SEC Announces Blockbuster FCPA Enforcement Actions Against ALL Issuers
[Today is April 1st, commonly referred to as April Fools Day. Please keep this in mind when reading this post. In other words, this post should not be taken literally. Even though this post is presented as satire, readers are encouraged to ponder the issues raised.]
Earlier today the SEC announced Foreign Corrupt Practices Act enforcement actions against all issuers subject to the FCPA.
Total SEC recovery in the enforcement actions – all resolved via administrative cease and desist orders and thus not subject to any judicial scrutiny was – approximately $925 billion dollars.
In announcing the enforcement actions, an SEC spokesperson stated:
“Using our data analytics tools, the SEC determined that it was more likely than not – given the SEC’s current FCPA enforcement theories – that all issuers subject to FCPA were in violation of the FCPA’s anti-bribery provisions, or at the very least the FCPA’s books and records and internal controls provisions.”
Pressed for more specifics on the enforcement actions, the SEC spokesperson stated:
Same Alleged Legal Violations, Yet Materially Different Sanctions
A basic rule of law principle is consistency.
In other words, the same legal violation ought to be sanctioned in the same way.
When the same legal violation is sanctioned in materially different ways, trust and confidence in law enforcement agencies is diminished.
The Foreign Corrupt Practices Act has always been a law much broader than its name suggests. The anti-bribery provisions are just one prong of the FCPA.
Indeed, most FCPA enforcement actions do not involve allegations of foreign bribery, but rather violations of the FCPA’s generic books and records and internal controls provisions. These provisions generally provide that issuers shall: (i) maintain books and records which, in reasonable detail, accurately and fairly reflect issuer transactions and disposition of assets (the books and records provisions); and (ii) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are properly authorized, recorded, and accounted for by the issuer (the internal controls provisions).
For lack of a better term, let’s call such actions “non-FCPA FCPA enforcement actions.” By one estimate, since the FCPA’s enactment in 1977, there have been approximately 1,200 “non-FCPA FCPA enforcement actions.”
Such actions are not dissected in the FCPA space and do not appear on the DOJ or SEC’s FCPA websites (here and here). Yet such actions are deserving of analysis because they highlight a troubling aspect of FCPA enforcement: that being how the same alleged legal violations are sanctioned in materially different ways.
For instance, the SEC recently announced an enforcement action against Stein Mart for materially misstating its pre-tax income, including almost 30% in one quarter. According to the SEC:
“Stein Mart’s internal accounting controls over […] markdowns were inadequate. For example – until at least the middle of 2011–the decision to characterize a markdown [a certain way] resided solely with Stein Mart’s merchandising department, which did not understand the impact that Stein Mart’s markdowns could have on inventory valuation accounting. As a reflection of the company’s inadequate internal accounting controls surrounding […] markdowns, Stein Mart’s chief financial officer, who was hired in 2009, did not learn of Stein Mart’s treatment of […] markdowns until the summer of 2011.”
According to the SEC’s order, Stein Mart also had inadequate internal accounting controls in the areas of software assets, credit card liabilities, and other inventory-related issues.
Based on the above findings, the SEC charged, among other things, violations of the FCPA’s books and records and internal controls provisions and ordered the company to pay a $800,000 civil penalty.
The SEC also recently announced an enforcement action against MusclePharm Corp. for failing to implement internal accounting controls for perks and other areas where the company committed accounting and disclosure violations. According to the SEC:
[Approximately] half-million dollars’ worth of perks [were] bestowed upon its executives, including approximately $244,000 paid to CEO Brad Pyatt related to automobiles, apparel, meals, golf club memberships, and his personal tax and legal services. Even after the company began an internal review of undisclosed executive perks and then-audit committee chair Donald Prosser became directly involved in the process, MusclePharm continued filing financial statements that failed to disclose private jet use, vehicles, and golf club memberships for its executives.
[,,,]
While the company focused on revenue growth, it failed to establish sufficient internal controls and keep proper books and records. As a result, between 2010 and 2013, engaged in a series of accounting and disclosure failures that resulted in the company filing materially false and misleading filings with the Commission from 2010 through July 2014. Specifically, as described further below, [MusclePharm] failed to disclose perquisite compensation to its executive officers, failed to disclose related party transactions, failed to disclose bankruptcies of its executive officers, and committed other financial statement, accounting, and disclosure failures.
