Second Circuit Rejects Government’s Expansive Theory in Ruling that FCPA Does Not Extend to Foreign Nationals Without U.S. Ties

The Second Circuit ruled on August 24 in United States v. Hoskins that the Foreign Corrupt Practices Act (FCPA) does not apply to foreign nationals who do not have ties to United States entities for bribery crimes that take place outside of U.S. borders. In doing so, the court rejected the government’s broadened theory of prosecution against Lawrence Hoskins, a U.K. citizen and former executive of the U.K.-based subsidiary of Alstom S.A., a global company headquartered in France that provides power and transportation services. United States v. Hoskins, No. 16-1010-CR, 2018 WL 4038192, at *1 (2d Cir. Aug. 24, 2018).

The alleged bribery scheme centers on Alstom S.A.’s American subsidiary, Alstom Power, Inc. (Alstom U.S.), headquartered in Connecticut. Hoskins was one of four Alstom executives charged with facilitating bribes to Indonesian officials in order to help the company win a $118 million power plant contract in Indonesia between 2002 and 2009. In 2014, Alstom S.A. pled guilty to the charge and paid a then record-setting $772 million fine.

The FCPA prohibits American companies and American persons, as well as their agents, from using interstate commerce in connection with the certain payments, or bribes, of foreign officials. 15 U.S.C. § 78dd-2. The FCPA likewise prohibits foreign persons or businesses from taking acts to further certain corrupt schemes, including ones causing the payment of bribes, while present in the United States. 15 U.S.C. § 78dd-3. Hoskins never worked directly for Alstom U.S. or traveled to the U.S. while the alleged scheme was ongoing. However, he was a former executive of the U.K subsidiary of the Alstom S.A., the parent company of Alstom U.S. that allegedly paid bribes to Indonesian officials. Based on his position, the government indicted Hoskins as an agent of Alstom U.S. under multiple theories of liability including conspiring to violate the FCPA.

The Second Circuit was faced with deciding the issue of whether a foreign person who does not reside in the United States can be liable for conspiring or aiding and abetting a U.S. company to violate the FCPA if that individual is not in the categories of principal persons covered in the statute. As the court phrased it, “[i]n other words, can a person be guilty as an accomplice or a co-conspirator for an FCPA crime that he or she is incapable of committing as a principal?” The Second Circuit held that such a person could not be liable.

In their analysis, the court noted that the FCPA defined precisely the categories of persons who may be charged and the statute clearly states the extent of its extraterritorial application. “The statute includes specific provisions covering every other possible combination of nationality, location, and agency relation, leaving excluded only nonresident foreign nationals outside American territory without an agency relationship with a U.S. person, and who are not officers, directors, employees, or stockholders of American companies.”

While the government argued that U.S. law has historically allowed for individual liability of a crime even if that person was incapable of committing the substantive offense, the Second Circuit noted that FCPA legislation clearly did not intend that accomplice liability extend to persons known as the “affirmative-legislative-policy exception.” The court explained that there is no specific provision in the FCPA which assigns liability to persons who are “nonresident foreign nationals, acting outside American territory, who lack an agency relationship with a U.S. person, and who are not officers, directors, employees, or stockholders of American companies.” The court also noted that the legislative intent behind the language of the FCPA was to protect foreign nationals who may not know American law.

The impact of the Second Circuit’s decision not to extend FCPA liability to Hoskins will have ongoing consequences, as recognized in the case’s concurring opinion by Judge Gerard E. Lynch. “It is for Congress to decide whether there are sound policy reasons for limiting the punishment of foreign nationals abroad to those who are agents of American companies, rather than to those who make American companies their agents. Our only task is to enforce the laws as Congress has written them.” But the impact of the decision in light of the current FCPA statute, as Judge Lynch notes, creates a pervasive result: “It makes little sense permit the prosecution of foreign affiliates of United States entities who are minor cogs in the crime, while immunizing foreign affiliates who control or induce such violations from a high perch in a foreign parent company. That is the equivalent of punishing the get-away driver who is paid a small sum to facilitate the bank robber’s escape, but exempting the mastermind who plans the heist.”

While the Second Circuit’s decision in Hoskins may have limited the scope of foreign individuals in FCPA cases for now, it is likely that the DOJ will continue to prosecute similar cases that test the jurisdictional reach of the FCPA.

MD&A-Related Claims against Corporate Execs Reinforce Recent SEC Enforcement Trends

A June 15, 2017 settlement with two former executives of a publicly-traded, multinational freight forwarding and logistics company provides the most recent example of two emerging SEC enforcement initiatives in financial reporting and accounting-based actions that we spotlighted recently – a non-reliance on financial statement materiality and an absence of fraud-based allegations. Exchange Act Rel. No. 80947 (Jun. 15, 2017). According to the SEC, Eric W. Kirchner and Richard G. Rodick, the former chief executive officer and chief financial officer of UTi Worldwide, Inc. (“UTi”), purportedly were responsible for inadequate Management’s Discussion & Analysis (“MD&A”) disclosures in a Form 10-Q that UTi issued during fiscal year 2013. Without admitting or denying the findings, both agreed to settle purported violations of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-13, and 13a-14, thereunder, and to pay a $40,000 civil penalty.

