Toronto B

Toronto B
Michael McIntyre
Corporate Performance Systems - MBUS833
15 May 2014
Corporate Governance Failure at Daimler:
Bribery of Foreign Officials
Between 1998 and 2008, Daimler, a German manufacturer and seller of luxury passenger
cars and industrial vehicles, paid over $56 million in illegal payments to corrupt foreign officials
in 22 countries to obtain government contracts in violation of German and American anti-bribery
laws. In doing so, it falsified its books and records to hide the transactions.1
Headquartered in Stuttgart, Germany, Daimler is a large decentralized company with
over 270,000 employees and 60 affiliates around the world2, and in 2006, the companys
revenues were $200 billion. The company enjoys the highest brand loyalty among luxury car
owners, and the brand is highly associated with prestige.3 The organization sells cars in various
countries around the world through local affiliates, and all foreign sales are overseen by a single
Head of Overseas Sales. The company is managed by a Board of Management, which is
appointed and monitored by its Supervisory Board.4 Daimler is a publicly listed stock issuer in
both Germany and the United States, and is therefore subject to both the German Act on
Combating Bribery of Foreign Public Officials in International Business Transactions and the
American Foreign Corrupt Practices Act.
In response to the legislation, and to the OECD Convention on Combating Bribery of
Foreign Public Officials, Daimlers Board of Management adopted an integrity code in 1999
the same year bribery became illegal in Germanywhich included anti-bribery provisions. At
the time, no supporting compliance structures or procedures were put in place, and it was not
until 2006 that Daimler finally formed a central department of Corporate Compliance, 5 the same
year it set up a whistleblower system.6 Well after compliance controls were put in place, illegal
payments continued and only subsided in January 2008after the US Department of Justice had
begun its investigation.7 According to Mythili Raman of the US Department of Justice,
[Daimler] saw foreign bribery as a way of doing business."8

1
Pages 1 and 2 of the SEC complaint. (Available:
https://www.sec.gov/litigation/complaints/2010/comp-pr2010-51.pdf)
2
Page 53 of the criminal complaint. (Available:
https://www.traceinternational2.org/compendium/file.asp?id=732)
3
2012 New Luxury Vehicle Loyalty Study, conducted by Polk and AutoTrader.com, available
at: http://www.weworkforyou.com/files/insights/pdf/
2012NewLuxuryVehicleLoyaltyStudy-NADASINGLEPAGES.pdf
4
In keeping with the two-tier board structure required by German corporations laws.
5
http://www.daimler.com/company/corporate-governance/integrity-andcompliance/organization
6
http://www.daimler.com/company/corporate-governance/integrity-and-compliance/bpowhistleblower-system
7
Page 4 of the criminal complaint.
8
U.S. judge OKs settlement in Daimler bribery case: http://www.reuters.com/

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Having been legal until 1997, 9 bribery was still ingrained in the culture at Daimler in
1999, and this led to a failure of governance, which resulted in flagrant and ongoing violations of
the law and the companys own code. Violations included using shell corporations to allow
foreign officials to submit sham consulting invoices to the company, and using internal accounts
controlled by third parties or affiliates from which cash could be withdrawn to pay bribes
without being accounted for properly. These accounts were authorized by top management and,
until 2002, employees could withdraw cash directly from the accounts without properly
recording the intended use of the cash that would then be used to bribe foreign officials.10
The companys internal audit department tried unsuccessfully to stop the improper
payments from these accounts. It raised a warning to senior management in May 2000 that the
accounts could be used to make improper payments, and later, in 2001, it recommended that all
such accounts be closed. 11 Senior management at the time did not implement the
recommendation,12 and it was not until 2005, after the violations had been uncovered and the
criminal investigation had begun, that all these accounts were finally closed.13
During its investigation, the Department of Justice uncovered a document written by
internal audit staff which appeared to educate managers on how to reduce the likelihood of
detection when making illegal payments by choosing an appropriate scheme such as payment of
fictitious services.14 This document demonstrates that not only was internal audit ineffective
in persuading management to implement the controls necessary to avoid fraud, but it also
assisted in the bribery program.
The violations were uncovered in 2004 by whistleblower David Bazzetta, a former
employee in the companys internal audit department, who filed a complaint alleging that he
was fired for protesting secret bank accounts used to pay foreign officials.15 The Securities and
Exchange Commission and the US Department of Justice (DOJ) concluded their investigations
in 2010 and settled with Daimler for $200 million in fines and disgorgement. 16
The failure of governance that allowed these violations to occur, at bottom, was characterized
by inadequate compliance effort, which consisted of the following weaknesses (as identified by
the US Department of Justice):

