The settled FCPA actions filed yesterday by the SEC should serve as a clear warning to issuers regarding the necessity for FCPA compliance programs and for strong controls not just at the company, but with regard to transactions with business partners and agents. SEC v. Con-way Inc., Civil Action No. 1:08-CV-01478 (D.D.C. August 27, 2008); In the Matter of Con-Way Inc., Adm. Proc. File No. 3-13148.

The complaint and Order for Proceedings allege that Con-way violated the books and records and internal controls provisions of the FCPA as a result of payments made by Philippine-based Emery Transnational. From 2000 to 2003, Emery made hundreds of small payments which totaled $417,000 to Philippine customs officials and to officials of numerous majority foreign state-owned airlines. The payments were made with the purpose and effect of improperly influencing these foreign officials to assist Emery to obtain and retain business.

According to the Commission, Con-way, through its U.S. based wholly owned subsidiary, Menlo Worldwide Forwarding, Inc., did business with Emery. Menlo received a yearly 55% dividend from Emery and Con-way and Menlo required that Emery report its net profits.

Based on these facts, the Commission concluded that Con-way and Menlo failed to ensure compliance with the FCPA by Emery. The Order for Proceedings states that “Con-way and Menlo Forwarding engaged in little supervision or oversight over Emery . . . Neither Con-way nor Menlo … took steps to devise or maintain internal accounting controls concerning Emery … to ensure that it acted in accord with Con-way’s FCPA policies, or to make certain that its books and records were detailed or accurate.” According to the Commission’s papers, none of the payments made by Emery were properly recorded on Con-ways books and records. As a result, the SEC concluded that Con-way violated the books and records provisions of the FCPA.

The improper conduct was discovered by Con-way, which conducted a broad review of the practices and disclosed the existence of possible FCPA violations to the SEC staff. At the conclusion of its inquiry Con-way imposed heightened financial reporting and compliance requirements on Emery, which like Menlo, was later acquired, and provided additional FCPA training and education to its employees. The SEC did not commend the company for its cooperation.

To resolve these matters, Con-way consented to the entry of an order in the civil action requiring that it pay a $300,000 civil penalty. In the administrative proceeding, the company consented to the entry of an order directing that it cease and desist from violations of the books and records provisions of the FCPA.

In view of the breadth of the FCPA books and records provisions, every issuer and particularly those with business partners in some corners of the world should carefully review its FCPA compliance procedures and its controls.

Naked short selling and its impact on the market is becoming a recurring topic. The SEC recently took the extraordinary step of banning short selling in the shares of Fannie Mae, Freddie Mac and primary dealers at commercial and investment banks unless certain steps are met in view of the current market crisis, as discussed here. Now, in the wake of criticism regarding the selective nature of the ban, the Commission is reportedly considering extending it.

In court, the SEC has had more difficulty with its short selling theories. In hedge fund cases involving the short selling of company shares in connection with a PIPE offering for example, the Commission has lost each claim it litigated with court’s rejecting the SEC’s argument that using the shares which would be registered under the resale registration statement of the PIPE violated Section 5 as discussed here.

Now, the Ninth Circuit has rejected state law claims based on naked short selling brought against the Depository Trust & Clearing Corporation, the Depository Trust Company and the National Securities Clearing Corporation. Whistler Investments, Inc. v. The Depository Trust and Clearing Corporation, Case No. 06-16088 (9th Cir. August 22, 2008).

In that case, Whistler Investments, Inc., a publicly traded company, claimed that naked short selling facilitated by the three clearing agency defendants drove down the price of its stock, thereby injuring the company and its shareholders. According to the complaint, National Securities Clearing created a Stock Borrow Program to facilitate the settlement of failure-to-deliver transactions. Under this program, when there is a failure-to-deliver settlement, it is facilitated by electronically “borrowing” the required number of shares of the undelivered security. Plaintiffs claim that, at times, the fails-to-deliver are not cured for long periods, which has the effect of creating more electronic shares in the marketplace. As a result, plaintiffs claim that Whistler’s share price is artificially driven down.

The Court affirmed the dismissal of the state law claims, concluding that they are preempted under Exchange Act Section 17A. There are two types of preemption, according to the Court. Under “field preemption,” Congress is said to have occupied the field, leaving no room for state law. Under “conflict preemption,” the statute must be examined to determine whether federal and state requirements are impossible.

Under Exchange Act Section 17A, Congress provided for the registration of clearing agencies to remove impediments to a uniform national system for the prompt and accurate clearance and settlement of securities transactions. The three defendants are registered under this Section. Rules promulgated to create the Stock Borrow Program were approved by the SEC.

The Ninth Circuit concluded that field preemption does not apply in view of the savings clause in the Exchange Act regarding state remedies. Conflict preemption however, precludes the claims brought under Nevada state law here because they directly challenge a program implementing rules approved by the SEC under Section 17A.

Other cases brought by issuers claiming that short selling caused their share price to decrease have also been dismissed. See, e.g., Atsi Communications, Inc. v. The Shaar Fund, Ltd., 493 F.3d 87 (2nd Cir. 2007) (affirming dismissal of complaint for failing to properly plead a manipulation claim, in part because it was not “plausible” within the meaning of the Supreme Court’s decision in Twombly as discussed here). Nevertheless, naked short selling seems to be a topic of continuing concern.