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The SEC Goes Searching

Last August (see here) when Robert Khuzami, the SEC’s Director of the Division of Enforcement, announced that the SEC would be creating a specialized FCPA unit he said, among other things, that:

“The Foreign Corrupt Practices Act unit will focus on new and proactive approaches to identifying violations of the Foreign Corrupt Practice Act…”

In February, Cheryl Scarboro (the head of the SEC’s FCPA Unit) similarly stated (here) that “the new unit will give us the resources and the ability to do even more going forward,” that the new unit will allow the SEC to do more industry investigations, and that one industry the SEC is focusing on is the pharmaceutical industry.

Given these comments, it should come as no surprise that a recent Wall Street Journal article notes that the SEC enforcement division sent letters “within the past two months” to several companies in the pharmaceutical and energy industries” “as part of an investigation by the SEC division that looks into potential violations of the FCPA.” According to the article, the letters ask the companies “about their internal controls to guard against bribery” specifically in terrorism-sponsor states such as Cuba, Iran, Sudan, and Syria. According to the article, “it isn’t clear which companies received the letters.” The article also notes that “the SEC probe, which is in its early stages, comes as the Justice Department’s criminal fraud section has sent letters in recent weeks to a number of pharmaceutical companies asking about payments made to foreign officials in several nations…” Both the SEC and DOJ declined to comment for the article.

Bribes for Books

A post earlier this week talked about the World Bank and other multilateral development banks (see here).

Fitting because recently the World Bank (see here) “debarred Macmillan Limited, a U.K. company, declaring the company ineligible to be awarded Bank-financed contracts for a period of six years in the wake of the company’s admission of bribery payments relating to a Trust Fund-supported education project in Southern Sudan.” According to the release, “the debarment can be reduced to three years subject to continued cooperation.”

In a press release yesterday (see here), the company said “the international publishing business, Macmillan Publishers Ltd UK (“Macmillan”), has today confirmed that it has voluntarily referred to the Serious Fraud Office its concerns over historic payments made by a subsidiary of its education business, Macmillan Education, to secure a contract in Southern Sudan.”

Step Up to the Podium Friday

Today’s post includes FCPA excerpts from various speeches/comments made by enforcement officials over the past couple of days.

Stepping to the podium will be Assistant Attorney General Lanny Breuer; Mark Mendelsohn – Deputy Chief of the DOJ Fraud Section; and Cheryl Scarboro – the head of the SEC’s newly formed FCPA unit.

Lanny Breuer

Breuer spoke at the ABA National Institute on White Collar Crime in Miami. See here for his comments.

As to the FCPA, here is what Breuer had to say.

“… As I’m sure many of you are aware, in a recent FCPA investigation, the Criminal Division’s Fraud Section used undercover law enforcement techniques to uncover what we allege to be widespread fraud and corruption. As a result, 22 executives and employees of companies in the military and law enforcement products industry were indicted for their involvement in schemes to bribe foreign government officials. This investigation involved the most expansive use ever of undercover techniques to uncover FCPA violations.”

Note – per the DOJ, there was no actual involvement by any real “foreign government official.” This dynamic raises some legal issues – see here.

Back to Breuer’s comments.

“Let me say a few more words about our very robust FCPA program, because it, in many ways, typifies how we are approaching crime in corporate America.”

“The FCPA investigation I just referenced is the largest single prosecution of individuals in the history of DOJ’s enforcement of the FCPA. It thus vividly illustrates one cornerstone of our FCPA enforcement policy: the aggressive prosecution of individuals. Put simply, the prospect of significant prison sentences for individuals should make clear to every corporate executive, every board member, and every sales agent that we will seek to hold you personally accountable for FCPA violations. As we focus on the prosecution of individuals, we will not shy away from tough prosecutions, and we will not shy away from trials. We are ready, willing, and able to try FCPA cases in any district in the country—as we demonstrated with our three FCPA trial victories just last year.”
Note – In one of the trials, William Jefferson was acquitted of FCPA substantive charges. He was convicted of, among things, conspiracy, a verdict that may or may not have, included conspiracy to violate the FCPA. See here. In another trial, Frederic Bourke was convicted of conspiracy to violate the FCPA. He was sentenced to 366 days in prison. At sentencing, Judge Shira Scheindin said – “After years of supervising this case, it’s still not entirely clear to me whether Mr. Bourke is a victim or a crook or a little bit of both.” See here.