Before 2006, the companys compliance function was being performed entirely by
internal audit. Internal audit was decentralized and had employees located in 27 local
departments globally, most of whom reported to local sales managers.17 This reporting
structure provided disincentive for internal audit to see its recommendations implemented

article/2010/04/01/us-daimler-bribery-idUSTRE6303WY20100401
9
S.E.C. Inquiry Latest Problem for Daimler
http://www.nytimes.com/2005/08/06/automobiles/06daimler.html?_r=0
10
Page 6 of the criminal complaint.
11
Pages 7 and 8 of the criminal complaint.
12
Page 8 of the criminal complaint.
13
Page 11 of the criminal complaint.
14
Page 10 of the criminal complaint.
15
Daimler to pay $200 mln, end bribery probe-report: http://www.reuters.com
/article/2010/02/12/daimler-probe-idUSN1223697020100212
16
Ibid.
17
Page 53 of the criminal complaint.

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since local managers would lose sales if they stopped bribing government officials. As
demonstrated by the educational memo described earlier, internal audits incentives
appear to have been aligned with those of the sales organization.
The companys financial control and legal functions reported directly to the sales
organizations within their country or business unit.18 This negated the independence of
the control aspect of the finance function by aligning the interests of the financial and
legal departments with sales, rather than with the best interests of the company itself.
The company lacked a head of compliance.19
There were no controls in place to prevent employees from taking cash from the
companys accounts to pay bribes.20
The company failed to train employees on the topic of anti-bribery.21

The failure of management to implement the necessary controls was either undetected by the
Supervisory Board or ignored. It was not until the 2004 complaint and subsequent SEC and DOJ
investigations that the company focused on implementing a robust corporate compliance
program. It is clear that the rules changed much more quickly than did the culture of the
organization at all levels.
As a result of the governance failure at Daimler, the company attracted a great deal of
negative press, but customer loyalty did not seem to suffer, likely because bribery appears to the
public to be a largely victimless crime. Some employees were fired, and others were docked
pay.22 Overall there was little impact to the organization besides the amount paid to settle the
complaints and the resulting changes to the companys compliance systems.
During the DOJ investigation in 2006, the company finally implemented specific
corporate compliance policies and guidelines. In its 2007 corporate governance report, 23 the
company outlined the steps it was taking to implement a compliance program: in 2007, the
company adopted a zero tolerance policy, approved additional disciplinary guidelines,
appointed 44 local compliance managers globally with centralized reporting, and trained 3,700
employees.24 The Board of Management established a compliance committee in 2006 to monitor
and approve the compliance systems.25 Despite the efforts of the company during this time, the
DOJ uncovered evidence that improper payments continued to occur through January 2008.

18
Ibid.
19
Ibid.
20
Ibid.
21
Page 54 of the criminal complaint.
22
At Daimler, a Former German High-Court Judge Leads Compliance Program:
http://online.wsj.com/news/articles/SB10001424052702304202204579252510107054576
23
Daimlers 2007 Corporate Governance Report (Available:
http://gb2007.daimler.com/daimler/annual/2007/gb/English/pdf/
07_DAI_AR2007_Corp-Gov.pdf
24
Ibid.
25
Ibid.