Because [MusclePharm] improperly recorded and/or reported its perquisites, related parties, revenue, losses on settlement of accounts payable, sponsorship commitments, manufacturing concentration, leases, and international sales, its books, records and accounts did not, in reasonable detail, accurately and fairly reflect its transactions and dispositions of assets. In addition, [MusclePharm] failed to implement internal accounting controls relating to its perquisites, related parties, revenue, losses on settlement of accounts payable, sponsorship commitments, manufacturing concentration, leases, and international sales, which were sufficient to provide reasonable assurances that transactions were recorded as necessary to permit the preparation of financial statements in conformity with GAAP and to maintain the accountability of assets.”
Based on the above findings, the SEC charged, among other things, violations of the FCPA’s books and records and internal controls provisions and ordered the company to pay a $700,000 civil penalty.
Against the above backdrop, consider the recent $25 million FCPA enforcement action against BHP Billiton in which the SEC found that the company violated the FCPA’s books and records and internal controls provisions because it had “insufficient internal controls over [its] Olympic hospitality program.”
Also consider the recent $12 million FCPA enforcement action against Mead Johnson in which the SEC found that the company violated the FCPA’s books and records and internal controls provisions because a subsidiary’s “records were incomplete and did not reflect that a portion of Distributor Allowance was being used contrary to Mead Johnson’s policies” and because the company “failed to devise and maintain an adequate system of internal controls” concerning distributor allowances.
Also consider the recent $16 million FCPA enforcement action against Goodyear in which the SEC found that the company violated the FCPA’s books and records and internal controls provisions because certain alleged improper expenditures were “falsely recorded as legitimate business expenses” on subsidiary books and records and the company “failed to devise and maintain sufficient accounting controls to prevent and detect” the expenditures.
Did the conduct at issue in BHP Billiton, Mead Johnson, and Goodyear involve (liked in Stein Mart and MusclePharm) a material misstatement of income or lack of controls over core financial reporting issues at the parent company?
Most certainly not.
Yet, the settlement amounts in BHP Billiton, Mead Johnson, and Goodyear far exceeded the settlement amounts in the Stein Mart and MusclePharm enforcement actions even though all of the enforcement actions alleged the exact same legal violations.
The end result is an obvious lack of consistency and transparency.
The SEC has some explaining to do and owes the legal and compliance community an explanation for why FCPA books and records and internal controls violations are not sanctioned in similar ways.
Issues To Consider From The BNY Mellon Enforcement Action
This recent post highlighted and offered initial commentary on the SEC’s FCPA enforcement action against BNY Mellon. This post continues the analysis by highlighting other issues to consider.
First Ever
FCPA practitioners would likely be hard pressed to imagine an enforcement action that includes alleged violations of the FCPA’s anti-bribery provisions and internal controls provisions, without alleged violations of the books and records provisions
There would be good reason for the struggle – it has never happened before – until earlier this week.
The BNY Mellon enforcement action is believed to be the first-ever SEC FCPA enforcement action not to include allegations or findings regarding books and records violations. A future post will explore this issue in more detail.
A Step Further Than Schering-Plough and Eli Lilly
The FCPA’s anti-bribery provisions expressly state, in pertinent part, that money, a gift, or anything of value must be given to, offered to, or promised to: (1) a foreign official; (2) a foreign political party of official or candidate for foreign political office; or (3) any person “while knowing that all or a portion of such money or thing of value will be offered, given, or promised, directly or indirectly, to any foreign official, to any foreign political party or official thereof, or to any candidate for foreign political office …”.
Regardless of the prong, as evident from the statutory text, the thing of value must ultimately be intended for a “foreign official.”
Previously in the Schering-Plough and Eli Lilly enforcement actions the SEC alleged that the companies violated the FCPA by making charitable contributions to a bona fide Polish charity dedicated to restoring historical cases. However, as alleged by the SEC, the charity was a pet project of an alleged Polish official with discretionary authority over the purchase of pharmaceuticals.
While perhaps a distinction without a difference, the charges/findings in both cases as to the above conduct were limited to the FCPA’s books and records and internal control provisions.
