This prior post went in-depth into the recent $123 million Foreign Corrupt Practices Act enforcement action against Herbalife and this post highlights additional issues to consider.
Timeline
As highlighted in this post, Herbalife disclosed its FCPA scrutiny in early 2017. Thus, from start to finish, its scrutiny lasted more than 3.5 years. I’ve said it many times, and will continue saying it until the cows come home, if the DOJ/SEC wants their FCPA enforcement programs to be viewed as credible and effective they must resolve instances of FCPA scrutiny much quicker.
This is particularly true in the Herbalife matter given that the conduct focused on a single country as well as the following language from the enforcement agencies.
From the DOJ:
“The Company received full credit for its cooperation with the United States’ independent investigation, which has included: making regular factual presentations to the United States and, after taking steps that the Company and its affiliates determined complied with applicable foreign data privacy, confidentiality, and discovery laws, voluntarily making employees available for interviews in the United States; producing documents and information located outside of the United States; providing translations of foreign language materials; proactively disclosing certain conduct of which the United States was previously unaware; and providing to the United States all relevant facts known to it.”
From the SEC:
“Herbalife’s cooperation included timely sharing of facts developed during the course of an internal investigation and voluntarily producing documents.”
A Joke?
The Herbalife enforcement action is based on the same core conduct as the DOJ/SEC’s November 2019 enforcement action against former Herbalife China executives Yanliang Li (a citizen of China and former Managing Director of a Chinese division of Herbalife) and Hongwei Yang (a citizen of China and former head the External Affairs Department of a Chinese division of Herbalife).
This prior post, discusses why it would be a joke if there was an enforcement action against Herbalife based on the conduct of Li and Yang (Defenants) as alleged in the indictment. The reasons were as follows based on the DOJ’s allegations:
- Defendants circumvented Herbalife’s internal controls.
- Defendants submitted “fraudulent reimbursement requests.”
- Defendants “obtained reimbursement for the bribes from China Subsidiary through false expense claims designed to conceal the true nature of the expenditures at issue.”
- Defendants “circumvented Herbalife’s internal accounting controls related to EA’s [the China Subsidiary’s External Affairs Department] expenditure on gifts and entertainment for Chinese government officials. These internal accounting controls, among other things, prohibited the payment of bribes; established limits on the value, frequency, and nature of expenditures on government officials; and required EA employees to provide receipts and other specific information, including the names of the government official involved, to obtain approval and reimbursement for their expenditures.”
- Defendants “conceal[ed] their fraud from Herbalife’s Internal Audit department.”
- Defendants instructed “two EA employees to falsely submit reimbursement requests.”
- Defendants “in order to prevent the scheme from being detected by Herbalife’s Internal Audit Department” directed others to “provide certain instructions to another colleague” and not to use company e-mail.
- Defendants expenditures “violated, among other things, Herbalife’s policies and controls prohibiting entertaining relatives of government officials.”
- Li “furthered the scheme and concealed the scheme by, among other things, routinely creating false records and certifications disclaiming any knowledge of fraud or circumvention of internal accounting controls.
- Over a nearly ten year period, Li signed certifications titled “Statement Regarding Facts and Circumstances Relating to Exchange Act Filings” which Li caused to be sent to Herbalife’s U.S. headquarters. “In these certifications, which Herbalife relied upon in the preparation of its public filings with the SEC, Li falsely certified that ‘nothing came to my attention that made me question the effectiveness of [the company’s] disclosure controls and procedures’ and that ‘I am not aware of any fraud, whether or not material, that involves management or other employees who have a significant role in Herbalife’s internal controls.”
- “During the time period relevant” to the indictment, the defendants “each participated in more than ten in-person and online trainings related to Herbalife’s anti-fraud and anti-corruption policies. Furthermore, Li and Yang both certified repeatedly that they understood and would adhere to Herbalife’s Code of Business Conduct and Ethics, which, among other things, required compliance with the FCPA.”
- Defendants instructed others to rewrite expenses reports to conceal the nature of payments
- Defendants coached others to give false stories to internal audit
- Defendants gave false assurances to internal audit
- Li falsely assured internal audit that he was otherwise committed to improving compliance of Herbalife’s internal FCPA and internal accounting controls.”
- Li “fasley assured internal audit that he would discipline and train employees to improve compliance of China subsidiary policies.”
Well – jokes happen as there obviously was a DOJ/SEC enforcement action against Herbalife.
