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The SEC’s Recent Alter Ego Theories

In addition to teaching a Foreign Corrupt Practices Act class (one of the few specific FCPA classes taught in U.S. law schools), in my professor life I also teach a variety of corporate law classes, including Corporations in which coverage includes corporate form, the general rule of limited liability, and exceptions to that general rule based on veil piercing / alter ego theories.

The general rule is that legal liability does not ordinarily hop-skip-and-jump around a corporate organization because separate legal entities (including even those within the same corporate hierarchy) are not liable for the legal liability of other entities (whether that liability arises in tort, contract or the FCPA).

However, if one entity is merely the “alter ego” of another entity, the other entity may be exposed to legal liability based on the conduct of the “alter ego.” The picture at left can demonstrate alter ego issues, namely that one entity will be the alter ego of another if the entities share the same heart, organs, nervous system, etc.

Against this backdrop, it is interesting to see how the SEC asserted alter ego theories in two recent FCPA enforcement actions.

In the PTC enforcement action [1], the allegations were nearly non-existent to support the finding that PTC itself violated the FCPA’s anti-bribery provisions. Rather, albeit without using the exact words “alter ego,” the SEC found that PTC violated the anti-bribery provisions because the PTC China entities were “alter egos” of PTC. Specifically the SEC’s order states:

PTC Exercised Substantial Control Over PTC-China

“During the relevant period, although PTC-China was structured as two entities, it conducted business as a single unit. Until July 2008, all China local employees were assigned to the Hong Kong subsidiary; in August 2008, they all became direct employees of the Shanghai subsidiary. And throughout this period, both the Hong Kong and Shanghai subsidiaries shared common directors, all of whom were senior members or officers of PTC’s legal and finance departments.

PTC exercised substantial control over PTC-China. The employees of PTC’s subsidiaries, including PTC-China, had global functional reporting lines to PTC, rather than an independent management structure. The functional reporting lines provided PTC with control over PTC-China’s activities, including its sales process. PTC-China’s senior sales staff reported to a Division Vice President of Sales, who was a PTC employee based in China. For most of the relevant period, this Division Vice President either reported to the General Manager of the Asia Pacific Region, or directly to PTC’s Executive Vice President of Sales, who was based in Needham, Massachusetts. For other functions, including sales operations and global services, various PTC-China employees reported up to PTC employees, both based in China and the United States. Consistent with the functional reporting structure, PTC often moved its key employees to various subsidiaries throughout the world.

For the sales, sales operations, and global services functions, the review of proposed transactions followed a hierarchical approach through PTC-China and, if needed, to employees at other PTC entities, including the parent company. PTC employees approved pricing discounts above certain thresholds for PTC-China and reviewed certain PTC-China contract documents. PTC, not PTC-China, was the counter party on most of the contracts with PTCChina’s SOE customers.

Further, PTC set the business and financial goals for its subsidiaries, including PTC-China. Each PTC function (including sales, marketing and finance) received a worldwide budget from PTC to allocate among its various subsidiaries. PTC also set regional sales targets (i.e., for the Pacific Rim, in which China was included) and had regional managers who allocated the sales targets among the countries and subsidiaries.”

Elsewhere, under the “Legal Standards and Violations” section, the SEC’s order states:

“PTC-China used third party business partners to pay bribes in the form of travel, gifts and entertainment to Chinese government officials to obtain and retain business. PTC exercised substantial control over PTC-China by, among other things, creating functional reporting lines, approving PTC-China’s key decisions, and setting PTC-China’s business and financial goals. PTC entered into contracts directly with the SOEs as a result of the bribes paid through PTC-China’s business partners, and earned significant income from these contracts. Under applicable agency principles, PTC-China and its employees acted as agents of PTC during the relevant time and were acting within the scope of their authority and for the benefit of PTC when participating in the bribery scheme.”

The other recent enforcement action in which the SEC asserted “alter ego” theories was SciClone Pharmaceuticals.

In the enforcement action [2], the SEC asserted that “employees of SciClone subsidiaries, who acted as agents of SciClone in conducting business in China, gave money, gifts and other things of value to foreign officials, including healthcare professionals (“HCPs”) who were employed by state-owned hospitals in China, in order to obtain sales of SciClone pharmaceutical products.” Specifically, the SEC order states:

“SciClone Pharmaceuticals International Ltd. (“SPIL”) is a wholly-owned subsidiary of SciClone that is incorporated in the Cayman Islands with an affiliate in Hong Kong. SciClone operates internationally primarily through subsidiaries, including SPIL and SPIL’s wholly-owned subsidiaries that sell and promote SciClone’s products in China. SciClone directs the relevant operations of SPIL and its subsidiaries and oversees SPIL’s operations through various means including through the appointment of directors and officers of SPIL, review and approval of its annual budget, business and financial goals, and oversight of its legal, audit, and compliance functions. SciClone also reviews and approves annual marketing and promotion budgets of SPIL and its subsidiaries. During relevant periods, some SciClone officers also served as officers and/or directors of SPIL, traveled frequently to China to participate in the management of SPIL, and were responsible for negotiating its contracts with its Chinese distributors. SPIL’s books and records are consolidated by SciClone and reported in its financial statements.”

While some of the factors the SEC articulated in the above enforcement actions (such as common directors) are indeed relevant factors in the “alter ego” analysis, the Supreme Court recently concluded in the Daimler v. Bauman action (see here [3] for the prior post) that many of the other factors were not relevant. In short, the Supreme Court held that the “alter ego” standard is not met just because a subsidiary engages in conduct or performs services that are important to the parent.

Philip Urofsky (a former high-ranking DOJ FCPA enforcement attorney) has been one of the more forceful critics of the common FCPA enforcement approach of holding parent companies seemingly strictly liable for subsidiary conduct has been. (See prior posts here [4] and here [5] for discussion of Urofsky’s analysis).