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ISSUES IN ACCOUNTING EDUCATION
Vol. 28, No. 3
2013
pp. 599–615
American Accounting Association
DOI: 10.2308/iace-50470
Nature’s Sunshine Products:
Anatomy of an FCPA Failure
Heather M. Hermanson and Audrey A. Gramling
ABSTRACT: Recently, Walmart and several other large corporations have faced
allegations of Foreign Corrupt Practices Act (FCPA) violations, subjecting the companies
to large fines and stock price declines. This instructional assignment introduces students
to the FCPA and provides an illustration of FCPA compliance problems at Nature’s
Sunshine Products (Nature’s). Students will (1) discuss the development, requirements,
and importance of the FCPA; and (2) identify red flags at Nature’s suggestive of FCPA
noncompliance. This instructional assignment also includes a supplemental requirement
whereby students are asked to identify ways that internal auditors could have assisted
Nature’s in achieving FCPA compliance. This instructional resource, which could be
used in undergraduate or graduate external or internal auditing courses or in managerial
or forensics courses, provides instructors with a resource for integrating real-world
problems involving international business issues into the course curriculum.
Keywords: bribery; compliance; Foreign Corrupt Practices Act (FCPA); internal audit;
international business issues; risk.
CASE
Nature’s Sunshine has always maintained the highest ethical standards in the way we
conduct our business, just as we are committed to the highest quality in the products we
make and sell.
—Douglas Faggioli, President and CEO of Nature’s Sunshine Products, Inc.
M
r. Faggioli made these remarks as he accepted a 2004 ‘‘100 Best Corporate Citizens’’
award from Business Ethics magazine. Nature’s Sunshine Products (Nature’s) received
the ethics award four years straight: 2003–2006. During this period, Nature’s discovered
its Brazilian subsidiary (Nature’s Brazil) was involved in a bribery scheme that exposed Nature’s to
enforcement under the Foreign Corrupt Practices Act (FCPA). Just two years after lauding his
company’s ethics, Mr. Faggioli and Nature’s CFO, Craig Huff, along with Nature’s, were named
Heather M. Hermanson is a Professor at Kennesaw State University, and Audrey A. Gramling is a Professor
at Bellarmine University.
We acknowledge the helpful comments of James Rebele, Rich Clune, Cami Cotuna, Dana Hermanson, David Stout, our
graduate forensic accounting and auditing students, the editor, associate editor, and two anonymous reviewers.
Published Online: April 2013
599
Hermanson and Gramling
600
plaintiffs in a class action lawsuit. How did Nature’s go from winning repeated ethics awards to
being subjected to Securities and Exchange Commission (SEC) enforcement violations?
By completing this assignment you will examine the history and reporting requirements of the
FCPA and its impact on operations at Nature’s. In particular, you will focus on the impact of
Nature’s operating in a ‘‘risky’’ region and industry, and having a decentralized operating structure
on Nature’s overall FCPA risk. Also, you will examine the personal implications of serving in a
supervisory capacity and signing documents as an officer of a reporting entity.
As presented in the following sections, it appears that Nature’s failed to implement a strategy
for dealing with all three aspects of the FCPA: (1) ensuring that its employees knew that bribery is
illegal, (2) requiring sufficient and accurate documentation for all transactions processed in the
accounting system, and (3) developing a system of controls to detect or prevent bribery (and cover
up) from occurring.
COMPANY BACKGROUND
Nature’s evolved from the kitchen table of Eugene and Kristine Hughes into a multi-milliondollar corporation in less than a decade. Eugene Hughes, an elementary school teacher suffering
from a bleeding stomach ulcer, took a neighbor’s advice and found cayenne pepper powder to be a
successful herbal treatment for his ulcer. Kristine suggested that Eugene encapsulate the powder,
making it easier and more palatable to consume, and a new family business emerged.1
The Hughes couple started selling their herbal ulcer treatment at a local health food store. Soon
they added other herbal remedies to their products and recruited a large number of door-to-door
salespeople. Through training and appearances at large sales conventions, the independent sales
staff grew, and so did the company. Nature’s focused on achieving record sales targets. In 1978, the
couple took the company public. They expanded the product offerings by adding water purifiers
and personal care products to the mix of existing herbal products. By the end of its first decade, the
company had annual sales of $25 million. The following decade, the company continued to grow,
with over 300 products and 25,000 distributors. By 1987, Nature’s was the U.S.’s largest producer
of encapsulated herbs. The focus then turned to growing sales beyond the U.S.
