Subject to Inquiry

Subject to Inquiry

White Collar, Congressional, SEC, Energy Enforcement & Other Government Inquiries

Government, Regulatory & Criminal Investigations Group
Compliance, Financial Regulation, Regulation, SEC, SEC Enforcement

Widening the Scope: The SEC Turns its Attention to Alternative Mutual Funds

In a recent speech to the Practising Law Institute’s Private Equity Forum, Norm Champ, Director of the SEC’s Division of Investment Management, discussed the SEC’s increasing attention to the growth in “alternative mutual funds,” or open-end mutual funds that feature investment strategies more typically seen in private funds. Similar to recent speeches and discussions related to the SEC’s oversight of hedge funds, which we have previously covered here and here, Champ’s speech contained useful guidance about the types of risks the SEC is monitoring in the alternative mutual fund space, but it also conveyed that the SEC will be ramping up inspection into whether investment advisers to these funds are fully complying with their duties.

What are alternative mutual funds and why are they becoming more popular?

Champ defined an alternative mutual fund as a fund whose primary investment strategy focuses on “(1) non-traditional asset classes (for example, currencies), (2) non-traditional strategies (such as long/short equity positions), and/or (3) illiquid assets (such as private debt).” As for why these funds are growing, Champ offered several reasons, but essentially, investors are seeking alternative investment strategies that will provide greater yield within the current low interest rate environment (and one suspects greater diversification as well), and these mutual funds are more accessible and cost-effective for a greater number of investors than private funds are. Further, mutual funds have more transparent pricing and disclosures, as well as greater liquidity, than private funds due to mutual funds’ regulation under the Investment Company Act of 1940 (“the ‘40 Act”) and regulations thereunder. This growth and increasing accessibility reflects a trend similar to what the former chief of the SEC’s Asset Management Unit referred to as the “retailization” of hedge funds. This has led to greater participation by “unsophisticated investors” and thus has likewise led to greater SEC scrutiny.

The SEC’s Areas of Concern

Champ identified the following particular risks and concerns with alternative mutual funds: valuation, liquidity, leverage and disclosure. Demonstrating the SEC’s avowed commitment to transparency and dialogue with industry participants, Champ went on to provide useful guidance related to each of these areas. For example, he explained how mutual funds under the ‘40 Act must calculate their net asset values (i.e., through market quotations when readily available, and through the calculation of a fair value for assets when quotations are not readily available), but he also provided suggestions for advisers’ valuation policies and procedures. He also unsurprisingly focused on the need for “clear, concise disclosure” regarding the fund’s investment strategies and principal risks. And he emphasized the importance of board oversight and board review of fund compliance programs.

Presence Exams and the Upcoming Industry Sweep

The Investment Management Division is not the only SEC unit paying attention to these funds. Champ confirmed that, as announced in its Examination Priorities for 2014, the National Exam Program (“NEP”) continues in its pledge to conduct so-called “presence exams” of “a significant percentage of advisers who have been registered with the Commission for more than three years, but have not yet been examined by the National Exam Program.” The SEC’s Office of Compliance Inspections and Examinations first announced this Presence Exam Initiative in 2012, through which NEP Staff would visit and examine a significant percentage of hedge fund and private equity fund advisers who registered with the Commission following Dodd-Frank’s expansion of registration requirements to such advisers. As announced in 2012, during these exams, NEP Staff will review what they perceive to be higher-risk areas of advisers’ operations, namely, marketing, portfolio management, conflicts of interest, safety of client assets, and valuation. Champ also noted that the National Exam Program issued a risk alert in January summarizing the Staff’s observations of advisers’ due diligence processes for selecting alternative investments.

Finally, and perhaps most importantly, Champ confirmed that beginning this summer or fall, OCIE will conduct a nationwide sweep exam of alternative mutual funds, which will focus on liquidity, leverage, and board oversight. Of course, while these “exams will produce valuable insight into how alternative mutual funds attempt to generate yield and how much risk they undertake,” they also raise the specter of potential enforcement referrals if the Staff discovers potential illegality. In light of the Staff’s increased focus on alternative mutual funds, the continuation of presence exams, and the upcoming sweep exam, advisers must act now to ensure that they are in compliance with regulatory requirements.


The SEC’s increased scrutiny of both hedge funds and alternative mutual funds reflects an SEC trend to apply greater oversight to investment strategies that historically were limited to wealthier private investors, but which have recently become more accessible to “main street” investors. The SEC’s obvious concern is that unscrupulous advisers could take advantage of these new market participants, so its solution is to encourage greater transparency, ensure more fulsome disclosure, and increase enforcement as necessary. It is attempting to accomplish these goals through more active engagement with the industry, but also through a robust examination program and more zealous enforcement. It is thus critical that advisers pay close attention to the rules and regulations, listen to what the SEC is saying, assess and update their compliance policies regularly, and prepare for the perhaps inevitable visit from the SEC.

