Business Writing > | Samantha Stainburn

When social networks go astray

(Chicago Booth Review, 09 December 2014)

Networking has become a daily obsession. According to the Pew Research Center, 74 percent of adults online use social-network sites such as Facebook and LinkedIn. And a 2013 report from Ipsos Open Thinking Exchange estimates that people spend an average of three hours daily on online social networks. That doesn’t count all the networking that takes place offline, at industry cocktail events, alumni reunions, and religious meetings, among other places.

Most of the time, developing and mining a network is a smart move. A person develops social networks hoping and expecting to gain something—whether that be a job, contact, investor, or simply a friend. He may turn to those networks when in need or feeling vulnerable, perhaps when trying to make a risky business decision.

But avid networker, beware: these social networks have a dark side. According to research by Christopher B. Yenkey, assistant professor of organizations and strategy at Chicago Booth, our networks can make us more vulnerable to fraud and even encourage us to cheat. “We shouldn’t be blind to the ways they can make us vulnerable to opportunism or even push us into doing things we shouldn’t do,” says Yenkey. His research findings could help you avoid becoming a victim.

The ‘people like us’ trap
Yenkey teaches a class that focuses on creating value by understanding social networks, of which there are many kinds, he explains to his students. To them, “social networks” refers to the ubiquitous online version, but some networks are comprised of direct relationships, and others include people who are linked by a common bond, such as an alma mater. They are, he tells his students, their “tribes.” And to study such networks, he went to an area of the world where tribal membership is explicit: in Kenya, most residents are members of one of 12 primary ethnic tribes that are important in economics and politics.

Interested in how networks play into frauds, he studied a major financial fraud at the Nairobi Securities Exchange. Starting in late 2006, agents at the country’s largest brokerage, Nyaga Stockbrokerage Ltd., began using clients’ shares to manipulate the market. With electronic access to client accounts, they were able to steal cash and shares, until the massive fraud was discovered in early 2008. At a time when the firm served approximately a fifth of the emerging market’s total investors, its brokers looted approximately one-quarter of the firm’s 100,000 clients’ accounts.

Yenkey was interested in whether tribal affiliations influenced which clients were preyed upon. In a country where 98 percent of all citizens vote with their tribe in elections, and where professional and social relationships are similarly influenced by tribal membership, was there any reason to think a corrupt manager would steal from his own group? Most research and our intuition about markets would predict that a corrupt agent would be more likely to cheat clients outside of his network, his tribe—especially those of a rival tribe. But Yenkey had another hypothesis: if we are more likely to trust people in our network, including those whom we are only tied to indirectly, that assumed trust could become a resource for committing fraud.

If we believe that members of our network are trustworthy, we give them more leeway for taking advantage of that trust.

To test this proposition, Yenkey accessed NSE databases (with regulators’ supervision) comprising detailed information about all of the market’s investors, including names, addresses, gender, portfolio composition, and more. With help from Kenyan research assistants from six different tribes, he used last names to identify which tribes the investors and agents belonged to. The research assistants reviewed and categorized 20,000 unique last names, capturing 94 percent of all investors.

The Nyaga firm was owned and operated by members of Kenya’s largest ethnic group, and approximately 60 percent of its clients belonged to that same tribe. But Nyaga’s client list also included investors belonging to almost all of Kenya’s tribes.

Yenkey compared lists of Nyaga’s clients with a list of investors who had registered claims with Kenya’s Investor Compensation Fund, which tracks victimization in the market, to see who had been cheated in the Nyaga fraud. His findings suggest that belonging to the broker’s tribe actually made people more vulnerable to the fraud. Even worse, investors who lived in areas where their tribal identity was critical to their safety—where being a member of another tribe could have made them targets of violence—were even more likely to be cheated.

Investors, Yenkey saw, initially used their social networks to select brokers, just as earlier research would indicate. That was particularly true in areas where there was more risk to the tribe. In December 2007, Kenya’s disputed presidential election led to intertribal violence that left 1,300 people dead and another 400,000 forced from their homes. In districts that experienced this violence, investors from the tribe that operated the Nyaga firm were about 40 percent more likely to choose a same-tribe broker. The investors were also more likely to choose a same-tribe stockbroker in areas where they were outnumbered by members of other tribes. In most locations the data captured, members of rival tribes avoided hiring stockbrokers from the tribe that ran Nyaga. Just like many of us do, those investors were presumably tapping into their network, their tribe, to find a trustworthy broker.

But quite often those investors got the opposite of what they were seeking. When Yenkey looked at the Nyaga firm’s 100,000 clients, he observed that a corrupt broker was almost 20 percent more likely to steal from a member of his own tribe. And the likelihood of a same-tribe client becoming a victim was almost double that when that client lived in an area affected by the political violence. A corrupt broker was more likely to steal from clients who belonged to his own tribe, “especially when they reside in the diverse and violent areas that led them to choose a same-tribe broker initially,” Yenkey writes. Moreover, wealthy clients were particularly at risk. While earlier research has suggested that criminals tend to avoid wealthy targets, in order to avoid stricter penalties if caught, Yenkey finds that wealthy same-tribe clients of a corrupt Kenyan broker were twice as likely to be cheated as lower-income clients in the tribe.

