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A Few FCPA Related Securities Fraud Claims Are Allowed To Proceed

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This recent post highlighted how securities fraud class actions in the aftermath of Foreign Corrupt Practices Act enforcement actions or mere instances of FCPA scrutiny are frequently dismissed.

This remains a true statement, but as highlighted in this post, sometimes a claim or two does advance past the motion to dismiss stage as was recently the case in matters involving Cognizant Technology Solutions and Obebrecht.

Cognizant

These pages have closely followed Cognizant’s FCPA scrutiny since it first surfaced in September 2016 (see here). Indeed, as highlighted in this post the company’s FCPA scrutiny presented an interesting case study as to the FCPA’s many “ripples” as disclosure of the scrutiny caused the company’s stock price to fall which then resulted in securities fraud class actions.

In this recent opinion, Judge William Walls (D.N.J.) granted defendants’ motion to dismiss in part, but also allowed certain of the plaintiffs’ claims to proceed.

In terms of background, Plaintiffs alleged that Cognizant, Francisco D’Souza (CEO during the relevant time period), Karen McLoughlin (CFO during the relevant time period who oversaw the company’s Internal Audit and Enterprise Risk Management functions), and Gordon Coburn (President from 2012 until his resignation in September 2016) violated various securities laws provisions “by making materially incomplete, false, and misleading statements that concealed a bribery scheme.”

The opinion provides the following background relevant to Cognizant’s India operations – background also relevant to the company’s FCPA scrutiny.

“Although its current headquarters are located in New Jersey, Cognizant began as an Indian company and maintains its principal operations there. During the operative timeframe, close to 150,000 of Cognizant’s 200,000 employees were located in India, many of whom were housed at its ten large IT campuses known as “global delivery centers.” As part of its effort to lower cost, Cognizant obtained licenses from central and regional Indian governments to construct and operate its facilities in designated Special Economic Zones (“SEZs”). Companies operating within SEZs are entitled to favorable treatment including tax exemptions and holidays, heightened access to credit, and relaxed customs and labor regulations. These tax breaks and other benefits helped lower operating costs, and Cognizant reported that the tax benefits derived from SEZ licenses increased net income by $201.4 million in 2015.

Although the $EZs were beneficial to the companies that operated within them, members of the Indian government were becoming skeptical oftheir continued value, and in February 2015 the Finance Minister Arun Jaitley indicated that the Indian government might begin to limit the tax benefits available to newly-constructed SEZs. Consistent with the plan of limiting SEZ benefits, India’s Central Board for Direct Taxes issued a draft proposal that would phase out SEZ tax benefits for new facilities commencing activities after April 2017. In February 2016 Minister Jaitley presented a final budget plan implementing a policy for phasing out SEZ benefits after April 1, 2020.

Cognizant continued to seek and obtain SEZ licenses after the February 2015 announcement, and constructed or expanded four SEZ-licensed global delivery centers during the Class Period. In September 2015, Cognizant signed agreements to expand its global delivery center in Coimbatore, and its Indian headquarters in Chennai, which together were projected to have the capacity to accommodate approximately 17,000 to 20,000 professionals. In March 2016, Cognizant received approval for an 8,500-employee facility in Hyderabad, and in August 2016 it received approval to construct a SEZ facility on a fifteen-acre plot in Kolkata. The land for the Kolkata facility was purchased from the state government’s Housing Infrastructure Development Corporation, which reportedly waived its development fee and ensured that the price of the land “would be ‘kept reasonable’ to sweeten the deal.” Around the same time, the state government refused to grant licenses to Cognizant’s competitors, Wipro and Infosys, which had both been assured by the state’s previous administration that their projects would receive SEZ status.

According to Plaintiffs, Cognizant acquired some of these SEZ licenses through a bribery scheme involving members of Senior Management, including company President Defendant Coburn.”

In terms of Plaintiffs’ allegations, the opinion states:

“The amended complaint sets out a number of statements that Plaintiffs allege are false and misleading. Those statements fall into five categories: a) statements highlighting the benefits of SEZ licenses; b) statements emphasizing legal compliance and anti-corruption controls; c) statements touting Cognizant’s low-cost services and attributing its financial results to legitimate business factors; d) overstatements of earnings resulting from improperly recording bribes as capital expenditures; and e) SOX certifications.”

The court first considered whether the amended complaint sufficiently alleged a material misrepresentation or omission.

As to statements regarding SEZ licenses, the court concluded that Plaintiffs adequately alleged a bribery scheme to acquire SEZ licenses and also found that “Cognizant’s statements touting the benefits of SEZ licenses were misleading.” Specifically, the court stated:

“Cognizant stated in SEC disclosures that its “Indian subsidiaries. . . are eligible for certain income tax holiday benefits granted by the Indian government for export activities conducted within Special Economic Zones, or SEZs.” It made statements quantifying the SEZ tax benefits on the company’s net income, and indicating its intent to locate newer development facilities in SEZs. A reasonable investor would view these benefits differently if he was aware that they were obtained through illegal conduct that could subject Cognizant to liability under the FCPA and the corresponding negative goodwill and cost of an internal investigation.”

