It’s as predictable as the sun rising in the east. In the aftermath of a Foreign Corrupt Practices Act enforcement action (and in some instances after mere FCPA scrutiny is disclosed) a plaintiffs’ lawyer representing a shareholder and working on a contingent fee basis files a securities fraud class action against the company and/or its executives.
Given the legal framework relevant to such actions (that is heightened pleading requirements as well as the Private Securities Litigation Reform Act) few of these actions actually get past the motion to dismiss stage.
Yet, recently a securities class action against VimpelCom (which recently changed its name to VEON Ltd.) did largely get past the motion to dismiss stage. Yet, even in this egregious instance of corporate bribery (see here and here for the prior posts), several of the plaintiffs’ allegations were deemed not viable.
As stated in a September 19th opinion by U.S. District Court Judge Andrew Carter (S.D.N.Y.)
“Plaintiffs allege that VEON’s conduct that formed the basis of its FCPA violations led to material misstatements and omissions in its SEC filings during the relevant time period. In particular, Plaintiffs allege that, when VEON referred to the increase in its broadband subscriptions, including in Uzbekistan, and revenue in general, it “put the topic of the cause of its financial success at issue,” thereby obligating the company to report that the increase in subscriptions in Uzbekistan was due, at least in part, to the bribes paid to Karimova.Plaintiffs do not allege that the actual numbers reported were inaccurate.
Plaintiffs also allege that VEON misrepresented that “[t]he government authorities responsible for supervising the telecommunications industry in the Republic of Uzbekistan are the Republic of Uzbekistan Cabinet and a specially authorized telecommunications agency.” Plaintiffs contend that this was a misrepresentation because it failed to disclose the role that Karimova played.
Finally, Plaintiffs identify a number of VEON’s disclosures in its annual reports regarding the company’s internal controls. In its annual reports for the calendar years 2010 and 2012, VEON stated that, “[b]ased on the assessment” of its “internal control over financial reporting,” its management “believes our company maintained effective internal control over financial reporting” during the relevant calendar year.Stated somewhat differently in its 2014 Form 20-F, the company disclosed that, “as a result of management’s assessment of our internal control over financial reporting as of December 31, 2014, management concluded, that that our internal control over financial reporting was effective.”That year, VEON also assured the market that its “internal control system was designed to provide reasonable assurance regarding the reliability of financial reporting.” Plaintiffs also quote from VEON’s website regarding the company’s compliance program.
Plaintiffs allege four categories of alleged misstatements and omissions during the relevant time period: (1) VEON’s financial disclosures without a corresponding disclosure of the bribery that enabled the company’s financial successes; (2) disclosures identifying the Uzbek authorities responsible for overseeing the company’s actions there without describing Karimova’s role and assertions regarding the availability of equal protection under Uzbek law; and (3) the company’s statements regarding the efficacy of its internal audit and compliance functions. VEON argues that none of these are misstatements or actionable omissions.”
As to financial disclosures, the opinion states as follows (internal citations omitted):
“VEON argues that Plaintiffs’ claims regarding the company’s financial disclosures are, in reality, an improper attempt to enforce the FCPA, which has no private right of action. It further argues that a company is not required to disclose uncharged wrongdoing, and Plaintiffs do not allege that the financial reporting was, itself, inaccurate. As described further in this section, Plaintiffs’ claim is not simply that VEON should be found liable for violations of Rule 10b-5 and § 20(a) because it did not disclose its FCPA violations. Plaintiff contends that, once VEON put at issue its increased subscribers and income in Uzbekistan, “it was duty bound not to omit the rest of the story, i.e., that the growth was attributable to falsely concealed bribery payments. By failing to do so, its omissions were actionable.” The Court agrees in large part.
As a preliminary matter, there is no real dispute that the FCPA does not contain a private right of action. Therefore, the question is whether disclosures made by VEON during the course of FCPA violations are independently actionable under the Exchange Act or if a claim based on the facts presented constitutes an impermissible end-run around the FCPA’s lack of a private right of action. The Court finds that Plaintiffs’ allegations regarding the misrepresentations in VEON’s SEC filings are sufficiently distinct to avoid any potential concern that Plaintiffs are seeking to enforce the FCPA by this securities fraud action.
