by T. GormanPosted on Posted in SECActions

Well designed compliance systems coupled with solid internal controls can be instrumental in preventing violations of the FCPA. Despite best of efforts, there is no doubt that even a well-constructed compliance system can be circumvented. Johnson Controls, a global firm which sold marine products in China through subsidiary China Marine, is a good example of this point. Fortunately, its cooperation mitigated the violations. In the Matter of Johnson Controls, Inc., Adm. Proc. File No. 3-17337 (July 11, 2016).

Johnson Controls acquired York International in 2005. At the time the firm was the subject of an FCPA investigation. Two years later York settled with the Commission in an action which alleged violations of the FCPA bribery, books and records and internal control provisions. The action centered on improper payments made at least in part through agents in China at shipyards to obtain and/or retain business. A monitor was installed. Following the merger York’s China operations were merged into China Marine.

Johnson Controls devoted additional resources to its compliance programs in the wake of the York action. Additional compliance personnel were hired, training was conducted and risk-based procedures were implemented. A new managing director was hired for China Marine. The use of agents was restricted in view of their involvement in the York action and all sales were routed through a China based sales team. Audits were conducted. China Marine reported to Johnson Marine’s Denmark subsidiary which oversaw the Global Marine business in multiple countries.

Nevertheless, the bribery scheme at China Marine continued. The new employees circumvented the procedures installed and the steps taken to prevent a repetition of the wrongful conduct:

  • The scheme involved virtually everyone in the office;
  • Vendors were used in place of agents because they were considered low risk but local employees failed to disclose that in some instances sales managers had an interest in the firm;
  • Sales managers added bogus costs for parts and services;
  • The dollar value of the transactions was set to fall below certain minimums to avoid scrutiny; and
  • A slush fund was created.

Despite a new manager and supervision by the Danish subsidiary, China Marine operated with little oversight. The new manager had significant autonomy and reliance was put in self-policing. Even in instances when those in Denmark reviewed transactions they did not understand some of the highly customized transactions at China Marine or the projects involving sham vendors. Not only did the managing director craft the scheme to make improper payments, China Marine employees were instructed to be cautious regarding their discussion of vendor payments with firm attorneys, accountants and auditors. From 2007 through 2013 Johnson Marine obtained the benefit of about $11.8 million as a result of over $4.9 million in improper payments made through eleven problematic vendors.

Johnson Marine finally learned about the misconduct in December 2012 when it received the first of two anonymous hotline reports about certain employees in China Marine. The reports arrived shortly after China Marine’s managing director left the company. John Controls self-reported and undertook an extensive series of steps to cooperate with the Commission’s investigation detailed in the Order. The Order alleges violations of Exchange Act Section 13(b)(2)(A).

To resolve the action the firm consented to the entry of a cease and desist order based on the Section cited in the Order. Johnson Controls agreed to pay disgorgement of $11,800,000 and prejudgment interest. In addition, the firm will pay a penalty of $1,180,000 or 10% of the disgorgement. The DOJ declined prosecution.

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by T. GormanPosted on Posted in SECActions

How effective is the SEC enforcement program at deterrence? With the adoption of the “broken windows” theory of enforcement the agency adopted a theory of market policing borrowed from the New York City police department. It is built on the notion that by prosecuting big and small violations everywhere would-be scofflaws will be deterred from violating the federal securities laws. To implement the program headlines heralding big dollar penalties, often tabulating sanctions imposed in multiple cases, are touted along with increasing numbers of actions.

For the New York City police this theory seems to have worked. The notion that there was an officer on every street corner helped combat urban crime – who would rob a bank or steal a car with a police officer standing there watching? But can the SEC effect the same result by packaging together multiple actions based on, for example, violations of Rule 105 prohibiting short selling before secondary offerings, to deters the market professional from insider trading or the company official from cooking the books?

Consider the SEC’s most recent insider trading prosecution. The case names as defendants a partner in a global accounting firm and two securities industry professionals. The accounting firm partner is alleged to have repeatedly tipped a securities profession who then tipped another in advance of corporate take-overs. The accounting firm partner did not trade but got kick-backs while the two securities professionals shared the profits. SEC v. Avent, Civil Action No. 1:16-cv-02459 (N.D. Ga. Filed July 7, 2016).

The action centers on trading in advance of three corporate take-overs: 1) The acquisition of Radiant Systems, Inc., by NCR Corporation, announced on August 24 2011; 2) the acquisition of Midas Incorporated, Inc., by TBC Corporation, announced on April 30, 2012; and 3) the acquisition of BrightPoint, Inc. by Ingram Micro Inc., announced on October 15, 2012. Named as defendants are: Thomas W. Avent Jr., a partner at KPMG, according to media reports, as well as a member of the bars of Mississippi, Washington, D.C. and New York; Raymond J. Pirrello Jr., a registered representative and supervisor at a Commission registered broker-dealer, identified in media reports as Garden State Securities Inc. in New Jersey; and Lawrence J. Penna, a former broker-dealer registered representative barred from the securities business in an earlier Commission enforcement action.

