This previous post highlighted the SEC’s Foreign Corrupt Practices Act enforcement action against Nu Skin Enterprises.
This post continues the analysis by highlighting additional issues to consider from last week’s enforcement action.
Similar, Yet Different
Before the Nu Skin action, there have been several FCPA enforcement actions that have included, in whole or in part, charitable donations as highlighted in this recent post.
All of the prior enforcement actions though appear to have been involved pre-existing, presumably bona fide charitable organizations that a “foreign official” nevertheless was involved in or was valued by the “foreign official.”
The SEC’s order in Nu Skin is a bit ambiguous regarding the charitable donation. On one hand, the SEC states that at the relevant time a “branch of the charity had not yet been established in the province and it had no operations there” suggesting that the underlying charity, but not the local branch, was a pre-existing charity. On the other hand, the SEC’s order paints a picture of the donation announcement and associated public donation signing ceremony being rushed to influence the “foreign official” at a particular moment in time.
In this regard, the Nu Skin charitable donation appears to be a bit more “pretextual” than the donations previously at issue in prior FCPA enforcement actions.
Timeline
According to Nu Skin’s previous disclosure:
“Since 2014, we have been in discussions with the Securities and Exchange Commission (“SEC”) regarding our Audit Committee’s internal review of our business in China and related matters. In particular, these discussions with the SEC have been focused on a charitable donation we made in China in 2013 and issues related thereto. In April 2015, the SEC informed us that it was initiating a non-public, formal investigation into these issues. We have provided a number of documents in connection with this investigation, some of which were given to the SEC pursuant to subpoena, and we continue to work with the SEC to provide it with all requested information. We have also made available certain of our employees in the U.S. and China to provide testimony and respond to the SEC’s questions. The SEC has advised us that the existence of the investigation should not be construed as an indication by the SEC or its staff that we or any of our officers or directors had violated any of the federal securities laws. We intend to continue to cooperate fully with the SEC’s investigation and provide the SEC with the requested information. This investigation could expand beyond its current scope and, regardless of its outcome, could adversely affect our business.”
The above disclosure is a bit ambiguous as to the precise start of the company’s FCPA scrutiny (i.e. there is a big difference between January 2014 and December 2014). Notwithstanding, Nu Skin’s FCPA scrutiny lasted approximately 2 – 2.5 years. Considering that the enforcement action involved a single issue / transaction, this relatively short timeline(compared to other FCPA enforcement actions) is perhaps not surprising, yet still a long time for a company to be under FCPA scrutiny.
Root Cause
It has been highlighted numerous times on these pages including in connection with the Avon enforcement action that also involved, like Nu Skin, 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 Nu Skin matter, only to put it in the proper perspective.
The root cause of Nu Skin’s (and Avon’s) FCPA scrutiny was that China had significant trade barriers and distortions applicable to direct selling of certain products.
As highlighted in the SEC’s order:
“The laws and regulations applicable to direct selling in China (the “Direct Selling Laws”) prohibit the multi-level commission structure employed by Nu Skin US domestically. Instead, Nu Skin China has to consummate its sales primarily through retail stores, where its sales transactions are processed even if the products in question were promoted through offsite meetings. […]
Moreover, the Direct Selling Laws provide that before a direct selling business such as Nu Skin China can operate within a particular geographic area in China, the company must receive direct selling licenses at the national, provincial, and city levels. These direct selling licenses are conditioned on a number of factors, which typically include the business reputation of the applicant.”
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, neither the Avon or Nu Skin enforcement action would have likely happened.
Set forth below is what Nu Skin previously disclosed about direct selling in China.
