Cobalt Experiences The Front Page Effect As Well
Wal-Mart’s stock is not alone in experiencing a wild ride based on recent front page news coverage of FCPA issues. Last week, Cobalt International (a Houston based oil exploration and production company) experienced a wild ride as well.
On Friday, April 13th, Cobalt’s shares closed at $28.38.
On Sunday, April 15th, the Financial Times (“FT”) published two articles: “Spotlight Falls on Cobalt’s Angola Partner” and “Angola Officials Held Hidden Oil Stakes” that spooked investors the following day. Never mind that, as in Wal-Mart’s case, Cobalt disclosed FCPA scrutiny weeks earlier – see here for the prior post. (Point taken that market reaction to Wal-Mart – the stock was down an additional 3% yesterday, down approximately 8% this week – is likely not just based on Wal-Mart’s potential FCPA scrutiny, but Wal-Mart’s response (or lack thereof) to the payments since 2005 and the impact this could have for senior leadership at the company).
The FT articles document how in 2008 Cobalt was looking to obtain rights to drill for oil in Angolan waters. According to the FT, an Angolan government stipulation was that Cobalt would have partner with Nazaki Oil & Gaz, described by the FT as “an obscure local company.” According to the articles, FT confirmed that “three of the most powerful figures in the Angolan regime have held interests in Nazaki.” The FT stated that these individuals “interests in Cobalt’s local partner could raise questions about compliance with U.S. anti-corruption laws, which make it a crime to pay or offer anything of value to foreign officials to win business.” For its part, Cobalt stated in the articles that its extensive and ongoing due diligence “has not found any credible support for the central allegation that Angolan government officials, and specifically the officials identified … have any ownership in Nazaki” and that the company “has at all times complied fully with both U.S. and Angolan laws.”
Nevertheless, in mid-day trading on Monday, April 16th, the company’s stock plunged approximately 11% and closed at $26.35, down approximately 7% from its previous close.
After watching its stock dive based on the FT article, Cobalt issued a release (here) strongly refuting “any allegations of wrong doing and once again stood behind its principles of full compliance with all laws in all jurisdictions in which it operates.” According to Cobalt’s release, “prior to publication of [the FT] articles, Cobalt went on the record asking for any documentation that the Financial Times could offer which was at odds with its position. The Financial Times declined Cobalt’s repeated requests for supporting documentation. In fact, in the course of these communications, Cobalt informed the Financial Times of certain egregious, demonstrably false allegations that it provided to Cobalt.” As noted in the release, “Cobalt began its investigation into its Angola business relationships in 2007. Cobalt has based its decisions and actions on the results of these extensive investigations and will continue to maintain rigorous due diligence in all of its worldwide activities. Cobalt remains confident that it has not violated any US or Angolan Law and will vigorously defend its reputation and legal rights in this matter.”
On Tuesday April 17th, as if on cue, a plaintiff shareholder firm announced (here) that it is investigating “potential claims on behalf of purchasers of the securities of Cobalt International Energy Inc. concerning whether the company and certain of its officers and directors have violated federal securities laws.” Other shareholder firms have joined in as well – see here.
Also on Tuesday April 17th, Morgan Stanley, in a morning equity summary, said that the “market is overreacting to worries of alleged” Cobalt violations and that Cobalt “has no risk of losing” its interest in the Angola blocks. The company’s shares climbed approximately 4% and closed at $27.44. Since then the company’s stock has generally trended downward, yesterday it closed at $26.41.
What to make of Cobalt’s potential FCPA exposure?
Time will tell of course, but the DOJ has previously brought FCPA enforcement actions where the thing of value given to the “foreign official” was provided in the context of a business relationship with a company owned or controlled by a “foreign official” or family members.
For instance, in both the Charles Jumet and John Warwick (these individuals were employed by Ports Engineering Consultants Corporation) charging documents (here and here) the DOJ generally alleged as follows.
“Government Official A was the Administrator of Panama’s National Maritime Ports Authority (APN), the Panamanian governmental entity responsible for operating and maintaining the lighthouses and buoys in the waterways near the Panama Canal.” “Government Official B” was at various times the Deputy Administrator or Administrator of APN. “Government Official C was a very high-ranking executive official of the Republic of Panama.”