Even so, the enforcement theory was clear: in analyzing “anything of value” the enforcement agencies will put themselves in the shoes of the alleged “foreign official” and ask how the recipient perceived the thing of value and whether the recipient subjectively valued the thing of value.
The BNY Mellon enforcement action goes a step further than Schering-Plough and Eli Lilly by finding violations of the FCPA’s anti-bribery provisions. The key language from the SEC is the following: “The internships were valuable work experience, and the requesting officials derived significant personal value in being able to confer this benefit on their family members.” (emphasis added).
Notable Findings
Notwithstanding the SEC’s findings that the Interns did not meet BNY’s Mellon’s supposed “rigorous criteria” for hiring and were not evaluated and hired through the company’s “established internship programs,” the following SEC findings are notable.
One of the Interns (Intern C) was not paid.
As to the other two interns, the SEC’s order states: “because Interns A and B had already graduated from college” BNY paid the interns “above the normal salary scale for BNY Mellon undergraduate interns but below the scale for postgraduate interns.”
In other words, the SEC found that BNY Mellon violated the FCPA’s anti-bribery provisions, not necessarily because of the compensation offered to the Interns, but rather the SEC’s belief that the Interns should never have been interns at BNY Mellon in the first place and because of this – again in the words of the SEC – the alleged “foreign officials” “derived significant personal value in being able to confer this benefit on their family members.”
Time Line
According to BNY Mellon’s disclosures: “in January 2011, the Enforcement Division of the U.S. Securities and Exchange Commission (the “SEC Staff”) informed several financial institutions, including BNY Mellon, that it had commenced an inquiry into certain of their business practices and relationships with sovereign wealth fund clients.”
Thus, BNY Mellon was under FCPA scrutiny for approximately 4.5 years.
Issues To Consider From The Mead Johnson Enforcement Action
This recent post highlighted the SEC FCPA enforcement action against Mead Johnson Nutrition Company.
This post continues the analysis by highlighting various issues to consider from the enforcement action. In sum, the short enforcement action contains several troubling issues that should cause alarm.
Imagine
Imagine a Foreign Corrupt Practices Act enforcement action without one single meaningful factual allegation against the corporate defendant resolving the action.
You don’t have to imagine. All you have to do is read the slim administrative cease and desist order against Mead Johnson.
The action was based on alleged conduct in China engaged in by Mead Johnson Nutrition (China) Co., Ltd. There was no finding, inference or suggestion in the SEC’s order that anyone associated with Mead Johnson, the issuer resolving the enforcement action, had knowledge of, participated in, or acquiesced in the improper conduct.
Rather, the order merely states the perfuctory finding that “Mead Johnson China’s books and records were consolidated into Mead Johnson’s books and records, thereby causing Mead Johnson’s consolidated books and records to be inaccurate” together with the conclusory legal finding that “Mead Johnson failed to devise and maintain an adequate system of internal accounting controls over Mead Johnson China’s operations sufficient to prevent and detect the improper payments that occurred over a period of years.”
Invoking a Standard That Does Not Even Exist In the FCPA
Relevant to the above conclusory legal finding, the SEC’s finding that issuers must devise and maintain internal controls “sufficient to prevent and detect” improper payments does not even exist in the FCPA.
As previously highlighted in this article ( “Why You Should Be Alarmed By the ADM FCPA Enforcement Action”) and subsequently in connection with other recent SEC enforcement actions, invocation of a ‘‘failure to prevent or detect’’ internal controls standard is alarming because such a standard does not even exist in the FCPA and is inconsistent with actual legal authority. Just as important, such a standard is inconsistent with enforcement agency guidance relevant to the internal-controls provisions.
The internal-controls provisions are specifically qualified through concepts of reasonableness and good faith. This statutory standard is consistent with congressional intent in enacting the provisions. Relevant legislative history states: ”
“While management should observe every reasonable prudence in satisfying the objectives called for [in the books-and-records and internal-controls provisions], . . . management must necessarily estimate and evaluate the cost/benefit relationships to the steps to be taken in fulfillment of its responsibilities . . . . The size of the business, diversity of operations, degree of centralization of financial and operating management, amount of contact by top management with day-to-day operations, and numerous other circumstances are factors which management must consider in establishing and maintaining an internal accounting controls system.”