Charging, Corporate Fraud, DOJ Policy, White Collar Crime

Supreme Court Bank Fraud Decision Offers Prosecutors a Second Act in Financial Crisis Prosecutions

Amidst a string of high-profile decisions released at the end of the Supreme Court’s most recent term, one under-the-radar decision may have far-reaching effects in the white collar world. Loughrin v. United States dealt with a narrow question of statutory construction in the federal bank fraud statute 18 U.S.C. §1344. Despite the limited question at issue, the effect of the decision was to significantly broaden the statute’s scope and dramatically expand the tools available to prosecutors in white collar cases.

Section 2 of the bank fraud statute criminalizes a scheme to obtain money or other property “owned by, or under the custody or control of” a financial institution by means of false or fraudulent representations. Kevin Loughrin was convicted under this section for presenting stolen checks at a retail store, where he purchased goods and then returned them for cash. He argued that he could not be convicted unless the government proved that he acted with the intent to defraud a financial institution. While he admittedly intended to defraud the true owners of the stolen checks, the involvement of a financial institution was wholly incidental to the scheme. All nine justices rejected this argument, holding that the statute did not require intent to defraud a financial institution.

The Court divided, however, over limiting principles. The justices acknowledged that the ruling could conceivably bring any fraud involving a check within the statute’s ambit. In dicta, five justices signed onto Justice Kagan’s view that the phrase “by means of” in the statute meant that the false statement must actually reach the financial institution. In a concurrence, Justice Scalia, joined by Justice Thomas, condemned this limiting principle as incorrect, intimating that it would prove unworkable in practice. He argued that any limiting principles should be worked out in future cases. Justice Alito refused to sign onto either opinion, instead suggesting a much broader reading of the statute generally.

As decided, Loughrin potentially paves a new way for prosecutors to charge financial institutions and their employees. One such approach is a “self-affecting” theory of fraud – a financial institution itself makes misrepresentations to third parties and thereby obtains funds already within its custody. Take, for example, one of the standard allegations made against banks in the aftermath of the financial crisis: a bank allegedly misrepresents the quality of a mortgage to an investor in order to induce her to purchase the mortgage. The investor buys the mortgage and pays using funds she already has on deposit at that bank. Thus, the bank obtains money “under the custody or control of” a financial institution, and does so “by means of” the misrepresentation. Since the bank itself made the misrepresentation, the false statement has reached the financial institution that has custody of the funds. Even assuming adherence to the majority’s limiting principle, a court could readily conclude that this conduct falls within the statute’s redefined scope. The Court’s division over the proper way to limit the bank fraud statutes gives prosecutors latitude to charge creatively and thus significantly expand the range of activity that constitutes bank fraud.

Prosecutors have a strong incentive to push these boundaries because bank fraud has a major advantage over most other federal fraud statutes insofar as it has a ten-year statute of limitations, versus the five-year statute of limitations applicable to most fraud statutes. As we move past the five-year period for activity at the heart of the financial crisis, bank fraud offers prosecutors the ability to bring cases for several more years. Hence, prosecutors have every incentive to fit as many forms of fraud as possible within the bank fraud statute. Accordingly, while investigations and prosecutions from the financial crisis have, in many respects, appeared to be winding down, prosecutors, who have continued to take criticism over their handling of the financial crisis, may only be starting the second act.

Compliance, Economic Sanctions, Export Controls

Latest US Sanctions Against Russia Target Financial Services and Energy Sector

On Wednesday, July 16, 2014, the United States announced additional sanctions against Russian interests in response to the continuing crisis in Ukraine. Starting in March of this year, the United States began imposing sanctions against Russian organizations and individuals, including a number of individuals associated with President Vladimir Putin’s inner circle. This latest round of sanctions includes targeted restrictions on financing transactions involving two major Russian financial institutions, Gazprombank OAO and VEB, and two Russian energy firms, OAO Novatek, an independent gas producer, and Rosneft, the state-owned oil company. U.S. persons may not provide financing for new debt of longer than 90 days maturity for these four entities or new equity for the two banks. The United States also announced comprehensive sanctions against Russian arms manufacturers and additional Russian government officials.

The Office of Foreign Assets Control (OFAC) of the United States Treasury Department administers and enforces economic and trade sanctions based on U.S. foreign policy and national security goals. OFAC’s sanctions programs targeting countries are implemented through country-specific regulations that restrict or, in some cases, prohibit financial transactions and other trade with the targeted country and entities located in that country. In addition, OFAC has designated thousands of individuals, companies and other entities because of their ties to a targeted government or their involvement in harmful activities. These individuals, companies and entities are known as Specially Designated Nationals (SDNs).

