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Development From The “Other Universe” – In Dismissing FCPA-Related Securities Fraud Claims, Judge Repudiates FCPA Enforcement Theory

parallel universe

Foreign Corrupt Practices Act issues often co-exist in two parallel universes.

One universe is ruled by all-powerful gods with big and sharp sticks  in which subjects dare challenge the gods.

Another universe consists of checks and balances in which independent actors call the balls and strikes.

The first universe refers to FCPA enforcement by the DOJ and SEC.

The second universe refers to litigation of FCPA-related claims in which judges make decisions in the context of an adversarial legal system. This second universe is often referred to as the rule of law universe.

There are several examples of theories used in the first universe that do not work in the second universe.

For instance, the FCPA enforcement agencies frequently take a seeming “if / then” position when it comes to issuer internal controls.  In other words, if some misconduct occurred somewhere within an issuer’s business organization or if some employee within that organization circumvented the issuer’s internal controls, then the issuer did not have effective internal controls.

However, when this simplistic theory is used in civil litigation, courts have routinely concluded that just because improper conduct allegedly occurred does not mean that internal controls must have been deficient.  (See e.g., Midwest Teamsters Pension v. Baker Hughes, 2009 WL 6799492 (S.D. Tex. 2009);  Freuler v. Parker Drilling 803 F.Supp.2d 630 (S.D. Tex. 2011).

This post concerns the most recent example regarding the parallel universes.

As readers likely know, a recent development in the first universe was the SEC’s enforcement theory in the BNY Mellon (“internship”) enforcement action (see here and here for prior posts) that bribery includes “things of value” provided indirectly to “foreign officials” if the thing of value is subjectively valued by the foreign official.

In the words of the SEC in BNY Mellon, ““The internships [for family members of alleged “foreign officials”] were valuable work experience[s], and the requesting officials derived significant personal value in being able to confer this benefit on their family members.”

Yet, in the other universe a federal court judge recently stated as follows.

“[The FCPA’s anti-bribery provision] does not bar a company from giving anything of value to a foreign government, as opposed to a foreign official personally, or to a third party such as a nonprofit in order to generate corporate goodwill, even if the gift indirectly influences government officials.” (emphasis added).

Those words were written by U.S. District Court Judge Melinda Harmon (S.D. Tex.) in dismissing securities fraud claims brought against Hyperdynamics Corporation in the aftermath of its FCPA scrutiny.  (See here for the opinion).

Before discussing the ruling, a bit of background.

It is often as predictable as the sun rising in the east.

When a company is the subject of FCPA scrutiny or resolves an FCPA enforcement action, plaintiff lawyers representing shareholders will emerge like bats from a cave bringing derivative actions and/or securities fraud actions against the company as well as officers and directors.  To learn more about this dynamic, see “Foreign Corrupt Practices Act Ripples.”

For instance, in September 2013 Hyperdynamics Corp. disclosed that it was the subject of FCPA scrutiny (see here for the prior post).  On the day of the disclosure, the company’s stock fell approximately 15%.  As sure as the sun rises in the east, a few days later, not one but two, plaintiffs firms issued releases (here and here) announcing an “investigation” and civil actions soon followed alleging Section 10(b) and Rule 10b-5 claims based on general risk disclosures in SEC filings referring to corruption.

As stated by Judge Harmon (certain internal citations omitted):

“Defendants issued twenty statements disclosing a risk of FCPA violations before they disclosed the FCPA subpoenas.  (“We operate in Guinea, a country where corrupt behavior exists that could impair our ability to do business in the future or result in significant fines or penalties.”). Seven of the statements further revealed Hyperdynamics had found “control deficiencies” in its accounting practices in 2009. (“Some of the identified internal control deficiencies contributing to our material weaknesses in financial reporting relate to our operations in Guinea. These material weaknesses make it more likely that [an FCPA] violation could have occurred.”). The control deficiencies are not identified in the record. Defendants state: “Hyperdynamics had historically had some difficulties—mainly during the period before the management and board were largely replaced beginning around 2009— maintaining adequate internal controls.” Four of the statements specifically deny violations of the FCPA. (“Neither the Company, nor any of its Subsidiaries, nor, to the Knowledge of the Company, any director, officer, agent, employee or other Person acting on behalf of the Company or any of its Subsidiaries, has, in the course of its actions for, or on behalf of, the Company, violated or is in violation of any provision of the [FCPA].”).