As highlighted here, the only judicial decision to directly address the substance of the internal-controls provisions states, in pertinent part, as follows:
“The definition of accounting controls does comprehend reasonable, but not absolute, assurances that the objectives expressed in it will be accomplished by the system. The concept of ‘‘reasonable assurances’’ contained in [the internal control provisions] recognizes that the costs of internal controls should not exceed the benefits expected to be derived. It does not appear that either the SEC or Congress, which adopted the SEC’s recommendations, intended that the statute should require that each affected issuer install a fail-safe accounting control system at all costs. It appears that Congress was fully cognizant of the cost-effective considerations which confront companies as they consider the institution of accounting controls and of the subjective elements which may lead reasonable individuals to arrive at different conclusions. Congress has demanded only that judgment be exercised in applying the standard of reasonableness.”
In addition, various courts have held—in the context of civil derivative actions in which shareholders seek to hold company directors liable for breach of fiduciary duties due to the company’s alleged FCPA violations— that just because improper conduct allegedly occurred somewhere within a corporate hierarchy does not mean that internal controls must have been deficient.
The ‘‘failure to prevent and detect’ standard is also alarming when measured against the enforcement agencies’ own guidance concerning the internal controls provisions. As highlighted here, the SEC’s most extensive guidance on the internal controls provisions states, in pertinent part, as follows:
“The accounting provisions’ principal objective is to reaching knowing or reckless conduct.”
“Inherent in this concept [of reasonableness] is a toleration of deviations from the absolute. One measure of the reasonableness of a system relates to whether the expected benefits from improving it would be significantly greater than the anticipated costs of doing so. Thousands of dollars ordinarily should not be spent conserving hundreds. Further, not every procedure which may be individually cost-justifiable need be implemented; the Act allows a range of reasonable judgments.”
“The test of a company’s internal control system is not whether occasional failings can occur. Those will happen in the most ideally managed company. But, an adequate system of internal controls means that, when such breaches do arise, they will be isolated rather than systemic, and they will be subject to a reasonable likelihood of being uncovered in a timely manner and then remedied promptly. Barring, of course, the participation or complicity of senior company officials in the deed, when discovery and correction expeditiously follow, no failing in the company’s internal accounting system would have existed. To the contrary, routine discovery and correction would evidence its effectiveness.”
Internal Controls – Which Is It?
Another trouble featuring of the Mead Johnson enforcement action is that the SEC makes contradictory findings regarding Mead Johnson’s internal controls.
On the one hand, the SEC finds:
“Mead Johnson has established internal policies to comport with the FCPA and local laws, and to prevent related illegal and unethical conduct. Mead Johnson’s internal policies include prohibitions against providing improper payments and gifts to HCPs that would influence their recommendation of Mead Johnson’s products.”[…]The use of the Distributor Allowance to improperly compensate HCPs was contrary to management’s authorization and Mead Johnson’s internal policies.”
Yet on the other hand, the SEC order contains the following conclusory legal finding:
“Mead Johnson failed to devise and maintain an adequate system of internal accounting controls over Mead Johnson China’s operations sufficient to prevent and detect the improper payments that occurred over a period of years.”
The Simplicity of But For
Numerous prior posts (see here along with embedded posts therein) have examined the simplicity of but for allegations or findings in FCPA enforcement actions (i.e. but for the alleged improper payments, the company would not have obtained or retained the alleged business at issue).
The Mead Johnson enforcement action contains such a simplistic finding as the SEC stated that Mead Johnson China “made improper payments to certain health care professionals (“HCPs”) at state-owned hospitals in China to recommend Mead Johnson’s nutrition products to, and provide information about, expectant and new mothers.” (emphasis added).
The but for inference is that without the alleged improper payments, the HCP’s would not have recommended Mead Johnson’s nutrition products.
Such a finding is fanciful.
Mead Johnson’s products (and those of other Western companies) are market leaders in China for the simple fact that “foreign infant formula became preferred by Chinese consumers after a milk scandal in 2008 in which domestic [Chinese] manufacturers mixed melamine with their infant formula products. Six infants died of severe kidney damage and an estimated 300,000 babies suffered painful kidney stones, causing Chinese customers to lose confidence in domestic [Chinese] infant formula products.” (See here and here).
