by T. GormanPosted on Posted in SECActions

“They trusted us” — Judge Stanley Sporkin explaining why 450 corporations self- reported in the 1970s Volunteer Program without a promise of immunity.

This is the first part of an occasional series. The entire paper will be published by Securities Regulation Law Journal early next year.

Introduction

Can one man make a difference? Stanley Sporkin is proof that the answer is “yes.” In the early 1970s he sat fixated by the Watergate Congressional hearings. As the testimony droned on about the burglary and cover-up, the Director of the Securities and Exchange Commission’s (“SEC” or “Commission”) Enforcement Division sat mystified. Witnesses spoke of corporate political contributions and payments. “How does a public company book an illegal contribution” the Director wondered. “Public companies are stewards of the shareholder’s money – they have an obligation to tell them how it is used” he thought. He decided to find out.

The question spawned a series of “illicit” or foreign payments cases by the Commission resulting in the Volunteer Program. Under the Program, crafted by Director Sporkin and Corporation Finance Director Alan Levinson, about 450 U.S. corporations self-reported illicit payments which had been concealed with false accounting entries. There was no promise of immunity but the Director had a reputation for doing the right thing, being fair. Ultimately the cases and Program culminated with the passage of the Foreign Corrupt Practices Act (“FCPA”), signed into law by President Jimmy Carter in 1977.

Today a statute born of scandal and years of debate continues to be debated. Business groups and others express concern about the expansive application of the FCPA by enforcement officials and the spiraling costs to resolve investigations. Enforcement officials continue to call for self-reporting, cooperation and more effective compliance. While the debate continues, both sides might do well to revisit the roots of the FCPA. The success of the early investigations and the Volunteer Program is not attributable to overlapping enforcement actions, endless investigations, draconian fines and monitors. Rather, it was a focus on effective corporate governance – ensuring that executives acted as the stewards of shareholder funds. Director Sporkin call this “doing the right thing.” A return to that focus may well end the debate and yield more effective compliance and enforcement.

The beginning

The Watergate Congressional hearings transfixed the country. A scandal was born from a burglary at the Watergate Hotel in Washington, D.C. by the Committee to Reelect the President, known as CREP. The hearings were punctuated by a series of articles in The Washington Post based on conversations with a source known only as “deep throat.” Later the two reporters would become famous. President Richard Nixon would resign in disgrace. His senior aides would be sentenced to prison. See generally, Carl Bernstein & Bob Woodward, All the President’s Men (1974).

A little-noticed segment of the hearings involved corporate contributions to politicians and political campaigns. Most observers probably missed the slivers of testimony about illegal corporate conduct since they were all but drowned in the seemingly endless testimony about the burglary, cover-up and speculation regarding the involvement of the White House.

One man did not. Then SEC Enforcement Director and later Federal Judge Stanley Sporkin was fixated. He listened carefully to the comments about corporate political contributions. The Director wondered how the firms could make such payments without telling their shareholders: “You know, I sometimes use the expression, ‘only in America could something like this happen.’ There I was sitting at my desk . . . and at night while these Watergate hearings were going on I would go home and they’d be replayed and I would hear these heads of these companies testify. This fellow Dorsey from Gulf Oil . . . and it was interesting that somebody would call Gulf Oil and they would say we need $50,000 for the campaign. Now everybody, I knew that corporations couldn’t give money to political campaigns . . . what occurred to me was, how do you book a bribe . . . ” A Fire Side Chat with the Father of the FCPA and the FCPA Professor, Dorsey & Whitney LLP Spring Anti-corruption conference, March 23, 2014, available at www.SECHistorical.org. at 3 (“Transcript”).

What, if any information did the outside auditors have was another key question, according to the Director. Stanley Sporkin, “The Worldwide Banning of Schmiergeld: A Look at the Foreign Corrupt Practices Act on its Twentieth Birthday,” 18 Nw. J. Int. L. & Bus. 269, 271 (1998) (“Sporkin”). Not only was he fascinated by the testimony but “something bothered him [Director Sporkin]. It was the thought of all that money moving around in businessmen’s briefcases. That money belonged to corporations. Corporations belong to investors. The SEC protects investors. So Sporkin investigated.” Mike Feensilber, He Terrorizes Wall Street, The Atlanta Constitution, Section C at 19, col. 1 (March 21, 1976); see also Wallace Timmeny, An Overview of the FCPA, 9 Syr. J. Int’l L. & Com. 235 (1982).

An informal inquiry was initiated. As Judge Sporkin recounts: “To satisfy my curiosity [about how the payments were recorded in the books and records] I asked one of my staff members to commence an informal inquiry to determine how the transactions were booked.” Sporkin at 571. This “was not one of these elaborate investigations where you have 5 people. I called in a guy named Bob Ryan and I said, Bob, go to Gulf Oil.” Transcript at 3. A day later the answer came back: “[W]hat happened was that Gulf Oil had set up two corporations; one called the ANEX, one called the ANEY, capitalized . . . with the $5 million each; took the money back to New York, put it into [Gulf Chairman] Dorsey’s safe at the head of Gulf Oil and there he [Dorsey] had a slush fund, a corporate fund of $10 million.” Id. at 4. The payments were not reflected in the books and records of the company – the shareholders were not told how their money was being used.