While most brokers were honest, the corrupt brokers took advantage of the ties that had brought clients to them.

“Essentially, we are vulnerable to being taken advantage of by people in our network because we assume they will take care of us,” Yenkey says. “We ask fewer questions ahead of time, and we are less likely to keep tabs on them later. Most of the time, this works very well for us. But when there is a bad apple in the network, it makes us more vulnerable.”

How networks create cheaters
Yenkey’s research suggests that not only can a social network increase a person’s vulnerability to fraud, it also can increase the chance that he or she may perpetrate one.

To arrive at this conclusion, Yenkey and the University of California-Davis’s Donald Palmer studied the world of professional cycling, which represents another kind of social network. Athletes, owners, managers, assistants, and staff form relationships as they work together, and some may depart at the end of the cycling season to join other teams.

This network has had its own battle with fraud, in the form of performance-enhancing drugs. Cyclists have long used these drugs to better compete in races including the Tour de France, a grueling 2,200-mile race that takes riders through the Pyrenees and the Alps and finishes on the Champs-Élysées in Paris. In the 1920s, riders boosted their energy with cocaine. Race organizers banned drug use in 1965, but in the late 1990s through the mid-2000s, there was rampant use of steroids; human growth hormone; a blood-boosting hormone called erythropoietin, or EPO; and amphetamines to improve performance at high altitudes, accelerate recovery, and provide energy.

In the mid-2000s, the International Cycling Union (officially called the Union Cycliste Internationale, or UCI for short) and the police in Europe began cracking down more seriously on cyclists’ drug use, instituting more and better testing and launching investigations into doping operations. The UCI began requiring cyclists to provide blood and urine samples several times throughout the year. A panel of anti-doping experts tracked each rider’s samples over time and assigned him a “suspicion score,” essentially a medical opinion of the likelihood that a cyclist was using performance-enhancing drugs. These scores, typically kept confidential and used only by racing officials, were in 2011 leaked to the press. Scores for all 198 participants in the 2010 Tour de France were leaked to French sports magazine L’Équipe.

Yenkey and Palmer used the leaked report to study links between cycling networks and fraudulent behavior. The data led them to two main observations.

The first is that the role a person has in a network can influence his or her tendency to cheat. People expected to perform complex and difficult tasks at specific points in time are under significant pressure to ensure they can live up to the challenge. This pressure leads them to consider all means available to them, be it legal or illegal. If a person was assigned a critical role on a cycling team, expected to perform a difficult task at a specific time—sprinting, for example—he was almost six times more likely to have a suspicious blood profile than a generalist rider. The cyclists assigned to assist that crucial team member were more than twice as likely than a generalist to have suspicious blood profiles. Those generalist riders, also known as free agents, were no more likely than the average cyclist to be suspected of drug use.

The second observation: people in a network teach others what behavior they can and can’t get away with. Using data from cycling fan websites, the researchers mapped the social networks of 195 of the 2010 Tour de France competitors by tracing the teams they had ridden for throughout their careers. Doing this, the researchers identified the present and past teammates of each rider, as well as what they call “twice-removed teammates,” or the teammates of former teammates (think of these as friends of friends).

The researchers also used data from fan websites that have cataloged more than 1,500 doping incidents that occurred between 1999 and 2010. The incidents included positive drug tests, and evidence of doping from hotel-room raids, phone taps, and vehicle searches. From this data, the researchers reconstructed the cyclists’ full careers, including documented doping incidents and any resulting sanctions.

They find that seeing a fellow rider punished deterred a teammate from committing the same offense. Only 45 percent of prior doping events experienced by people in the riders’ networks led to sanctions, but just over half of the time, those sanctions were major: guilty riders were suspended from competition for more than six months. And the researchers saw that when riders had doped and been sanctioned, their teammates tended to have lower suspicion scores leading up the 2010 Tour de France. The opposite was true for riders whose teammates had doped but had not been sanctioned.

The effect was particularly strong for cyclists whose current teammate had been caught doping. Contemporary teammates were 94 percent less likely to have more-suspicious blood values, while twice-removed teammates were just 8 percent less likely if the prior infraction had been strongly punished. If a cyclist had been caught doping and hadn’t been heavily sanctioned, a contemporary teammate was 27 percent more likely to have a high suspicion score, compared to 3 percent for twice-removed teammates.

The takeaway: people closer to you in your network have more influence on you. You also learn things from people who are more distant in a network, but you do so at a lesser rate.

“If your social network is telling you, ‘Watch out, there are strong consequences for doing this,’ you’re less likely to do it,” Yenkey says. “But if your network contains people who have cheated and basically gotten away with it, it teaches you this is something you can do, and so you do it.”

Drawing lessons about fraud
Frauds are clearly moving through social networks far beyond Kenya and professional cycling. Networks are key to a number of Ponzi schemes, including the Bernard Madoff scandal, where Madoff used social ties to recruit new investors and victims. Before Madoff, Charles Ponzi swindled his Catholic neighbors in Boston, even his own parish priest. The blog ponzitracker.com is updated regularly with news of the latest alleged and confirmed schemes.