Back to Breuer’s comments.

“To be sure, we are not focusing on individuals to the exclusion of corporations. We will continue to insist on corporate guilty pleas or to bring criminal charges against corporations in appropriate cases – when the criminal conduct is egregious, pervasive and systemic, or when the corporation fails to implement compliance reforms, changes to its corporate culture, and undertake other measures designed to prevent a recurrence of the criminal conduct. We will continue to insist on appropriately stiff corporate fines, applying a consistent, principled approach that considers the facts and circumstances within the Department’s established framework and that is guided by the Sentencing Guidelines in arriving at an appropriate sanction.”

“I also want to assure you that the Department’s commitment to meaningfully reward voluntary disclosures and full and complete corporate cooperation will continue to be honored in both letter and spirit. I know that many of you often grapple with the difficult question of whether to advise your client to make a voluntary disclosure. I strongly urge any corporation that discovers an FCPA violation – or any other criminal violation, for that matter – to seriously consider making a voluntary disclosure and to cooperate with the Department. The Sentencing Guidelines and the Principles of Federal Prosecution of Business Organizations obviously encourage such conduct, and your clients will receive meaningful credit for that disclosure and cooperation.”

Mark Mendelsohn

Mendelsohn recently spoke at the Dow Jones Global Ethics Summit in New York City. DOJ has not released a transcript of his remarks, but a collection of media sources covered his comments.

See here, here, and here.

As to the Africa Sting case, Main Justice reports the following from Mendelsohn:

That the government is “in a strong position because of the massive volumes of information it has collected. “That should give you an idea of the strength of our case,” he said. Specifically, Mendelsohn said that a simple meeting in a New York hotel to discuss a bribery scheme would fall under the FCPA, even if the rest of the scheme took place entirely outside the U.S. Money and, potentially, e-mails, electronically transferred through the U.S. could bring a bribery scheme under the jurisdiction of the FCPA, he said.”

Cheryl Scarboro

Scarboro, an SEC veteran, was recently appointed to lead the SEC’s new FCPA unit (see here). Jesse Sunenblick at Main Justice recently sat down with Scarboro for a Q&A (see here).

As to the new FCPA unit Scarboro said:

“… [T]he new unit will give us the resources and the ability to do even more going forward. People on the ground will be focusing exclusively [on FCPA investigations], making them smarter about industry practices problem areas. We will be able to leverage resources and leads we get from others. There are ongoing investigations exactly like oil for food: not just concerning one company, but looking beyond into widespread practice in particular areas. I would expect filed cases in the short term, in a matter of months. These cases will be an illustration of what we’ve already been doing. But the new unit will allow us to do even more of it. We have areas and industries we are focusing on—pharmaceutical is one.”

“Game-Changing” Day at the SEC

In August 2009, Robert Khuzami, the SEC’s Director of the Division of Enforcement, announced that the SEC will be creating five “national specialized units dedicated to particular highly specialized and complex areas of securities law” – including an FCPA unit. (see here).

Khuzami also announced that the SEC was working on other initiatives of interest to FCPA followers including creation of “a public policy statement that will set forth standards to evaluate cooperation by individuals in enforcement actions” as well as “recommend[ation] to the Commission that the SEC enter into Deferred Prosecution Agreements, in which the [Division of Enforcement] agree[s] in the appropriate case to forego an enforcement action against an individual or entity subject to certain terms, including full cooperation, a waiver of statutes of limitations, and compliance with certain undertakings.”

Yesterday, there were developments on each of these issues.

First, the SEC (see here) announced that Cheryl J. Scarboro will lead the FCPA unit. As indicated in the release, Scarboro is an SEC veteran having served as Associate Director, Assistant Director, Deputy Assistant Director, and Staff Attorney in the Division of Enforcement. For many years, Scarboro has been a primary SEC voice on FCPA issues and an active participant at many FCPA conferences.

Second, the SEC (see here) announced a series of measures “to further strengthen its enforcement program by encouraging greater cooperation from individuals and companies in the agency’s investigations and enforcement actions.”

“New cooperation tools” not previously available to the SEC, will now include, among other things:

* “Cooperation Agreements — Formal written agreements in which the Enforcement Division agrees to recommend to the Commission that a cooperator receive credit for cooperating in investigations or related enforcement actions if the cooperator provides substantial assistance such as full and truthful information and testimony.”

