FCPA Developments Include Increased Enforcement Related to UN Oil-for-Food Program and Reinstatement of Charges in Kozeny Case

FCPA Developments Include Increased Enforcement Related to UN Oil-for-Food Program and Reinstatement of Charges in Kozeny Case

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The Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) recently brought two enforcement actions against entities who made improper payments to the Iraqi regime under the United Nations Oil-for-Food Program (OFFP).Although previous cases have been brought relating to oil sales under the OFFP,[i] the new cases involving York International Corporation and Textron Inc.are the first relating to companies selling humanitarian goods under the program. Many more humanitarian goods cases currently are under investigation. The York and Textron cases seem to confirm that FCPA antibribery charges are not appropriate in OFFP cases because these cases involve kickbacks made to the Iraqi government rather than to Iraqi government officials. The enforcement authorities nonetheless have brought charges using other provisions. Other developments include a new deferred prosecution agreement with Paradigm, B.V., and a reversal by Judge Shira Scheindlin of her previous dismissal of certain FCPA charges against David Pinkerton and Frederic Bourke.

York International Corporation

On October 1, 2007, the SEC and DOJ announced agreements with York International Corporation (York), which was acquired by Johnson Controls, Inc. (JCI) in 2005. WilmerHale served as counsel to York and JCI. There are several notable aspects to the case. First, it is yet another case that arose in the context of an M&A transaction; notably, the acquirer was not charged by the government. Second, the case involves transactions in which the company allegedly paid kickbacks to the Republic of Iraq in return for Iraqi government contracts in connection with the OFFP, as well as transactions in other countries in which the company allegedly made improper payments both to government officials and to commercial customers in exchange for business. The DOJ used the conspiracy and wire fraud statutes to prosecute the former transactions and the FCPA’s books and records provisions to prosecute the latter. Third, the criminal case was resolved through a deferred prosecution agreement in recognition of the company’s significant cooperation. Fourth, the company paid just over $22 million, in the aggregate, to settle all the charges. Finally, both the SEC and the DOJ required York to retain an independent compliance monitor.

Textron

On August 23, 2007, the SEC entered into a settlement with Textron Inc., a Rhode Island-based industrial equipment company, for violations of the FCPA’s books and records and internal controls provisions by its wholly owned fifth-tier French subsidiaries. On the same day, the DOJ entered into a non-prosecution agreement with Textron relating to the same conduct. Two of Textron’s French subsidiaries allegedly authorized and made kickback payments in connection with their sale of humanitarian goods to Iraq under the OFFP. Like York, Textron was alleged to have paid bribes in connection with other transactions unrelated to the OFFP—another case in which the OFFP investigations seem to be resulting in companies finding other improper conduct in their business operations.

Paradigm, B.V.

On September 21, 2007, the DOJ announced a deferred prosecution agreement with Paradigm B.V., relating to improper payments made through agents in Kazakhstan, China, Mexico, Nigeria and Indonesia. Paradigm is a Netherlands company that was considered a “domestic concern” under the FCPA because its principal place of business had been gradually relocated to Houston from its prior location in Herzliya, Israel. This case is noteworthy because the facts were discovered during due diligence in connection with the company’s initial public offering, which resulted in a voluntary disclosure to the DOJ. In addition, the DOJ did not require an independent compliance monitor but instead permitted Paradigm to engage its own counsel to review its compliance program and recommend enhancements.

FCPA Charges in SDNY Reinstated

On July 16, 2007, Judge Scheindlin reinstated some of the FCPA charges in the Southern District of New York against David Pinkerton and Frederic Bourke that she had earlier dismissed on statute of limitations grounds. Bourke and Pinkerton had been indicted for allegedly conspiring with Viktor Kozeny to bribe Azerbaijani officials in the privatization of Azerbaijan’s state-owned oil company. This is the first case to conduct a detailed analysis of the tolling provisions applicable to the FCPA for situations in which the government seeks evidence from foreign countries. The court had held that the DOJ must apply for and receive a tolling order prior to the termination of the initial statute of limitations. In another part of the opinion, the court also suggested that a defendant’s knowledge of a preexisting corrupt payment that benefits him may be sufficient to create liability under the FCPA. After a request for reconsideration by the government, the court reinstated FCPA charges that occurred within the limitations period.