Generally, “[d]isclosure is not a rite of confession, and companies do not have a duty to disclose uncharged, unadjudicated wrongdoing.” However, the failure to disclose uncharged criminal conduct may be actionable where the failure to do so would make other disclosures materially misleading. This duty to disclose may arise when a company “puts the topic of the cause of its financial success at issue.”
Under these circumstances, the company is “obligated to disclose information concerning the source of its success,” including illegal sources.
While some courts have read Van der Moolen to suggest that accurate financial reporting may be an actionable misstatement if some of the revenue derived from illegal activity, the Court agrees with the district courts that have read Van der Moolen more narrowly. The district court’s decision in Marsh & Mclennan draws a sensible distinction: “[A] company’s misleading statements about the sources of its revenue do not make the company’s statements of the revenue figures misleading; rather, liability is limited to the misleading statements themselves.” That is, accurately reported income derived from illegal sources is non-actionable despite a failure to disclose the illegality. By contrast, statements “putting the source of those revenues at issue” may be actionable.
The recent decision in In re Virtus Inv. Partners, Inc. Sec. Litig., 195 F. Supp. 3d 528 (S.D.N.Y. 2016), provides a useful comparison. In that case, the district court found that the defendant’s statements regarding the source of “strong relative investment performance,” where that performance was described as “a key driver of [defendant’s] high levels of sales and net flows,” were actionable misstatements because the company failed to disclose certain related conflicts of interest. By contrast, the company’s disclosure that revenues increased “primarily as a result of an increase in average assets and an increase in average management fees” was not actionable because it did “nothing more than put into words information reflected in the company’s financial statements.”
Here, the Court finds that many of the statements identified by Plaintiffs are nothing more than a narrative restatement of accurate financial reporting that is not, without more, actionable. Sometimes Plaintiffs cite a portion of VEON’s disclosures that is not a narrative at all; Plaintiffs refer only to the financial reporting itself. See, e.g., Am. Compl. ¶¶ 96 (Dec. 2, 2010 Form 6-K) (reporting increased broadband subscriptions in Uzbekistan), 98 (Mar. 29, 2011 Form 6-K) (reporting net operating revenue increase in Uzbekistan), 99 (June 1, 2011 Form 6-K) (same), 102 (2010 Form 20-F) (reporting number of customers in Uzbekistan), 116 (2011 Form 20- F) (same), 132 (2012 Form 20-F) (same); see also ¶¶ 145 (Mar. 6, 2014 Form 6-K), 156 (Aug, 6, 2014 Form 6-K), 158 (Nov. 12, 2014 Form 6-K), 161 (Feb. 26, 2015 Form 6- K), 167 (May 14, 2015 Form 6-K), 169 (Aug. 6, 2015 Form 6-K). The references to sales and subscriber numbers in Uzbekistan without further statements regarding the nature of those numbers or their importance to VEON’s business do not sufficiently place the company’s sales in Uzbekistan at issue so as to require further disclosure regarding the bribes paid to Karimova.
However, certain other of the statements—particularly, those in VEON’s Forms 6-K reporting quarterly earnings —sufficiently place the reasons for growth in Uzbekistan at issue to make further disclosure necessary. For example, in VEON’s September 7, 2011 Form 6-K, VEON asserted that its “sales and marketing efforts” in Uzbekistan resulted in increased mobile subscribers and revenues, which it asserted “demonstrat[e] the underlying strength of our core.” The Court’s review of that disclosure provides even greater context to the statement quoted in the Amended Complaint. In particular, VEON disclosed that “[d]espite intensified competition in some of the CIS countries, revenues are growing at double digit rates in nearly all CIS markets as a result of the improving macroeconomic situation, product quality and efficient sales and marketing efforts.” While the growing revenues may have been due to “improving macroeconomic situation, product quality and efficient sales and marketing efforts,” Plaintiffs allege that, in Uzbekistan, at least, this growth also was due to bribes VEON paid to Karimova.
