The year 2016 may well be one for the books in the enforcement of the Foreign Corrupt Practices Act (FCPA). In February there were nearly as many FCPA enforcement actions as there were in all of 2015. Yet the summer of 2016 brought some significant enforcement actions which may well portend long-term changes in FCPA enforcement. In my new eBook,  I explore these enforcement actions, discuss the underlying facts of each and provide the lessons for the compliance practitioner. I will also look at the enforcement actions in the context of the Yates Memo and recently announced change in the way the Department of Justice (DOJ) will assess damages in its prosecutions based upon the FCPA Pilot Program, announced in April, 2016.

My latest eBook is published by Corporate Compliance Insights and joins a list of books which I have partner with CCI to publish. You can download this eBook for free by clicking here. At the 2016 FCPA enforcement year moves towards conclusion, it may well be one for the books. The summer of 2016 may prove to be as significant a three month period of FCPA as we have seen in some time.

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 Not Your Father’s FCPA-Summer 2016, the New Era of Enforcement

 

qtq80-OzJJ18The Securities and Exchange Commission (SEC) settled a Foreign Corrupt Practices Act (FCPA) enforcement action against an individual earlier this month when it announced the resolution of a matter involving Jun Ping Zhang, via a Cease and Desist Order (Order). The matter involved Harris Corporation (Harris) and its Chinese business unit Hunan CareFX Information Technology, LLC (CareFx China). Ping, a US citizen served as both Harris Corporation’s Vice President of Technology and CareFx China’s Chairman and Chief Executive Officer (CEO) in 2011 and 2012. Harris employed Ping with its acquisition of the US entity CareFX Corporation.

Harris interviewed Ping in its pre-acquisition phase of due diligence of CareFX and its Chinese subsidiary. However, Ping was not asked any questions about engaging in bribery or corruption, failed to disclose he was leading a massive bribery effort or lied to the pre-acquisition due diligence investigators. He continued to lead this bribery and corruption effort after Harris closed the acquisition of CareFX and thus the Chinese subsidiary of Harris made “approximately $200,000 to $1 million in improper gifts to Chinese government officials.” For these illegal gifts, CareFX China was awarded “over $9.6 million in contracts with state-owned enterprises.” Ping agreed to a civil penalty of $46,000.

It was in the post-acquisition integration phase that Harris became aware of its troubles in China. As Jaclyn Jaeger reported in Compliance Week, “Following the closing, the company said it “became aware that certain entertainment, travel and other expenses in connection with the Carefx China operations may have been incurred or recorded improperly.”

“In response, we initiated an internal investigation and learned that certain employees of the Carefx China operations had provided pre-paid gift cards and other gifts and payments to certain customers, potential customers, consultants, and government regulators, after which we took certain remedial actions.”

This matter involved yet another US company which came to FCPA grief because of (1) the corrupt actions of its Chinese subsidiary and (2) where the US had entered the Chinese market through acquisition rather than an organic growth strategy. The bribery scheme was funded by fraudulent expense reimbursements which were created and/or approved by Ping. The Order stated, “With Ping’s knowledge and under his management, CareFx China sales staff submitted bogus expense receipts labeled as “entertainment,” “office expenses,” or “transportation” to CareFx China’s accounting department for cash reimbursement.” The “sales staff used the cash generated from these sham expense reimbursements to pay for gifts to government officials. Ping and the supervisors that he managed authorized the bogus expense claims, knowing that they were fabricated and that the “reimbursed” funds were used to pay for gifts to government officials to influence their decisions to purchase CareFx China’s products and services.”

The Order confirmed Ping knew what he was doing when it said, “Ping knew that these bogus expenses were improperly recorded in CareFx China’s books and records as legitimate sales expenses or consulting fees and that, as a result, their true nature would not be disclosed to Harris.” However, “After the Harris acquisition, it was Ping’s responsibility to review CareFx China’s monthly expense summary reports before they were submitted to Harris. Ping consistently permitted these monthly expense summary reports to be submitted despite knowing that they contained false information. By doing so, Ping enabled CareFx China to cloak its illicit gifts to government officials in the guise of legitimate business expenses and, thereby, hide the practice from Harris.”