According to the charging documents, Government Official A owned a shell corporation, Soderville Corporation, which become a majority shareholder of Ports Engineering Consultants Corporation (PECC). Government Official B’s relatives were corporate officers of Warmspell Holding Corporation, which became a shareholder of PECC.
The DOJ alleged a conspiracy “to pay money secretly to Panamanian government officials in return for awarding PECC contracts to maintain lighthouses and buoys along Panama’s waterways.” According to the DOJ, part of the conspiracy was that Government Official A and Government Official B received “corrupt payments” in the form of purported ‘dividends’ and that Government Official C received “bearer” shares from PECC as part of the conspiracy.
Doing business with a “foreign official” of course is not per se illegal under the FCPA and several FCPA Opinion Procedure Releases discuss the issue – see here, here and here for instance.
Yet one of the red flags when engaging foreign partners is when a company is told by the foreign government who to do business with. In such a situation, a company needs to ask itself – why are we being told to do business with this company? A company needs to do sufficient pre-engagement due diligence, as Cobalt claims it did in Angola, to understand who the owners are to be satisfied that it is not being told to do business with the particular entity simply as an indirect way of enriching foreign officials.
Friday Roundup
From the dockets, an FCPA compliance defense – yes or no, hiring a woman closely associated with a foreign official, and a focus on the FCPA’s “red-haired stepchild” – it’s all here in the Friday Roundup.
From the Dockets
Last month when Judge Lynn Hughes dismissed, at the close of the DOJ’s case, the FCPA charges against John Joseph O’Shea (see here for the prior post), it was only a partial victory as O’Shea still faced non-FCPA charges. Complete victory is imminent as yesterday the DOJ filed a motion to dismiss (here) the remaining charges (conspiracy, money laundering and obstruction) against O’Shea.
In July 2011, Patrick Joseph (a former general director for telecommunications at Haiti Teleco and thus a “foreign official” according to the DOJ) was added to the extensive Haiti Teleco case. (See here for the prior post). Because the FCPA does not apply to bribe recipients, the DOJ charged Joseph with a non-FCPA offense: one count of conspiracy to commit money laundering. Earlier this week, Joseph pleaded guilty to the charges (see here). Pursuant to the plea agreement, Joseph agreed to forfeit approximately $956,000. It is clear from the plea agreement that Joseph was likely an early cooperator in the Haiti Teleco case as the plea agreement refers to a June 2009 proffer agreement with the DOJ. Many of the other individual defendants in the Haiti Teleco case were charged in December 2009 (see here). The plea agreement requires Joseph’s continued cooperation and later this month a trial is to begin as to other defendants in the wide-ranging Haiti Teleco case.
FCPA Compliance Defense – Yes or No?
That is the title of a free webcast on February 21st to be hosted by Bruce Carton’s Securities Docket (see here to sign up and for more information). I will be discussing my paper “Revisiting a Foreign Corrupt Practices Act Compliance Defense”and will argue in favor of Congress creating an FCPA compliance defense. On the other side of the issue, Howard Sklar (Senior Counsel, Recommind and a frequent commentator on FCPA issues at, among other places, his Open Air Blog) will argue that Congress should not include a compliance defense to violations of the FCPA.
Former Employee Alleges FCPA Issues at GE
As previously reported by Chris Matthews at Wall Street Journal Corruption Currents (see here) Khaled Asadi (a dual U.S. and Iraqi citizen) who was previously employed by G.E. Energy (USA) LLC (“GE Energy”) as its Country Executive for Iraq, located in Amman, Jordan, has filed a civil complaint (here) in the Southern District of Texas against G.E. Energy. GE Energy is a wholly-owned subsidiary of General Electric Company (“GE”).
