Top Menu

Navigation

RAE Systems Held Liable For The Acts Of Its Subsidiaries’ Joint Venture Partners

By on December 13, 2010 in 2010 Enforcement Actions, Anything of Value, China, DOJ Enforcement Action, FCPA Investigative Costs, Foreign Official, Internal Controls, Joint Venture, Non-Prosecution Agreement, RAE Systems, SEC Enforcement Action, Security Industry, Voluntary Disclosure

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.

Smith & Wesson’s Recent Disclosures

By on July 2, 2010 in Africa Sting, Amaro Goncalves, Books and Records, Debarment, FCPA Investigative Costs, Internal Controls, Smith and Wesson

In January, Amaro Goncalves was one of the individuals indicted in the Africa Sting case.

Goncalves is described in the indictment as “the Vice President of Sales for Company A, a United States company headquartered in Springfield, Massachusetts. Company A was a world-wide leader in the design and manufacture of firearms, firearm safety/security products, rifles, firearms systems, and accessories. The shares of Company A were publicly traded on the NASDAQ stock exchange.”

Company A is Smith & Wesson, a fact quickly acknowledged by the company in this press release.

I noted in January:

“At present, this case only involves individuals.

However, as indicated by Assistant Attorney General Breuer in yesterday’s DOJ release (here) the investigation is “ongoing” and you can bet that many of the companies which employ these individuals are “lawyering up” as past FCPA enforcement actions demonstrate that corporate enforcement actions or investigations often, but not always, precede or follow individual enforcement actions.”

Indeed, the companies indirectly implicated in the Africa Sting by their employees alleged conduct did “lawyer up.”

Because Smith & Wesson is a public company, the public is provided a better glimpse of how the Africa Sting case is affecting this company compared to the many other companies indirectly implicated – many of which are small, private businesses.

On June 30th, Smith & Wesson reported its Fourth Quarter and Full Year 2010 Financial Results Ended April 30, 2010 (see here). The company release contains this paragraph:

“Operating expenses of $89.1 million, or 21.9% of sales, for fiscal 2010 decreased versus operating expenses of $170.5 million, or 50.9% of sales, for fiscal 2009. Excluding the impact of the impairment charge recorded in the second quarter of fiscal 2009 and $9.7 million of operating expense at USR not contained in prior year results, operating expenses increased $7.1 million for the current fiscal year. This increase included $3.2 million in legal and consulting fees related to allegations against one of our employees under the Foreign Corrupt Practices Act (FCPA).”

If nothing more, Amaro Goncalves is probably not on the short-list for employee of the month because of his alleged conduct.

Yesterday, Smith & Wesson filed its annual report (see here). The report contained the following:

“Foreign Corrupt Practices Act (FCPA)

On January 19, 2010, the U.S. Department of Justice (“DOJ”) unsealed indictments of 22 individuals from the law enforcement and military equipment industries, one of whom was our Vice President−Sales, International & U.S. Law Enforcement. We were not charged in the indictment. We also were served with a Grand Jury subpoena for the production of documents. We have always taken, and continue to take seriously, our obligation as an industry leader to foster a responsible and ethical culture, which includes adherence to laws and industry regulations in the United States and abroad. Although we are cooperating fully with the DOJ in this matter and have undertaken a comprehensive review of company policies and procedures, the DOJ may determine that we have violated FCPA laws. We cannot predict when this investigation will be completed or its outcome. There could be additional indictments of our company, our officers, or our employees. If the DOJ determines that we violated FCPA laws, or if our employee is convicted of FCPA violations, we may face sanctions, including significant civil and criminal penalties. In addition, we could be prevented from bidding on domestic military and government contracts, and could risk debarment by the U.S. Department of State. We also face increased legal expenses and could see an increase in the cost of doing international business. We could also see private civil litigation arising as a result of the outcome of the investigation. In addition, responding to the investigation may divert the time and attention of our management from normal business operations. Regardless of the outcome of the investigation, the publicity surrounding the investigation and the potential risks associated with the investigation could negatively impact the perception of our company by investors, customers, and others.

