Such protection is necessary because the position of employees is often different from that of company executives. Employees have little to no freedom in executing job duties. Even if they suspect the company is engaged in illegal or corrupt activities, they may lack the ability to stop them. Compassion towards employees’ awkward positions may be one of the reasons why the two employees involved in the current bribery case were not prosecuted.

That being said, everyone has a negative duty not to carry out illegal actions as well as a moral responsibility to report immoral or illegal acts. No matter the position a person holds in a company, this statement still stands true. If employees suspect the company of carrying out illegal acts, they should report those acts to the authorities.

In the U.S., whistleblowers on illegal commercial activities in particular are protected and incentivized by the Dodd–Frank Wall Street Reform and Consumer Protection Act, enacted in 2010 (Library of Congress, 2010). Section 922 of the Act incentivizes whistleblowers by giving them financial awards through the SEC if the information provided leads to a monetary sanction exceeding USD 1 million. Foreign bribery and other violations of the Foreign Corrupt Practices Act are one of the common violations of federal securities laws leading to an SEC award (Zuckerman and Stock, 2016). The Act also protects whistleblowers by prohibiting retaliation against employees providing information to the SEC (Library of Congress, 2010).

Whistleblowers are also readily protected in the UK by The Public Interest Disclosure Act 1998 (The Charity Commission, 2013), as long as the wrongdoing disclosed is of public interest. Complaining about a company breaking the law is explicitly protected by the UK (United Kingdom Government).

The position of a company director is obviously another matter, and for the reasons given above it is sensible to impose a duty on people in such positions to ensure ethical conduct of the company. Another significance of the Och-Ziff case lies in the fact it is the first instance when individuals (e.g. CEO, CFO) of a company are held responsible for the company’s misconduct. This has two implications: (1) society or government is no longer in the position of not knowing who to blame when a company is involved in unethical and illegal activities; and (2) there is clear legal liability for company executives, i.e. executives are held liable for the company’s business misconduct, no matter whether they deliberately caused the misconduct or allowed it by negligence. Therefore, company executives may be more mindful when managing the company so that its conduct is transparent and ethical.

  • Breach of fiduciary duty to investors

Although hedge funds are less regulated, hedge fund managers are still essentially bound by a fiduciary duty to the investors whose funds they manage (SEC, 2012). This means the fiduciary duty of a hedge fund manager is like that of mutual fund manager. The fund manager is holding the investor’s funds in trust, so she must act with absolute good faith by managing the funds with reasonable care (Langevoort, 2005). As stated in the Investment Company Act of 1940, section 36, “gross misconduct”, “gross abuse of trust” or “personal misconduct” would possibly amount to a breach of fiduciary duty (Langevoort, 2005).

By using investor funds for bribery, Och-Ziff’s conduct likely falls into the scope of “gross abuse of trust” because bribing African officials would in no way serve investors’ interests in reducing investment risks. Therefore, it is clear Och-Ziff breached its fiduciary duty to investors by using investor funds to benefit itself instead of maximizing investors’ interests.

POLICY RECOMMENDATIONS

The fine charged in the present case of $413 million is the fourth largest fine in history (Germaine, 2016), $213 million of which is a criminal penalty on the company. This is the first time a hedge fund has been charged with FCPA violations (Jones, Hur and Nichols, 2016). Previously, no hedge fund managers had ever been held criminally liable individually for overseas corruption or for violating the FCPA. Even Och and Frank in the present case were only paying the fine to settle civil charges brought by the SEC (Germaine, 2016). The law should be used more effectively to punish violators of the FCPA.

Given the above observations, the following policy recommendation may be adopted to combat unethical behavior, as well as out-and-out corruption, in the business world.

Targeting individuals for a company’s violation of FCPA

According to Professor Andrew B. Spalding at the University of Richmond School of Law and Jason Linder, head of Irell & Manella LLP’s global investigations and anti-corruption practice and a former senior trial attorney focusing on FCPA, the potential downside of more aggressive prosecutions against individuals for company wrongdoing is having more resources exhausted with less deterrence, as companies are easier to prosecute than individuals. This is because companies usually go for quick solutions, i.e. settlement, and would conduct their own investigations. Individuals would fight fiercely and go to trial if prosecuted, increasing the time needed to hold an individual criminally liable (Bishop, 2017). As a result, prosecuting companies may lead to much higher rates of successful prosecutions than trying to convict individuals, and the deterrent effect would be more than prosecuting a vast number of individuals. Therefore, prosecuting companies is more cost-effective than prosecuting individuals.

Yet, the law should not only be about cost-effectiveness and even resource allocation; it should also reflect society’s moral values to some extent, e.g. people committing criminal acts should be punished. In the case of the FCPA, another important consideration besides resource allocation would be to hold as many persons involved in financial illegality responsible as possible, so as to demonstrate the law is not selective and does not let people escape criminal liability just because it is hard to hold them liable.

Executives manage companies and every business decision must be proposed if not approved by them. It is difficult to imagine why, when the party involved in corruption is a company, no one is blameworthy and company executives should not be criminally liable for bribery. The starting point should be that whenever companies are involved in corruption, if the prosecutor can prove beyond a reasonable doubt the company executives knew of and approved the suspicious transactions, those executives would be held criminally liable (Tapper and Collin, 2010).

Criminal liability may be a step up in deterrence. Company executives are usually persons of tremendous wealth. Civil settlements would create minimal financial difficulty for them. Except damage to reputation, they have virtually nothing to lose, so the deterrence is insufficient. On the other hand, loss of freedom may be a much stronger incentive for company executives to monitor the company with much greater attention, thus preventing illegal business activities like corruption, preferably in the field of hedge funds.

In June 2017, Nicholas G. Garaufis, a U.S. federal judge, intensely criticized the Justice Department for only prosecuting one middleman in the FCPA action involving Och-Ziff while other people involved are “off on some golf course.” That middleman, Samuel Mebiame, has been sentenced to two years imprisonment (Bishop, 2017).

 

Editor: Eric Witmer

References:

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