According to the SEC’s Order, UTi began experiencing serious risks in liquidity and capital resources no later than the third quarter of fiscal year 2013 due to the problematic rollout of a proprietary operating system that hindered the timely transmission of invoices to its customers. These problems allegedly caused UTi to accumulate an unusually high amount of unbilled receivables, thereby delaying its ability to receive payment for both its freight services and significant transportation-related cash outlays that were eligible for customer reimbursement through invoicing. To manage its cash flow problem, UTi supposedly began delaying payment of its obligations and obtained amendments to certain loan covenants from its lead lender.

The Order alleged that Kirchner and Rodick were aware of these liquidity and capital difficulties, yet failed to ensure that UTi provided adequate information in the MD&A section of the third quarter Form 10-Q to allow investors and others to meaningfully assess the company’s financial condition and results of operations. While the SEC acknowledged that the MD&A made reference to a sharp year-to-date decline in UTi’s cash position (and had provided readers with the specific financial impact), it claimed that the company attributed this decline to the seasonal nature of UTi’s business rather than its ongoing billing delays. The Order further contended that, under Kirchner and Rodick’s direction, UTi only revealed the cause and extent of its invoicing problem during the following fiscal year. By that time, the company’s lead lender had notified UTi that it would provide no further loan amendments and the company’s outside auditor had amended its opinion on the annual financial statements for fiscal year 2013 to issue a going concern.

Consistent with other recent settlements, this enforcement action is noteworthy in that the claims related exclusively to the purported incompleteness of a public company’s financial disclosures rather than the material inaccuracy of its financial statements. Here, the Order stated that the MD&A section of the periodic filing gave rise to a Section 13(a) violation because it failed to satisfy Regulation S-K Item 303, which is intended to provide investors with “an opportunity to look at the company through the eyes of management.” The SEC claims that Kirchner and Rodick’s conduct caused UTi to run afoul of Item 303’s requirement that registrants disclose in their MD&A “any known trends or uncertainties that will result in or that are reasonably likely to result in the registrant’s liquidity increasing or decreasing in any material way.”

This enforcement proceeding was also significant in that, similar to other financial reporting and accounting-related settlements during the latter stages of Mary Jo White’s tenure as SEC Chair, it was predicated entirely on strict liability-based claims. As in those previous settlements, this Order recited numerous instances in which the offending parties supposedly became aware of factual circumstances that were contrary to information provided in a later public filing, yet never attempted to assign any state of mind to the particular conduct alleged. There are many occurrences, of course, in which allegations grounded in knowledge or recklessness are simply unwarranted; nonetheless, this apparent pattern of heightened reliance on strict liability-based legal theories suggests that there may be certain instances in which the charges have been strategically designed to eliminate certain defenses and facilitate settlement. This particular proceeding offers a preliminary indication that this enforcement strategy may continue under Chair Jay Clayton’s leadership.

 

SEC Affirms Commitment to FCPA Enforcement Actions

Andrew J. Ceresney, Director of the Division of Enforcement, reaffirmed the SEC’s focus on FCPA enforcement actions at the International Conference on the Foreign Corrupt Practices Act. Mr. Ceresney’s speech focused on companies’ need to self-report violations.

Mr. Ceresney stated that the SEC uses “a carrot and stick approach to encouraging cooperation,” where self-reporting companies can receive reduced charges and deferred prosecution and non-prosecution agreements, while companies that do no self-report do not receive any reduction in penalties. Mr. Ceresney warned that “companies are gambling if they fail to self-report FCPA misconduct.”

Mr. Ceresney gave examples of how this policy has benefited companies recently. Mr. Ceresney highlighted the SEC’s decision not to bring charges against the Harris Corporation after it self-reported violations and mentioned to examples where the SEC entered into non-prosecution agreements as a result of self-reporting.

Mr. Cerseney stated that the SEC’s “actions have sent a clear message to the defense bar and the C-Suite that there are significant benefits to self-reporting [to] and cooperation with the SEC” and that he expects “the Division of Enforcement will continue in the future to reinforce this message and reward companies that self-report and cooperate.”

Mr. Cerseney also spoke about recent cases that highlight “the Enforcement’s Division’s renewed emphasis on individual liability in FCPA cases[,]” noting that seven actions in the past year involved individuals. Mr. Cerseney stated that “pursuing individual accountability is a critical part of deterrence and . . . the Division of Enforcement will continue to do everything we can to hold individuals accountable.”

Mr. Cerseney’s remarks demonstrate that the Division of Enforcement does not expect to change its recent focus on FCPA violations and individual liability as it transitions to the new administration.

