This is not the first post regarding the parasitic nature of most Foreign Corrupt Practices Act related shareholder litigation. (See this September 2012 with the same title as this post).
The game is very predictable. In the days and weeks following an FCPA enforcement action, or even a company disclosing or otherwise being the subject of FCPA scrutiny, the lawsuits and/or “investigations” by plaintiffs firm will start to mount.
Foreign Corrupt Practices Act enforcement actions are often simplistic regarding the reasons why a company obtained or retained the business at issue in the enforcement action.
The DOJ and/or SEC allege of course that it was because of the alleged improper payments and often ignore other valid and legitimate reasons why the company at issue obtained or retained business.
Indeed, the vast majority of FCPA enforcement actions are against business organizations that are otherwise viewed as industry leaders who sell the best products or offer the best services for the best prices.
With such companies can it truly be said that but for the alleged improper payments the company would not have obtained or retained the business?
This general topic has been explored numerous times on these pages (see here, here, here, and here). Call it the causation gap in most FCPA enforcement actions.
As previously highlighted, the lack of causation between an alleged improper payment and any alleged business obtained or retained is not a legal defense because the FCPA’s anti-bribery provisions prohibit the offer, payment, promise to pay or authorization of the payment of any money or thing of value. Indeed, several FCPA enforcement actions have alleged unsuccessful bribery attempts in which no business was actually obtained or retained.
Nevertheless, causation should be relevant when calculating FCPA settlement amounts, specifically disgorgement which is often the most prominent component of an SEC FCPA settlement. However, the prevailing FCPA enforcement theory often seems to be that because Company A made improper payments to allegedly obtain or retain X, then all of Company A’s net profits associated with X are subject to disgorgement.
Consider the December 2014 FCPA enforcement action against Avon. At $135 million, it was the third-largest FCPA enforcement action of all-time against a U.S. company.
At its core, the enforcement action alleged that various things of value were provided to Chinese officials to induce the officials to award Avon a national direct selling license. The enforcement action alleged that Avon received the license because Chinese officials were provided things of value such as wallets, designer bags, watches, meals, and travel benefits.
In other words, the allegations are simplistic – but for Chinese officials receiving the above things of value, Avon would not have received the license.
However, this ignores other valid and legitimate reasons why Avon got the license. Indeed, as highlighted in this post for years the U.S. government was encouraging the Chinese government to award direct selling licenses to U.S. companies pursuant to China’s commitment to do so by virtue of its World Trade Organization membership.
Set forth below are relevant excerpts from United States Trade Representative documents during the same time period at issue in the Avon enforcement action.
2004 REPORT TO CONGRESS ON CHINA’S WTO COMPLIANCE
“China is scheduled to implement its distribution services commitments by December 11 of this year and thereby allow foreign enterprises to freely distribute goods within China. While China has issued regulations that call for timely implementation of these commitments, China has not made clear the precise means by which foreign enterprises will actually be able to apply for approval to provide any of the various types of distribution services. In addition, China has not yet fulfilled its commitment to open its market for sales away from a fixed location, or direct selling, by December 11, 2004, as none of the measures necessary to allow foreign participants have been issued. The Administration will pay particular attention to these areas over the coming months to ensure that China fully meets these important WTO commitments.
[…]
In its accession agreement, China committed to eliminate national treatment and market access restrictions on foreign enterprises providing these services through a local presence within three years of China’s accession (or by December 11, 2004), subject to limited product exceptions.
[…]
China committed to lift market access and national treatment restrictions in the area of sales away from a fixed location, or direct selling, by December 11, 2004. China did not agree to any liberalization before that date. China first permitted direct selling in 1990, and numerous domestic and foreign enterprises soon began to engage in this business. In the ensuing years, however, serious economic and social problems arose, as so-called “pyramid schemes” and other fraudulent or harmful practices proliferated. China outlawed direct selling in 1998, although some large U.S. and other foreign direct selling companies continued to operate in China after altering their business models. Throughout 2004, MOFCOM has been drafting three measures to implement China’s direct selling commitment, the Measures for the Administration of Direct Marketing, the Measures for the Administration of Sales Personnel Training and the Regulations on the Prevention of Anti-Pyramid Sales Scams. Despite U.S. requests and the December 11 deadline for China to implement its direct selling commitment, MOFCOM has not made drafts of these measures available for public comment. To date, it has only discussed them in a November 2004 meeting with selected enterprises.
Based on the November 2004 meeting and subsequent bilateral engagement by the United States, it appears that the draft direct selling measures may contain several problematic provisions. For example, one provision raises serious national treatment concerns, as it apparently allows direct selling of domestically produced goods, but requires imported goods to be sold at a fixed location. Other provisions, meanwhile, impose operating requirements that seem designed to make direct selling commercially unviable. The United States has urged MOFCOM to reconsider these provisions. Through the end of 2004 and into 2005, as necessary, the United States will work closely with U.S. companies in an effort to ensure that China develops and implements direct selling measures that facilitate legitimate commerce and are WTO-consistent.”
2005 REPORT TO CONGRESS ON CHINA’S WTO COMPLIANCE
“China only issued the regulations implementing its commitment to open its market for sales away from a fixed location, also known as “direct selling”, in September 2005, and these regulations contain several problematic provisions that the United States has urged China to reconsider. The Administration will continue to pursue these important issues in 2006 to ensure that China fully meets its commitments.
