Tognum Probes $32 Million Paid to South Korean Sales Agent

Tognum AG (TGM), which is being acquired by Daimler AG (DAI) and Rolls-Royce Group Plc (RR/), uncovered 23 million euros ($32 million) in commissions at its MTU Friedrichshafen unit that may have been wrongfully paid in connection with sales of defense-related products in South Korea.

Some funds were used to host members of the Korean military at Asian vacation resorts and night clubs in the Bangkok red- light district, according to a management summary of a draft report obtained by Bloomberg News that was prepared for Tognum by Ernst & Young GmbH. The document, part of an internal review, focused on commissions paid to a South Korean businessman.

Ernst & Young recommended “an examination of the implementation of current compliance measures” for sales partners and payments at Tognum’s units outside Germany, the accounting firm said in the advisory section of the draft report dated Sept. 26.

German companies have beefed up anti-corruption efforts since Siemens AG was embroiled in a bribery scandal involving 1.3 billion euros of “unclear payments” that led to a $1.6 billion settlement with German and U.S. prosecutors. Daimler last year agreed to pay a total of $185 million to resolve a U.S. probe of bribes paid in 22 countries.

Joint Venture

In a 50-50 joint-venture bid announced in March, Daimler and Rolls-Royce secured at least about 97 percent of Tognum shares, Daimler said Aug. 26. Daimler had previously owned Friedrichshafen, Germany-based Tognum before selling it to private equity firm EQT Partners in 2006.

Tognum, the world’s second-biggest manufacturer of high- speed diesel engines for the marine, energy and defense industries, confirmed the probe in an e-mailed statement yesterday without disclosing any details.

The investigation may be completed this week and the company will release details “in due course,” Tognum spokesman Stefan Wortmann said.

The supervisory board’s audit committee has been informed of the probe from its start, Wortmann said. After receiving a request for comment on the story by Bloomberg News, Tognum yesterday also informed German prosecutors about the case.

A member of Tognum’s legal department came to see prosecutors in Ravensburg, Germany, yesterday to inform them about the issue, Karl-Josef Diehl, spokesman for the prosecutors’ office said in an interview today. The lawyer informed them only orally, without providing any written documentation, said Diehl.

Ernst & Young

“Tognum told us that we would receive the Ernst & Young report once it’s final,” said Diehl. “We can decide only then whether to open a probe into the issue and whom to investigate.”

The company retained Ernst & Young after receiving an e- mail in January from German magazine Der Spiegel asking about three payments made by MTU in 2008 “in connection with a submarine deal in South Korea,” the accounting firm said. The payments of 938,671 euros, 474,986 euros and 208,935 euros to a sales representative may have been used “to bribe decision makers,” the report cites the Der Spiegel e-mail as saying.

Ernst & Young identified the amounts in a series of payments totaling 39.9 million euros made by Tognum’s MTU unit from 2000 through 2011. The money went to companies and accounts controlled by Chung Eui Sung, a South Korean business man.

Chung, an independent sales representative, was an employee at MTU from 1977 to 1987 after serving 14 years in the South Korean Navy, the report says.

Local License

In 1987, Chung started his own business. MTU deemed his services necessary for a part of its business in Korea regulated by the country’s rules for defense-related purchases. The government required MTU and its competitors to sell defense products through licensed local companies.

Without Chung’s support, MTU wouldn’t have been able to keep its market share, Ernst & Young cited MTU managers as saying during interviews conducted in the probe.

Chung was taken into custody in 1993 because a 300 million South Korean Won ($263,000) donation to the navy chief for setting up an institute was “erroneously interpreted as bribery,” he said during Ernst & Young interviews, the accounting firm said in the report.

Chung’s work on such “licensed products” was contrary to internal MTU rules and contracts with the local customer products were licensed to. Both barred any third-party participation in the transactions. Commissions for the brokering of “licensed products” sales were also banned in a clause that applied though 2008 in an Agency Agreement Chung’s company, Systech Korea Co. Ltd., signed with MTU.

