May 18, 2018

Editor’s note: The below is contributed content.

By Jingyi Li Blank, Director at Mintz Group

Wesley Batista and his brother Joesley deserved much more scrutiny. In 2017, the CEO and former chairman, respectively, of JBS S.A., in Brazil, one of the world’s largest meat processing companies, entered into a plea bargain with investigators, admitting to bribing more than 1,800 politicians.[1] Financial journalists and compliance specialists have said that the scandal — the damage to the company’s reputation and the subsequent fall of a titan – could have been discovered beforehand, if only someone had thought to look.

Over the past couple decades, savvy food company executives have been quickly arming themselves with a full suite of top-tier solutions to industry-wide problems: lab testing; product tracking; and regulatory, environmental, labor, and standards audits. Those tools focus on the food products themselves, and on detecting missteps or fraud after the fact. There is another significant tool that food executives among other industry officials have increasingly relied on – due-diligence services, focusing on individuals and companies, whose malfeasance can spoil the quality and consistency of any product or corporate initiative. The idea is to spot problems before they arise. Preventive measures (also known as vulnerability assessment) contain two important aspects: business intelligence and supply-chain control.

Government and regulatory bodies around the world have been increasing oversight over supply chains, but given their complexity, there are severe limitations on regulation alone protecting the food supply. According to a December 2015 World Health Organization report, one in 10 people become ill every year from eating contaminated food.[2]  The U.S. Federal Drug Agency (FDA) still suffers from an inefficient and often incomplete food-recall process, according to a December 2017 Department of Health and Human Services report.[3]  Companies are left to prevent brand reputation damage almost on their own. One of the key ways they can protect themselves is utilizing due-diligence tools to get ahead of the avoidable crises. “Food companies seem to be lagging behind other industries, such as the retail and toy industries, in their efforts and focus to prevent problems,” according to an experienced quality-control executive with whom we spoke.

In my line of work, doing due diligence for corporate clients, I have found that diligence services are used more effectively by some management teams than others. The following four scenarios illustrate where management teams can get the most bang for their buck.

Intelligence: On Business Partners

After apologizing for well-publicized food safety scandals in 2012 and 2014, both McDonald’s Corp. and Yum Brands Inc. exited their Chinese businesses in 2016, once one of their largest markets. In the fallout from the scandal, media sources found that McDonald’s’ largest meat supplier, OSI, had subsidiaries in China that were not adequately audited or monitored. The meat company failed to “ensure Chinese plants followed standards coming from OSI’s Illinois headquarters” 6,600 miles away, according to a September 2014 Forbes article.[4] The language barrier also posed a problem, as “Chinese managers wrote documents in Chinese and didn’t translate them, so English-speaking employees often couldn’t understand operations or data.”

In a recent case on behalf of a private equity firm investing in a Chinese food business, we discovered through conversations with former employees and industry experts that the company was experiencing financial difficulties and suffered from operational problems, despite seemingly attractive financial results. Multiple employees told us that a foray into a new brand had caused huge losses at the company, and its cow herd had extraordinarily high death rates. The company had been engaging in riskier projects to draw more investors for an IPO, explained a source familiar with the company’s strategy.

These situations highlight the importance of vetting partners locally – at the sites where they operate – before and during a business relationship. Skillful interviews of relevant human sources, such as former employees or business partners of a company, and usually in the source’s native local language, yield the most valuable insight into potential problems. Good interviewers require years of training and on the ground experience.

While conducting due-diligence research in advance of transactions, we look for inconsistencies, omissions, or other undisclosed controversies or problems involving potential business partners or their key managers. For example, when conducting background checks of this nature, we regularly focus on undisclosed legal disputes, financial problems, regulatory actions, media controversies, or evidence of potentially salacious, personal relationships, all of which may have a direct bearing on the integrity and reputation of a potential business partner or its executives.

2. Supply Chain: Spot Check

Given the number of intermediaries in the food supply chain, many of our corporate clients hire us to spot-check their suppliers and distributors in addition to conducting audits. In contrast to audits, where the subject company is aware of the timing and process, our spot-checking work is discreet, leaving no fingerprints that would alert the company or individual manager that we have been checking them out.

The financial costs resulting from brand damage can be significant and well in excess of the direct economic losses flowing from product recalls. Consider Bill Marler, for example. Over the last 20 years, Marler, a food-safety attorney, has represented victims filing lawsuits against companies including Cargill, Chili’s, ConAgra, Dole, McDonald’s, Odwalla, Peanut Corporation of America, Taco Bell, and Wendy’s. He has secured over US$600 million in settlements and verdicts for victims of E. coli, salmonella, listeria, botulism, and other foodborne illnesses, according to a December 2017 Food Safety News article.[5]

When conducting supply chain investigations, clients often ask us to estimate the scope and scale of production at a subject company. To figure this out, we compile data from a variety of sources, including comparing the inputs and outputs of products that do not line up. This technique is a proven method of uncovering adulterated food and other food frauds.

