In this episode, I visit with Marc Bohn, Counsel at Miller & Chevalier on the recent 11th circuit opinion limiting the SOL on profit disgorgement claims to 5 years and the IRS tax letter holding payments for profit disgorgement not deductible. We work through a hypothetical which a company might face in a FCPA matter on the issue. We discuss the following scenario:

Hypothetical: Self-Disclosure Considerations: Let’s assume a publicly-listed U.S. company with a global footprint has identified potentially improper payments by a wholly-owned subsidiary in Latin America to a local government official that was provided to secure a lucrative contract. Let’s say the U.S. parent had no involvement in or knowledge of the misconduct, but may have consolidated over $1 million in what seem to be illicit gains into its financial statements. Assuming the myriad of other factors relevant to a self-disclosure decision are equal, how might the various disgorgement-related developments we’ve been discussing impact a decision by the company on (a) whether or not to voluntarily disclose; and (b) how to approach such a self-disclosure?

For more information, see the following articles by Bohn and others at Miller on the issue of profit disgorgement.

  1. Eleventh Circuit Restricts SEC’s Ability to Impose Disgorgement;
  2. Disgorgement: the Devil You Don’t Know
  3. Disgorgement, an overlooked aspect of the Ralph Lauren settlement?

IMG_3310This week I have been exploring the Key Energy, Inc. (Key Energy) Foreign Corrupt Practices Act (FCPA) enforcement action. Today, I want to consider the actions taken by Key Energy to obtain the very good resolution the company achieved in the form of a declination from the Department of Justice (DOJ) and the profit disgorgement of $5MM.

The Key Energy matter concluded with the filing of an Order instituting a Cease and Desist Order (Order) in a Securities and Exchange Commission (SEC) administrative proceeding. The matter involved conduct in the US corporate office and also its Mexican subsidiaries, “Key Energy Services de Mexico S. de R.L. de C.V., and a service payroll company, Recursos Omega S. de R.L. de C.V., which is the legal employer of Key Energy’s employees in Mexico” and which were collectively referred to as “Key Mexico” in the Order.

By any stretch, Key Energy obtained an excellent result from its FCPA journey. The company received a declination to prosecute from the DOJ and its only financial penalty was a $5MM disgorgement order from the SEC. The company remediated so thoroughly that it did not require a monitor going forward. All of this means, the Key Energy FCPA enforcement action should be studied by compliance professionals to determine how Key Energy obtained these positive results.

It is incumbent to note that this result was achieved even though Key Energy did not self-disclose to the DOJ or SEC. The Order reports that the SEC contacted Key Energy in January 2014 “with respect to potential FCPA violations”. In April 2014, “Key Mexico employees reported to Key Energy information they had received suggesting the recently resigned country manager had promised bribes to one or more Pemex employees during his employment with Key Mexico.” At that point, Key Energy reported these allegations to the SEC and the company undertook a “broad internal investigation and risk assessment of Key Energy’s international operations.”

However, from that point forward, it appears that the cooperation afforded by Key Energy to the SEC was exemplary as “To the extent the internal investigation identified additional issues of concern, Key Energy provided updates to the Commission staff.” Key Energy provided translated documents to the SEC and provided overall cooperation to the SEC; all of which “assisted the staff in its investigation.”

Key Energy also engaged in extensive remediation to its compliance program after it was notified by the SEC. Initially the company hired a new Chief Compliance Officer (CCO) who led an effort to make “significant remedial measures”. As set out in the Order, the company accomplished the following during the pendency of the investigation. These measures included:

  • the suspension of payments to all vendors and third parties in Mexico shortly after the independent investigation/internal review began;
  • the engagement of a manual review of over 600 vendors in Mexico for purposes of clearing legitimate payments and assessing whether to move forward with those vendors in current and future operations;
  • reviewing all vendors in use in Russia and Colombia and instituting an enhanced due diligence procedure for all vendors globally;
  • establishing enhanced financial controls around the procedure-to-pay process in Mexico, Colombia, and Russia including interim employee certifications requirements, revised vendor onboarding requirements, and heightened payment approval requirements;
  • implementing a new business opportunities protocol to help Key Energy legal better understand business risks including the role played by agents, consultants or other vendors/business partners, so as to enable better assessment of corruption-related risks in future business opportunities;
  • installing new controllers in the Colombia and Mexico businesses and more effectively enforcing a solid line reporting relationship to the U.S. Controller and ultimately the CFO;
  • in-person visits to each international location by the CCO and others to, among other things, conduct training of all international employees; and
  • developing and/or reviewing several company policies and procedures including the Code of Business Conduct, the FCPA and Anti-Corruption policy, the Travel and Expense policy, and the New Hire Screening Form; and
  • a coordinated wind-down and exit of all markets outside of North America, and a commitment to exit Mexico by the end of 2016.

