Bribery tends to throw up some colourful characters and this Korean case is no exception. It illustrates how the lack of fraud controls can result in consequences significantly more serious than a simple financial loss. The best place to start, they say, is at the beginning, so here is a little context.
Background
As a result of the Korean War in the early 1950’s, the country was split North-South by a de-militarised zone along the 38th parallel. South Korea’s autocratic president resigned after the 1960 Student Uprising and, after a year of political instability, was replaced with another autocrat when General Park Chung-hee led a military coup. Park was a ruthless dictator but the South Korean economy grew significantly under his rule. His government was also responsible for delivering the nationwide expressway and the Seoul subway before his assassination in 1979. Then followed another military coup, further martial law and brutal suppression, which continued until democratic elections in 1987. Seoul hosted the Olympic Games in 1988, which was a boost for both the country’s image and its economy, and South Korea became a member of the United Nations in 1991. The economy continued to grow. Between 1962 and 1994, it grew at an average 10% annually, fuelled by annual export growth of 20%.
However, tensions with North Korea remained and in 2010, there was an escalation including the sinking of a South Korean warship and the shelling of Yeonpyeong Island by North Korean artillery. The lack of a strong response to these attacks caused significant anger amongst the South Korean public and may have been a factor in the 2012 elections which returned a conservative president, Park Geun-hye, Korea’s first female president and the daughter of General/President Park Chung-hee.
KT Corporation
KT Corporation, formerly known as Korea Telecom, is listed in the US and, in a securities filing dated April 2020, disclosed a number of Korean prosecutions. The filing included the following:
- A former Chief Executive Officer was charged with embezzlement and breach of fiduciary duty and a former President was charged as a co-conspirator. After sentencing and appeals in relation to the embezzlement, both men were eventually acquitted by the Seoul High Court.
- KT made donations to two non-profit foundations at the request of President Park Geun-hye. An aide of President Park also asked a previous CEO to hire two individuals and to award advertising contracts to an advertising agency in which the aide owns a 70% equity interest.
- President Park Geun-hye was indicted on charges including bribery, coercion and abuse of power and in August 2018, she was sentenced to a prison term of 25 years and a fine of USD15.6mn, having been found guilty on many of the charges, including those related to KT.
- In January 2018, the Korean Prosecutor’s Office indicted a former member of the National Assembly, for soliciting donations or financial sponsorships from various businesses, including KT. At the same time, Korean police began investigating whether current and former executives and employees of KT violated the Political Funds Act of Korea, by making donations or gifts to various lawmakers using corporate funds.
- In March 2019, the KT New Labour Union filed criminal complaints against a previous CEO, alleging a criminal breach of fiduciary duty in connection with management consulting contracts between KT and former public officials.
- In April 2019, four former executive officers were indicted in relation to improper hirings during the public recruiting process of college graduates in the second half of 2012; in October 2019, the Seoul Southern District Court found all four guilty.
It’s no surprise that the filing also revealed the company was co-operating with a US Securities and Exchange Commission (SEC) investigation into alleged violations of the Foreign and Corrupt Practices Act (FCPA). In February 2022, the SEC announced that KT will pay USD6.3mn to resolve charges that it violated FCPA by providing improper payments for the benefit of government officials in Korea and Vietnam. The SEC stated:
For nearly a decade, KT Corp. failed to implement sufficient internal accounting controls with respect to key aspects of its business operations, while at the same time lacking relevant anti-corruption policies or procedures.
Show Me the Money
Bribery relies on the transfer of an illegal and, if you want to be successful, unrecorded benefit between two parties. Cash is king; other benefits may be acceptable, but where do you get them? Thanks to the SEC, keep reading for some great examples which may prompt you to look at your own processes and controls.
The KT Slush Fund Story
Between 2009 and 2017, high-level executives of KT maintained slush funds, comprised of both off-the-books accounts and physical stashes of cash, in order to provide items of value to government officials, among others.
From 2009 to 2013, a KT executive operated a scheme which approved inflated bonuses to other company officers and executives, which they returned to him in cash, allowing him to generate a slush fund of approximately USD1mn. Some of the funds were held in a personal bank account, while the cash was stored in a safe in KT’s offices. Nobody at KT recorded the recipients of the gifts, although KT executives knew the money was used for gifts and payments to government officials. In October 2013, there were media reports about the bonus scheme, resulting in the resignation of the executive responsible during the following month. Criminal charges were laid in April 2014. The bonus scheme had become unsustainable, and KT executives had to come up with a new scam to support their slush fund.
