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The Former CFO Of RAE Systems Speaks

How often have you heard the former Chief Financial Officer of a company that recently resolved a Foreign Corrupt Practices Act enforcement action speak on camera regarding his experience and that of the company?

The answer is probably never.

That is what makes this recent video of Randall Gausman, the former CFO of RAE System, interesting and instructive.  If I were a corporate board member, I would make it required viewing for the CFO to best demonstrate how FCPA scrutiny can be burdensome and distracting to the company.

First, a bit of background.

As discussed in this prior post, in December 2010 RAE System (a San-Jose, California publicly-traded company and “a leading global provider of rapidly deployable connected, intelligent gas detection systems” resolved parallel DOJ and SEC FCPA enforcement actions.  The conduct at issue concerned “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.  In connection with the SEC enforcement action, the then 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.”

Back to the video which was recorded by the Markkula Center for Applied Ethics at Santa Clara University (here).

In the video, Gausman speaks of discovery of the problem giving rise to the enforcement action and the company’s internal investigation and voluntary disclosure.  Gausman also tells how the company’s FCPA scrutiny came to derail his other jobs duties and, at approximately six minutes of the video, Gausman describes a falling out with the company’s CEO that raises a host of questions.

Of note, Gausman also explains how the company’s pre-enforcement action professional fees and expenses (approximately $4.2 million) exceeded the combined fine and penalty amount ($2.95 million) it paid to resolve the enforcement action.  This has become common when a company is the subject of FCPA scrutiny.

[The above video, as well as several others, are included on the FCPA Profesor YouTube channel – here]

Customer Reward Programs

At this moment, it is likely that some company operating in China has a customer rewards program whereby customers are awarded points based on the level of purchases.

At this moment, it is likely that some person employed by an entity with some level of state-ownership or control just received an iPad or camera because the individual redeemed points under the program based on the purchase the individual previously authorized.

The SEC is concerned about the customer rewards program and whether it complies with the FCPA and the company is spending hundreds of dollars an hour investigating the program so that it can present its conclusions to the SEC and the DOJ.

Your first response upon reading the above paragraph might be – are you serious or is this paragraph from the Onion (see here), a satire news organization that parodies just about everything.

Nothing make believe about the first paragraph, it is derived from RAE Systems May 12th proxy statement filed with the SEC.

In the filing (here), RAE Systems stated as follows.

“In the course of telephonic discussions between April 15 and 19, 2011, outside counsel for [RAE] was asked by the SEC whether RAE China had adopted a sales program whereby customers are awarded points based on the level of their purchases of RAE products and are then eligible to redeem those points at year-end for gifts such as iPads or cameras, and whether such a program complies with the Foreign Corrupt Practices Act (“FCPA”). We do not believe that any RAE China personnel have been engaging in such a practice. We are conducting a review in response to the SEC’s inquiry, and intend to provide our conclusions to the SEC and Department of Justice.”

In December 2010, RAE Systems resolved a DOJ/SEC enforcement action concerning the acts of its subsidiaries’ joint venture partners in China. See here for the prior post. RAE Systems agreed to pay approximately $2.95million in fines and disgorgement and agreed to a three-year DOJ non-prosecution agreement (here).


The clock is now ticking to see who will publish (presumably) the first client alert or host the first webinar on “The FCPA Compliance Risks of Customer Rewards Programs.”

In the meantime, there is likely a “foreign official” somewhere with his eye on the six piece stoneware gourmet mixing bowl set (here) available for 2000 points under Coke’s rewards program.


Interested in reading more about the Harris Corporation enforcement action? As highlighted earlier this week (see here) the recent Lindsey Manufacturing case was not the first instance of a company putting the DOJ to its burden of proof in an FCPA trial. Harris Corporation (and certain of its executives) did just that and prevailed in an FCPA trial. As described in the post, U.S. District Judge Charles A. Legge (N.D. Cal.) directed a verdict of acquittal after the DOJ’s case.

Michael H. Huneke (Hughes Hubbard & Reed – see here) was kind to send the Defendants’ motion for acquittal, the DOJ’s response, and the transcript of oral arguments and Judge Legge’s ruling.

If old FCPA enforcement actions are your thing – here you go! If others have interesting FCPA enforcement documents from … say 1978 – 1995 – send them my way.

A good weekend to all.

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.


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.”


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.

The Pipeline

It’s been a slow last few months in FCPA enforcement land.

Excluding individual pleas or enforcement actions, the last FCPA enforcement action against a corporation (non-Iraqi Oil for Food) was way back in July against Control Components, Inc. (see here).

We keep hearing about those 100+ FCPA investigations in the pipeline, so let’s take a look at a few of those cases. In fact, its been a very active week on the FCPA disclosure front as the following companies’ SEC filings evidence: RAE Systems, Inc.; Global Crossing Limited; Maxwell Technologies, Inc; and Innospec Inc.

Set forth below are the relevant disclosures.

