Show Notes for Episode 35, week ending January 13, the Friday the 13th edition:

  1. Hernandez and Beech FCPA guilty pleas. Hernandez Criminal Information, Beech Criminal Information.
  2. VW guilty plea in emissions-testing scandal. Link to article in New York Times.
  3. VW executive Oliver Schmidt arrested in US. See article on FCPA Compliance and Ethics Blog.
  4. Zimmer Bio-Met in follow-up FCPA enforcement action. See article on FCPA Blog.
  5. Mondelez FCPA enforcement action. See SEC Cease and Desist Order and article on FCPA Compliance and Ethics Blog.
  6. Supreme Court to take up 5 year statute of limitations for profit disgorgement under Securities Act, which applies to FCPA enforcement actions brought by SEC. Article in Law360.
  7. NFL Playoff update on Patriots, Cowboys and Texans.

In almost every Foreign Corrupt Practices Act (FCPA) enforcement action, there are nuggets to be gleaned for any Chief Compliance Officer (CCO) or compliance practitioner. All one has to do is look for them. Back in 2012, many of us scratched our collective compliance heads when we read and tried to understand the Oracle FCPA enforcement action brought by the Securities and Exchange Commission (SEC). The question which most of us asked was how there could be a FCPA violation with no allegation of bribery.

Since that time the answer has become clear. The Accounting Provisions, including books and records, and internal controls are viewed as the equivalent to strict liability under SEC enforcement theories. The Oracle civil Complaint revealed, “Oracle’s Indian subsidiary Oracle India Private Limited (“Oracle India”) secretly “parked” a portion of the proceeds from certain sales to the Indian government and put the money to unauthorized use, creating the potential for bribery or embezzlement. These Oracle India employees structured more than a dozen transactions so that a total of around $2.2 million was held by the Company’s distributors and kept off Oracle India’s corporate books.” The parent company “failed to accurately record these side funds on the Company’s books and records, and failed to implement or maintain a system of effective internal accounting controls to prevent improper side funds in violation of the FCPA, which requires public companies to keep books and records that accurately reflect their operations.” All of the above led to a penalty with no evidence of a bribe being paid by Oracle or its Indian subsidiary.

Last week brought the Mondelēz FCPA enforcement action, which was settled via a Cease and Desist Order (Order). Mondelēz paid a $13MM fine for the violations. Mondelēz, formerly known as Kraft Foods Inc., has “acquired Cadbury, a U.K.-based confectionary and snack beverage company that had securities registered with the Commission” in 2010. Earlier that year, “Cadbury India Limited (“Cadbury India”), a subsidiary of Cadbury, retained an agent (“Agent No. 1”) to interact with Indian government officials to obtain licenses and approvals for a chocolate factory in Baddi, Himachal Pradesh, India.” It was this Agent No. 1 who laid Mondelēz low with FCPA grief.

There were a few anomalies around this Agent No. 1 and his retention by Cadbury. First there was no substantive due diligence performed on Agent. No. 1, largely at the insistence of Cadbury India employees. He was approved by Cadbury India management without such due diligence. Further, “Other than the invoices from Agent No. 1, which contained a description of the specific licenses or approvals obtained as support for that invoice, Cadbury India did not receive documentary support for Agent No. 1’s services and did not have any written contract with Agent No. 1 when it paid Agent No. 1.”

While the Order ominously notes that Cadbury India employees prepared the required license applications which Agent No. 1 was hired to procure. Added to this was just over $110,000 paid out for six months’ worth of services described as “providing consultation, arrange statutory/government prescribed formats of applications to be filed for the various statutory clearances, documentation, preparation of files and the submission of the same with govt. authorities for specific licenses”. After a tax deduction, Agent No. 1 withdrew “most or all of the funds in cash.” There was no sufficient record of what Agent No. 1 did with the money it withdrew.

While of this was going on with Agent No. 1, Mondelēz acquired Cadbury. The Order noted, “Because of the nature of the acquisition, Mondelēz was unable to conduct complete pre-acquisition due diligence, including anti-corruption due diligence.” Moreover, even though “Mondelēz engaged in substantial, risk-based, post-acquisition compliance-related due diligence reviews of Cadbury’s business”; the “post-acquisition due diligence review did not identify the relationship between Agent No. 1 and Cadbury India.” At some time later in 2010, Mondelēz engaged in an internal investigation of Agent No.1 and “required Cadbury India to end the relationship with Agent No. 1 and no further payments were made.”