This continued reliance on Ping to review and approve the illegal expense reimbursements speaks to a wider and more systemic failure of Harris’s internal controls, particularly around the issue of segregation of duties (SODs). It is a basic rule of any financial control process that there should be a second set of eyes in the reimbursement process. Clearly here, where Ping set up the fraudulent scheme to create the pot of money to fund the bribes, he was also in the position to approve all the fraudulent submissions by his sales team in China. This should be a key point for any Chief Compliance Officer (CCO) or compliance practitioner, whether a Country or Regional Manager has this type of approval which does not have an appropriate level of corporate oversight.

This individual SEC FCPA enforcement action may well portend another enforcement action involving Harris going forward. Whatever happens to Harris, this case makes clear the need for robust pre-acquisition due diligence, followed up by an even more robust post-acquisition forensic audit of the books and records of high-risk business units. China has been on the FCPA radar for many years and since 2010, approximately 20% of all enforcement actions have come out of China. This is not new information and companies are on clear notice that failure to perform these basic steps can lead to some catastrophic results.

The cost for Harris’s failures have not been insignificant even though CareFx’s revenues accounted for less than 1% of Harris’s gross revenues. In December 2011, Harris dissolved CareFx as a separate business entity. According to the order, in 2012 Harris sold all of CareFx China’s “outward facing operations” and in “2015, Harris terminated all employees in CareFx China and no longer has any active China-based business operations.” The inability of companies to do business in compliance with the FCPA has now caused two recent enforcement actions to note that the companies have pulled out of jurisdictions entirely. The first was Key Energy and now we have this same effect with Harris.

Yet all was not negative news for as the SEC announced it would not be pursuing the company for any FCPA violations. A SEC Press Release stated, “The SEC determined not to bring charges against Harris, taking into consideration the company’s efforts at self-policing that led to the discovery of Ping’s misconduct shortly after the acquisition, prompt self-reporting, thorough remediation, and exemplary cooperation with the SEC’s investigation.” This follows on from the May, 2016 Department of Justice (DOJ) decision, also reported by Jaclyn Jaeger in Compliance Week, to decline to pursue criminal charges against the company. These actions led Robert Kent, a partner with law firm Baker & McKenzie, to note in a Client Release that the declinations by both the SEC and DOJ make this a key a case, because it “represents the first time in a ‘pure’ FCPA investigation that a multinational corporation has avoided prosecution entirely, while one of its former employees was sanctioned for FCPA violations that created clear potential FCPA liability for the company.” (Emphasis supplied).

 

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

board-of-directorsAt least he fessed up that it was not the (non) rogue 5,300 employees that were responsible for defrauding Wells Fargo customers. At the Senate Banking Committee hearing, held on Tuesday 20th September, Wells Fargo Chief Executive Officer (CEO) John Stumpf admitted that he was responsible for the failure. (He did, of course, claim he was either misquoted or simply misinterpreted.) As much as I was pleased he owned up to being a leader, I was more than a little bemused when Stumpf admitted that he had known about the scandal since 2013 and the company’s Board of Director’s had known about it since 2014. One might reasonably ask what they did in the intervening two years to stop the illegal activity and remediate? Of course, Wells Fargo has not even suspended the sales compensation plan which led to this fiasco, keeping it open until the end of the year so I guess things move more slowly in the banking sector than in non-financial industries.

As I continue to mine the Wells Fargo scandal for lessons to be learned by the compliance professional, today I want to consider the roles of senior management, a Board of Directors and corporate governance. Unfortunately for Stumpf, it appears his cultural leadership of cross-selling; more cross-selling; and then even greater cross-selling of the bank’s products and services to customers, whether wanted or needed, was in large part the reason for the scandal. Of course, with some 255,000 employees, Stumpf can simply claim (and did) that he cannot be responsible for them all.

This typical CEO misdirection was answered by Susan M. Ochs, in a New York Times (NYT) Op-Ed piece, entitled “At Banks, the Buck Stops Short”, when she articulated three reasons why senior management should be held accountable. First, “illicit behavior involving thousands of people and two million fraudulent accounts cannot be dismissed as the work of a few bad apples”. Second, the systemic Wells Fargo’s “problems here stemmed from “cross-selling” — soliciting customers to buy multiple products — which Wells Fargo has promoted as the cornerstone of its retail business model” and what Stumpf was pushing, pushing, pushing. Third, and finally, having been made aware of the problem, it was on senior management to then prevent further illegal activity and remediate the issues.