Similarly, in the company’s November 14, 2011 and March 13, 2012 Forms 6-K, VEON attributed its growth in Uzbekistan to particular causes, such as its “sales and marketing activities, regional 3G network roll-out and data development,” or “efficient SG&A spending,” without mentioning the bribes paid to Karimova. (May 15, 2012 Form 6-K) (describing increased competition as one of reasons for EBIDTA margin), (Aug. 15, 2012 Form 6-K) (noting “record mobile internet user growth” in Uzbekistan), (Nov. 14, 2012 Form 6-K) (describing reasons for EBITDA increases), (Mar. 6, 2013 Form 6-K) (attributing revenue increase to growth of “high value subscribers”), (May 15, 2013 Form 6-K) (same), 141 (Aug. 7, 2013 Form 6-K) (same), (Nov. 6, 2013 Form 6-K) (same). The Court finds that these disclosures are in line with those that the district court found actionable in Braskem, where the defendant disclosed certain reasons supporting the price it paid for a particular raw material, but did not disclose that the price also was due to a side agreement the company had secured through bribery.”
As to government authorities in Uzbekistan and Uzbek law, the opinion states as follows (certain internal citations omitted):
“VEON also argues that its disclosures regarding the government authorities in Uzbekistan responsible for overseeing the telecommunications sector were accurate and not materially misleading despite their failure to disclose Karimova’s involvement. Plaintiffs did not respond to VEON on this point. Relatedly, VEON argues that its disclosures regarding equal protection under Uzbek law are not actionable. The Court agrees with VEON’s argument regarding governmental oversight, but not equal protection. Accordingly, only claims based on the former disclosures are dismissed.
First, in each of its annual reports for 2010 to 2012, VEON disclosed that “[t]he government authorities responsible for supervising the telecommunications industry in the Republic of Uzbekistan are the Republic of Uzbekistan Cabinet and a specially authorized telecommunications agency [‘UzACI’].” In alleging that these statements were materially misleading, Plaintiffs do not allege that the Republic of Uzbekistan Cabinet and UzACI were not responsible for overseeing VEON and others in the telecommunications sector. See Am. Compl. ¶¶ 28, 45, 48, 64 (noting continued involvement of UzACI in approval processes). Plaintiffs’ contention is not that these governmental entities had no oversight authority, but that VEON needed Karimova’s support to secure favorable concessions from those authorities. The Court agrees with VEON that the disclosures regarding the relevant government oversight bodies are non-actionable, true statements. The Court also finds that the failure to disclose Karimova’s involvement does not render the statements materially misleading because, while Karimova was connected to those in government and allegedly held “several positions” in the Uzbek government, she was not a “government authority,” herself and had no oversight authority in the telecommunications industry.
Second, Plaintiffs allege that VEON made a material misrepresentation when it stated that “[a]ll owners of telecommunications networks have equal rights and enjoy equal protection guaranteed by the law.” They allege that this statement was materially misleading because VEON had to engage in bribery to enter and remain in the Uzbek market. Plaintiffs’ argument is not simply, as VEON contends, that the existence of FCPA violations renders VEON’s interpretation of Uzbek law inaccurate. In the DPA, VEON admitted that bribes were necessary “for, among other things, the opportunity to conduct future operations [in Uzbekistan] without hurdles,” and that the failure to pay bribes would lead to “a number of negative governmental reactions.” Based on these subsequent admissions, Plaintiffs have adequately alleged that, at a minimum, VEON did not “enjoy equal protection guaranteed by the law,” making that statement at best misleading. Nor has VEON made any meaningful argument regarding this statement’s lack of materiality to investors. The only decision VEON cites, In re Yukos Oil Co. Sec. Litig, No. 04-cv-5243 (WHP), 2006 WL 3026024, at *15 (S.D.N.Y. Oct. 25, 2006), involves the defendant’s interpretation of a Russian law. Here, by contrast, Plaintiffs do not argue that VEON misinterpreted Uzbek law, only that VEON knew that any promise of equal protection contained in Uzbek law was illusory given the necessity of bribes.”