[…]
Meanwhile, MOFCOM’s ninemonth delay in issuing regulations on sales away from a fixed location, or direct selling, postponed the start-up of direct selling activities by foreign enterprises. A similar delay affected the wholesaling and retailing of pharmaceuticals. These delays have been disappointing, given the fundamentally important nature of China’s distribution services commitments and the repeated assurances by senior-level Chinese government officials that China would implement these commitments on time. In 2006, the United States will closely monitor how MOFCOM and relevant provincial and local authorities exercise their approval authority. In particular, the United States will work to ensure that the approval systems operate expeditiously, in a non-discriminatory manner and without creating any new trade barriers.
[…]
Sales away from a fixed location China first permitted direct selling in 1990, and numerous domestic and foreign enterprises soon began to engage in this business. In the ensuing years, however, serious economic and social problems arose, as so-called “pyramid schemes” and other fraudulent or harmful practices proliferated. China outlawed direct selling in 1998, although some direct selling companies were permitted to continue operating in China after altering their business models. In its WTO accession agreement, China committed to lift market access and national treatment restrictions in the area of sales away from a fixed location, or direct selling, by December 11, 2004. China did not agree to any liberalization before that date. As early as 2002, MOFCOM and SAIC began drafting measures to implement China’s direct selling commitment. Despite U.S. requests and the December 11, 2004 deadline for China to implement its direct selling commitment, the Chinese authorities did not make any drafts of these measures publicly available, instead only providing unofficial drafts to select direct selling enterprises. The Chinese authorities subsequently issued final versions of these measures – the Measures for the Administration of Direct Selling and the Regulations on the Administration of AntiPyramid Sales Scams – in September 2005, nine months late. The final versions of the direct selling measures made some improvements to provisions apparently included in the earlier drafts. Nevertheless, these measures still contain several problematic provisions. For example, one provision would outlaw practices allowed in every country in which the U.S. industry operates – reportedly 170 countries in all – by refusing to allow direct selling enterprises to pay compensation based on team sales, where upstream personnel are compensated based on downstream sales. The United States has pointed out that China could revise this provision to permit team-based compensation while still addressing its legitimate concerns about pyramid schemes. Other problematic provisions include a three-year experience requirement that only applies to foreign enterprises, not domestic ones, restrictions on the cross-border supply of direct selling services and high capital requirements that may limit smaller direct sellers’ access to the market. The United States has urged the Chinese authorities to reconsider the problematic provisions in the direct selling measures, both bilaterally and during the transitional review before the Council for Trade in Services, held in September 2005. MOFCOM has since offered to meet with U.S. and other foreign industry representatives to hear their concerns. This meeting is expected to take place in January 2006. The United States will work closely with U.S. companies in urging China to revise its direct selling measures to facilitate legitimate commerce and to comply with its WTO commitments.”
2006 REPORT TO CONGRESS ON CHINA’S WTO COMPLIANCE
“Another key area involves China’s commitment to open its market for sales away from a fixed location, also known as “direct selling.” Initially delayed, China’s implementation of this commitment has since proceeded slowly and has subjected foreign direct sellers to unwarranted restrictions on their business operations. The United States will continue to pursue these important issues in 2007 to ensure that China fully meets its commitments and will take further appropriate actions seeking the revision or elimination of problematic policies, including through WTO dispute settlement, where appropriate.”
[…]
China first permitted direct selling in 1990, and numerous domestic and foreign enterprises soon began to engage in this business. In the ensuing years, however, serious economic and social problems arose, as so-called “pyramid schemes” and other fraudulent or harmful practices proliferated. China outlawed direct selling in 1998, although some direct selling companies were permitted to continue operating in China after altering their business models.
In its WTO accession agreement, China committed to lift market access and national treatment restrictions in the area of sales away from a fixed location, or direct selling, by December 11, 2004. China did not agree to any liberalization before that date.
As early as 2002, MOFCOM and SAIC began drafting regulations to implement China’s direct selling commitment. Despite U.S. requests and the December 11, 2004 deadline for China to implement its direct selling commitment, the Chinese authorities did not make any drafts of these measures publicly available, instead only providing unofficial drafts to select direct selling enterprises. The Chinese authorities subsequently issued final versions of these measures – the Measures for the Administration of Direct Selling and the Regulations on the Administration of Anti-Pyramid Sales Scams – in August 2005, nine months late. In September 2006, after releasing a draft for public comment, MOFCOM issued the Administrative Measures on the Establishment of Service Network Points for the Direct Sales Industry, which clarified some aspects of the earlier measures.
The final versions of the August 2005 direct selling measures made some improvements to provisions apparently included in the earlier drafts, but they also contained several problematic provisions. For example, one provision essentially outlaws multi-level marketing practices allowed in every country in which the U.S. industry operates – reportedly 170 countries in all – by refusing to allow direct selling enterprises to pay compensation based on team sales, where upstream personnel are compensated based on downstream sales. The United States has pointed out that China could revise this provision to permit team-based compensation while still addressing its legitimate concerns about pyramid schemes. Other problematic provisions include a three-year experience requirement that only applies to foreign enterprises, not domestic ones, a cap on single-level compensation, restrictions on the cross-border supply of direct selling services and high capital requirements that may limit smaller direct sellers’ access to the market. The new service center regulations also include vague requirements that could prove excessively burdensome for small and medium-sized direct sellers.
