This prior post discussed the New York Times lengthy Wal-Mart investigative piece published over the weekend.
This post analyzes the likely issues and the road ahead.
The Times article is both unremarkable and remarkable at the same time.
The unremarkable portion of the Times article is that a foreign subsidiary of a multi-national company operating in a FCPA high-risk jurisdiction allegedly made payments to “foreign officials” to facilitate or grease the issuance of certain licenses or permits. According to the Times, Wal-Mart’s subsidiary in Mexico “had taken steps to conceal [the payments] from Wal-Mart’s headquarters in Bentonville, Ark.” and Wal-Mart Mexico’s chief auditor altered reports sent to Bentonville discussing various problematic payments. In short, there is nothing in the Times report to suggest that Wal-Mart’s board or top executives (with the exception of Eduardo Castro-Wright – discussed below in more detail) knew of or authorized the problematic payments.
By unremarkable I do not mean to suggest that such payments will not attract DOJ and SEC scrutiny under the FCPA’s anti-bribery provisions. They surely will, even if Congress likely intended to exclude such payments from the FCPA’s reach and even if the only case law of precedent on the issue is muddled. (Both issues were discussed in the prior post).
Even if the Mexican payments do not meet the elements of an FCPA anti-bribery violation, the enforcement agencies are likely to assert that such payments violate of the FCPA books and records and internal control provisions. For instance, the Times article suggests that the Mexican payments were routed through Mexican gestores who were told to submit invoices full of secret code words. The enforcement agencies frequently take the position that payments recorded on a subsidiary’s books and records become the parent company issuer’s problem on the theory that such subsidiary books and records are consolidated with the issuers for purposes of financial reporting.
The enforcement agencies also expect that a parent company implement effective internal controls throughout its organization, including foreign subsidiaries. On this issue, one of the most significant issues is likely to be, as the Times article details, that in 2003 Wal-Mart engaged Kroll Inc. on an apparent unrelated issue in which Kroll concluded that Wal-Mart Mexico “executives had failed to enforce their own anticorruption policies, [and] ignored certain internal audits that raised red flags.” According to the Times article, “Wal-Mart then asked Kroll to evaluate Wal-Mart de Mexico’s internal audit and antifraud units” and that “Kroll wrote another report that branded the units ‘ineffective.'”
An issue the enforcement agencies are likely to explore is how Wal-Mart reacted to the 2003 Kroll audit and if it didn’t react why not? The same general issue is present in Avon’s current FCPA scrutiny. As noted in this February Wall Street Journal article, a grand jury is probing how certain U.S. executives reacted to a 2005 internal audit by the company that concluded Avon employees in China may have been bribing officials in violation of the FCPA. As in Avon, an issue in the Wal-Mart matter, including as to individual executives who may not have participated in or authorized any Mexican payments, will likely be willful blindness as to the Mexican audit.
The remarkable aspects of the Times investigation include the conduct (or lack thereof) of Wal-Mart and its top executives upon learning of problematic conduct in its Mexican subsidiary. Even in 2005 and continuing today, most business leaders, audit committees, and boards tend to overreact to FCPA issues and often reflexibly launch broad internal investigations.
However, the payment issues at Wal-Mart Mexico apparently resulted in exactly the opposite at Wal-Mart’s corporate headquarters. Wal-Mart’s conduct will not be viewed favorably by the enforcement agencies.
For instance, under the DOJ’s Principles of Federal Prosecution of Business Organizations (here) a factor the DOJ will consider in arriving at its enforcement decision include “the corporation’s timely and voluntary disclosure of wrongdoing and its willingness to cooperate in the investigation of its agents.” While the FCPA does not contain any affirmative disclosure obligation, most companies the size and stature of Wal-Mart tend to disclose conduct that could implicate the FCPA, particularly given the SEC’s position that all payments in violation of the FCPA are qualitatively material, even if not quantitatively material.
Lacking such a voluntarly disclosure, a company should, at the very least, thoroughly investigate the alleged wrongdoing and implement effective remedial measures, including by disciplining and terminating culpable employees. Once again, the Principles of Prosecution state that “the corporation’s remedial actions, including any efforts to implement an effective corporate compliance program or to improve an existing one, to replace responsible management, to discipline or terminate wrongdoers, to pay restitution, and to cooperate with the relevant government agencies” is a factor the DOJ will consider in arriving at its enforcement decision. As to this factor, the relevant comment in the Principles of Prosecution states as follows. “In determining whether or not to prosecute a corporation, the government may consider whether the corporation has taken meaningful remedial measures. A corporation’s response to misconduct says much about its willingness to ensure that such misconduct does not recur. Thus, corporations that fully recognize the seriousness of their misconduct and accept responsibility for it should be taking steps to implement the personnel, operational, and organizational changes necessary to establish an awareness among employees that criminal conduct will not be tolerated. Among the factors prosecutors should consider and weigh are whether the corporation appropriately disciplined wrongdoers, once those employees are identified by the corporation as culpable for the misconduct.”