The FCPA’s Antibribery and Accounting Provisions

The FCPA’s antibribery provisions make it unlawful for any issuer, domestic concern or person acting within the United States to offer or make a payment of anything of value directly or indirectly to a foreign official, international organization, political party, party official, or any candidate for public office, for the purpose of influencing that official to assist in obtaining or retaining business.[i] A covered company can be held liable for payments made on its behalf by agents or distributors.

The FCPA’s accounting provisions require companies with securities listed in US trading markets to keep books, records and accounts that accurately and fairly reflect any transaction and disposition of assets in reasonable detail, and to maintain an adequate system of internal accounting controls.[ii] A covered company is responsible for ensuring that its controlled subsidiaries, including foreign subsidiaries, comply with the FCPA’s accounting provisions.

York International Corporation

In 2005, York International, which was an “issuer,” agreed to be acquired by another public company, Johnson Controls, Inc. (JCI). Prior to the consummation of the merger, the United Nations notified York that it had discovered possibly improper transactions relating to the OFFP. York and its buyer initiated an internal investigation and made a preliminary self-report to both the SEC and DOJ, which revealed improper transactions. Both companies promised to continue the investigation and to cooperate with both agencies. The parties then closed the merger.

As reflected in the SEC and DOJ settlement papers, the case ultimately revolved around two kinds of problems. First, it was alleged that York had made improper kickbacks to the Iraqi government in connection with six OFFP transactions. Second, it was alleged that York had made improper payments, through consultants, to government officials and commercial customers in order to obtain business.

The DOJ Settlement

On October 1, 2007, the DOJ filed a three count criminal Information against York. The Information charged York with conspiracy, wire fraud and FCPA books and records violations. Notably, the DOJ did not charge JCI, York’s acquirer. The Dubai office of York’s wholly owned subsidiary, York Air Conditioning and Refrigeration (YACR), served as the headquarters for York’s Middle East operations. YACR was a “domestic concern” as defined by the FCPA. York Air Conditioning and Refrigeration FZE (FZE) was a wholly owned subsidiary of YACR, and was responsible for York’s Iraqi business. FZE was headquartered in Dubai. According to the Information, FZE paid approximately $647,000 in kickbacks to the Iraqi government in return for the award of contracts under the OFFP, which were valued at approximately $7 million. FZE concealed the kickbacks from the UN—which had to review and approve all OFFP contract awards—by inflating its prices by 10 percent and submitting the inflated invoices. The Information alleged that both FZE and York disguised these payments on their respective books and records by describing them as “consultancy” or “commission” payments.

The Information also alleged that YACR and FZE authorized hundreds of other kickbacks and bribes in connection with obtaining or retaining contracts in Bahrain, Egypt, India, Turkey and the United Arab Emirates (UAE). These contracts were valued at approximately $42 million. The scheme ran from September 1999 through December 2005. As described in the Information, contractors and employees would generate and submit invoices for services they had not performed. YACR and FZE would pay the invoices, and the consultants would return the excess cash to YACR and FZE, who in turn would use it to pay bribes and kickbacks.

Count one of the Information is the conspiracy charge. In this count, the government alleged that the primary purpose of the conspiracy was to pay kickbacks to Iraqi officials and to make improper payments to officials in other countries.

Count two is the wire fraud count. In this count, the government alleged that York, acting through FZE, caused international wire communications to be transmitted from a bank in New York that held the OFFP account, to a bank in Dubai at which FZE had its account, thereby authorizing the eventual payment by the UN to York. Count two also alleged that FZE caused international wire communications to be transmitted from an inspection company in Iraq to the UN, informing the UN that goods had been received and inspected in Iraq, thereby triggering payment for those goods by the UN to FZE. These payments were obtained through false and fraudulent pretenses, as a result of York and FZE’s kickback scheme.

The final count in the Information is the books and records count. In this count, the government alleged that York recorded the kickbacks it paid in connection with the OFFP program, as well as the payments made in connection with contracts in Bahrain, Egypt, India, Turkey and UAE, as “commission” or “consultancy” payments, when in fact it understood that the payments were used to generate cash in order to pay bribes and kickbacks, and were not payments for any legitimate service.