The complaint alleges that G.E. harassed, pressured Asadi to vacate his position, and ultimately terminated him after he informed his supervisor and G.E.’s Ombudsperson “regarding potential violations of the Foreign Corrupt Practices Act committed by G.E. during negotiations for a lucractive, multi-year deal with the Iraqi Ministry of Electricity.” The substance of Asadi’s complaint is that “on or about June of 2010 Mr. Asadi was alerted by a source in the Iraqi Government that GE had hired a woman closely associated with the Senior Deputy Minister of Electricty (Iraq) to curry favor with the Ministry while in negotiation for a Sole Source Joint Venture Contract with the Ministry of Electricity. (According to the complaint, the Joint Venture Agreement between GE and the Ministry of Electricity was signed in Baghdad on December 30, 2010 and that the exclusive materials and repairs provision is estimated to be valued at $250,000,000 for the seven year agreement.)
Hiring friends, family members, etc. of a “foreign official” at the request of the ‘foreign official” has been the basis, in part, for previous FCPA enforcement actions – particularly if the hired individual was not qualified for the position, did not engage in any meaningful work, or was paid an unreasonably high salary. For instance, the 2011 FCPA enforcement action against Tyson Foods (see here for the prior post) involved, in part, allegations that a company subsidiary placed the wives of Mexican “foreign officials” on its payroll and provided them with “a salary and benefits, knowing that the wives did not actually perform any
services” for the company.
In the WSJ Corruption Currents article, a GE spokesman stated as follows. “Mr. Asadi’s termination had absolutely nothing to do with any allegations he is making. Regarding our contracts in Iraq, GE followed all requirements and his allegations are false.”
Travel Act Readings
A few informative Travel Act readings to pass along.
In this article from Thomson Reuters News & Insight, Mike Emmick (Sheppard Mullin Richter & Hampton) calls the Travel Act the “FCPA’s red-haired stepchild” and says that in conducting an internal investigation “there are some additional rocks to flip over” before celebrating findings of no payments to “foreign officials.”
In this article from Bloomberg Law Reports, John Rupp and David Fink (Covington & Burling) note that a “move by U.S. authorities to target commercial bribery robustly is a distinct possibility.” The piece discusses the laws that could be used by U.S. authorities to prosecute foreign commercial bribery.”
*****
A good weekend to all.
Questions Abound In IBM Enforcement Action
Last week, the SEC announced (here) a settled FCPA enforcement action against International Business Machines Corporation (“IBM”).
This post summarizes the enforcement action and then addresses the many questions raised by the enforcement action.
Summary of Enforcement Action
According to the SEC complaint (here): “During the period from 1998 through 2009, in violation of the Foreign Corrupt Practices Act of 1977, employees of certain of [IBM’s] subsidiaries and a majority-owned joint venture provided cash payments, improper gifts, as well as improper travel and entertainment to government officials in South Korea and China.”
The conduct at issue focused on:
IBM-Korea, Inc. (“IBM-Korea”), a South Korean corporation “wholly-owned indirectly by IBM International Group B.V, which, in turn is wholly-owned by IBM;”
LG IBM PC Co. Ltd. (“LG-IBM”), a South Korean joint venture formed in 1996 by IBM-Korea (51% owner of the JV) and LG Electronics (“LG”) (49% owners of the JV); and
IBM (China) Investment Company Limited and IBM Global Services (China) Co. Ltd. (collectively “IBM-China”) – entities “owned by IBM China/Hong Kong Limited, a Hong Kong company that is ultimately owned by IBM.”
In summary fashion, the SEC alleged as follows.
“From 1998 to 2003, employees of [IBM-Korea] and [LG-IBM] made payments to various government officials in South Korea. The purpose of these payments was to secure the sale of IBM products through IBM-Korea and LG-IBM’s business partners. During the relevant period, these managers paid approximately KRW 216,832,500 (South Korean Won), or $207,000, in cash bribes to South Korean government officials, including providing improper·gifts and payments of travel and entertainment expenses.”
“From at least 2004 to early 2009, employees of [IBM-China] engaged in a widespread practice of providing overseas trips, entertainment, and improper gifts to Chinese government officials. The misconduct in China involved several key IBM-China employees and more than 100 IBM China employees overall.”
As to IBM, the parent-company issuer, the SEC alleged as follows.
“Despite its extensive international operations, IBM lacked sufficient internal
controls designed to prevent or detect these violations of the FCPA. During the period 1998 to 2009, IBM had corporate policies prohibiting bribery and procedures relating to compliance with the FCPA; however, deficient internal controls allowed employees of IBM’s subsidiaries and joint venture to use local business partners and travel agencies as conduits for bribes or other improper payments to South Korean and Chinese government officials over long periods of time.”