The same dynamics that led brokers and cyclists to cheat are at work in networks of all kinds, around the world. According to the 2011 PricewaterhouseCoopers Global Economic Crime Survey, insiders committed 56 percent of all serious corporate frauds reported worldwide.

The research findings, therefore, have broad application. They suggest that to avoid becoming a victim of a fraud, know that while your network can be a great source of information, contacts, and leads, deviants in the network may be looking to take advantage of your trust. Use your network to your advantage, but also with caution.

If you or someone else plays a critical role in an organization—for example as the “rainmaker” responsible for bringing in new business—monitor decisions and actions when the pressure builds. The data suggest that the pressure of meeting expectations can drive people in critical roles to make bad decisions.

And if you find fraud in your network or organization, be vigilant about punishing the wrongdoers. Otherwise, you may encourage more of the same behavior.

Works Cited

Donald Palmer and Christopher B. Yenkey, “Drugs, Sweat, and Gears: An Organizational Analysis of Performance Enhancing Drug Use in the 2010 Tour de France,” Working paper, September 2013.

Christopher B. Yenkey, “Tribes and (Dis)trust: The Role of Social Capital in Fraud Victimization,” Working paper, February 2013.

Read this article at Chicago Booth Review.

Global Law: New Rules In a New Age

(Crain’s Chicago Business, 22 September 2008)

In 1996, a U.S. company hired Eric Hargan to help it buy a factory in Asia. Mr. Hargan, a corporate lawyer working in Jakarta, Indonesia, called the manufacturer to set up a tour, due diligence he considered “a normal, check-the-box thing.”

But the response was far from normal. First the factory manager said the site was inaccessible because the only train that went there had derailed. Mr. Hargan said he would rent a jeep. The manager claimed the roads had been washed away by heavy rains.

The factory’s contracts appeared to be in order, but the manager’s reluctance to let Mr. Hargan see the facility made him suspicious. On closer inspection, he noticed the numbers in the work contracts did not match the financial statements. Ultimately, he and his client, whom Mr. Hargan declines to identify for confidentiality reasons, concluded the factory didn’t exist.

U.S. companies walk away from acquisitions all the time after performing due diligence, but how often does a deal fall apart because the buyer concludes the asset doesn’t exist? “That’s rare in the U.S.,” says Mr. Hargan, now a partner at McDermott Will & Emory LLP in Chicago.

Along with finding the right partnerships, deciphering cultural nuances and bridging communication gaps, navigating legal differences is a major hurdle to doing business abroad. Bumping up against those differences happens more often these days as more Chicago companies expand abroad.

“The most common misperception that U.S. companies have is that their experience doing business transactions with other U.S. companies gives them the ability to do those same type of transactions in foreign jurisdictions,” says Susan Greenspon, a partner in Chicago at Kelley Drye & Warren LLP, who has advised U.S. clients on corporate transactions in the Bahamas, Vietnam and Eastern Europe.

Foreign laws often punch loopholes into routine transactions, favoring local companies and costing American businesses time and money. In the Bahamas, for example, a foreigner can’t buy land — even private property — without permission from the government, a process that can take up to a year if the government is distracted by elections or has concerns about the buyer’s reputation.

Under Western law, joint-venture partners are largely left alone to negotiate a purchase price and share value. But in China, joint-venture agreements can be subject to government approval, even for non-state assets.

And resolving an international dispute is not as straightforward as filing a lawsuit in Cook County. Some foreign courts are at worst corrupt and at best biased toward local companies. Even if you win, there may not be a process or the will to enforce the judgment.

STEERING CLEAR

So how do you avoid all this trouble?

First, tap U.S. law firms to help you assemble a team of well-connected foreign attorneys. They can advise you on whether agreements with suppliers and other business partners will be protected under their laws.

In places like China, where laws are evolving, go a step further and retain lawyers with government contacts who can provide warnings on upcoming legal changes.

You’ll still need U.S. lawyers on your team to interpret the information coming from their foreign counterparts. But your U.S. lawyers must be careful not to step on anyone’s toes.

“The last thing you want to do is show disrespect for your local counsel, because they’re critical in the ability to get transactions done,” Ms. Greenspon says. “When it comes to communicating with opposing counsel abroad, that’s their job.”

Second, avoid unpleasant surprises by getting to know your foreign business partners away from the negotiating table. Go to lunch or have drinks at the bar to equip yourself to evaluate their motivations and expectations.

Finally, slow down.

“The road is littered with U.S. investors whose Chinese operations have been unprofitable, in part, because they’ve plunged into equity investments or contractual arrangements with Chinese parties without carefully considering Chinese laws on investments, the repatriation of capital contributions or other regulations,” says Philip Stamatakos, a partner at Jones Day in Chicago, who represents companies in cross-border transactions.

Lawyers agree: Cutting corners to get a deal done may be a risk worth taking in the United States, where businesses are more transparent and it’s relatively inexpensive to take a troublemaker to court. But when you’re a stranger in a strange land, it’s just asking for trouble.

China: Chasing copycats and profit margins

Four years ago, one of Jeffery Duncan’s clients was having trouble with copycats in China.

