EARNING COOPERATION CREDIT IN AN FCPA CASE

Cooperation is often critical to effective law enforcement. SEC enforcement director Robert Khuzami has acknowledged this point in recent public remarks, noting that he would like to develop incentives to encourage more cooperation by individuals.

For corporations, the SEC, like the Department of Justice and other federal law enforcement agencies, has long held out the prospect of credit in the charging process in exchange for cooperation. While there is no talismanic test which will guarantee a company that it can secure enough credit to avoid being charged, the SEC’s Seaboard Release, discussed here, contains an example of a company that did in fact earn sufficient credits and discusses general principles regarding cooperation.

Typically, when acknowledging that a company has cooperated, the Commission does not enumerate what specific acts were done or how they benefited the company. One notable exception last year occurred in In the Matter of Black, Adm. Proc. File No. 3-13625 (Sept. 24, 2009) and SEC v. Black, Case No. 09-cv-0128 (S.D. Ind. Sept. 24, 2009). These are the Reg. FD actions brought against Christopher Black discussed here. There, the Commission discussed the reasons an action was not brought against the company.

The Commission’s discussion of the cooperation of NATCO Group Inc. in resolving an FCPA case this week provides an additional window into the otherwise opaque world of cooperation credit. In the Matter of NATCO Group Inc., Adm. Proc. File No. 3-13742 (Filed Jan. 11, 2010); SEC v. NATCO Group, Inc., Civil Action No. 4:10-CV-98 (S.D. Tex. Filed Jan. 11, 2010). See also Litig. Rel. 21374 (Jan. 11, 2010). These FCPA cases were settled with a consent by the company to a cease and desist order based on the FCPA books and records and internal control provisions and the payment of a $65,000 penalty.

Houston-based NATCO manufacturers and markets oil and gas production equipment and systems that are used worldwide. TEST Automation & Controls is a wholly owned subsidiary with an office in Kazakhstan. The subsidiary fabricates and sells control panels and packaged automation systems and furnishes related field services.

According to the Order, TEST won a contract to provide certain instrumentation and electrical services in Kazakhstan. The subsidiary hired local Kazakh workers and expatriates to perform the work. During an audit of TEST in 2007, Kazakh immigration prosecutors claimed that the expatriate workers did not have the proper documentation and threatened to impose fines and to either jail or deport the workers if the company did not pay the fines. TEST senior management approved the payments based on the belief that the workers would be jailed. A February 2007 $25,000 wire transfer made to an affected employee was inaccurately described as a salary advance. A subsequent $20,000 wire transfer to reimburse other payments advanced by the individuals was booked as “visa fines.”

TEST used consultants to assist in obtaining immigration documentation for the expatriate employees. One consultant who did not have the proper license, but had close ties to the Ministry of Labor requested cash in two instances to facilitate obtaining the visas. To secure the payments, the consultant provided TEST with bogus invoices totaling $80,000 for the funds. The invoices, which were necessary under local law to withdraw the money from the bank, were later submitted to TEST and reimbursed despite knowledge of the true purpose.

The cooperation of the company was critical to the settlement. The Order for Proceedings details eleven specific steps taken by the company which the Commission considered in evaluating credit which do not reference the waiver of privilege:

1) NATCO discovered the TEST payments during a routine internal audit review in 2007;

2) The company conducted an internal investigation and self-reported to the SEC;

3) It undertook what were described as “numerous remedial measures” including “employee termination and disciplinary actions;”

4) It revised the form of documentation for agent agreements;

5) New due diligence procedures for the vetting and the retention of third party intermediaries were created;

6) Staffing in the global compliance department was bolstered including the retention of a full time Chief Compliance Officer;

7) The company joined a non-profit association which specializes in anti-bribery due diligence and screens potential partners and other third parties that work with multinational corporations;

8) Improved FCPA compliance training was implemented;

9) The company invested heavily in software to assist in enhancing internal controls and compliance;

10) It restructured its internal audit function and enhanced its monitoring and audit process for the compliance programs; and

11) In view of its initial findings, the company expanded its review into other high risk areas and did not find any malfeasance.

To foster cooperation in the future it would be beneficial if the Commission continues to provide such guidance.

CONCLUSION: TRENDS IN SECURITIES ENFORCEMENT 2010

This is the conclusion to a series of articles examining future trends in securities enforcement.

The SEC has long been the leader in securities enforcement, not just in the United States, but around the globe. Its hard and often visionary work over the years has helped make the U.S. securities markets the envy of the world. The leadership of the agency in areas ranging from the Foreign Corrupt Practices Act to insider trading and corporate governance under Sarbanes Oxley has been emulated around the world. The FCPA, for example, was heavily criticized when first enacted in the 1970s as a statute which would cause the U.S. to lose its competitive edge. Now it has been emulated in many countries that join with the Commission and DOJ in their enforcement efforts. Its campaign against insider trading, on-going since at least the 1980s, is being duplicated in other countries like the UK, where the first criminal insider trading case was brought last year, Sweden, which brought its largest ever insider trading case, and Hong Kong, where the first prison sentences were hand down last year for insider trading.

