FCPA Compliance and Ethics Blog

December 28, 2010

Top FCPA Investigations of 2010, Part I

Last week, we reviewed our Top 10 Enforcement actions of 2010. In the next two posts we will review our Top 10 investigations of 2010. While enforcement actions can provide the some of the DOJ/SEC most current thinking on FCPA compliance best practices the public information made available during investigations can provide to the FCPA, Bribery Act or other compliance professional many opportunities for teaching points and lessons learned by others. So with the opportunity for many educational occasions in mind we present our favorite investigations of 2010, Part I. 

1. Avon-What is the cost of non-compliance?

As noted by the FCPA Professor, one of the significant pieces of information to come out of the Avon matter is the reported costs as reported in the 2009 Annual Report the following costs have been incurred and are anticipated to be incurred in 2010: 

Investigate Cost, Revenue or Earnings Loss
Investigative Cost (2009) $35 Million
Investigative Cost (anticipated-2010) $95 Million
Drop in Q1 Earnings $74.8 Million
Loss in Revenue from China Operations $10 Million
Total $214.8 Million

 2. Gun Sting Case-Organized Crime Fighting Techniques Come to FCPA Enforcement 

On January 18, 2010, on the floor of the largest annual national gun industry trade show in Las Vegas, 21 people from military and law-enforcement supply companies were arrested, with an additional defendant being later arrested in Miami. The breadth and scope was unprecedented. Assistant Attorney General for the Criminal Division of the US Department of Justice (DOJ), Lanny Breuer, who led the arrest team, described the undercover operation as a “two-and-a-half-year operation”. The arrests represented the largest single investigation and prosecution against individuals in the history of the DOJ’s enforcement of the FCPA. 

As explained in the indictments, one FBI special agent posed “as a representative of the Minister of Defense of a country in Africa (Country A), [later identified as Gabon] and another FBI special agent posed “as a procurement officer for Country A’s Ministry of Defense who purportedly reported directly to the Minister of Defense”. Undercover criminal enforcement techniques such as wire taps, video tapes of the defendants and a cooperating defendant were all used in the lengthy enforcement action. In a later indictment, and seemingly unrelated to the “Africa” part of this undercover sting operation, allegations were included that corrupt payments were made to the Republic of Georgia to induce its government to purchase arms. 

3. HP-Questions, Questions and More Questions 

How does one begin to discuss HP’s compliance year? From FCPA to Mark Hurd’s very public departure for (alleged) sexual harassment to the recent announcement, reported in the WSJ, that the SEC is investigating Hurd in, ‘a broad inquiry that includes an examination of a claim the former chief executive officer shared inside information.” However we will focus on the FCPA matter which involves the alleged payment of an approximately $10.9 bribe to obtain a $47.3 million computer hardware contract with the Moscow Prosecutor’s Office. 

In an April 15, 2010, WSJ article, Mr. Dieter Brunner, a bookkeeper who is a witness in the probe, said in an interview that he was surprised when, as a temporary employee of HP, he first saw an invoice from an agent in 2004. “It didn’t make sense,” because there was no apparent reason for HP to pay such big sums to accounts controlled by small-businesses such as ProSoft Krippner, Mr. Brunner said. Mr. Brunner then proceeded to say he processed the transactions anyway because he was the most junior employee handling the file, “I assumed the deal was OK, because senior officials also signed off on the paperwork”.

Why didn’t HP self report? 

The WSJ article reported that by December 2009, German authorities traced funds to accounts in Delaware and Britain. In early 2010, German prosecutors filed a round of legal-assistance requests in Wyoming, New Zealand and the British Virgin Islands, hoping to trace the flow of funds to new sets of accounts. Further, HP knew of the German investigation by at least December 2009, when police in Germany and Switzerland presented search warrants detailing allegations against 10 suspects. The New York Times, in an article dated April 16, 2010, reported that three former HP employees were arrested back in December 2009 by German prosecutors. Although it was unclear from the WSJ article as to the time frame, HP had retained counsel work with prosecutors in their investigation. Apparently, since the SEC only announced it had joined the German and Russian investigation last week, HP had not self-disclosed the investigation or its allegations to the US Department of Justice (DOJ) or SEC. 