SEC Investigation

Subsequent to the end of fiscal 2010, we received a letter from the staff of the SEC giving notice that the SEC is conducting a non−public, fact−finding inquiry to determine whether there have been any violations of the federal securities laws. It appears this civil inquiry was triggered in part by the DOJ investigation into potential FCPA violations. We have always taken, and continue to take seriously, our obligation as an industry leader to foster a responsible and ethical culture, which includes adherence to laws and industry regulations in the United States and abroad. Although we are cooperating fully with the SEC in this matter, the SEC may determine that we have violated federal securities laws. We cannot predict when this inquiry will be completed or its outcome. If the SEC determines that we have violated federal securities laws, we may face injunctive relief, disgorgement of ill−gotten gains, and sanctions, including fines and penalties, or may be forced to take corrective actions that could increase our costs or otherwise adversely affect our business, results of operations, and liquidity. We also face increased legal expenses and could see an increase in the cost of doing business. We could also see private civil litigation arising as a result of the outcome of this inquiry. In addition, responding to the inquiry may divert the time and attention of our management from normal business operations. Regardless of the outcome of the inquiry, the publicity surrounding the inquiry and the potential risks associated with the inquiry could negatively impact the perception of our company by investors, customers, and others.”

Smith & Wesson’s disclosure is hardly surprising. Anytime a company’s employee is criminally indicted for an FCPA violation, it is reasonable to assume that the DOJ will wonder “who knew what and when” and will seek to discover whether the employee’s alleged conduct is isolated or evidence of broader, more systemic conduct. When that employee is the “Vice President−Sales, International & U.S. Law Enforcement” it is virtually guaranteed that the DOJ will ask such questions.

It is unlikely that Smith & Wesson is the only company implicated in the Africa Sting case under investigation. However, as stated above, because Smith & Wesson is a public company, the public is provided a better glimpse of how the Africa Sting case is affecting this company compared to the many other companies implicated – many of which are small, private businesses. These companies are “domestic concerns” and thus subject to the FCPA, it’s just that FCPA inquiries of non-public companies generate less attention that FCPA inquiries of public companies.

Nor is it surprising that Smith & Wesson disclosed the existence of an SEC investigation.

I noted in January:

“Given that one of the individuals indicted is employed by a public-company issuer, the SEC may also be interested in that company from, at the very least, an FCPA books and records and internal control perspective.”

Even if Smith & Wesson is never charged with violating the FCPA’s antibribery provisions, it is likely that the company could face some exposure under the FCPA’s books and records and internal control provisions.

The SEC’s analysis would likely be as follows.

Goncalves, if the alleged conduct is true, no doubt, while a Smith & Wesson employee, made entries on the company’s books and records that did not accurately or fairly represent the transactions at issue. That, in and of itself, would be an FCPA books and records violation. Further, the SEC will take the position that if Smith & Wesson had effective internal controls, Goncalves could not have engaged in the conduct he is alleged to have engaged in. If he did, this in and of itself, is evidence that Smith & Wesson lacked effective internal controls.

A bit simplistic, yes. But this is perhaps how the Smith & Wesson inquiry will play out.

A final point.

Smith & Wesson is a supplier to numerous government customers and military installations. Under guidelines issued by the Office of Management and Budget, a person or firm found in violation of the FCPA may be barred from doing business with the Federal government. Add this issue to the list of issues to follow as the Smith & Wesson FCPA inquiry escalates. However, this sanction (to my knowledge) has never been used against an FCPA violator.

If the SEC Was An Issuer …

By on November 29, 2009 in Books and Records, Internal Controls, SEC

The FCPA’s books and records and internal control provisions require issuers (i.e. publicly-traded companies) to: (i) “make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer;” and (ii) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that (among other things) transactions are executed in accordance with management’s general or specific authorization, transactions are recorded as necessary to maintain accountability of assets, and access to assets is permitted only in accordance with management’s general or specific authorization.

