Yesterday the DOJ and SEC announced (see here and here) a parallel Foreign Corrupt Practices Act enforcement action against medical device manufacturer Analogic Corp. and BK Medical ApS (Analogic’s Danish subsidiary) in which the entities agreed to pay approximately $14.9 million.
The conduct at issue involved alleged improper payments by BK Medical, primarily in Russia through distributors, and the government alleged that BK Medical took various steps to conceal its conduct from Analogic.
The enforcement action involved a DOJ non-prosecution agreement with BK Medical in which the company agreed to pay a $3.4 million criminal penalty and an SEC administrative order against Analogic in which the company agreed to pay approximately $11.5 million in disgorgement and prejudgment interest. In connection with the same administrative order, the SEC also announced that “Lars Frost, BK Medical’s former Chief Financial Officer, agreed to pay a $20,000 civil penalty to settle charges that he knowingly circumvented the internal controls in place at BK Medical and falsified its books and records.
The DOJ enforcement action involved BK Medical ApS (“BK Medical”) described as “a wholly owned subsidiary of Analogic headquartered in Harlev, Denmark.” According to the NPA: “BK Medical produces ultrasound equipment, which, depending on the geographic region, was either sold directly to clinical end-users or to third party distributors, which in turn sold to clinical end-users. During the relevant period, in Russia, BK Medical sold its products exclusively through distributors.”
Under the heading “Improper Payments,” the NPA states:
“From at least 2001 through early 2011, BK Medical engaged in a scheme to channel approximately $20 million in improper payments to various third parties and to conceal those payments by creating fictitious invoices and causing its parent corporation, Analogic, to falsify its books and records.
For example, BK Medical engaged in hundreds of transactions with Distributor 1 [described as BK Medical’ s distributor in Russia who would purchase ultrasound equipment from BK Medical and would in turn sell that equipment to clinical end-users in Russia] wherein after the actual terms of a purchase of equipment had been agreed upon, and after BK Medical had invoiced Distributor 1 for the equipment, Distributor 1 would request that BK Medical provide Distributor 1 with a second invoice reflecting an inflated sales price.
Following these requests from Distributor 1, BK Medical employees would create a fictitious invoice (commonly referred to at BK Medical as a “special” invoice) outside the normal invoice-generation and accounting system that reflected an inflated amount of payment due to BK Medical, as requested by Distributor 1. At the time these invoices were prepared, BK Medical employees were aware that they did not reflect the true purchase price for the equipment, and instead reflected an inflated sales price that had been requested by Distributor 1. Thus, BK Medical would keep two invoices in its books and records – a correct invoice created pursuant to the Company’s accounting procedures, and a fictitious invoice created outside these procedures.
BK Medical would then provide the fictitious invoice to Distributor 1, which would subsequently make payment against the inflated invoice, resulting in an overpayment to BK Medical. BK Medical would hold the excess funds in accounts receivable.
At some point after the excess payment was made, Distributor 1 would direct BK Medical to wire a payment to a third-party recipient from the excess funds in BK Medical’s custody resulting from the overpayment. None of these third-party recipients had a business connection to BK Medical of which BK Medical was aware, and BK Medical did not conduct any due diligence on these recipients, but merely sent them money at Distributor 1 ‘s direction. Some of these third-party recipients were named individuals, while others were shell companies.
On certain occasions, Distributor 1 would send BK Medical an invoice that purported to be from the third-party entity that was to receive a payment from BK Medical. These invoices referred to services being rendered to BK Medical as, among other things, “marketing,” “logistic service,” and “commission.” BK Medical employees have confirmed that none of these entities actually rendered any services to BK Medical and that they understood this fact at the time these invoices were received by BK Medical. Payments to the third parties, including the third-party entities that submitted invoices to BK Medical, were made from the accounts receivable system. As a consequence, the third-party entities were not subject to Analogic’s required vendor approval process for payments made from the accounts payable system.
On at least two occasions, BK Medical made payments to third parties at the direction of Distributor 1 using its own funds prior to being reimbursed by Distributor 1 because, at the time the payments were requested by Distributor 1, BK Medical was not holding any excess funds from Distributor 1 on its books.