“During the period 1998 to 2009, IBM failed to make and keep books and records that accurately reflected the improper payments made in South Korea and China. Instead, these payments were recorded as legitimate business expenses.”
The body of the SEC’s complaint alleges various “things of value” provided to alleged South Korean “foreign officials” including shopping bags filled with thousands of dollars, cash-filled envelopes exchanged in parking lots and free personal computers, and travel and entertainment expenses.
According to the SEC, such “things of value” were: “in exchange for designating IBM-Korea a preferred supplier of mainframe computers to [an alleged government entity] and for placing orders with IBM-Korea at higher prices;” “in exchange for (1) maintaining IBM-Korea as the supplier of mainframe computers to [an alleged government entity]; and (2) for helping an IBM-Korea business partner win bids to supply mainframe computers and storage equipment to [an alleged government entity] worth more than [$21 million]; “in exchange for [an alleged “foreign official’s] assistance to IBM-Korea in obtaining a contract with [an alleged government entity] worth approximately [$13 million] for the installation of a mainframe computer in 2002;” “to entice [foreign official’s] to purchase IBM products:” “to win a contract to supply 657 (later increased to 825) personal computers valued at [approximately $1.4 million]; “in exchange for providing LG-IBM with certain confidential information regarding the product specifications on [an alleged government entity’s] request for procurement;” “to persuade employees of [an alleged government entity] to purchase IBM products;” and to entice alleged foreign officials “to purchase IBM products or to provide information to assist LG-IBM in the bidding process.”
The body of the SEC’s complaint as to China conduct alleges as follows.
“From at least 2004 to early 2009, IBM-China employees created slush funds at local travel agencies in China that were then used to pay for overseas and other travel expenses incurred by Chinese government officials. In addition, IBM-China employees created slush funds at its business partners to provide a cash payment and improper gifts, such as cameras and laptop computers, to Chinese government officials. IBM failed to record accurately these payments in its books and records.”
Specifically, the SEC alleged as follows:
“Between 2004 and 2009, IBM’s internal controls failed to detect at least 114
instances in which (1) IBM-China employees and its local travel agency worked together to create fake invoices to match approved [Delegation Trip Requests] DTRs; (2) trips were not connected to any DTRs; (3) trips involved unapproved sightseeing itineraries for Chinese government employees; (4) trips had little or no business content; (5) trips involved one or more deviations from the approved DTR; and (6) trips where per diem payments and gifts were provided to Chinese government officials.”
Based on the above allegations, the SEC charged IBM with violating the FCPA’s books and records and internal control provisions. As noted in the SEC release, IBM, without admitting or denying the SEC’s allegations, consented to the entry of a final judgment permanently enjoining the company from future FCPA violations. IBM agreed to pay $10 million (disgorgement of $5.3 million, $2.7 million in prejudgment interest, and a $2 million civil penalty).
Peter Barbur and Evan Chessler (Cravath, Swaine & Moore – here and here) represented IBM.
Questions Abound
For starters, this is not the first time IBM has been the focus of an FCPA enforcement action.
In December 2000 (see here), the SEC found, in a cease and desist proceeding, that IBM violated the FCPA books and records provisions in connection with a $250 million contract to integrate and modernize computer systems in Argentina. As part of the settlement, “IBM consented to the entry of an Order that requires IBM to cease and desist from committing or causing any future violation of [the FCPA’s books and records provisions].
Given that IBM was charged last week with FCPA books and records violations, IBM has clearly violated this 2000 court order.
In my recent “Facade of FCPA Enforcement” article (here), I highlight various pillars that contribute to the facade of FCPA enforcement.
Pillars include, unsupported legal conclusions serving as the foundation for an enforcement action, including as to “foreign official” and disgorgement issues; the tendency of factually similar cases being resolved materially different ways; and bribery, yet no bribery.
These pillars are present in the IBM enforcement action.