The SEC enforces these provisions against issuers.

Often times, the SEC enforces these provisions against issuers aggressively (see here and here).

It seems to not matter to SEC enforcement officials whether the improper recording in the company’s books or records occurred at a far flung, fifth-tier subsidiary by a rogue employee or whether the issuer actually had knowledge that a far flung subsidiary was engaged in improper conduct.

The SEC’s position is that if the far-flung subsidiary’s financial results are consolidated with the parent company issuer’s financial results for purpose of financial reporting, then the subsidiary’s violation is the issuer’s violation.

Further, it seems to not matter to SEC enforcement officials whether the violation resulted from a rogue employee acting contrary to clearly articulated and well communicated company policies and procedures prohibiting the improper conduct because, after all, if the company’s internal controls were effective, rogue employees would not exist or, if they do exist, proper controls would be put in place to monitor their behavior before it occurred.

Every so often, it is fun to spend a few moments in “hypothetical land.”

The issue in “hypothetical land” today is – if the SEC was an issuer.

If the SEC was an issuer, it would have some serious FCPA books and records and internal control issues to deal with as a result of the Government Accountability Office’s (“GAO’s”) recent “Financial Audit – Securities and Exchange Commission’s Financial Statements for Fiscal Years 2009 and 2008” (see here).

As detailed in the audit, the GAO “identified six significant deficiencies that collectively represent a material weakness in SEC’s internal control over financial reporting.” In short, the GAO concluded that “SEC’s internal control over financial reporting was not effective as of September 30, 2009.”

Most notably, the GAO found material weaknesses that have: (i) “resulted in unsupported entries and errors in the general ledger”; (ii) “ineffective financial reporting controls and general ledger system reporting limitations”; and (iii) “ineffective processes and related documentation concerning budgetary transactions.” (p. 5).

Among other specifics, in terms of the general ledger system and the supporting processes the SEC uses to prepare its financial statements, the GAO found that:

“unauthorized personnel can view, manipulate, or destroy data” (p. 64);

SEC controls to compensate for the general ledger limitations “are cumbersome and largely detective nature, increasing the risk that errors or fraud that could result in a misstatement to the financial statements would not be prevented” (p. 65);

in connection with deposit account activity, the SEC’s processes are “labor-intensive” and that “it does not have dedicated resources assigned to address this issue” (p. 69); and

“obligations […] were not always recorded timely and were not always supported by documentation evidencing the obligation as having been approved by an authorized individual” (p. 70).

Under the FCPA, not only is it important for issuers to have effective internal controls, but issuers must also monitor those internal controls to make sure that they are effective.

The GAO was critical of the SEC on this score as well.

The report notes:

“We also identified weaknesses in SEC’s monitoring process which indicate a lack of effective oversight of controls. Management’s monitoring of controls should include whether the controls are operating as intended and include an assessing of the design and operation of controls on a timely basis and taking necessary corrective actions. As discussed previously, we found that SEC’s monitoring procedures did not address all identified risks. Further, SEC’s management oversight was not sufficient given the frequency and sensitivity of the control activity, and monitoring procedures were not always completed in accordance with SEC’s stated testing plan.” (p. 71-72).

According to the GAO – “[b]ecause of inherent limitations, [the SEC’s] internal control[s] may not prevent or detect and correct misstatements due to error or fraud, losses, or noncompliance.” (p. 8).

Because of the above identified deficiencies, if the SEC was an issuer – would: (i) the SEC’s main DC office be strictly liable for branch office deficiencies; (ii) the SEC disgorge all of its “profits” connected (no matter how remotely) to the improper recording or the deficient internal controls; and (iii) would high-level SEC officials be accountable under “control person” theories for the books and records and internal control violations?

As readers of this blog know, all of the above “theories” are straight from recent SEC enforcement actions against issuers.