Where were the SEC and DOJ? 

On April 16, 2010, the FCPA Professor wondered in his blog if it was merely coincidence that a few weeks ago the US concluded a Foreign Corrupt Practices Act (FCPA) enforcement action against the Daimler Corporation, an unrelated German company, for bribery and corruption in Russia and now it is German and Russian authorities investigating a US company for such improper conduct in Russia. The Professor put forward the following query: is such an investigation “Tit for tat or merely a coincidence?” And much like Socrates, he answered his own question with the musing “likely the later”. The WSJ LawBlog noted in its entry of April 16, 2010, that it would be somewhat unusual for the DOJ or SEC to stand by and watch European regulators conduct a sizable bribery investigation of a high-profile US company; phrasing it as “It’s like asking a child to stand still after a piñata’s been smashed open”.

In September, the WSJ reported that the HP bribery probe has widened and HP, itself, has announced that investigators have “now expanded their investigations beyond that particular transaction.” This original investigation pertained to an investigation of allegations that HP, through a German subsidiary, paid bribes to certain Russian officials to secure a contract to deliver hardware into Russia. The contract was estimated to be worth approximately $44.5 million and the alleged bribes paid were approximately $10.9 million. In a 10-Q filing made with the SEC, HP stated that the investigation has now expanded into transactions “in Russia and in the Commonwealth of Independent States sub region dating back to 2000.” The WSJ noted that US public companies, such as HP, are only required to report FCPA investigations in SEC filings if they “are material for investors.” 

4. Team Inc.- no de minimis exception in FCPA.  

As reported by the FCPA Professor, in August 2009, Team disclosed that an internal investigation conducted by FCPA counsel “found evidence suggesting that payments, which may violate the Foreign Corrupt Practices Act (FCPA), were made to employees of foreign government owned enterprises.” The release further noted that “[b]ased upon the evidence obtained to date, we believe that the total of these improper payments over the past five years did not exceed $50,000. The total annual revenues from the impacted Trinidad branch represent approximately one-half of one percent of our annual consolidated revenues. Team voluntary disclosed information relating to the initial allegations, the investigation and the initial findings to the U.S. Department of Justice and to the Securities and Exchange Commission, and we will cooperate with the DOJ and SEC in connection with their review of this matter.” 

There is no de minimis exception found in the FCPA there are books and records and internal control provisions applicable to issuers like Team. Thus, even if the payments were not material in terms of the company’s overall financial condition, there still could be FCPA books and records and internal control exposure if they were misrecorded in the company’s books and records or made in the absence of any internal controls. 

In its 8K, filed on January 8, 2010, Team reported “As previously reported, the Audit Committee is conducting an independent investigation regarding possible violations of the Foreign Corrupt Practices Act (“FCPA”) in cooperation with the U.S. Department of Justice and the Securities and Exchange Commission. While the investigation is ongoing, management continues to believe that any possible violations of the FCPA are limited in size and scope. The investigation is now expected to be completed during the first calendar quarter of 2010. The total professional costs associated with the investigation are now projected to be about $3.0 million.” 

So the FCPA Professor posed the question: 

A $3 million dollar internal investigation concerning non-material payments made by a branch office that represents less than one-half of one percent of the company’s annual consolidated revenues?” 

And his answer: “Wow!” 

In August, 2010, when disclosing its interim financial results for this year, Team reported, “The results of the FCPA investigation were communicated to the SEC and Department of Justice in May 2010 and the Company is awaiting their response. The results of the independent investigation support management’s belief that any possible violations of the FCPA were limited in size and scope. The total professional costs associated with the investigation were approximately $3.2 million.” 

So $50,000 in (possibly) illegal payments equate to over $6 million investigative costs, so far. 