For starters, who were the “government officials in South Korea and China.” Were they traditional bona-fide government officials or employees of alleged state-owned or state-controlled enterprises and thus “foreign officials” under the enforcement agencies’ interpretation – an interpretation currently the subject of judicial challenges?
As to the South Korean officials, the complaint merely alleges that the “foreign government officials involved worked for sixteen South Korean government entities.” These officials included the “Chief of Operations for the Electronic Operations Division” of an entity; an employee of the same entity; a “manager of the government-controlled entity”; the “Director of Planning” of another entity; employees of an entity; an employee of a “state-owned agency of the South Korean government;” a “Director of Information Technology” at another entity; employees of another entity; and “key decision makers at ten other” entities.
As to the Chinese officials, the complaint merely alleges that the individuals were associated with “government-owned or controlled customers in China for hardware, software, and other services.”
Based on the descriptions in the complaint, it seems as if the “foreign officials” were all employees of SOE entities. If so, two out of three corporate FCPA enforcement actions in 2011 (IBM and Maxwell Technologies – see here) involve SOE employees.
Why no FCPA anti-bribery charges against IBM or the relevant subsidiaries (accepting of course the SEC’s “foreign official” interpretation)?
According to the SEC, the conduct at issue took place between 1998 and 2009. Further, according to the SEC, “in connection with the conduct described herein, IBM, directly or indirectly, made use of the mails or the means or instrumentalities of interstate commerce in connection with the acts, transactions, practices and courses of business alleged in this Complaint.”
Why no DOJ involvement?
It is very common for the DOJ and SEC to announce FCPA enforcement actions on the same day. Thus, one can assume (perhaps future events will prove otherwise) that the DOJ elected to sit this one out.
Why?
The SEC’s complaint alleges vivid instances of bribery (not always seen in FCPA enforcement actions) in connection with multi-million dollar contracts.
Yet, no bribery – not even civil FCPA anti-bribery charges.
Is this another instance where the U.S. enforcement agencies look first at the corporate offender, its customers, and its products, and then craft a resolution that will hurt the least?
After all, one of IBM’s largest customer segments is the government (federal, state, etc.) see here.
Did this play any role in how the enforcement action was resolved?
The SEC charged IBM only with FCPA books and records and internal controls violations. Yet, as in several other cases, the SEC pursued a disgorgement remedy. As noted in my Facade article (pages 981-984) non-FCPA disgorgement case law clearly holds that disgorgement may not be used punitively. It is difficult to see how mis-recording of a payment (a payment the SEC does not allege violated the FCPA’s anti-bribery provisions) can properly give rise to a disgorgement remedy. See also here from Philip Urofsky and Danforth Newcomb on this issue.
In a transparent legal system, similar facts are supposed to be resolved with similar charges. However, it is questionable whether this fundamental principle (one that inspires trust and confidence in a legal system) is followed in many FCPA enforcement actions.
The China-related charges against IBM regarding excessive travel and entertainment expenses are nearly identical to two previous FCPA enforcement actions – the December 2007 enforcement action against Lucent Technologies and the December 2009 enforcement action against UTStarcom, Inc.
Lucent was resolved via a DOJ non-prosecution agreement (here) and an SEC enforcement action charging only FCPA books and records violations (here).
UTStarcom was resolved via a DOJ non-prosecution agreement (here) and an SEC enforcement action charging FCPA anti-bribery as well as books and records and internal controls violations (here).
IBM, as detailed above, is presumably being resolved without any DOJ involvement and an SEC enforcement action charging only FCPA books and records violations.
Three cases – all involving in whole or in part allegations of providing excessive travel and entertainment expenses to Chinese “foreign officials” – resolved in three different ways.
*****
And now, as one reader put it, the question all FCPA Professor blog readers (at least this particular reader) are dying to know.
Butler or Wisconsin?
I am a born and raised cheesehead and graduate of the University of Wisconsin Law School.
However, my allegiance is to my employer – Butler University. Let’s face it, Butler is an awesome, feel-good story. Student-athletes in every sense of the word, home games at historic Hinkle Fieldhouse, a coach who, a few years ago, left his job selling pharmaceuticals to become a volunteer coach (since promoted), and a small, cozy campus to top it off.
BU-TLE- R U a Bulldog – hell ya!