Initiatives 1-3 generally describe investigatory efforts; initiatives 4-5 are creation or enhancement of internal controls; initiative 6 speaks to appropriate business personnel to effect the doing of compliance; initiative 7 relates to putting on in-person training and having a CCO who gets out of the corporate office and visits the employees in the field; initiative 8 relates to updating and upgrading Hallmark Two of an effective compliance program as set out in the FCPA Guidance, including the company’s Code of Conduct and written policy and procedures; finally, initiative 9 demonstrates why a company should create an effective compliance program, as the company is moving away from all international markets, save and except Canada.

There is one other noteworthy component to this SEC resolution and that is the disgorgement of $5MM. There is no other financial penalty listed. One must assume this is based upon the company’s cooperation and remediation and its financial condition. Indeed, one paragraph of the Order reads, “In determining to accept the Offer, the Commission considered cooperation Key Energy afforded to the Commission staff and the remedial acts undertaken by Key Energy. In addition, in determining the disgorgement amount and not to impose a penalty, the Commission has considered Key Energy’s current financial condition and its ability to maintain necessary cash reserves to fund its operations and meet its liabilities.” In a section entitled ‘Undertakings’ the Order also specifies the actions the company will take if it is forced into or voluntarily goes into bankruptcy. Key Energy agreed to “undertake all reasonable efforts to obtain authorization from the bankruptcy court having jurisdiction over Respondent’s bankruptcy to pay the disgorgement amount”.

These final two provisions make clear the SEC has no interest in putting a company out of business. But, more importantly, it recognizes modern business economic reality including (but not limited to) the state of the energy industry, corporate debt and its attendant obligations, the unanticipated actions of creditors in forcing companies into involuntary bankruptcy, the maintenance of cash reserves and other factors as well. While there have been other FCPA resolutions which took into account a company’s ability to pay when assessing the fine or penalty; the Key Energy resolution makes clear they understand and accept the business realities on the ground.

The enforcement action presents clear evidence of what a company can do, when it finds itself in the throes of FCPA violations. While it is not clear if the same result would have been achieved before the advent of the Pilot Program, the company’s Declination received from the DOJ and the relatively modest overall penalty assessed by the SEC demonstrate that when a company shows its willingness to work with the DOJ and SEC in a manner which they have articulated, the government will actively reward such cooperation.

And finally, but certainly not least, to the Key Energy CCO and his compliance team. You all worked long, hard and diligently to get your company through all of this very challenging issue and very difficult economic times. The work you did in remediation and credibility you established with the government is reflected in both the declination and the SEC Order. A tip of the hat for a job well done.

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

Kenny BakerKenny Baker died last week. For those not familiar with that name, you are most assuredly familiar with the character he played, that being R2D2. Baker had a long history in English vaudeville before filling the role of one of the most lovable characters in all of Star Wars. In his New York Times (NYT) obituary, Baker was quoted that “This film came along and I turned it down. I said, ‘I don’t want to be stuck in a robot, what for, for goodness sake.” But take it he did and he loved it, later saying, “he would do it again for free.” Free or for pay, we are all better off for Kenny Baker’s decision.

Yesterday I began a what I thought would be a two-part series on the Key Energy, Inc. (Key Energy) Foreign Corrupt Practices Act (FCPA) enforcement action. However (and as usual), I got carried away so today I will review the lessons to be learned from the underlying actions which led to the FPCA violations. Tomorrow, I will consider the actions taken by Key Energy to obtain the very good resolution the company achieved in the form of a declination from the Department of Justice (DOJ) and the profit disgorgement of $5MM.

The Key Energy matter concluded with the filing of an Order instituting a Cease and Desist Order (Order) in a Securities and Exchange Commission (SEC) administrative proceeding. The matter involved conduct in the US corporate office and also its Mexican subsidiaries, “Key Energy Services de Mexico S. de R.L. de C.V., and a service payroll company, Recursos Omega S. de R.L. de C.V., which is the legal employer of Key Energy’s employees in Mexico” and which were collectively referred to as “Key Mexico” in the Order.

The vast majority of the corrupt payments were made through a “Consulting Firm”, which had close connections with a Pemex official, who had decision making authority over Key Mexico contracts. The Consulting Firm apparently did not have a written contract with the company, the contract was not approved by the Key Energy legal department and did not go through any background due diligence, even though both were required under the Key Energy compliance program in place at the time of the issues involved. Even more amazingly is that when these issues became known to the corporate headquarters of Key Energy, the third party was allowed to continue.

Yet even without the minimum of any enforcement of a contract management process or third party risk management process, Key Energy also failed in having a set of internal controls around payments. The Order noted that out of the $561,000 in payments made to the Consulting Firm, “at least $229,000 were payments made through April 2013 in connection with consulting services that were described in Key Mexico’s accounting system as “Expert advice on contracts with the new regulations of Pemex/Preparation of technical and economic proposals/Contract Execution.”” Such description of services is a clear red flag, which should always warrant additional investigation.