For example, in one notable investigation a few years ago, a food fraud relating to the import and export of Italian olive oil unraveled when government investigators “noticed that Italy was importing more olive oil than it was exporting – 470,000 tonnes against 250,000 tonnes – prompting questions as to where the imported stuff was ending up,” according to a December 2011 Telegraph UK article.[6] Apparently, the imported oil was being mixed with the higher quality Italian product and then fraudulently passed off as top shelf, according to the article.

3. Supply Chain Review

In response to a number of widely reported (and not so widely reported) scandals, we have been tasked with conducting diligence on companies and management personnel as part of our clients’ review process to determine how the supply chain could have been better prepared and how to use that information to prevent another scandal. In many instances, a check of local courts and with regulators would have revealed warning signs.

For example, we recently discovered two high-profile bribery cases in China that mentioned a potential business partner by name. Although he was never convicted of a crime (apparently because of his cooperation with prosecutors), the court documents revealed how he had bribed multiple local government officials and business executives over the last five years.

Typically, we recommend a targeted adverse background check of a potential business partner before entering into a new relationship. This review would cover a potential business partner’s entire business history, including his or her record of success or failure. Our research would focus on any litigation or regulatory actions naming the person or the companies where he or she has worked, and would cover every jurisdiction in which he or she had been employed. A more in-depth due-diligence check could include conducting spot-check visits to key factories, and conducting discreet inquiries with government, local, and industry sources.

4. Intelligence: In Challenging Jurisdictions

In her well-researched book Swindled, food journalist Bee Wilson writes, “Bangladesh would seem to have all the components which … encourage swindling to flourish: long chains between producer and consumer coupled with a lack of mutual trust, incoherent food laws, a wild undisciplined market economy, a politics which is by turns apathetic and corrupt and a culture in which consumers feel powerless to complain … Bangladesh has one great asset on its side: it belongs to an information age that can transmit information with greater speed than ever in the past.”

Wilson’s observations about Bangladesh also apply to other regions of the world where business opportunities abound, but regulatory oversight is weak. Even though fraud is more frequently uncovered in developing countries, the horse meat scandal in Europe has clearly demonstrated that no region is immune.

The most useful measure to prevent food fraud is to visit the headquarters and factories of a company you are doing business with and speak with its employees and business associates. When this is not possible, perhaps because the company’s operations are far-flung across many locations, our clients often ask us to conduct the visits and make the inquiries on their behalf.

We often find good news instead of bad, locating information that puts the business partner in a more sympathetic light. On the other hand, we sometimes gather insights that help our clients in litigation with their partners. In any event, we believe that with the proper amount of due diligence, clients can leverage this information to form business relationships with local partners throughout the world without being blindsided by scandal and unwanted negative attention.

Finally, when checking out our clients’ potential business partners, we maintain the highest professional and ethical standards, paying strict attention to applicable laws, including local anti-corruption and data privacy laws. The fallout from brand damage can be long-lasting and painful, so learning about the companies and key management you are doing business with can go a long way – and we can help.

About the Author

Jingyi Li Blank is a director of the Mintz Group in Hong Kong. She specializes in due-diligence background checking in M&A and fraud cases, and has particular expertise in the food and drug sectors. She has conducted investigations for multinational companies, law firms, financial institutions, regulatory bodies, stock exchanges, and high net worth individuals, and has advised on financial, political, regulator,y and fraud matters. She previously worked as a banker in New York and Hong Kong with two international investment banks, specializing in leveraged and structured debt. Ms. Blank can be reached at jblank@mintzgroup.com.

Founded in 1994, the Mintz Group is a global investigations company with offices in 15 cities throughout the U.S., Europe, Latin America, Africa, and Asia. The Mintz Group’s team of more than 270 investigators includes former investigative reporters; former federal and state investigators and prosecutors; former anti-corruption investigators from international organizations; and former intelligence officers.

[1] http://fortune.com/2017/09/14/jbs-batista-brazil-temer-corruption-insider-trading/

[2] http://www.who.int/mediacentre/news/releases/2015/foodborne-disease-estimates/en/

[3] https://www.courthousenews.com/wp-content/uploads/2018/01/HHS-FDA-Audit.pdf

[4] http://fortune.com/2014/09/02/why-mcdonalds-supplier-failed-in-china/

[5] http://www.foodsafetynews.com/2017/12/jack-in-the-box-e-coli-outbreak-25th-anniversary/#.WnJpXGluaUk

[6] http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/8978053/Four-out-of-five-bottles-of-Italian-olive-oil-debased.html

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