York and the DOJ entered into a three-year deferred prosecution agreement in which York acknowledged responsibility for the actions of its two subsidiaries. The agreement requires York to pay a $10 million criminal penalty and have its compliance program and procedures reviewed by an independent monitor for three years. The DOJ agreed to defer prosecution in recognition of York’s early discovery and reporting of the kickback payments, its thorough review of the payments, its implementation of enhanced compliance policies and procedures and its willingness to engage an independent monitor.

The agreement with York is unique in that the DOJ has agreed not to charge JCI or York, including any subsidiaries, for conduct that occurred beforethe date of the deferred prosecution agreement, even if this conduct is discovered subsequently, provided two conditions are satisfied: 1) the conduct is disclosed to the DOJ (and the SEC); and 2) the DOJ determines, in its sole discretion, that the past conduct is of “similar nature and order of magnitude” to the conduct disclosed prior to the execution of the deferred prosecution agreement.

The SEC Settlement

According to the SEC’s Complaint, FZE authorized and paid approximately $647,110 in kickbacks in connection with six contracts for the sale of humanitarian goods to Iraq under the OFFP. In addition to the OFFP conduct, the complaint alleges that York made over $7.5 million in improper payments through subsidiaries to secure commercial and government projects in the Middle East, India, China, Nigeria and Europe. York allegedly received approximately $8,017,814 in net profits from these contracts.

The SEC alleged that this conduct violated the books and records and internal controls provisions of the FCPA. In particular, it found York’s system of internal controls inadequate because “despite the knowledge of endemic corruption problems in the Middle East,” York “took on faith, without adequate confirming steps” that regional heads responsible for ensuring compliance with the FCPA were exercising their duties to properly manage compliance issues. According to the SEC, the parent company knew, or had the means to easily find out, that the company’s operations in the Middle East and other regions did not follow consistent compliance practices. The SEC provided the following factors as evidence of York’s failure to maintain adequate internal controls: 1) the extent and duration of the illicit payments made by the subsidiaries; 2) the involvement of multiple subsidiaries and numerous managers and employees; 3) the improper recording of payments in York’s books and records; 4) the failure of York’s management to detect irregularities; and 5) York’s failure to implement controls after an internal audit report and self-assessment on fraud risk highlighted problems.

The SEC indirectly acknowledged that OFFP payments to the Iraqi government do not trigger liability under the antibribery provisions of the FCPA. First, the Complaint distinguished between payments to “government end-users” and those made to Iraq under the UN OFFP. Second, the Complaint stated that anti-bribery allegations were linked to corrupt payments in the UAE in connection with a luxury hotel project. In contrast, the improper OFFP payments were tied to violations of books and records and internal accounting controls provisions of the FCPA.

The SEC brought antibribery charges for conduct of a York subsidiary based in Dubai that paid $522,500 to an intermediary while allegedly knowing that the money was intended to bribe officials in the UAE to secure contracts in connection with the construction of the government-owned luxury hotel discussed above.

Under its settlement with the SEC, York agreed, without admitting or denying the allegations, to pay $2 million in civil penalties, and approximately $10 million—including pre-judgment interest—in disgorgement of profits. It consented to entry of a final judgment, which permanently enjoins it from further FCPA violations under the 1934 Securities Exchange Act. And, as was the case in its agreement with the DOJ, York agreed to retain an independent compliance monitor. Although not included in the SEC’s court documents, the SEC agreed, like the DOJ, not to charge York for conduct that occurred before the filing of the Complaint, subject to the same conditions set forth in the deferred prosecution agreement.

According to the SEC’s litigation release, the government considered “remedial acts promptly undertaken by York International, which self-reported, and cooperation afforded the Commission staff in its continuing investigation” in arriving at this settlement.

York provides several lessons regarding FCPA enforcement:

  • Potential FCPA liability continues to be a major consideration in M&A transactions; in certain circumstances, at least, the DOJ and SEC will exercise their discretion by not bringing charges against the acquirer for pre-acquisition conduct where the acquirer has cooperated extensively and taken other strong remedial steps.
  • The DOJ and SEC offer leniency where there has been self-reporting and full cooperation, but even so the financial penalties can still be considerable.
  • Vigilance cannot be relaxed after the merger takes place, especially when the acquirer is on notice that the target has a history of actual or potential FCPA violations. Purchasers must integrate the target into an appropriate compliance program as quickly as possible and ensure that there are no continuing violations.