The Russian businessmen with close ties to President Putin who previously were added to the SDN list include Gennady Timchenko, Yuri Kovalchuk, Arkady and Boris Rotenberg, and Igor Sechin, the president of Rosneft. In addition, a number of Russian government and military officials and commercial entities have been designated, including:

  • OAO Bank Rossiya;
  • Volga Group, an investment company owned by Timchenko;
  • InvestCapitalBank and SMP Bank, controlled by the Rotenberg brothers;
  • Stroytransgaz Group, an energy company that maintains Gazprom’s domestic natural gas pipeline network; and
  • Transoil, a railway transporter of oil and oil products.

For all of the individuals and entities that have been placed on the SDN list, all property and property interests in the United States or that come within the possession or control of a U.S. person are blocked. U.S. persons may have no dealings with the property interests of a designated person, and transactions with a designated person or a business owned by the designated individual are prohibited. (OFAC previously issued guidance that an entity is considered owned by a designated person if the person owns 50 percent or more of the entity.)

When the earlier designations were announced in the spring, news reports indicated that if the situation in Ukraine failed to improve, future U.S. sanctions were likely to target specific Russian industries, including financial services and energy. The sanctions announced on July 16 fit within that framework. By barring U.S. persons from providing financing that extends beyond 90 days to Gazprombank, VEB, Novatek and Rosneft, the United States is seeking to close the medium- and long-term U.S. dollar lending window to these Russian institutions. The assets of these four entities are not frozen, and they have not been placed on the SDN list. Indeed, the new status of these entities has caused OFAC to create another list, the Sectoral Sanctions Identifications List (SSIL), to capture those persons for whom dealings are restricted, but not prohibited.

By contrast, the other sanctions targets announced on July 16 were placed on the SDN list. The new additions to the list are:

  • eight Russian firms that produce military arms or equipment, including Kalashnikov Concern, the largest firearms producer in Russia;
  • the Luhansk People’s Republic and the Donetsk People’s Republic, both of which have asserted governmental authority over regions of Ukraine, as well as Aleksandr Borodai, the self-declared prime minister of the Donetsk People’s Republic;
  • Feodosiya Enterprise, operator of a key shipping facility in the Crimean Peninsula for oil imports and exports; and
  • four additional Russian government officials.

U.S. persons and their employers should be mindful of OFAC’s regulations prohibiting “facilitation.” U.S. persons may not approve, finance or facilitate any transaction by a foreign person where that transaction by a foreign person would be prohibited if performed by a U.S. person or from the United States. As a result, a person in the United States will be considered to have violated the regulations if he steers a prohibited transaction to a colleague overseas and thereby indirectly assists in advancing the transaction. When a U.S. person is confronted with a proposed transaction in which he cannot lawfully engage, the U.S. person must step away from the transaction without doing anything to direct the transaction to a person who is not covered by OFAC sanctions.


Corporate Compliance, False Claims Act, Qui Tam, Whistleblowers

D.C. Circuit Protects Scope of Privilege in Internal Investigations

On June 27, in In re Kellogg Brown & Root, Inc.,1 the United States Court of Appeals for the D.C. Circuit quickly allayed the fears of government contractors and other businesses concerned by U.S. District Judge James S. Gwin’s March 6, 2014, decision2 that created a “but for” threshold test to determine whether the attorney-client privilege applied to documents developed during an internal investigation.

Granting the extraordinary remedy of a writ of mandamus,3 the D.C. Circuit vacated the U.S. District Court for the District of Columbia’s decision, determining that uncertainties in the application of the attorney-client privilege would “eradicate” the privilege for businesses that typically would be able to disclose sensitive facts to counsel during internal investigations conducted pursuant to legally required compliance programs. Contrary to the general understanding of the attorney-client and work-product privileges, the District Court’s decision rendered internal investigation documents unprotected unless the investigation was conducted solely for the purpose of seeking legal advice or the documents were prepared in anticipation of litigation.

The District Court’s surprising ruling stemmed from Henry Barko’s qui tam suit under the False Claims Act alleging that a government contractor and subcontractor inflated costs and accepted kickbacks while administering services in Iraq. Granting Barko’s motion to compel documents, the District Court held that in order for a business to invoke the attorney-client privilege for documents created during an internal investigation, it must show that the communications would not have been made “but for” the fact that legal advice was being sought. The D.C. Circuit determined that this narrow application of the attorney-client privilege to internal investigations was simply wrong.4

The District Court’s decision rested on the following: 1) the investigation was conducted pursuant to internal compliance procedures and Department of Defense regulations; 2) the investigation was conducted by non-attorney investigators under the direction of the in-house legal department and outside counsel was not involved; and 3) the employees interviewed were never informed, orally or in confidentiality agreements, that the investigation was being conducted for the purpose of legal advice.