Working closely with U.S. industry, the United States immediately began urging the Chinese authorities to reconsider the problematic provisions in the direct selling measures, both bilaterally and during the transitional review before the Council for Trade in Services, held in September 2005. After the direct selling measures went into effect in December 2005, moreover, many companies began to apply for direct selling licenses but were confused by the opaque license review process. Despite MOFCOM’s regulatory requirement that direct selling licenses be reviewed within ninety days, many foreign and domestic companies have waited for many months for MOFCOM and SAIC to review their license applications. Accordingly, the United States urged China to address the slow pace and lack of transparency in the licensing process, along with the problematic restrictions in the direct selling measures, during the run-up to the April 2006 JCCT meeting. In response, MOFCOM agreed to hold an informal dialogue with U.S. and other foreign industry representatives in the following months to better understand their concerns about the direct selling measures and to facilitate their efforts to navigate the application and approval process for obtaining licenses. Since then, five U.S. companies had obtained licenses (as of early December 2006), and MOFCOM generally remained slow in processing a growing number of license applications from foreign and domestic companies. The United States, meanwhile, has continued to urge China to revise its direct selling measures and to process direct selling applications in a timely and transparent manner in order to facilitate legitimate commerce and to comply with its WTO commitments, both in bilateral meetings and at the November 2006 transitional review before the Council for Trade in Services. The United States will continue these efforts in 2007.”
In any given year there tends to be 7 – 10 core Foreign Corrupt Practices Act enforcement actions, the vast majority of which are not actually litigated.
While courts have concluded that the FCPA does not contain a private right of action, often times FCPA-related issues are litigated in connection with other substantive causes of action.
For more on this dynamics, see the article “Foreign Corrupt Practices Act Ripples.”
Many of these cases tend to be derivative actions in which a shareholder claims that officers and directors breached fiduciary duties by allegedly allowing the company to operate without sufficient FCPA compliance policies or procedures and/or not properly monitoring and supervising those policies and procedures in place. Such breach of fiduciary duties claims are state law claims arising under the corporation’s state of incorporation.
In connection with its FCPA scrutiny that was resolved in 2014 (see here for the prior post), Avon was hit derivative claims filed in state court, the typical venue for derivative claims.
However, Avon was also hit with a derivative claim filed in federal court and that is the focus of this post.
In Pritika v. Moore, 2015 WL 1190157 (S.D.N.Y., March 16, 2015), an Avon shareholder alleged the typical breach of fiduciary claims against current and former Avon officers and directors and asserted that the federal court had subject matter jurisdiction of the claims because they were “dependent on the resolution of substantial questions of federal law.” The defendants filed a motion to dismiss for lack of subject matter jurisdiction and the court (Judge Paul Gardephe) granted the motion.
After noting that federal courts are courts of limited jurisdiction, the court did acknowledge that “even where a claim finds its origins in state rather than federal law” there may exist a “special and small category of cases in which arising under jurisdiction still lies”
In short, the court concluded that the Avon shareholder’s claims were not within the category.
The analysis section of the opinion states as follows (certain internal citations omitted).
“Here, it is undisputed that Plaintiff’s state law claims for breach of fiduciary duty, waste of corporate assets, and unjust enrichment are predicated on the allegation that Defendants caused or permitted Avon to violate the FCPA. Accordingly, this Court will assume, for purposes of resolving Defendants’ motion to dismiss … that the state law claims (1) raise a federal issue that (2) is actually disputed.
Plaintiff’s jurisdiction argument falters, however … [because they] do not raise a substantial federal issue, because any issue related to the FCPA that is presented by this case lacks the requisite “importance … to the federal system as a whole.” As noted above, “it is not enough that the federal issue be significant to the particular parties in the immediate suit,” and here the significance of the federal issue does not extend beyond the parties to this particular dispute.
Although Avon’s compliance with the FCPA will be one of the critical issues in this litigation, this case does not implicate the validity of the FCPA or the requirements that the Act imposes. Moreover, this case does not involve the application of a “complex federal regulatory scheme,” such as the “complex reimbursement schemes created by Medicare law, or the web of rate-making laws and regulations applicable to cable television providers. The FCPA-as Plaintiff describes it-only “prescribes a ‘reasonableness’ or prudent person standard for assessing [the] adequacy of issuers’ practices.” Finally, this case involves, at best, the application of a federal legal standard to private litigants’ state law claims. It will not have broad consequences to the federal system or the nation as a whole.
The critical issues in this case are primarily factual: whether Avon’s employees committed acts that violate the FCPA and, if so, whether Defendants caused or permitted these violations. While “[t]here is no doubt that resolution of [these questions under the FCPA’s legal standard] is important to the particular parties in the case[,] … something more, demonstrating that the question is significant to the federal system as a whole, is needed.” That “something more” is lacking here.
