BAE Systems, Defense Industry

Luxury cars, posh hotels, lavish parties, , secret agents, and corrupt officials—if the media reports around UK defence technology company, BAE Systems, and its long-standing business relations with Saudi Arabia are anything to go by, the recent history of the firm has all the ingredients of a Hollywood blockbuster. But this is no movie. Critics contend that between 2002 and 2004 gifts and payments worth more than £60m were paid to members of the Saudi royal family, £17m alone to the key Saudi arms purchaser, Prince Turky bin Nasser, funding a global jet-setter’s lifestyle for him, his family, and his 35-strong entourage of servants, drivers, and bodyguards.

The money was allegedly paid to secure the latest instalment in the ‘Al Yamamah’ (The Dove) project, which, according to former BAE chair Sir Richard Evans, has provided BAE with no less than £43bn of revenue since 1986. The project started shortly after the US Congress had banned arms exports to Saudi Arabia by US firms, leaving a large chunk of the global arms market to competitors. It is said to have kept BAE afloat in the 1990s, at a time when, after the fall of the iron curtain, the defence expenditure of most governments slumped considerably. Investigators, however, have calculated that more than £6bn may have been distributed over a 20-year span in corrupt commissions to secure the Al Yamamah deals.  The interest in this case shown by prosecutors, the media, and NGOs is not just fuelled by the magnitude of the alleged payments, but also by the conspicuous role of the British government in the scandal.

Furthermore, the Al Yamamah scandal is only one of many allegations BAE has faced over the years. Allegedly, the company has tried to sell electric-shock batons fit for torturing to Saudi Arabia; delivered fighter planes to Indonesia that were subsequently used to oppress freedom fighters in East Timor; and secured deals with widely criticized regimes in Zimbabwe and Tanzania. Even in 2008, the company was still being subjected to new revelations about supposed illicit payments. According to a police document leaked to the UK’s Guardian newspaper, the company secretly paid more than £100m on ‘financially incentivising’ South African politicians to purchase a controversial fleet of warplanes, at a time when the country was in the grip of crippling unemployment and an AIDS epidemic. 

The defence industry and business–government relations

To understand the nature of alleged corruption in cases such as the BAE Al Yamamah deals, it is helpful to look at the peculiarities of the defence industry, most notably the close relationships that defence companies need to nurture with governments. Looking at the demand side of the market, not only does the industry nearly exclusively sell to governments, in most countries the parliament also has to agree the level of spending and often even the type of equipment that should be bought. Furthermore, governments often demand offset deals from defence companies, asking them to produce some part of the equipment domestically in order to secure employment and some benefits for the respective local economy. For instance, it was reported that BAE was able to secure a £1.5bn deal in South Africa in 1999 because it offered the best local offset deal to the government.

On the supply side, again governments of the arms-exporting countries are deeply involved. The UK, which is the world’s second largest arms exporter, has a special unit in the government department for UK Trade and Investment to promote its defence companies, the Defence Export Services Organization (DESO). Most deals also involve the government’s Export Credits Guarantee Department (ECGD) to secure loans and provide payment guarantees to exporters. Furthermore, with tens of thousands of UK jobs being provided by the defence sector, securing employment is often a strong driver in governmental support for its domestic arms industry. The development of new defence systems increasingly involves international co-operation—BAE has customers and partners in over a hundred countries—which again involves governmental consent and support in an area of potential concern to national security. As a result, relations between defence companies and their home governments are close and unsurprisingly, BAE chair Evans was known to be one of the few businessmen who could see the prime minister on request.

Given this context, it is perhaps not surprising that the defence industry has maintained its claim to notoriety for being a hotbed for all sorts of ethical dilemmas and controversies. A limited number of very powerful buyers (mostly governments) and a limited numbers of competitors (often co-operating with each other in at least some area of their business) have led to a situation where we cannot really talk of a ‘free’ market. Many deals rely on long-term business relationships and strong personal relations, such that the arms industry is ‘a bit like a cottage industry’ where ‘everybody knows everyone else and everything is connected’, as BAE chair Evans was once quoted.

There are other reasons too why the defence industry has had a chequered ethical history. Given the sensitivities around security issues, most deals are concluded in secret. Moreover, the number of contracts is relatively few, but almost always of a very high value, making every transaction a major business-critical event. Such dynamics also make it relatively easy to hide commissions and other payments. As a result, it comes as little surprise that the industry, though only accounting for 1% of global trade, accounts for about half of all bribes paid globally, according to an estimate by the US Department of Commerce.