On this issue, another remarkable aspect of the Times investigation is how Eduardo Castro-Wright (at the critical time period the CEO of Wal-Mart Mexico) was known by others at Wal-Mart to be involved in the Mexican payments, but was nevertheless continuously thereafter promoted by Wal-Mart. For instance, as noted in this January 7, 2005 release, Wal-Mart announced that “Eduardo Castro-Wright, currently president and chief executive officer of Wal-Mart Mexico, will become executive vice president and chief operating officer of the Wal-Mart Stores Division in the United States.” In the release, Wal-Mart President and CEO Mike Duke stated as follows. “Eduardo is a proven leader who has helped Wal-Mart Mexico achieve outstanding results. His experience, perspective and management skills will be a valuable addition to our division here in the United States.” In this June 2010 release, the company announced that “Vice Chairman Eduardo Castro-Wright has been appointed President and CEO of Global.com and Global Sourcing.” Wal-Mart President and CEO Mike Duke stated as follows. “Eduardo has made extraordinary contributions to Walmart U.S. over the past five years, and many contributions are still to come. He is a visionary thinker who has strengthened our overall business and built a foundation that positions us well for the future.”
As to other Wal-Mart executives, while there is no suggestion at this point that they knew of or authorized the Mexican conduct while it was occurring, their conduct since learning of the misconduct is likely to attract regulatory scrutiny. Such scrutiny is likely to include certification issues under Sarbanes-Oxley (SOX) as well as other executive statements to the market since 2005 when they became aware of the payments at issue. You can bet that the SEC in particular will be analyzing every SEC filing, specifically the Management Discussion & Analysis section, and all other statements to the market since 2005 by executives regarding Wal-Mart Mexico.
As to SOX certification issues, as noted in this prior post, in 2011 the SEC charged Paul Jennings, the former CEO and CFO of Innospec. Jennings was charged in connection with the payments, but also charged with violating Exchange Act Rule 13b2-2 by making false statements to accountants and violating Exchange Act Rule 13a-14 by signing false personal certifications required by SOX that were attached to annual and quarterly Innospec public filings. As to these charges, the SEC alleged as follows. “From 2004 to February 2009, Jennings signed annual certifications that were provided to auditors where he falsely stated that he complied with Innospec’s Code of Ethics incorporating the company’s Foreign Corrupt Practices Act policy, and that he was unaware of any violations of the Code of Ethics by anyone else. […] Jennings also signed annual and quarterly personal certifications pursuant to SOX in which Jennings made false certifications concerning the company’s books and records and internal controls. Jennings also signed false management certifications to Innospec’s auditors indicating that the books and records were accurate and that Innospec had appropriate internal controls.” Then SEC FCPA Unit Chief, Cheryl Scarboro stated as follows: “we will vigorously hold accountable those who approve such bribery and who sign false SOX certifications and other documents to cover up the wrongdoing.”
Also perhaps relevant is the 2009 SEC FCPA enforcement action against Nature’s Sunshine Products (“NSP”) including its executives Douglas Faggioli (President and Chief Executive Officer of NSP and a member of its board of directors during the relevant time period) and Craig Huff (the company’s CFO). The SEC complaint did not allege that these executives knew of or participated in the improper payments at issue, but the SEC nevertheless charged the executives on a control person theory of liability. The complaint charged that Faggioli and Huff, as “control persons” of NSP, violated the FCPA’s books and records and internal control provisions and generally alleged that both Faggioli and Huff had “supervisory responsibilities” over NSP’s senior management and policies, yet as “control persons,” “failed to make and keep books, records, and accounts, which in reasonable detail, accurately and fairly reflected the transactions of NSP” and failed to devise and maintain an adequate system of internal accounting controls.
Not only will the DOJ and SEC likely be examining the conduct of Wal-Mart executives, but so too will plaintiff law firms representing shareholders who will likely scour Wal-Mart’s SEC filings and other statements to the market in bringing derivative claims alleging breach of fiduciary duty and potential Section 10(b) claims based on material omissions concerning Wal-Mart Mexico. On this score, shareholders are likely to allege, among other things, that Wal-Mart’s officers and directors demonstrated conscious disregard for fiduciary duties by failing to act diligently in the face of known facts suggesting a duty to act.
Whether remarkable or unremarkable, the information revealed in the Times article is likely to be a long and costly exercise for Wal-Mart and certain of its executives. Wal-Mart’s statement over the weekend indicated that it already is conducting a world-wide review of its operations and such “where else” investigations frequently uncover additional problematic conduct. Among other things, the enforcement agencies are likely to take a keen interest in how Wal-Mart obtained foreign licenses or permits in other FCPA high-risk jurisdictions around the world. This world-wide review will take time and for this reason FCPA scrutiny of the type that Wal-Mart is currently under is likely to last 2-4 years.