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Further To The SEC’s Inconsistent Approach To Enforcing The FCPA’s Books And Records And Internal Controls Provisions

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As highlighted in previous posts on this subject (herehere and here), a basic rule of law principle is consistency.

In other words, the same legal violation ought to be sanctioned in the same way. When the same legal violation is sanctioned in materially different ways, trust and confidence in law enforcement is diminished.

However, there sure does seem to be a lack of consistency between how the SEC resolves Foreign Corrupt Practices Act books and records and internal controls violations.

As most readers no doubt know, the FCPA has always been a law much broader than its name suggests.   The anti-bribery provisions are just one prong of the FCPA.

Indeed, most FCPA enforcement actions do not involve allegations of foreign bribery, but rather violations of the FCPA’s generic books and records and internal controls provisions. These provisions generally require that issuers shall: (i) maintain books and records which, in reasonable detail, accurately and fairly reflect issuer transactions and disposition of assets (the books and records provisions); and (ii) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are properly authorized, recorded, and accounted for (the internal controls provisions).

For lack of a better term, let’s call such actions “non-FCPA FCPA enforcement actions.” Such actions are not dissected in the FCPA space and do not appear on the DOJ or SEC’s FCPA websites (here and here). Yet such actions are deserving of analysis because they highlight a troubling aspect of FCPA enforcement: that being how the same alleged legal violations are sanctioned in materially different ways.

Two recent examples further highlight this point.

In this December 11th administrative order, the SEC found that The Hain Celestial Group, Inc. (a New York-based marketer, manufacturer, and seller of organic and natural food and personal care products) violated the FCPA’s books and records and internal controls provisions. The conduct concerned U.S. sales personnel giving sales incentives to certain distributors to promote sales at the end of quarters in which the company had “inadequate documentation of the incentives and lack[ed] of sufficient internal accounting controls to provide reasonable assurances that the incentives were accounted for correctly.”

As stated by the SEC:

“These incentives varied by distributor (and by quarter), but could include: (1) cash incentives (up to $500,000), (2) extended payment terms (up to 90 days), (3) discounts off list price (up to 20% off), and (4) spoils coverage, whereby Hain agreed to reimburse the distributor for products that spoiled or expired before the distributor could sell through to retailers. None of these types of incentives are improper; however, they could have financial reporting implications.”

According to the SEC:

“Hain lacked sufficient policies and procedures to provide reasonable assurances that EOQ [end of quarter] sales were accounted for properly. Hain’s sales personnel were not appropriately trained or knowledgeable about the accounting implications of their sales practices. Further, there were insufficient policies and procedures to monitor incentives made in sales transactions, which could have potential revenue recognition implications.

In addition, the EOQ sales with Distributor 1 were not fully communicated outside of the sales department, to the appropriate personnel in Hain’s accounting and finance departments, to take into consideration any relevant accounting implications. Hain lacked clear policies and procedures regarding when distributor incentives required approval and/or notification beyond the sales team (whether based on the concession’s size or character). For example, the extended payment terms granted to Distributor 1 had not been previously disclosed to the appropriate personnel in Hain’s accounting and finance departments, or to corporate management.”

Regarding Distributor 2, the SEC likewise found:

“Hain had insufficient policies and procedures in place to provide reasonable assurances that incentives offered by sales personnel were properly accounted for. Hain’s sales personnel working with Distributor 2 were not appropriately trained or knowledgeable about the accounting implications of their sales practices, which could have potential revenue recognition implications.

In addition, the EOQ sales with Distributor 2 were not fully communicated outside the sales department, to the appropriate personnel in Hain’s accounting and finance departments, to take into consideration any relevant accounting implications. For example, Hain repeatedly provided Distributor 2 with 90-day extended payment terms, yet these terms had not been previously disclosed to the appropriate personnel in Hain’s accounting and finance departments, or to corporate management.”

Incentives to third parties, sales personnel not appropriately trained, insufficient internal controls and policies. If these things happened in an FCPA enforcement action involving foreign conduct, one might expect a multi-million dollar settlement.

Yet, the settlement amount in the Hain matter was nothing. Rather the company was merely required to cease and desist from future violations of the FCPA’s books and records and internal controls provisions.

In this December 10th administrative order, the SEC found:

“Agria [Corporation –  a Cayman Islands company engaged in the agricultural business, with operations in People’s China, New Zealand, and Australia with American Depository Shares traded on the NYSE] violated the anti-fraud, reporting, books and records, and internal accounting control provisions [that is the FCPA’s books and records and internal controls provisions] of the federal securities laws. Between 2010 and 2013, Agria engaged in a course of fraudulent accounting related to its July 2010 divestiture of Taiyuan Primalights III Modernized Agriculture Development Co., Ltd. (“P3A”), a consolidated affiliated entity. Agria materially overstated the value of the consideration it received in the transaction and concealed material losses as a result of the divestiture.”

According to the SEC, the various fraudulent accounting practices were material to the company. As stated by the SEC:

“Agria concealed a loss of approximately $17.45 million, which would have tripled its net reported loss. Further, by failing to impair the carrying value of the land use rights Agria concealed an additional loss of $59.2 million. Had the carrying value of the land use rights been impaired in 2010 as required, Agria’s reported net loss would have increased by a factor of six, and the equity on its balance sheet would have been reduced by 27%.”

As stated in the SEC’s release:

“Agria’s fraudulent accounting hid from investors the significant loss it sustained when it divested its principal operation in China, and Mr. Lai artificially inflated the share price to maintain Agria’s NYSE listing,” said Charles E. Cain, Chief of the SEC Enforcement Division’s FCPA Unit.  “Disclosure of accurate information is vital to the integrity of our markets, and both Agria and Mr. Lai have been appropriately held to account for their deceptive misconduct.”

As noted in the release, Lai Guanglin (the company’s executive chairman) also settled SEC charges that he manipulated the company’s share price.

Can you imagine an FCPA enforcement action involving foreign conduct that involved fraudulent accounting practices that were material to the issuer and related charges against the company’s executive chairman? How large would that settlement amount be?

Yet the Agria enforcement action was resolved for $3 million. By way of comparison, the SEC’s internship action against Credit Suisse earlier this year was resolved for approximately $30 million.

As these two recent examples once again demonstrates, the SEC has some explaining to do and owes the legal and compliance community an explanation for why FCPA books and records and internal controls violations are not sanctioned in similar ways.

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