* “Deferred Prosecution Agreements — Formal written agreements in which the Commission agrees to forego an enforcement action against a cooperator if the individual or company agrees, among other things, to cooperate fully and truthfully and to comply with express prohibitions and undertakings during a period of deferred prosecution.”

and

* “Non-prosecution Agreements — Formal written agreements, entered into under limited and appropriate circumstances, in which the Commission agrees not to pursue an enforcement action against a cooperator if the individual or company agrees, among other things, to cooperate fully and truthfully and comply with express undertakings.”

The SEC release notes that “similar cooperation tools have been regularly and successfully used by the Justice Department in its criminal investigations and prosecutions.”

More details about these measures can be found in a revised and newly issued version of the SEC’s enforcement manual beginning at pg. 119 (see here).

The SEC news conference announcing these appointments and initiatives is available on the SEC’s website.

While not FCPA specific, these measures as applied to FCPA enforcement are likely to lead to even less judicial scrutiny (not that there is much judicial scrutiny at present) as to SEC interpretations of the FCPA and as to whether factual evidence actually exists to support each element of an FCPA charge.

In fact, as set forth in the manual (p. 130) “[a]n admission or an agreement not to contest the relevant facts underlying the alleged offenses” is a key factor the SEC will consider in determining whether a company should receive a deferred prosecution agreement.

For those anxious to see FCPA enforcement actions contested in an open, transparent, and adversary proceeding, yesterday’s announcements will be a blow as I expect FCPA enforcement to become even more opaque in the future.

Stay tuned as much is surely to be written about these new measures in the coming weeks and months.

If the SEC Was An Issuer …

The FCPA’s books and records and internal control provisions require issuers (i.e. publicly-traded companies) to: (i) “make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer;” and (ii) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that (among other things) transactions are executed in accordance with management’s general or specific authorization, transactions are recorded as necessary to maintain accountability of assets, and access to assets is permitted only in accordance with management’s general or specific authorization.

The SEC enforces these provisions against issuers.

Often times, the SEC enforces these provisions against issuers aggressively (see here and here).

It seems to not matter to SEC enforcement officials whether the improper recording in the company’s books or records occurred at a far flung, fifth-tier subsidiary by a rogue employee or whether the issuer actually had knowledge that a far flung subsidiary was engaged in improper conduct.

The SEC’s position is that if the far-flung subsidiary’s financial results are consolidated with the parent company issuer’s financial results for purpose of financial reporting, then the subsidiary’s violation is the issuer’s violation.

Further, it seems to not matter to SEC enforcement officials whether the violation resulted from a rogue employee acting contrary to clearly articulated and well communicated company policies and procedures prohibiting the improper conduct because, after all, if the company’s internal controls were effective, rogue employees would not exist or, if they do exist, proper controls would be put in place to monitor their behavior before it occurred.

Every so often, it is fun to spend a few moments in “hypothetical land.”

The issue in “hypothetical land” today is – if the SEC was an issuer.

If the SEC was an issuer, it would have some serious FCPA books and records and internal control issues to deal with as a result of the Government Accountability Office’s (“GAO’s”) recent “Financial Audit – Securities and Exchange Commission’s Financial Statements for Fiscal Years 2009 and 2008” (see here).

As detailed in the audit, the GAO “identified six significant deficiencies that collectively represent a material weakness in SEC’s internal control over financial reporting.” In short, the GAO concluded that “SEC’s internal control over financial reporting was not effective as of September 30, 2009.”

Most notably, the GAO found material weaknesses that have: (i) “resulted in unsupported entries and errors in the general ledger”; (ii) “ineffective financial reporting controls and general ledger system reporting limitations”; and (iii) “ineffective processes and related documentation concerning budgetary transactions.” (p. 5).

Among other specifics, in terms of the general ledger system and the supporting processes the SEC uses to prepare its financial statements, the GAO found that:

“unauthorized personnel can view, manipulate, or destroy data” (p. 64);

SEC controls to compensate for the general ledger limitations “are cumbersome and largely detective nature, increasing the risk that errors or fraud that could result in a misstatement to the financial statements would not be prevented” (p. 65);

in connection with deposit account activity, the SEC’s processes are “labor-intensive” and that “it does not have dedicated resources assigned to address this issue” (p. 69); and

“obligations […] were not always recorded timely and were not always supported by documentation evidencing the obligation as having been approved by an authorized individual” (p. 70).