The D.C. Circuit wholly rejected the District Court’s reasoning. It held that the defendants’ assertion of the attorney-client privilege was “materially indistinguishable” from the seminal case Upjohn Co. v. United States,5 in which the Supreme Court held that the attorney-client privilege applied to an internal investigation led by company lawyers. The D.C. Circuit clarified Upjohn and held that the privilege applies if one of the significant purposes of the investigation was to obtain or provide legal advice, regardless of whether the investigation was also conducted for compliance or policy reasons.

While the D.C. Circuit’s In re Kellogg Brown & Root, Inc., decision is a relief, it highlights the need to carefully craft compliance and internal investigation procedures. In addition to privilege concerns, compliance officers must be mindful of the potential for waiver of the privilege, which was not an issue addressed in the D.C. Circuit’s decision. In order to avoid the possibility of having to turn over documents, businesses and in-house legal departments should take the time to structure internal investigations prior to taking the first step.

1In re Kellogg Brown & Root, Inc., 14-5055, 2014 WL 2895939 (D.C. Cir. June 27, 2014).
2United States ex rel. Barko v. Halliburton Co., 1:05-CV-1276, 2014 WL 1016784 (D.D.C. Mar. 6, 2014).
3The defendants sought a writ of mandamus when the District Court denied a request to certify for interlocutory appeal the ruling that internal investigation documents were not privileged and ordered the documents produced within days.
4The D.C. Circuit did not directly address the work-product privilege issue in In re Kellogg Brown & Root, Inc.
5Upjohn Co. v. United States
, 449 U.S. 383 (1981).

Financial Regulation, Regulation, SEC, SEC Enforcement

The SEC Moves to Improve “Intermediation” in the Municipal and Corporate Fixed Income Markets

The average investor does not get very far when trying to buy a bond in today’s municipal and corporate fixed income markets. Some may find it difficult to find the exact bond they want to purchase, while many grow frustrated with the lack of transparency in bond pricing. Contrasted with the equity markets, where information seems to be at anyone’s fingertips at any given moment, bond markets continue to operate under a decentralized model, where dealers seem to control the flow of information and, ultimately, the market participants. The U.S. Securities and Exchange Commission (SEC) wants to change how bond trading works, and Wall Street should take notice.

On June 20, 2014, in a speech entitled “Intermediation in the Modern Securities Markets: Putting Technology and Competition to Work for Investors,” SEC Chair Mary Jo White focused on the issues of technology and competition, and particularly on how they influence “intermediation” in the securities markets. Ms. White defined intermediation as simply the services provided by brokers, dealers, and exchanges to execute buy and sell orders of investors. Her overall message was clear: The SEC’s efforts to improve efficiencies in intermediation in the equities markets have led to widespread benefits for all investors, and it’s time for those same efficiencies and benefits to be realized in the municipal and corporate bond markets.

Ms. White explained that bond markets today operate essentially the same as they did several years ago. She expressed concern that technology seemingly has been used to increase efficiencies for market intermediaries in the “old, decentralized method of trading” and not leveraged to benefit retail investors. Efforts to change that could provide everyday bond investors with increased availability of pre-trade pricing information, decreased search costs and greater price competition.

To help address her concerns, Ms. White announced the following new initiatives the SEC will undertake:

  • Assist the Financial Industry Regulatory Authority (FINRA) and Municipal Securities Rulemaking Board (MSRB) to finalize a “best execution” rule for the municipal securities market and develop practical guidance for brokers to achieve best execution;
  • Work with FINRA and MSRB to develop rules by the end of the year to require disclosure of markups (i.e., dealers’ compensation) in “riskless principal” transactions for both municipal and corporate bonds, which should help investors better understand the cost of bond transactions; and
  • Focus on a regulatory initiative to increase the public availability of pre-trade pricing information and require the dissemination of best prices by electronic dealer trading networks in the municipal and corporate bond markets.

These announcements come only two weeks after Ms. White announced the SEC’s intention to strengthen equity markets by reviewing the fairness of trading in high-speed markets, enhancing trading venue regulation, and mitigating broker conflicts.

The move by the SEC to strengthen competition in the bond markets could significantly impact the advantages enjoyed by many large dealers. It’s certainly easy to imagine how more information related to the supply and demand of certain bonds could lead to increased interest in bond securities by smaller investors and, ultimately, more competition in a profitable dealer business. But these regulatory initiatives target only a portion of the overall bond market, and any regulation may stifle trading and leave the normal bond market players to enjoy an effectively unchanged environment. Time will tell how the SEC’s moves impact an important segment of the bond markets.

Enforcement Actions, Financial Regulation, Judgments, News, SEC, SEC Enforcement, Securities Class Actions

Update: Second Circuit Vacates Judge Rakoff, Clarifies Standard of Review for Consent Decrees.