It is not sufficient-as Plaintiff suggests-that in determining whether Defendants’ conduct meets FCPA standards, a court may be required to interpret certain provisions of the Act, and may thereby affect the development of the law. The same could be said for every case that involves state law claims invoking a federal standard. Whenever a court applies a given legal standard, that court’s opinion could theoretically affect other courts’ interpretation of that legal standard. If this were a sufficient basis for “arising under” jurisdiction, the “extremely rare exception[ ]” discussed in Gunn, 133 S.Ct. at 1064, would swallow up the general rule. “Arising under” jurisdiction would be available in any case premised on state law claims, so long as parties cited a federal statute as providing the legal standard. Such a result is particularly problematic in cases such as this, where Congress has declined to grant a private right of action under the federal statute. See Lamb , 915 F.2d at 1024 (“[N]o private right of action is available under the FCPA.”).“[I]f the federal … standard [under the FCPAJ without a federal cause of action could get a state claim into federal court, so could any other federal standard without a federal cause of action.”
Plaintiff argues, however, that “the body of federal case law interpreting the FCPA is quite small,” and that “[u]nder these circumstances … the federal interest in affording federal courts every opportunity to issue the first authoritative statements about this important federal law is even more substantial.” There is no evidence, of course, that any significant novel issue under the FCPA will be raised in this litigation. But even if such a question could be anticipated, “whether a particular claim arises under federal law” does not turn “on the novelty of the federal issue.”
Accordingly, assuming arguendo that the FCPA is not commonly the subject of litigation, that fact does not create a substantial federal interest in this case.
Finally, this Court could not exercise subject matter jurisdiction here “without disturbing [the] congressionally approved balance of federal and state judicial responsibilities.” While “the absence of a federal private right of action [i]s … not dispositive of the ‘sensitive judgments about congressional intent’ that [arising under jurisdiction requires] Congress’s decision not to grant a private right of action is nonetheless “relevant to” this Court’s inquiry.
Here, exercising subject matter jurisdiction over Plaintiff’s state law claims would be tantamount to recognizing a private right of action under the FCPA. Such an approach would “open the floodgates” to federal court litigation of private disputes raising issues under the FCPA, an outcome directly contrary to Congress’s apparent intent. Whenever a company disclosed an FCPA investigation, it could expect a federal court lawsuit founded on state law claims. Congress intended that federal court litigation under the FCPA would proceed by way of SEC and DOJ enforcement actions, however, and not via private suit. Accordingly, exercising subject matter jurisdiction over Plaintiff’s state law claims would violate the “congressionally approved balance of federal and state judicial responsibilities.”
In short, shareholder derivative actions in the FCPA context belong in state court, not federal court.
As to those claims filed in state court, shareholders rarely proceed past the motion to dismiss stage. However, this has not prevented opportunistic plaintiffs’ counsel (who often take such cases on a contingency fee basis) from filing such actions in connection with numerous instances of FCPA scrutiny.
This recent post dived deep into the Avon FCPA enforcement action.
This post continues the analysis by highlighting various issues to consider associated with the enforcement action.
The Gray Cloud of FCPA Scrutiny Lasted A Long Time And Was Very Expensive
Avon disclosed its FCPA scrutiny in China in October 2008. In other words, it was 6 years and 2 months from the time of disclosure to the actual enforcement action. While FCPA scrutiny typically lasts between 2-4 years, Avon’s FCPA scrutiny was extraordinarily long. (For additional reading see this prior post “The Gray Cloud of FCPA Scrutiny Simply Lasts Too Long”).
Avon’s FCPA scrutiny was also very expensive. For years, the whisper in the FCPA community was how expensive – and dragged out – FCPA’s internal investigation and pre-enforcement professional fees and expenses were. Not all companies disclose pre-enforcement action professional fees and expenses, but Avon did and those figures were approximately $500 million (see here).
Avon’s FCPA scrutiny thus supported the claim in my article “Foreign Corrupt Practices Act Ripples” that settlement amounts in an actual FCPA enforcement action are often only a relatively minor component of the overall financial consequences that can result from FCPA scrutiny or enforcement in this new era. Indeed, the broader effects of Avon’s FCPA scrutiny (including pre-enforcement action professional fees and expenses and an impact on bond ratings) is discussed in the article.
Given the above-mentioned whispers, one of the most interesting portions of the DOJ’s DPA was the following.
“The Department also considered that the Company, taking into account its own business interests, expended considerable resources on a company wide review of and enhancements to its compliance program and internal controls. While the Company’s efforts in this regard were taken without Department request or guidance, and at times caused unintended delays in the progress of the Department’s narrower investigations, the Department recognizes that the Company’s efforts resulted in important compliance and internal controls improvements.”
Root Cause
It has been highlighted numerous times on these pages (see here for instance).
The root cause of many FCPA enforcement actions are foreign trade barriers and distortions. The narrative is rather simple.
The following is not meant to excuse Avon’s conduct, only to put it in the proper perspective.
The root cause of Avon’s FCPA scrutiny was that China had significant trade barriers and distortions applicable to direct selling of products. As highlighted in the resolution documents, “under China’s newly promulgated direct selling regulations, to conduct direct sales, a company was required to obtain a national direct selling license and approvals from each province and municipality in which it sought to conduct direct sales.”
