by T. GormanPosted on Posted in SECActions

The SEC prevailed in an appeal of a financial fraud action. SEC v. Monterosso, Nos. 13-10341, 13-10342, 13-10464 (11th Cir. Opinion June 30, 2014). A key issue in the case is the application of the Supreme Court’s decision in Janus Capital Group, Inc. v. First Derivative Traders, 131 S.Ct. 2011 (2011).

The action centers on a financial fraud at GlobeTel Communications Corporation, a telecom company. In 2007 the Commission brought an action against Joseph Monterosso and Luis Vargas. Mr. Monterosso manged GlobeTel’s wholesale telecom business beginning in September 2006. He also served as president of one if its subsidiaries and as COO from July 2006 through May 2007. Mr. Vargas was vice president of subsidiary Centerline Communications and owned Carrier Services, Inc., another telecom company. The Commission’s complaint alleged violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a) and 13(b)(2)(A). Shortly after filing that action the agency filed a second complaint based on the same financial fraud. That action named as defendants the company and three additional officers, two of whom settled.

The Commission’s complaint alleged a fraudulent scheme to inflate revenue. Between 2004 and 2006 GlobeTel bought and sold large blocks of calling minutes with particular origination and termination points. The firm generated revenue by connecting individual callers with locations they called. The calls were routed through GlobeTel’s switch. Firms such as GlobeTel pay by the minute for the right to route calls through the switches to the network of another company. GlobeTel’s revenue depended on the traffic routed through its switch.

In 2004 the “off-net” program was implemented to enhance reported revenue. The program referred to telecom traffic run on a switch that was not owned GlobeTel or its subsidiaries, Volta, Lonestar and Centerline. In essence the program created false invoices to reflect transactions between GlobeTel’s subsidiaries and other companies. For example, invoices were created showing Volt sales. Yet the subsidiary never sold anything. Other invoices showed that Centerline engaged in transactions with a company called CSI. Centerline never bought or sold anything to or from CSI. The defendants participated in the scheme.

In 2004 and 2005 the fraudulent off-net revenue accounted for about 58% and 87.4% of GlobeTel’s revenue, respectively. For the first quarter of 2006 it accounted for about 92% of the revenue.

The District Court granted summary judgment in favor of the Commission and against Messrs. Monterosso and Vargas. Both were found liable for violations of the antifraud provisions and for aiding and abetting violations of the books and record sections cited in the complaint. The Court entered a permanent injunction against each man, prohibiting future violations of the Sections cited in the complaint. The Court also held the two defendants jointly and severally liable for disgorgement of $675,000, along with prejudgment interest, and imposed penalties of $300,000 and $150,000 against, respectively, Mr. Monterosso and Mr. Vargas. An officer and director bar was imposed as to each defendant.

On appeal a key issue argued by the two defendants hinged on the application of Janus. Each defendant contended that they could not be held liable under the antifraud provisions in view of the Supreme Court’s decision.

Janus addressed the scope of liability under Section 10(b) and Rule 10b-5. In its decision the Court focused on the provision in the rule which states that it is unlawful to “make any untrue statement of a material fact in connection with the purchase or sale of securities,” the Circuit Court noted. The Janus Court held that the maker of a statement is the person or entity with the ultimate authority over it, including the content and how to communicate it. In that case participating in preparing a prospectus was not sufficient to impose liability.

The defendants in this case contend that while they may have participated in the “off-net” program, they did not make any statement and therefore cannot be held liable. The Court rejected this contention. Janus only addressed Rule 10b-5(b), it does not concern Rule 10b-5(a) and (c) or Securities Act Section 17(a). Indeed, the language of Section 17(a) does not require a defendant to “make” a statement to be liable. Likewise, subsections (a) and (c) of Rule 10b-5 do not incorporate that requirement. And, in any event, the case here does not hinge on making a false statement. Rather, the action is concerned with the commission by the defendants of deceptive acts as part of a scheme to generate fictitious revenue for GlobeTel. Thus Janus is not relevant. The Court affirmed the grant of summary judgment.

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by T. GormanPosted on Posted in SECActions

Compliance Week published its 2014 Anti-Bribery and Corruption Benchmarking Report, a survey of over 180 executives involved in ethics and FCPA compliance and internal audit (here). The Survey focused on risk, dealing with third parties and due diligence.

Risk: The Survey assessed areas of responsibility for the Chief Compliance Offer or CCO of the company. In the area of cyber security and privacy, business organizations reported varying practices with respect to the role of the COO:

  • 43.9% — COO responsible for data privacy laws and breach disclosure, not cyber security
  • 31% — COO has no oversight in these areas
  • 22.5% — COO responsible for both areas

The COO is, however, almost uniformly responsible for traditional corruption areas such as anti-bribery. With respect to other corruption issues, companies have adopted varying practices regarding the responsibility of the COO:

  • Anti-bribery – 95.7% stated the COO was responsible for this area
  • Bid-rigging – 64.7% stated that the COO is responsible for this area
  • Money Laundering – 62.6%, the COO is responsible
  • Price-fixing – 59.9%, the COO is responsible
  • Conflict minerals – 24.1%, the COO is responsible

In assessing risk, business organizations were close to evenly split on whether bribery and corruption would continue to increase over the next three years. This is an interesting assessment given the efforts of U.S. enforcement official in this area and the increasing efforts of officials in other countries:

  • Increase – 50.8% noted the risk would increase
  • Remain the same – 29.9% indicated that the risk would remain about the same
  • Decrease – 5.3% responded that the risk would decrease

Third parties: Affiliations with third parties frequently present significant risk for business organizations. The DOJ and the SEC, for example, have brought a number of FCPA actions centered on third parties. Despite this fact over half of those surveyed did not provide any training on anti-bribery and corruption issues to third parties:

  • Never – 58.3% indicated that they never provide training on anti-bribery and corruption issues to third parties
  • Annually – 19.8% of those responding indicated that they provide training annually
  • Bi-annually – 14.4% provide training every two years
  • Every 3 to 5 years – 7.5% provide training every few years

For those that do provide training to third parties, the vast majority include them in their Code of Conduct while many use a certification, on-boarding questionnaire and web based training:

  • 70.5% — Include in Code of Conduct
  • 59% — Certification included in contract materials
  • 57.7% — Part of on-boarding questionnaire and process
  • 52.6% — On-line or web-based training
  • 44.9% –Distribute materials for employees to review
  • 42.9% –In-person on-site training

Due diligence: Due diligence is a continuing area of focus in anti-bribery and corruption actions. It can be particularly critical in mergers and acquisitions. One issue centers on the type of information would influence a corporate decision not to work with a third party:

  • 77% — Allegations/rumors of bribes but no proof
  • 64.2% — History of litigation
  • 59.9% — Politically exposed person
  • 55.1% — Not well known for doing the work needed

Business organizations also reported using a variety of methods in conducting due diligence including:

  • 69.2% — Reference checks
  • 64.1% — Information collected by business units
  • 56.4% — Public English data bases
  • 51.3% — Adverse local language media searches
  • 51.3% — Corporate legal department reviews
  • 50% — Public data bases, local language
  • 37.2% — Litigation searches in local jurisdiction
  • 37.2% — Adverse media services, English only
  • 34.6% — Investigation by professional investigators
  • 33.3% — Reputational interviews in local jurisdiction
  • 28.2% — U.S. commercial services
  • 23.1% — Opinion of local or international law firm

Overall the Survey provides insight practices and views of business organizations on key questions regarding anti-bribery and corruption compliance.

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