In a much anticipated decision, on June 4 the Second Circuit vacated District Court Judge Rakoff’s rejection of a consent judgment approving a $285 million settlement between the U.S. Securities and Exchange Commission (SEC) and Citigroup. In 2011, the SEC alleged that Citigroup created and sold mortgage bond investments without disclosing that the people assembling the deal were betting against the performance of the securities. In November 2011, Rakoff blocked the proposed consent judgment because the settlement allowed Citigroup to neither admit nor deny the SEC’s allegations. Although the “no admit, no deny” policy is common practice in the SEC’s settlement agreements, Rakoff objected to the practice because, he said, it denied courts the ability to assess whether a settlement was fair.

In a decision largely seen as a rebuke to Rakoff, the Second Circuit emphasized that it is the SEC, not the courts, that has the authority to decide the terms of an agreement. Acknowledging that the agency’s resources are limited and that consent decrees are a legitimate means of enforcement, the court stated, “Trials are primarily about truth. Consent decrees are primarily about pragmatism.”

On remand, Judge Rakoff will have less leeway to review the settlement. The Second Circuit held that a district court’s responsibility is to assess whether the settlement is “fair and reasonable.” In doing so, the Second Circuit outlined the relevant considerations:

  • the basic legality of the decree;
  • whether the terms of the decree, including its enforcement mechanism, are clear;
  • whether the consent decree reflects a resolution of the actual claims in the complaint;
  • whether the consent decree is tainted by improper collusion or corruption between the SEC and the defendant; and
  • whether the public interest would not be disserved (if the deal contains an injunction).

Absent a substantial basis in the record for concluding that the proposed consent decree does not meet these requirements, the district court is required to enter the order. Once a determination of fair and reasonable is made, the review ends.

The case now returns to Rakoff’s desk, where the consent decree most certainly will be approved.

In June 2013, the SEC announced a new policy that it would require defendants to make admissions in certain cases, such as in cases with a large market impact or which involve egregious misconduct. Since that announcement was made, the SEC has required defendants to make admissions in a handful of high-profile settlements. Nonetheless, it has long been presumed that the SEC has great control over the terms of its settlement agreements, including whether a defendant must admit or deny allegations, and on June 4, the Second Circuit affirmed this presumption.

False Claims Act, Qui Tam

In Fraud Suit Against Lance Armstrong, Court Rejects Application of Wartime Suspension of Limitations Act to False Claims Act

In a decision last Thursday, the United States District Court for the District of Columbia held that the Wartime Suspension of Limitations Act (WSLA) does not apply to the current version of the False Claims Act (FCA). United States ex. rel. Landis v. Tailwind Sports Corporation, No. 10–cv–00976 (RLW), 2014 WL 2772907, at *39-42 (D.D.C. June 19, 2014), available here. This is a significant decision that is the first to counter many recent decisions holding that the FCA’s statute of limitations is suspended indefinitely by the WSLA until formal conclusion of the conflicts in Iraq and Afghanistan.

During times of war, the WSLA suspends statutes of limitations for offenses involving fraud against the United States until five years after termination of hostilities. 18 U.S.C. § 3287. Originally enacted in 1942 and amended in 1944, the WSLA is intended to allow the United States sufficient time to investigate and prosecute fraud offenses committed against it during times of war when it is distracted by the demands of war. The FCA’s standard, codified statute of limitations bars claims brought more than six years from the violation date, or more than three years from when the government knew or should have known about the violation, but in no event more than ten years after the violation date, whichever occurs last. 31 U.S.C. § 3731(b). Recently, though, several courts have held that the FCA’s statute of limitations has been suspended by the WSLA based on the conflicts in Iraq and Afghanistan — which are not yet considered terminated for purposes of the WSLA — thus reviving otherwise stale claims in the cases and creating the potential for nearly indefinite tolling of the FCA’s statute of limitations. Courts have even applied the WSLA to cases with no connection to wartime hostilities and cases where the government has declined to intervene.

Until last Thursday, almost all present-day authority supported the application of the WSLA to the FCA. The Landis decision essentially reached the opposite conclusion — that the WSLA does not apply to the post-1986 versions of the FCA. The Landis court observed that the WSLA applies only to cases that “include fraud as an essential ingredient” (citing two 1953 Supreme Court cases, Bridges and Grainger); that the post-1986 versions of the FCA provide that “no proof of specific intent to defraud is required”; and that Rule 9(b), which applies to FCA cases, allows allegations of intent, knowledge, and condition of mind to be averred generally. Landis, 2014 WL 2772907, at *41. The court thus concluded that “it is clear in this Circuit that civil FCA actions under the modern version of the statute do not require proof of fraud as an ‘essential element’”; that the relator does not contend that proof of specific intent to defraud is required for his FCA claims; and, therefore, that the WSLA does not toll the statute of limitations for the FCA claims in the case. Id. at *41-42.