As I have long argued, the way to reduce bribery is not just to bring more corporate enforcement actions. It is to address the root causes of bribery by seeking a reduction in trade barriers and distortions.
Two Enforcement Actions In One
The Avon enforcement action was really two distinct enforcement actions in terms of conduct.
On one level, Avon’s indirect China subsidiary intentionally disguised certain payments of things of value (individually small, but in the aggregate large) from Avon during the general time period in which they were occurring.
Yet, the second prong of the enforcement action, more problematic from a corporate governance standpoint, is that once Avon learned of the improper conduct in 2005/2006, Avon failed to take steps to stop and remedy the situation.
Much like the developing story around Wal-Mart’s FCPA scrutiny, Avon appears to be more of a corporate governance sandwich with the FCPA as a mere condiment. Based on the conduct alleged by the DOJ and SEC, Avon (the parent company) appeared to fail to take ownership of the issues at its indirect China subsidiary on a real-time basis. (For additional details on this aspect of the enforcement action see this prior post).
If “only” the alleged improper payments by Avon China had taken place, it stands to reason that the settlement amount would have been much lower.
Surprisingly Limited
Based on Avon’s pre-enforcement action disclosures, many were expecting that the Avon FCPA enforcement would be broader than just China. After all, Avon disclosed that it was conducting an internal review in a “number of countries selected to represent each of the Company’s international geographic segments” and according to its website the company does business in over 100 countries.
That the Avon enforcement action was limited to China highlights an issue that can be highlighted in most FCPA enforcement actions. While it is easy in hindsight to fault a company for internal control failures as to the specific payments alleged, that the company conducted an internal review in many other countries and found nothing (at least nothing serious enough to be alleged in an FCPA enforcement action) does suggests that the company’s overall internal controls were reasonable and adequate.
Earlier this week, the DOJ and SEC announced resolution of Avon’s long-standing FCPA scrutiny in China. The conduct at issue took place between 2004 and 2008 and Avon disclosed the conduct to the enforcement agencies in 2008.
In short, the DOJ and SEC alleged that Avon’s indirect subsidiary (Avon China) provided approximately $8 million in things of value, including gifts, cash, and non-business travel, meals and entertainment, which it gave to Chinese officials in order to obtain and retain business benefits for Avon China. Avon resolved FCPA books and records and internal controls charges related to this conduct.
Consistent with Avon’s prior disclosure, the aggregate settlement amount was $135 million. While not a top-ten Foreign Corrupt Practices Act enforcement action, the settlement is the third-largest ever against a U.S. company.
The enforcement action included:
This post summarizes the approximately 175 pages of resolution documents. Because all of the resolution documents have substantial overlap, the core allegations are highlighted in connection with the Avon China criminal information, yet repeated in the other resolution documents as well.
DOJ
Avon Products (China) Co. Ltd. (“Avon China”) is described as an indirect subsidiary of Avon incorporated in China. According to the information, Avon China and its affiliates manufactured and sold beauty and healthcare products through direct sales, as well as through “beauty boutiques” that were independently owned and operated. The information states that in addition to independent sales representatives, Avon China had between 1,000 and 2,000 employees. According to the information, Avon China’s books, records and accounts were consolidated into Avon’s books and records and reported by Avon in its financial statements.
Under the heading “The Chinese Regulatory Regime for Direct Selling” the information states:
“In or around 1998, the Chinese government outlawed direct selling in China for all companies. In or around 2001, as a condition of its entry into the World Trade Organization, China agreed to lift its ban on direct selling. In or around 2005, in order to test its planned regulations for direct selling, the Chinese government decided to issue one company a temporary license to conduct direct sales (the ‘test license.’). In or around March 2005, the Chinese government awarded the test license to Avon China, the defendant. In or around late 2005, China lifted its ban on direct selling and allowed companies to apply for licenses to conduct direct sales. Under China’s newly promulgated direct selling regulations, to conduct direct sales, a company was required to obtain a national direct selling license and approvals from each province and municipality in which it sought to conduct direct sales. In order to obtain a license, a company was required to satisfy a number of conditions, including, in pertinent part, having a ‘good business reputation’ and a record that demonstrated no material violations of Chinese law for the preceding five years. In or around February 2006, Avon China, the defendant, obtained its national direct selling license. Between in or around February 2006 and in or around July 2006, Avon China, the defendant, obtained all of its provincial and municipal approvals to conduct direct selling.”
According to the information, Avon China created and maintained a Corporate Affairs Group whose duties included maintaining “guanxi (good relationships) with government officials and lobbying those officials on behalf of Avon China.”
Under the heading, “Overview of the Scheme to Falsify Books and Records,” the information states that from 2004 to 2008, Avon China, and Avon, acting through certain executives and employees, together with others, conspired to falsify Avon China’s and, thereby ultimately, Avon’s books and records in order to disguise the things of value Avon China executives and employees provided to government officials in China.
Specifically, the information alleges that from 2004 to 2008 Avon China “acting through certain executives and employees, disguised on its books and records over $8 million in things of value, including gifts, cash, and non-business travel, meals and entertainment, which it gave to Chinese officials in order to obtain and retain business benefits for Avon China.