The client, a well-known U.S. audio-equipment maker, found that Chinese companies were duplicating its receivers’ and CD players’ faceplates, slapping them on garbage electronics and selling the fakes on the Internet as the American brand.

So Mr. Duncan, an intellectual property lawyer at Brinks Hofer Gilson & Lione in Chicago, had associates in China file for a patent that prevents anyone from duplicating the U.S. company’s design. Since then, they have succeeded in shutting down several of these companies by sending them cease-and-desist letters. The online solicitations have disappeared.

“They may be surfacing somewhere else, but at least the most visible harm we’re seeing, listing these things on the Web as ‘a genuine xyz receiver,’ is coming down,” Mr. Duncan says.

Chinese officials have become more vigilant in enforcing patent and trademark laws as they seek to safeguard foreign investment and protect local companies, which increasingly are manufacturing products of their own.

Still, when filing for trademark protection in China, it’s a good idea to register the name or symbol using English and Chinese characters, since English is often used in the country’s advertising campaigns. Once you have registered your intellectual property, set up systems to ensure suppliers aren’t violating those patents or trademarks. At minimum, employ an automatic Web crawler program to detect if anyone is advertising knockoffs of your product online.

Other areas where U.S. companies stumble in China:

LACK OF TRANSPARENCY: There are plenty of state-owned companies in China that U.S. firms would like to buy. But Americans often find that Chinese companies won’t disclose how much their assets are worth or whether they are profitable.

“It’s not a question of shady people vs. unshady people so much as there are enormous cultural differences between China and the U.S. and Western Europe,” says Douglas Tucker, a partner at Quarles & Brady LLP in Chicago. “The Chinese are wildly offended when you ask them to open their books. It’s a huge show of disrespect.”

That’s why you need to give yourself double the time you usually would for due diligence to build the relationships that are essential for getting anything done in China.

“The first time you meet the plant manager, you take him out for dinner,” Mr. Tucker says. “The second time, you walk around the plant and tell them how you’re really impressed. The third or fourth time, you start inching over to that topic. Now you’re friends, and he’ll say, ‘Of course you can see our books and records.’ ”

COMPETITION: Unlike in the United States, foreign companies that license the rights to manufacture their products to Chinese distributors cannot forbid these companies from tweaking the product and selling the new version as their own.

To cut down on this practice, Mr. Duncan’s clients use contracts that require the Chinese firm to secure its promises with bonds worth hundreds of thousands of dollars and spell out dire consequences like revoking the distribution license or seizing the bond if the terms are violated.

Also, non-compete agreements in China require companies to make payments to former employees during the period they are prohibited from competing. That can create other problems.

“Sometimes people run from the payments,” says Sharon Barner, a partner at Foley & Lardner LLP. “They don’t want you to pay them because they don’t want the non-compete to be enforceable.”

IF YOU DO GET INTO A DISPUTE: When going to court in China, location matters. Each province has the right to interpret the law as it sees fit. Courts in Guangdong Province, which has welcomed outside investors and businesses since it became a special trade zone in the 1970s, and courts in the economic capitals of Beijing and Shanghai have reputations for being the most fair toward foreign companies.

India: You don’t want to go to court

What American companies don’t know about Indian law can hurt them. Brad Peterson, a partner at Mayer Brown LLP in Chicago, had one client that used a standard contract to buy a license for software developed in India. Everything was fine until the U.S. company began to squabble with the developers about whether their work met specifications, and the Indian firm looked more closely at the contract.

Turns out the agreement didn’t specify that the U.S. company was buying rights to use the software in the United States, nor that it was purchasing those rights forever. Both these factors are assumed under the U.S. Copyright Act when doing a licensing deal with a U.S.-based company.

But under Indian law, which governed this case because the software was created in India, licensing agreements last five years and pertain only to use of a product in India, unless otherwise stated.

“The American company could have gotten exactly what they wanted with better drafting and an understanding of the presumptions in Indian law,” Mr. Peterson says.

But in this case, the Indian company required the Americans to pay extra for rights they thought they were buying in the first place.

Other challenges U.S. companies face in India:

INTELLECTUAL PROPERTY: While India has IP protections, the government lacks the resources to seize infringing goods or shut down computer systems of companies that violate the law.

That’s why, when doing business there, you have to make it harder for employees and contractors to steal ideas in the first place. For example, give employees computers without USB ports and limit their access to printers. And make sure your contracts with Indian partners spell out what you require them to do to maintain security, such as not hiring people who fail background checks or separating work duties so no single employee has complete knowledge of your process.

“Then, when you walk into their facility and security is not adequate, you can point to the contract and say, ‘We have a promise. I’m withholding money or taking back all of my assets unless you fix this problem,’ ” Mr. Peterson says.

WORKING WITH PARTNERS AND SUPPLIERS: Infrastructure and skills vary widely across India’s 28 states and seven union territories, and location often determines how easy and efficient an offshore or outsourcing arrangement will be.

“A tier-one site in Bangalore has the capabilities of an office complex in Naperville,” Mr. Peterson says. “At a tier-four site in India, communication is difficult, the roads may make it inaccessible and the people may have low levels of English.”