It was apparent that corporate officials “knew they were doing something that was wrong because the reason they set [it] up this was . . . is because they didn’t want to expense the money so they capitalized it. And why did they want to expense the money . . . [Director Sporkin explained is] Because they were afraid, not of the SEC, but of the IRS. So it . . . right from the beginning . . . it showed me that there was something afoul here,” Director Sporkin later recounted. Id. at 4. Indeed, it was clear that senior corporate officials had painstakingly designed a methodology to secrete what they knew were wrongful transactions. Sporkin at 271.

Next: The Illicit or foreign payments cases

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by T. GormanPosted on Posted in SECActions

In Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010) the Supreme Court delimited the reach of Exchange Act Section 10(b), concluding that the Section has no extraterritorial reach. Rather, the Section is confined to the United States – securities transactions that are on an exchange in this country or which occur here. The Court reached that conclusion by applying a presumption against extraterritorial reach and by considering the focus of the statute which is the purchase and sale of a security.

Now the Second Circuit has applied the teachings of Morrison to the Commodities Exchange Act private remedies. Ludmila Loginovskaya v. Oleg Batratchenko, Docket No. 13-1624-cv (2nd Cir. Decided September 4, 2014). Plaintiff is a Russian citizen resident in that country. The defendants include Oleg Batratchenko, a U.S. citizen resident in Moscow, and various Thor Group entities, including Thor United which is a New York corporation. Several of the group entities are registered participants in the commodities markets as commodity pool operators or commodity trading advisors.

In early 2006 Plaintiff was solicited by Mr. Batratchenko to invest in the Thor programs. Russian language materials were furnished to plaintiff in connection with the solicitation. Ms. Loginovskaya agreed, transferring $720,000 to Thor’s bank in New York. Under the contracts with Thor United which were executed in Russia, Ms. Loginovskaya invested directly in that company. Thor in turn placed the funds in the Thor program. In part the money was put in U.S. real estate investments which suffered significan losses.

Ms. Loginovskaya brought suit under CEA Sections 4o and 22. The district court dismissed the claim under Morrison. The Second Circuit affirmed.

Section 4o is an antifraud provisions which is similar to Exchange Act Section 10(b). Section 22 provides for a private right of action where the claim results from: 1) receiving trading advise for a fee; 2) making a contract of sale or deposit in connection with any order to make such a contract; 3) the purchase, sale, or order for a commodity interest; and market manipulation in connection with a swap or contract of sale.

In rejecting the Second Circuit’s “effects or conducts” test regarding extraterritorial reach, the Morrison Court began with the presumption against extraterritoriality. Under that presumption, a statute is presumed not to have such reach absent clear Congressional intent to the contrary. The CEA as a whole is silent as to extraterritorial reach. Likewise Sections 4o and 22 do not evidence Congressional intent that would contradict the presumption.

Following the approach of the Morrison Court, the Second Circuit then turned to what it called the “focus of congressional concern.” In making this inquiry the Court considered Section 22 since it grants a private right of action rather than Section 4o, a general antifraud provision. Section 22 essentially limits clams to those of a plaintiff who actually traded in the commodity market. Accordingly, suits under the Section must be based on transactions “occurring in the territory of the United States.” Therefore under Morrison a “private right of action exists only when a plaintiff shows that one of the four transactions listed in Section 22 occurred within the United States.” This draws a distinction between private actions and government enforcement cases which are not limited by Section 22.

Here plaintiff’s claim arises, according to the complaint, from the purchase, sale or placing of an order for the purchase or sale of an interest or participation in a commodity pool. To bring this claim within the limits of Section 22, plaintiff is required to “demonstrate that the transfer of title or the point of irrevocable liability for such an interest occurred in the United States.” In view of this requirement the claim fails because the agreement was entered into in Russia, not the United States. In reaching this conclusion the Court expressly declined to reach the question of how the presumption would impact Section 4o.

Judge Lohier dissented noting: “Ludmila Loginavoskaya in a sense never had a change. Enticed by the array of investment opportunities in the vaunted commodities markets of the United States, she was the victim of an old-fashioned fraud that a more perceptive investor, or a United States regulator, might have identified from a mile away.” The main perpetrator is a U.S. citizen registered as a principal of commodity pool operators and commodity trading advisors under the CES. He is a member of the National Futures Association. Most of the Thor corporate defendants are based in the US and several are registered under the CEA. One of the defendants is a registered commodity pool.

According to Judge Lohier, “my colleagues in the majority will not dispute that the defendants’ allegedly fraudulent acts were sufficiently domestic to fall within the scope of CEA Section 4o . . .” yet plaintiff has no cause of action. This results largely from applying the presumption to Section 22 which does not regulate conduct or impose liability but only defines the category of persons that can seek a remedy. The central question here should have been whether Section 4o reaches the conduct alleged in the complaint. Applying Morrison to that Section is quite different. It prohibits fraud without any requirement that it be in connection with any particular transaction or event. Under this Section plaintiff would have had a cause of action since at least part of the conduct occurred in this country. Such a result would be consistent with the purpose of the CEA.

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