Subject to Inquiry

Subject to Inquiry

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

Government, Regulatory & Criminal Investigations Group
Dodd-Frank, SEC, Whistleblowers

Second Circuit Decides Dodd-Frank Does Not Apply Extraterritorially, Skips Addressing Whistleblower Protection for Internal Reporting

The Dodd-Frank Act prohibits employers from retaliating against employees who act as whistleblowers by providing information related to a violation of the securities laws to the Securities and Exchange Commission (SEC) in a manner established by the SEC. Dodd-Frank Act, 15 U.S.C. § 78u-6(h)(1). The jurisdiction and scope of this law have been tested recently in the U.S. Courts of Appeals for the Second and Eighth Circuits. In the Eighth Circuit, the court was asked to take up an interlocutory appeal to determine whether individuals who do not provide information directly to the SEC qualify as “whistleblowers” under Dodd-Frank. The Eighth Circuit declined to take up the appeal. The Second Circuit also was asked to weigh in on whether whistleblowers are protected if they report violations only internally, but the court did not need to reach that question. Instead, the Second Circuit held that Dodd-Frank does not apply extraterritorially, and because the plaintiff failed to allege that any of the events took place within the United States, Dodd-Frank did not apply. Liu v. Siemens AG, Docket No. 13-4385, (2d Cir. Aug. 14, 2014).

In Liu v. Siemens AG, the Second Circuit was presented with multiple issues, including whether the Dodd-Frank Act applied outside of the United States and whether Dodd-Frank’s definition of whistleblower included an individual who reported violations only internally, within his or her company. The court did not need to reach the internal reporting issue, as it followed the Supreme Court’s decision in Morrison v. Nat’l Australia Bank Ltd., 561 U.S. 247 (2010), in concluding that the Dodd-Frank Act was not intended to apply extraterritorially. Morrison stands for the proposition that a law will not be applied extraterritorially unless Congress affirmatively indicated that the law was meant to be so applied. Id. at 265. Relying on this precedent, the Second Circuit rejected Liu’s arguments that the broad language of the Dodd-Frank Act could be read to imply extraterritorial application. The Second Circuit held that “there is no explicit statutory evidence that Congress meant for the antiretaliation to apply extraterritorially . . . . Thus ‘we must presume [that the antiretaliation provision] is primarily concerned with domestic conditions.’ ” Liu, Docket No. 13-4385, at 20 (quoting Norex Petroleum Ltd. v. Access Industries, Inc., 631 F.3d 29, 32 (2d Cir. 2010)

By affirming the lower court on the extraterritoriality question, the Second Circuit did not reach the issue of whether the Dodd-Frank Act protects would-be “whistleblowers” who do not report violations directly to the SEC. While Liu did not result in an opinion on that subject, the proceeding did provide insight into the SEC’s point of view, as the SEC filed an amicus brief urging the court to defer to the SEC’s interpretation of Dodd-Frank’s whistleblower protection, discussed in additional detail on this blog . In its brief, the SEC argued that Dodd-Frank’s anti-retaliation provisions apply to any individual engaging in protected whistleblowing activities, including reporting internally to the company as Liu did. The SEC reasoned that it had crafted its rules to provide “strong incentives” to report internally in the first instance, and pointed out that “if internal compliance and reporting procedures are not utilized or working, our system of securities regulation will be less effective.”

The Eighth Circuit also had the opportunity to address the internal reporting question in Bussing v. COR Clearing, LLC. In Bussing, the district court denied COR Clearing’s motion to dismiss a former executive’s claim under the Dodd-Frank Act based on retaliatory termination after the executive reported potential violations to COR Clearing’s top executives and to FINRA, but not to the SEC. COR Clearing argued that because the executive did not report directly to the SEC, Dodd-Frank did not apply. U.S. District Court Judge John Gerrard rejected this argument but allowed COR Clearing to pursue an interlocutory appeal to the Eighth Circuit. The court of appeals did not take COR Clearing up on its invitation and the case presumably will proceed at the district court level.[1]