But even the most qualified Indian partners interpret business terms differently than suppliers and contractors in the United States. For example, a U.S. business may request that a partner inform it of problems promptly. But the definition of promptly in India is not the same as in the United States because of cultural differences. So be sure to specify a time frame.

IF YOU DO GET INTO A DISPUTE: Indian courts are notorious for backlogs. Waiting five to 10 years for a trial is not unusual. That’s why preserving evidence and making sure all depositions are completed is important. There is no guarantee that older executives will be alive to discuss the facts of the case a decade after it occurred. Otherwise, follow what many companies do to avoid going to court in India: use alternative dispute resolution.

U.S.S.R.: Russia raises red flags

Recent stories about Kremlin strong-arming have made plenty of U.S. companies nervous about doing business in Russia.

Since January, Russian police have searched BP PLC’s Moscow offices several times amid a spat between the London-based energy company and its Russian partners over expansion plans. The government has charged a Russian BP manager who holds an American passport with spying and has withdrawn the visas of 148 other foreign employees.

In another case, businessman William Browder was barred from the country after he and his investment firm, Hermitage Capital Management Ltd., ran afoul of the Putin government. After the Kremlin canceled his visa in 2005, police seized documents and computers from the offices of Hermitage Capital and its attorneys. Then Mr. Browder learned someone had transferred ownership of Hermitage’s Russian holding companies to a convicted murderer.

In cases like these, there’s not much you can do, says George McKann, a partner at Drinker Biddle & Reath LLP in Chicago, who has advised U.S. companies working in Russia since the 1970s.

“There’s nothing to prevent the government from deciding they want you out or they want your Russian partner to be a 60% owner vs. a 50-50,” he says. “That’s the risk of doing business in essentially a totalitarian regime.”

But these are extreme cases, says Arthur George, a partner at Baker & McKenzie LLP in Chicago who co-founded the firm’s Moscow and St. Petersburg offices. “The activities of companies in most sectors of the economy are really below the radar of the authorities,” he says.

More-common predicaments that U.S. companies face in Russia:

CORRUPTION: Russian distributors attempting to circumvent customs duties and taxes often propose shipping to ports in countries like Germany or Finland.

“Sometimes they’ll ask our clients to contract with some other company outside of Russia and then just ship to a designated point,” says Mr. George, whose clients include U.S. automakers and drug companies. “When the payments are not from Russia, there’s some kind of corruption going on there. You have to say no, because there are going to be problems under Russian law as well as U.S. law.”

Fears that organized crime has infiltrated all levels of Russian business are overblown, Mr. McKann says, but mob-run sham companies do exist, so you must be careful.

When embarking on a venture with a Russian company, “you do everything you possibly can to find out its history,” he says, from Googling to checking its reputation with the U.S. Embassy.

EMPLOYEES: As in most of Europe, there is no at-will employment in Russia. To dismiss an employee, the company must explain which article of the Russian labor code permits it. Every Russian has a passport-like document called a “workbook,” which contains a worker’s entire employment history. Anytime an employer promotes, disciplines or fires an employee, it must be noted in the workbook.

“If you don’t have on file that they’ve been warned, you can’t fire them,” Mr. George says.

IF YOU DO GET INTO A DISPUTE: Litigating in Russia takes less time and money than in the United States, but companies are not allowed to gather evidence from an opponent, which could lead to an unfavorable ruling. “If we anticipate the case is going to be long and complicated and involve a lot of money, we recommend it be heard in arbitration,” Mr. George says. “If our client is selling something to a Russian buyer for $50,000 and they don’t pay, we might be happy to let the case be resolved in a Russian court because a judge is perfectly capable of deciding whether they paid or not.” A note of caution: Many Russian companies that work with foreign firms have operations outside Russia, and sometimes U.S. companies sign contracts with their offshore subsidiaries. Make sure these companies have assets to draw on in the event of an arbitration award or insist on signing a contract with the Russian parent company.

Latin America: What to do about bribery

In some parts of the world, local companies often give government officials a little extra cash to secure a license or contract. Latin American officials, in particular, are notorious for requesting bribes to move business along.

In fact, 29% of Latin American companies reported that they had experienced corruption and bribery in the past three years, compared with 9% of companies in North America, 14% in Western Europe and 21% in the Asia-Pacific region, according to a 2007 global fraud survey by New York-based risk consultant Kroll.

Since 1977, the Foreign Corrupt Practices Act has forbidden U.S. companies, their partners and employees from paying bribes to foreign officials and has required public companies to record financial transactions accurately, which means no labeling bribes as “toner cartridges.”

Until five years ago, U.S. officials didn’t aggressively enforce the law. But priorities have changed as the feds have received more tips from U.S. companies, which are taking a closer look at their operations under Sarbanes-Oxley, and from officials in the other 29 Organisation for Economic Cooperation and Development countries, which have embraced new anti-bribery laws.

“The Americans sitting in America know not to pay bribes to foreign government officials, and they have training for their U.S. employees who operate overseas,” says Charles Smith, a partner at Skadden Arps Slate Meagher & Flom LLP in Chicago. “The problem usually comes when they buy into a local business that doesn’t have that history.”