There is evidence that at least some of these payments to third parties were ultimately [paid] to doctors employed by Russian state-owned entities.”
Regarding the alleged recipients of the payments, the NPA states:
“BK Medical’s employees were aware that ultimate sales by its distributor in Russia were to hospitals or other medical facilities that were controlled by the government of Russia and performed functions that the Russian government treated as its own, and thus were instrumentalities of the Russian government as that term is used in the FCPA. Employees of these customers were therefore “foreign officials” as that term is used in the FCPA. BK Medical employees were aware that many of its end-users were Russian state-owned entities whose employees were Russian government officials.”
The NPA continues:
“For example, on or about May 5, 2004, a BK Medical employee wrote an e-mail to an employee of Distributor 1, providing a draft explanation of the overpayments, which the Distributor 1 employee could then send back to BK Medical. The e-mail stated: “Please note that this is simply a part of the Russian market conditions and it is a result of our process going from the former Soviet planning economy to the more western and democratic market economy. It will take many years before we will reach a real market economy and the level of official salaries in many sectors are extremely low which makes it impossible to maintain a reasonable standard of living. The money we request you to transfer are not in anyway money for [Distributor 1], you already know about this, but is is [sic] for various obligations that is not in our control. We know that sometimes that money goes back into the regions for education and training, which under normal conditions would not be possible, but also for general improvement of the living standard among a lot of different persons, not only persons on high levels … If you cannot continue to help us with the money transfers, we will risk up to 90% of our B-K business … Please understand that your Western word ‘bribe’ is not used in our Russian market …
While the scheme with Distributor 1 was the most extensive, totaling approximately $16 million in improper payments and false accounting, BK Medical also received overpayments, issued fictitious invoices, and made payments to unknown third-party recipients in agreement with its distributors in five other countries.”
Under the heading, “Causing Analogic to Falsify Its Books, Records, and Accounts,” the NPA states:
“During the relevant time period, BK Medical caused Analogic to falsify its books, records, and accounts in connection with the improper payment scheme. As a wholly owned subsidiary of Analogic that was responsible for Analogic’s ultrasound division and whose financials were consolidated into Analogic’s books, records, and accounts, BK Medical was required to provide representations and certifications to Analogic about BK Medical’s financials and financial controls.
For example, BK Medical was required to complete division quarterly review checklists (the “checklists”) and submit them to Analogic’s controller. Among other things, these checklists required BK Medical to report on any side letters that modified existing contract terms, confirm whether there were any internal controls issues to report, confirm compliance with all Analogic corporate accounting policies, and certify that BK Medical’ s financial records were in accordance with U.S. GAAP. In each quarter that Analogic required the checklists, certain BK Medical executives provided the required confirmations and certifications, but never reported the overpayments or third-party payments even though those executives knew about the improper payments.
BK Medical was also required to provide certifications of BK Medical’ s financial statements for Sarbanes-Oxley consolidation purposes (the “subcertifications”) prior to the issuance of Analogic’s quarterly reports. In relevant part, the subcertifications required a BK Medical executive to certify that “all material financial transactions of the subsidiaries for which I am responsible have been properly recorded on the books of the subsidiaries, and there have been no intentionally false or misleading statements, entries, or omissions made in connection with my activities or the activities of my subsidiaries.” In each quarter that Analogic required the subcertifications, the BK Medical executive certified “true without exception,” and again failed to report the overpayments or third-party payments in spite of this executive’s knowledge of the payments.
In addition, BK Medical maintained as part of its books, records, and accounts the fictitious invoices it issued to distributors, as well as the fictitious invoices it received from Distributor 1 purportedly from certain of the third-party entities receiving payment. These books, records, and accounts were consolidated into Analogic’s books and records and reported by Analogic in its financial statements.”
Based on the above, the NPA states that the DOJ will not prosecute BK Medical for “its knowing and willful falsification of the books, records, and accounts of its parent company Analogic Corporation.”