“Our operations in Mainland China are subject to significant regulatory scrutiny. The legal system in Mainland China provides government authorities broad latitude to conduct investigations and many Chinese regulations, including those governing our business, are subject to significant interpretation, which may vary from jurisdiction to jurisdiction. Because of significant government concerns in Mainland China regarding improper direct selling activities, government regulators closely scrutinize activities of direct selling companies and activities that resemble direct selling. The government in Mainland China continues to inspect and interview the direct selling industry on a regular basis, which has and may continue to increase regulatory scrutiny of the industry and our business. Government regulators frequently make inquiries into our business activities and investigate complaints from consumers and others regarding our business. Some of these inquiries and investigations in the past have resulted in the payment of fines by us or members of our sales force, interruption of sales activities at stores and warnings. We continuously face the risk of new regulatory inquiries and investigations, and any determination that our operations or activities, or the activities of our sales employees, independent direct sellers or independent marketers, are not in compliance with applicable regulations could result in substantial fines, extended interruptions of business, and termination of necessary licenses and permits, including our direct selling and other licenses, all of which could harm our business.
We work diligently to train our sales force in Mainland China on how our Mainland China business model differs from our global business model. However, Sales Leaders in Mainland China may attend regional and global events and foreign Sales Leaders may participate in business meetings in Mainland China. Because our global model varies significantly from our Mainland China business model, mistakes may be made as to how those working in Mainland China should promote the business in Mainland China. These mistakes by our sales force may lead to government reviews and investigations of our operations in Mainland China. For example, as a result of allegations that, among other things, certain of our sales force in Mainland China failed to adequately follow and enforce our policies and regulations, in 2014 Chinese regulators commenced a review of our business model and operations in Mainland China. For a further description of these matters, see “– Negative news reports in Mainland China led to a review by Chinese regulators into our business in Mainland China and caused us to temporarily modify some of our business practices in that market and resulted in fines and other monetary penalties. These temporary modifications, any similar sanctions imposed on us by the Chinese authorities and any associated adverse publicity may continue to harm our business and financial condition.”
In January 2014, a series of articles were published by prominent media outlets in Mainland China. These articles contained a number of allegations including that our compensation practices violated Chinese regulations against pyramid and multi-level sales organizations, that our recruiting and training techniques were unlawful or inappropriate, that some of our products were not licensed for sale in Mainland China, that certain of our products were causing adverse reactions in some users and that our employees had taken actions to “hush up” these problems, that certain of our sales force had misrepresented the scientific efficacy of our products and the nature and extent of our connections with the scientific advisors who have helped in developing or testing our products and that certain of our sales people have falsely claimed endorsement of our products by public figures, media outlets and organizations.
Under the direction of Mainland China’s State Administration for Industry and Commerce, the Shanghai Administration for Industry and Commerce, where our Mainland China business is headquartered, and the Beijing Administration for Industry and Commerce, where we maintain a branch office, investigated the allegations. Administrations for Industry and Commerce in other provinces also made inquiries regarding these allegations. As a result of this regulatory review, Nu Skin China was fined in March 2014 in the amount of $524,000 (RMB 3.3 million) for the sale of certain products by independent direct sellers that, while permitted for sale in Nu Skin China’s retail stores, were not registered for the direct selling channel. Nu Skin China was also fined $16,000 (RMB 0.1 million) for product claims that were deemed to lack sufficient documentary support. Fines in an aggregate amount of $241,000 (RMB 1.5 million) were also imposed for unauthorized promotional activities by six of our sales employees. In addition, Nu Skin China was asked to enhance the education and supervision of its sales representatives.
In January 2014, in response to this media and regulatory scrutiny, we voluntarily took a number of actions in Mainland China, including temporarily suspending our business promotional meetings, temporarily suspending acceptance of applications for new sales representatives, and extending our product refund and return policies. Following completion of this government review, in May 2014 we resumed business meetings and acceptance of applications for new sales representatives in Mainland China. Adverse publicity and the suspension of business promotional meetings and acceptance of applications have had a significant negative impact on our revenue and number of Sales Leaders and Actives. We continue to act cautiously to properly educate and train our sales force. We may encounter unanticipated complications or other difficulties in rebuilding our business in Mainland China, which could further impact our business negatively. Continuing media and regulatory scrutiny and investigations in Mainland China, and any further actions taken by us or by regulators, could negatively impact our revenue, sales force and business in this market, including the interruption of sales activities, loss of licenses, and the imposition of fines, and any other adverse actions or events.”