Yet the overriding function of senior management is to establish the corporate culture. Even if there were three years of culture and ethics training not to break the law; if an employee’s supervisor was on the back of an employee each afternoon at 3 PM asking about the number of cross-selling calls made that day or your job is on the line, the message is clear. Culture means more than having a robust paper Code of Conduct or even saying we do business the right way; it means you must burn those values into your company. Not that you will be fired for missing your monthly sales quotas.

Ochs wrote, “Culture can feel amorphous, and it is always tempting to blame the systems; they are more tangible and easier to deconstruct. But the impact of corporate culture cannot be overstated. For example, sales targets exist in many industries — the key is how they are met. Intimidation, public shaming and micromanagement — as alleged by Wells Fargo employees — will create a culture of fear in which people think they must deliver at any cost.”

What about the Board? They are far from blameless in this fiasco as well. It turns out they were informed about the illegal activity back in 2014. Although you might wonder why it took CEO Stumpf one year to inform the Board? What did the Board do when it was informed of this issue? Where were the Board’s actions to protect its shareholders? Where was the Board’s audit committee?

These questions have not been answered, as yet, but one thing is certain, the once solid reputation of Wells Fargo now lays in shreds. This reputational risk is the province of the Board and as noted in a Financial Times (FT) lead Op-Ed Piece, entitled “The high cost of Wells Fargo’s sales practices, this matter has demonstrated that “trust is the most precious currency in banking. Without it the system is prone to dry up, with dire consequences for institutions and to the detriment of the public.” The FT piece ended with the following, “Confidence in banking requires boards to accept their responsibilities.”

Interestingly, one of the reasons for the seeming Board inertia is that Wells Fargo’s Board of Directors is older and longer-tenured than other US banks. Could this have played into its seeming inertia when it came to this scandal or simply the fact that the monies generated by the fraud were so small and certainly not material to a $50bn plus sized organization? In another FT piece, entitled “Wells scandal stiffens resolve to end board inertia”, reporters Stephen Foley and Alistair Gray noted, “Wells has some of the oldest and long-serving directors among 17 US banks with more than $100bn in assets” with the tenure of director at 9.7 years and an average age of 64.5 years old.

Another concern raised in the FT piece was that there is one person in both the CEO role and the Chairman of the Board role. One shareholder activist, Gerald Armstrong, said he planned to “resubmit a proposal for an independent chairman at the bank’s annual meeting next spring.” Armstrong, as quoted in the article, said “How can they argue against my proposal now? Where is the board? Where is the audit committee of the board? It appears they go to the meetings, pick up their cheques and they go home.” As CEO Stumpf was also the Chairman of the Board, it might reasonably be asked if the relationship was too cozy and it might well be time to consider Armstrong’s proposal.

The most pressing issue will be of clawbacks. In an article in a Wall Street Journal (WSJ), entitled “Wells Fargo Board Comes Under Fire”, Michael Rapoport and Joann S. Lublin reported that Senate Banking Committee members were very critical of the Wells Fargo Board of Directors. But more than the theater of any major Congressional hearing, investors also expressed frustration that the bank has not “moved aggressively” to remediate the problems at issue. The article noted, “In particular, the board’s oversight of the bank’s compensation is under fire because of an incentive-pay structure that fueled the scandal by rewarding employees for selling more products to existing customers. Some think the board should have realized the bank’s pay incentives would lead to misbehavior.” Jill Fisch, a University of Pennsylvania law professor, was quoted for the following, “You might say the board of directors should have been sensitive to how the compensation structure might have induced them to behave that way.”

In his Senate testimony, Stumpf demurred on questions relating to salary and compensation clawbacks for executives saying that was for the Board to decide. However, with the now former head of the consumer banking group due to retire with a package estimated to be worth up to $127MM, it is clearly a very large question. It is also one of optics, with, at this point, seemingly low level hourly workers terminated over the scandal and no executives terminated, sanctioned or in any manner disciplined. In this Senate testimony, Stumpf could not name one executive who had been in any way disciplined or terminated over this scandal.

Whether you consider Senate hearing political theater or simply theater, John Stumpf and Wells Fargo did not come out looking very good.

 

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