According to the NPA, the resolution was “based on the individual facts and circumstances presented by this case and the Company.” The NPA then states:
“Among the factors considered in deciding what credit the Company should receive were the following:
a) the Company, through its parent company Analogic Corporation (“Analogic”), voluntarily and timely disclosed to the Offices the conduct described in the Statement of Facts …, which were known to the Company at the time of the disclosure, and thus the Company received full credit for its voluntary disclosure;
b) the Company did not receive full cooperation credit because, in the view of the Offices, the Company’s cooperation subsequent to its self-disclosure did not include disclosure of all relevant facts that it learned during the course of its internal investigation; specifically, the Company did not disclose information that was known to the Company and Analogic about the identities of a number of the state-owned entity end-users of the Company’s products, and about certain statements given by employees in the course of the internal investigation;
c) except as provided in (b) above, by the conclusion of the investigation, the Company had provided to the Offices all relevant facts known to it, including information about individuals involved in the FCPA misconduct;
d) the Company engaged in extensive remedial measures, including enhanced financial controls related to payments and invoicing, enhanced FCPA training, and a new distributor due diligence program;
e) accordingly, after considering (a) through (d) above, the Company received an aggregate discount of 30% off the bottom of the U.S. Sentencing Guidelines fine range;
f) the Company has committed to continue to enhance its compliance program and internal controls, including ensuring that its compliance program satisfies the minimum elements set forth in [an attachment to the NPA];
g) based on the Company’s remediation and the state of its compliance program, and that of its parent company Analogic, and the Company’s agreement to report to the Offices as set forth [in the NPA], the Offices determined that an independent compliance monitor was unnecessary;
h) the nature and seriousness of the offense, including that the Company engaged in an at least 10-year scheme to create fraudulent invoices to conceal approximately $20 million in improper payments associated with the Company’s distributors;
i) the Company has no prior criminal history; and
j) the Company has agreed to continue to cooperate with the Offices in any ongoing investigation of the conduct of the Company and its officers, directors, employees, agents, business partners, distributors, and consultants relating to violations of the FCPA, and to cooperate with foreign authorities that are prosecuting individuals involved in this matter.”
Pursuant to the NPA, BK Medical agreed to pay a $3.4 million criminal penalty and to report to the DOJ annually during the 3-year NPA “regarding remediation and implementation of the compliance measures” set forth in the NPA.
The NPA has a standard “muzzle clause” in which BK Medical and others speaking on its behalf agree not to make any public statement “contradicting the acceptance of responsibility by the Company” set forth in the NPA or the facts set forth in the NPA.
The SEC action is principally based on the same Russian conduct alleged in the DOJ action.
In summary fashion, the SEC’s administrative order states:
“This matter concerns violations of the books and records and internal accounting controls provisions of the FCPA by Analogic, a medical device manufacturer headquartered in Peabody, Massachusetts, and by Lars Frost, a citizen and resident of Denmark and the former Chief Financial Officer of Analogic’s wholly-owned Danish subsidiary, BK Medical ApS (“BK Medical”), which sells ultrasound equipment.
From at least 2001 through early 2011, BK Medical participated in hundreds of highly suspicious transactions at its distributors’ direction which posed a significant risk of bribery or other improper conduct. The suspicious transactions involved BK Medical’s distributor in Russia, as well as, to a lesser extent, its distributors in Ghana, Israel, Kazakhstan, Ukraine, and Vietnam. The transactions routinely involved fictitious invoices issued by BK Medical at inflated prices, overpayments to BK Medical from the distributors against the inflated invoices, and subsequent payments by BK Medical out of the distributors’ excess funds to unknown third parties all over the world for unknown reasons. In short, for at least nine years, BK Medical acted as a conduit for its distributors to funnel money to parties, and for reasons, unknown to BK Medical. Approximately $20 million flowed through BK Medical from these distributors, with over $16 million from BK Medical’s Russian distributor.