While Key Energy had a compliance program in place, it certainly did not engage in doing compliance. The corporate offices failed in the basic oversight of Key Mexico around compliance and did not monitor compliance in Mexico to “ensure they complied with and enforced anti-corruption policies and kept accurate records concerning payments to consultants and gifts to Mexican government officials.” Additionally, there was no oversight and monitoring by compliance or internal audit, who could enforce the requirements of the company’s anti-corruption compliance program or even clean up the mess with remedial actions.

Finally, there was one paragraph in the Order which demonstrated Key Energy’s complete failure of internal controls. More importantly, the SEC laid out in this same paragraph how the information about the violation could have been used by the company to stop the illegal conduct. In short, it lays out how transaction monitoring can be used on a case-by-case basis to detect and remediate illegal conduct and prevent it going forward. The specific issue was around monies made as a donation for a Christmas raffle intended to benefit Pemex employees.

No doubt there will be commentators who will use this paragraph to claim that money or gifts donated for customer raffles violates the FCPA. Such views miss the entire point of this paragraph. The Order stated, “in 2012, Key Energy approved Key Mexico’s contribution of gifts totaling approximately $118,000 to Pemex’s annual Christmas season celebration with the understanding that the gifts were to be intended for a raffle.” However, of this amount some $55,000 was designated to some 130 specific Pemex officials, not a general donation for the benefit of all Pemex employees.

The Order went on to specify the amount was nine times greater than the amount donated for the Christmas raffle for Pemex employees in 2010 and some 26 times the amount spent in 2011 for the same event. More interestingly, the SEC pointed out “Key Energy also failed to consider the implications of the explanation by Key Mexico’s country manager that the higher gift amount in 2012 was correlated to Key Mexico having done more business with Pemex that year.” If Key Energy had engaged in such transaction monitoring, it would have seen an increase in business with Pemex, which, of course, could then have been further investigated. As the Order noted, “Had Key Energy sought more information, it may have learned that Key Mexico was providing gifts to Pemex officials during a period Key Mexico was engaged in ongoing negotiations with Pemex, including negotiations to obtain additional funding for work required under its contracts with Pemex.”

This transaction monitoring analysis laid out by the SEC in its Order clearly intones the SEC will be expecting this type of monitoring going forward. This means a Chief Compliance Officer (CCO) or compliance function will need visibility into not only gifts, travel, entertainment and donation spends in high risk areas but also sales information so they can be correlated and reviewed from the compliance perspective. This is a new level of detail we have not seen before.

Tomorrow will focus on Key Energy’s comeback in the face of its compliance failure.

 

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 SaundersJohn Saunders died last week. He was a reporter at ESPN and the host of the Sunday talking heads show, the Sports Reporters. The tributes for Saunders came from far and wide. By all accounts, he was one of the most beloved on-air talents at the network. Saunders also brought something else to the table as he was a black man from Canada. His perspective on American society was drawn from this diverse background. He did not often choose to bring this perspective to his commentary but when he did it was compelling and powerful. His voice will be missed.

Last week witnessed the conclusion of the Key Energy, Inc. (Key Energy) Foreign Corrupt Practices Act (FCPA) enforcement action, which I will review over the next couple of blog posts. Today I want to consider the background facts and allegations. Tomorrow, I will review the lessons to be learned from this enforcement action.

The Key Energy matter concluded with the filing of a Cease and Desist Order (Order) in a Securities and Exchange Commission (SEC) administrative proceeding. Key Energy had previously announced it had received a declination to prosecute from the Department of Justice (DOJ) in an April, 8K filing, which read, “Key has been informed by the Department of Justice that the Department has closed its investigation and that it has decided to decline prosecution of the Company.” The Order reported that Key Energy agreed to profit disgorgement of $5,000,000.

These basic facts lead the compliance practitioner to several interesting lessons learned from the FCPA enforcement action which can be used to improve a compliance program as well as lessons in the steps to take if your company finds itself in a FCPA investigation. Additionally, the case has implications for other companies or indeed industries which now find themselves in an economic downturn such as the energy industry because while the amounts of profit Key Energy obtained through bribery and corruption were not insignificant, the Order noted, “On September 4, 2015, Key Energy announced that for 30 consecutive trading days the price for Key’s common shares was below the minimum $1.00 per share requirement for continued listing on the NYSE. Key Energy’s common shares have continued to trade below $1.00 since that time. Between December 2014 and October 2015, Moody’s downgraded Key Energy’s bonds three times and changed its outlook to “negative.””

