The Scale of the Stupidity at Leo Burnett

With the shock of the $20 million fraud scandal at Leo Burnett now 48 hours old, it’s time to assess the sheer scale of the stupidity which led to the $15.5 million settlement the agency paid to avoid being sued by the feds. The agency itself said this to the WSJ:

“Leo Burnett believes the government’s claims are without merit,” the company said. It also said the settlement “will not affect Publicis Groupe’s earnings since the payment amounts have been fully accrued in prior fiscal periods.”

The notion that the settlement has already been worked into Publicis’s numbers is not surprising. The French company only fully reports its finances every six months, with a partial report for the other two quarters. BNET readers learned last October that this allows Publicis to conceal any number of expenses in the off-quarters. I’m going to take a wild guess that the settlement was worked into Publicis’s off-quarter reports. It will be interesting to see if it appears in the annual report.

The next issue that beggars belief is that Burnett attempted to pull a fast one on the government at all. Anyone with a passing knowledge of government ad contracts knows that the feds — and the military specifically — have one of the most thorough, complicated billing-and-auditing systems imagineable.

TMP Worldwide, for instance, lost the $20 million U.S. Air Force Reserve account in 2004 in part because they couldn’t get the billing right. (There was no wrongdoing — the agency just couldn’t handle the complex billing process.)

Next, the penalties for screwing the feds are potentially enormous. Ogilvy & Mather account chief  Shona Seifert got 18 months in federal prison in 2005 for overbilling the White House anti-drug account. Ogilvy CFO Tom Early got 14 months in the same caper. (Also pleading guilty were media director Ray Simko, contract coordinator Al DiOrio, broadcast director Peter Chrisanthopoulos, and planning director Robert Zach.)

And you don’t have to screw over the government; at Grey Global Group, print chief Mitch Mosallem got 70 months in the pen for operating a kickback scheme on the Procter & Gamble and Brown & Williamson accounts.

In short, the feds are the only clients who have their own army of FBI agents and prosecutors — and an unlimited budget with which to fund them — so why take the risk?

The device of the fraud — claming that wholly owned units were third-party contractors — is a tactic that is still in use today. Deutsch was accused in a lawsuit of running a TV production shop that it used to bid on contracts that were supposed to be competitive.

WPP in India just announced it will try to funnel as many contracts as possible to its own in-house production studio. WPP’s shop is called Sharp Shooters and will service all WPP agencies in India such as O&M, JWT, Grey Worldwide and Bates. Presumably, WPP agencies will be completely transparent with their clients when presenting the in-house bid next to the outside ones.

Another aspect of the fraud is mentioned only briefly in the suit. It’s the part that says:

Under standard practices in the advertising industry, LBUSA treated Other Direct Expenses as “pass-through” costs without mark-up or other profit added. But for Army contracts, LBUSA marked-up ILEO work and subcontractor work for additional profits, above and beyond the fees it was already receiving.

Agencies have long argued — and clients, bizarrely, have sometimes agreed — that vendor discounts, rebates and give-backs belong to the agency, not the client. This is to reward the agency for its bulk buying power, created by massing its clients together as a single purchaser. But these arrangements often contradict agency-client contracts, almost all of which have a standard clause in them stating that the client’s bills will be paid at net price not gross price. The gap between the two positions leaves agencies open to fraud accusations. That was what happened with Interpublic Group in 2004 and 2005, when it was forced to return $250 million in “agency volume bonification” monies to clients. (More details on that here.)

Don’t think “agency volume bonification” is a big issue in the agency biz? Then why is it on the agenda of the ANA’s next agency finance meeting?

Perhaps the most worrying part for employees and clients of Burnett, however, is the failure of leadership. When ex-CFO Eric Martinez objected to Burnett keeping a secret account filled with Army overcharges, ex-CEO Linda Wolf fired him.

Note to management: If you have to set up a secret account for anything, you’re probably doing something wrong. And if someone alerts you to such a scheme, it may be inconvenient but they’re actually trying to save you from the fate of Ogilvy CEO Bill Gray, who in the anti-drug trial was forced to testify that although he personally did no wrongdoing, he said “get a fix on it” to Seifert when problems arose on the account. (He also testified that he didn’t understand the contract he had signed, and he was confused by his own agency’s revenue projections. Nice!)

Burnett will now enter some very interesting negotiations over whether it must pay full price on a bunch of NASCAR ad inventory it has already bought — $3.4 million worth. Part of the settlement requires Burnett to pay for this media, which it already bought for the Army. The agency may ask that NASCAR let it slide in hopes of maintaining its goodwill. (Chrysler, for instance, has slashed its NASCAR spend by 30 percent, so the race car operation needs to be as kind to its customers as possible.)

Considering the alternatives, everyone involved in this fiasco got off lightly.

• For more of BNET’s coverage of ad agency pricing issues:
• Leo Burnett Pays $15.5 Million to Settle Allegations It Defrauded the U.S. Army
  
• WPP’s In-House Commercial Production Shop Courts Controversy With Clients
  
• Levi’s Asks for Transparency and Media Buyers Balk