FCPA Violations

Mondelēz was charged by the SEC with violations of both prongs of the Accounting Provisions. Under the books and records component, the company did not keep its accounts “in reasonable detail, accurately and fairly reflect the transactions and disposition of the assets of the issuer” and the books and records “did not accurately and fairly reflect the nature of the services rendered by Agent No. 1.”

Under the internal controls prong, there was not sufficient due diligence performed on Agent No. 1 (yes due diligence is an internal control) and no control around enlisting Agent No. 1 without an appropriate exception protocol. Additionally, “Cadbury, did not accurately and fairly reflect the nature of the services rendered by Agent No. 1.” Finally, “by failing to devise and maintain internal accounting controls that were sufficient to provide reasonable assurances that access to assets and transactions were executed in accordance with management’s authorization and specifically to detect and prevent payments that may be used for improper or unauthorized purposes. As a result of Mondelēz’s acquisition of Cadbury stock, Mondelēz is also responsible for Cadbury’s violations.”

Unfortunately, there is no information presented as to the basis of the penalty of $13MM. One might engage in a lengthy round of speculation but based upon the public record, it would only be speculation to try and guess the basis of this penalty.

Lessons Learned

For any CCO or compliance practitioner, there are multiple lessons to be garnered from the Mondelēz FCPA enforcement action. First, and foremost, is to always remember, as we all learned from the Oracle FCPA enforcement action, there is no requirement for the payment of a bribe for there to be a civil enforcement action brought by the SEC. From a compliance program perspective, no third party representative can ever be hired without appropriate due diligence. If there is some level of due diligence that is less than standard, there must be an appropriate level of compliance review, coupled with senior management and, perhaps, even Board oversight. All contracts must be in writing with clearly specified terms. All invoices must be in writing, with sufficient specificity to enable a regulator (or auditor) looking at it years later to determine what services were delivered that were compensated by the company.

Finally, is the area of auditing of third parties as Mondelēz was specifically sanctioned for “not monitoring the activities of” Agent No. 1. Audit rights are specifically set out in the FCPA Guidance as appropriate compliance terms and conditions for every contract with third party representatives. But you must do more than simply secure such rights, you must actually use them to make sure your third party representative is not using the funds you pay them for nefarious purposes.

The Mondelēz FCPA enforcement action provides quite a bit of matter for any CCO or compliance practitioner to consider for their compliance program. Yet the most valuable lesson might well be that having a compliance program is far from doing compliance. If you only draw one lesson from this case, that would be one well worth remembering.

 

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2017

venice-foggyWelcome to my annual Venice travel edition. This week I will have a series of Venice themed posts all centered around a deep dive in to the JP Morgan Chase FCPA enforcement action. We arrived this weekend to find Venice shrouded in a deep fog, which seem an appropriate visual representation of this enforcement action. Once again we have a Chinese business unit of a major US entity which engages in conduct, with clear intent to hide its actions from corporate parent. And, once again, we see a corporate parent who is reluctant to look very closely at a business unit in a high-risk jurisdiction, engaging in conduct identified by the corporate parent as high risk, which somehow cannot seem to see the illegal conduct for at least seven years.

JP Morgan Chase (JPM)  and its subsidiary, JPMorgan Securities (Asia Pacific) Limited (JPM-APAC) resolved its Foreign Corrupt Practices Act (FCPA) matter last week, obtaining a Non-Prosecution Agreement (NPA) from the Department of Justice (DOJ) with a penalty of $72MM, agreeing to a Cease and Desist Order (Order) from the Securities and Exchange Commission (SEC), with a penalty consisting of profit disgorgement and interest of $135MM, and reaching an agreement with the Federal Reserve Bank (Fed) for a Consent Cease and Desist Order (Fed Order) to put in place a best practices compliance program and pay a penalty of $61MM. The total fines and penalties paid by JPM for its violation of the FCPA was $268 MM. This week I will review the underlying facts of the enforcement action, consider the penalties, the egregious conduct and attempts to hide their actions and discuss the multiple lessons to be garnered for the compliance professional.

