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.
Friday Roundup
It has been a few weeks since my last Friday Roundup.
As a result this is a souped-up edition.
Is paying an FCPA fine merely a cost of business, are FCPA internal investigations getting just a bit out-of-hand, have you heard that a new cottage industry of FCPA experts has emerged, quit picking on Canada, will Julian Messent (or others) be prosecuted for FCPA violations, Assistant Attorney General Breuer on the Kleptocracy Asset Recovery Initiative, Proclamation 7750 news, and a son who wants to keep the New York condo … it’s all here in the Friday roundup.
Is Paying an FCPA Fine Merely a Cost of Business?
One may wonder, and legitimately so, whether getting caught for violating the FCPA is simply a cost of doing business whereby the company pays a fine and then continues to do business, including with, in many cases, the U.S. government. See here for my post on Siemens – The Year After, here for my post on BAE’s recent $40 million contract with the FBI (note because of the facade of FCPA enforcement, BAE was not charged with violating the FCPA – see here).
Denis McInerney, Chief of the DOJ’s Fraud Section, rejected such an assertion during an October 21st speech before the American Bar Association.
According to Inside U.S. Trade, McInerney “sought to rebut charges that FCPA enforcement relies too heavily on settlement agreements and that it is therefore like a licensing regime under which ‘companies are allowed to bribe, but if caught they have to pay a fee.'” According to Inside U.S. Trade, McInerney said that in the past two years, DOJ has imposed fines of $59 million, $19 million, $365 million, $338 million, $400 million, $376 million, $579 million and $800 million and he “emphasized that the companies paying these penalties are subject to monitoring which can lead to criminal prosecution if new offenses occur.” According to Inside U.S. Trade, McInerney said “I guarantee you that these firms do not view these are mere licensing fees.”
Is This Getting a Bit Out of Hand?
Avon previously disclosed the existence of an internal investigation focused on potential FCPA issues (see here for the prior post).
Here is what the company said in its 10-Q filing (here) yesterday:
“As previously reported, we have engaged outside counsel to conduct an internal investigation and compliance reviews focused on compliance with the Foreign Corrupt Practices Act (“FCPA”) and related U.S. and foreign laws in China and additional countries. The internal investigation, which is being conducted under the oversight of our Audit Committee, began in June 2008. As we reported in October 2008, we voluntarily contacted the United States Securities and Exchange Commission and the United States Department of Justice to advise both agencies of our internal investigation. We are continuing to cooperate with both agencies and inquiries by them, including but not limited to, signing tolling agreements, translating and producing documents and assisting with interviews.
As previously reported in July 2009, in connection with the internal investigation, we commenced compliance reviews regarding the FCPA and related U.S. and foreign laws in additional countries in order to evaluate our compliance efforts. We are conducting these compliance reviews in a number of other countries selected to represent each of the Company’s four other international geographic segments. The internal investigation and compliance reviews are focused on reviewing certain expenses and books and records processes, including, but not limited to, travel, entertainment, gifts, and payments to third−party agents and others, in connection with our business dealings, directly or indirectly, with foreign governments and their employees. The internal investigation and compliance reviews of these matters are ongoing, and we continue to cooperate with both agencies with respect to these matters. At this point we are unable to predict the duration, scope, developments in, results of, or consequences of the internal investigation and compliance reviews.”
Here is what Avon had to say in the fling about its net global expenses:
“The increase in Net Global expenses for both the three and nine months ended September 30, 2010, was primarily attributable to significant professional and related fees associated with the FCPA investigation and compliance reviews described in Note 5 to the consolidated financial statements included herein of approximately $24 (up approximately $17 from the three months ended September 30, 2009) and approximately $72 (up approximately $49 from the nine months ended September 30, 2009), respectively. The increase in Net Global expenses for the nine months ended September 30, 2010 was also due to higher costs associated with global initiatives and costs associated with business acquisitions. Professional and related fees associated with the FCPA investigation and compliance reviews, while difficult to predict, are expected to continue during the course of this investigation.”
Those figures are not mere dollars, but millions of dollars. And, as noted in the disclosure, the expenses are expected to increase.
