Prior posts here and here concerned the Foreign Corrupt Practices Act enforcement action earlier this week against Johnson Controls (JCI). This post continues the analysis by highlighting additional issues to consider.
Timeline
According to the SEC’s Order “JCI self-reported the potential FCPA violations to the SEC staff and DOJ in June 2013.” Thus, from start to finish JCI’s FCPA scrutiny lasted 3 years and 1 month.
If the DOJ/SEC want the public to have confidence in their FCPA enforcement programs, they must resolve instances of FCPA scrutiny much quicker.
Damned If They Did, Damned If They Didn’t
The JCI enforcement action was based entirely on the conduct of employees at China Marine, an indirect JCI subsidiary acquired via an acquisition of York.
According to the SEC:
“After acquiring York, JCI devoted additional resources to its compliance program, including hiring compliance personnel, conducting trainings, and implementing risk-based procedures and controls. With respect to China Marine, JCI terminated the individuals involved in [prior] conduct and hired a new managing director of China Marine to oversee the business. The managing director, a Chinese national and resident, reported to the Marine business management in JCI’s Denmark subsidiary, which oversaw the Global Marine business in multiple countries. Because the misconduct identified in the prior civil action involved the improper use of agents, JCI limited the use of agents in its China Marine business model and required that all sales go through its internal sales team based in China. […] JCI conducted multiple compliance trainings for the China Marine employees, including trainings on the FCPA. JCI also conducted audits of China Marine …”.
The SEC further stated that JCI implemented “Delegation of Authority thresholds” applicable to China Marine.
If JCI would not have employed these steps, JCI presumably would have violated the FCPA’s internal controls provisions in the eyes of the SEC.
Even though JCI did employ these steps, the SEC still found JCI in violation of the internal controls provisions.
Why?
According to the SEC, “despite the efforts taken by JCI,” China Marine employees “devised another avenue to continue the [prior problematic payments].” Indeed, the SEC stated that the “several members of the China Marine staff, including the managing director, colluded with each other and circumvented and manipulated JCI’s internal and financial controls.” According to the SEC, the Managing Director of China Marine “masterminded the scheme” to enrich himself and other China Marine employees including “instructing China Marine employees to be cautious about their discussions regarding vendor payments to JCI lawyers, accountants, and auditors, as well as to avoid or delete documentation about vendor payments.”
In other words, JCI was damned if it didn’t and damned if it did.
Yet, with the perfect benefit of hindsight, the SEC stated:
“JCI failed to devise and maintain an adequate system of internal accounting controls. JCI knew that the China Marine subsidiary had a history of FCPA problems and that the China Marine business was high risk. Despite taking steps to address the monitor’s recommendation that the company integrate the Marine business more closely into JCI’s compliance culture, JCI put almost all of its reliance for oversight of China Marine on a newly hired managing director to self-police his high risk business. On paper, the China Marine business was formally overseen by JCI Denmark. However, no one in Denmark reviewed vendor transactions or reviewed sales reports or projects that were below two million dollars in value or had profit margins above 10%. The average China Marine project was valued between $3,000 and $100,000 and therefore was rarely, if ever, scrutinized by the Denmark office. Further, despite conducting some audits of the China Marine business, JCI failed to ensure that its audit and testing procedures would adequately review payments that were routinely below their testing threshold. Denmark managers stated that even if they had performed additional review, they did not have sufficient knowledge and understanding of China Marine’s projects to recognize when certain vendor payments were unnecessary, whether goods ordered had actually been delivered, or whether design fees were necessary given JCI had an in-house design service. Because the China Marine employees operated so independently, a culture of impunity existed, and several members of the China Marine staff, including the managing director, colluded with each other and circumvented and manipulated JCI’s internal and financial controls for over six years. JCI failed to detect the improper vendor scheme, which did not come to light until an anonymous report came in after the managing director departed the company.”
8-K Disclosure Issue?
As highlighted in prior posts, JCI received a DOJ so-called “declination letter” on June 21, 2o16 (approximately 2.5 weeks prior to the SEC’s enforcement action being announced and JCI’s press release announcing the development).
As an issuer, JCI is obligated, in the words of the SEC, – in addition to annual and quarterly filings – to “report certain material corporate events on a more current basis” via Form 8-K. Issuers have four days from the trigger event to file a Form 8-K.
Is a “declination letter” from the DOJ sufficient to trigger this obligation?
No-Charged Bribery Disgorgement
The JCI enforcement action is the latest of numerous examples of the SEC ordering disgorgement even though the offending company was not charged with violating the FCPA’s anti-bribery provisions.
As highlighted in this previous post, so-called 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.”
If Graham Were Applied
SEC v. Graham was a recent appellate court decision holding that disgorgement is subject to a five-year limitations period. (See here for the prior post).
As noted in this prior post, Graham of course should matter to FCPA enforcement; however, the reality is that Graham will likely not matter because legal elements, legal exceptions, legal defenses, and other general legal principles often only directly matter to the extent an adversarial proceeding takes place and a litigant is forced to prove things consistent with the applicable burden of proof.
Like other corporate FCPA enforcement actions, the SEC was not put to its burden of proof in the JCI matter.
According to the SEC, the conduct giving rise to the enforcement action occurred from 2007 to 2013. Obviously conduct occurring 9 years prior to an enforcement action is beyond any conceivable limitations period. Further, if Graham were applied, the statute of limitations would only reach back to mid-2011. Presumably then approximately half of the $13.2 million in disgorgement and pre-judgment interest the SEC extracted in the settlement, likely would not have survived judicial scrutiny.