5. ALSTOMArrests in the Board Room. 

As reported by the FCPA Blog, the UK Serious Fraud Office reported in dramatic fashion the arrest of three top executives of French industrial giant ALSTOM ‘s British unit. The three ALSTOM Board members were suspected of paying bribes overseas to win contracts. The SFO Press Release stated that “[t]hree members of the Board of ALSTOM in the UK have been arrested on suspicion of bribery and corruption, conspiracy to pay bribes, money laundering and false accounting, and have been taken to police stations to be interviewed by the Serious Fraud Office.” 

According to the release, search warrants were executed at five ALSTOM businesses premises and four residential addresses. The operation, involving “109 SFO staff and 44 police officers” is code-named “Operation Ruthenium” and centers on “suspected payment of bribes by companies within the ALSTOM group in the U.K.” According to the release, “[i]t is suspected that bribes have been paid in order to win contracts overseas.” 

ALSTOM released a statement which said: 

Several Alstom offices in the United Kingdom have been raided on Wednesday 24 March by police officers and some of its local managers are being questioned. The police apparently executed search warrants upon the request of the Swiss Federal justice. Alstom has been investigated by the Swiss justice for more than 3 years on the motive of alleged bribery issues. Within this frame, Alstom’s offices in Switzerland and France have already been searched in the past years. Alstom is cooperating with the British authorities. 

While not an FCPA investigation, this is one of the first cases where arrests were made of Board members. With the April 1 implementation date for the UK Bribery Act, we would anticipate a much more robust and aggressive enforcement by the UK SFO. 

We are indebted to our fellow bloggers, the FCPA Blog and the FCPA Professor for providing up to date and excellent reviews of many of the Top 10 investigations of 2010. If you did not review their sites daily in 2010, you should do so in 2011. 

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2010

December 12, 2010

RAE and Settlement of FCPA Violations in China

As reported on Friday, December 10, 2010 in the FCPA Blog and by others, RAE Systems, Inc., (RAE) a California-based gas detection company settled Foreign Corrupt Practices Act (FCPA) charges on this date with the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) for $2.9 million. The DOJ’s letter to the RAE CEO and its legal counsel, dated December 10, 2010, declined to prosecute the company and its subsidiaries for its admitted “knowing” of violations of the internal controls and books and records provisions of the FCPA. The DOJ entered into this Non-Prosecution Agreement (NPA) based upon four listed factors, which were detailed as follows: (1) timely and voluntary disclosure; (2) the company’s thorough and “real-time” cooperation with the DOJ and SEC; (3) extensive remedial efforts undertaken by the company; and (4) RAE’s commitment to periodic monitoring and submission of these monitoring reports to the DOJ. We will review this enforcement action and NPA over several blog postings. Today we will discuss the facts underlying the allegations and findings of bribery and corruption. 

I.                   The Joint Ventures and Due Diligence 

a. KLH 

The DOJ Statement of Facts, attached to the NPA as Appendix A, reports that RAE sold its products into China primarily through “two second tier subsidiaries” which were organized as joint ventures with local Chinese entities. One of these joint ventures, RAE-KLH, Limited (KLH) was originally owned 64% by RAE. This interest in KLH was initially purchased by RAE in 2004. Later, in 2006, RAE increased its ownership interest to 96%. Prior to its initial purchase of a stake in KLH, RAE conducted due diligence on the Chinese entity. This report made what the DOJ called “troubling findings” by noting: 

As the important clients are those related to the government, it is very important for the company to keep very good relationship [sic] with those government people. In normal practice, KLH will determine its internal product price, the salesmen can negotiate the price with the client based on that and can take away the difference between the internal product price and the final sales price as commission. It is the salesmen, not the company, who will decide the [sic] whether and how much amount of the commission they should give to the clients. The salesmen didn’t get the commission in cash directly, but instead they get the cash by provide [sic] different acceptable invoices. These invoices will then be used as original supporting documents for accounting records. They are recorded as different expenses in the financial statements. To some extent, the financial statements have been distorted by these commissions [sic]. 

With the change of market regulations in China, the government influence will be less important, there is a challenge as to whether KLH could still keep these clients. Although KLH let the salesmen to deal with the kickback, still they are the employees of the company and they represent the company in the transaction. 