The conduct involved JPM-APAC’s Client Referral Program, named the “Sons & Daughters Program” (Sons and Daughters), which targeted children of high Chinese government officials and employees of state owned enterprises, together with other close family members and even close friends and associates of these officials and employees for hiring in a blatant attempt to win business. It was designed, created and implemented by the top management of JPM-APAC, which went so far as to keep a tally of those persons hired by JPM-APAC and JPM to specific business development. As noted in the NPA, “certain senior executives and employees of (JPM-APAC) conspired to engage in quid pro quo agreements with Chinese officials to obtain investment-banking business, planned and executed a program to provide specific personal benefits to senior Chinese officials in the position to award or influence the award of banking mandates, and repeatedly falsified or caused to be falsified internal compliance documents in place to prevent the specific conduct at issue”. The language quid pro quo is replete throughout the settlement documents because that is the specific language used by JPM-APAC personnel when discussing Sons and Daughters.

These actions led to over $100MM in profit to JPM. While JPM was certainly aware that many of these hires did not meet the companies stringent hiring requirements, there never seemed to be oversight of JPM-APAC over this illegal program or even investigation into the clear red flags presented throughout the conduct at issue. What is more JPM knew the high-risk in hiring family members of government officials as far back as 2001 and indeed, had a written policy prohibiting such conduct. However, in 2006, this program morphed into a targeted program “directly attributable linkage to business opportunity”, and lasted until 2013.

According to the Order, “Over this seven-year period, JPMorgan hired approximately 200 interns and full-time employees at the request of its APAC clients, prospective clients, and foreign government officials. This included nearly 100 candidates referred by foreign government officials at more than twenty different Chinese SOEs. A number of the referral hires resulted in business for JPMorgan APAC…. JPMorgan also hired referrals from more than 10 different government agencies.” Sons and Daughters involved several different hiring programs at JPM, including new hires out of university, summer interns and lateral hires.

As noted above JPM-APAC tracked the metrics of Sons and Daughters, the “employee, whose responsibilities included supervising employees hired under the Client Referral Program, created and then updated a spreadsheet that tracked hires to specific clients, while also tracking revenue attributable to those hires. The spreadsheet included columns for each hire, the referring client, the relationship of the candidate, and the amount of revenue generated attributable to the hire in U.S. dollars. One of the purposes of the spreadsheet was to track deals that resulted from the hires and measure revenue associated with Client Referral Program hires.” So the corruption scheme and the benefits obtained therefrom were fully documented.

Initially, Son and Daughters had five requirements to be considered for hire at JPM-APAC. As set out in the NPA, they were “(1) whether the applicant was qualified for the position; (2) whether the applicant had gone through the normal interviewing process; (3) whether the referring client/potential client was government-related; (4) whether the firm was actively pitching for any business from the client/potential client; and (5) whether there was an “expected benefit to JPMorgan” for hiring the referred candidate.” Written documentation was prepared and submitted to at least JPM-APAC Human Resources (HR) and compliance functions which disguised the true nature of these hires.

Worse, it appears that both the HR and compliance functions were complicit in the scheme because on at least one instance where the JPM-APAC business unit sponsor noted on the form “[t]he hiring of this candidate will place JPMorgan in a more favorable position for securing future

business from the client.” This somehow morphed into the next iteration, which read, “The candidate will be trained by JPMorgan for couple of years and then go to local bank. Thus, will bring more business.” However, JPM-APAC compliance and HR functions “instructed the JPMorgan-APAC employee to remove the offending language, writing, “[h]iring of the candidate should not be for the purposes of securing future business of the firm. Please remove.” Further damning to the JPM-APAC compliance and HR functions was that of the more than 200 candidates hired through the Sons and Daughters program, none were rejected by either HR or compliance.

In 2009 JPM-APAC even went so far as to refine the Sons and Daughters program. Moreover, after approval by the head of investment banking for APAC, JPM-APAC implemented the revised Client Referral Program. According to the Order, it required each potential hire under the program to have “Clear accountability for deal conversion and accountability for abuse of the program.” The Order went on to note that the “revised program was managed by the JRM business support team with input from senior JPMorgan APAC investment bankers. Certain senior bankers were given a “quota” of Referral Hires that could be made each year. Subsequent JRM reports from 2009 through 2012 contained the same language regarding the “revised” referral hiring program with the selection criteria of a “[d]irectly attributable linkage to business opportunity.” These presentations were discussed with the head of investment banking for JPMorgan APAC and other JPMorgan APAC senior executives.”