On a much smaller (yet still meaningful) scale, on August 31st, Orthofix disclosed (here) the existence of an internal investigation relating to FCPA issues focused on its Mexican subsidiaries, an entity that accounts “for approximately one percent of the Company’s consolidated net sales and consolidated total assets.”
Recently, Orthofix provided this update in an 8-K filing (here):
“Operating income in the third quarter of 2010 included the impact of $3.7 million in legal expenses associated with the DOJ investigation of the bone growth stimulation industry and the Company’s internal investigation into its compliance with the Foreign Corrupt Practices Act in its subsidiary in Mexico.”
Newsweek Notices FCPA Inc.
Newsweek recently carried a short blurb (here) titled “Going After Graft.” Among other things, the piece states:
“With prosecutions likely to continue—the FBI has doubled the number of agents tasked to FCPA cases—business is responding in kind. Law firms are competing for top FCPA talent, banks financing international deals are insisting on anti-bribery stipulations in contracts, and a new cottage industry of experts has emerged, offering country-by-country advice on gifts and local laws. In the words of an FBI spokesperson, FCPA are ‘four letters you need to be aware of if you’re doing business in the international marketplace.'”
Quit Picking On Canada
What if, in the U.S., there was no fallback FCPA books and records and internal control charges, there was no voluntary disclosure culture, there were no “overzealous prosecutions,” and there were no prosecutions undertaken as “publicity stunts.”
According to Cyndee Todgham Cherniak (here), FCPA enforcement would likely resemble the sparse enforcement of Canada’s Corruption of Foreign Public Officials Act.
At least that is my take-away from her recent post (here) on the Trade Lawyers Blog.
For more on Canada’s Corruption of Foreign Public Officials Act (see here and here).
Will Julian Messent (Or Others) Be Prosecuted For FCPA Violations?
Earlier this week, the U.K. Serious Fraud Office (SFO) announced (here) that Julian Messent was sentenced to 21 months in prison “after admitting making or authorizing corrupt payments of almost US $2 million to Costan Rican officials in the state insurance company, Instituto Nacional de Seguros (INS) and the national electricity provider Instituto Costarricense de Electricidad.”
Messent, a former director of London-based insurance business PWS International Ltd. (PWS), was the head of the Property (Americas) Divison at PWS in which role “he was responsible for securing and maintaining contracts for reinsurance in the Central and South America regions.”
According to the SFO release, “Messent authorized 41 corrupt payments” “to be paid to Costa Rican officials, their wives and associated companies, as inducements or rewards for assisting in the appointment or retention of PWS as broker of the lucrative reinsurance policy for INS.”
The SFO release also indicates that Messent was ordered to pay £100,000 in compensation to the Republic of Costa Rica. (In the U.S., FCPA fines flow solely into the U.S. Treasury).
Messent was charged under the U.K.’s Prevention of Corruption Act 1906 (see here).
According to this report in the Guardian, “the SFO decided not to prosecute PWS because the firm, which has been sold, had a substantial deficit in its pension fund.”
According to the Guardian, “the covert payments were routed through bank accounts in the names of the wives of the Costa Rican officials and through accounts in Panama and the US, and a travel agency in Florida.”
Under the 78dd-3 prong of the Foreign Corrupt Practices Act, persons other than an issuer or domestic concern (i.e. in this case foreign nationals) can be subject to the FCPA if the improper payments have a U.S. nexus.
Will FCPA prosecutions of Messent (and perhaps others) follow?
Breuer on the Kleptocracy Asset Recovery Initiative
As highlighted in this prior post, in November 2009, Attorney General Eric Holder called asset recovery from corrupt officials a “global imperative” and he announced a “redoubled commitment on behalf of the United States Department of Justice to recover” funds obtained by foreign officials through bribery.
In July 2010, Holder announced (here) the Kleptocracy Asset Recovery Initiative “aimed at combating large-scale foreign official corruption and recovering public funds for their intended – and proper – use: for the people of our nations.” Holder announced that the DOJ is “assembling a team of prosecutors who will focus exclusively on this work and build upon efforts already underway to deter corruption, hold offenders accountable, and protect public resources.”
