The FCPA: The New SEC and DOJ Enforcement Priority – Part VII, Industry Wide Investigations

Two hallmarks of the new FCPA enforcement priority is industry wide investigations and a focus on individuals. In the past the focus tended to be on individual business organizations. Now however both the SEC and DOJ have broadened their focus to key on entire industries while, at the same time giving increased attention to the prosecution of individuals.

Perhaps the largest industry wide inquiry centers on the United Nations Oil For Food Program (“OFFP”). According to the Report of the Independent Inquiry Committee Regarding the OFFP, produced by a committee chaired by former Federal Reserve Chairman Paul Volker, “Iraq manipulated the Program to dispense contracts on the basis of political preference and to derive illicit payment from companies that obtained oil and humanitarian goods contracts.” The report concludes that 2,253 companies made over $1.8 billion in illicit payments to the Iraqi government. Subsequently, a number of companies disclosed inquiries related to the program.

Following the issuance of the Report, the SEC and DOJ opened investigations. A number of enforcement actions related to the OFFP have been brought. Some of these actions have been brought with the assistance of other regulators such as the Office of Foreign Asset Control (“OFAC”). The prosecutions have involved contracts on both the oil and humanitarian side of the program. On the oil side, the cases typically involve the payment of “surcharges” to Iraq’s Oil Marketing Organization by the contracting company. On the humanitarian side the actions typically involve the payment of “after sales service fees” frequently paid by inflating the value of the contract and the agent’s commissions. Examples of the cases brought to date include the following:

El Paso Corporation: Based on the oil side of the program the SEC claimed the company paid $2.1 million in surcharges on 15 contracts on which the company made a profit of $5.4 million. The SEC action was settled with a statutory injunction prohibiting future violations of the books, records, and internal control provisions and the payment of $5.4 million in disgorgement (tied to the criminal settlement) and a civil penalty of $2.2 million. The criminal inquiry was resolved with a non-prosecution agreement under which the company agreed to forfeit $5.48 million which will be transferred to the Development Fund of Iraq sanctioned under a U.N. resolution. SEC v. El Paso Corp., Civ. Action No. 07-00899 (S.D.N.Y filed Feb. 7, 2007).

Textron, Inc.: Based on the humitarian side of the OFFP, the case centered on what the SEC claimed were “kickback payments” of $650,000 paid by two French subsidiaries as “after sales service fees” made by inflating the value of the contract and the agent’s commissions which the company later reimbursed. To resolve the SEC inquiry the company consented to the entry of a statutory injunction prohibiting future violations of the books, records and internal control provisions and the payment of $2.2 million in disgorgement, $450,000 in prejudgment interest and an $800,000 civil penalty. Textron also agreed to comply with certain undertakings regarding its FCPA program. The DOJ inquiry was resolved by entering into a non-prosecution agreement and agreeing to pay a fine of $1.15 million. SEC v. Textron, Inc., Civ. Action No. 07001505 (D.D.C. Filed Aug. 23, 2007); see also DOJ press release here.

Additional actions brought last year based on the OFFP include:

—SEC v. York International Corp., Civil Action No. 7-01750 (D.D.C. Filed Oct. 1 2007); U.S. v. York International Corp., No. 07-01750 (D.D.C. Filed Oct. 1, 2007).

—SEC v. Ingersoll-Rand Co. Ltd., Civil Action No. 07-01955 (D.D.C. Filed Oct. 31, 2007); U.S. v. Thermo King Ireland Ltd., No. 07-296 (D.D.C. Filed Oct. 31, 2007); U.S. v. Ingersoll-Rand Italiana S.P.A., No. 07-00294 (D.D.C. Filed Oct. 31, 2007).

—U.S. v. Chevron Corp., Civil Action No. 07-10299 (S.D.N.Y. Filed No. 14, 2007); (in addition to the SEC action the DOJ inquiry was resolved with a non-prosecution agreement; the inquiries by OFAC and New York County District Attorney’s Office were resolved with the payment of fines).

Finally, one settlement of note involve SEC v. Akzo Nobel, N.V., Civil Action No. 07-02293 (D.D. C. Filed Dec. 20, 2007) and the related DOJ inquiry. The SEC action was settled with a standard statutory injunction prohibiting future violations of the FCPA books, records and controls provisions, the payment of $1.6 million in disgorgement, $584,000 in prejudgment interest and a civil penalty of $750,000. The DOJ investigation concluded with a non-prosecution agreement. As part of this agreement DOJ deferred the payment of any fine in view of the expected action by the Dutch authorities. This is the first time DOJ has deferred to a foreign regulator in an FCPA case.