BK Medical and, by extension, Analogic derived millions in profits from its sales to the distributors that directed these suspicious transactions. BK Medical’s participation in the transactions resulted in Analogic failing to maintain accurate books and records. Analogic also failed to devise and maintain an adequate system of internal accounting controls sufficient to prevent and detect this improper conduct that occurred over nearly a decade.
[…] Lars Frost, who was BK Medical’s Chief Financial Officer from 2008 to 2011, personally authorized approximately 150 conduit payments to unknown third parties during his tenure at BK Medical despite knowing that the payments violated BK Medical’s internal accounting controls. Frost also submitted numerous false quarterly sub-certifications to Analogic. As a result of his conduct, Frost was a cause of Analogic’s violations …”.
Regarding the non-Russian conduct, the order states:
“During this same period, BK Medical participated in similar arrangements, but to a lesser degree, with its distributors in Ghana, Israel, Kazakhstan, Ukraine, and Vietnam. The arrangements broadly followed the same structure, though the degree to which fictitious documents were created varied by distributor. Over this period, BK Medical served as a conduit for at least 80 payments to third parties pursuant to arrangements with these other distributors, totaling approximately $3.8 million.
BK Medical’s participation in these payment arrangements with its distributors created a significant risk that BK Medical was facilitating bribery or other prohibited conduct, such as embezzlement or tax evasion.”
Under the heading “Identification of Bribery Risks Associated with Distributors,” the order states:
“In or around 2004, BK Medical’s Vice President of Sales for distributors asked his principal contact at the Russian distributor about the purpose of the payments to third parties and later memorialized his understanding in the form of a ghostwritten email from the contact to himself. The email stated, among other things, that the payments were necessary due to “Russian market conditions”; that “the level of official salaries in many sectors are still extremely low”; that the payments are for, among other things, “general improvements of the standard of living of … persons on high levels”; and that “[i]f you cannot continue to help us with the money transfers, we will risk up to 90% of our B-K business.” The email then stated: “Please understand that your western word ‘bribe’ is not used in our Russian market. We talk about customer obligations, nothing else ….” Notwithstanding these red flags, the payments to unknown third parties continued for six more years.
In 2008, a Senior Vice President at Analogic concluded that BK Medical presented a “significantly greater risk” of violating the FCPA than Analogic’s other business lines, because BK Medical’s products “go in completed form to … hospitals, many of which are government owned.” In addition to recommending that BK Medical implement a FCPA training program, the Senior Vice President recommended in an email to Analogic’s senior management that BK Medical put in place an “official process for validating that their distribution partners do not, or are not likely to engage in prohibited behavior.” Analogic then provided a business ethics and FCPA compliance training to BK Medical sales and finance staff, but no official process was implemented, and no steps were taken to validate whether its Russian distributor or any other distributor was engaged in prohibited behavior.”
Under the heading “Analogic Failed to Make and Keep Accurate Books and Records and Maintain an Adequate Internal Accounting Control System,” the order states:
“BK Medical’s participation in the transactions involved the routine creation and/or ratification of several types of fictitious documents, which BK Medical maintained in its books and records and, in some cases, used to support payments made to third parties. These documents included fictitious BK Medical invoices, contracts, and invoices from third parties for services never rendered to BK Medical. Moreover, BK Medical made and recorded hundreds of transactions in its books and records for which BK Medical did not know the business purpose and therefore was unable to account for accurately. These recorded transactions, and the fictitious documents upon which they were predicated, were incorporated into Analogic’s books and records, which were rendered inaccurate as a result.
Analogic’s internal accounting controls system was also deficient. BK Medical was able to process hundreds of sham, conduit transactions involving millions of dollars in payments outside the company’s accounting systems for nearly ten years.”
Under the heading “Lars Frost’s Role in Analogic’s Inaccurate Books and Records and Internal Accounting Controls Failures,” the order states:
“Frost joined BK Medical’s finance department in 1999 and was promoted ultimately to BK Medical’s Chief Financial Officer position in approximately October 2008, which position he held until Analogic caused BK Medical to terminate his employment in September 2011. In the CFO role, Frost was BK Medical’s chief accounting officer, was responsible for ensuring BK Medical’s compliance with its internal accounting controls, and reported directly to Analogic’s corporate controller and chief accounting officer in the United States.