RAE Systems Held Liable For The Acts Of Its Subsidiaries’ Joint Venture Partners
If every company voluntarily disclosed that its distant subsidiaries and/or its distant subsidiaries’ joint venture partners provided minor things of value (such as a notebook computer, kitchen appliances, and business suits) to someone deemed a “foreign official” by the enforcement agencies, then instead of 15 to 20 core FCPA enforcement actions per year, there would probably be something like 150 to 200 FCPA enforcement actions per year.
If every issuer voluntarily disclosed that its internal controls were imperfect as to distant subsidiaries or its distant subsidiaries’ joint venture partners, and that such distant entities failed to follow issuer instructions or issuer provided training and guidance, then instead of 15 to 20 core FCPA enforcement actions per year, there would probably be something like 1,500 to 2,000 FCPA enforcement actions per year (recognizing that the FCPA’s books and records and internal control provisions equally apply to domestic operations).
So why did RAE Systems voluntarily disclose such conduct to the DOJ and the SEC? Would it not have been more efficient and cost-effective for the company to effectively remedy these issues internally?
Do the high professional expenses connected with voluntary disclosures (compared to effectively remedying issues internally) have anything to do with the increase in voluntary disclosures? (See here for a prior post on the issue). In RAE Systems annual report for the year ended December 31, 2009 (see here), filed in March 2010, the company disclosed that it had (at that point) incurred $4 million in professional fees in connection with the FCPA investigation.
From an enforcement standpoint, is the Foreign Corrupt Practices Act becoming an all-purpose corporate governance instrument? Should it?
These are some of the questions raised by the odd RAE Systems enforcement action.
Last Friday, the DOJ and SEC announced (see here and here) a joint enforcement against RAE System (a San-Jose, California based company with shares on the New York Stock Exchange) “a leading global provider of rapidly deployable connected, intelligent gas detection systems that enable real-time safety and security threat detection.” (See here for the company website). In September, RAE Systems signed a definitive agreement to be acquired by Battery Ventures. The transaction is expected to close by the end of the first quarter of 2011.
This post summarizes the DOJ and SEC enforcement actions in which RAE Systems agreed to pay approximately $2.95 million in fines and disgorgement.
DOJ
Pursuant to a three-year non-prosecution agreement, RAE Systems acknowledged its “knowing violations of the internal controls and books and records provisions” of the FCPA “arising from and related to improper benefits corruptly paid by employees of two joint ventures majority owned and controlled by RAE Systems to foreign officials of departments, agencies, and instrumentalities” of the Chinese government.” Pursuant to the NPA, RAE Systems agreed to pay a $1.7 million penalty.
According to the NPA, RAE Systems “had significant operations” in China organized “under a holding company called RAE Asia, headquartered in Hong Kong.” RAE Systems “sold products and services in mainland [China] primarily through second-tier subsidiaries organized as joint ventures with local Chinese entities.
One of the joint ventures is RAE-KLH (Beijing) Co., Limited (“RAE-KLH”). RAE Systems acquired a 64% stake in RAE-KLH in 2004 and upped the stake to approximately 96% in 2006. The other joint venture is RAE Coal Mine Safety Instruments (Fushun) Co., Ltd. (“RAE-Fushun”). In 2006, RAE Systems acquired a 70% interest in RAE Fushan.
Both RAE-KLH’s and RAE Fushun’s financial results were included in the consolidated financial statements that RAE Systems filed with the SEC.
According to the NPA, “a significant number of RAE-KLH’s and RAE Fushun’s customers” in China were “government departments and bureaus and large state-owned agencies and instrumentalties.” The NPA states as follows. “The Lanzhous City Honggu Mining Safety Bureau, for example, was a government customer. Other government clients included regional fire departments, emergency response departments, and entities under the supervision of the provincial environmental agency, among others. Accordingly, officers and employees of a significant number of RAE-KLH’s and RAE Fushun’s customers were ‘foreign officials’ within the meaning of the FCPA …”.
The NPA then contains a heading that states, “RAE System’s Knowing Failure to Implement Systems of Effective Internal Controls at RAE-KLH and RAE Fushun Post Closing.”