The Hughes couple hired Alan Kennedy, a direct-marketing leader formerly at Avon, to take
the company to the next level. Kennedy expanded the sales force to 100,000 independent sales
representatives, and expanded operations into Mexico, Costa Rica, Venezuela, Colombia, and
Brazil. By the early 1990s, sales exceeded $125 million (Grant 1996).
As the global market for natural remedies grew during the 1990s, sales of encapsulated herbs
dominated Nature’s. In 1994, Nature’s created a subsidiary in Brazil (Nature’s Brazil), which
became its biggest foreign market. During 1999–2000, the Brazilian government reclassified certain
herbal products as medicines. This reclassification required Nature’s Brazil to register many of its
products as medicines. Nature’s Brazil was unable to register a large number of its products, so
sales declined dramatically. This put pressure on Nature’s to get the products into Brazil. As a
result, Nature’s Brazil made undocumented cash payments to customs brokers (some of which were
ultimately received by customs officials) that allowed unregistered products to be imported and sold
in Brazil. Essentially, Nature’s Brazil employees funneled bribes to officials through customs
brokers, so the officials would allow the products to be sold in Brazil. Because bribery violates the
FCPA, the company had to ‘‘hide’’ these payments through a series of journal entries designed to
make the bribes appear to be legitimate expenditures (SEC 2009).
1
The company was initially formed as Hughes Development Corporation and then Amtec Industries Incorporated
before the 1982 change to Nature’s Sunshine Products. Company history is adapted from the International
Directory of Company Histories (Grant 1996) and SEC filings.
Issues in Accounting Education
Volume 28, No. 3, 2013
Nature’s Sunshine Products: Anatomy of an FCPA Failure
601
FOREIGN CORRUPT PRACTICES ACT
The Foreign Corrupt Practices Act, enacted in 1977, contains three distinct provisions:
1. It is illegal to bribe foreign officials to obtain/retain business.
2. Companies must keep books and records that accurately reflect their transactions.
3. Companies must maintain adequate internal controls.
The FCPA stems from Watergate-era investigations into illegal contributions to President
Nixon’s reelection campaign. What started as concern about illegal corporate campaign
contributions gave way to broader concerns about the way U.S. corporations operated abroad.
An investigation by the Securities and Exchange Commission (SEC 1976) documented that at least
400 companies spent in excess of $300 million bribing foreign officials to obtain favorable business
status. Examples of the types of bribery documented by the SEC (1976) include:
!
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United Brands Company (Chiquita Bananas) bribed the president of Honduras to lower the
export tax on bananas.
Lockheed Aircraft Company bribed the prime minister of Japan to help sell jets to a Japanese
airline.
Exxon Oil Corporation bribed Italian officials to obtain a natural gas contract.
While many corporate leaders argued that bribery was the only means of securing business in
many countries overseas, Congress and President Jimmy Carter pushed through the FCPA, arguing
that bribery has grave repercussions for foreign policy and free markets. Corrupt business practices
had sullied the reputation of American business and capitalism in general. The FCPA was intended
to restore confidence in our markets.
FCPA enforcement falls across two governmental agencies: the SEC (civil enforcement) and
Department of Justice (DOJ) (civil and criminal enforcement). Exhibit 1 highlights the five required
elements for an FCPA violation, and some important terms and rules related to the FCPA.
In 1977, the U.S. was the only country to criminalize bribery of foreign officials. In fact, some
European countries treated bribery of foreign officials as tax deductible. U.S. multinationals faced a
competitive disadvantage in markets where bribery was an accepted practice for other participants.
To level the playing field, the U.S. lobbied heavily to engage other countries in enacting similar
legislation. It took another 20 years until a consensus of other major countries adopted something
similar to the FCPA—the Organization for Economic Cooperation and Development (OECD) AntiBribery Convention. For over two decades following the FCPA enactment, the U.S. government
and corporations largely ignored enforcement of the FCPA.2
It took the financial fiascos of the early 2000s and the creation of the Sarbanes-Oxley Act
(SOX) in 2002 to rejuvenate interest in the FCPA. Since the passage of SOX, the DOJ and SEC
have pursued FCPA cases with vigor. In fact, the SEC recently created a special FCPA unit within
its enforcement division. Since 2004, SEC and DOJ enforcement cases have gone from a combined
total of five in 2004 to 74 in 2010 (Gibson, Dunn & Crutcher 2011). Recent SEC FCPA
enforcement actions include General Electric, Johnson & Johnson, Siemens, and Tyson Foods.