At least one court has rejected the argument relied on by the Landis court — that the WSLA does not apply to the post-1986 versions of the FCA because they do not include fraud as an essential ingredient. See United States v. Wells Fargo Bank, N.A., No. 12 CIV. 7527 JMF, 2013 WL 5312564, at *12 (S.D.N.Y. Sept. 24, 2013). The Landis court did not consider other arguments FCA defendants have made against application of the WSLA to the FCA. With the exception of a split in authority for cases where the government has declined to intervene, courts have rejected most of these arguments as well. These arguments include:

  1. The WSLA should only be applied to criminal “offenses,” not civil claims like those brought under the civil FCA;
  2. The WSLA should only extend to claims related to wartime contracting;
  3. The WSLA should only apply in FCA cases where the government has intervened;
  4. Because of the FCA’s ten-year statute of repose, FCA cases still may not be brought more than ten years from the alleged violation dates given that (a) the WSLA should only apply to statutes of limitations, not to statutes of repose, and (b) the FCA’s absolute ten-year limit should supersede the WSLA even if the WSLA did apply to it;
  5. Applying the WSLA without limitations like the FCA’s statute of repose risks indefinite tolling, which is contrary to the Supreme Court’s ruling in Gabelli v. SEC.
  6. The pre-2008 version of the WSLA was not triggered by the Iraq and Afghanistan conflicts because the United States was not “at war” during those conflicts as defined by that version of the statute; and
  7. The retroactive application of the post-2008 version of the WSLA, which was triggered by the Iraq and Afghanistan conflicts, is unconstitutional.

Still, as the first decision to flatly reject the application of the WSLA to the FCA, the Landis decision is a significant development for current and potential FCA defendants seeking to apply the FCA’s standard, codified statute of limitations to stale claims and wishing to avoid the WSLA’s nearly indefinite tolling of that statute of limitations.

FCPA, FCPA Investigations, White Collar Crime

“The FCPA Does Not Define the Term ‘Instrumentality,’ and this Court Has Not Either.” The 11th Circuit Issues a Decision “Defining” Instrumentality

On May 16, 2014, the U.S. Court of Appeals for the 11th Circuit ruled in U.S. v. Esquenazi that the Foreign Corrupt Practices Act’s (FCPA’s) “instrumentality” provision could include state-owned businesses.

Joel Esquernazi and Carlos Rodriquez co-owned Terra Communications (Terra). In 2011, a jury convicted Esquernazi and Rodriquez on 21 counts related to their business dealings with Telecommunications D’Haiti, S.A.M. (Teleco). Esquernazi and Rodriquez were sentenced to prison terms of 15 and 7 years, respectively.

Esquernazi and Rodriquez challenged their convictions on the ground that the district court’s FCPA jury instructions were erroneous. The jury was instructed that an “instrumentality of a foreign government is a means or agency through which a function of the foreign government is accomplished. State-owned or state-controlled companies that provide services to the public may meet this definition.”

The central question before the court was the meaning of “instrumentality” under the FCPA. The court provided the following list of factors to determine if an entity is an instrument of a foreign government.

• Does the government control the entity? Consider:

  • the nature of the foreign government’s formal designation of the entity;
  • whether the government has a majority interest in the entity;
  • the government’s ability to hire and fire entity principals;
  • the extent to which the entity’s profits, if any, go directly to the government;
  • the extent to which the government funds the entity if it fails to break even; and
  • the length of time these indicia have existed.

• Is the entity an instrumentality of a foreign government? Consider:

  • whether the entity has a monopoly over the function it exists to carry out;
  • whether the government subsidizes the costs associated with the entity providing services;
  • whether the entity provides services to the public at large; and
  • whether the public and the government of the foreign country generally perceive the entity to be performing a governmental function.

Teleco is a Haitian telecommunications company formed in 1968. An expert witness testified that the company was given a monopoly on telecommunication services in Haiti, as well as significant tax breaks, and that, at the company’s inception, the Haitian government appointed two members of the board of directors of Teleco.

The court said there was enough evidence to show that Teleco was controlled by the Haitian government and that, by providing nationalized telecommunications, Teleco was an instrumentality of the Haitian government and subject to the FCPA’s anti-bribery laws. The convictions and sentences of Esquernazi and Rodriquez were affirmed.

This case provides a roadmap for domestic companies to use when engaging in business transactions with state-owned companies. The 11th Circuit is the first court of appeals to weigh in on the question of the meaning of “instrumentality” under the FCPA. With this ruling, a foreign company does not have to be an agency or department of the government; being state-owned can be enough to trigger anti-bribery statutes. Domestic companies should use the same care and restraint in business dealings with state-owned companies as they do when conducting business directly with foreign officials.