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The settlement in 2010 required the company to, among other things, hire an independent
monitor and adopt a more rigorous compliance program. 26 The company brought in Louis
Freeh, a former director of the Federal Bureau of Investigation to fill the role of independent
monitor.27 Freehs first report in 2010 noted, unsurprisingly, that not enough progress had been
made in the area of compliance.
The company then hired Christine Hohmann-Dennhardt, a former German high-court
judge, as its first compliance chief. 28 By placing Hohmann-Dennhardt on its Management
Board, Daimler gave the department more teeth than the internal auditors had previously.
Hohmann-Dennhardt made further enhancements to companys compliance program during her
tenure. According to the Wall Street Journal, one of the new measures required any business
dealings that could involve government officials to be scrutinized by a central compliance desk.
The compliance team also does an annual analysis of which countries have the highest risk of
bribery... 29
In addition to tighter controls and oversight, Hohmann-Dennhardt set about changing the
culture at the company:
In addition to town-hall meetings and employee training programs, Daimler has
used more whimsical means to boost awareness of ethics and compliance. It has
sent an "integrity truck" to its plants to solicit employees' views on workplace
matters, hired a performer who poked fun at the company and its compliance
problems, and put together an animated movie about compliance.30
Hohmann-Dennhardt recently told the Wall Street Journal as compliance activities, such
as special training for countries with a higher risk of bribery, became a normal part of Daimler
employees' working lives, the climate improved.31
Daimler was forced to implement an improved compliance program because of a criminal
investigation, but it was always the responsibly of the Supervisory Board to ensure that the
Board of Management had an adequate compliance system in place. The reasons for the
Supervisory Boards failure at this task may only be speculated upon, but one possible reason
lies in the composition of the board itself. Specifically, German governance laws call for codetermination, which results in half of a boards members being made up of employees. Ingo
Saenger explored the potential negative impact on governance of co-determination in 2005,
writing:
the co-determined supervisory board might be weakened as a means for
reducing agency costs and in its function as an internal and institutionalized
control mechanism. This is due to the self-evident fact that employee
representatives' interests and shareholder representatives' interests are not
necessarily the same. Additionally, from a psychological perspective, workers'
representatives lacking the expert business knowledge of other supervisory board

26
At Daimler, a Former German High-Court Judge Leads Compliance Program:
http://online.wsj.com/news/articles/SB10001424052702304202204579252510107054576
27
Ibid.
28
Ibid.
29
Ibid.
30
Ibid.
31
Ibid.

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members must be inclined to retreat to a more secure terrain, and that is their
knowledge of the workers' concerns.32
In addition to the weakening of independence of the Supervisory Board caused by codetermination, often supervisory board members are former Board of Management members, as
seen with the example of Dr. Manfred Bischoffa former member of the Board of Management
who has been appointed Chairman of Daimlers Supervisory board until 2016. Saenger notes:
it is doubtful whether a former manager's presence is compatible with the
supervisory board's monitoring function and with the system of strict separation
of the company's two administrative bodies, namely the supervisory and the
management board. It is likely that the transition of the old to the new
management is exacerbated due to a reciprocal dependence of both organs.
Especially with regard to the supervisory board's retrospective supervision, a
former management board member has to take part in its own supervision, a task,
which can hardly be fulfilled without being prejudiced.33
It is possible that a stronger, more independent Supervisory Board would have pressed
Daimler management towards compliance sooner and without the intervention of government
authorities.

32
Saenger, Ingo. "Conflicts of interest of supervisory board members in a German Stock
Corporation and the demand for their independence: an investigation in the context of the current
corporate governance discussion." Corporate Governance Law Review 1.1 (2005): 147+.
Academic OneFile. Web. 14 May 2014.
Document URL
http://go.galegroup.com/ps/i.do?id=GALE%7CA160812786&v=2.1&u=queensulaw&it=r&p=A
ONE&sw=w&asid=1042cc65044c4caf7e03850da3db58b4
33
Ibid.

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