Ipse Dixit
The FCPA’s internal controls provisions require issuers to have “internal accounting controls sufficient to provide reasonable assurances” that (generally speaking) corporate money is properly spent. The FCPA then provides the following definition of “reasonably assurances” and “reasonable detail” – “such level of detail and degree of assurance as would satisfy prudent officials in the conduct of their own affairs.”
Beyond these general definitions, there is no binding authority on what constitutes, in any particular context, “sufficient” internal controls to provide “reasonable” assurances.
Rather, the SEC often advances an enforcement theory that represents little more than ipse dixit (an unsupported statement that rests solely on the authority of the individual who makes it).
Consider the charitable donation at issue in Nu Skin.
According to the SEC “Nu Skin China personnel had alerted Nu Skin US of the proposed donation.” Thereafter, according to the SEC:
“Nu Skin identified that a large donation in China could pose FCPA risks, so it advised Nu Skin China to consult with outside U.S. legal counsel based in China to ensure that the donation complied with the FCPA. Outside counsel, in turn, recommended that Nu Skin China include anti-corruption language, which included language regarding the illegality of influencing government officials, in the written donation agreement with the charity. That language was inserted into a draft of the donation agreement between Nu Skin China and the charity.”
The above would certainly seem to be a “sufficient” internal control designed to provide the company “reasonable assurances” that corporate money was properly being spent. Presumably, if Nu Skin did not take these steps, the SEC would have found the company’s internal controls deficient.
According to the SEC, however Nu Skin China “failed to disclose the relationship between the donation and the AIC investigation, or the relationship between the request for recommendation letters and the AIC investigation” and “the anticorruption language … was removed from the final version of the donation agreement that Nu Skin China executed. Nu Skin US was not aware that the language had been removed.”
The end result according to the SEC? An internal control violation because:
“Nu Skin did not ensure that adequate due diligence was conducted by Nu Skin China with respect to charitable donations to identify links to government or political party officials and to prevent payments intended to improperly influence such persons in violation of the company’s anticorruption policy and the FCPA.”
In other words, this represents ipse dixit enforcement and the SEC saying, with the perfect benefit of hindsight, because I said so.
Recording of the Donation
The FCPA’s books and records provisions require issuers to “make and keep books, records, and accounts, which in reasonable detail, accurately and fairly reflect the transactions and disposition of the assets of the issuer.”
The charitable donation at issue in Nu Skin was recorded as a charitable donation. However, the SEC’s enforcement theory seems to disagree with the bona fides of that recording. In the words of the SEC.
“Nu Skin China inaccurately and/or unfairly described the purpose of the payment to the charity in its books and records as a donation rather than an improper payment to obtain the Party Official’s influence.”
In short, the charitable donation in Nu Skin was accurately recorded, it’s just that the SEC disagreed with the bona fides of the donation.
Another instance in which this similar enforcement theory was advanced was in the Noble Corp. enforcement action as well as the related SEC enforcement against against Mark Jackson and James Ruehlen. There the payments in connection with the Nigerian permit were recorded on the company’s books and records as a facilitating payment. However, the SEC disagreed with the company’s legal conclusion that the payments were facilitating payments and on that basis charged both the company and the individuals with, among other things, violating the FCPA’s books and records provisions.
Not the First
When putting together a list of companies that are likely to become the subject of FCPA scrutiny, small Utah-based companies that sell healthcare products is surely to be at the bottom of the list.
Yet, the Nu Skin enforcement action was not the first FCPA enforcement action against a small Utah-based company that sells healthcare products.
See here for the SEC’s 2009 FCPA enforcement action against Nature’s Sunshine Products.
The take-away point is this. Sure certain companies in certain industries have a higher FCPA risk profile than others, but any company doing business in the global marketplace has FCPA risk that needs to be on the radar screen of company managers.
No-Charged Bribery Disgorgement
Nu Skin was not charged or found to be in violation of the FCPA’s anti-bribery provisions. Yet the bulk of the $765,688 settlement amount comprised disgorgement and pre-judgment interest.
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.”