What happens when a Japanese company has a German-based subsidiary, which in turn has a South African subsidiary, that both allegedly make improper payments to a South African political party?

Why of course, $19 million to the U.S. treasury because the Japanese company just happened to have American Depositary Shares traded in the U.S.

In the latest Foreign Corrupt Practices Act enforcement action against a foreign company, yesterday the SEC announced an enforcement action against Tokyo-based Hitachi, Ltd.  for violating the FCPA “when it inaccurately recorded improper payments to South Africa’s ruling political party in connection with contracts to build two multi-billion dollar power plants.”

As alleged in this settled SEC civil complaint:

“In 2005, Hitachi created a subsidiary in South Africa for the purpose of establishing a local presence in that country to pursue lucrative public and private contracts, including government contracts to build two new major power stations.

Hitachi sold 25% of the stock in the newly created subsidiary to Chancellor House Holdings (Pty) Ltd. (“Chancellor”), a local South African company that was a front for the African National Congress (“ANC”), South Africa’s ruling political party. Hitachi’s arrangement gave Chancellor- and by proxy the ANC- the ability to share in the profits from any power station contracts secured by Hitachi. Hitachi also entered into an undisclosed “success fee” arrangement with Chancellor, wherein Chancellor would be entitled to “success fees” in the event that the contract awards were “substantially as a result” of Chancellor’s efforts.

During the bidding process, Hitachi was aware that Chancellor was a funding vehicle for the ANC. Hitachi nevertheless continued to partner with Chancellor and encourage Chancellor’s use of its political influence to help obtain the government contracts.

As a result, Hitachi was awarded power station contracts in South Africa worth approximately $5.6 billion. In April and July 2008, Hitachi paid the ANC- through Chancellor- “success fees” totaling approximately $1 million.

Hitachi’s South African subsidiary inaccurately recorded its “success fee” payments to Chancellor as “consulting fees” in its books and records for the year ended December 31, 2008. The inaccurate books and records of Hitachi’s subsidiary were consolidated into Hitachi’s financial statements for the fiscal year ended March 31, 2009, which were filed with the Commission.

In 2010, Hitachi’s South African subsidiary also inaccurately recorded a dividend worth over a million dollars to be paid to Chancellor, its 25% shareholder. The journal entry recorded this dividend as “Dividends Declared” in the subsidiary’s books and records for the year ended December 31, 2010. The books and records did not reflect that the dividend was, in fact, an amount due for payment to a foreign political party in exchange for its political influence in assisting Hitachi land two government contracts. The subsidiary’s inaccurate books and records were consolidated into Hitachi’s financial statements for the fiscal year ended March 31, 2011, which were filed with the Commission.”

Based on the above allegations, the SEC charged Hitachi with violating the FCPA’s books and records and internal controls provisions.

The conduct at issue focused on:

• Hitachi Power Europe GmbH (“HPE”), during the relevant time period a wholly-owned subsidiary of Hitachi based in Germany, that was an international supplier of boilers for power stations; and
• Hitachi Power Africa (Pty) Ltd. (“HPA”), during the relevant time period, a majority-owned subsidiary of HPE based in South Africa, that executed power station orders in South Africa.

The SEC’s complaint alleges as follows regarding Chancellor House:

“Chancellor House Holdings (Pty) Ltd. is a South African investment finn created by the ANC as a funding vehicle. Chancellor was named after a building in downtown Johatmesburg that in the 1950s housed the law finn of Nelson Mandela and Oliver Tambo, two future ANC presidents. From 2005 to at least 2008, Chancellor’s parent organization, Chancellor House Trust, was administered by a member of the ANC National Executive Committee and a director of Eskom Enterprises, an Eskom subsidiary.”

Eskom is described as follows.

“Eskom Holdings SOC Ltd. (“Eskom”) is a government-owned and government-run public utility established by the Government of South Africa. Eskom supplies approximately 95% of all electricity in South Africa and the Government of South Africa is Eskom’s sole shareholder. Thus, Eskom is an instrumentality of a foreign government. From 2006 to at least 2008, Eskom’s chainnan simultaneously served as a member of the ANC’s National Executive Committee.”

According to the SEC:

“While its political com1ections were extensive, Chancellor lacked any engineering or operational capabilities that could assist Hitachi with contract perfotmance should it secure the Eskom contracts. Chancellor differed in this respect from at least one other local South African entity that Hitachi initially considered for partnership with HPA.

Hitachi was fully aware of Chancellor’s operational shortcomings, and sought a partnership with Chancellor precisely because Chancellor would not provide it operational support. From an internal profile of Chancellor prepared in 2005, HPE’s senior management was advised that Chancellor “has a lean HQ staff and it does not get involved in the operational business of the companies in which it invests. Supp0rt for invested companies is provided via networking at board level.” The internal profile also specifically highlighted Chancellor’s “good connections within Eskom.”

The SEC further alleged:

“[I]n total, Chancellor – the ANC’s funding vehicle – received approximately $10.5 million from Hitachi, a return of over 5,000% on its investment in HPA.”

As to internal controls, the SEC specifically alleged:

“During the time it was registered with the Commission, Hitachi failed to devise and maintain an adequate system of internal accounting controls. HPE and HPA were able to enter into a shareholders’ agreement and an undisclosed “success fee” arrangement with Chancellor- a front for the ANC- to pay that entity for exerting its political influence. Although HPE had a code of conduct in place before the success fees were paid that specifically prohibited contributions to political parties, HPA paid Chancellor more than $1.1 million pursuant to this side-arrangement. HPA was able to do so despite a stream of reporting in the South African media that publicized the fact that HPA’s 25% shareholder was a funding vehicle for the ANC.

HPA also was able to record Chancellor’s invoices for success fee payments as “consulting” expenses, which they were not, without proper documentation or reasonable detail. Hitachi’s intemal accounting controls failed again when Hitachi declared and recorded as dividends to be paid to Chancellor transactions that, in fact, would instead be payments to a foreign political party for its assistance in securing govemment contracts. Among other further intemal accounting controls deficiencies, Hitachi failed to conduct adequate due diligence of Chancellor, a potential agent and a potential shareholder of HPA, and to keep records of such due diligence, even though Hitachi intended for Chancellor to use its political influence to help obtain government contracts.

Hitachi’s intemal accounting controls, or lack thereof, also were inadequate to provide reasonable assurances that Hitachi would not violate its own codes of conduct and compliance policies, the FCPA, or South African law. For example, Hitachi failed to adequately supervise and ensure compliance with its policies and procedures, and neither HPE nor HP A conducted any FCPA-specific compliance training during the time period in which Hitachi through HPE and HPA- was seeking lucrative contracts with an instrumentality of a foreign government and authorizing the payments of”success fees” to a foreign political party.”

As noted in the SEC’s release, without admitting or denying the SEC’s allegations, Hitachi agreed to settlement that requires it to pay a $19 million penalty and to be enjoined from future FCPA books and records and internal controls violations.

Hitachi was represented by Linda Chatman Thomsen (a former SEC Director of Enforcement, currently at Davis Polk & Wardwell).