B-226269, Oct 3, 1990

B-226269, Oct 3, 1990

MISCELLANEOUS TOPICS - Agriculture - Agricultural programs - Exports Conflicts of interest DIGEST: The Foreign Agricultural Service's conflict of interest regulations dealing with the activities of participants in the foreign market development programs, do not prohibit an association which is acting on behalf of and which is a member of a cooperator-association, from engaging in commercial export-related activities of the same commodity through a wholly owned subsidiary.

FAS' Conflict of Interest Regulations on Foreign Market Development Program B-226269; Code 483547:

This responds to your question regarding the Foreign Agricultural Service's (FAS) conflict of interest regulations dealing with the activities of participants in the foreign market development programs. The chairman of the Committee on Agriculture, House of Representatives, has requested GAO's views on whether these regulations, issued in September 1989, have satisfactorily addressed the conflict of interest problems identified in a 1987 GAO report on FAS' management of the livestock cooperator program.

Specifically, you asked whether FAS' conflict of interest regulations prohibit a particular association the Holstein-Friesian Association, which is acting on behalf of and which is a member of a cooperator-association the Purebred Cattle Association, from engaging in commercial, export- related activities through a wholly owned subsidiary Holstein Services. As explained below, while the regulations prohibit program participants (i.e., cooperators such as Purebred) and their affiliated organizations from engaging in commercial export activities concerning the same commodities they are promoting under the program, this prohibition does not specifically cover a member of a cooperator.

Under FAS' foreign market development program, FAS contracts with private, nonprofit agricultural interests (i.e., cooperators) to engage in various FAS-funded activities to promote foreign markets for United States agricultural products. In a 1987 report, we addressed livestock exporters' complaints of conflict of interest and unfair competition because certain livestock cooperators, through their subsidiaries, were exporting the same commodity that they were promoting with government funds. /1/ The exporters alleged that the cooperators had received commercial sales or commissions stemming from trade leads that were developed during FAS-funded trips. Some of these complaints concerned the Holstein-Friesian Association of America (Holstein), a livestock cooperator at that time whose wholly owned subsidiary, Holstein Friesian Services (Holstein-Services), also engaged in the commercial export of livestock.

Our report disclosed that existing legislation did not contain any specific restrictions concerning cooperators' market development activities, that FAS had not issued regulations for the program, and that FAS' guidelines did not prohibit or otherwise preclude the above activities. We therefore recommended that appropriate action be taken to finalize and implement conflict of interest provisions that FAS had drafted addressing the noted problems. /2/

In April 1988, FAS issued for public comment proposed conflict of interest regulations intended in part to insure that no U.S. firm or individual derives an unfair advantage or benefit from program activities. /3/ The proposed regulations prohibited cooperators, together with their parent organizations, subsidiaries and affiliates, from making export sales of the same type of commodities they are promoting with FAS funds. In September 1989, FAS issued the conflict of interest regulations in final form. They substantially reflected the proposed regulations, but the final rule contained a new definition section specifying who the rule covered. /4/ Explained later in more detail.

We understand that in January 1989, prior to the issuance of the final regulations, FAS terminated several livestock cooperators from the program, including Holstein, because the cooperators did not want to end their commercial export activities. The associations then joined the Purebred Cattle Association (Purebred), a newly established national cooperator association representing the United States purebred dairy cattle industry. We understand that Holstein provides the funding for about 65 percent of Purebred's operations and has continued its dairy cattle export activities through its wholly owned subsidiary, Holstein Services.

You question whether FAS' regulations prohibit Holstein from engaging in these export activities, and if not, whether Holstein's arrangement with Purebred is an improper circumvention of those regulations. You point out that Holstein appears to be engaging in the same FAS program activities as a Purebred member that it previously engaged in as a cooperator, and therefore nothing has really changed since the issuance of our report, despite the fact that FAS has issued conflict of interest regulations.

FAS's conflict of interest regulations contain various requirements and restrictions regulating the conduct of firms and individuals that participate in FAS' foreign market development programs. The pertinent restriction states as follows: /5/

"(1) Neither program participants nor their affiliated organizations shall, during the term of the agreement, make export sales of agricultural commodities of the kind which are promoted, in whole or in part, with project funds."

According to the literal terms of the above provision, FAS' prohibition is directed to "participants and their affiliated organizations." The regulations define the term "participant" as any entity entering into a market development project agreement (i.e., a cooperator), and the term "affiliated organization" is defined as "any partnership, association, company, corporation, trust, or other legal entity in which the program participant has any investment other than an investment in any mutual fund." /6/

Because a member of a cooperator does not fall within either of the above definitions, in our opinion the subject prohibition technically does not apply to the export-related activities of such members. Consequently, FAS' regulations do not specifically prohibit Holstein from engaging in export-related activities so long as Holstein is only a member of Purebred and not a participant or an affiliated organization of a participant.

The FAS Administrator recently expressed similar views in responding to the same question raised by a dairy cattle exporter. In a letter dated January 9, 1990, to the Managing Director of Ag-World Exports, the FAS Administrator stated as follows:

"... The fact that a cooperator has members that are actively engaged in export sales does not, in itself, contravene our regulations. The regulation precludes participation only if the cooperator has investment in the exporting entity. In this way we attempted to ensure that no exporting firm would be in a position to take unfair advantage of opportunities developed through the market development efforts of the cooperator."

