The FCPA: The New SEC and DOJ Enforcement Priority – Part IX, Promotional Expenses and Mergers

The payment of travel and entertainment expenses for foreign officials can raise significant issues under the FCPA. Last year there were two significant SEC cases and two DOJ opinions on this question.

In SEC v. Lucent Technologies, Inc., Civil Action No. 07-092301 (D.D.C. Filed December 21, 2007), the Commission’s complaint alleged that over a three year period Lucent, through a subsidiary, paid over $10 million for about 1,000 Chinese foreign officials to travel to the U.S. The SEC concluded that about 315 of the trips had a disproportionate amount of sightseeing, entertainment and leisure. Some of the trips were, in fact, vacations to places such as Hawaii, Las Vegas, the Grand Canyon, Disney World and similar venues. These expenses for officials Lucent was either doing business with or attempting to do business with were booked to a “factory inspection account.” The company failed over the years to provide adequate FCPA training.

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

To resolve the DOJ’s inquiry, the company entered into a non-prosecution agreement. As part of the agreement the company agreed to pay a $1 million fine.

The SEC’s action against Dow Chemical Company last year also involved the question of travel and entertainment expenses. In its complaint, the SEC alleged that a Dow subsidiary in India made improper payments to an Indian government official consisting of over $37,000 in gifts, travel, entertainment and other items. Payments were also made to an official of the Central Insecticides Board to expedite the registration of three products.

To resolve the SEC action, Dow consented to the entry of a permanent injunction prohibiting future violations of the books and records provisions of the FCPA. The company also agreed to pay a civil penalty of $325,000. SEC v. The Dow Chemical Company, Civil Action No. 07-00336 (D.D.C. Filed February 13 2007).

DOJ also issued two releases last year concerning the question of travel and entertainment expense. In FCPA Op. Proc. Rel. 2007-01, the Department stated that it would not bring an enforcement action where a company paid domestic travel expenses for six foreign government officials in connection with a visit to the requestor’s U.S. sites. DOJ conditioned its opinion on three key points: 1) the expenses must be properly recorded; 2) a legal opinion stating that the payments were proper in the home country must be obtained; and 3) any gifts must be of nominal value.

A second opinion, FCPA Op. Proc. Rel. 2007-02, is similar to the first. Two additional points were added to the request: 1) the payment of modest daily incidental expenses; and 2) a modest four-hour sightseeing tour of the city. DOJ did not object as long as the expenses were backed by receipts.

Finally, a number of the cases brought recently involve mergers or matters discovered during due diligence. One such case is SEC v. Delta & Pine Land Co. and Turk Deltapine, Inc., Case No. 07-01352 (D.D.C. Filed July 25 2007). During pre-merger due diligence, Monsanto discovered Turk Deltapine made payments of about $43,000 to officials of the Turkish Ministry of Agriculture and Rural Affairs to obtain government reports and certifications. Monsanto reported to the government that a parent and subsidiary were involved.

The SEC brought an administrative proceeding against the parent. That action was settled with a cease and desist order. The order also required that an independent consultant be retained.

A civil injunctive action was brought against the subsidiary. That action was settled when the company consented to the entry of a permanent injunction prohibiting future violations of the FCPA books and records violations and the payment of a $300,000 penalty.

Next: Significant pending cases

Canadian Pharmaceutical Company Biovail Settles a Financial Fraud Case While Four Of Its Executives Continue To Litigate

Leading Canadian pharmaceutical company Biovail Corporation whose shares are traded on the NYSE and four of its senior executives were named as defendants in a financial fraud complaint. The defendants included Eugene N. Melnyk, the founder and former chairman, Brian Crombie, former CFO and current senior vice president for strategic development, John Miszuk, vice president, controller and assistant secretary and Kenneth G. Howling, recently promoted to senior vice president and CFO. SEC v. Biovail Corporation, Civil Action 08 CV 02979 (S.D.N.Y. Filed March 24, 2009).

The SEC’s complaint alleges that the company was “obsessed with meeting quarterly and annual earnings guidance” and thus repeatedly overstated its earnings and concealed losses by:

–falsely attributing nearly half of its failure to meet third quarter 2003 guidance to a truck accident involving a shipment of one of its products which in fact had nothing to do with the loss;

–improperly moving about $47 million in expenses off its financial statements and onto those of a special purpose entity over several reporting periods in 2001 and 2002;

–creating a fictitious bill and hold transaction to record approximately $8 million in revenue in the second quarter of 2003; and

–intentionally misstating foreign exchange losses in the second quarter of 2003, understating them by about $3.9 million.

According to the complaint each of these fraudulent accounting schemes had a material impact on the financial statements of the company. The complaint also alleges that Mr. Melnyk failed to include in his Schedule 13D filings company shares held by several off-shore trusts that he controlled.

The company settled with the SEC by consenting to the entry of a permanent injunction prohibiting future violations of the antifraud provisions as well as and books and records provisions of the Exchange Act. In addition, the company agreed to pay $1 in disgorgement and a $10 million civil penalty.

The individual defendants did not settle with the SEC. Indeed, each of the individuals remains with the company. Mr. Melnyk, a Canadian citizen and a resident of Barbados, previously agreed to resign as chairman and CEO under a settlement entered into with the Ontario Securities Commission in May 2007, about the time the SEC issued a Wells notice to the company. Messrs. Howling and Miszuk are being reassigned by the company to non-executive positions.