So next time an FCPA practitioner and his/her corporate client representative are seated across the table from an SEC enforcement official who asks, “how could this payment have not been recorded properly in subsidiary X’s books and records, how could the issuer not put in place effective internal controls, how could those controls not be monitored and assessed, etc. etc.” the most candid response just might be “I don’t know, you tell me – such issues happen at the SEC as well.”

One more thing, when enforcing the FCPA’s books and records and internal control provisions against issuers, the SEC insists on remedial measures and wants to see evidence of those remedial measures being put into place “yesterday.” An issuer comment, such as “this takes time,” would likely fall on deaf ears.

Yet, here is what SEC Chairman Mary Schapiro had to say about the GAO report and its findings of various deficiencies: “some deficiencies are likely to be resolved during the first half of FY 2010, while others – which have been the result of long-term and growing constraints affecting our information technology and human resources – will take longer to fully resolve.” (p. 29). This statement was also repeated by Kristine Chadwick, SEC CFO and Associate Executive Director (p. 33).

Alas, time to come back to reality, the SEC is not an issuer, but a couple minutes in “hypothetical land” does provide some useful perspectives as to the SEC’s enforcement of the FCPA’s books and records and internal control provisions.

“We Don’t Want The Auditors Raising Any Questions on Iraq Business”

By on October 1, 2009 in AGCO Corporation, Agriculture Industry, Deferred Prosecution Agreements, DOJ Enforcement Action, Internal Controls, Iraq, Oil for Food Enforcement Action, SEC Enforcement Action

Yet another Iraqi Oil-For-Food enforcement action.

Yesterday, the DOJ and SEC announced resolution of an enforcement action against AGCO Corp. (a Georgia-based manufacturer and supplier of agricultural machinery and equipment) as well as AGCO Limited (AGCO’s a wholly-owned subsidiary headquartered in the United Kingdom responsible for AGCO’s business in Europe, Africa, and the Middle East)(see here, here, here, here, and here).

Big picture, AGCO acknowledged responsibility for improper payments made by its subsidiaries and agents to the former government of Iraq in order to obtain contracts with the Iraqi Ministry of Agriculture under the United Nations Oil-For-Food program.

DOJ filed a criminal information against AGCO Limited charging one count of conspiracy to commit wire fraud and to violate the FCPA’s books and records provisions.

According to the DOJ, AGCO Limited paid approximately $550,000 to the former government of Iraq to secure three contracts. DOJ and AGCO entered into a three-year deferred prosecution agreement under which DOJ will defer prosecution upon, among other things, AGCO’s payment of a $1.6 million penalty. According to the DOJ, the basis for the deferred prosecution agreement was, among other things, AGCO’s cooperation in the DOJ’s investigation, its implementation of remedial measures, and its settlement with the SEC (see below).

Why no substantive FCPA anti-bribery charges in this case and other Iraqi Oil-For-Food cases (Novo Nordisk, Fiat, AB Volvo, etc.)? The anti-bribery provisions apply to payments to “foreign officials,” not foreign governments. Thus, in this and the other cases, conspiracy to commit wire fraud and to violate the FCPA books and records provisions were charged.

Because AGCO is an issuer, the SEC also played a role in the enforcement action. The SEC filed a settled civil complaint charging AGCO with violating the FCPA’s books and records and internal control provisions.

According to the SEC, certain AGCO subsidiaries made – through a Jordanian agent – approximately $5.9 million in kickback payments to Iraq in the form of “after-sales service fees” to secure contracts worth approximately $14 million. These payments were disguised or improperly recorded in the subsidiaries’ books and records which were consolidated with AGCO’s for SEC filing purposes. According to the SEC, “AGCO knew or was reckless in not knowing that kickbacks were paid in connection with its subsidiaries’ transactions.”

The SEC ordered AGCO to pay $18.3 million in combined disgorgement, interest, and penalties.

In a previous post (see here), it was noted that FCPA compliance is a task that not just company lawyers need to be concerned with, but rather a task that internal audit and finance should also be concerned with and actively involved in as well. It was noted that internal audit and finance personnel must be specifically trained to approach their specific job functions with “FCPA goggles” on.