SEC “Claws Back” Bonuses and Stock Sale Profits From CFOs of Public Company Charged With Accounting Fraud

On February 10, 2015, the SEC announced settlements with two former chief financial officers of Saba Software, a Silicon Valley software company, that require the CFOs to repay Saba more than $500,000 in bonuses and profits from stock sales earned subsequent to Saba’s false filings. Notably, the SEC did not allege that either former officer violated the federal securities laws in any fashion, nor was there evidence of either officer’s knowledge of, or complicity in, the underlying conduct that prompted the company to settle accounting fraud charges lodged against it by the SEC in September 2014. See Press Release, SEC Announces Half-Million Dollar Clawback from CFOs of Silicon Valley Company that Committed Accounting Fraud (Feb. 10, 2015).

The first CFO, William Slater, a former accountant who served as CFO from November 2011 through February 2013, and the second, Peter E. Williams III, a California attorney who served as CFO from March 2004 through July 2007 and again on an interim basis from October 2011 through January 2012, agreed to reimburse the company approximately $337,000 and $142,000, respectively, pursuant to Sarbanes-Oxley Section 304(a).

Section 304(a) provides that in the event an “issuer,” as defined under the Securities and Exchange Act of 1934, is required to issue a restatement of its accounting records as a result of misconduct under the securities laws, the issuer’s CEO and CFO “shall reimburse the issuer” for any bonus, “incentive-based,” or “equity-based” compensation, or for the profits from the officers’ personal sale of any of the issuer’s securities during the 12-month period following the first issuance of each allegedly violative financial statement. See 15 U.S.C. § 7243(a).

In September 2014, the SEC charged Saba with accounting fraud, and the company agreed to a settlement. The company was required to restate its financial records for the years 2008–2011 and for parts of 2012. In connection with the settlement with Saba, the SEC alleged that two Saba vice presidents had overseen a practice of misstating the hourly work of international consultants, both pre-booking and underbooking time statements, in order to adhere to prearranged time estimates. The practice violated GAAP and allegedly led to an overstatement of Saba’s revenues by approximately $70 million. The vice presidents responsible for the misconduct agreed to a collective disgorgement of approximately $55,000 and a collective penalty of $100,000, while the company agreed to pay a $1.75 million fine. At the time of the settlement, Saba’s CEO agreed to reimburse the company for more than $2.5 million in bonus, incentive, and equity-based pay that he received during the 12-month periods following the original issuance of the financial statements containing the alleged fraud. See Press Release, SEC Charges Software Company in Silicon Valley and Two Former Executives Behind Fraudulent Accounting Scheme (Sept. 24, 2014).

The SEC claims that “Section 304 does not require that a chief financial officer [or chief executive officer] engage in misconduct to trigger the reimbursement requirements.” William Slater, CPA and Peter E. Williams, III, Securities & Exchange Act of 1934 Release No. 74240, File No. 3-16381 (Feb. 10, 2015) at 5. Indeed, despite no evidence of fault or liability, Mr. Williams, who served as interim CFO for only four months between 2011 and 2012, was forced to reimburse the company for more than $140,000 in compensation he had received as a result of the allegedly violative financial statements.

This draconian clawback provision went into effect in 2002, although the SEC declined to actively enforce it until 2009. That year, the enforcement division settled accounting fraud charges with CSK Auto and four of its former executives, but in that case, it did not stop there. As former SEC Director of Enforcement Robert Khuzami announced in a December 8, 2009 speech, the SEC sought “to clawback more than $4 million in bonuses and stock sale profits from the former CEO, despite the fact that he was not alleged to have personally participated in the underlying financial wrongdoing.” Khuzami noted that, going forward, the SEC would use this “powerful enforcement tool” in “appropriate circumstances” in order to prevent CEOs and CFOs from “personally profit[ting] from misstated financial filings” and to incentivize these officers “to ensure the accuracy of [their] compan[ies’] financials.” Robert Khuzami, Remarks at AICPA National Conference on Current SEC and PCAOB Developments (Dec. 8, 2009).

Though Khuzami touted the new priority of the enforcement of this provision in another speech, see Robert Khuzami, Remarks at AICPA National Conference on Current SEC and PCAOB Developments (Aug. 5, 2009)  (“This is the first Section 304 action seeking to clawback compensation from an officer that was not alleged to have personally participated in the underlying financial wrongdoing.”), it is unclear when and why the staff will deem officers “appropriate” targets for clawbacks. In fact, because the provision requires no proof of culpability on the part of the corporate officers, the employment of this enforcement tool is particularly difficult to forecast.

Looking ahead, because Section 304(a) does not provide for a private right of action that would allow shareholders to seek reimbursement from CEOs and CFOs, see Cohen v. Viray, 622 F.3d 188, 193-194 (2d Cir. 2010), the SEC remains the exclusive enforcement entity of this powerful provision. There is some indication that we may see an expansion of requirements related to companies’ internal clawback policies through the implementation of Dodd-Frank, see Kara M. Stein, Remarks at the “SEC Speaks” Conference (Feb. 21, 2014) (“We also need to finalize rules about executive compensation, including provisions requiring issuers to have policies in place to claw back compensation.”), but in the meantime, enforcement will remain at the SEC’s whim.