The information alleges that:
Avon China “falsely and misleadingly described the nature and purpose of certain transactions on Avon China’s books and records, in part, because they believed that Chinese government officials did not want a paper trail reflecting their acceptance of money, gifts, travel, entertainment and other things of value from Avon China executives and employees. The executives and employees also knew that, contrary to how the expenses were being described in Avon China’s books and records, the expenses were not incurred for legitimate business purposes.”
According to the information:
“Avon executives and employees, including high-level executives, attorneys, and internal auditors, learned that executives and employees of Avon China, the defendant, had in the past routinely provided things of value to Chinese government officials and failed to properly document it. Instead of ensuring the practice was halted, disciplining the culpable individuals, and implementing appropriate controls at Avon and Avon China to address the problem, the Avon executives and employees, in conjunction with Avon China executives and employees, took steps to conceal the significant concerns raised about the accuracy of Avon China’s books and records and its practice of giving things of value to government officials. These Avon and Avon China executives and employees, knowing that Avon China’s books and records would continue to be inaccurate if steps were not taken to correct Avon China’s executives and employees’ conduct, failed to take steps to correct such actions, despite knowing that Avon China’s books and records were consolidated into Avon’s books and records.”
The information then alleges various categories of payments.
Under the heading “gifts for government officials,” the information details designer wallets, bags, or watches “to obtain benefits from government officials, such as obtaining and retaining the direct selling license and requisite provincial and local approvals, avoiding fines, avoiding negative media reports, obtaining favorable judicial treatment, and obtaining government approval to sell nutritional supplements and healthcare apparel products, via direct selling, that did not meet or had yet to meet government standards. According to the information, Avon China executives and employees, at various times, falsely or misleadingly described the gifts, including describing them as employee travel and entertainment, samples or public relations business entertainment.” Specific gifts mentioned include a $890 gift or entertainment expense, a $960 gift purchased from Louis Vuitton, a $800 Gucci Bag, and a $460 gift from Louis Vuitton.
Regarding avoiding negative media reports, the information alleges that a leading government-owned newspaper intended to run a story about Avon China improperly recruiting sales associates and that this article could cause Avon China to lose its direct selling license. According to the information, “in order to convince the newspaper not to run the article … an Avon China employee caused Avon China to pay approximately $77,500 to become a “sponsor” of the paper at the request of a government official at the paper who was in charge of determining whether the potential article would run and who may have received a commission on monies received from sponsors.”
Under the heading “meals and entertainment,” the information alleges that Avon China “routinely entertained government officials in order to obtain the same business benefits highlighted above. According to the information, executives and employees of Avon China, “intentionally concealed these improper meal and entertainment expenses in Avon China’s books and records by (1) intentionally omitting reference to the participation of government officials in order to conceal their participation, using descriptions like business entertainment, public relation entertainment, or no description at all; or (2) revealing the participation of government officials but intentionally describing the event inaccurately by omitting the identity or number of officials, the cost of the event, or the true purpose of the event.”
Under the heading “travel for government officials,” the information alleges that executives and employees of Avon China caused Avon China to “pay for travel expenses for government officials, and sometimes their families” in order to obtain the same improper business benefits highlighted above. According to the information, “to conceal the true nature of these expenses, these executives and employees intentionally omitted from or concealed in Avon China’s records the name of the government officials, the fact that the travelers were government officials or relatives of government officials, and, at times, the number of travelers.” The information also alleges that executives and employees of Avon China “intentionally falsified in Avon China’s books and records the purpose of the travel, which often was for personal, not legitimate business, purposes. For example, the information alleges that certain personal trips for government officials (and occasionally their spouses and children) were described as “study trips” or “site visits” when the officials were instead sightseeing or taking a beach vacation.” Specifically, the information alleges, among other trips, that Avon China paid for six officials from the Guandong Food and Drug Administration to travel to Avon’s headquarters in New York City and its research and development facility in upstate New York for a “site visit/study visit.” According to the information, the “officials never visited Avon’s headquarters, only spent one morning at Avon’s research and development facility, and spent the rest of the 18-day trip sightseeing and being entertained by an Avon China employee in New York, Vancouver, Montreal, Ottawa, Toronto, Philadelphia, Seattle, Las Vegas, Los Angeles, Hawaii, and Washington D.C.
Under the heading “cash for government officials,” the information alleges that “executives and employees of Avon China, gave cash to government officials in order to obtain benefits for Avon China and falsified Avon China’s records to conceal the true recipient of and purpose for the money.” According to the information, “these employees accomplished this by submitting for reimbursement meal or entertainment receipts given to them by government officials and falsely claiming that the receipts reflected employee business expenses. In truth, the employees had no such expenses, and the receipts were used to obtain cash to make payments to government officials. The information also alleges other instances in which executives and employees of Avon China “gave cash to government officials in order to obtain business benefits for Avon China and falsely reported the payments as fine payments.” In other instances, the information alleges that Avon China executives and employees “made payments to organizations designated by government officials.”