To avoid problems, lawyers advise U.S. companies to review their Latin American partners’ financial records for unexplained commissions, suspicious donations to charities and fake or incomplete invoices. If they find a company is paying bribes, they should ask how critical those payments are, says Margaret Gibson, a partner at Kirkland & Ellis LLP in Chicago.

“It’s all well and good for a U.S. investor to say, ‘I’m going to buy this business and you’re going to stop and run clean,’ ” she says, but, “It may be that the company will not get the business it used to get without those payments.”

Other areas in which U.S. companies trip up:

INDEPENDENT CONTRACTORS AND EMPLOYEES: Many Latin American countries require foreign companies that want to fire their local distributors to cover investments the sales reps have made to develop the market, even if those dealers haven’t done a good job.

Those laws prevent foreign companies from using new distributors until the old dealers are paid. The three-year old Central American Free Trade Agreement released U.S. companies from that obligation in the six signatory countries: Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras and Nicaragua.

But “if you are dealing with a country like Paraguay, which has a strict law that is not subject to relief by any treaty, then you need to make a call as to whether it makes sense for the growth of your product line to risk non-performance by a dealer there,” says Miguel Noyola, a partner at Baker & McKenzie LLP in Chicago.

Also, Latin American countries generally require companies to give employees benefits American workers don’t get.

In Brazil, for example, each employee must be given a yearly bonus totaling one-third of annual salary. Employers also must put 8% of every employee’s salary into an interest-earning “employment security fund.” If the employee is laid off, that money plus 40% of his or her annual salary goes toward a one-time severance payment.

POLITICAL INSTABILITY: Latin American countries started opening up to international trade and investment in the late 1980s. But in recent years, some countries have reintroduced protectionist regulations.

In Venezuela, for example, President Hugo Chavez has imposed restrictions on foreign capital ownership in certain industries like petroleum and natural gas.

“If you’re a private-equity investor who’s hoping to sell that company one day, the Latin American political environment is much less stable than in the U.S.,” Ms. Gibson of Kirkland & Ellis says.

IF YOU DO GET INTO A DISPUTE: Latin American countries have slow, process-driven civil law systems in which most arguments are submitted in writing rather than verbally. Jury trials almost never happen. Awards, even for significant breaches of contract, are small compared with what companies get in the United States. That is why Americans often seek to resolve disputes with Latin American firms through international arbitration.

Europe: Across the pond

Michael Hanna learned the hard way that European labor laws are more employee-friendly than those at home.

Eight years ago, he owned a Chicago technology consulting firm that opened an office in Milan, Italy, after acquiring a company there. When he decided to fire an Italian employee for poor performance, he discovered local law required a severance package equal to about one year’s pay. It was money he was sorry to lose.

“We get spoiled in the United States because we don’t have all these rules,” he says.

Now CEO of NewMedical Technology Inc., a medical-device manufacturer in Northbrook, Mr. Hanna, 48, outsources distribution in Australia, Europe and South America to avoid hiring employees there. His entire staff is in North America, where they are at-will hirees.

“In the U.S., you have the hire-and-fire mentality and make quick decisions to downsize and right-size,” says Dieter Schmitz, a partner at Baker & McKenzie LLP in Chicago. “The European culture and legal rules really don’t allow that.”

Not only do European countries have severance requirements, which can be hefty in places like France and Belgium, but companies may have to go to labor court — something that doesn’t exist in the United States — to win approval for hirings and firings.

Other potential minefields for U.S. companies in Europe:

INTELLECTUAL PROPERTY: In the United States, you own the trademark you use, whether you’ve registered it or not. In Europe, your trademark is only protected if you register it there. Companies that don’t plan ahead can find their trademarks in the hands of opportunistic European companies and individuals who make money selling them back.

To avoid problems, U.S. companies can apply for a “Community Trademark,” valid in all 27 countries in the European Union. Prices start at $2,345, much cheaper than registering 27 individual trademarks.

Companies working in Europe also must register their patents, keeping in mind that European courts interpret patents differently than U.S. courts. In Europe, you have to prove the patented material or process is the result of an “inventive step” not obvious to a skilled person in that field — another concept that doesn’t exist in the U.S. That’s one reason Pfizer Inc.’s patent for the active ingredient in its cholesterol drug Lipitor was revoked by the Federal Patent Court in Munich, Germany, last fall.

IF YOU DO GET INTO A DISPUTE: In the civil law systems of continental Europe, there’s no trial by jury. You appear before a judge, who asks all the questions. You can’t demand documents or other evidence from your opponents like you can in the United States, and if you lose, you pay their legal fees and court costs. For these reasons, Europeans are more likely to mediate or arbitrate business disputes than rush to court like Americans. You can pick where you want to arbitrate and describe the type of arbitrator you want — for example, an English-speaking, U.K.-trained, non-German judge. Lawyers recommend putting these preferences in contracts with your European partners to avoid haggling over the details after the goodwill between you is gone.

Women to Watch: Susan Manske

(Crain’s Chicago Business, 07 May 2007)

WHY WE SHOULD WATCH HER: Her success in the financial markets determines whether charitable organizations, from international human rights programs to juvenile justice initiatives, continue to be funded.