Root Cause
It has been highlighted numerous times on these pages including in connection with the Avon enforcement action and the Nu Skin enforcement action – enforcement actions that like Herbalife – also involved a direct selling license in China.
The root cause of many FCPA enforcement actions are foreign trade barriers and distortions. The narrative is rather simple.
- Trade barriers and distortions create bureaucracy.
- Bureaucracy creates points of contact with foreign officials.
- Points of contact with foreign officials create discretion.
- Discretion creates the opportunity for a foreign official to misuse their position by making bribe demands.
The following is not meant to excuse the conduct at issue in the the Herbalife matter, only to put it in the proper perspective.
The root cause of Herbalife’s (and Avon’s and Nu Skin’s) FCPA scrutiny was that China had significant trade barriers and distortions applicable to direct selling of certain products.
As alleged by the DOJ:
“In China, to engage in direct selling – selling a company’s products through independent sales representatives – Chinese law required a company to obtain a direct selling license from national authorities as well as local authorities for each province in which a company intended to engage in direct selling.”
As stated in the SEC’s order, “direct selling licenses from the Chinese government [were] a prerequisite for Herbalife China to conduct its direct selling business in China.”
As I have long argued, the way to reduce bribery is not just to bring more corporate enforcement actions. It is to address the root causes of bribery by seeking a reduction in trade barriers and distortions.
Simply put, if China did not have direct selling prohibitions on certain products, the Herbalife, Avon and Nu Skin enforcement actions would have likely happened.
Invoking A Standard That Does Not Even Exist
Once again, in the Herbalife enforcement action the SEC invoked a legal standard that does not even exist in the FCPA. The SEC’s order states: “Certain Herbalife executives received reports of high travel and entertainment spending in China and violations of Herbalife’s internal FCPA policies, but failed to detect and prevent improper payments and benefits and falsifications of expense reports.”
However, you can read the FCPA statute until the cows come home but you will never find the words “detect and prevent” in the statute – quite simply because that is not the statutory standard.
Rather, the internal controls provision state that an issuer shall “devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that” certain financial objectives are met. The FCPA then defines “reasonable assurances” to “mean such level of detail and degree of assurance as would satisfy prudent officials in the conduct of their own affairs.”
Is it asking too much for SEC enforcement officials to articular the proper statutory standard?
Moreover, post-enforcement action, Herbalife agreed to “undertake two follow-up reviews, incorporating any comments provided by the Commission staff on the previous report, to further monitor and assess whether Herbalife’s policies and procedures are reasonably designed to detect and prevent violations of the FCPA and other applicable anticorruption laws.”
The concept of internal controls being “reasonable” does appear in the FCPA, but again the statutory standard is “devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that” certain financial objectives are met. In other words, Herbalife has agreed post-enforcement action to standards that don’t even exist in the FCPA.
No Charged Bribery Disgorgement
The Herbalife enforcement action represents yet another so-called “no-charged bribery disgorgement action.”
In other words, the approximate $67.3 million SEC settlement amount consisted entirely of disgorgement (and associated prejudgment interest) even though the SEC only found violations of the FCPA’s books and records and internal controls provisions.
As highlighted in this previous post (and numerous prior posts thereafter), no-charged bribery disgorgement is troubling. Among others, Paul Berger (here) (a former Associate Director of the SEC Division of Enforcement) has stated that “settlements invoking disgorgement but charging no primary anti-bribery violations push the law’s boundaries, as disgorgement is predicated on the common-sense notion that an actual, jurisdictionally-cognizable bribe was paid to procure the revenue identified by the SEC in its complaint.” Berger noted that such “no-charged bribery disgorgement settlements appear designed to inflict punishment rather than achieve the goals of equity.”
No Liu Impact
On June 22nd, the Supreme Court’s held in Liu – as to the statutory scheme relevant to SEC federal court actions – that “a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible” under the relevant statutory scheme. (See here for the prior post).
Despite commentary that Liu will make “a significant change to how corporate FCPA settlements will be reached” with the SEC, this prior post predicted that Liu will not have a meaningful impact on administrative actions brought by the SEC (as the WAC and nearly all issuer enforcement actions are) and that the Supreme Court’s most FCPA relevant observations in Liu were merely dicta.
Liu did not seem to have an impact on the $67 million disgorgement (and prejudgment interest) amount in the Herbalife enforcement action.
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