Reading the SEC complaint against AGCO, it is clear that various AGCO personnel could have used a pair of “FCPA goggles” as the complaint is an indictment of the entire company’s control function.

In para 23, the SEC charges, among other things, that:

the “accrual account [where the kickback payments were recorded] was created by AGCO Ltd.’s marketing staff with virtually no oversight from AGCO Ltd.s’ finance department;”

“no one questioned the existence of the dual accounts;”

“no one questioned why the [accrual account] contained approximately ten percent of the contract value despite the fact that there was no contract in place requiring that such ten percent be paid to the ministry or anyone else;”

“when the finance department authorized payments from the [accrual account], it did not ask for or receive any proof of service to warrant the payments;” and

an employee cautioned the business manager for Iraq and his supervisor that “we don’t want the auditors raising any questions on Iraq Business!”

Further, in para 25, the SEC charges, among other things, that:

“Sales and marketing personnel were able to enter into contracts without review from the legal or finance departments;”

“an accounting employee described the Finance Department employees as ‘blind loaders’ who input information into AGCO’s books without any adequate oversight role;” and

“marketing personnel were able to create accrual accounts […] without any oversight and caused accounts to be created and payments to be made without proper documentation.”

In para. 26, the SEC charges, among other things, that:

“AGCO Ltd.’s structure at the time allocated inappropriate accounting and finance responsibilities to the marketing department;” and

“turnover in the marketing department […] was high and employees were forced to shoulder a great deal of the accounting burden.”

AGCO’s management and legal department did not fare much better.

In para. 27, the SEC charges, among other things, that:

“AGCO did not conduct any due diligence on the [Jordanian] agent or require that the agent undergo FCPA training;” and

the “agent’s contract with AGCO did not accurately explain the agent’s services and payments, and lacked any FCPA language.”

What would the results look like if your company or your client’s company was “put under the internal controls microscope” in an FCPA enforcement action?

Books and Records and Internal Controls Compliance … The Importance of FCPA Goggles

By on September 21, 2009 in Books and Records, Compliance, Internal Controls, York

A reader recently commented that most companies know “what to do” when it comes to FCPA anti-bribery compliance training, but that when it comes to FCPA books and records and internal controls compliance training most people “scratch their heads.”

Below, I offer some thoughts on books and records and internal controls compliance training, but by no means does this cover the entire landscape.

I think the reader is correct in that most companies do in fact focus compliance efforts (if they have pro-active compliance efforts – see here) on the FCPA’s anti-bribery provisions. The FCPA’s other prong – the books and records and internal control provisions are usually mentioned (if at all) in passing.

An explanation for why likely has to do with the statute itself.

The anti-bribery provisions have specific elements tied to things we can all generally understand such as – things of value, foreign official, and obtain or retain business – and companies can easily tailor compliance training to those elements, or it is probably more accurate to say, DOJ and SEC’s interpretations of those elements.

In contrast, the FCPA’s book and records and internal control provisions are rather generic and have key terms such as “reasonable detail,” “accurately and fairly,” “sufficient,” “reasonable assurances, and “general or specific authorization.”

Tailoring compliance training to such general concepts can be difficult. Moreover, the books and records, and internal control provisions apply to issuers in ALL instances, not just those instances in which the company is doing business or seeking business abroad. Thus, it may be more difficult to frame books and records and internal control issues to training, because the provisions apply to everything an issuer does.

Against this backdrop, what works best I think is to view FCPA compliance as not just a task that company lawyers and selected key positions from an anti-bribery perspective (i.e. sales, marketing, business development) need to be concerned with, but rather a task that internal audit and finance should also be concerned with and actively involved in as well.

This means that internal audit and finance personnel must be specifically trained to approach their specific job functions not only in a traditional way, but also with “FCPA goggles” on.

It is clear from recent FCPA enforcement actions that the SEC expects much more from non-legal personnel when it comes to FCPA compliance, including the ability to spot FCPA issues and display a high degree of (I’ll call it) intellectual curiosity as to certain issues.