In a recent keynote address at the Money Laundering Enforcement Conference (here), Assistant Attoney General Lanny Breuer had this to say about the initaitive:
“This Initiative represents a concrete step toward fulfilling that commitment. The Kleptocracy Initiative will involve three key sections in the Criminal Division: the Asset Forfeiture and Money Laundering Section, which will lead it, and the Office of International Affairs and the Fraud Section, which will provide critical support. Once fully implemented, this Initiative will allow the Department to recover assets on behalf of countries victimized by high-level corruption, building on the Justice Department’s already robust enforcement of the Foreign Corrupt Practices Act. Through the Kleptocracy Initiative, the Department will ensure that corrupt leaders cannot seek safe haven in the United States for their stolen wealth. And, if we uncover such wealth, the Justice Department will forfeit and return this stolen money to its rightful owners – the people and governments from whom it was taken.”
In his speech, Breuer also discussed (in a non-FCPA context) how the DOJ wants “companies that uncover illegal conduct to come forward voluntarily.”
Proclamation 7750 News
In 2004, President Bush signed Proclamation 7750 “To Suspend Entry As Immigrants or Nonimmigrants of Persons Engaged In or Benefiting From Corruption” (see here).
Proclamation 7750 basically says the U.S. can suspend entry into the country “of certain persons who have committed, participated in, or are beneficiaries of corruption in the performance of public functions where that corruption has serious adverse effects on international activity” subject to an exception where denying such entry would be “contrary to the interests” of the U.S.
Last year, the New York Times (here) ran an article quoting a former State Department official as saying the State Department(which is responsible for enforcing the proclamation) “seem[s] to lack the backbone to use this prohibition.”
Earlier this month, David Johnson (Assistant Secretary, Bureau International Narcotics and Law Enforcement Affairs, U.S. Department of State) stated at the Third Committee of the 65th Session of the UN General Assembly (see here) as follows:
“The United States continues to broaden its efforts to deny entry into our own country of public officials who receive bribes as well as those who supply them. Corrupt officials are not welcome in the United States.”
Joe Palazzolo (Wall Street Journal – Corruption Currents) followed up with Johnson and noted in a recent article that the “State Department is stepping up its game” in seeking to enforce Proclamation 7750. As Palazzolo reports, it is not hard to “step up the game” when “for a long time, one part-official […] handled 7750 matters.”
Palazzolo reports that the State Department recently hired two new employees and is “processing paperwork for two additional hires, who will focus the majority of their time on 7750 issues.” The article quotes a State Department official as saying, “it is our hope and intention that the new hires will result in greater capacity.”
Son Fights to Keep New York Condo
This prior post discussed the DOJ’s civil forfeiture complaint filed in July against certain U.S. properties “that represent a portion of illegal bribes paid to the former president of Taiwan and his wife.”
Joe Palazzolo (Wall Street Journal – Corruption Currents) recently reported that “the son of former Taiwanese President Chen Shui-bian has quietly hired legal counsel to prevent a Manhattan condominium, which prosecutors say was purchased with bribes, from falling into the hands of the government.”
According to Palazzolo, the son, Chen Chih-chung, has retained Jonathan Harris (see here) to defend against the forfeiture action and Harris is quoted as saying he will be filing a motion to dismiss “shortly.”
*****
A good weekend to all.
Friday Roundup
The former DOJ top cop speaks, Senator Feingold joins the debarment discussion, anything is possible, and a House Resolution focused on BP … it’s all here in the Friday roundup.
Mendelsohn Interview
During the period of the FCPA’s resurgence, Mark Mendelsohn was the public face and voice on FCPA issues at the Department of Justice. In April, he announced his departure and now maintains an FCPA private practice at Paul Weiss. (See here and here for more).
See here for Mendeloshn’s recent interview with The Metropolitan Corporate Counsel as he reflects back on his DOJ tenure and other issues.
Senator Feingold Joins The Debarment Discussion
Earlier this week Senator Russ Feingold (D-WI) testified before the Senate Judiciary Subcommittee on Administrative Oversight and the Courts (see here). The hearing was on the topic of “Protecting the Public Interest: Understanding the Threat of Agency Capture.” He began his testimony by stating that a better job needs to be done to ensure that there are no significant conflicts of interest or other inappropriate ties between regulators and the corporations they purport to regulate.”
