Part X: SEC Enforcement Trends And Priorities, 2008 – The FCPA (cont)

The SEC and DOJ have taken an expansive view of the FCPA as part of their renewed emphasis on enforcement. Their approach here echoes that taken to the insider trading cases. Two key limitations illustrate this approach.

The first is the limitation on the antibribery provision that the payment must be to obtain or retain business. This provision was incorporated in the Act in 1978 and has remained unchanged through the 1988 amendments. It was intended to reflect the fact that not all payments to foreign officials violated the Act, but only those to obtain business or retain business. The legislative history at the time the FCPA was first passed suggests that payments regarding taxes were not within this provision, although the legislative reports from the 1988 amendments suggest to the contrary despite not changing the statutory language.

Nevertheless, both DOJ and the SEC are expanding the obtain/retain business provision to include matters relating to taxes. In two decision in U.S. v. Kay, the court of appeals has expansively read this key limitation to include payments about taxes. The first decision focused only on the adequacy of the language of the indictment while the second followed the remand and trial of the case. U.S. v. Kay, 359 F.3d 738 (5th Cir. 2004) (Kay I); U.S. v. Kay, 2007 WL 3099140 (5th Cir. Oct. 24, 2007) (Kay II). In these decisions, the court concluded that in certain instances payments regarding taxes may fall within the obtain/retain business limitation. In Kay II, the court held that since the defendants testified that payments to officials to reduce certain taxes were necessary because everyone was doing it, then those payments must in fact be necessary to obtain or retain business. As such, they are within the prohibitions of the antibribery sections.

The SEC has recently taken a similar position in a settled administrative proceeding. In the Matter of Bristow Group, Admin. Proc. File No. 3-12833, SEC Release 5633 (Sept. 26, 2007).

The second limitation concerns the payment of promotional expenses. 15 U.S.C. § 78dd-2(c)(2) permits the payment of a “reasonable and bona fide expenditure, such as travel and lodging expenses …” and the payment of expenses for “the promotion, demonstration, or explanation of products or services.”

Last year, the SEC brought two key cases involving this section. Perhaps the most significant is SEC v. Lucent Technologies, Inc., Civil Action No. 07-092301 (D.D.C. Dec. 21, 2007). In this settled civil injunctive action, the SEC’s complaint alleged that over a three year period the company paid over $10 million of about 1,000 Chinese foreign officials to travel to the U.S. According to the complaint 315 of those trips had disproportionate amounts of sightseeing, entertainment and leisure. The trips had been booked to a “factor inspection account.” The SEC also claimed that Lucent had inadequate FCPA training.

To resolve the case, Lucent consented to the entry of an injunction prohibiting future violations of the books and records provisions of the FCPA. In addition, the company agreed to pay a $1.5 million civil penalty.

To settle with DOJ, Lucent entered into a non-prosecution agreement that required the payment of a $1 million fine.

The SEC brought a similar action against Dow Chemical Company. That settled action was based on the payment of $37,000 in gifts, travel, entertainment and other items. SEC v. The Dow Chemical Co, Civil Action No. 07-00336 (D.D.C. Feb. 13, 2007).

The Department of Justice also published two rulings regarding travel and entertainment which define limitations in this area consistent with these cases. FCPA Op. Proc. Rel 2007-01; Rel 2007-02.

Next: Financial fraud

This Week In Securities Litigation (May 2, 2008 edition)

This week in securities litigation familiar themes continued to be the key topic: the health of the SEC’s enforcement program, insider trading and option backdating.