All sorts of stuff in these disclosures which evidence that no industry is immune from FCPA scrutiny and no one country is FCPA risk free.

The companies involved are in the following industries: (i) a developer and manufacturer of rapidly deployable chemical and radiation detection monitors and multi-sensor networks; (ii) telecommunications solutions; (iii) energy storage and power delivery solutions; and (iv) specialty chemicals.

The conduct at issue took place in the following countries: China, Latin American countries, and Iraq.

The conduct at issue involved/arose because of M&A activity and use of foreign sales agents.

And for good measure one disclosure references a “tag-along” investigation in the U.K.

RAE Systems, Inc. (see here)

“The company is actively engaged in discussions with the Department of Justice and the Securities and Exchange Commission to settle the outstanding joint investigation into the company’s alleged violations of the Foreign Corrupt Practices Act (FCPA). Although no assurances can be given as to whether the matter will settle or the amount of any settlement, the company booked an accrual of $3.5 million in the third quarter 2009 relating to this potential settlement.”


“During the quarter, to ensure our long-term success, we furthered initiatives to run the company more efficiently, particularly in China,” said Robert Chen, president and CEO of RAE Systems. “Globally, we are prioritizing cost management, business controls and cash generation. For the nine months ended September 30, 2009, we increased our cash balance by $1.3 million to $16.2 million. In China, we installed a new management team; instituted mandatory, ongoing, FCPA compliance training; and began consolidating certain operations.”

Global Crossing Limited (see here p. 24, 40)

“We are subject to the Foreign Corrupt Practices Act (“FCPA”), which generally prohibits companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or keeping business and/or other benefits. Although we have policies and procedures designed to ensure that the Company, its employees and agents comply with the FCPA, there is no assurance that such policies or procedures will work effectively all of the time or protect us against liability under the FCPA for actions taken by our agents, employees and intermediaries with respect to our business or any businesses that we acquire. We operate in a number of jurisdictions that pose a high risk of potential FCPA violations. In May 2007, we acquired Impsat, which was also subject to the FCPA prior to the acquisition. As described in “Additional Information Regarding Impsat” in Item 4 below, the facts developed in our review of certain payments made by Impsat employees to government officials and foreign government proceedings concerning Impsat personnel show that: first, although Impsat had policies in place prior to the May 9, 2007 acquisition relating to FCPA compliance and contracting with third-party agents, those policies were not implemented; second, Impsat’s documentation relating to third-party agents and certain government contracts was not sufficient; and third, the corporate environment at Impsat did not reflect a sufficient focus by senior management on promotion of, and compliance by the Company with, these policies. We conducted a review of certain agents, government contracts, and potential unauthorized payments in Latin American countries. That review is now substantially complete. We have also brought these matters to the attention of government authorities in the U.S, including the Securities and Exchange Commission, which has commenced a preliminary inquiry into the matter. We are cooperating with that inquiry which may result in legal action. At this point we are unable to predict the duration, scope or result of that inquiry. Failure to comply with the FCPA and other laws governing the conduct of business with government entities (including local laws) could lead to criminal and civil penalties and other remedial measures (including further changes or enhancements to our procedures, policies, and controls and potential personnel changes and/or disciplinary actions), any of which could have an adverse impact on our business, financial condition, results of operations and liquidity. Any investigation of any potential violations of the FCPA or other anti-corruption laws by U.S. or foreign authorities could have an adverse impact on our business, financial condition and results of operations. Furthermore, any remediation measures we take in response to such potential or alleged violations by Impsat or other acquired businesses of the FCPA or other anti-corruption laws, including any necessary changes or enhancements to our procedures, policies, and controls and potential personnel changes and/or disciplinary actions, may adversely impact our business, financial condition and results of operations.” (see additional information on pg. 39 of the filing).

Maxwell Technologies, Inc. (see here)

“As reported previously, the company is conducting an internal review of payments made to an independent sales agent in China in connection with sales of high voltage capacitor products produced by Maxwell’s Swiss subsidiary. The company believes that the amount of the payments was immaterial in all periods involved. However, because the company’s international operations make it subject to the U.S. Foreign Corrupt Practices Act (FCPA), management is conducting further review to determine how these payments should be treated for FCPA purposes. The internal review has not been completed, and the company is voluntarily sharing information related to the review with the Securities and Exchange Commission and Department of Justice and has provided documents as requested by the SEC in connection with its review of this matter.”

Innospec Inc. (see here)

“On February 7, 2006, the Securities and Exchange Commission (“SEC”) notified the Company that it had commenced an investigation to determine whether any violations of law had occurred in connection with certain transactions conducted by or involving the Company, including those conducted by its wholly owned indirect Swiss subsidiary, Alcor Chemie Vertriebs GmbH (“Alcor”), under the United Nations Oil for Food Program (“OFFP”) between June 1, 1999 and December 31, 2003. As part of its investigation, the SEC issued a subpoena requiring the production of certain documents, including documents relating to these transactions, by the Company and Alcor. Upon receipt of the SEC’s notification and initial subpoena, the Company undertook a review of its participation in the OFFP.