He then stated:
“I want to raise a concern that a new, more subtle type of agency capture is beginning to emerge as a result of our increasing reliance on government contractors. The Council of the Inspectors General on Integrity and Efficiency recently reported that the total number of suspensions and debarments in FY 2008 was half the total from five years ago, and that suspensions and debarments had been steadily decreasing over the last five years. This is a disturbing statistic, especially when you consider that the number of contract fraud, Foreign Corrupt Practices Act, and other corruption investigations involving contractors is on the rise.”
For more on debarment issues, including an FCPA debarment bill pending in the House see here and here and here.
Is It Possible?
Is it possible to spend $3.2 million on “professional costs” associated with an internal investigation “limited in size and scope” to a branch office that represents approximately one-half of one percent of the company’s annual consolidated revenues?
Apparently it is.
In January I ran this post about Team Inc. and its voluntary disclosure of less than $50,000 in potentially improper payments in its Trinidad branch.
Earlier this week, when disclosing its financial results, the company stated as follows:
“The results of the FCPA investigation were communicated to the SEC and Department of Justice in May 2010 and the Company is awaiting their response. The results of the independent investigation support management’s belief that any possible violations of the FCPA were limited in size and scope. The total professional costs associated with the investigation were approximately $3.2 million.” (emphasis added).
Exhibit A for how even isolated instances of improper conduct under the FCPA in a branch office can be very expensive or Exhibit A for just how out of whack professional costs associated with an FCPA internal investigation and disclosure have become?
It’s your conclusion to make.
BP House Resolution
This recent post discussed Senator Charles Schumer’s (D-NY) request that the Department of Justice investigate BP for FCPA violations.
On July 30, House Resolution 1597 was introduced. Sponsored by Representative Daniel Maffei (D-NY) and co-sponsored by Representatives Christopher Lee (R-NY) and Michael McMahon (D-NY) the resolution (see here) encourages the United Kingdom to “investigate British Petroleum (BP) for foreign corrupt practices.”
The reason?
The same as offered by Senator Schumer – that BP attempted to influence the August 2009 release of Abdel Baset al-Megrahi, the Libyan terrorist convicted of the 1988 bombing of Pan-Am flight 103 that killed 270 people, including 189 Americans.
The resolution states, in part:
“Whereas the Scottish courts released al-Megrahi from prison on August 20, 2009, under the understanding that he was suffering from terminal prostate cancer;
Whereas the Scottish authorities have never clarified why al-Megrahi could not receive humane treatment while still in captivity;
Whereas al-Megrahi seems to have well outlived his original diagnosis;
Whereas it is very troubling that al-Megrahi received a hero’s welcome to his home country of Libya;
Whereas British Petroleum (BP) admitted on July 15, 2010, that a delayed prisoner-transfer between Britain and Libya ‘could have a negative impact’ on BP’s oil negotiations;
Whereas there are allegations that BP inappropriately attempted to affect the Scottish Government’s decision and possibly even the doctor’s diagnosis; and
Whereas al-Megrahi’s release sends an incredibly offensive message to the families that lost loved ones on Pan Am Flight 103: Now, therefore, be it
Resolved, That the House of Representatives encourages the United Kingdom to investigate British Petroleum (BP) for foreign corrupt practices.”
As I asked in my original post – following Schumer’s (and now Maffei’s) lead will a British politician request that the U.K. Serious Fraud Office or the U.S. government investigate a U.S. company because it lobbied its own government officials in connection with a business purpose?
*****
A good weekend to all.
Digi’s Disappearing Act … And A Proposal
SEC filings are carefully crafted, tightly worded documents created by in-house specialists and often vetted by outside professionals. In short, precise words matter in SEC filings.
In a July 22nd 8-K filing (here), Digi International Inc. provided an update on its previously disclosed FCPA internal investigation including this statement: “[t]he investigation also identified certain books and records and related internal controls issues under the FCPA.” (emphasis added).
Given the above wording, it would seem reasonable to conclude that the company (with the assistance and input from outside counsel) identified conduct that implicated the FCPA. Why else would the disclosure contain the clause “under the FCPA”?
Fast forward to August 2nd when the company issued a press release (here) stating, in reference to the July 22nd 8-K and the investigation, that: “Digi has now received confirmation through discussions with representatives of the DOJ and the SEC that they will not be initiating any enforcement proceedings against Digi.”
That’s quite the disappearing act. And a quick one at that.