"In drafting the conflict of interest regulations, the Department was not trying to prevent Cooperator organizations from accepting as members private firms or other organizations which are involved in export trade. To have done so would have resulted in excluding several broad-based Cooperator Program participants which draw support, contributions, and board members both from farm groups and agribusiness corporations.

The active and informed participation of private sector entities has been a source of strength and balance for the Department's market development programs."

FAS evidently feels that the benefits derived from the active participation in its market development programs of members of cooperators and others that may be involved in export trade outweighs the inherent risk of an improper conflict of interest. In the absence of substantive evidence or other information analyzing these benefits versus the risks, it is difficult for us to question FAS' views on this point.

Clearly, however, extending the current prohibition to all firms and organizations involved in program activities, including members of cooperators, may well eliminate many of the real, potential, or apparent conflicts of interest situations that may arise as a result of a Holstein- Purebred type of arrangement. On the other hand, the establishment of such a broad prohibition could possibly have a severe detrimental impact on the program if substantial numbers of firms and organizations decide not to participate in order to retain their export businesses.

Another FAS restriction that should be considered is the general standard of conduct that FAS has established for firms and individuals that participate in FAS' programs. As emphasized in the first part of FAS' conflict of interest regulations, the regulations are designed to ensure that program benefits are as broadly distributed throughout the relevant agricultural sector as feasible and that no program participant derives an unfair advantage or benefit from program activities. /7/ This objective is reflected in the following prohibition in FAS' regulations: /8/

"(3) Participants in approved program activities shall not use the activities to promote self-interests or conduct private business ..."

We note, however, that the above prohibition by its terms is directed only to program "participants," defined in section 1550.2(h) as any entity entering into a market development project agreement. It is therefore questionable whether this prohibition covers other firms, organizations, or individuals who are members of a participant, but who are not themselves participants in FAS' market development program. /9/

We have discussed this matter with Mr. Len Kreitzberg of the Department of Agriculture's Office of General Counsel, and he recognized the validity of this point. Mr. Kreitzberg told us, however, that FAS intended a broad application of the prohibition and that FAS would question any program activity by any firm or individual that appeared to give them an unfair advantage or benefit. Nevertheless, we believe that to remove any doubt GAO should recommend that this section be clarified to extend to any firm, organization, or individual involved in the program, whether or not such an entity is a "participant."

Turning to the second part of your question-- whether Holstein's arrangement with Purebred is in effect an improper circumvention of FAS' regulations-- we do not believe that the information available at this point would support such a conclusion. The fact that Holstein finances about 65 percent of Purebred's operations and plays a dominant role in Purebred's activities does not alone, in our view, suggest any impropriety. Moreover, a FAS Administrator's letter of January 9 indicates that FAS is clearly aware of and does not object to this arrangement:

"... In the case of the Purebred Dairy Cattle Association, a number of significant players in the industry have come together to attempt to better coordinate their efforts overseas. We believe that the structure they have come up with will provide improved joint oversight for government/private sector cooperation in dairy cattle export promotion."

Finally, we also assessed your point that nothing has really changed since the issuance of our report because Holstein appears to be engaging in the same activities as a member of Purebred that Holstein engaged in as a cooperator. As a cooperator, Holstein previously carried out FAS promotional activities while its subsidiary (Holstein Services) engaged in export activities involving the same commodity. As a member of Purebred, Holstein presently is carrying out FAS promotional activities while its subsidiary continues to engage in export activities. We understand, however, that NSIAD has not found any evidence suggesting that Holstein in fact has engaged in activities from which it derived an unfair advantage or benefit.

Although Holstein's continued participation in FAS' programs-- while it still engages in export activities through Holstein- Services-- could be viewed as creating the same types of problems that the FAS conflict of interest regulations were intended to avoid, FAS appears to rely on Holstein's adherence to the conflict of interest regulations, particularly the general standard of conduct that participants shall not use program activities to promote self-interests or conduct private interests. As we discussed above, however, FAS' conflict of interest regulations do not specifically cover members of cooperators such as Holstein. Clarifying language thus may be needed.

/1/ FAS Management of Livestock Cooperator Program, GAO/NSIAD-88-24, October 26, 1987.

/2/ The Congress enacted legislation in August 1988 directing the Secretary of Agriculture to take appropriate action to prevent conflicts of interest among cooperator organizations participating in the cooperator program. Section 4214 of the Omnibus Trade and Competitiveness Act of 1988, Pub.L. No. 100-418, August 23, 1988.

/3/ 53 Fed.Reg. 13125 (1988).

/4/ 54 Fed.Reg. 37781 (1989), codified in 7 C.F.R. Parts 1485 and 1550.

/5/ 7 C.F.R. Sec. 1550.5(e)(1).

/6/ 7 C.F.R. Sec. 1550.2(h) and (b), respectively.

/7/ 7 C.F.R. Sec. 1550.5(b).

/8/ 7 C.F.R. Sec. 1550.6(e)(3).

/9/ This restriction, as set out in FAS' proposed regulations, covered all entities participating in FAS programs, therefore extending to members of cooperators. See 53 Fed. Reg. 13128 (1988).