On October 10, 2007 and November 1, 2007, the SEC served two additional subpoenas on the Company. These additional subpoenas required the production of documents relating both to the OFFP, and also to transactions conducted by the Company or its subsidiaries with state owned or state controlled entities between June 1, 1999 and the date of such subpoenas, concerning the use of foreign agents and the possibility of extra-contractual payments to secure business with foreign governmental entities in the context of the U.S. Foreign Corrupt Practices Act (“FCPA”) and other laws. In a coordinated investigation, the Company was also notified by the U.S. Department of Justice (“DOJ”) regarding the possibility of violations by the Company or its subsidiaries arising under other laws stemming from matters covered by the SEC investigation as well as certain preliminary inquiries regarding compliance with anti-trust laws applicable to the U.S. and international tetra ethyl lead markets. The subjects into which the SEC and DOJ have inquired include areas that concern certain former and current executives of the Company, including our former CEO, who resigned on March 20, 2009. The Company, and its officers and directors are cooperating with the SEC and DOJ investigations.

On February 19, 2008, the Board of Directors of the Company formed a committee comprised of the chairmen of the Board, the Audit Committee and the Nominating and Governance Committee, all of whom were independent directors. (The chairman of the Nominating and Governance Committee retired as a director of the Company effective May 6, 2008, but his services were retained in an independent capacity as a member of the committee until October 1, 2009 when he resigned. Mr. Haubold did not resign as a result of any dispute or disagreement with the Company or the committee). External counsel to the Company, reporting to the committee has, on behalf of the committee, conducted and will continue to conduct an investigation into the circumstances giving rise to the SEC and DOJ investigations. External counsel reports directly to the committee and assists in connection with communications and interactions with the SEC and DOJ.

On March 5, 2008, a letter was received by the Company from the DOJ in which a request for a wider and more detailed range of documents was made. A further letter was received from the DOJ on June 13, 2009 which contained requests for information made by the U.S. Office of Foreign Assets Control (“OFAC”). In addition to the voluntary disclosure made in relation to the Bycosin disposal OFAC is inquiring into business the Company may have conducted in countries in respect of which there are U.S. laws and regulations that restrict trade.

On July 31, 2009, the DOJ issued a press release in which it disclosed the arrest of an individual and the unsealing of an August 7, 2008 indictment in the U.S. District Court for the District of Columbia against the individual for certain FCPA violations relating to his alleged participation in an eight-year conspiracy to defraud the OFFP and to bribe Iraqi government officials on behalf of a publicly traded U.S. chemical company in connection with the sale of a chemical additive used in the refining of leaded fuel. This individual is the Company’s former agent for Iraq and certain other markets and the Company understands the indictment to relate to the matters that are the subject of the OFFP and related FCPA investigations of the Company.

Separately, on May 21, 2008, the United Kingdom’s Serious Fraud Office (“SFO”) notified Innospec Limited, a wholly owned subsidiary of the Company, that it had commenced an investigation into certain contracts involving British companies under the OFFP. As part of this investigation, the SFO has asked the Company to produce documents in respect of the Company’s participation in the OFFP between January 1, 1996 and December 31, 2003. Following receipt of the SFO’s notice the Company has instructed external legal counsel to advise and assist in relation to the investigation and the Company and its directors and officers intend to cooperate with the SFO. On October 16, 2008, the Company was further notified that the scope of the SFO’s investigation would extend to matters relating to potential bribery involving overseas commercial agents that are already in the large part the subject of the ongoing DOJ and SEC investigations. This investigation by the SFO similarly includes areas that concern certain former and current executives of the Company.

The Company and its officers and directors intend to continue to cooperate with the SEC, DOJ and SFO.

The outcome of these investigations remains uncertain to the Company. Discussions with the SEC, DOJ and SFO are ongoing in an effort to resolve these investigations, but whether agreement can be reached, and on what terms, is uncertain. On the facts available to us we are currently unable to determine the amount, if any, of probable disgorgement, penalties and/or fines that we may be subject to. The amount of any disgorgements, penalties and/or fines that the Company could face depends on a number of eventual factors which are not currently known to the Company or have not yet been resolved with the relevant government authorities, including findings by relevant authorities regarding the amount, nature and scope of any improper payments, the amount of any pecuniary gain involved, the Company’s ability to pay, and the level of cooperation provided to government authorities during the investigations. For accounting purposes, based on a potential settlement range of $18.3 million to $63.4 million in connection with the ongoing discussions with government authorities, we have recorded in the third quarter of 2009 an $18.3 million accrual for potential global settlement of these investigations as required under U.S. GAAP.”

The former agent referenced in Innospec’s disclosure is presumably Ousama Naaman (see here).

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