Judgments, News, SEC, Securities Litigation

All Relief Sought by SEC Subject to 5-Year Statute of Limitations

As we reported last year, the U.S. Supreme Court’s decision in Gabelli v. SEC precludes the SEC from using the “discovery rule” to extend the five-year statute of limitations on the government’s claims for civil penalties available under 28 U.S.C. § 2462. In Gabelli, the Supreme Court expressly declined to address whether the statute of limitations under Section 2462 also applies to disgorgement and an injunction. Early last week, U.S. District Judge James King in the Southern District of Florida answered that question in the affirmative. In issuing a Final Order of Dismissal in SEC v. Graham, Judge King significantly expands Gabelli by applying Section 2462 to all forms of relief, not just civil penalties, sought by the SEC in that matter.1 Given that SEC investigations often take years, this decision likely will incentivize the SEC to expedite investigations and charging decisions.

SEC v. Graham involved an action against five former executives of the defunct Cay Clubs Resorts and Marinas in connection with an alleged offering fraud and Ponzi scheme. According to the SEC, more than 1,400 investors were defrauded into investing more than $300 million through purchases of units at Cay Clubs’ resort locations based on promises of, among other things, immediate income from a guaranteed 15-percent return and a future income stream through a rental program. The SEC filed the action in 2013, following a protracted investigation spanning more than seven years. In the action, the SEC sought declaratory relief, injunctive relief, civil money penalties, a sworn accounting, and the repatriation and disgorgement of all ill-gotten gains. The defendants moved for summary judgment that the five-year statute of limitations under Section 2462 barred the SEC’s claims.

Judge King raised sua sponte the issue of whether the Court had subject matter jurisdiction to entertain the SEC’s case. In deciding whether Section 2462 was jurisdictional, the Court dismissed the notion that the statute operated as a “claim-processing rule” and determined that Congress “clearly states that a threshold limitation on a statute’s scope shall count as jurisdictional.”2 Moreover, the Court stated that statutes of limitation, especially the “more absolute” kind whose text speaks to the power of a court to act, as opposed to those that “seek primarily to protect defendants against stale or unduly delayed claims” can remove such claims not brought within the time limit from the court’s adjudicatory authority.3 Applying this standard to Section 2462 and relying on established conclusions reached in Gabelli, the Court determined that because the date of accrual is a fixed date and the SEC could not take advantage of the “discovery rule” to delay that accrual, the SEC had to begin the cause of action within five years of the last act that gave rise to the claim. Stating that the statutory language provided by Section 2462 “is a congressional removal of a court’s power to entertain – its adjudicatory authority and jurisdiction – cases not brought within five years of accrual,” Judge King opined that the Court could not maintain subject-matter jurisdiction.

The Court also considered whether the language of Section 2462 – “for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise” – applied to other forms of relief that the SEC sought. Although Gabelli expressly declined to address whether disgorgement and injunctive relief were covered by Section 2462, this Court invoked the “long-held policies and practices that underpin” the Gabelli decision,4 along with the text of Section 2462 itself, to reach the conclusion that this statute did include the types of relief the SEC sought. The Court maintained that to agree with the SEC’s position that Section 2462 did not apply in this instance “would make the Government’s reach to enforce such claims akin to its unlimited ability to prosecute murderers and rapists.” The SEC relied on United States v. Banks, which concluded that the “plain language of § 2462 does not apply to equitable remedies” and therefore the “clear expression of Congress” required before the application of the statute of limitations was not present in Section 2462.5 The Court stressed that Banks dealt with a different kind of remedy to enjoin a different kind of harm compared to the issue at present. Banks involved the United States’ sovereign capacity to enforce the Clean Water Act to enjoin the continuing harm of discharging fill into U.S. waters, not punish the defendants for discharging that fill.

Furthermore, the Court ruled that even though the words “declaratory relief,” “injunction” and “disgorgement” do not appear in the statute, penalties, “pecuniary or otherwise,” are at the heart of all forms of relief sought in this case. The SEC sought to declare the defendants in violation of the federal securities laws and label them “wrongdoers.” The injunctive relief the SEC sought to forever bar defendants from future violations of the federal securities laws is meant to punish, and the SEC’s pursuit to disgorge the ill-gotten gains realized from the alleged violations “can truly be regarded as nothing other than a forfeiture … which remedy is expressly covered by § 2462.” The Court declared that “to hold otherwise would be to open the door to Government plaintiffs’ ingenuity in creating new terms for the precise forms of relief expressly covered by the statute in order to avoid its application.” The Court held that Section 2462 applied to all forms of relief sought by the SEC, thereby legitimizing the statute in the Court’s evaluation of the established time-barred claims, and resulting in the Court’s loss of subject-matter jurisdiction.

Therefore, because the SEC “failed to meet its serious duty to timely bring this enforcement action” against the defendants within the five-year period, Judge King dismissed the case.