As to internal controls, the opinion states:
“Finally, with regard to VEON’s disclosures regarding its internal controls, VEON argues that Plaintiffs really have alleged corporate mismanagement, which is not actionable under Santa Fe Indus., Inc. v. Green, 430 U.S. 462 (1977). VEON further contends that its statements about internal controls are nonactionable forward-looking statements or mere puffery regarding the adequacy of its controls. Plaintiffs counter that the safe harbor for forward-looking statements does not protect VEON’s alleged statements. For the reasons that follow, the Court finds that VEON’s statements about its internal controls are actionable.
First, the Court agrees with Plaintiffs that Santa Fe Industries and the line of decisions involving corporate mismanagement are not applicable here. Plaintiffs’ claim is not based solely on the underlying failures of VEON’s internal controls to detect and prevent the FCPA violations; Plaintiffs allege that VEON’s disclosures regarding the existence and efficacy of those controls were false. That distinguishes the allegations in this action from those in Santa Fe Industries, In re Citigroup, Inc. Sec. Litig., 330 F. Supp. 2d 367 (S.D.N.Y. 2004), and the other decisions VEON cites that involved “a breach of fiduciary duty … without any deception, misrepresentation, or nondisclosure.” Contrary to Citigroup, for example, the issue here is not simply that VEON did not follow the internal controls that it touted in its disclosures. To the extent Plaintiffs’ claim is based merely on the failure to follow internal controls, without more, that aspect of their claim is dismissed.
The facts admitted in the DPA also make this case distinguishable from Andropolis v. Red Robin Gourmet Burgers, Inc., 505 F. Supp. 2d 662 (D. Colo. 2007), which VEON cites and which otherwise appears factually analogous. In Andropolis, the district court held that the defendant’s statements regarding the efficacy of its internal controls were not actionable because the plaintiff did not allege that management had failed to review the internal controls or had reviewed the controls and found them to be ineffective, but that, “had management evaluated the Company’s disclosure and financial reporting controls correctly, it would have or should have found them to be deficient-considering the widespread abuse.” By contrast here, Plaintiff alleges, based on VEON’s admissions in the DPA, that management knowingly failed to implement adequate controls governing due diligence, contract approval, and internal audit, and, at the time, was aware that its internal controls were not effective.
Second, VEON argues that its disclosures and certifications regarding “financial reporting” controls are distinct from the admissions it made in the DPA regarding the deficiencies in its due diligence, conflicts of interest review, and other internal audit functions, making the statements alleged factually true. VEON’s disclosures regarding internal controls over financial reporting relate to Exchange Act Rules 13a-15(f) and 15d-15(f). With one exception, those rules do not cover the types of due diligence and conflict of interest review that Plaintiffs identify as lacking and regarding which VEON made admissions in the DPA. Falsely recording a bribe as the acquisition of an asset or consulting services, would seem to violate policies or procedures that “[p]ertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions … of the issuer.”
Third, VEON argues that, even if false, its statements are protected by the PSLRA’s safe harbor for forwardlooking statements. This safe harbor protects only those statements that are “identified” as such and are “accompanied by meaningful cautionary language,” are immaterial, or where “the plaintiff fails to prove that it was made with actual knowledge that it was false or misleading.” However, many of the statements regarding VEON’s internal controls are backward, not forward, looking, taking them outside of the ambit of the safe harbor and the common law “bespeaks caution” doctrine see Am. Compl. ¶¶ 106, 136, 164 (each disclosing that, based on company’s review, management “believed” or “concluded” internal controls over financial reporting were effective in fiscal year being reported). They are statements of historical fact, not predictions of future compliance. Moreover, even if the safe harbor were applicable, as it might be to certain of the other more general or forward-looking disclosures, it would not protect statements made with actual knowledge of falsity.
Further, with respect to VEON’s statements on its website, in particular, those disclosures are more specific than statements courts typically discount as mere “puffery,” including those cited by VEON.”
Strategies For Minimizing Risk Under The FCPA
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