For instance, in the 2007 York matter, the SEC alleged in its civil complaint (see here at para 51) that (i) “York International’s management had the ability to review or cause internal audit to review [the problematic contracts] and, had this been done, it would have been immediately apparant that the consultancy agreements were a sham; and (ii) it was “clear that local finance personnel did not provide an independent internal control function, but rather acquiesced in questionable practices and documentation without critical review.”

Again, because the FCPA’s books and records and internal control provisions are rather generic, I think a “best practice” (not only for issuers, but for any company) is to specifically train internal audit and finance personnel to view their job with “FCPA goggles” on.

This means that internal audit and finance personnel should:

(1) Understand the broad interpretations given to the anything of value, foreign official, and obtain or retain business elements of anti-bribery violation so that they clearly understand that conduct other than a “suitcase full of cash to a government official to get a government contract” is problematic. For instance,
excessive travel and marketing expenses, payment of scholarships, etc. can be things of value. Internal audit and finance personnel also need to understand that employees of state-owned or state-controlled companies are considered “foreign officials” by DOJ/SEC (even if that interpretation has not been tested or challenged). This means that things a company does to “wine and dine” its purely private customers can become problematic when state-owned or state-controlled customers receive the same treatment. In terms of state-owned or state-controlled customers, it is also a good idea for a company to maintain a roster of such entities so that heightened review will be triggered when any corporate personnel deals with such customers or prospective customers. Internal audit and finance personnel also need to understand that payments which result in a company securing a foreign license, permit, or certification can satisfy the “obtain or retain business” element of an anti-bribery violation on the theory that such payments help the company, in the general sense, obtain or retain business.

(2) Pay particular attention to employee reimbursement requests and think about FCPA issues in connection with these requests. For instance, if a specific sales and marketing employee is the designated “wine and dine” person, is there any heightened scrutiny of that individuals reimbursement requests?

(3) Be aware of the FCPA’s third-party payment provisions and be able to spot (and follow-up on) the following issues relevant to engaging and supervising a foreign agent or representative: payments made to personal (rather than company) bank accounts; payments to off-shore bank accounts; payments which could be made in one lump sum but are split up to avoid detection; and payments made to an account in a country different than where the service provider is located. When utilizing third parties, commission payments are obviously a big FCPA risk. Thus, internal audit and finance personnel need to ask what steps the company has taken to assure itself that the commission payments are reasonable. Moreover, such personnel should specifically look for evidence that the third party actually provided legitimate value-added services before payment was made by the company.

(4) Figure out who within the company, the relevant business unit, etc. has the authority to authorize large payments and make sure those authorizations are scrutinized. Because of title, prestige and in some countries – gender – certain individuals are subjected to less oversight and scrutiny when it comes to authorizing payments. If any such trends or patterns emerge within a company as to this issue, internal audit and finance personnel must be diligent in understanding why.

(5)Pay particular attention to the following accounts (all of which, per recent FCPA enforcement actions, were used to conceal improper payments) – “additional assessments,” “extra costs,” “extraordinary expenses,” “urgent processing,” “urgent dispatch,” “customs processing,” “importation advances,” . These accounts, and all other accounts described in a vague or ambiguous manner, should be subject to heightened scrutiny by internal audit and finance personnel.

Back to the original issue raised by the reader as to how best to offer FCPA books and records, and internal controls compliance training. Again, because the books and records and internal control provisions are so generic, I think the “best practice” is to couple such training with anti-bribery training and to make sure that internal audit and finance personnel have the FCPA tools necessary to properly execute their jobs.

Internal audit and finance personnel clearly have an FCPA compliance role to play, and the SEC is clearly expecting them to play that role. However, internal audit and finance personnel can only raise FCPA issues if they first know what FCPA issues to look for. Providing internal audit and finance personnel with a good pair of “FCPA goggles” is a good way to achieve books and records, and internal controls compliance.

Powered by WordPress. Designed by WooThemes