The corruption was in the company’s Mexican subsidiary, which “consisted of Key Energy Services de Mexico S. de R.L. de C.V., and a service payroll company, Recursos Omega S. de R.L. de C.V., which is the legal employer of Key Energy’s employees in Mexico” and they collectively referred to as “Key Mexico” in the Order. Key Mexico made illegal payments to an “employee at Petróleos Mexicanos (“Pemex”), the Mexican state-owned oil company, to induce him to provide Pemex inside information as well as advice and assistance on contracts with Pemex and amplifications or amendments to those contracts.” These payments were funded through an un-named Consulting Firm.

The corruption scheme was also interesting in that Key Mexico was paying for insider information, made available earlier than public announcements, in addition to using the Consulting Firm for ‘influence’. With the exception of four payments totaling $6,400, there was no evidence presented of either direct payments from Key Mexico to Pemex employees for contracts or even payment amounts through the third party Consulting Firm. Finally, Key Mexico apparently used the Consulting Firm to increase components to contracts “through a series of amendments of “amplifications”” one of which was a $60MM increase in contract value.

Key Mexico hired the Consulting Firm in 2010. The firm was not subjected to the company’s requirement for due diligence. The Mexico country manager never disclosed to Key Energy that the “Consulting Firm had ties to the Pemex employee and that payments to the Consulting Firm were used to funnel Key Mexico funds to the Pemex employee in exchange for his assistance with obtaining Pemex business”. Lastly, this entire arrangement was not even reduced to writing in a contract.

All of the nefarious actions by Key Mexico did not absolve Key Energy of its responsibilities under the company’s anti-corruption compliance program. At some point, the Key Energy legal department became aware of the relationship, yet allowed it to continue and indeed flourish. The Order stated, “Although the consulting arrangement with the Consulting Firm violated Key Energy compliance policies because it had been entered without pre-approval from Key Energy legal, because no due diligence had been conducted on the Consulting Firm and because no written contract had been entered with the firm, Key Energy allowed the relationship and payments to continue, and Key Mexico allowed payment of the invoices from the Consulting Firm despite a lack of sufficient documentation supporting the purported services and the ties between the Consulting Firm and the Pemex employee.”

The Consulting Firm sent to Key Mexico emails with attachments which included, “Pemex internal memoranda concerning certain new contracts that Pemex intended to put out for tender”. There were also emails referenced in the Order “which contained detail of internal Pemex deliberations”. This information was forwarded from Key Mexico to the US corporate headquarters “but the recipients at Key Energy apparently did not question how or why the country manager was in possession of and sharing such communications.”

Moreover (and rather amazingly), the Key Energy senior Vice President (VP) immediately sought a contract uplift of $90MM. This was communicated back down the line into Key Mexico, eventually to the Consulting Firm. As the Order stated, “One week later, on February 23, the Pemex employee, again from his Pemex e-mail account, forwarded the Key Mexico country manager an unexecuted internal Pemex memo, under which Pemex personnel recommended an increase of $60 million to the funds available to pay Key Mexico under Contract No. 8861. The Pemex employee wrote in the cover e-mail to the country manager: “I am sending this to you so you can see I am working.” On March 24, 2011, a little more than a month later, Key Mexico and Pemex executed an amendment to Contract No. 8861 increasing the contract amount by approximately an additional $60 million.” [emphasis supplied]

The Consulting Firm was rewarded handsomely for its efforts, “Between August 16, 2010 and May 7, 2014, Key Mexico made 58 payments to the Consulting Firm totaling approximately $561,000. Of that amount, at least $229,000 were payments made through April 2013 in connection with consulting services that were described in Key Mexico’s accounting system as “Expert advice on contracts with the new regulations of Pemex/Preparation of technical and economic proposals/Contract Execution.” Additionally, and for reasons not made clear in the Order, the Key Mexico country manager also made four direct wire transfers from his personal bank account into the personal bank account of Pemex official who awarded the contract and uplifts to Key Mexico. These four payments totaled $6,400.

Tomorrow I will consider what Key Energy did to obtain the result it achieved and highlight the lessons to be learned from this enforcement action.

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

 

Show Notes for Week ending August 12

  1. SEC In-House ALJ Program Upheld. Compliance Building and Second Circuit Court of Appeals opinion.
  2. Abbott, sales pressure and suicide. NYT article, “Driven to Suicide by Inhuman Pressure to Sell
  3. Airbus under investigation for allegations of bribery to make airliner sales in emerging markets. FT article Airbus probe poised to shake up Boeing rivalry”.
  4. Lily King, finger wagging and calling out the Russian, ­­­­­Yulia Efimova for her history of doping. Inc. article, “Yes, U.S. Swimmer Lily King Was Absolutely Right to Blast Yulia Efimova for Doping
  5. Jay Rosen appearance on Masters of Disasters
  6. Maurice Gilbert’s list of questions every CCO should ask in an interview.
  7. Link to Red Flag Group registration and information for Webinar 2 of a 4 part series on Supply Chain risk management, click here.