During his tenure at BK Medical, Frost approved approximately 150 payments outside of BK Medical’s accounts payable system to unknown third parties, approximately 10 of which were while he was the BK Medical CFO. At times, he authorized the payments by applying his initials to fictitious invoices from third parties for services never rendered to BK Medical. BK Medical had regularly participated in these transactions before Frost became CFO of BK Medical and he took no steps to stop them after he became CFO.
Frost authorized payments to unknown third parties outside the accounts payable system knowing that doing so was inconsistent with – and circumvented – the internal accounting controls in place at BK Medical, which required all payments to be processed through accounts payable. Further, both before and after he became BK Medical’s CFO, Frost executed internal sub-certifications for Analogic on a quarterly basis certifying BK Medical’s compliance with its accounts payable controls, among other internal accounting controls, notwithstanding knowledge that the payments violated those controls. As BK Medical’s CFO, Frost also signed quarterly financial-statement sub-certifications for Analogic, certifying that all material financial transactions at BK Medical had been properly recorded, notwithstanding that Frost did not know the business purpose of the payments to third parties. Both of these sets of sub-certifications were incorporated into Analogic’s books and records. Frost was also aware of the fictitious contracts that BK Medical’s Russian distributor requested BK Medical execute. Finally, Frost also completed quarterly checklists for Analogic’s controller, the purpose of which was to identify unusual transactions and changes in the status of internal controls, among other matters. Frost failed to disclose the payment arrangements in connection with these checklists or in related discussions with Analogic’s controller. These incomplete checklists were also incorporated into Analogic’s books and records.”
As noted in the SEC’s release:
“Analogic agreed to pay $7.67 million in disgorgement and $3.8 million in prejudgment interest to settle the SEC’s charges that it failed to keep accurate books and records and maintain adequate internal accounting controls.”
As further noted in the SEC’s release:
“Frost, a Danish citizen, consented to the SEC’s order without admitting or denying the findings that he caused Analogic’s violations and that he violated provisions of the federal securities laws and a related SEC rule that prohibit the knowing circumvention of internal controls and knowing falsification of books and records.”
Under the heading “Analogic’s Self-Report, Cooperation, and Remedial Efforts,” the order states:
“Upon discovering the payment arrangements at BK Medical, Analogic halted the transactions, conducted an internal investigation, and subsequently self-reported its findings, including an accounting of all of the suspicious payments to third parties by distributor and recipient. Analogic thereafter generally cooperated with the Commission staff’s investigation. Analogic further took a number of remedial efforts, including (1) terminating BK Medical’s relationship with eight distributors; (2) improving BK Medical’s distributor due diligence and distributor agreements; (3) terminating a number of BK Medical employees (including Lars Frost and the Vice President of Sales for distributors) and disciplining other BK Medical employees involved in the transactions; (4) enhancing Analogic’s general oversight of BK Medical and hiring a corporate compliance officer; (5) remediating and improving BK Medical’s internal accounting controls; and (6) requiring additional and ongoing compliance training for BK Medical and Analogic employees.
In determining to accept Analogic’s Offer, the Commission considered Analogic’s self-report, cooperation, and remedial acts.”
The order further states:
“Analogic acknowledges that the Commission is not imposing a civil penalty based in part upon BK Medical’s payment of a $3,402,000 criminal fine as part of BK Medical’s settlement with the United States Department of Justice.”
In the SEC’s release, Kara Brockmeyer (Chief of the SEC’s FCPA Unit) stated:
“Analogic’s subsidiary, BK Medical, allowed itself to be used as a slush fund for its distributors, funneling millions of dollars around the world at its distributors’ direction without knowing the purpose of the payments or anything about the recipients. Issuers and their subsidiaries cannot turn a blind eye to suspicious payments, even if they believe they are simply ‘helping out’ a business partner.”
William Paine and Jay Holtmeier (Wilmer Cutler) represented the Analogic entities.
Yesterday, Analogic’s stock price closed up .14%.