The information also contains a separate section regarding payments to Consulting Company A that was retained by Avon China “purportedly” to provide various services to Avon China. The information alleges that these services “were memorialized in a scant two-page contract” and that Avon China “did not conduct any due diligence of Consulting Company A, nor did they require Consulting Company A to comply with Avon’s Code of Conduct (in particular, the provisions related to payments to government officials), even though Consulting Company A was retained specifically to interact with government officials on behalf of Avon China.” The information alleges that executives and employees of Avon China caused Avon China to pay Consulting Company A additional monies for purportedly legitimate, though ambiguously described, services even though an Avon China executive knew Consulting Company A’s invoices were often false, and no Avon China executives or employees knew of any legitimate services being provided by Consulting Company A.
Based on the above conduct, Avon China was charged with one count of conspiracy to violate the FCPA’s books and records provisions.
The information also contains a separate section titled “Discovery of the Falsification and Cover-Up.” In pertinent part, the information alleges:
According to the plea agreement, the advisory Sentencing Guidelines fine range was $73.9 million to $147.9 million. Pursuant to the plea agreement, Avon China agreed to pay a criminal fine in the amount of $67.6 million.
In the plea agreement, Avon China waived all defenses based on the statute of limitations.
The information is based on the same core conduct alleged in the Avon China information.
Under the heading “Avon’s Internal Controls,” the information alleges, in pertinent part, as follows.
“Although Avon … and certain of its subsidiaries had policies in place relating to the review and approval of employee expenses, it lacked adequate controls to ensure compliance with those policies and thus, in practice, employee expenses were not adequately vetted to ensure that they were reasonable, bona fide, or properly documented.
Avon … lacked sufficient controls to ensure the integrity of its internal audit process, particularly with regard to its review of allegations of and testing for improper payments made to foreign government officials. Avon’s internal audit group also failed to devote adequate funding, staffing, and resources to Avon China.
Avon … did not have adequate internal accounting and financial controls designed to detect and prevent, among other things, corruption-related violations, including FCPA violations. In particular, after senior Avon executives … learned of specific corruption issues in China related to the provision of cash, meals, gifts, travel, and entertainment to government officials, Avon failed to take the necessary steps to implement appropriate controls to address such issues and prevent such risks in the future.
Avon … had an inadequate compliance program. In fact, Avon did not have a dedicated compliance officer or compliance personnel. Avon’s compliance program was particularly weak with regard to risks associated with foreign bribery. For example, even though Avon operated in over 100 countries, including many countries with high corruption risks, Avon did not have a specific anti-corruption policy, nor did it provide any stand alone FCPA-related training. Moreover, although Avon had a code of conduct that covered all of its employees and its subsidiaries’ employees, which, among other things, prohibited paying bribes, many employees of Avon and its subsidiaries were unaware of its existence.
Avon .. did not conduct corruption-related due diligence on appropriate third parties or have effective controls for the meaningful approval of third parties. Avon also did not require adequate documentation supporting the retention of payments to third parties.
Avon … did not undertake periodic risk assessments of its compliance program and lacked proper oversight of gifts, travel, and entertainment expenditures. Avon’s failure to maintain an adequate compliance program significantly contributed to the company’s failure to prevent the misconduct in China.”
Based on the core conduct and the specific allegations detailed above, Avon was charged with one count of conspiracy to violate the FCPA’s books and records provisions as well as one count of violating the FCPA’s internal controls provisions for knowingly failing to implement a system of internal accounting controls sufficient to provide reasonable assurance of various aspects of its business as required by the provisions.
Pursuant to the three year DPA, Avon admitted, accepted and acknowledged that it was responsible for the conduct alleged in the information.
Under the heading “Relevant Considerations,” the factors the DOJ considered in resolving the action were:
“(a) the Company’s cooperation, which included conducting an extensive internal investigation in China and other relevant countries; voluntarily making U.S. and foreign employees available for interviews; collecting, analyzing, translating, and organizing voluminous evidence and information for the Department; (b) the Company’s voluntary disclosure of its employees’ and its subsidiary’s employees’ misconduct to the Department, which came relatively soon after the Company received a whistleblower letter alleging misconduct but years after certain senior executives of the Company had learned of and sought to hide the misconduct in China; (c) the Company’s extensive remediation, including terminating the employment of individuals responsible for the misconduct, enhancing its compliance program and internal controls, and significantly increasing the resources available for compliance and internal audit; (d) the Company’s commitment to continue to enhance its compliance program and internal controls, including ensuring that its compliance program satisfies the minimum elements [set forth in the DPA]; and (e) the Company’s agreement to continue to cooperate with the Department …”
The DPA also states:
“The Department also considered that the Company, taking into account its own business interests, expended considerable resources on a company wide review of and enhancements to its compliance program and internal controls. While the Company’s efforts in this regard were taken without Department request or guidance, and at times caused unintended delays in the progress of the Department’s narrower investigations, the Department recognizes that the Company’s efforts resulted in important compliance and internal controls improvements.”
Based on the conduct at issue, the DPA sets forth an advisory Sentencing Guidelines range of $84.6 million to $169.1 million. The DPA sets forth a criminal fine amount of $67.6 million and the above-mentioned Avon China criminal fine was deducted from this amount.
Pursuant to the DPA, Avon agreed to retain an independent compliance monitor for an 18 month term and agreed to various periodic reporting obligations to the DOJ.