In addition to the tying of business to the hirings under the Sons and Daughters program, there was the additional problem that these hires did not meet JPM’s basic hiring and retention standards. According to the Order, one JPM-APAC representative described those hired under the program “as a protected species requiring [senior management] input. His reporting line to you is accountable but like national service.” Both the Order and NPA were replete with document evidence that the hires under Sons and Daughters did not meet minimum hiring standards and they often failed to meet minimum standards for retention at the company. Below is a Box Score summary from the NPA of some of the candidates which clearly did not meet JPM hiring standards, yet who were hired and where such hires under the Sons and Daughters program brought benefits to JPM.

Foreign Official or SOE employee Reasons for hire Candidate deficiencies Deficiencies as JPM employee Benefit tied to hire
Client 1 Maintain good relationship with client $4.82MM profit
Client 2 Quid pro quo for business JPM-APAC lead underwriter on IPO
Client 3 Not very impressive, poor GPA Attitude issue. He doesn’t seem to care about work. Don’t need to have an intern doing nothing JPM-APAC lead underwriter on IPO
Client 4 Promised IPO work Not qualified for job at JPM. Tech and quantitative skills ‘light’ Communication skills and interest in work lagged his peers JPM-APAC lead underwriter on IPO. $23.4MM profit
Government Official 1 Father would go the extra mile to help JPM Worst business analyst candidate ever seen Immature, irresponsible and unreliable. Sent out sexually inappropriate emails JPM-APAC lead underwriter on IPO
Government Official 2 Hire would ‘significantly’ influence role of JPM-APAC Unlikely to meet hiring standard New York not comfortable with his work. Recommends he follow a different career path JPM-APAC lead underwriter on IPO

Probably the most amazing thing about this case is the superior result achieved by JPM in its resolution. Not only did it gain a 25% discount off the bottom of the US Sentencing Guidelines fine range but it received a NPA and not even a Deferred Prosecution Agreement (DPA) and no outside monitor was required of the company going forward. While some of this result is due to having excellent defense counsel, a large part is due to the cooperation by JPM and the remediation engaged in by the company. Tomorrow Commissario Guido Brunetti will inform our discussion of how the company’s actions led to this outstanding result.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2016

qtq80-uikD1eToday I continue my exploration of the recently announced Department of Justice (DOJ) and Securities and Exchange Commission (SEC) Foreign Corrupt Practices Act (FCPA) enforcement action with the announcement of the resolution of the Embraer SA (Embraer) matter. The resolution documents included a Deferred Prosecution Agreement (DPA) and Criminal Information (Information) with the DOJ and a Compliant with the SEC. Today I want to consider the bribery schemes of Embraer in some detail so that a Chief Compliance Officer (CCO) or compliance practitioner can use them to determine what they might want to look for in their organization.

I. The Bribery Schemes

  1. Dominican Republic

The SEC Compliant specified that from 2008 until 2010, Embraer paid $3.52 million to an influential government official in the Dominican Republic via a false agency agreement to secure a contract to sell the Dominican Air Force eight military aircraft for approximately $96.4 million. Immediately before the Dominican Republic Senate was to vote on the contract for the airplanes at issue, the Dominican official handling the country’s negotiations requested a commission from Embraer, even though he was a government official.

This commission was to be paid through three Dominican companies. The SEC Compliant specifies the amounts paid were to be as follows:

  1. “Dominican Agent A” ($100,000);
  2. “Dominican Agent B” ($920,000); and,
  3. “Dominican Agent C” ($2.5 million).

Embraer did not conduct any due diligence on these three companies; nor were the payments “based on any legitimate services rendered by these agents to Embraer.” These payments were made in spite of the fact that the company’s “legal department viewed consulting agreements that were signed after the execution of a sales contract as “high risk.”” Most conveniently when the Embraer legal department continued its objections to the commission payments, “senior executives at Embraer merely instructed subordinates to find a solution that did not involve the legal department.”

