One of treats each month for the compliance professional is reading the GRC Illustrated column by Carole Switzer, President of the Open Compliance and Ethics Group (OCEG), in the Compliance Week magazine. Not only does Switzer write a highly informative and useful column but she also includes two standard features. The first is an illustrated guide that lays out visually her counsel and the second is that she also includes interviews from a Roundtable of compliance industry participants. In the July edition Switzer discussed an issue that brings much gnashing of teeth to both compliance practitioners, lawyers from the legal department and business folks alike; the situation where you must terminate a third party relationship.
In the article, entitled “Breaking Up Is Hard To Do”, Switzer relates how ‘to avoid pain by planning for the end of a third party relationship’, together with an illustrated diagram of “Third Party Risk Management in Financial Service”; she couples these with a Roundtable on “Financial Sector Third Party Risk” with participants Walter Hoogmoed, Jr., a Principal at Deloitte, Marie Patterson, VP-Marketing at Hiperos, and Billy Spears, Chief Ethics, Privacy and Compliance Officer at Hyundai Capital America.
Switzer begins by noting that it all should begin with “an exit strategy, a transition plan or a pre-nup—whatever the title, it’s best to begin by planning for the end which, in the case of business at least, will always eventually come. Whether due to contract completion or material breach, turning over responsibility to another party, or abandonment of the contracted activity altogether, contract termination is an inevitable phase in the third-party relationship lifecycle.” Planning for the end is important because, “The more long term and layered the relationship, the more difficult it will be to disentangle. The deeper the third party is embedded in and uses the confidential information of the company and its customers, the greater the risks presented by failing to design a smooth transition process.”
It should originate with clearly specified contract termination rights but that is only the starting point, “ To work out a smooth transition, the plan must also include internal change management processes and policies, designated transition team members, contingencies, and adequate resources and time allowances.” While speaking to risk from cyber-security, Switzer details some of the points for consideration. You should have clear procedures for “data retention or destruction, termination of access control for shared technology, and removal of system connectedness, including consideration of what fourth parties (your third party’s third parties) may have.” Your corporate values must be protected by “clearly designating the disposition of shared intellectual property and infrastructure assets.” Next you need to think through your transition plan by “ensuring rights to hire or continue use of key contractor employees who have been servicing your account, arranging to bringing new contractors or internal managers up to speed, and filing any regulatory or other required notifications.” Finally, bear in mind that your reputation must be protected during this transition process “by controlling and planning for issuance of public statements and social media postings by terminated contractors or their employees, or the best laid transition plans may be for naught.”
In the Illustrated component to her article, Switzer lays out a five-step integrated risk management process, which is a useful view of the entire cycle:
- Plan and Organize. Under this step you should develop a plan to evaluate the level and complexity of risk. Switzer suggests some of the things you should consider are the volume of business engaged in by the third party representative, the nature of the risks involved, the extent to which the third party representative will use sub-contractors and any required legal or regulatory approvals required for the geographic areas which the third party representative will conduct business with or for you.
- Perform Due Diligence. Here you should assess each third party’s compliance controls relative to the level of risk you have determined is present. Here the standard inquiries are such items as ultimate beneficial owners, anti-corruption compliance and risk management controls currently in place, incident management and reporting and conflicts of interest.
- Manage Contracts. This step involves the ongoing review and assessment of the contractual relationship. If new or greater risks arise and they have not been previously addressed, you may need to add new contract terms to address them going forward. In addition to your standard anti-corruption compliance terms and conditions, you should have key performance indicators (KPIs), confidentiality terms and conditions and sub-contractor requirements.
- Conduct Ongoing Monitoring. Under this step, you need to “oversee and pro-actively monitor and review each third party relationship at a level commensurate with risk” and “ensure that issues are identified and appropriately escalated for remediation.”
- Manage Terminations. If required, you should follow your established plan for transition to ending the relationship and transitioning to another third party representative. You should also consider the need to “protect information, maintain smooth operations and protect reputation during the transition.”
In her Roundtable, Switzer received some very useful information from the participants in a couple of broad areas. The first was the use of sub-contractors by a company’s third party representatives, which Switzer articulated as ‘fourth parties’. Patterson commented that “If the third party is going to sub-contract work, the bank needs to ensure that the third party has adequate controls in place to assess and manage their sub-contractor risk and that the bank has the ability to terminate their relationship with the third party in the event there is an issue with the fourth party.” Hoogmoed emphasized the ‘interdependences’ of the relationships. He said that “contract provisions should be enhanced for clarity of controls and liability, approvals for serial outsourcing should be implemented, and selective testing for fourth/fifth parties should be considered.” Spears pointed not only to due diligence but also strong contract terms as a key to the management of this issue, “Due diligence coupled with a strong legal contract team are crucial. It is very important to develop a minimum standard, in the contract with the third party, to ensure that the third party only does business with fourth parties that meet the first-party requirements… The provisions should include that no sharing beyond a fourth party is allowable. The last critical point of this is to ensure that the first party adds a mechanism for accountability. This mechanism is what prevents this from becoming a rabbit hole.”
Switzer ended the Roundtable by asking what was the most important part about third party risk management? Spears pointed that “having a solid plan for setting the tone with third parties is the key.” From Hoogmoed’s perspective, it all begins with understanding on risk, or as the FCPA Guidance intones, it all begins with a risk assessment. He said, “Developing some advanced risk tiering and assessment methods will help organizations focus their limited resources on managing the risk, compliance, and controls on the most critical/highest risk relationships. Engaging senior management in the risk analysis and reporting is also very important to balance the appropriate level of risk taking with the costs and investments necessary for the business.” Patterson took a different approach focusing on the feedback that Hiperos has received from their customers, and said, “the most important aspects of the recent guidance all deal with impact. The scope of the guidance has been broadened, both in terms of the expansion of what a “critical” activity is and the redefinition from vendor to third party. The importance of these obligations has been elevated with the explicit inclusion of the board at a much deeper level than previously, and the requirement for independent audit to be involved. And finally, the effort has been expanded significantly to include the entire lifecycle of third party management from planning through termination and every step in between.”
As usual, Switzer’s monthly column provides solid information to the compliance practitioner about what you need to know to inform your compliance regime. This month is no different. Although rarely written about, the termination of a third party relationship can be as important a step as any other in the management of the third party lifecycle. While having the contractual right to terminate is a good starting point, it is only the starting point. You not only need to have a compliance and legal plan in place but a business plan in place as well. For if you do not, you may well find yourself in the same place that Switzer started her article, quoting Neil Sedaka that “Breaking Up Is Hard To Do.”
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