Now, however, the Securities and Exchange Commission is at a cross road. The opportunities are great, but the pitfalls are many and it has a dismal record in recent years to overcome. As the worst market crisis since the Great Depression begins to slowly subside, there are new calls for regulation and oversight. Following years of deregulation and a free market philosophy which saw regulatory authority more often than not curtailed, there is a recognition that the regulatory landscape has to be redrawn. Congress is poised to act and give regulators such as the SEC, CFTC and others new authority. New regulators may be created. While the precise contours of the new regulations are only now coming into focus, it seems certain that the SEC will receive more authority and more resources.

Through her first year in office, SEC Chairman Mary Schapiro and the other Commissioners have positioned the Commission to take advantage of the new environment. Taking over an embattled agency mired in scandal, Ms. Schapiro moved quickly to stem talk of merging the agency out of existence and has made it a player at the regulatory table, vying for additional authority and recognition. An ambitious list of rule-making projects has been initiated, ranging from short selling to dark pools to investment advisers. New senior staff has been brought in with a mandate to reorganize, rejuvenate and move forward quickly and efficiently.

In enforcement, new Director Robert Khuzami has been busy implementing the Commission’s mandate. To speed the processes Mr. Khuzami has been given authority previously reserved to the Commission to issue formal orders of investigation and authorize the institution of subpoena enforcement actions. To facilitate investigations, more boots are being put on the ground by reorganizing the division and eliminating a layer of management. New processes have been instituted to speed the intake and analysis of tips about possible cases and management expertise for the entire division has been added. All of this is being supplemented with additional expertise that the new specialty groups will bring to the division.

A creative and aggressive approach threads through the case load of the Enforcement Division last year which suggests the program is on the mend. Cases such as Dorozhko, Cuban, Rorech and Condroyer reflect the kind of aggressive approach that has made the SEC the world leader in insider trading enforcement. Others such as INTECH, Equity Services, Ameriprise and Perry Corporation clearly suggest that enforcement is actively policing the markets and the interests of investors.

At the same time, there are cautionary notes on the horizon. Leading the pack is the Bank of America debacle. The Commission’s claims there its investigation was blocked by privilege and that the large penalty offered would send a message to the shareholders about the kind of management at the bank more than earned the court’s scathing rejection.

The lack of market crisis cases despite the huge investment of resources also raises concerns about the effectiveness of enforcement, as does the need to repeatedly replead the complaint in Fraser simply to state a cause of action. Surely after a lengthy investigation of years old conduct by a now bankrupt company the staff can find sufficient facts to state a cause of action.

Likewise, the overly harsh interpretation of SOX 304 in Jenkins, which ironically is built on the fraud in Fraser, also raises significant concerns. Perhaps the Commission’s reading of the statute is supported by a literal reading of the statute text. At the same time however, it represents, at best, questionable enforcement policy. This approach does not encourage management to do a better job of monitoring. Rather, it simply punishes the luckless who had the misfortune of working with those who turned out to be secretly dishonest.

This same approach seems to be driving what is clearly an over reliance on corporate penalties at the expense of the Commission’s traditionally creative approach to the use of ancillary relief to prevent a replication of violations in the future. The settlement in General Electric, for example, may generate big headlines. After those fade, however, there is nothing in place to safeguard the shareholders and the markets from a replication of the wrongful conduct in the future. Yet, in this case, the underlying conduct was at least, in part, in part as unseemly as the infamous Enron barge deal.

The settlement in the Ernst & Young only raises more questions about the focus of enforcement. While the settlement does contain undertakings offered by the firm, their adequacy is at best unclear. There is no evaluation of the procedures offered by the firm or on-going monitoring process. Unfortunately, what is clear is the fact that a key component of the settlement is the payment “in the nature of a penalty.”

The notion that big penalties are a substitute for remedial procedures should have been debunked by the Bank of America deal, where the bank all but said it was simply buying peace while insisting it did nothing wrong. Stated differently, payment of the penalty simply means that the shareholders are out a substantial amount of cash. Bank management is not changing a thing in the future. In the end big penalties for big corporations equal big headlines, nice statistics and good congressional testimony, but not effective enforcement.

The question moving forward is whether the Securities and Exchange Commission can again be the leading securities market regulator. The good workmanlike start to rejuvenating the SEC and its enforcement program should not be confused with returning to the leadership position the agency once enjoyed. Lists of rule-making projects, new management and reorganizations are useful and perhaps saved the SEC from being dismantled but they do not restore the Commission to its position of leadership. Speed and efficiency are all well and good, but they are only a means to an end. Likewise, touting the interests of investors is consistent with the statutory mandate of the agency, but it is not a substitute for a vision of how the federal securities laws will bring a new ethics to the marketplace in a new decade.

If the SEC is to regain its perch as the preeminent securities regulator, it starts with this vision. There is a good start. The systems are in place. Congress is poised to act. Now it is time to roll out the vision and implement it.

Seminar sponsored by the ABA Criminal Justice Section: January 13, 2010, Enforcement Trends in Securities & Commodities Actions 2010, in person in Washington, D.C. at 600 14th St. N.W. 9th Floor and webcast nationally. http://www.abanet.org/cle/programs/t10ets1.html

Speakers: Adam Safwat, Deputy Chief, Fraud Section, Department of Justice; Steve Obie, Director, Division of Enforcement, CFTC; Laura Josephs, Assistant Director, SEC Division of Enforcement and Cheryl Evans, Special Counsel U.S. Chamber Initiatives For Legal Reform.