Alarming Language from the SEC
As troubling as the above issues are, the most alarming aspect of the short Mead Johnson enforcement action is the seeming suggestion by the SEC that issuers have an obligation to self-report internal investigation results that do not find evidence of FCPA violations.
By way of background, the SEC’s order states that in 2011 “Mead Johnson received an allegation of possible violations of the FCPA in connection with the Distributor Allowance in China. In response, Mead Johnson conducted an internal investigation, but failed to find evidence that Distributor Allowance funds were being used to make improper payments to HCPs. Thereafter, Mead Johnson China discontinued Distributor Allowance funding to reduce the likelihood of improper payments to HCPs, and discontinued all practices related to compensating HCPs by 2013.” (Emphasis Added).
Even though the SEC noted that Mead Johnson’s internal investigation failed to find evidence of FCPA violations, the SEC’s order next states: “Mead Johnson did not initially self-report the 2011 allegation of potential FCPA violations and did not thereafter promptly disclose the existence of this allegation in response to the Commission’s inquiry into this matter.” Subsequently, the SEC’s order similarly states: “Despite not self-reporting the 2011 allegation of potential FCPA violations or promptly disclosing the existence of this allegation in response to the Commission’s inquiry into this matter, Mead Johnson subsequently provided extensive and thorough cooperation.”
Perhaps it was merely inartful language, but if the SEC’s position is that issuers have an obligation to self-report internal investigation results that do not find evidence of FCPA violations, then such a position is truly alarming and without any legal support.
Timeline
Contrary to this report, Mead Johnson did not first disclose its FCPA scrutiny “early last year” but rather in October 2013 (see this prior post).
Nevertheless, the time between public disclosure and the enforcement action was less than two years, an unusually speedy resolution given that the norm in FCPA inquiries is often 2-4 years with several examples in the 5-7 year range.
The SEC Frequently Alleges Or Finds Only Books And Records And Internal Controls Violations In FCPA Enforcement Actions
This recent post highlighted critical commentary regarding the recent BHP Billiton enforcement action.
One theme from much of the commentary was that the BHP action was somehow unique in charging (or finding as the case may be since it was an SEC administrative action) books and records and internal controls violations in the absence of anti-bribery violations.
More broadly, some FCPA commentators have suggested (here and here) that the SEC is placing a new emphasis on internal controls in the absence of anti-bribery violations.
However, the enforcement approach in BHP Billiton was hardly unique and more broadly the SEC has long charged or found books and records and internal controls violation in the absence of anti-bribery violations or findings.
Set forth below are numerous instances over the past five years in which the SEC has alleged or found only books and records and internal controls violations in Foreign Corrupt Practices Act enforcement actions. (All actions can be found on the SEC’s FCPA website).
2014
Avon
Bruker
HP
In other words 3 of 7 (43%) corporate SEC FCPA enforcement actions in 2014 did not allege or find anti-bribery violations.
2013
ADM
Stryker
Philips Electronics
In other words, 3 of 8 (38%) corporate SEC FCPA enforcement actions did not allege or find anti-bribery violations.
2012
Allianz
Oracle
Pfizer
Orthofix
In other words, 4 of 8 (50%) corporate SEC FCPA enforcement actions did not allege of find anti-bribery violations.
2011
Aon
Watts Water
Diageo
Comverse
Rockwell Automation
Ball Corp
IBM
Tenaris
In other words 8 of 13 (62%) corporate SEC FCPA enforcement actions did not allege or find anti-bribery violations.
2010
Natco
Veraz Networks
General Electric
In other words, 3 of 19 (16%) corporate SEC FCPA enforcement actions did not allege or find anti-bribery violations. (Note 2010 enforcement statistics are impacted by the 7 related Panalpina enforcement actions. If one counts these related actions as one, 3 of 12 (25%) corporate SEC FCPA enforcement actions did not allege or find anti-bribery violations).
So prominent is SEC FCPA enforcement actions without anti-bribery violations or findings that the term non-bribery charged disgorgement has been part of the FCPA vocabulary for years. (See here).