Foreign Corrupt Practices Act issues often co-exist in two parallel universes.
One universe is ruled by all-powerful gods with big and sharp sticks in which subjects dare challenge the gods. Another universe consists of checks and balances in which independent actors call the balls and strikes.
The first universe refers to FCPA enforcement by the DOJ and SEC. The second universe refers to litigation of FCPA-related claims in which judges make decisions in the context of an adversarial legal system. This second universe is often referred to as the rule of law universe.
There are several examples of theories used in the first universe that do not work in the second universe. For instance, the FCPA enforcement agencies frequently take a seeming “if / then” position when it comes to issuer internal controls. In other words, if some misconduct occurred somewhere within an issuer’s business organization or if some employee within that organization circumvented the issuer’s internal controls, then the issuer did not have effective internal controls.
However, when this simplistic theory is used in civil litigation, courts have routinely concluded that just because improper conduct allegedly occurred does not mean that internal controls must have been deficient. (See e.g., Midwest Teamsters Pension v. Baker Hughes, 2009 WL 6799492 (S.D. Tex. 2009); Freuler v. Parker Drilling 803 F.Supp.2d 630 (S.D. Tex. 2011).
This post concerns the most recent example regarding the parallel universe. Interestingly, the recent development comes from the same judge (U.S. District Court Judge Melinda Harmon (S.D. Tex.) highlighted in this September 2015 post about the parallel universe.
Before discussing Judge Harmon’s ruling in an FCPA-related case involving Key Energy Services, a bit of background.
It is often as predictable as the sun rising in the east.
When a company is the subject of FCPA scrutiny or resolves an FCPA enforcement action, plaintiff lawyers representing shareholders will emerge like bats from a cave bringing derivative actions and/or securities fraud actions against the company as well as officers and directors. To learn more about this dynamic, see “Foreign Corrupt Practices Act Ripples.”
For instance, in May 2014 Key Energy Services disclosed that it was the subject of FCPA scrutiny (see here for the prior post). Over the next few days, the company’s stock dropped approximately 7%. As sure as the sun rises in the east, civil actions soon followed alleging Section 10(b) and Rule 10b-5 claims based on Key Energy’s general risk disclosures in SEC filings referring to corruption.
As stated by Judge Harmon:
“Plaintiffs have identified four broad categories of allegedly false and misleading statements during the Class Period that it claims violated Section 10(b) and Rule 10b-5: (1) statements in the Company’s Code of Business Conduct and FCPA Compliance Manual; (2) statements about Key’s business in Mexico and Russia that purportedly omitted disclosing that Key’s growth and growth strategy largely resulted because of FCPA violations; (3) statements allegedly falsely portraying Key’s business in Mexico; and (4) statements in certifications accompanying Key’s SEC filings that purportedly omitted internal control deficiencies and FCPA violations.”
Given the relevant legal standards and pleading requirements for such claims, Judge Harmon did what most federal court judges have done with FCPA-related securities fraud claims on their docket. She granted the defendant’s motion to dismiss. (See In re Key Energy Services Inc. Securities Litigation, 2016 WL 1305922 (March 31, 2016)
In doing so, Judge Harmon made the following FCPA-relevant points. The decision is worth a read (that Judge Harmon cited my 2010 article “The Facade of FCPA Enforcement” is merely icing on the cake).
- “An investigation [of FCPA issues] is not a violation” of the FCPA.”
- “Plaintiffs also fail to plead any facts showing that there were FCPA violations, no less that they were responsible for or an integral part of Key’s growth in Mexico and Russia and that they generated any revenue for Key.”
- “Plaintiffs assert that because Key and the SEC were investigating possible FCPA violations, such FCPA violations must have occurred and Individual Defendants must have known about them at the time statements issued. Here, too, such scienter-by-inference arguments have been standardly rejected by the courts.”
- “The alleged misrepresentations are generic, forward-looking statements concerning Key’s overall business in Russia and Mexico or mere puffery about Key’s internal controls. None of the statements is a guarantee that the FCPA investigations or violations would never occur in relation to Key’s operations in these area, nor that Key’s internal controls were foolproof.”
- “[T]here is no allegation that international audits are a requirement or that they are required for a company to have adequate internal controls over financial reporting.”
- “[C]onclusory allegations that [individual defendants] must have known of the alleged fraud due to their positions and/or ability to access information are insufficient to state a claim.”
- “Lead Plaintiff’s assertion that all Defendants must have been aware of unidentified FCPA violations because Mexico and Russia are “notoriously corrupt” and because the SEC and the DOJ are investigating Key also fails. Key did disclose the jurisdictions where it has business operations and warned investors of the risks of an FCPA violation in each of its quarterly and annual SEC filings, yet Plaintiffs ignore these admonitions. Many American companies conduct international business in markets like Mexico and Russia. or make any statement challenged in the complaint false or misleading.”
- “The complaint repeatedly claims that numerous statements were false or misleading mainly because Key concealed that its growth and growth strategy were large due to conduct that violated the FCPA and because Key created the erroneous impression that it had internal controls in place to prevent such violations. Lead Plaintiff cannot rely on vague assertions that the SEC and DOJ have increased their vigilance over FCPA violations generally or that Mexico and Russian are rife with corruption to establish that there were violations of the FCPA in Mexico and Russia by Key during the Class Period or vaguely to assert that during the Class Period, Key somehow violated the statute in its operations in these countries. Indeed not a single specific violation of the FCPA (identifying the nature of the violation, when, where, and who was involved) is alleged.”
- “[T]he complaint contends that Key’s Code of Business Conduct and FCPA Compliance Manual, on which Key’s all-too-vaguely described internal controls were based, were filled with false representations and omissions for purposes of § 10(b) and Rule 10b-5. Not only have the Court and Defendants shown that courts has found such sources to be aspirational and immaterial puffery, but Lead Plaintiff has failed to allege particular facts demonstrating any breach by any particular Defendant, with scienter, of any employee responsibility in any particular statement set forth in those documents.”