Finally, the dismissal order does not address whether Section 2462 applies to other remedies available to the SEC, such as the imposition of a corporate monitor or undertakings, and the SEC undoubtedly will argue that Section 2462 does not apply to such claims because they are not penalties.

The full Order can be found here:

To learn more about the Graham case, the SEC litigation release can be found here:

1 SEC v. Graham, No. 13-1001 (S.D. Fla. May 12, 2014).
2 See Arbaugh v. Y&H Corp., 546 U.S. 500, 515-16 (2006).
Citing John R. Sand & Gravel v. United States, 552 U.S. 130, 133 (2008).
4 “But this case involved penalties, which go beyond compensation, are intended to punish, and label defendants wrongdoers.” See Gabelli v. SEC, 133 S. Ct. 1216, 1233.
15 F.3d 916, 919 (11th Cir. 1997)

Anti-Corruption, Charging, DOJ Policy, FCPA

Not Every Payment to a Foreign Official is a Bribe

On those rare occasions in which a U.S. business is confronted with the possibility of making a payment to a foreign official that is unrelated to the official’s government service, there is an understandable temptation to reject the payment and run in the opposite direction. In some cases, however, that is a very unattractive option. For example, if the foreign official is owed some amount as a result of his prior interest in the foreign subsidiary of the U.S. business and he is assuming a minister-level position in another country’s central monetary and banking agency, the U.S. business will be motivated to make the payment while navigating the FCPA-related obstacles associated with the situation. The Department of Justice’s first FCPA Advisory Opinion of 2014, Opinion No. 14-01 (Opinion), demonstrates that such a payment is permissible and will not prompt an enforcement action as long as the arrangement is transparent and steps are taken to undercut any suggestion of corrupt intent. The recently released Opinion emphasizes that the determination of whether a commercial transaction with a foreign official implicates the FCPA is fact intensive and offers beneficial guidance on DOJ’s FCPA enforcement analysis.

The facts giving rise to the Opinion are as follows. In March 2007, a U.S. company, through a wholly owned subsidiary, purchased a majority interest in a foreign financial services firm (foreign company) founded and managed by a foreign businessman (foreign shareholder). The 2007 purchase agreement prohibited the foreign shareholder from selling his minority interest in the foreign company for five years, unless the foreign shareholder was appointed to a “minister-level position or higher” in the foreign country’s government. The purchase agreement also provided the subsidiary with a buyout option, including a formula to value the minority shares.

In December 2011, as anticipated by the purchase agreement, the foreign shareholder was appointed to serve as an official in the foreign country’s central monetary and banking agency (foreign agency). There is no dispute that the foreign shareholder, by virtue of his appointment, became a “foreign official,” as that term is defined by the FCPA. Shortly after the appointment, the subsidiary foreign company entered into negotiations to purchase the foreign shareholder’s minority shares. Of note, both parties agreed that the buyout formula contained in the 2007 purchase agreement undervalued the foreign shareholder’s shares. Therefore, the parties engaged an independent accounting firm to provide a binding valuation of the purchased shares. Likewise, the parties carefully disclosed the relationship and potential sale to relevant authorities in the U.S. and in the foreign country. The matter was complicated by the fact that the foreign agency was a long-time client of the U.S. company, which provides asset management and investment banking services to the foreign agency. In line with DOJ’s prior guidance on this issue, see FCPA Opinion Procedure Release 2000-01 (Mar. 29, 2000), the U.S. company and the foreign company subsidiary represented that they would take appropriate steps to screen employees from the foreign shareholder and the foreign shareholder agreed to recuse himself from any decisions concerning awards of business to the U.S. company or the foreign company. The U.S. company sought guidance from DOJ on the FCPA implications of the proposed buyout.

Ultimately – as you probably inferred from the introduction – DOJ opined that enforcement action was not warranted by the proposed buyout. The Opinion outlines four factors that DOJ considers in analyzing business relationships with foreign officials: (1) whether there is the indicia of corrupt intent; (2) whether the transaction is transparent to the foreign government and the general public; (3) whether the transaction conforms with local law; and (4) whether the transaction includes necessary safeguards to prevent the foreign official from improperly using his position to award business to the company. Here, DOJ was satisfied with the parties’ actions and assurances, most notably that an independent firm valued the shares, thus avoiding any appearance that the purchase price was payment for some corrupt purpose.

Commercial transactions with foreign officials should be approached with care and restraint. Cynical law enforcement may view such arrangements as a disguise for a corrupt payment. However, as long as the transaction is transparent and lawful in the official’s country, appropriate safeguards against corrupt decision-making are installed, and the payment reflects the market value of the transaction − as in this case − then the payment can go forward. As even DOJ will recognize, such a payment is not a bribe.