Earlier this week a most interesting non-Foreign Corrupt Practices Act (FCPA) bribery and corruption enforcement, actions was announced by the Securities and Exchange Commission (SEC). It involved a clear quid pro quo benefit was provided by United Airlines to David Samson, the former Chairman of the Board of Directors of the Port Authority of New York and New Jersey, the public government entity which has authority over, among other things, United Airlines operations at the company’s huge east coast hub at Newark, NJ.
The reason that it is so interesting from an enforcement prospective is that it is not foreign corruption but domestic corruption, therefore not subject to the FCPA. However, the actions of United’s former Chief Executive Officer (CEO), Jeff Smisek, in personally approving the benefit granted to favor Samson violated the company’s internal controls around gifts to government officials. That sounds suspiciously like a books and records violation of the FCPA. The $2.4 million penalty levied on United was a civil violation, added to this summer’s Non-Prosecution Agreement (NPA) settlement with the Department of Justice (DOJ), which resulted in a penalty of $2.25 million. Chairman Samson has also pled guilty in July for putting pressure on United to reinstitute a flight service which was near his weekend residence.
The scandal also cost the resignation of Smisek and two high-level executives from United. In a Press Release at the time of the resignations, the company stated, “The departures announced today are in connection with the company’s previously disclosed internal investigation related to the federal investigation associated with the Port Authority of New York and New Jersey. The investigations are ongoing and the company continues to cooperate with the government.”
The affair involved a flight from Newark to Columbia, South Carolina. The flight was reported to be a money-losing route, yet it was reinstated by United at either the request of the Chairman of the Port Authority of New York and New Jersey, Samson, or was reinstated by United to obtain a benefit from Samson. Samson had a weekend home at Aiken, which is near Columbia, SC and was not happy there was no direct flight service from Newark. So he got a direct flight. The flight was money loser it was derisively named “the chairman’s flight.” The SEC Cease and Order (Order) said that United lost some $945,000 on the flight.
However, at the time United was in the midst of trying to renegotiate its lease at Newark airport with the Port Authority. The flight from Newark to Columbia was cancelled after Samson resigned his post as Chairman.
According to the Order, “In the summer and fall of 2011, representatives of United and the Port Authority’s Aviation Department (which manages Newark Liberty) negotiated a proposed agreement that the Port Authority would lease approximately three acres of land at Newark Liberty to United for the construction and operation of a wide-body aircraft maintenance hangar (the “Hangar”). The Hangar would facilitate United’s ability to perform maintenance on its incoming fleet of wide-body aircraft at Newark Liberty, rather than having to perform such maintenance at a suitable United facility at another airport. Based on preliminary assessments and using information available at the time, United estimated that the Hangar would result in efficient routings that would drive $47.5 million in value to the United network on an annual basis post-construction.”
During this time period, Samson was communicating through a third party his desire that United reinstate the Chairman’s Flight. This culminated in a dinner meeting between Smisek, his senior team and Samson. Samson once again pressured for a reinstitution of the route, “Samson stated that Continental Airlines used to have a non-stop route between Newark Liberty and Columbia, South Carolina and asked the CEO to consider re-establishing that non-stop route.”
United’s “Network Planning Group analyzed the projected financial performance of the South Carolina Route… United’s standard process for initiating new routes generally included: the preparation and consideration of financial forecasts and other market data of how the route could be expected to perform, review and approval by several levels of United’s Network Planning Group, including approval by the Chief Revenue Officer (“CRO”) or his staff, and thereafter presentation of the route and its details to a group of senior United executives at a regularly scheduled marketing meeting.”
This review determined that the Chairman’s Flight would likely be a money loser and, indeed, when it was previously operated by Continental Airlines, prior to its merger with United, the route “was continually one of the hubs poorest performing markets”. (Recall the Order reflected the flight did lose United $945K.)However, after United declined to reinstitute the Chairman’s Flight, Samson pulled the proposal from consideration by the full Board, effecting scuttling the arrangement. Shortly after this development, “the CEO (Smisek) approved the establishment of the [Chairman’s]route.” On the same day, United’s contract for the new hangars was approved by the Port Authority.
At the time United’s Code of Conduct prohibited “United employees from directly or indirectly making bribes, kickbacks or other improper payments to government officials, civil servants or anyone else to influence their acts or decisions” and that “[n]o gift may be offered or accepted if it will create a feeling of obligation, compromise judgment or appear to improperly influence the recipient.” Only the United Board of Director’s could grant a waiver to the Code and none was sought or obtained by Smisek. The Order concluded, “The [Chairman’s] Route was initiated in violation of United’s Policies.”
Mike Volkov has often worried that if that companies create internal controls and then do not follow those internal controls, will be prosecuted for such action (or perhaps inaction). This is the situation which led to the SEC enforcement action against United. The company had a Code of Conduct, it was not followed but was violated by the CEO and this caused the company to violate Section 13 of the Securities Exchange Act of 1934. It would be easy enough to see this resolution in the FCPA context but this was all domestic conduct and jurisdiction. This may be the first time the violation of a Code of Conduct resulted in an enforcement action by the SEC around domestic bribery and corruption.
Yet the company was also sanctioned for not having internal controls in place to prevent such actions as those taken by Smisek, with the SEC also finding this was a violation of Section 13. This was in the face of detailing the protocol for United instituting or reinstituting a route. The Order stated, “In particular, United had insufficient internal accounting controls in place to prevent approval of the South Carolina Route in derogation of United’s Policies.”
Also interesting was the remedial action engaged in by United. It included the following actions:
- Termination of the culpable employees;
- Improving the company’s compliance function and creation of “new senior legal position focusing on global corruption risk”;
- Enhancing the company’s Code of Conduct and anti-corruption policies;
- Conducting anti-corruption training; and
- Developing a third-party due diligence process and anti-corruption compliance audit capability.
All of the underlying facts, enforcement theories and remediation points towards the use of failure of internal controls when domestic bribery corruption occurs. This might well be a new enforcement theory to use inside the United States, for domestic bribery allegations. Imagine if United’s profit estimates of $47.5 million had been used as the basis of a profit disgorgement order.
The United matter was the first where the SEC used internal controls violation as the basis for a domestic bribery enforcement action.Click to tweet
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© Thomas R. Fox, 2016