The bane of every first-year law student, at least in Civil Procedure, is Pennoyer v. Neff. This is because (1) it is usually studied very early in the semester; (2) is viewed as the first true introduction to how strikingly convoluted legal issues can be; and (3) has the most turgid legal writing from the 19th century imaginable to attempt to read and understand. Fortunately for all of us, in a case called International Shoe v. Washington, the US Supreme Court overturned Pennoyer v. Neff and held that if a person is not present within the forum, then he (or she) must have such minimum contacts with the forum that the maintenance of the action must not offend traditional notions of fair play and substantial justice. Courts have named these two tests (1) the minimum contact analysis and (2) the reasonableness inquiry.

I discuss Pennoyer v. Neff (it’s never just Pennoyer) to bid farewell to the Professor who taught that class to literally generations of law school students across the country, John Reed. Professor Reed taught me this case as a first-year law student at the University of Michigan – School of Law where he was on the faculty from 1949 up until the time of his death. Professor Reed’s tenure at Michigan was interspersed with visiting professorships at Yale, Harvard, Princeton, Chicago, New York University, and San Diego. He also served as Dean of the University of Colorado and Wayne State University Law Schools and the Director of the Institute for Continuing Legal Education at the University of Michigan. He continued on as a Professor of Law Emeritus after his retirement from teaching in 2000.

Professor Reed was always a natty dresser, this in a time when most law school professors were very dapper dressers. Professor Reed always had a spring in his step and a way to make the most nervous first year student at ease during his Socratic inquiries. While many of us remember Professor Reed as one of the most personable law school Professor’s around, he was one of the few who could make civil procedure come alive. Even Pennoyer v. Neff.

I thought about the inscrutability of Pennoyer v. Neff when reading the Securities and Exchange Commission (SEC) Cease and Desist Order (Order) involving the FCPA enforcement action involving Elbit Imaging Ltd. (Elbit), an Israeli company which trades on the Tel Aviv Stock Exchange and the NASDAQ. The matter involved the company’s actions around it purchase and subsequent sale of certain real estate in Romania, the Casa Radio Project. Elbit purchased 75% interest in the property in 2007 after having hired an un-named “third-party offshore entity” (“the 2006 agent”) to provide “consulting services” to help facilitate the purchase. In 2011, Elbit sought to purchase an additional 15% holding in the Casa Radio Project and to help facilitate this purchase, the company retained yet another “third-party offshore entity” (the “2011 agent”).

There was no due diligence performed on either the 2006 or 2011 agent, nor was there any record of any of the services they provided to Elbit. However, they were paid approximately $14MM from 2007 to 2012. The payments were disguised on the company’s books and records as payments for “legitimate business expenses for services rendered” when, as the SEC Order noted, “some or all of the funds may have been used to make corrupt payments to Romanian government officials or were embezzled.”

Later in 2011, Elbit and a subsidiary flipped another portfolio of properties they owned through a joint venture (JV) interest. Here Elbit employed yet another “third-party offshore agent” (Sales Agent A) to facilitate the purchase. However, Sales Agent A, transferred all of its rights to another offshore entity, Sales Agent B. For a sales price of $1.428bn for the portfolio properties, Sales Agents A was paid $13MM for which there was no evidence of services provided to Elbit. Subsequently Sales Agent A transferred its payment to Sales Agent B, allegedly without the knowledge of Elbit. Once again, Elbit mischaracterized these payments as contracted payments for legitimate services delivered.

In February 2014, Elbit was reorganized in a process similar to Chapter 11 under the US Bankruptcy Code. New equity owners took over and a new Board was empaneled. Apparently through this exercise, an internal investigation commenced and the above issues were detected. Elbit self-reported to both Romanian and US authorities. Elbit engaged in thorough cooperation. However, in the area of remediation, the Order noted “The Commission also considered that Elbit is in the process of selling its principal assets in order to service its debt obligation, and does not plan to develop current or new business.”

Elbit was charged with violations of the Accounting Provisions of the FCPA, both books and records and lack of effective internal controls. Continuing in the inscrutable category is the amount of the penalty, assessed at a flat $5000,000, which was based upon the cooperation of Elbit in the investigation and apparently the lack of hard evidence that any bribes were paid.

The Elbit FCPA enforcement action demonstrates once again that there need not be evidence of bribes offered or paid for a company to violate the FCPA. A mischaracterization of payments to third-parties or failure to follow your own internal controls or even failure to follow the Ten Hallmarks of an Effective Compliance Program, can be evidence of the failure of internal controls as required under the FCPA.

For the best discussion of Pennoyer v. Neff (other than Professor Reed’s lecture) see this YouTube clip. I think I finally understand it.

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© Thomas R. Fox, 2018