After a New York Times investigative article in 2012, Walmart publicly announced an internal
investigation into possible violations in Mexico, where it is alleged to have engaged in bribes
totaling more than $24 million (Barstow 2012).
2
Currently, 38 countries have adopted the OECD Anti-Bribery Convention. However, China, India, Russia, and
numerous other significant South American, African, and Asian countries have failed to participate in the antibribery initiative.
Issues in Accounting Education
Volume 28, No. 3, 2013
Hermanson and Gramling
602
EXHIBIT 1
Key FCPA Terms and Rulesa
Panel A: Five Required Elements for an FCPA Violation
1
Who
2
Corrupt Intent
3
Payment
4
Recipient
5
Business Purpose Test
Any individual, firm, director, employee, or agent of a firm who is
either U.S. based or has U.S. registered securities. As long as the
company is U.S. based or registered, the fact that the bribe occurs
in another country does not protect against prosecution.
Whether it succeeds or not, if the intent of the payment is to
influence a foreign official to use his/her power to affect a
business decision, then corrupt intent is met.
Paying, promising to pay, or offering anything of value is
prohibited.
Foreign officials include any officer or employee of a foreign
government, a public international organization, or any person
operating in an official capacity.
Payments made in order to obtain or retain business or direct
business to any person are prohibited. The business does not have
to be with the foreign government.
Panel B: Intermediaries/Third Parties (e.g., Customs Brokers)
It is illegal to make payments to an intermediary knowing that a portion of the money will be paid
directly or indirectly to foreign officials. The Department of Justice defines knowing as conscious
disregard or deliberate ignorance.
Panel C: Facilitating Payments
Payments made to expedite a routine government action (e.g., obtaining permits, licenses, processing
visas, providing power and water, protecting perishable goods, and scheduling inspections) are
allowed. Facilitating payments do not include officials awarding new business or continuing with
previous contracts.
Panel D: Criminal and Civil Penalties
Criminal fines for corporations may be up to $2,000,000, and $100,000 for individuals (officers,
directors, employees, agents). Individuals may receive prison terms of up to five years (the average is
about two years).
Civil fines may be brought by either the DOJ or the SEC in amounts ranging up to $500,000.
a
Adapted from the Department of Justice FCPA Lay-Person’s Guide (DOJ 2011).
FCPA noncompliance can be very costly. A study examining the total costs of FCPA internal
investigations and legal fees estimates the cost to be approximately 1.13 percent of the company’s
total market value (Karpoff et al. 2012). Based on this analysis and Walmart’s approximate market
value of $212 billion prior to the FCPA allegations, Walmart may incur as much as $2.4 billion in
incremental costs to investigate and defend the FCPA violation allegations. Karpoff et al. (2012)
caution that the real costs relate not to the bribery itself, but to the actions taken to cover up the
bribery. Firms that misrepresent their financial statements to hide bribery face much larger losses
(e.g., based on a small sample in their study, total FCPA losses that included fraud allegations were
Issues in Accounting Education
Volume 28, No. 3, 2013
Nature’s Sunshine Products: Anatomy of an FCPA Failure
603
51.58 percent of market value, a substantial reputational loss). In addition, individuals face being
sentenced to prison, with the average FCPA sentence being about two years (FCPA Blog 2012).3
FCPA COMPLIANCE PROBLEMS AT NATURE’S
Exhibit 2 shows the pattern of sales of Nature’s Brazil before and after the requirement to
register many of its products as medicines and includes commentary from the company’s annual
report. The exhibit highlights the impact of the new registration requirements on Nature’s Brazil’s
sales. According to the SEC’s case against Nature’s, Nature’s Brazil made an attempt to bypass the
new import restrictions by making cash payments to aid the import of unregistered products into
Brazil. Payments to customs brokers totaling over $1 million were made between 2000 and 2001,
and some of this money ultimately was paid to customs officials as bribes. To hide the nature of
these payments, Nature’s Brazil classified them as ‘‘importation advances,’’ a legitimate import
expense.