Next: Cases against individuals

This Week in Securities Litigation (March 7-13, 2008): Insider Trading, The End of A Controversial Hedge Fund Survey and the Sub-Prime Crisis

Insider trading – An international merger

Based on trading in advance of Eurex Frankfurt A.G.’s $2.8 billion cash merger with International Securities Exchange Holdings, Inc. (“ISE”), the SEC and the Department of Justice brought, respectively, civil and criminal insider trading actions against three individuals. Named as defendants were John F. Marshall, Vice Chairman of ISE’s board, Chairman of its Audit and Finance Committee, a member of its Executive Committee and a partner in Marshall-Tucker, a New York financial consulting partnership; Alan L. Tucker, a partner in Marshall-Tucker; and Mark Larson, also a partner in Marshall-Tucker.

According to the SEC’s complaint, Mr. Marshall, through his positions at ISE, received detailed information about the pending merger with Eurex. Defendant Marshall tipped his partners, Alan Tucker and Mark Larson by providing them with material non-public information about the pending merger. Messrs. Tucker and Larson used this information to purchase ISE securities in their personal brokerage accounts. Mr. Tucker invested more than $1 million in ISE securities, purchasing 20,000 shares of common stock and over 900 call options with a strike price above the then current trading price. About half of those purchases were paid for with $500,000 in Marshall-Tucker partnership funds wired to the account by Mr. Tucker. During the same period, Mr. Larson purchased 1,700 ISE shares on margin, putting up about $81,000. The three defendants communicated about their trading in a series of e-mails.

Following the April 30, 2007 announcement of the merger, ISE’s share price nearly doubled. By the close of trading Mr. Tucker had made over $1 million in illegal profits while Mr. Larson had over $31,000. Both cases are in litigation. The Litigation Release regarding SEC v. Marshall, Civil Action No. 08-CV-2527 (S.D.N.Y. March 13, 2008) is here.

Insider trading – by a subcontractor

Earlier this week, the SEC filed a settled insider trading case against Kent Barkouras. According to the complaint, Mr. Barkouras received material non-public information about Mentor Corporation through its subcontractor, MyPrint Corporation, of which he is the CEO and largest shareholder. Specifically, Mr. Barkouras learned that Mentor had received approval from the FDA to begin preliminary shipments of their breast implant starter kits. MyPrint was to store and ship the kits.

On the morning Mentor announced the FDA approval a MyPrint employee sent Mr. Barkouras an e-mail stating “Buy Mentor stock Now $$.” At the time, according to the SEC, Mr. Barkouras was purchasing 543 Mentor call options. He also tipped a relative who traded. Following the public announcement of the FDA approval Mentor’s shares increased over 10%.

To settle the action, Mr. Barkouras consented to the entry of a statutory injunction prohibiting future violations of the antifraud provisions of the federal securities laws. In addition, he consented to the entry of an order requiring him to disgorge his trading profits as well as those of a relative he tipped totaling over $166,000, prejudgment interest and a civil penalty equal to the amount of the disgorgement. The Litigation Release regarding SEC v. Barkouras, Civil Action No. SACV 08-0260 (C.D. Cal. Mar. 10, 2008) is here.

The end of the hedge fund survey

The SEC has decided not to proceed with a controversial questionnaire it tested last August as part of its war on insider trading. The questionnaire, distributed to hedge funds and other large traders, sought information about those who have access to material non-pubic information. Many complained that the questionnaire constituted an invasion of privacy. One of the leading critics was the U.S. Chamber of Commerce.

Yesterday, Bloomberg reported that SEC Chairman Cox has agreed to discontinue the use of the questionnaire.

The President’s Working Group on Financial Markets

The President’s Working Group on Financial Markets issued its “Policy Statement on Financial Market Developments” yesterday, discussing the current turmoil in the financial markets and the sub-prime crisis. While noting that events in these markets are currently unfolding, the report stated the principal underlying causes of the turmoil include: 1) a breakdown in underwriting standards for subprime mortgages; 2) a failure by those involved in the securitization process to obtain adequate risk disclosures; 3) flaws in credit rating agencies’ assessments of subprime residential mortgage-backed securities and other complex structured credit products including collateralized debt obligations; 4) risk management weakness at some large financial institutions; and 5) regulatory policies that failed to mitigate risk management weaknesses.

Based on its findings, the group made several recommendations which include: 1) reform key parts of the mortgage origination process; 2) enhance disclosure in the securitization process; 3) reform rating agencies’ process to ensure integrity and transparency; 4) ensure that financial institution take appropriate steps to address the weaknesses in risk management and reporting practices; and 5) ensure that prudential regulatory policies for banks and securities firms include capital and disclosure requirements and give strong incentives for effective risk management practices.