Defendants do not contend the statements above were adequate disclosures of FCPA related risks. Defendants tentatively argue: “Plaintiff never meaningfully addresses the Company’s risk disclosure language, including its disclosure beginning in 2009 that certain internal control weaknesses ‘make it more likely that a[n] [FCPA] violation could have occurred.’” Defendants maintain FCPA violations did not occur.

Plaintiffs respond that the disclosures were false or misleading by omission, because violations occurred. Plaintiffs have not, however, established that FCPA violations occurred. The only authoritative evidence in the record that FCPA violations occurred is Hyperdynamics’s disclosure of subpoena requests by the DOJ in September 2013 and the SEC in January 2014.  On March 12, 2014, Hyperdynamics’s partner Tullow Guinea Limited declared these subpoenas a force majeure event but retracted the declaration in May 2014. These disclosures do not establish that FCPA violations occurred or that Defendants knowingly omitted FCPA violations. See Konkol v. Diebold, Inc., 590 F.3d 390, 402 (6th Cir. 2009) (“The mere existence of an SEC investigation does not suggest that any of the allegedly false statements were actually false . . . [,] nor does it add an inference of scienter.” (quoting In re Hutchinson Tech., Inc. Secs. Litig., 536 F.3d 952, 962 (8th Cir. 2008))). Defendants cannot be held liable for not preempting the SEC process and issuing a public confession. See City of Pontiac Policemen’s & Firemen’s Ret. Sys. v. UBS AG, 752 F.3d 173, 184 (2d Cir. 2014) (rejecting argument that “in addition to disclosing the existence of an investigation, defendants were required to disclose that [defendant] UBS was, in fact, engaged in an ongoing tax evasion scheme,” because “disclosure is not a rite of confession”).”

Judge Harmon next stated and concluded (certain internal citations omitted):

“Plaintiffs have not alleged FCPA-related facts which would render either the sixteen risk disclosures or the four specific denials misleading by omission and which Defendants had a duty to disclose. Furthermore, Plaintiffs have failed to allege facts which would render the specific denials false or misleading.

The FCPA prohibits a company from making an “offer, gift, promise to give, or authorization of the giving of anything of value” to a “foreign official for purposes of . . . influencing any act or decision of such foreign official in his official capacity” in obtaining business. This prohibition does not bar a company from giving anything of value to a foreign government, as opposed to a foreign official personally, or to a third party such as a nonprofit in order to generate corporate goodwill, even if the gift indirectly influences government officials. Nor does it prohibit misappropriation by a foreign official without the company’s knowledge.

Here, Plaintiffs have alleged Defendants made donations to the government of Guinea during three phases of negotiations over Hyperdynamics’s concession. Plaintiffs claim these donations constituted bribery under the FCPA. The first donation occurred after Hyperdynamics received a letter in 2005 indicating the government had cancelled its concession. Defendants met with the Secretary General of Guinea at the Presidential Palace and were told the letter was a “fake” but that further review was necessary. On August 1, 2006, Defendant CEO Kent Watts founded a nonprofit organization called American Friends of Guinea for the purpose of making charitable contributions “for the welfare of the Guinean population.”  Shortly thereafter, on September 22, 2006, the government approved the first renegotiated concession.