The health of SEC enforcement

The debate over the future of the SEC’s enforcement program, as well as its current health, and a past transgression continued this week. First, the debate over the adequacy of the SEC’s budget and a proposal for regulatory reform continued. Previously, SEC Chairman Cox had largely embraced the administration’s proposed fiscal 2009 budget for the agency as discussed here. In an editorial in the New York Times published on April 29, 2008, former SEC Chairmen William Donaldson, Arthur Levitt Jr. and David Ruder offer the constructive and sensible suggestion that before there are any regulatory reforms such as those proposed by Treasury Secretary Paulson to, in part, merge the SEC and CFTC, there should be a complete study by the Commission of the situation. Following a careful assessment of what happened, the three former Chairman argue that “any reforms undertaken … should not undermine the SEC’s central roles as an investor’s advocate and a law enforcement agency.” They go on to note that, in part, the “the problem with the SEC today is that it lacks the money, manpower and tools it needs to do its job. The Commission’s 2009 enforcement budget does not keep pace with inflation, although it does provide significant increases in the risk-assessment function” as also previously discussed here.

Second, Chairman’s Cox’s claim that the SEC enforcement program is healthy as evidenced in part by the record results obtained so far this year was severely criticized in an article that appeared in Financial Week on April 28, 2008. Responding to the Chairman’s claim, the article states: “FUZZY MATH? SEC chairman Christopher Cox wrote [in an April 1, 2008 letter to Senator Dodd discussed here] that former United Health CEO William McGuire paid the ‘largest financial sanction ever asserted against an individual.’ Fresh from his assertions last month that Bear Stearns was well capitalized, Christopher Cox has told another whopper.” As noted here, virtually all of the money in the settlement with Dr. McGuire is attributable to the class and derivative actions which were settled together with the SEC’s case.

Finally, the SEC lost another round over its botched Pequot investigation. Previously it had been criticized in a Congressional report for mishandling the inquiry as discussed here. Last week, the agency was ordered to turn over the transcripts of interviews with Pequot founder Arthur Samberg, along with trading records and other documents pursuant to a FOIA request made by former staff member and whistleblower Gary Aguirre. Aguirre v. SEC, Civil Action No. 1:06-cv-01260 (D.D.C. July 14, 2006). It seems like it is more than time for the Commission to resolve this sad affair, make any necessary reforms and move on – the medicine it usually requires of those ensnared in its enforcement net.

Insider trading

Insider trading continues to be an enforcement priority as previously reported here. This week one high profile criminal case continued, while the SEC brought another family trading case.

• In U.S. v. Nacchio, No. 07-1311 (10th Cir. Aug. 2, 2007) the government requested rehearing en banc following the panel decision reversing the former Quest Communication CEO’s convictions on insider trading (here). In their brief, prosecutors disputed the panel conclusion that the district court’s exclusion of expert testimony offered by the defense required a reversal of the convictions and a retrial. The excluded testimony from Professor Daniel Fischel would have informed the jury that the inside information Mr. Nacchio had was not significant enough to require disclosure.

• In SEC v. Norton, Civil Action No. 2:08-CV-541 (D.Nev. April 29, 2008) the Commission filed a settled civil injunctive action which named a father and corporate director and his son as defendants in an insider trading case based on trading ahead of a merger as discussed here.

Option backdating

The option backdating scandal continued to move slowly forward as the SEC and government prosecutors plow slowly through their inventories of cases.

• The former CFO of Pixar Animation Studios, now owned by Walt Disney, and a current Google director, was given a Wells notice, indicating that the SEC staff is considering recommending an enforcement action against her based on allegations tied to option backdating. Both the SEC and criminal prosecutors have been investigating questions of option backdating at Pixar.

• The SEC brought a civil injunctive action against the former COO and former controller of Monster Worldwide, Inc. based on claims related to the backdating of options. SEC v. Treacy, Civil Action No. 08 CV 4052 (S.D.N.Y. April 30, 2008). This case is in litigation. At the same time the SEC is continuing its investigation.

First swap case

This week the SEC filed its first enforcement action involving security-based swap agreements – a derivative which in this case involved an agreement to exchange periodic interest rate payments on an amount of debt. The case also involves the sale of municipal bonds. The action focuses on kickbacks paid by a municipal bond dealer to a public official through an intermediary to obtain the bond and swap business as discussed here. SEC v. Langford, Civil Action No. cv-08-B-0761-S (N.D. Ala. April 30, 2008).