From 2014 to 2017, KT’s Corporate Relations (CR) function managed the slush fund. They did this by purchasing gift cards, which were then converted to cash for the slush fund. A CR senior manager would tell a CR mid-level manager how much cash to obtain and the mid-level manager would then raise an order for gift cards from a particular vendor on an internal purchasing system. When buying gift cards to convert to cash, they would be described as “CR Case Benchmarking,” in the purchasing system. Once the vendor’s invoice was paid, he would meet the mid-level manager in a van in the parking lot next to the KT building. The vendor would hand over a paper bag containing a large manila envelope of cash, corresponding to the value of the gift cards purchased, minus the vendor’s slice of the action. The mid-level manager then passed the cash to the CR senior manager who placed it in a double-locking cabinet (well, you just can’t trust people, can you?).
The CR senior manager passed this cash to KT officers and managers, with the understanding that they would transfer the funds electronically to the contribution accounts for various Korean lawmakers. Once the transfer was made, the CR employee would inform the particular lawmaker’s aide that the contribution came from KT. You won’t be surprised to learn that most of the funds went to lawmakers who sat on committees with the ability to impact the telecoms industry and, consequently, KT’s business. Corporate Relations also generated an additional USD910,211 for improper gift and entertainment expenses, resulting in a total value for the slush fund of USD1.3mn. KT booked the gift card expenses as either “research and analysis” or “entertainment”. In November 2021, Korean authorities indicted KT and fourteen high-level executives for criminal violations in connection with the gift card scheme.
Unofficial Payments
Between 2015 and 2016, KT made payments of over USD1.6mn to various organisations at the request of high-level government officials. The foundations for sports and for Korean culture were established by a close associate of the President and the payments were made in response to encouragement from the Blue House (Korea’s presidential residence and office). All of these payments were disguised as charitable donations or as sponsorship. KT took no steps to establish whether these were legitimate donations and the investigation established that the original donation request was made and the first payments were agreed by KT before the foundations actually existed!
In response to a Blue House request, KT senior management also agreed to hire two advertising executives with personal connections to the Blue House. After they were hired they were transferred to more desirable positions. KT also altered its criteria for outside advertising agencies in order to hire a new agency established by the same close associate of the President who had established the foundations. Communications between the Blue House and KT referred to the President as ‘the VIP’. The Blue House official who requested these appointments told KT that the VIP “had major concerns about KT’s advertisements” and that these moves were “important to the VIP.” So, without conducting due diligence on the individuals or the agency, KT paid the two individuals a total of USD454,000 in salaries and the advertising firm a total of USD5.88mn in fees.
The Vietnam Scams
KT made bids for projects in Vietnam, including a solar cell power system in Quang Binh province and a project with the Vietnam Ministry of Labour, Invalids and Social Affairs to provide hardware, software, and training for five vocational colleges. KT employees internally discussed providing money to third parties connected to government officials in Vietnam in order to obtain contracts for these two projects.
In 2014, KT entered into an arrangement with a construction company to pay a bribe of USD95,031 to a high-level official of Vietnam’s Quang Binh province in order to secure the solar power project. On September 10, 2014, a junior employee in KT’s Hanoi office told an employee of a subcontractor to the construction company:
KT Hanoi will handle the matter of deliver[ing] money to the right person. Only KT Hanoi office now can handle this matter because others couldn’t make it. We will do it in the right way and make it work. So please arrange to transfer the money within today or before next Monday.
The construction company wired money to the employee’s bank account and he withdrew it in cash before he, and a construction company representative, travelled to the Sun Spa resort in Quang Binh, where the government official received the money. Subsequently, a member of the sales team recorded the payment as “a rebate to the project owner”.
In 2018, the construction company applied for reimbursement of the bribe money from KT, described as:
expenses for engaging in sales activities with the ordering organization
KT paid the construction company approximately USD200,000 to settle outstanding dues and described the payment as ‘support/consulting’ in their books.
As part of the solar power project, the government customer was required make an advance payment in January 2015. By March 2015, the payment had not been made, due to delays in the Ministry of Finance. A KT Senior Vice-President instructed a senior employee in the Hanoi office to:
give money to the public officials so that they can speed up the performance of their duties
Using a KT Hanoi office credit card, the senior employee conducted four cash-back transactions at a Hanoi restaurant, totalling approximately USD3,000, which he used to pay the Ministry officials. This money greased the wheels and suddenly the Ministry was able to complete the advance payment to KT.