The second instance of alleged bribery occurred during negotiations from late 2007 to 2009, after the renegotiated concession became a local news story and the government again threatened to cancel it. In September 2007, a delegation led by the Secretary General visited Hyperdynamics’s office in Houston, and vice versa. Over the next year, American Friends of Guinea “delivered and paid for antibiotics and glucose fluids for men, women, and children who were stricken with cholera and quarantined as a result thereof. AFG also planned new water well projects to get to the source of solving the problem.”  In addition, Plaintiffs cite an  investor forum,, which cites an article from a Guinean news website,, stating the Minister Secretary General “disbursed by means of [H]yperdynamics, the sum of five hundred (500) million Guinean francs, which were distributed to some of Ioubards [hooligans] Municipality of Kaloum and other districts in the capital of Guinea. Ioubards [were seen] in the streets two days before the fateful day of the strike of January 10, 2008. . . .”  Plaintiffs allege the “hooligans” supported the President and organized street protests against the Prime Minister. On February 8, 2008, according to a Wikileaks cable,Hyperdynamics CFO Briers met with the U.S. Embassy. The cable states, “Briers raised the issue of FCPA violations” by the Company during the meeting, and did so “without prompting.” Briers denied the Company paid the 500 million Guinea francs to the reported hooligans. Briers also denied Hyperdynamics had paid the Secretary General “to push through their contract.” Plaintiffs argue, “Despite Briers’ denials of specific instances of alleged bribery, his voluntary whistleblowing of FCPA violations further reinforced the Embassy’s view that Hyperdynamics was violating the act.” The cable explains the Embassy declined Brier’s request for assistance in negotiating with the government on grounds that “commercial advocacy would be very difficult, if not impossible, due to the fact that the [U.S. Government] does not recognize the military junta as a legitimate government.” According to another Wikileaks cable, Tidiane Diallo, a new employee of the Ministry of Mines who formerly worked at USAID told the Embassy, “I am sure Hyperdynamics was the minister’s ticket for his appointment.” According to the cable, Diallo based his statement on the fact that “the minister was appointed on August 27 . . . and that Hyperdynamics was at the ministry the very next day. The company’s contract was reinstated a few days later.” Diallo also claimed Hyperdynamics had offered to donate $56 million to the government to pay its annual bill for power plant fuel. The cable states: Diallo reportedly warned the minister of mines to reject the offer, pointing out that it is not clear what Hyperdynamics wants in return, and accepting a “donation” at this point would undermine the [government’s] future bargaining power. He said that the [government] has not yet decided whether or not to accept the funds, but that the ministers of mines and finance may decide to do so because of significant budgetary pressures. The embassy officer asked Diallo directly if the donation was a bribe, and Diallo responded, “yes and no.” Diallo explained, “[O]n the one hand, the offer is public and no one is trying to negotiate a deal behind closed doors. At the same time, the fact that the [government] does not know what Hyperdynamics wants in return raises questions about the company’s intent.” Again, Defendants’ negotiations bore fruit. On September 11, 2009, a Memorandum of Understanding was signed, partially affirming and modifying Hyperdynamics’s concession.  On September 29, 2009, Hyperdynamics made a donation to American Friends of Guinea of stock. On the same day, a director of Hyperdynamics resigned, following the firing of the CEO and resignation of the CFO and another director during the summer of 2009. The concession was approved by presidential decree in May 2010.

The third instance of alleged bribery occurred in 2011, after the concession was again disputed by the transitional government and modified by way of a mining code promulgated in September 2011. Plaintiffs cite testimony from confidential witness CW-1, a former Logistics Operations Manager for Hyperdynamics, alleging Hyperdynamics donated and installed $20,000 of computer equipment for the Ministry of Mines in 2011 and $8,000 to $10,000 of computer equipment for the Guinean Offshore Department of Environment, “an agency that the Company helped to create from scratch.” Plaintiffs do not specify any particular official action influenced by the computer donations. Plaintiffs also fail to plead donations to the government and the American Friends of Guinea constituted gifts to a “foreign official for purposes of . . . influencing any act or decision of such foreign official in his official capacity.”

In sum, Plaintiffs’ FCPA-related fraud claims are based on speculations of uncharged, unadjudicated FCPA violations that are not plausibly material.”

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