To overcome the problems raised by (apparently) lower level Embraer legal functionaries; a “senior Embraer legal executive became involved.” This senior legal department executive either thought up or approved another bribery scheme whereby another corrupt agent “Dominican Agent D” would be paid the full amount of the bribe. This Dominican Agent would then and did distribute the illegal payments.

Rather amazingly or perhaps brazenly, Embraer then wired the corrupt and illegal payments from its New York bank to the bank of Dominican Agent D, which was located in Uruguay. The payments were characterized as “Sales Commission”; “Selling Expense” and “Commercialization Expense” in the company’s books and records. The internal controls failures, listed in the DOJ Information were, “EMBRAER had conducted no diligence on the shell company, did not have a signed contract with the shell companies and knew that the shell company had not performed any legitimate services in exchange for the payment.”

2. Saudi Arabia

From 2009-2011, Embraer paid $1.65 million to an official at a Saudi Arabian state-owned and -controlled company via a false agency agreement to secure that instrumentality’s agreement to purchase three aircraft from Embraer for approximately $93 million. The specific scheme was another direct payment to the Saudi Arabian government official who headed up the country’s negotiating team. There was an agreed commission rate paid of $550,000 per aircraft sold.

The bribes were paid through a South African company unrelated to the transaction. Once again there was no due diligence performed on the agent who was the bribery conduit. Conveniently, “the same senior legal executive who was involved in the Dominican Republic bribery scheme, approved the selection of the South African company as the agent in the transaction with the Saudi state-owned enterprise. On March 5, 2010, Embraer RL executed a consulting agreement with the South African company, and the senior Embraer legal executive signed it on behalf of Embraer RL. There was no business justification for using the South African company as an agent given its lack of qualifications.”

Obviously also relying on a banking system that was now well-traveled, the company again wired the bribe money from its New York bank but this time the money was sent to the South African agent’s bank. This agent then wired the money to a bank account in Switzerland, which was controlled by the father of the Saudi Arabian official who was to receive the bribe. Following the same books and records façade, the payments were characterized as “Sales Commission”; “Selling Expense” and “Commercialization Expense” in the company’s books and records. The internal controls failures, listed in the DOJ Information were, “EMBRAER made payments to Agent B, even though it had conducted minimal due diligence on Agent B, did so almost exclusively on the basis of information Embraer Executive B personally provided to its contracts and legal departments, and did not require any proof of services from Agent B before making payment.”

3. Mozambique

In 2008-2009, Embraer paid $800,000 via a false agency agreement with an intermediary designated by a high-level official at Mozambique’s state-owned commercial airline, Linhas Aéreas de Moçambique S.A. (LAM), to secure LAM’s agreement to purchase two aircraft from Embraer for approximately $65 million. Mimicking the Dominican Republic negotiations, approximately one month before the purchase was to go through, the Mozambique agent involved, “told at least one senior Embraer employee that Embraer should make a “gesture” to unidentified officials in the government of Mozambique when delivering the first aircraft. This agent was a “middleman or agent for the government officials involved in the deal, and Embraer employees believed they needed to pay the Mozambican Agent in order to win the contract.””

The bribe price was negotiated to be $800,000 fixed, rather than the original commission per aircraft. The bribe was paid when “Embraer’s U.S.-based subsidiary, Embraer RL, executed a consulting agreement with a company based in the Democratic Republic of São Tomé and Príncipe that the Mozambican Agent controlled and which had only been incorporated in or about November 2008. Once again there was no due diligence performed on this third party entity nor was there any legitimate consulting services engaged in by this corrupt agent.

The company again wired the bribe money from its New York bank but this time the money was sent to the agent’s bank in Portugal. Following the same books and records façade, the payments were characterized as “Sales Commission”; “Selling Expense” and “Commercialization Expense” in the company’s books and records.

4. India

In 2009, Embraer paid an agent $5.76 million pursuant to a false agency agreement with a shell company in connection with a contract it secured to sell the Indian Air Force three aircraft for approximately $208 million. The company used a corrupt agent to facilitate the transaction, even though the Embraer “employees understood that India prohibited the use of commercial agents for military sales. For that reason, in January 2005 Embraer executed a consulting agreement with a company domiciled in the UK (the “UK Entity”), which had a relationship with the Indian Consultant.”