As noted in a prior post (here) Digi is “the leading supplier of multifunction communication devices to the U.S. Federal Government.”
FCPA enforcement (or lack of enforcement in this case) is already largely an opaque process and Digi’s curious disappearing act serves as another example for why transparency and accountability in FCPA enforcement is needed.
So here is my proposal to shed more light on the DOJ and SEC’s enforcement of the FCPA.
In instances such as Digi (i.e. when a company voluntarily discloses an FCPA internal investigation to the DOJ and the SEC and when the DOJ and the SEC decline enforcement) require the DOJ and the SEC to publicly state, in a thorough and transparent manner, the facts the company disclosed to the agencies and why the agencies declined enforcement on those facts.
Here is why I think the proposal makes sense and is in the public interest.
For starters, the DOJ and the SEC are already wildly enthusiastic when it comes to talking about FCPA issues. Enforcement attorneys from both agencies are frequent participants on the FCPA conference circuit and there seems to be no other single law that is the focus of more DOJ or SEC speeches than the FCPA. Thus, there is clearly enthusiasm and ambition at both agencies when it comes to the FCPA.
Further, both the DOJ and the SEC have the resources to accomplish this task. Both agencies have touted the increased FCPA resources in their respective offices and the new personnel hired to focus on the FCPA. Combine enthusiasm and ambition with sufficient resources and personnel and the proposal certainly seems doable.
Most important, the DOJ is already used to this type of exercise. It is called the FCPA Opinion Procedure Release (see here) a process the DOJ frequently urges those subject to the FCPA to utilize.
Under the Opinion Procedure regulations, an issuer or domestic concern subject to the FCPA can voluntarily disclose prospective business conduct to the DOJ which then has 30 days to respond to the request by issuing an opinion that states whether the prospective conduct would, for purposes of the DOJ’s present enforcement policy, violate the FCPA.
The DOJ’s opinions are publicly released (see here for the most recent one) and the FCPA bar and the rest of FCPA Inc. study these opinions in great detail in advising clients largely because of the general lack of substantive FCPA case law.
If the DOJ is able to issue an enforcement opinion as to voluntarily disclosed prospective conduct there seems to be no principled reason why the enforcement agencies could not issue a non-enforcement opinion as to voluntarily disclosed actual conduct
Such agency opinions would seem to be more valuable to those subject to the FCPA than the already useful FCPA Opinion Procedure Releases. If the enforcement agencies are sincere about providing guidance on the FCPA, as they presumably are, such agency opinions would seem to provide an ideal platform to accomplish such a purpose.
Requiring the enforcement agencies to disclose non-enforcement decisions after a voluntary disclosure could also inject some much needed discipline into the voluntary disclosure decision itself – a decision which seems to be reflexive in many instances any time facts suggest the FCPA may be implicated.
(For more on the important voluntary disclosure decision and the role of FCPA counsel see here.)
Notwithstanding the presence of significant conflicting incentives to do otherwise, it is hoped that FCPA counsel advises clients to disclose only if a reasonably certain legal conclusion has been reached that the conduct at issue actually violates the FCPA. Accepting this assumption, transparency in FCPA enforcement would be enhanced if the public learned why the enforcement agencies, in the face of a voluntary disclosure, presumably disagreed with the company’s conclusion as informed by FCPA counsel. If the enforcement agencies agreed with the conclusion that the FCPA was violated, but decided not to bring an enforcement action, transparency in FCPA enforcement would similarly be enhanced if the public learned why.
A final reason in support of the proposal is that it would give companies such as Digi a benefit by contributing to the mix of public information about the FCPA.
In most cases, companies spend millions of dollars investigating conduct that may implicate the FCPA and on the voluntary disclosure process. When the enforcement agencies decline an enforcement action, presumably because the FCPA was not violated, these costs are forever sunk and the company can legitimately ask why it just spent millions investigating and disclosing conduct that the DOJ and the SEC did not conclude violated the FCPA.
However, if the enforcement agencies were required to publicly justify their declination decision, the company would achieve, however small, a return on its investment and contribute to the mix of public information about the FCPA – a law which the company will remain subject to long after its voluntary disclosure and long after the enforcement agencies declination decision. Thus, the company, the company’s industry peers, and indeed all those subject to the FCPA would benefit by learning more about the DOJ and the SEC’s enforcement conclusions.