CROSSROAD: Amid high turnover at Ameritech Corp., she stayed at the company from 1987 to 2000, moving to different investment divisions such as capital markets and risk management as colleagues left. That gave her the range of experience she needed to become a chief investment officer.

Susan Manske loves the intellectual challenge of investing. And she’s good at it, which is why more forests in Latin America are being saved and more human rights initiatives in Africa are getting funded.

Since Ms. Manske joined the MacArthur Foundation four years ago, her team’s investments have increased the foundation’s endowment to $6 billion from $3.8 billion in 2003, at an average 19% annual gain. That beats the Standard & Poor 500’s average annual gain of 13% over the same period.

Foundations are required to give away 5% of their assets every year, so by increasing assets by $2.2 billion, Ms. Manske’s team generated an additional $110 million for good works. This year, for example, MacArthur will give $5.5 million — $1 million more than last year — to 180 local arts organizations, including the Art Institute and Northlight Theatre.

“I strongly believe that teams with diverse skills — the fixed-income person, the equity person, the private-companies person — generate better ideas than individuals do,” says Ms. Manske, who supervises 11 people. “We’re long-term investors with a globally diversified portfolio.”

Previously chief investment officer of trust investments for Chicago-based Boeing Co., Ms. Manske, 48, has applied an investment formula that has beaten most major charities for the past four years. In 2005, MacArthur’s 15.5% rate of return was higher than 61 of the 64 non-profits surveyed by the Chronicle of Philanthropy, beating both the Rockefeller Foundation (12%) and the Bill and Melinda Gates Foundation (5.2%).

For non-profits, getting good returns isn’t easy, says Stacy Palmer, editor of the Chronicle of Philanthropy. “Non-profit organizations have to protect their assets and not invest in anything too risky,” she says. “There are rules that govern how foundations need to be prudent investors. On the other hand, if you don’t invest aggressively enough, you don’t have enough money to give away.”

Talk about pressure: If Ms. Manske doesn’t make the right choices, millions of dollars for charity disappear. When MacArthur had lower returns in the early 2000s, it avoided a dramatic dip in grant-making by spending more than the required 5% of its endowment, but couldn’t give extra support to some deserving programs.

Crain’s Fast 50

(Crain’s Chicago Business, 2 June 2008)

Chicago’s 50 Fastest-Growing Companies

No. 39. WMS Industries Inc., Waukegan

2007 revenue: $539.8 million

Four-year growth: 202%

Profitable? Yes

Local employees: 850

Worldwide employees: 1,414

Five years ago, WMS Industries, a leading player in the $90-billion global casino gambling industry, was in trouble. Sales were slowing, and the company was losing money.

Then WMS introduced the Bluebird, an ergonomically designed slot machine featuring high-quality audio provided by Bose Corp. and video that filled the screen.

“They were the game-changer in terms of what a slot-machine box looks like,” says David Katz, a gambling analyst with Oppenheimer & Co. in New York.

Priced at $10,000 each, Bluebirds tilted the odds in WMS’ favor. By the end of 2007, the company had shipped nearly 100,000 new machines or upgrades, a key reason WMS revenue soared 202% in four years.

WMS’ growth also has come from leasing 9,000 slot machines to casinos around the country. Among its offerings are “Monopoly Big Event,” a bank of networked Monopoly-themed slot machines that allows players to enter special bonus rounds together, and a “Wizard of Oz” game with surround sound and 3-D animation. Revenue from leased machines increased 87% between 2003 and 2007, to $174 million.

WMS, which started as Williams Manufacturing Co. in 1943, has never shied away from innovation. Founded in Chicago by Harry Williams, inventor of the tilt mechanism for pinball machines, the company made pinball games and jukeboxes, then switched to arcade video games. As arcades disappeared, the company, which renamed itself WMS when it went public in 1987, invented the video lottery terminal in 1992, then a video poker game for casinos. In 1994, it designed its first slot machines.

Casinos abroad bought 29% of WMS’ machines in 2007, up 36% from a year earlier. The company boosted international sales by acquiring two European game makers in the past two years: Orion Gaming B.V. of the Netherlands and Systems in Progress GmbH of Austria. WMS also maintains design studios in Australia and England that adapt games for foreign markets and enable the company to ship new games in all currencies and languages at the same time the U.S. version is released.

“We are in a hit-driven business,” says CEO Brian Gamache, 49. “Players around the world want to play what’s hot, and if we don’t give them products simultaneously, someone else will.”

WMS designers already are working on what industry analysts say is the next big thing — server-based gambling, in which slot-machine content can be controlled by a central computer, so if a particular game is popular one night, casino managers can download it on more machines from a back room. The Bluebird 2, scheduled for release by yearend, will have this capability.

Q&A: A Hands-Off Approach

(Crain’s Chicago Business, 6 February 2006)

It’s been 33 years since Princeton University economics professor Burton Malkiel advised investors to fill their portfolios with index funds. Over time, he argued in his book “A Random Walk Down Wall Street,” passively managed index funds outperform actively managed mutual funds or stocks. Crain’s asked Mr. Malkiel, 74, why he’s still convinced that’s the way to go.