The NPA then cites various company documents that suggest RAE was aware that KLH sales personnel were making kickbacks or otherwise engaging in questionable sales tactics with its customers. The NPA cites a document from a RAE Systems employee from the United States who met with KLH personnel that stated “we knew this risk all along and have accepted it upon entering the JV deal.”
Following the acquisition, the NPA states that “RAE Systems did provide some FCPA training to RAE-KLH personnel and did tell RAE-KLH personnel to stop paying bribes and providing other improper benefits, but such steps were half-measures.” The NPA states that “RAE Systems did not impose sufficient internal controls or make sufficient changes to high-risk practices.”
As to RAE-Fushun, the NPA states that “RAE Systems did not conduct pre-acquisition corruption due diligence of RAE Fushun” but that “given RAE’s System’s experience with KLH described above, the high-risk nature of the location, and the existence of numerous government customers, pre-acquisition corruption-focused due diligence was merited. The NPA further states “as was later confirmed, improper business practices had occurred at RAE Fushun before the acquisition and continued post-acquisition, as RAE Systems failed to implement an effective system of internal controls at RAE Fushun.”
Based on the above facts, the NPA states that “RAE Systems knowingly failed to implement a system of effective internal accounting controls at RAE-KLH and RAE Fushun…”.
According to the NPA, the “lack of effective internal accounting controls permitted improper payments to continue at RAE-KLH and RAE-Fushun after acquisition.”
As to RAE-KLH, the NPA states that certain sales representatives at RAE-KLH “used cash advances and reimbursements for improper purposes, including the corrupt giving of gifts and paying for entertainment, as well as direct or indirect payments to customers.” According to the NPA, “the gifts included, among other things, a notebook computer for the son of the deputy director of a state-owned chemical plant as part of efforts to obtain business from that entity.” The NPA also states that RAE-KLH made payments under contracts with a purported consultant and that some or all of the payments were funneled to officials of a state-owned enterprise and government departments.
As to RAE Fushun, the NPA likewise statements that certain sales representatives at RAE Fushun “used cash advances and reimbursements for improper purposes including the corrupt giving of gifts and paying for entertainment, as well as making direct or indirect payments, to officers and employees of customers.” According to the NPA, “these gifts to certain officials of state-owned enterprises and government departments included, among other things, a variety of luxury items, such as jade, fur coats, kitchen appliances, business suits, and high-priced liquor.”
The NPA then states that the “lack of effective internal controls and continued improper payments led to inaccurate books and records.”
During the three-year term of the NPA, RAE Systems agreed to undertake a host of compliance reforms and to report to the DOJ on an annual basis.
The DOJ agreed to enter into the NPA “based in part, on the following factors: (a) RAE System’s timely, voluntary, and complete disclosure …; (b) RAE System’s thorough, real-time cooperation with the DOJ and SEC; (c) the extensive remedial efforts already undertaken and to be undertaken by RAE Systems; and (d) RAE System’s commitment to submit periodic monitoring reports to the DOJ.”
SEC
The SEC’s complaint (here) is based on the same core set of facts described above. It charges RAE Systems, not only with FCPA books and records and internal control violations, but anti-bribery violations as well.
The complaint begins by alleging that “from 2004 through 2008” RAE Systems violated the FCPA “by paying, through two of its joint venture entities in China, approximately $400,000 to third party agents and government officials in China to influence acts or decisions by foreign officials to obtain or retain business for RAE Systems.” According to the complaint, the payments “were made primarily by the direct sales force utilized by RAE Systems” at its two Chinese joint-venture entities: RAE-KLH and RAE-Fushun.
According to the SEC, RAE System’s “illicit payments to government officials and third-party agents generated revenues worth over $3 million and gross margin of $1,147,800.”
The complaint states: “While the payments were made exclusively in China and were conducted by Chinese employees of RAE-KLH and RAE-Fushun, RAE Systems was aware of significant indications of ongoing bribery at RAE-KLH. At the time, RAE Systems failed to effectively investigate these indications, or red flags, and to stop the bribery from continuing. RAE System’s failure to act on these significant red flags allowed, at least in part, bribery to continue at RAE-KLH.”