As to statements regarding legal compliance and anti-corruption controls, the judge found that:

“[These] statements [in the company’s Code of Conduct and Anticorruption Policy] were made in aspirational documents outlining the company’s policies for best corporate practices, not as affirmative guarantees that every employee would adhere to these practices in all cases. Therefore, the statements are not rendered false by the failure of certain employees to adhere to company policy. […] Allowing claims to proceed on the basis of code of conduct violations would be overbroad; any instance of corporate misconduct would violate a company’s compliance policy. Given the near-universal adoption of codes of conduct, and the breadth their proscriptions, allowing securities plaintiffs a cause of action every time a code of conduct is violated would “turn all corporate wrongdoing into securities fraud.”

However, the judge found that statements in the company’s Sustainability Reports were materially false and misleading and stated:

The 2014 Sustainability Report states that Cognizant “delivered 333,114 hours of Code of Ethics training through eLearning in 2014,” and “delivered Code of Ethics trainings to targeted audiences of over 18,000 associates in India and the Philippines.” The 2014 Sustainability Report gave further detail about its training programs, and went on to state that “our Enterprise Risk Management group conducts annual risk analysis surveys covering all business units and corporate functions to assess the likelihood of various risks including corruption.” The 2014 Report also stated that there were “no incidents [of corruption] reported.” The 2015 Sustainability Report also stated that there were “no incidents [of corruption] reported,” and additionally that “no [significant risks related to corruption] reported.” These are not aspirational statements of company policy, but statements of fact and representations about the current state of affairs that are capable of falsity and upon which a reasonable investor may rely.

The Court finds that Plaintiffs have adequately alleged that the statements in the Sustainability Reports about anticorruption training were materially false and misleading. At the time that Cognizant was making statements highlighting its anticorruption training, it was allegedly engaged in a bribery scheme involving members of senior management.”

As to statements touting Cognizant’s low-cost services and attributing its financial results to legitimate business factors, the judge found such statements to constitute inactionable puffery or accurate statements of historical fact.

As to statements regarding overstated earnings by capitalizing bribes that should have been expenses, the judge found that such misstatements were material due to the qualitative factor that they involved concealment of an unlawful transaction.

As to the SOX certifications, the court found that because each alleged misleading statement was preceded with the qualifier “based on our most recent evaluation of internal controls over financial reporting” that the complaint did not allege that either Individual Defendant had any reason to believe that the statement was misleading when made. Thus, the judge found that the SOX certifications were not actionable.

Having found certain statements materially misleading, the judge next considered whether the amended complaint alleged sufficient facts to give rise to a strong inference of scienter. The court found that the facts alleged in the amended complaint gave rise to a strong inference of scienter on the part of Cognizant, but not Defendants D’Souza and McLoughlin. Regarding Defendant Coburn, the court found that the amended complaint sufficiently alleged that he was “a participant in the bribery scheme and, consequently, that he had actual knowledge that statements touting SEZ licenses, touting compliance procedures, and misrepresenting financial statements were false and misleading.”

Regarding scienter of Cognizant, the court stated:

“The Court emphasizes that corporations may not be held liable for the knowledge of every employee, or even every member of senior management. However, considering the breadth and duration ofthe alleged bribery scheme, the importance of SEZ licenses to the company, and the alleged involvement of Defendant Cobum and other unnamed members of senior management, there is a strong inference of scienter as to the corporate defendant. Defendant’s motion to dismiss as to Defendant Cognizant is denied.”

Odebrecht

As highlighted in this prior post, in late 2016 Brazil-based Odebrecht/Braskem resolved a net $252 million FCPA enforcement action. In the aftermath of the enforcement action, certain investors brought claims against various Odebrecht entities alleging various securities laws violations.

In this recent opinion, Judge Gregory Woods (S.D.N.Y) granted defendants’ motion to dismiss in part, but also allowed certain of the plaintiffs’ claims to proceed. The court stated:

“In sum … the only statements and omissions that Plaintiffs sufficiently plead as the basis for this Section 10(b) and Rule 10b-5 claims are: (1) [Odebrecht’s] statements contained in the offering memoranda regarding the reasons for its success and [its] failure to disclose the bribery scheme in connection with those statements; (2) [Odebrecht’s] statements contained in its 2012 through 2014 financial statements regarding the company’s credit ratings; and (3) the statement made in [Odebrecht’s] third quarter 2014 earnings release that the Petrobras investigation has not impacted [it].”

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