Under the FCPA, not only is it important for issuers to have effective internal controls, but issuers must also monitor those internal controls to make sure that they are effective.

The GAO was critical of the SEC on this score as well.

The report notes:

“We also identified weaknesses in SEC’s monitoring process which indicate a lack of effective oversight of controls. Management’s monitoring of controls should include whether the controls are operating as intended and include an assessing of the design and operation of controls on a timely basis and taking necessary corrective actions. As discussed previously, we found that SEC’s monitoring procedures did not address all identified risks. Further, SEC’s management oversight was not sufficient given the frequency and sensitivity of the control activity, and monitoring procedures were not always completed in accordance with SEC’s stated testing plan.” (p. 71-72).

According to the GAO – “[b]ecause of inherent limitations, [the SEC’s] internal control[s] may not prevent or detect and correct misstatements due to error or fraud, losses, or noncompliance.” (p. 8).

Because of the above identified deficiencies, if the SEC was an issuer – would: (i) the SEC’s main DC office be strictly liable for branch office deficiencies; (ii) the SEC disgorge all of its “profits” connected (no matter how remotely) to the improper recording or the deficient internal controls; and (iii) would high-level SEC officials be accountable under “control person” theories for the books and records and internal control violations?

As readers of this blog know, all of the above “theories” are straight from recent SEC enforcement actions against issuers.

So next time an FCPA practitioner and his/her corporate client representative are seated across the table from an SEC enforcement official who asks, “how could this payment have not been recorded properly in subsidiary X’s books and records, how could the issuer not put in place effective internal controls, how could those controls not be monitored and assessed, etc. etc.” the most candid response just might be “I don’t know, you tell me – such issues happen at the SEC as well.”

One more thing, when enforcing the FCPA’s books and records and internal control provisions against issuers, the SEC insists on remedial measures and wants to see evidence of those remedial measures being put into place “yesterday.” An issuer comment, such as “this takes time,” would likely fall on deaf ears.

Yet, here is what SEC Chairman Mary Schapiro had to say about the GAO report and its findings of various deficiencies: “some deficiencies are likely to be resolved during the first half of FY 2010, while others – which have been the result of long-term and growing constraints affecting our information technology and human resources – will take longer to fully resolve.” (p. 29). This statement was also repeated by Kristine Chadwick, SEC CFO and Associate Executive Director (p. 33).

Alas, time to come back to reality, the SEC is not an issuer, but a couple minutes in “hypothetical land” does provide some useful perspectives as to the SEC’s enforcement of the FCPA’s books and records and internal control provisions.

Potpourri

The SEC recently posted on its website (see here) a draft “Strategic Plan for Fiscal Years 2010-2015” setting forth the Commission’s “mission, vision, values, and strategic goals” for the future.

Part of strategic goal 1 – to “foster and enforce compliance with the federal securities laws” – is a commitment to expand its “coordination efforts with foreign authorities, including […] close cooperation with foreign authorities in investigations relating to […] the Foreign Corrupt Practices Act.” (see pg. 16).

While not FCPA specific, a performance metric the SEC intends to use to gauge its progress of “fostering and enforcing compliance with the federal securities laws” is the percentage of enforcement cases successfully resolved (see pg. 17). The SEC notes that “[i]n general, the SEC strives to successfully resolve as many cases as possible, but, at the same time, aims to file large, difficult, or precedent-setting cases when appropriate, even if success is not assured.”

Setting FCPA precedent through the filing of a complaint, even if success is not assured, that is then subject to valid legal defenses based on the statute in a transparent, adversarial proceeding?

Wow, that’s a novel concept and in contrast to the current situation where FCPA “precedent” is set (or at least viewed as being set with the SEC’s encouragement) by the SEC alone through its enforcement program wherein the SEC is both a party and an adjudicator.

****

I previously posted about the “War of Words in Ecuador” (see here)- a post about Chevron’s mammoth legal battle in Ecuador involving allegations of environmental contamination and how the long, messy battle now includes an FCPA component.

The posted ended by saying “this long, messy legal battle is getting more murky by the day.”

As detailed in a recent story in the New York Times (see here) “in recent days the plot has thickened further.”

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