Nevertheless, internal RAE documents simply noted that RAE knew “how much [FCPA] risk we are taking.” 

All of these practices were continued after RAE obtained its ownership interest in KLH. Indeed a RAE employee who reviewed KLH after the joint venture became effective noted “If you want them to be aggressive and grow business per set goals, they will do”. This same RAE employee, commenting on the institution of a FCPA compliance program for the joint venture, stated: 

It will be a challenge to restructure because it changes the way they have been “successful” and rewarded in the past. As you know, KLH sales guy [sic] behave/get compensated as distributors and get “discretionary discount structure” (any residual = compensation to keep or to dispense as they see fit to close deal. To kill the sales model that has worked for them all these years is to kill the JV deal value or hurt sales momentum. 

So we need to tread carefully in designing something halfway that won’t choke the sales engine and cause a distraction for the sales guys. We knew this risk all along and have accepted it upon entering the JV deal. 

After these reports, RAE did provide FCPA training and did inform KLH employees not to pay bribes. However, RAE seemed to believe that “we told them about [about the FCPA]…and that’s all we can do.” As you might guess, based upon this non-action, these bribery practices continued unabated even after such conduct was reported again to RAE management. The DOJ noted that while RAE senior management did indicate such bribery payment should cease, the company made “no effective effort to actually stop the practice.” Most interestingly, the RAE Financial Controller in China was directed to perform an internal audit on these issues but “he never provided any findings.” 

So just what is “troubling” about this sales method? Initially, it appears that the sales person involved in each transaction sets the price, without corporate oversight. But for FCPA purposes the most troubling aspect is that the sales person involved would receive the difference in the internal product price and final sales price as a commission. To compound the problem there was apparently a double accounting of these amounts in the books and records which distorted the company’s financial statements. This structure allowed KLH employees to use this money “under table greasing to get deals regardless if profitable/collectible or not, kosher or not, etc.” 

The DOJ reported that as late as 2008, sales representatives of KLH used monies from this commission scheme for improper purposes. These purposes included the “corrupt giving of gifts and paying for entertainment, as well as direct and indirect payment, to customers”. 

            b. Fushun 

In December, 2006 RAE purchased a 70% interest in another Chinese company named Fushun. RAE also operated Fushun as a joint venture but included Fushun’s financial results in the consolidated financial statements that RAE filed with the SEC. For reasons not stated in theNPA, RAE did not conduct pre-acquisition due diligence on Fushun. However, sometime later, RAE obtained information that Fushun did engage in business practices improper under the FCPA and thereafter, failed to implement an effective system of internal controls at the joint venture. 

II.                The Payment Scheme(s) 

As noted above, the KLH sales force set pricing and was able to obtain the difference between the price book pricing and the as-purchased pricing. In addition to this source of cash, which could be used for bribery and corruption, both joint ventures had reimbursement schemes through which joint venture employees would submit alleged Chinese governmental tax documents which did not support the claimed reimbursement, yet RAE would pay out cash for reimbursement purposes. From such reimbursements, gifts were made to family members of Chinese governmental officials and two contracts for “consulting services” valued over $300,000 were used to funnel monies to Chinese governmental officials. The Fushun joint venture used this reimbursement scheme to provide gifts to officials of state owned enterprises which included “jade, fur coats, kitchen appliances, business suits and high-priced liquor.” 

From all of the above information, the DOJ was able to conclude that RAE knowingly failed to implement a system of effective internal accounting controls at both joint ventures which was sufficient to provide reasonable assurances that: (i) transactions were executed in accordance with management’s general or specific authorization; (ii) transactions were recorded as necessary to (a) permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and (b) maintain accountability for assets; (iii) access to assets were permitted only in accordance with management’s general or specific authorization; and (iv) the recorded accountability for assets was compared with the existing assets at reasonable intervals, and appropriate action taken with respect to any differences. 

Download the DOJ’sNon-Prosecution Agreement with RAE Systems Inc. here.

Download the SEC’s civil complaint against RAE Systems Inc. here.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2010

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