FCPA Compliance and Ethics Blog

December 23, 2010

Top Ten FCPA Enforcement Actions in 2010-Part II

Yesterday we posted Part I of our Top 10 Foreign Corrupt Practices Act (FCPA) enforcement actions of 2010. Today we conclude the list. Although the holiday season is here, we would be remiss if we did not note that Houston Chronicle sports columnist Richard Justice pointed out in his column this morning that there are only 55 days until pitchers and catchers report to Spring Training. So for you baseball mavens out there, and we know who we are, good tidings abound. Now to Part II…

6. Panalpina Settlements-In what the FCPA Blog termed a history making day “for the most companies to simultaneously settle FCPA-related violations”, the worldwide logistics firm Panalpina and five of its oil-and-gas services customers resolved charges with the DOJ and SEC, and another customer settled with the SEC for a total fines and penalties of $236.5 million. The customers of Panalpina which settled were Shell Nigeria Exploration and Production Company Ltd. (“SNEPCO”), a Nigerian wholly-owned subsidiary of Royal Dutch Shell; Transocean, Inc.; Pride International Inc. and Pride Forasol S.A.S.; GlobalSantaFe [now owned by Transocean], Tidewater, Inc. and Noble Corporation which did not receive a DPA but was granted a Non-Prosecution Agreement.

However more was announced yesterday than simply raw dollars. Each resolved enforcement action provided to the FCPA compliance practitioner significant information on the most current DOJ thinking on what constitutes a best practice FCPA program. Each of the Deferred Prosecution Agreements released yesterday, included an Attachment C, a document entitled “Corporate Compliance Program”. Each Corporate Compliance Program was the same in all the DPAs announced yesterday. This same information was also attached to the Noble Non-Prosecution Agreement as “Attachment B”. Hence, this information is a valuable tool by which companies can assess if they need to adopt new or to modify their existing internal controls, policies, and procedures in order to ensure that their FCPA compliance program maintains: (a) a system of internal accounting controls designed to ensure that a Company makes and keeps fair and accurate books, records, and accounts; and (b) a rigorous anti-corruption compliance code, standards, and procedures designed to detect and deter violations of the FCP A and other applicable anti-corruption laws. It is noted that in the Preamble to each Corporate Compliance Program noted that these suggestions are the “minimum” which should be a part of a Company’s existing internal controls, policies, and procedures.

7. RAE Systems, Inc.-Lessons learned-companies are fully liable for their joint ventures actions and that even with actual knowledge of FCPA violations, conduct during the DOJ investigation can result in a Non-Prosecution Agreement. However this liability need not lead to criminal sanctions as RAE received a letter of Non-Prosecution from the DOJ. The DOJ’s letter to the RAE CEO and its legal counsel 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 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.

Representatives from both the DOJ and SEC have been preaching the virtues and tangible benefits of self-disclosure and thorough cooperation with their respective agencies in any FCPA investigation or enforcement action. This RAE matter would appear to provide specific evidence of the benefits of such corporate conduct. The NPA reports that RAE had actual knowledge of FCPA violations yet no criminal charges were filed. Further, no ongoing external Corporate Monitor was required. Clearly RAE engaged in actions during the pendency of the investigation which persuaded the DOJ not to bring criminal charges.

Any company facing a FCPA enforcement action should study this matter quite closely and, to the extent possible, determine the steps that RAE engaged in or performed. The RAE enforcement action together with the Noble enforcement action which resulted also in a Non-Prosecution Agreement, were also reached with no external Corporate Monitor. No criminal penalties and no External Monitor are important examples of the tangible benefits for working closely with the DOJ in any FCPA enforcement matter.

8. Gerald and Patricia Green-Although this FCPA criminal enforcement action was tried to a jury in the summer of 2009, the two defendants, husband and wife Gerald and Patricia Green were not sentenced until the summer of 2010. The trial judge’s sentence would appear to reflect the growing disparity between the sentences that the DOJ requests and those handed down by courts. The DOJ had originally sought a sentence of 25 years for Gerald Green (later reduced to requesting 10 years) and a ten year sentence for Patricia Green. US District Judge George Wu sentenced the couple to 6 months each.

While this sentence reduction may result in more personal freedom, Judge Wu granted the DOJ request for asset forfeiture, which means simply, as noted by the FCPA Blog “any assets derived from proceeds traceable to a violation of the FCPA, or a conspiracy to violate the FCPA, can be forfeited”. Each of the Greens owe $1,049,465 under the forfeiture, plus their shares in their company, Artist Design Corp., and its pension plan. The amount owed is so great that the DOJ is attempting to seize the home residence of the Greens because the forfeiture penalty cannot be fully satisfied without the proceeds of the home sale. The DOJ has obtained such complete forfeiture of the couples’ assets such that they have filed in forma pauperis appeals.

9. Haitian Telecom-While this case generated much discussion in the FCPA world, particularly regarding an idea derived from an article in the Wall Street Journal entitled “Democrats and Haiti Telecom” that enforcement of the FCPA in Haiti should be suspended in the aftermath of the devastating earthquake which hit the island earlier this year. This was based on the fact that US companies simply could not do business in Haiti without violating the FCPA so they simply refuse to do so. To entice US companies to assist in the rebuilding efforts, the DOJ should suspend enforcement of the FCPA for some limited period of time. This idea was not seized upon by the DOJ.

While this debate was interesting, this case makes the Top 10 list because of what happened to the foreign officials who accepted the bribes. The FCPA only applies to bribe givers and not bribe recipients, the charges brought against the foreign officials who accepted the bribers were not FCPA charges, but rather a money laundering conspiracy charge. As reported by the FCPA Professor, these money laundering charges led to guilty plea by Robert Antoine (a former Director of International Relations of Haiti Teleco responsible for negotiating contracts with international telecommunications companies on behalf of Haiti Teleco). He was sentenced to four years in prison. In addition, Antoine was ordered to serve three years of supervised release following his prison term, ordered to pay $1,852,209 in restitution, and ordered to forfeit $1,580,771.

10. Innospec-Fine and Penalty waiver for inability to pay? In March 2010, Innospec agreed to pay $40.2 million in combined DOJ/SEC/SFO fines and penalties for violating the Foreign Corrupt Practices Act and other laws. However, as noted by the FCPA Professor, it could have been worse. The SEC release noted that Innospec, without admitting or denying the SEC’s allegations, was ordered to pay $60,071,613 in disgorgement, but because of Innospec’s “sworn Statement of Financial Condition” all but $11,200,000 of that disgorgement was waived. The release states that “[b]ased on its financial condition, Innospec offered to pay a reduced criminal fine of $14.1 million to the DOJ and a criminal fine of $12.7 million to the SFO. Innospec will pay $2.2 million to OFAC for unrelated conduct concerning allegations of violations of the Cuban Assets Control Regulations.” As noted by the FCPA Professor, “Innospec got a pass on approximately $50 million.”

So Ho Ho Ho to all our readers and we hope you have a very Merry Christmas.

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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