RAE Systems was held liable for RAE-KLH’s improper payments even though the SEC complaint states that “RAE Systems Instruct[ed] KLH Personnel to Stop Bribery Practices.” According to the SEC, “while RAE Systems communicated these instructions to RAE-KLH personnel, RAE Systems did not impose sufficient internal controls or make any changes to the practice of sales personnel obtaining cash advances.” According to the SEC, RAE System’s CFO visited RAE-KLH’s Chinese facilities and observed that certain cash advances may be used for “grease payments, to supplement sales employees’ incomes and as bribes.” In response, RAE Systems, “implemented FCPA compliance training and required each RAE-KLH employee to certify that he or she did not engage in bribery practices.” However, the SEC alleged “again, however, [RAE Systems] did not impose sufficient internal controls or make changes to the practice of sales personnel obtaining cash advances.”
Without admitting or denying the SEC’s allegations, RAE Systems agreed to pay $1,147,800 in disgorgement (plus $109,212 in prejudgment interest) and to undertake a host of FCPA compliance measures.
Cheryl Scarboro (Chief of the SEC’s FCPA Unit) stated as follows. “RAE Systems develops products to detect harmful emissions, yet it did not have adequate measures in place to detect and root out internal wrongdoing. Companies that fail to respond to red flags can be held liable for the acts of their joint venture partners.”
Carlos Ortiz (a former DOJ attorney now at LeClair Ryan – here) and Roy McDonald (DLA Piper – here) represented RAE Systems.
A Double Standard? Part III
A government official sets up a foundation to aid local organizations. It is funded by business entities that often turn to the government official for help – and usually succeed in getting such help.
Over a six week period, a company sends at least $45,000 in donations to four charitable programs founded by government officials – just as the companies were seeking approval of favorable legislation.
Another company supports a fundraiser for the scholarship fund of a government official.
Another company sponsors a sport competition to help the favorite food bank of a government official.
Another company subsidizes a spa outing in a popular tourist destination to aid the charity of a government official.
Another company helps sponsor a golf tournament benefiting the foundation of a government official.
Another company acknowledges that it participates in government officials’ charitable events to get access to the officials to push the company’s agenda.
*****
“Google” Foreign Corrupt Practices Act and charitable giving and you will have enough reading material to keep you busy the rest of the day.
This material will likely reference the 2004 FCPA enforcement action against Schering-Plough (see here).
In that action, the SEC alleged (here) that Schering-Plough violated the FCPA when its wholly-owned Polish subsidiary (“S-P Poland”) improperly recorded a bona fide charitable donation to a Polish foundation where the founder/president of the foundation was also the director of a government health fund (the “Director”) that provided money to hospitals throughout Poland for the purchase of pharmaceutical products.
Although the SEC and Schering-Plough ultimately resolved the matter based only on violations of the FCPA’s books and records and internal control provisions, the enforcement action is commonly viewed as broadening the “anything of value” element of an FCPA anti-bribery violation. (See here).
The SEC’s tacit interpretation of the “anything of value” element in the Schering-Plough matter is significant because there was no allegation or indication that any tangible monetary benefit accrued to the Director, an individual deemed by the SEC to be a “foreign official” under the FCPA.
Rather, the SEC brought the enforcement action on the basis of its apparent conclusion that S-P Poland’s bona fide charitable donations constituted a “thing of value” to the “foreign official” because the donations were subjectively valued by the official and provided him with an intangible benefit of enhanced self-worth or
prestige.
*****
So will the above donations to government official charities result in FCPA scrutiny?
Nope!
Why not?
Because the government officials are U.S. government officials. See here for the recent New York Times story.
The U.S. has a domestic bribery statute (18 USC 201) (see here) which has similar elements to the FCPA. Yet, I would not hold your breath waiting for domestic bribery prosecutions.
This all begs the question – is there a double standard?
Will a U.S. company’s interaction with a “foreign official” (however that term is interpreted) be subject to more scrutiny and different standards than its interaction with a U.S. official?
Do we reflexively label a “foreign official” who receives “things of value” from private business interests as corrupt, yet when a U.S. official similarly receives “things of value” from private business interests we merely say “well, no one said our system is perfect”?