Transparency, accountability, useful guidance, a return on investment.
All would be accomplished by requiring the enforcement agencies to publicly justify a declination decision in the limited instances where no enforcement action follows a voluntary disclosure.
The FCPA’s Long Tentacles
There are numerous reasons to comply with the Foreign Corrupt Practices Act.
One reason is that mere existence of an FCPA inquiry can significantly throw a wrench into a company’s ability to sell itself. Another reason is that mere existence of an FCPA inquiry can cause an analyst to downgrade a company’s stock.
Both are discussed in this post starting with a real-world case study.
The case study involves Allied Defense Group, Inc. (here).
It turns out that Smith & Wesson (see here) is not the only publicly traded company affected by the Africa Sting case (see here for prior posts).
Also affected is ADG – a “multinational defense business focused on the manufacture and sale of ammunition and ammunition related products for use by the U.S. and foreign governments.” According to its website, ADG has “has two operating units in the Weapons & Ammunition industry: Mecar, S.A. and Mecar USA.”
On January 19, 2010, ADG agreed to be acquired by Chemring Group PLC (see here). See here for the release.
January 19, 2010 turned out to be an eventful day at ADG because on that same day, the company received a subpoena from the DOJ requesting that it produce documents relating to its dealings with foreign governments. ADG learned that the subpoena was related to an employee of Mecar USA being indicted in the Africa Sting case. The employee (reportedly Mark Frederick Morales) was terminated the next day and ADG stated that Mecar USA transacted business, either directly or indirectly, with six individuals indicted in the Africa Sting case.
In a June 2010 press release (see here), ADG stated as follows:
“The DOJ recently advised ADG that it is conducting an industry-wide review, and therefore the DOJ’s investigation of ADG will be ongoing. As a result, Chemring indicated that it was unwilling to consummate the merger pursuant to the terms of the merger agreement.”
Cherming Group noted (see here) that because of the DOJ’s expanded review “it could not complete the acquisition of ADG pursuant to the Merger Agreement.”
Instead, Cherming “entered into a new conditional agreement with ADG to acquire ADG’s two principal operating businesses – Mecar S.A., based in Nivelles, Belgium and Mecar US, based in Marshall, Texas (collectively “Mecar”). Pursuant to this new agreement, Chemring agreed to acquire the entire issued share capital of Mecar S.A. and the business and assets of Mecar US for a total cash consideration of $59 million.
Fast forward to last week.
ADG filed its definitive proxy statement regarding the merger.
In pertinent part it stated as follows:
“ADG’s audit committee, with the assistance of independent outside counsel, is conducting an internal review of the matters raised by the DOJ’s subpoena and the related indictment of Mecar USA’s former employee. ADG has been cooperating with the DOJ and is working to comply with the DOJ’s subpoena. ADG has also been providing regular updates to Chemring on the progress of the internal review and has been responding to Chemring’s requests for additional information.”
“As a result of the DOJ subpoena, the special meeting of stockholders to adopt the Merger Agreement with Chemring, originally scheduled for April 8, 2010, was postponed twice and then adjourned several times, most recently to June 30, 2010. As discussed below, our board of directors determined that these postponements and adjournments were desirable, for among other reasons, to continue ADG’s internal review, to respond to requests from Chemring for additional information and, with respect to the later adjournments, to provide additional time for ADG and Chemring to discuss restructuring Chemring’s acquisition of ADG.”
Restructuring did indeed occur.
As stated in the proxy materials:
“After Chemring indicated it would not complete the originally contemplated merger pursuant to the Merger Agreement, we entered into the Sale Agreement to restructure the acquisition as a purchase of our assets in order to address Chemring’s concerns about the uncertainties arising out of the DOJ subpoena. This revised transaction structure allows us to complete the sale of our operating assets to Chemring while retaining liabilities and expenses associated with the DOJ subpoena.”
[Note – in an asset sale an acquirer ordinarily does not acquire the selling entity’s liabilities, in a stock sale or merger the acquirer ordinarily does]
“Our board of directors’ original decision to enter into the Merger Agreement, and its subsequent decision to restructure the acquisition as the proposed Asset Sale, were the result of a decision-making process that evaluated ADG’s strategic alternatives, including its prospects of continuing as a stand-alone company, and that followed a market test process with the assistance of our financial advisor.”