No doubt befitting its UK locus, the company moved to a more James Bond approach by keeping the contract for the illegal payments “stored in a safe deposit box in London that could only be opened by the simultaneous use of a key maintained by Embraer’s legal department and a card key in the possession of a representative of the UK Entity.” Perhaps one or both parties forgot where they kept their respective keys, as the agreement under which the corrupt payments were to be made, expired in its safely stored in its safe deposit box. This required another agreement under which to pay the bribe. This time it was through a Singaporean entity.

The company again wired the bribe money from its New York bank but this time the money was sent to the agent’s bank in Portugal. Following the same books and records façade, the payments were characterized as “Sales Commission”; “Selling Expense” and “Commercialization Expense” in the company’s books and records. The internal controls failures listed in the DOJ Information were “the only due diligence that EMBRAER conducted on Agent C’s company was Iimited to collecting the company’s registration documents, corporate by-laws, and board minutes from Agent C himself, and EMBRAER did not require any proof of services from Agent C before making payment.”

Lastly, it should be noted on the specific involvement of the Embraer legal department in making all of the above possible. The SEC Compliant stated in the final paragraph before the Claims for Relief, “Embraer’s legal department was responsible for approving the consultants its senior legal executive engaged on behalf of ERL. As a result, senior Embraer executives in Brazil, including a senior legal executive at the time, at least two other senior Embraer executives, and several Embraer managers, circumvented the Company’s internal accounting controls by, among other things, approving the engagement of third parties through sham contracts to act as conduits for bribes to foreign officials, and concealing bribe payments as legitimate expenses under contracts obtained in countries that bore no relation to any legitimate services rendered and that were intended largely to pay bribes to foreign government officials.” One might only hope the appropriate bar group or legal society will take appropriate disciplinary action against those lawyers involved in the illegal conduct.

Tomorrow I will consider how Embraer was able to extricate itself from these very serious facts and even receive a discount from the low end of the sentencing range. (Hint: It involves hiring some excellent FCPA counsel.)

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2016

john-fogertyI recently saw John Fogerty in concert. For those you are not aware, he was a founding member and the driving force behind Creedence Clearwater Revival (CCR), one of the very top American groups from the 1960s and early 1970s. After the band’s disintegration, Fogerty continued on as a solo artist. CCR was distinctive in that its rock and roll roots were Stephen Foster as much as anyone and in the middle of the British invasion brought a uniquely American sound with a very hard edge. From the anthem of Vietnam vets, Who’ll Stop the Rain, to the greatest Halloween song Bad Moon Rising (that is – after Boris Karloff’s version of the Monster Mash); CCR brought serious American root chops to rock.

Fogerty continues to rock out and played a 2.5 hour set straight through from his opening song of Proud Mary to his encore performances of Travelin’ Band, Bad Moon Rising and Fortunate Son; it was one great night of rock and roll for any who listened to music in the 60s or 70s. His son played lead guitar for him and it was very obvious that Fogerty had a father’s joy in working with his son. If he comes to your town, I suggest you run, don’t walk, to the show.

Fogerty’s performance informs today’s blog post about the recent Foreign Corrupt Practices Act (FCPA) enforcement action brought by the Securities and Exchange Commission (SEC) against Nu Skin Enterprises Inc. (Nu Skin) and its Chinese subsidiary, Nu Skin (China) Daily Use & Health Products Co. Ltd. (Nu Skin China). Nu Skin is a Utah based entity, which, according to the SEC Cease and Desist Order (Order), is “in the business of manufacturing and marketing cosmetic and nutritional products primarily through direct selling, or multi-level marketing [MLM], channels.”

Although it was a relatively small enforcement action with a civil money penalty in the amount of $300,000, coupled with a disgorgement profits in the amount of $431,088, plus prejudgment interest of $34,600, the matter has several interesting aspects for the Chief Compliance Officer (CCO) or compliance practitioner to consider. First, although it might seem somewhat unusual for such an entity to become embroiled in a FCPA enforcement action it is the uniqueness of it that points to several lessons to be garnered by any company doing business under a MLM sales model. Next the case involved corruption around a charitable donation and it, therefore, serves as a stark reminder of the high-risk of charitable donations under the FCPA. Finally, the matter reminds everyone of the strict liability nature of violations of the Accounting Provisions of the FCPA including both internal control provisions and books and records provisions of the Act.