Nature’s Brazil did not have supporting documentation (e.g., detailed invoices from legitimate
vendors) for as many as 80 cash payments (since they were bribes), so Nature’s Brazil purchased
fictitious documentation for these payments in order to make it appear that the bribes were
legitimate expenses. None of this activity was disclosed in its 10-K filed with the SEC. At this
point, two of the three provisions of the FCPA were violated. Nature’s Brazil was (1) bribing public
officials, and (2) failing to keep books and records that accurately reflected its transactions. One
could argue that the third FCPA provision also was violated because it does not appear that Nature’s
system of internal controls prevented or detected the problem such that it was brought to the
attention of corporate management. Once Nature’s Brazil engaged in the ‘‘cover up’’ of its bribery,
it exposed itself to fraud charges (e.g., willful financial misrepresentation).
Around this time, two controllers from Nature’s (headquarters) visited Nature’s Brazil and
discussed the declining sales situation with Nature’s Brazil’s operations manager. The operations
manager indicated that in order to find a customs broker willing to facilitate the importation of
unregistered products, Nature’s Brazil had to pay fees representing 25 percent of the value of its
products (SEC 2009). The operations manager told the controllers from Nature’s that months of
inventory were sitting in port because customs brokers were not willing to risk facilitating
unregistered products (e.g., it was difficult to find anyone willing to bribe the necessary officials to
let the products into Brazil). Also, some products that Nature’s Brazil did manage to get into the
country were sold illegally. The operations manager explained that he had reported the situation to
the Nature’s Brazil general manager, but that the general manager stated that Nature’s
(headquarters) knew about the problems in Brazil. At the very least, the two controllers from
headquarters now knew about the problem. These controllers had responsibility for Nature’s books
and records and for preparing financial reports that included the results of Nature’s Brazil.
Risks of FCPA Noncompliance at Nature’s
As part of its system of internal controls, Nature’s should have had a process for assessing the
risk of exposure to FCPA and for implementing appropriate controls such that (1) bribery would
be prevented/detected, and (2) the accounting records provided enough detail to substantiate
legitimate transactions and record them in the appropriate accounts. It appears that Nature’s failed
to focus on its risk of FCPA noncompliance, including geographic risk, industry risk, and
organizational risk.
3
The FCPA Blog (2012) reports that the FCPA sentencing range is huge and unpredictable.
Issues in Accounting Education
Volume 28, No. 3, 2013
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604
EXHIBIT 2
Nature’s Brazil Sales Data (in Millions) as Reported in Annual Form 10-K
Excerpts from Management’s Discussion & Analysis
FY 1999 Report:
During 1999 and 1998, the Company’s sales revenue was negatively impacted by foreign currency
devaluation in the majority of its international markets, most notably Brazil, and increased
competition in the Company’s domestic market. Eliminating the adverse effect of foreign currency
devaluation, sales revenue for the year ended December 31, 1999, would have increased
approximately 3 percent.
FY 2000 Report:
No separate mention of Brazil was made in the MD&A of this report.
FY 2001 Report:
During 2001, the Company’s operation in Brazil experienced a 57 percent decrease in sales revenue
to $9.6 million, compared to $22.1 million in 2000. The decrease in sales revenue was due to import
regulations imposed by the Brazilian government. The Company expects these new regulations to
continue to adversely impact sales revenue and operating results during 2002.
FY 2002 Report:
Sales revenue for 2002, 2001, and 2000 in our operations in Brazil was $5.2 million, $9.6 million,
and $22.1 million, respectively. The decrease in sales revenue was due to import regulations imposed
by the Brazilian government. We expect these new regulations to continue to adversely impact sales
revenue and operating results during 2003.
FY 2003 Report:
Net sales revenue for 2003, 2002, and 2001 in our operations in Brazil was $2.6 million, $4.9
million, and $9.1 million, respectively. The decrease in net sales revenue was due to import
regulations imposed by the Brazilian government. We expect these new regulations to continue to
adversely impact net sales revenue and operating results during 2004. [Note: It is unclear why 2002
and 2001 Brazil sales changed in this report.]
Geographic Risk
Nature’s could have considered the corruption risk of the countries in which it operates.
Transparency International (TI) rates the relative corruption of different countries (see http://www.
transparency.org). TI defines corruption as ‘‘the abuse of entrusted power for private gain.’’ TI
distinguishes between two types of corruption: according to the rule and against the rule.
According to the rule is where a bribe is paid to receive preferential treatment (e.g., the …
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