The proxy materials then state:
“Our board of directors recommends that you vote FOR the authorization of the Asset Sale.”
The special meeting of shareholders is currently scheduled for August 31, 2010.
The ADG – Chemring saga is an interesting case study of the FCPA’s long tentacles.
It is particularly relevant given the recent General Electric settlement of a SEC FCPA enforcement action for $23.4 million. As noted in this prior post, GE’s exposure was primarily based on the conduct of two entities GE acquired after the conduct at issue occurred. Yet, as the SEC alleged, GE acquired the liabilities of these entities, along with assets, in the acquisition and that GE is the successor to the liability of these entities.
ADG – Chemring is not the only deal in which the FCPA is an issue.
For another real-world example look no further than The PBSJ Corporation – WS Atkins merger.
Remember PBSJ?
In January, the company disclosed the existence of an internal investigation to “determine whether any laws, including the Foreign Corrupt Practices Act (“FCPA”), may have been violated in connection with certain projects undertaken by PBS&J International, Inc., one of our subsidiaries with revenue of $4.3 million in fiscal year 2008 and $3.9 million in fiscal year 2009, in certain foreign countries.” (See here).
In its May 10-Q filing (see here) PBSJ stated that the “udit Committee completed the internal investigation in May 2010. The results of that investigation suggest that FCPA violations may have occurred.”
According to this recent filing, the company has spent $7 million on the FCPA investigation … that’s nearly twice the FY 2009 revenue of the relevant subsidiary!
Yesterday, PBSJ announced (see here) “that it has entered into a definitive merger agreement by which WS Atkins plc, [headquartered in the United Kingdom] the world’s 11th largest design firm, will acquire PBSJ in an all-cash transaction for $17.137 per share of PBSJ.”
The merger agreement (see here) states that PBSJ “has fully disclosed to [WS Atkins] all information that would be material to a purchaser’s assessment of the FCPA Investigation or that has been prepared or gathered in connection with the FCPA Investigation that could reasonably be expected to have a Company Material Adverse Effect.” The agreement further states that the parties “agree that neither the existence of the FCPA Investigation nor any particular development in the FCPA Investigation shall, in and of itself, constitute a Company Material Adverse Effect, but any significant effect, event, development or change relating to the FCPA Investigation may be considered in determining whether there has been a Company Material Adverse Effect.”
One more example of the FCPA’s long tentacles?
Analysts may downgrade a company because of FCPA issues.
That is exactly what Cowen & Co. recently did with Raytheon Company.
Among the reasons for the downgrade to neutral from outperform was the FCPA.
In a report authored by Cai von Rumohr, Gautam Khanna, and Mark Hokanson the authors state:
“Since second-quarter 2009, Raytheon has conducted ‘a self-initiated review’ of FCPA issues with ‘possible areas of concern’ regarding ‘a jurisdiction where we do business.’ It’s unclear when the review might end or if it’s related to early retirement of D. Smith, president of IDS when Raytheon signed the $3.3 billion UAE Patriot order. FCPA issues are a risk given: (1) increased Department of Justice priority; (2) rising size of FCPA fines (top four year-to-date average equals $300 million-plus); (3) noncompliance is fined even with voluntary disclosure and strict ethics programs; and (4) whistleblower provision in Financial Reform Law.”
The company’s most recent 10-Q filing (see here) states as follows:
“We are currently conducting a self-initiated internal review of certain of our international operations, focusing on compliance with the Foreign Corrupt Practices Act. In the course of the review, we have identified several possible areas of concern relating to payments made in connection with certain international operations related to a jurisdiction where we do business. We have voluntarily contacted the SEC and the Department of Justice to advise both agencies that an internal review is underway. Because the internal review is ongoing, we cannot predict the ultimate consequences of the review. Based on the information available to date, we do not believe that the results of this review will have a material adverse effect on our financial position, results of operations or liquidity.”
Raytheon “is a technology and innovation leader specializing in defense, homeland security and other government markets throughout the world.” The company is one of the largest defense contractors to the U.S. government and the majority of its revenue comes from U.S. government contracts.