In 2013-14, KT participated in a consortium bid for the vocational colleges project. The customers were the Vietnam Ministry of Labor, Invalids and Social Affairs and the General Department of Vocational Training (“GDVT”). A high-level official at GDVT introduced KT to a Vietnamese company to serve as a local agent. KT was assured that there was a better chance of winning when using the company designated by the GDVT Official. In addition, KT learned that 10% of the project cost would go to the agent, who would pass on 7% of the project cost to the GDVT Official. But, in May 2015, the consortium partner due to pay the agent’s fee told KT it didn’t want to take responsibility, due to the risk involved. Undeterred, KT reorganised the consortium and assumed responsibility for the agent’s fee. KT and the agent agreed that the fee would be 8.5%, which included USD550,000 for the GDVT official, who planned to retire soon and wanted his money up front.
KT arranged for a subcontractor to become a consortium partner, and then tasked it with paying the agent’s fee. This distanced KT from the agent, and also concealed the agent from KT’s internal agent review process. This agent review process wasn’t an anti-corruption review. The purpose of this review was to mitigate financial risk but KT managers wanted to avoid any questions about KT’s relationship with the agent. Paying the agent’s fee via the subcontractor enabled them to avoid KT’s agent review process.
On May 19, 2015, the subcontractor sent KT a quotation supposed to cover a site survey plus legal and technical consulting. The agent fee of approximately USD735,000 was hidden in the quotation as “site survey for installation”. The sales lead for KT gave the following explanation to the SVP:
As for the fee for the agent… it would not be separately indicated… it will be included in the estimate for additional tasks based on [the subcontractor’s] consent.
KT managers clearly understood that this fee was for the agent and that it was concealed to avoid review. On May 28, 2015, the KT consortium executed the contract for the vocational colleges.
When KT had difficulty with the government customer, it turned to the agent for assistance. For example, on June 6, 2015, the SVP emailed the sales team:
It is ridiculous that [GDVT] approval is going to take 1 week. Through [the agent], make [a PMU official] get the approval in one day. Do everything and anything to have this done… Immediately push them to prepare the required documents for the [GDVT] approval. Also use [the agent] when you do this.
You need to discuss these matters tomorrow, Sunday. When it is difficult, use [the agent] to move [a PMU official].
At least one interim payment was made to the agent for these services and in January 2017, KT paid the subcontractor approximately USD775,000 for an undocumented consulting service. Of course, in reality this was reimbursement for payments made to the agent in order to bribe the GDVT Official.
What Do You Think?
Here’s a reminder of what the SEC said:
For nearly a decade, KT Corp. failed to implement sufficient internal accounting controls with respect to key aspects of its business operations, while at the same time lacking relevant anti-corruption policies or procedures.
Someone at the SEC is a master of understatement. The Foreign and Corrupt Practices Act was enacted in 1977, and KT was founded in 1981. Based on the SEC findings above, I can’t help wondering if their corrupt activities began in 2009 or whether KT has ignored FCPA from the beginning. In 2002, the Sarbanes-Oxley Act (SOX) brought in additional requirements relating to corporate and auditing accountability, responsibility, and transparency. 15 years wasn’t long enough for KT to catch up with that either.
It was reassuring to see the number of investigations and prosecutions initiated by the Korean authorities, but if I was a KT shareholder I would still be asking questions, including:
- Are there other corruption examples which could result in further penalties from US authorities? May other significant frauds have also gone undetected?
- Is the company’s board confident it can make full and timely disclosures to the authorities for any further suspected corruption?
- Who did KT employ to investigate and audit their business, and what were they doing?
- Did external auditors do their job effectively in this period?
- Are sufficient resources being put into remediation activities?
Maybe I’ve overlooked possible cultural influences, but what struck me most about this case was that KT management criminalised their colleagues by involving them in bribery, whilst still assuming they could be trusted to handle millions of dollars of off-record and untraceable cash. How much of the slush fund went missing in the pipeline?
I hope this example has demonstrated how weak preventive and detective controls can be abused. This may have given you ideas about checks you might perform in your own business. This article promised you colour but most of that colour comes from all the red flags! Look out for the sequel to this article, which introduces three colourful characters, a new telecoms player and fills in more details about the money trail.