The mechanics of corruption in the defence industry typically follow a common pattern. Companies looking to bribe public officials will often use local agents and front companies to dispense ‘the less orthodox inducements’, as one industry executive termed them. These are often recorded as ‘commissions’, ‘marketing services’, and other terms, and are usually financed by slush funds or simple overcharging on the contracts. In the Al Yamamah deal, for instance, payments were reportedly made through a complex web of front companies, including BAE’s man in Saudi-Arabia (a former Royal Air Force wing commander), the agency ‘Travellers World Ltd.’, and another BAE company, Robert Lee International. Rather than handing out cash directly, these agencies are supposed to have picked up the royal Saudi family’s fairy-tale bills for shopping sprees, presidential suites in the world’s finest hotels, Rolls-Royces, Aston-Martins, and private jets—to name just some of the key items. According to investigative journalists, the cash for all these payoffs came from overcharging—a supposition supported by accidentally released UK documents which reveal that the basic price of the planes was inflated by 32%, to allow for an initial £600m in commissions.

The UK government’s anti-corruption efforts target BAE

Despite the obviously close relationships between the government and defence companies, corruption is also a major issue for governments to deal with. In the 2000s, the UK government sought to strengthen its anti-corruption efforts. This led to the introduction of new anti-bribery regulations in 2001, which made it illegal for UK companies to pay bribes. However, despite the tougher regulatory stance, the Serious Fraud Office (SFO), which investigates bribery claims, received no additional budget from the government, and to date has failed to bring a single prosecution to court for bribery. Finally, in 2006, the UK government gave the issue greater attention by setting up an ‘anti-corruption squad’, with a mooted £1m annual budget.

One of the key investigations of the SFO over the past decade has been the allegations of corruption at BAE, in particular the deals with Saudi Arabia. A full-scale investigation was launched in 2003 and according to media reports, by 2006 the organization had spent around £2m investigating BAE and was making ‘excellent progress’. However, in December 2006, with the SFO on the brink of accessing key Swiss bank accounts involved in the alleged payments, the UK government forced a sudden reversal and pressured the SFO into dropping the investigation completely. Claiming that the ‘wider public interest …outweighed the need to maintain the rule of law’, the government’s dramatic intervention was defended on the grounds of ‘national security’. Among the reasons given were that the Saudi government had threatened to stop sharing intelligence with British authorities about Al-Qaida terrorist activities if the investigations continued. According to the UK prime minister, this meant that British lives could be at risk unless the case was dropped. The Saudis were also alleged to have threatened to pull out of the next stage of Al Yamamah, worth another £6bn to BAE, and offer it to a French defence rival—a prospect which had prompted frantic lobbying from BAE in efforts to halt the SFO inquiry.

The decision by the government to close down the investigations brought fierce criticism from anti-corruption campaigners and prompted a strong rebuke from the OECD. However, following a judicial review, the tide appeared to be turning against BAE again when the decision to shut down the investigation was judged ‘unlawful’ by the high court in April 2008—only for the ruling to be overturned by the House of Lords three months later.

BAE seeks to rebuild its tarnished image

Despite their successes in having the SFO inquiry stopped, BAE emerged from the affair with a severely tarnished reputation, and a number of critical ethical challenges ahead. Having been rather hostile towards its critics in the past, the company began to adopt a somewhat more conciliatory approach in the late 2000s. Most notably, the company hired the former chief justice Lord Woolf to head a committee to review the company’s ethical conduct. His report, published in May 2008, confirmed that BAE’s leaders ‘acknowledged that the company did not in the past pay sufficient attention to ethical standards and avoid activities that had the potential to give rise to reputational damage’. He also reported that the firm had ‘a greater culture of secrecy … than is necessary or desirable’. Although criticized in some quarters for bypassing judgement on BAE’s past corruption scandals, Woolf proposed 23 recommendations for enhancing business ethics at the company, which it is committed to implementing by 2011.

By summer 2009, four of the 23 points had been addressed, including the appointment of a managing director for corporate responsibility, the implementation of a global code of conduct, a more robust system of vetting external agents, and an externally assured corporate responsibility report. To make this happen, 60 executive staff had been seconded to work at least part time on implementing Woolf’s recommendations.

According to the newly appointed corporate responsibility officer, though, the next step appears to be the toughest: to address the root of corruption by changing the firm’s business model. Rather than working with local agents—who often are the linchpin of corruption—BAE wants to cut out the middleman altogether. This would imply that a significant part of its operations in engineering, manufacturing, and sales would need to be moved to countries with whose governments BAE would then be able to deal directly.

Whether such radical changes will be realistic to implement remains to be seen. There are certainly encouraging examples: BAE’s main US rivals, Boeing and Lockheed Martin, which had similar scandals decades ago, today count among the models of ethics and compliance practice. For BAE though, the legacy of the past may be even harder to escape. With corruption investigations under way in several countries, including the US and Austria, the truth or otherwise about the firm’s ‘less orthodox inducements’ may still come to light.

Questions

1.     To what extent can BAE be blamed for its part in the alleged bribery, or are the UK and Saudi governments ultimately more responsible for any wrongdoing?

2.     If you were hired by BAE to advise on its ethical challenges, what would your recommendations be?