The Clippers Saga, Part II: Contracts

Today we continue with the scandal of the Los Angeles Clippers, slammed by the National Basketball Association last week for arranging sham endorsement deals to avoid the NBA's salary cap. Compliance professionals still have lots to learn here from how the misconduct happened: sketchy business contracts with third parties, and why those deals went unchallenged by management. Let's dig in. For those who missed our first post on l'affaire de Clippers last week, the background is as follows. The NBA accused the Clippers and its senior management, including team owner Steve Ballmer, of orchestrating sham endorsement deals for one of its star players, Kawhi Leonard. The Clippers leaned on business partners to sign deals with Leonard; and in exchange, the Clippers did more business with those companies — essentially, putting money in the coffers of those companies so they could put money into the coffers of Leonard. All of this violated NBA rules. The NBA dropped the hammer on the team last week: a $30 million fine, loss of first-round draft picks for five years, and multiple team executives (including Ballmer) suspended for up to one year. The league also published a damning report from law firm Wachtell Lipton that documented the Clippers' abuses in painful detail; and said the Clippers will be 'subject to a compliance and monitoring program overseen by the league' for five years. Ballmer and the team insist they did nothing wrong and will appeal their punishments through binding arbitration. From the compliance officer's perspective, however, this case is fascinating because we talk about corruption hidden in sketchy third-party contracts all the time — and here that issue is again, on the professional basketball court. In hindsight, as one reads the Wachtell investigation report, all these deals clearly were vehicles for corrupt behavior. So what controls, systems, and processes should businesses erect to make such arrangements stand out like a sore thumb? That's the question we need to ponder. Best Practices for Governing Contracts One great place for compliance officers to start is the FCPA Resource Guide published by the U.S. Justice Department. The guide devotes an entire section to how companies should govern contracts with third parties (the material starts on Page 62), and it includes a list of issues compliance officers should consider. For example: Do you understand the qualifications and associations of your third-party partners? Do you understand the business rationale for including the third party in your transaction? Are the contract terms clear and do they specifically describe the services to be provided? What are the payment terms, and how do those terms compare to your industry and company standards? Is the compensation commensurate with the work being provided? Does the contract describe how the third party will document the work that it has provided? The above are all good questions a compliance officer (or anti-fraud auditor) should be ready to ask about any consulting agreement or similar contract, but appreciate the larger issue these questions are driving at. They are meant to help a business understand what a defensible third-party agreement is. If you can't answer those questions about a deal, it might not be legitimate. Well, you answer those questions with documentation. So as we think about how to stamp out corruption funneling through one sham agreement or another, the more precise question compliance officers should ask is, 'What documentation policies and procedures should my company have in place so that we can confirm an arrangement with a third-party is defensible and legitimate?' Those documentation requirements should ideally be written down as formal policies and procedures. Someone should occasionally audit the effectiveness of your contract management system, to confirm that the proper documentation actually is gathered for each agreement. Even better, connect those documentation requirements to your accounting system, so that no payment goes out the door to a third party without that documentation first having been collected and reviewed. It's Not That Simple I also published my first post about the Clippers scandal on LinkedIn, and received some excellent comments from readers about other points to consider when trying to build contract governance systems. For example, Andrew Deaton, an investigations director with the inspector general's office at the U.S. Army, stressed importance of looking at multiple contracts and arrangements altogether, as part of one larger picture: One test I have found useful in high-consequence oversight work is external defensibility. Even if an arrangement can be technically explained by the people closest to it, can it withstand scrutiny from someone outside the decision process who is looking at purpose, timing, value exchanged, documentation, and who benefited? That question matters because problematic conduct often hides inside arrangements that look plausible one piece at a time. The governance failure becomes clearer when those pieces are viewed together. That's an excellent point: you need an ability to see the whole forest through the individual trees. So compliance officers might want to consider how you can assemble a contract management or monitoring system that allows you to examine multiple contracts in some aggregate fashion. (AI would probably be a helpful tool for a task like this.) Another compliance professional, Amanda McAdams, raised a similar point; that each deal, when viewed in isolation, might be just plausible enough to survive scrutiny, especially from lower-level people who assume senior management knows what it's doing: What deserves more attention is what happens to the person below the executive level who might have noticed something off. In isolation, any one of these red flags has a plausible enough story attached to it (cultivating a new sponsor, exploring a new revenue relationship) that a reasonable person could talk themselves out of raising it. Not because the story would hold up to real scrutiny, but because it's just believable enough to make someone second-guess their own instinct. That's the harder problem for compliance to solve. It's not just catching the scheme. It's making sure the person closest to noticing it doesn't first convince themselves there's nothing to see. This is such a good point. Yes, compliance and audit executives are supposed to exercise professional skepticism — but that's far easier said than done, especially when the skepticism you're exercising is against the boss. So we need documentation policies and procedures that act as forcing mechanisms, where compliance officers could essentially say, 'Sorry, boss; but we all know the policies and requirements are clear and leave me no choice but to ask about this. Just doing my job.' What those policies and procedures are, every company and compliance team needs to figure out on its own. But without that structure, without that forcing mechanism, everyone is at the mercy of senior management's subjective judgment about what's important for the business and how to go about achieving those objectives — and look where that can bring you.