BAE SUBSIDIARY ARMOR HOLDINGS SETTLES FCPA ACTIONS

Armor Holdings, Inc. resolved FCPA charges with the Department of Justice and the SEC. The charges stem from bribes paid by subsidiaries to obtain three contracts to supply body armor for U.N. peacekeepers. In a bit of irony the DOJ noted that the company will not be required to have a monitor because it has incorporated the compliance systems of its new parent BAE which was fined $400 million for FCPA violations just last year.

Armor Holdings is an issuer which manufactures body armor. Two subsidiaries of the company involved here are Armor holdings Products, LLC or AHP, headquartered in Florida, and Armor Products International, Ltd or API, owned by a U.K subsidiary of AHP. Between 2001 and 2006 API was awarded two contracts and an extension on one by the U.N. to supply body armor. The first was in October 2001 while the second was in February 2003. In 2006 the company secured the one year extension. From these contracts the company obtained gross revenue of about $7.1 million and profits of about $1.5 million.

According to the SEC’s complaint, the contracts were obtained as a result of a scheme involving an AHP vice president and an API senior officer who were allegedly acting as agents of Armor Holdings.. The two officers caused API to enter into a sham consulting agreement with a third party intermediary for purported services in connection with obtaining the U.N. contracts. Beginning in 2001 API received various invoices from the third party intermediary supposedly rendered in connection with securing the contacts. The commissions charged were as high as 20% of the value of the goods Agents of Armor Holdings “knew or consciously disregarded that some portion of these commissions would be offered to a U.N. official,” according to the Commission. This is because in September 2001 the intermediary instructed API to provide a signed, but otherwise blank, pricing sheet that would be completed after learning from a U.N. procurement official about the non-public bids submitted.

The commissions were not properly accounted for in the books and records. Typically AHP sent the foreign-government customer an invoice which included the sales prices plus the commission. Internally the company recorded the sale net of the commission. GAAP however requires that the sales be recorded at the full sales price with the commission shown as a separate entry. The difference between the booked amount and the payment would be transferred through a series of accounts and then disbursed to the third party sales intermediary. Those amounts were never recorded as commissions on the books and records of Armor Holdings. Over the period about $4.3 million was paid in commissions in 92 transactions.

Armor Holdings resolved the matter with the Department of Justice by entering into a deferred prosecution agreement and paying a fine of $10.2 million. The company also agreed to continue implementing the policies and procedures of BAE and report to the DOJ on the status of those efforts. The settlement reflects the fact that the company self-reported, conducted an internal investigation, cooperated with the Department and the SEC and extensively implemented the systems of BAE according to the DOJ.

To settle with the SEC, Armor Holdings consented to the entry of a permanent injunction prohibiting future violations of the anti-bribery and books and records and internal controls provisions of the FCPA. The company also agreed to pay disgorgement of $1,552,306 along with prejudgment interest and a civil penalty of $3,680,000. Armor Holdings was also ordered to comply with certain undertakings regarding its FCPA compliance program. The Commission noted that the company conducted a through internal investigation and cooperated with its inquiry. SEC v. Armor Holdings, Inc., Case No. 1:11-cv-01271 (D.D.C. Filed July 13, 2011).

THE GUPTA CASE: EFFECTIVE LAW ENFORCEMENT BEGINS WITH FAIRNESS

Fairness, and the appearance of fairness, is critical for regulators and law enforcement officials. This helps foster respect for the law which in turn encourages cooperation with enforcement officials and compliance. In contrast, actions which are unfair, or appear to be, can seriously undermine the effectiveness of law enforcement officials.

The question of fundamental fairness is at the center of the recent decision by Judge Rakoff to deny a motion to dismiss filed by the SEC in Gupta v. SEC, Civil Action No. 11 Civ 1900 (S.D.N.Y. Ruling dated July 11, 2011). The court concluded that Mr. Gupta had raised an issue of equal protection under the Constitution which states a viable claim.

The suit was brought by Rajat Gupta, the former Goldman Sachs director who is a Respondent in a Commission administrative proceeding accusing him of insider trading. He was also a witness at the trial of Raji Rajaarathnam. In the Matter of Rajart Gupta, Adm. Proc. File No. 3-14279 (March 1, 2011). In his complaint Mr. Gupta claims, among other things, that he has been denied his right to equal protection under the law as guaranteed by the U.S. Constitution. The claim has two key facets. First, every other Galleon related defendant accused of insider trading has been named as a defendant in a case filed in Federal District Court. He is the only person named as a Respondent in an SEC administrative proceeding. Second, the SEC wants to retroactively apply the provisions of Dodd-Frank, passed after the acts alleged in the complaint, to impose a civil penalty which could not have been ordered at the time of the alleged wrongful conduct.

As Judge Rakoff takes pains to point out in his opinion, normally claims for selective prosecution or bad faith prosecution are dismissed. It is clear that law enforcement agencies such as the SEC have broad prosecutorial discretion which vests them with the right to configure the charges and select an appropriate forum. Typically that discretion will not be second guessed by the courts. This is as it should be.

Nice legal arguments were made by the SEC suggesting the case should be dismissed. Those center on claims related to procedure, immunity or wrong forum. None have anything to do with the merits. Judge Rakoff carefully analyzed each. In his opinion he rejected each one. The court did narrow the claims to center on one involving equal protection.

Whether the Commission ultimately prevails in this case is a question for another day. Even if the SEC ultimately wins it will not erase the tinge of unfairness here. As the Court points out in its opinion, 28 other persons and entities accused of Galleon related insider trading have had actions brought against them in Federal Court. The allegations in those cases are substantially similar to those asserted in the administrative proceeding against Mr. Gjupta. These facts alone raise questions about the Gupta administrative proceeding.

The suggestion of unfairness is only enhanced by consideration of the types of actions typically brought in administrative proceedings and the procedural difference between that forum and Federal Court. Rarely has the SEC brought an insider trading case as an administrative proceeding. The forum of choice is, as the Galleon related cases demonstrate, Federal Court, not an SEC administrative proceeding.

The procedural differences are also significant. In Federal Court all parties can develop the pertinent facts using the extensive discovery tools available. In an administrative proceeding, in contrast, there is virtually no discovery. The SEC staff, however, will have had ample opportunity to fully develop the facts through the Commission’s extensive investigative powers prior to filing the proceeding. The Respondent has no such right or opportunity. In Federal Court the Federal Rules of Evidence carefully sift the evidence to ensure its trustworthiness and reliability. Those Rules do not apply in administrative proceedings meaning a Respondent in such a proceeding does not have the same safeguards as a defendant in Federal Court.

The request for a civil penalty against Mr. Gupta amplifies the odor of unfairness. Prior to the passage of Dodd-Frank the Commission could not seek to impose a civil penalty on a person such as Mr. Gupta in an administrative forum. Nothing in the Dodd-Frank provision indicates it was intended to be retroactive. Indeed, provisions which enhance punishment typically can not be given retroactive effect. There is no doubt that the conduct at issue in the case against Mr. Gupta occurred prior to Dodd- Frank and that applying the new penalty provision in his case increases punishment. Again the SEC may be able to make nice legal arguments to support its claim, but it appears unfair.

Overall, by bringing the insider trading case against Mr. Gupta as an administrative proceeding the Commission looks like the gambling house that puts it thumb on the roulette wheel, tilting the role to its advantage. Good, effective law enforcement can ill afford such an appearance. This is particularly true for an agency that has struggled in recent years to restore its lost luster in the wake of a string of high profile errors and gaffs. Regardless of the outcome of the suit before Judge Rakoff, the SEC has already lost. More importantly, effective law enforcement has lost.