Textron

On August 23, 2007, the SEC entered into a settlement with Textron Inc., a Rhode Island–based industrial equipment company, for violations of the FCPA’s books and records and internal controls provisions. On the same day, the DOJ entered into a non-prosecution agreement with Textron relating to the same conduct.

According to the SEC’s Complaint, from approximately 2001 to 2003, two of Textron’s French subsidiaries authorized and made approximately $650,539 in kickback payments in connection with their sale of humanitarian goods to Iraq under the UN OFFP. The subsidiaries, DB Guinard Pumps (DBG) and DB Transmissions France (DBTF), paid Middle East consultants to facilitate sales of industrial pumps and gears to Iraq under the OFFP. In connection with these contracts, Textron’s subsidiaries agreed to pay a 10 percent surcharge on top of the contract price, and then concealed from the UN the fact that the contract price contained a kickback to the Iraqi government.

According to the Complaint, DBG knew of and approved separate side agreements between the consultant and the Iraqi government. Copies of internal forms show that DBG’s management approved the payments on forms that contained the term “side agreement” and showed that the consultant was to receive 50 percent of the surcharge amount at the time a letter of credit on the UN contract was opened. Furthermore, when goods were held up at the Iraqi border for failure to pay the 10 percent surcharge, an employee at DBG obtained proof of the payments from the consultant so that the goods could be unloaded. At DBTF, a French sales manager understood that payments were not authorized under the UN program, and noted that written agreements should be avoided. He also discussed the issue with his superiors and received approval to include the amount of the payments of approximately $167,000 to be funneled to Iraq through a Jordanian consultant.

In addition, as in the York case, the SEC further alleged that DBG and DBTF made illicit payments from 2001 to 2005 in countries other than Iraq. These included payments to employees of government-owned gas companies in the UAE and payments to two “friends” employed by a government-owned fertilizer company in Bangladesh, as well as payments in Indonesia, Egypt and India, all in violation of the books and records and internal controls provisions of the FCPA. These payments totaled approximately $114,995.

The SEC alleged that Textron was reckless in not knowing that illicit payments were made in connection with all these transactions, that it failed to maintain an adequate system of internal controls to detect and prevent improper payments, and that management of the subsidiaries failed to report the transgressions to higher level managers. In particular, and couched in identical language as in York, the SEC faulted Textron for “tak[ing] on faith, without adequate confirming steps, that its managers and employees were exercising their duties to manage and comply with compliance and control issues,” despite knowledge of endemic corruption problems in the Middle East. Furthermore, Textron failed to properly record the nature of the company’s payments for its OFFP transactions.

Without admitting or denying the allegations in the SEC’s Complaint, Textron consented to the entry of a final judgment permanently enjoining it from future violations of the FCPA’s books and records and internal controls provisions. Textron was ordered to disgorge $2,284,579 in profits, plus $450,461.68 in pre-judgment interest, and to pay a civil penalty of $800,000.

The DOJ’s non-prosecution agreement does not specify the violations allegedly engaged in by Textron, but it referenced improper payments made by the French subsidiaries to the Iraqi government, as well as the accounting and record-keeping associated with the improper payments. As in York, the SEC and DOJ focused on accounting-related charges, despite what appear to be clear instances of bribery in the charging papers. This again seems to demonstrate that the government has abandoned bringing antibribery allegations in the OFFP context because the kickbacks were made to the Iraqi government rather than Iraqi officials.

Paradigm, B.V.

On September 21, 2007, Paradigm B.V., which provides software to the oil and natural gas exploration and production industry, entered into a non-filed deferred prosecution agreement with the Department of Justice. The agreement required Paradigm to pay a $1 million fine. Although Paradigm is a Netherlands company, it was considered a “domestic concern” under the FCPA because it had gradually moved its principal place of business to Houston, Texas, from Herzliya, Israel. Paradigm discovered the violations during due diligence that it was conducting in connection with its initial public offering and made a voluntary disclosure to the government.

