by T. GormanPosted on Posted in SECActions

Doing business in high risk areas of the world requires additional diligence to avoid corruption issues. The SEC’s latest FCPA settlement is an example of an action where the parent company took proactive steps, but they proved insufficient. In the Matter of Nu Skin Enterprises, Inc., Adm. Proc. File No. 3-17556 (Sept. 20, 2016).

Nu Skin Enterprises manufactures and markets cosmetic and nutritional products largely through direct selling or multi-level marketing. Its wholly owned subsidiary, Nu Skin (China) Daily Use & Health Products Co. Ltd., is based in Shanghai, China.

The Direct Selling Laws in China prohibit the direct selling, multi-level commission structure used by the firm in the United States. The company adopted its model, using primarily retail outlets. Nevertheless, the Direct Selling Laws provide that before a business such as Nu Skin China can operate, the firm must receive direct selling licenses at the national, provincial and city level.

In 2013 Nu Skin China held an unauthorized promotional meeting in a city despite the fact that it did not have a store or a direct selling license. Representatives of the Administration of Industry and Commerce for the province discovered the meeting and opened an investigation. Nu Skin China was subsequently informed that the agency had enough evidence to establish unauthorized activity.

The firm was concerned about the prospect of charges on its long term ability to obtain the required licenses. Firm employees decided to initiate a charity project in the province to influence the outcome of the investigation. A Party Official was contacted to suggest a charity. The official proposed a charity which at that point in time did not have a branch in the province, although the official was associated with the entity. The official also at one point was the superior of the agency head.

Subsequently, the agency informed the company that it would be charged along with certain employees. A fine would be imposed. The Party Official was requested to intervene in return for a one million RMB donation to the charity. Nu Skin China also requested that its parent expedite recommendations to a U.S. college for the child of the Party Official – a request had previously been made but languished.

The China subsidiary alerted its parent of the donation but not its purpose. The parent proposed that the subsidiary consult with U.S. counsel because of the high risk of a possible FCPA violation in the country. After consultation with counsel, anti-corruption language was inserted in a draft of the papers with the charity. In the final version that clause was omitted. The parent did not request to see the final version of the papers.

Following a ceremony involving the charity and the Party Official, the donation was made. The payment was not properly characterized in the books. Subsequently the agency declined to prosecute. The parent company failed to devise and maintain a reasonable system of internal accounting controls over its subsidiary, according to the Order: “Specifically, given the well-known corruption risks in China, Nu Skin US. did not ensure that adequate due diligence was conducted by Nu Skin China with respect to charitable donations to identify links to the government or political party officials and to prevent payments intended to improperly influence . . .” such persons, contrary to the FCPA. According, the Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B).

To resolve the matter the firm consented to the entry of a cease and desist order based on the Sections cited in the Order. It also agreed to pay disgorgement of $431,088 – the amount of the fine initially proposed by the agency — prejudgment interest and a penalty of $300,000.

Program: The Future of Insider Trading: The Supreme Court and Salman (here).

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by T. GormanPosted on Posted in SECActions

The SEC has long stressed auditor independence. The agency has brought a series of cases over the years to reinforce the point. Two settled actions involving accounting giant Ernst & Young LLP and others are the first, however, based on close personal relationships between the firm’s auditors and client financial personnel.

In the Matter of Ernst & Young LLP, Adm. Proc. File No. 3-17552 (Sept. 19, 2016) names as Respondents the audit firm and Gregory S. Bednar, CPA. Mr. Bednar served as the coordinating partner for a new EY engagement team for Client I after the firm had been terminated. The engagement team reported to him. While the engagement partner was responsible for the day-to-day engagement, Mr. Bednar had overall responsibility for the engagement and focused on the “relationship piece” with Client I.

E&Y had independence related policies in effect at the time. Those polices provided that all activities with clients have a valid business purpose requiring an expectation of meaningful business discussions or activity. The policy also stipulated that close personal relationships between engagement team members and audit client employees could create independence issues.

During 2012 – 2014 Mr. Bednar developed and maintained a close personal relationship with the CFO and members of his family. He spent extensive leisure time with the executive and his family. There were frequent out of town and overnight trips with the CFO and his family; overnight stays at his home; repeated social events and gifts; tickets to professional sports events for the CFO and his family; and other social contacts throughout the period. While other EY partners became aware of the close personal relationship, they failed to act.

Firm policies at the time required audit engagement teams for public companies to comply with certain annual and quarterly procedures to assess the firm’s independence. They also required engagement team members to certify their independence. While the firm recognized that a close personal relationship could cause an independence issue, it never asked about such relationships. The individual certifications focused on possible employment relationships but not close personal relationships.

Here Mr. Bednar lacked independence from Client I under Rule 2-01(b) of Regulation SX. EY also lacked independence and Mr. Bednar aided and abetted and caused the firm’s violations.

In resolving the action EY undertook to improve its policies and procedures. The firm and Mr. Bednar also consented to the entry of cease and desist orders based on Rule 2-02(b) and Exchange Act Section 13(a). EY was censured and Mr. Bednar denied the privilege of appearing or practicing before the Commission as an accountant with the right to request reinstatement after three years. EY will also pay disgorgement of $3,562,400, prejudgment interst and a penalty of $1.2 million.

In the Matter of Ernst & Young LLC, Adm. Proc. File No. 3-17553 (Sept. 19, 2016) is similar. In addition to the audit firm, the proceeding names as Respondents Robert J. Brehl, CPA, Pamela J. Hartford, CPA and Michael T. Kamienski. Mr. Brehl served as chief accounting officer of public Client 2 while Ms. Hartford acted as the EY engagement partner and later the coordinating partner for Client 2 and Mr. Kamienski served as the coordinating partner on the engagement from 2009 through 2013.

EY served as outside auditor to Client 2 from 2004 through 2014. From March 2012 through June 2014, while Ms. Hartford served first as the engagement partner and later the coordinating partner, she and Mr. Brehl maintained a romantic relationship. That relationship was marked by a “high degree of personal intimacy, affection and friendship, near daily communications that were personal as well as work related and occasional exchanges of small gifts. While the two tried to secrete their relationship, they were unsuccessful. During the time he served as coordinating partner Mr. Kamienski became aware of certain red flags but failed to properly follow-up.

In June 2014 a firm vice president at Client 2 made an internal whistleblower complaint regarding a possible inappropriate relationship between Mr. Brehl and Ms. Hartford. The company conducted an internal investigation and reported its findings to EY. The audit firm removed Ms. Hartford from the engagement team, conducted its own investigation and eventually withdrew its audit reports issued on the 2012 and 2013 financial statements of the firm and other reports.

To resolve the matter each Respondent consented to the entry of a cease and desist order based on Rule 2-02(b)(1) of Regulation S-X and Exchange Act Section 13(a) and Rule 13a-1. EY was censured while Respondents Hartford, Kamienski and Brehl were denied the privilege of appearing before the Commission as accountants. Respondents Hartford and Kamienski may apply for reinstatement after three years; Mr. Brehl may apply after one year. EY will also pay disgorgement of $3,168,500, prejudgment interest and a civil penalty of $1 million. Respondents Hartford and Brehil will each pay a civil penalty of $25,000.

Program: The Future of Insider Trading: The Supreme Court and Salman (here)

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