The DPA contains a standard “muzzle clause” in which it (or those associated with it) agreed not to make any public statements contradicting its acceptance of responsibility under the DPA.
In this release, Assistant Attorney General Leslie Caldwell stated:
“Companies that cook their books to hide improper payments will face criminal penalties, as Avon China’s guilty plea demonstrates. Public companies that discover bribes paid to foreign officials, fail to stop them, and cover them up do so at their own peril.”
U.S. Attorney Preet Bharara of the Southern District of New York stated:
“For years in China it was ‘Avon calling,’ as Avon bestowed millions of dollars in gifts and other things on Chinese government officials in return for business benefits. Avon China was in the door-to-door influence-peddling business, and for years its corporate parent, rather than putting an end to the practice, conspired to cover it up. Avon has now agreed to adopt rigorous internal controls and to the appointment of a monitor to ensure that reforms are instituted and maintained.”
Assistant Director in Charge Andrew G. McCabe of the FBI’s Washington Field Office stated:
“When corporations knowingly engage in bribery in order to obtain and retain contracts, it disrupts the level playing field to which all businesses are entitled. Companies who attempt to advance their businesses through foreign bribery should be on notice. The FBI, with our law enforcement partners, is continuing to push this unacceptable practice out of the business playbook by investigating companies who ignore the law.”
SEC
Based on the same core conduct alleged in the DOJ actions, in this civil complaint the SEC charged Avon with violating the FCPA’s books and records and internal controls provisions. In summary, the SEC’s complaint states:
“This matter concerns violations by A von Products, Inc. (“A von”) of the corporate record keeping and internal controls provisions of the federal securities laws. […] . From 2004 through the third quarter of 2008, Avon’s books and records failed to accurately and fairly reflect payments by Avon Products (China) Co., Ltd. (“Avon Products China”) to Chinese government officials. Avon Products China provided cash and things of value, including gifts, travel, and entertainment, to various Chinese government officials, including government officials responsible for awarding a test license, and subsequently a direct sales business license, that would allow a company to utilize direct door-to-door selling in China. Avon Products China was, in fact, awarded a test license and, then, the first official direct selling business license in China. Avon Products China also adopted an internal “no penalty policy” and provided cash and things of value to Chinese government officials to avoid fines and other penalties in order to maintain an ostensibly pristine corporate image. Avon Products China also paid a third-party consultant for purportedly legitimate interactions with government officials, even though Avon Products China management knew the consultant’s invoices were often false and could not point to legitimate services provided by the consultant. At times , payments were made to suppress negative news in state-owned media and to obtain competitor information. In addition, Avon Products China provided cash to government officials on behalf of other Avon subsidiaries in China. Avon Products China falsified its books and records so as to conceal the cash and things of value provided to government officials. Near the end of 2005, an Avon internal audit team reported potential issues concerning things of value provided to Chinese government officials. Nevertheless, remedial measures sufficient to address the issues were not implemented at Avon Products China. Similar issues related to Avon Products China were raised at the end of 2006. Again, responsive remedial measures were not implemented. The books and records at A von Products China were consolidated into the books and records of Avon. Avon thus violated [the books and records provisions] by failing to make and keep books, records , and accounts, which, in reasonable detail , accurately and fairly reflected the transactions and disposition of assets of the issuer. By failing to ensure that it maintained adequate internal controls sufficient to record the nature and purpose of payments, or to prevent improper payments, to government officials, Avon failed to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that its transactions and the disposition of its assets were recorded correctly, accurately, and in accordance with authorization of management. Avon thereby violated [the internal controls provisions]. Finally, in May 2008, Avon began a review of its compliance with the Foreign Corrupt Practices Act (“FCPA”), the U.S . legislation that, among other things, prohibits payments to foreign government officials to obtain or retain business. As a result of its review, the company instituted extensive, related reforms.”
In certain respects, the SEC’s complaint contains additional details regarding certain of the alleged conduct such as:
As noted in this SEC release:
“Avon, which neither admitted nor denied the allegations, agreed to pay disgorgement of $52,850,000 in benefits resulting from the alleged misconduct plus prejudgment interest of $14,515,013.13 for a total of more than $67.36 million. In the parallel criminal matter, Avon entities agreed to pay $67,648,000 in penalties. Avon also is required to retain an independent compliance monitor to review its FCPA compliance program for a period of 18 months, followed by an 18-month period of self-reporting on its compliance efforts. Avon would be permanently enjoined from violating the books and records and internal controls provisions of the federal securities laws. In reaching the proposed settlement, which is subject to court approval, the SEC considered Avon’s cooperation and significant remedial measures.”
In the release, Scott Friestad (Associate Director in the SEC’s Enforcement Division) stated:
“Avon’s subsidiary in China paid millions of dollars to government officials to obtain a direct selling license and gain an edge over their competitors, and the company reaped substantial financial benefits as a result. Avon missed an opportunity to correct potential FCPA problems at its subsidiary, resulting in years of additional misconduct that could have been avoided.”
In this release, Sheri McCoy (CEO of Avon Products, Inc.) stated: “We are pleased to have reached agreements with the DOJ and the SEC.”
Avon was represented by Evan Chesler and Benjamin Gruenstein of Cravath, Swaine & Moore.