Side Deals

To circumvent that, MTU and Systech, which in 2006 was renamed UBMTech Korea Co. Ltd, entered into side deals regulating the sales representative payments, according to the report.

Chung and UBMTech didn’t reply to an e-mail seeking comment yesterday. Chung’s administrative assistant at UBMTech said to submit all questions via e-mail.

The practice was known to Peter Kneipp, who was chief of MTU’s Asian unit 2004 to 2010 and is now a management board member at Tognum, Ernst & Young said.

When German tax authorities audited MTU in 2009, Kneipp was asked to provide all relevant sales representative agreements. In his fax reply to MTU’s German headquarters dated Feb. 2, 2009, Kneipp only sent the Agency Agreement and didn’t include the side agreements, the report said.

Hidden Contracts

Systech hid the contracts and had them stored outside South Korea to put them out of the reach of local authorities, Ernst & Young said.

“Korean tax authorities or prosecutors could have found the documents in one of their investigations, which would have been disadvantageous for Systech and MTU alike,” Ernst & Young said, citing an explanation from UBMTech. “There have been several investigations from the Korean side in the past, which didn’t yield any results because the side agreements weren’t present in Korea.”

Ernst & Young’s investigators found funds were spent to host military officials. MTU and Systech financed “on-the-job training” for members of the Korean military. While the official part of the programs consisted of training on MTU products, there was also an “unofficial” element that included trips to Phuket, Bali and other Asian resort destinations, Ernst & Young said.

The goal was to “support and intensify” relationships with officers, the report said. Kneipp knew about the trips, according to Ernst & Young.

Night Club Visits

Lists with costs of the trips include visits to night clubs. Internet searches revealed these clubs were “notorious establishments in Bangkok’s red-light district,” the Ernst & Young investigators said. Some money was spent on items that may have been given to members of the military as gifts, including golf equipment and swimming gear, Ernst & Young said.

The investigators also said MTU didn’t properly document the performance of Chung’s companies under the various contracts.

“Because of the lacking performance documentation it can’t be finally cleared to what extent the commission payments were based on an actual broker service which justifies the amount of commissions paid,” the report says.

Chung was questioned as part of the investigation about what he did to earn the commissions. He said that UBMTech did “project engineering,” “contractual negotiations” and “after service (after contract works),” Ernst & Young said.

Korean Army, Navy

“UBMTech is promoting MTU interests in the Korean Army and Navy,” Chung said in a May 20 letter, according to the Ernst & Young report. “It is practically impossible to describe how UBMTech promotional works are practically carried out.”

From 2001 to 2002, MTU paid part of the commissions to an account in Singapore set up for an entity called Far Eastern Trading and Consulting. From 2006 to 2008 a share of 9.8 million euros was paid to Prisma Corporate Ltd., incorporated in the British Virgin Islands, which also had an account in Singapore. Both were controlled by Chung, according to the report.

Chung told Ernst & Young investigators that he was asked by MTU to set up an off-shore account where “unofficial commissions” could be paid.

From 2000 to 2004, Chung received 21 checks from MTU totaling 1.1 million euros, Ernst & Young says. Nine checks were cashed by MTU employees and the money was handed over to Chung.

A South Korean Defense Ministry spokesman declined to comment. Ernst & Young spokesman Dag-Stefan Rittmeister declined to comment on the report.

Daimler spokeswoman Ute von Vellberg declined to comment, saying it is an issue for Tognum. Rolls-Royce didn’t reply to e- mails seeking comment yesterday.

Der Spiegel didn’t publish a story on the payments following its January e-mail request.

To contact the reporter on this story: Karin Matussek in Berlin at kmatussek@bloomberg.net

To contact the editor responsible for this story: Anthony Aarons at aaarons@Bloomberg.net.

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