The allegations are that Nu Skin China made a donation which totaled approximately $154,000 to a charity in China to secure the intercession of a Chinese Communist Party (CCP) official to stop an ongoing investigation of the company. Nu Skin China had engaged in direct selling in China, in violation of Chinese domestic law, and was under investigation by the Administration of Industry and Commerce.

Nu Skin China decided, rather than comply with the law, it would seek to influence the investigation through corrupt means. According to the Order, “A Nu Skin China employee contacted the Party Official, who was his acquaintance, to suggest a charity located in the province. The Party Official had a pending request to Nu Skin China to facilitate obtaining college recommendation letters to U.S. universities from an influential U.S. person for his child. The Party Official proposed a charity, although at the time a branch of the charity had not yet been established in the province and it had no operations there. The Party Official, however, was associated with the entity that was responsible for establishing the charity in the province. Further, the provincial head of the AIC had previously reported to the Party Official.” Not only was a donation to the Party officials suggested charity made by but “the request for the recommendation letters was elevated to “top priority” as it was “becoming increasingly important” for Nu Skin China. Nu Skin US subsequently reported to Nu Skin China that it had secured an agreement from an influential U.S. person to write the college recommendation letters for the Party Official’s child.”

Nu Skin China did not inform its US parent of the true nature of the donation; to wit, to corruptly influence the AIC investigation and proposed fine of approximately $485K. Because of the size of the donation, the US parent had to approve and advised its Chinese subsidiary that such a “large donation in China could pose FCPA risks, so it advised Nu Skin China to consult with outside U.S. legal counsel based in China to ensure that the donation complied with the FCPA. Outside counsel, in turn, recommended that Nu Skin China include anti-corruption language, which included language regarding the illegality of influencing government officials, in the written donation agreement with the charity. That language was inserted into a draft of the donation agreement between Nu Skin China and the charity. The anticorruption language, however, was removed from the final version of the donation agreement that Nu Skin China executed. Nu Skin US was not aware that the language had been removed.”

All of this presents several significant and important lessons for the CCO and compliance practitioner. There was no evidence that Nu Skin self-reported so it is not clear how the SEC was made aware of the FCPA violation. However, it is not too far a stretch to opine that the Chinese government could have tipped off the SEC. The case also demonstrates that it is every transaction that matters as this enforcement action was for a one-time transaction. Ongoing due diligence, compliance terms and conditions in contracts and monitoring the relationship after the contract is signed are mandatory for any high-risk transaction. This donation had been flagged by the US entity as high-risk yet there was no oversight by the US entity to make sure that the compliance mandates were followed.

This enforcement action also reinforces the need for robust management of FCPA high-risk charitable donations. As was noted in the Order, “given the well-known corruption risks in China, Nu Skin US did not ensure that adequate due diligence was conducted by Nu Skin China with respect to charitable donations to identify links to government or political party officials and to prevent payments intended to improperly influence such persons in violation of the company’s anticorruption policy and the FCPA.” The reason there are levels of oversight in any best practices compliance program is to prevent just this type of FCPA violation from occurring. It really does not matter if the China subsidiary misrepresented to the US parent both what it was doing and then failed to follow specific instructions. Oversight is there to make sure that internal rules and procedures are followed. That is the responsibility of the US parent.

Finally, companies need to understand the strict liability nature of enforcement actions involving Accounting Provision violations of the FCPA. The statute itself refers to “devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances” as the SEC had interpreted this portion of the FCPA to set a reasonableness standard. If there are payments which violate the FCPA, there were not sufficient internal controls to prevent them. It may sound like very backward logic but that is the reality of SEC enforcement actions and it points directly to the need for companies to have functioning internal compliance controls in place.

John Fogerty took me back many years to some great music I listened to and indeed loved as a teenager. The Nu Skin FCPA should remind every CCO and compliance professional that vigilance must be maintained in any high-risk country or high-risk transaction, even if you are selling through MLM. Failure to follow through with all required compliance program steps, including oversight from the home corporate office, can lead to serious consequences.

 

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2016