The message of your book can be summarized as, “You can’t beat the market average, so invest in index funds.” Is there more to your investment philosophy than that?
One ought to either invest entirely in index funds or, at the very least, the core of one’s portfolio should be in index funds. But I have some actively managed funds. I even own a few individual securities. If you think a particular stock is a great buy, then buy it. You can do it with a lot less risk if the core of the portfolio is indexed. And don’t just have stocks, but have some bonds and some money in real estate investment trusts. And your stocks shouldn’t just be domestic. The major growth in the world over the next decade or two will not be in the United States or Europe. It will be in places like China and India and some Latin American countries.

So, the fact that the S&P 500 index was relatively flat this past year shouldn’t deter investors from buying index funds?
The reason the S&P has been doing a little worse, particularly over the last five years, is that smaller companies have been performing better than the huge, big-cap companies. And that’s why the S&P, which is a big-cap index, has been underperforming broader indexes such as the Dow Wilshire 5000. Indexing, for me, is not just buying the S&P, but buying the total stock market. Of course, even the broad-index investor is going to lose money when the stock market goes down. But you don’t lose your shirt.

Why can’t fund managers beat the indexes?
Markets are pretty efficient over the long haul, and the active manager charges a big fee. You can now buy index funds with an expense ratio of 10 basis points or less, meaning the management fee is one-tenth of 1% or less. The active managers charge about 1.5%.

How do you explain, then, stock-picking stars like Warren Buffett?
If I had known 30 years ago when I first wrote my book that Warren Buffett was going to be Warren Buffett, I wouldn’t have given the advice to go buy index funds. I would have said go buy Berkshire Hathaway. You know what? There will be three or four Warren Buffetts over the next 30 years, but you don’t know who they are, and I don’t know who they are. It’s not that they don’t exist, but they are impossible to identify in advance.

Index funds are supposed to match the return of the index they are following. Are there any times when this does not occur?
Not if the index manager is doing what he or she is supposed to. There are things that are called enhanced index funds, where the manager tries to do a little better. But on a pure index fund, you get the index. There are a few index funds that charge very high expense ratios, over 1%, and they will underperform the index.

Does it matter which fund provider you go with?
Look for low cost. Basically, if you’re going to be in a fund, it means going to people like Fidelity Investments or the Vanguard Group. Vanguard has the largest selection, because they got into indexing first.

Q&A: The Numbers Game

(Crain’s Chicago Business, 22 August 2005)

Ask and ye shall receive? Not necessarily, says Field Museum Chairman Marshall Field V, who’s leading the charge to raise $200 million for capital improvements. Times have changed since he helped John Bryan collect all those $1-million checks for Millennium Park, says Mr. Field, who is also a trustee at the Art Institute of Chicago. Crain’s talked to Mr. Field, 64, about the art of fund raising during a donation drought.

What’s the climate for corporate giving in Chicago these days?
It’s worse than in past years. The museums and colleges all went crazy during the ’90s. You could raise tons of money then because everyone’s stock portfolio was going up so fast they didn’t know what to do with their money. Now, that’s all changed, so for the major institutions, there’s a reduced pile of money. Also, Millennium Park came in and took $150 million out of the market, and a lot of people are still paying that off.

Several prominent Chicago institutions have $100-million-plus capital campaigns going on right now. Is this a problem?
Yes. There are too many big campaigns going after a finite pool of dollars. The other problem is, all the institutions have gone to five-year campaigns. So, somebody just finishes paying out their five-year thing, and wham — there it is again. I think people are getting tired of it.

What’s your fund-raising strategy in this environment?
My strategy is to plug away. It’s just going to take longer and be more frustrating. And I think schools and museums are going to have to cut back on their plans.

Is desperation for dollars prompting organizations to come up with innovative ways of fund raising?
Organizations are trying to make the way they approach plugging away more sophisticated. So, for instance, at the Art Institute, the person who ran development has now been assigned to do nothing but go after big gifts, because that’s what he’s good at. Someone else will be brought in to do the lower gifts development.

What trends are you noticing in corporate giving?
Companies now want their gifts to work for the stockholder — promote the company and its business, almost like special advertising through donations.

How do you make your organization stand out in a sea of causes?
Make friends and bring them into the sphere. All of the big organizations’ boards now are 40-plus people, so they’re not really boards anymore, they’re talent pools, and the work is done at the executive committee level or by other committees. And that’s so potential donors can join the family, if you will.

Does the up-and-coming generation of philanthropists have a different approach to giving than their predecessors?
Younger donors aren’t satisfied with just writing a check. They want to get involved, they want to help the organization with what they feel are their own talents, so it’s a more complicated relationship than it used to be.

Asking for money can be awkward. How can you stand to do so much of it?
I don’t push people hard, unless they’re a board member who isn’t giving. As long as people give to some charity, I don’t fault them for having interests that may not be the same as mine. It’s a numbers game. If I call on a hundred people, 25 are going to give to me and 75 aren’t. So if I get three turndowns, fine — then I’m owed a “yes.”

Samantha Stainburn

Writer | Editor

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