According to the Statement of Facts relating to the agreement, Paradigm made improper payments through agents in Kazakhstan, China, Mexico, Nigeria and Indonesia. The agreement notes that in Kazakhstan, Paradigm failed to perform due diligence on its agent and failed to have a written agreement detailing the services to be provided. The agent then sent an invoice requesting a “commission,” but there was no evidence that any services were, in fact, performed. In China, Paradigm engaged an agent in connection with a transaction involving the Chinese state-owned oil company. The agent agreement contemplated passing commissions to representatives of the oil company. The Statement of Facts alleges that Paradigm also retained employees of Chinese national oil companies as “consultants” and paid them to encourage their companies to purchase Paradigm software. In Mexico, according to the Statement of Facts, Paradigm used an agent with which it had no written agreement and on which it had performed no due diligence and agreed to pay him through five different entities. Paradigm also allegedly invited a Mexican governmental decision-maker on a trip to Napa Valley worth approximately $12,000 and spent $10,000 more on other entertainment involving the official. Paradigm also hired the official’s brother as a driver and leased a house from the wife of another official. The Statement of Facts notes that in both cases, some legitimate services were provided. In Nigeria, Paradigm retained an agent and allegedly agreed to make corrupt payments of between $100,000 and $200,000 through the agent to secure a contract award. Finally, in Indonesia, according to the Statement of Facts, Paradigm used an agent to make payments to employees of Pertamina, Indonesia’s national oil company.

The case illustrates a number of significant points:

  • Even companies that are incorporated outside the United States and are not “issuers” can be considered “domestic concerns” subject to the FCPA, if they locate their headquarters in the United States. Paradigm gradually relocated its principal place of operations over several years and was eventually deemed a “domestic concern” as the balance of its operations became US-based.
  • While numerous recent FCPA cases have arisen out of facts discovered during due diligence related to a merger or acquisition, this is the first reported case in which violations were discovered during due diligence in connection with an IPO. This suggests that companies engaged in many kinds of strategic transactions should be alert to FCPA issues in the due diligence process and should train their diligence teams to spot FCPA concerns.
  • The case reflects once again the credit that companies can expect to receive from voluntary disclosure and cooperation. Paradigm paid a relatively small fine in comparative FCPA terms, was subjected to an 18-month rather than a three-year deferral period, and was permitted to enter into a letter agreement rather than a filed Information setting forth potential charges. In addition, Paradigm was not required to engage an independent compliance monitor but was instead permitted to engage its own outside counsel to assess its compliance program and recommend enhancements.
  • The Statement of Facts notes as problematic travel and entertainment expenses that included per diems, cash payments for shopping, dinners, drinks, and one trip to Napa Valley. This suggests that the DOJ remains concerned about what, in its view, constitutes lavish travel and entertainment of government officials.

FCPA Charges in SDNY Reinstated

On May 12, 2006, a federal grand jury indicted Viktor Kozeny, Fredric Bourke and David Pinkerton on charges of conspiring to bribe senior government officials in the Republic of Azerbaijan in order to profit from the privatization of the State Oil Company of the Azerbaijan Republic (SOCAR).[iii] On June 21, 2007, Judge Shira Scheindlin of the Southern District of New York dismissed, on statute of limitations grounds, 11 out of 12 charges against Bourke, and six out of seven charges against Pinkerton, including all FCPA charges in the indictment.[iv] After a request for reconsideration by the government, the court, on July 16, 2007, reinstated three of the eleven counts it previously dismissed, concluding that they were not time barred. The court did not alter its reading of the statute of limitations, but agreed that the counts alleged conduct that occurred within the limitations period.

WilmerHale lawyers regularly speak on legal developments under the Foreign Corrupt Practices Act and related enforcement issues. Below is a listing of upcoming topics and events:

Roger Witten, Partner

  • November 9, 2007: New York City Bar Program on the FCPA
  • November 13-14, 2007: ACI Conference, Alexandria, Virginia

Kimberly Parker, Partner

  • January 24-25, 2008: ACI Conference, FCPA Boot Camp, Houston, Texas

[i] 15 U.S.C. §§ 78dd-1 to -3.

[ii] Id. § 78m(b).

[iii] See August 2007 FCPA Briefing Series.

[iv] While the indictment charged Bourke, Pinkerton, and Kozeny, the charges against Kozeny were not dismissed as the United States is attempting to extradite him from the Bahamas (Kozeny argues that he is not subject to the US antibribery laws and thus cannot be extradited).

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