Mr. Avent was the partner-in-charge of KPMG’s Mergers and Acquisitions Tax Practice for the Southeast Area, based in Atlanta. In that position he was charged with conducting due diligence on each of the three acquisitions involved here. Thus he obtained material, non-public or “inside information” about each deal. Prior to the events here he opened an account at Garden State Securities. Mr. Pirrello was the account executive, a position through which he learned of Mr. Avent’s position in the KPMG M&A group. While at times the very aggressive trading positions Mr. Avent adopted made him money, he also suffered a loss of over $500,000 which he demanded Mr. Pirrello make-up.

Messrs. Pirrello and Penna have known each other for years. Mr. Pirrello worked for Mr. Penna when he first entered the securities business. Both men declined to testify during the SEC’s investigation, citing their constitutional privilege.

The allegations of trading in advance of each of the three corporate transactions are substantially similar, although not identical. The trading in advance of the Radiant Tender is illustrative. In June 2011 NCR engaged KPMG to conduct tax due diligence regarding a planned tender offer for Radiant. By June 23 Mr. Avent was hard at work on the deal, churning out a tax due diligence report by Friday, July 8. That same day the KPMG partner tipped broker Pirrello, according to the complaint. The allegation is based on communications between the two men on the phone and in text messages that same day.

Later on July 8 broker Pirrello called his long-time friend Penna. Mr. Penna, in turn, called his Son shortly thereafter. Son purchased shares of Radiant stock in a trust for the benefit of his father and through a brokerage account in his own name. The same evening broker Pirrello and Mr. Penna exchanged text messages: Broker Pirrello: “How many did we get”? Mr. Penna: “2500”. Broker Pirrello: “We should make 25k”; Mr. Penna: “Only Bgt Stock – should I go back for more?”

On the next trading day, Monday July 11, NCR announced a tender offer for Radiant priced at $28.00 per share in cash following the close of the market. On Tuesday the share price increased 30.5% over the prior day’s close.

Son liquidated the shares of Radiant. Later that evening Messrs. Pirrello and Penna exchanged text messages regarding the profits. After the broker noted that things were “a little tight” Mr. Penna agreed to make a payment to Mr. Pirrello’s American Express Account. Less than a week later $5,000 was transferred by Mr. Penna to the broker’s American Express account. The next month Mr. Pirrello sent a $50,000 personal check payable to “cash” to Mr. Avent, who later deposited it.

The communication and trading patterns in advance of the Midas tender offer and the BrightPoint acquisition are similar. Overall Mr. Penna and his family are alleged to have made more than $111,000 in illicit insider-trading profits. The complaint alleges violations of Exchange Act Section 10(b) by Messrs. Avent and Pirrello. It also alleges violations of Exchange Act Section 14(e) by each of the three defendants. The case is in litigation. See Lit. Rel. No. 23593 (July 8, 2016).

Interestingly, the complaint does not allege a cover-up. There is no allegation that the three men took any steps to conceal their activity. Yet broken windows and its “everywhere” concept of deterrence through headlines and large penalties has been in effect for years. The SEC and the DOJ have successfully prosecuted numerous insider trading cases, honing their ability along the way to fret out such conduct. The repeated actions of the three professionals in Aven,t who undoubtedly knew about these efforts, thus raises a significant question regarding the deterrent impact of current SEC efforts.

If deterrence through “everywhere” enforcement, headlines and penalties is not the answer, then what is? Undoubtedly there is no “one size fits all” answer to this. Greed is powerful as Adam Smith noted long ago and Gordon Gecco reiterated in the movie Wall Street.

Nevertheless, one point is clear. Preventing future violations begins with respect for the law. The CFO who cannot make his or her numbers without cooking the books must respect the law – part of “tone at the top” in compliance terms — if violations are to be avoided; the market professional with inside information has to honor his or her obligations and the law if violations are to be avoided.

Today, however, there are repeated questions being raised regarding SEC enforcement. This is reflected in the rash of suits against the agency concerning the institution of enforcement actions. It is bolstered by the significant disparity in results between those cases brought in an administrative forum and federal district court. This creates at least the perception of unfairness. And, even the perception of unfairness in the program can undercut its goals while leading to disrespect for the law.

This suggests that the SEC should carefully review the perception and impact of its enforcement efforts. Beginning today would be particularly appropriate as former Commissioner Irving Pollock, the founder and first Director of the SEC’s enforcement program, is laid to rest. Under his tutelage, and that of his immediate successors, the SEC enforcement program was known as one of the best and most effective in government. That program was built on integrity, respect for the law, fairness and doing the right thing.

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