FBI STING OPERATION NETS HUGE FCPA CASE: BLUE COLLAR TACTICS IN WHITE COLLAR CASES

The Galleon insider trading cases have drawn considerable attention for their use of techniques not typically seen in white collar crime cases. Those include the use of wire taps and informants wearing wires. These techniques permitted the government to witness or listen in on exchanges of what is alleged to be inside information and illegal trading.

These so-called blue collar tactics have long been used in organized crime and other types of criminal cases. Now these techniques are being used in FCPA cases. DOJ and the FBI unveiled an undercover sting operation used to build FCPA charges against twenty-two individuals charged in sixteen indictments. The cases, filed in the District of Columbia, represent what the Department is calling the first large scale use of undercover law enforcement techniques in an FCPA case. It is also the largest action ever undertaken by DOJ against individuals for violations of the Foreign Corrupt Practices Act.

The indictments, unsealed yesterday, all center a sting operation in which an undercover FBI agent, posing as a sales agent, met with executives of various companies in the defense supply business. The executives were told that the defense minister for an African country was prepared to spend $15 million to outfit the country’s presidential guard. The so-called agent then told the executives that a 20% “commission” was required. Half of the commission would go to the agent and half to the minister. To participate, the executive would then agree to create two price quotes for the equipment. One quote did not have the commission. The other included it.

U.S. v. Goncalves, Case No. CR – 09-335 (D.D.C. Unsealed Dec. 19, 2009), which names as a defendant Amaro Goncalves, is typical of the indictment stemming from the sting. The defendant is the Vice President of Sales of Company A, a U.S. entity headquartered in Springfield, Massachusetts. The company, whose shares are traded on NASDAQ, is a world wide leader in the design and manufacture of firearms.

According to the indictment, Mr. Goncalves met with a self-employed sales agent friend, who in turn introduced him to an agent (identified as UA-1) claimed to be tasked by the Minister of Defense of the African country with obtaining the required material. In reality, UA-1 was an under cover FBI agent. During a meeting at the Ritz-Carlton Hotel in Washington, D.C. with the sales agent and UA-1, Mr. Goncalves is alleged to have agreed to proceed with a deal involving the African country in which the 20% sales commission would be added to the cost of the merchandise. The deal was set up in two phases. The first was a small “test” and the second was the actual deal.

During the test phase, Mr. Goncalves is alleged to have confirmed the arrangement in e-mails. Those included price quotations with the so-called commissions. Mr. Goncalves is also alleged to have sent a wire transfer of the 20% commission to UA-1’s bank account. Half of the payment was for UA-1 and half for the Minister.

Mr. Goncalves was later told at a meeting with the sales agent and another undercover FBI agent that the Minister of Defense was pleased with the test. He was furnished with a written agreement for the second phase. That agreement, which contained the alleged corrupt commissions, was executed by the defendant.

The indictment contains counts alleging conspiracy to violate the FCPA, violations of that Act and conspiracy to commit money laundering. It also contains a forfeiture count. The other fifteen indictments are based on the same core of factual allegations.

To date, the SEC has not brought parallel actions.

SEC’S ORDER REQUIRING RESTITUTION REJECTED AS “NONSENSE”

The D.C. Circuit reversed a Commission ruling upholding an order requiring a broker to pay restitution in a “trading away” case. The court concluded that “the SEC decision borders on whimsical or rests on notions of strict liability.” The case was sent back to the SEC for reconsideration. Siegel v. SEC, Case No. 08-1379 (D.C. Cir. Decided Jan. 12, 2010).

The case is based on a disciplinary action brought by the NASD against Michael Siegel. From 1997 through June 1999, Mr. Siegel was employed as a registered representative with Rauscher Pierce Refsnes, Inc., an NASD firm member. The NASD’s Department of Enforcement filed a complaint against Mr. Siegel in 2002 alleging that while employed with Rauscher he violated the Code of Conduct rules with respect to four clients. Those clients invested in World Environmental Technologies, Inc., a speculative start-up company which eventually failed, wiping out their investment.

The NASD complaint claimed that Mr. Siegel violated NASD Conduct Rules 3040 and 2110 when he “sold away,” that is engaged in private securities transactions on behalf of his clients without notifying the firm. It also alleged violations of Rules 2310 and 2110 when he recommended World ET without having reasonable grounds to do so. The record demonstrated that the clients were sophisticated and wanted to speculate. Mr. Siegel, who knew the company and had served on its board, did not read the prospectus he furnished the clients about the company. He did not make anything on the transactions.

The hearing panel concluded that Mr. Siegel violated the rules as alleged in the complaint. It imposed a six month suspension and a $20,000 fine for the violation of Rules 3040/2120 and a six month suspension and a $10,000 for violations of Rules 2310/2110. It did not require restitution. The suspensions were to be served concurrently. On appeal to the NASD’s National Adjudicatory Council, the decision of the panel was affirmed. However, Mr. Siegel was ordered to pay restitution and his suspensions were to be served concurrently. The SEC affirmed this decision.

The DC Circuit reversed and remanded the case to the SEC for further consideration by the on the question of restitution. That question focuses on the cause of the loss suffered by the clients, the court noted. Restitution is payable under Principle 5 in NASD’s Sanction Guidelines to remediate misconduct in certain circumstances. Specifically, it can be order when “when an identifiable person . . . has suffered a quantifiable loss as a result of a respondent’s misconduct, particularly where a respondent has benefited from the misconduct.”

Under this principle, there must be a demonstration of a causal connection between the broker’s misconduct and any loss at issue. In assessing the question of causation the Circuit Court noted that there are various theories of causation which range from “but for” to “proximate” to “substantial factor” to “loss causation.” Each theory approaches the question of causation from a different vantage point. “But for” causation, the Court noted, may be almost limitless. “Proximate causation,” on the other hand, would require a direct relation between the conduct and the alleged injury. The “substantial factor” test is used when there have been two or more concurrent causes. In contrast, “loss causation” focuses on the reason why the investment was lost and would preclude an award where the investment would have been lost regardless of the fraud.

After reviewing these tests, the Court noted that the use of these tests may not always be clear or mutually exclusive. Nor is the list exhaustive. At the same time, the Court stated it did not know which test should be used under Principle 5. Making this determination is the responsibility of the SEC. The Commission, however, failed to offer any explanation of the applicable test of causation. Rather, the SEC offered only a footnote commenting on causation which the court described as “nonsense.” Accordingly, the matter was remanded to the SEC to reconsider the question of causation and restitution.