With the Second Circuit sidestepping the issue and the Eighth Circuit refusing to take it up, the Fifth Circuit, in Asadi v. G.E. Energy (USA) LLC, 720 F.3d 620 (5th Cir. 2013), is the only appellate court to have spoken on the issue, holding that the Dodd-Frank Act’s protection of whistleblowers does not apply to individuals who do not provide the SEC with information relating to securities law violations. While not binding outside the Fifth Circuit, the court’s opinion in Asadi is at least persuasive, and at odds with the SEC’s point of view as articulated in its amicus brief in Liu. Against this backdrop, an employee seeking to guarantee protection under Dodd-Frank should provide information of securities violations directly to the SEC. In addition, employers should assume that an employee reporting internally also will be making a report with the SEC, and the employer should act quickly to investigate the claims. Employers should take great care when dealing with potential whistleblowers to avoid any actions that may appear to be retaliatory in nature, particularly in light of the SEC’s view.

1. Stephanie Russell-Kraft, 8th Circ. Denies Appeal on Dodd-Frank Whistleblower Limits,,, (Sept. 4, 2014 4:03 PM ET).

Anti-Money Laundering, Financial Crimes, Suspicious Activity Reports

Don’t Turn a Blind Eye – Individual Liability for Failure to Comply with BSA Reporting Requirements

The Financial Crimes Enforcement Network (FinCEN) announced on August 20, 2014, that it had reached an agreement with a casino official permanently barring him from working in financial institutions as a result of his willful violations of the Bank Secrecy Act (BSA).

The individual in question, Mr. George Que, assisted high-end customers in avoiding detection of their large cash transactions by agreeing not to file suspicious activity reports (SARs) or currency transaction reports (CTRs), which are required under the BSA to assist law enforcement in detecting money laundering. As a result, Mr. Que was criminally charged for (a) willfully participating in causing the casino to fail to report transactions in currency;1 and (b) willfully participating in causing the casino to fail to report suspicious activity.2 He entered a deferred prosecution agreement and agreed to a civil monetary penalty of $5,000. In addition, he is permanently barred from working in the financial industry.

The lesson here reaches well beyond the gaming industry, however. Relationship managers for banks, hedge funds and all financial institutions should certainly deny any requests to assist a customer in evading the BSA’s reporting requirements. But they must do more. Individuals with day-to-day customer interaction are often the only ones who receive such an illicit request, making them the only ones with knowledge of the request. For example, in Mr. Que’s case, the consent order points out that he “was in a unique position to ensure that the Casino reported the suspicious activity. He had personal knowledge, based on multiple conversations … in which the request was made. Nonetheless, Mr. Que, and through him, [his employer], failed to report the activity as suspicious.”

As a result, simply denying a customer’s request for help in evading the BSA’s reporting requirements is not enough. The request itself should be reported as suspicious activity through the organization’s anti-money laundering compliance channels. If not, it could be grounds for a finding of willful participation in causing the organization to fail to report suspicious activity, which is a violation of federal law.

A series of poor choices, which may or may not have benefitted Mr. Que financially, have resulted in his debarment from the financial industry. Let this be a reminder to all in the industry that compliance with the BSA’s reporting requirements begins, and sometimes fails, at the ground level.


1131 U.S.C. §§ 5313, 5324(a)(1) and 31 C.F.R. § 1021.311
2231 U.S.C. § 5318(g) and 31 C.F.R. § 1021.320


SEC, SEC Enforcement, Whistleblowers

The SEC Waives Eligibility Requirement and Awards Whistleblower $400,000

Waiving one of the whistleblower award eligibility requirements, the Securities and Exchange Commission recently awarded more than $400,000 to a whistleblower who reported a fraud to the SEC after the company failed to address the issue internally.

Notably, the Claims Review Staff initially recommended that the whistleblower’s claim be denied, as the information did not appear to be “voluntarily” provided under the definition of Rule 21F-4(a)(ii) because the information was provided after an inquiry by a self-regulatory organization (“SRO”) into the matter. However, after the whistleblower provided a detailed chronology of events, the Commission was persuaded that the whistleblower had engaged in “diligent efforts to correct and to bring to light the underlying misconduct” and determined that there were “materially significant extenuating circumstances,” such that it “was in the public interest and consistent with the protection of investors” to waive the “voluntary” requirement. In ordering the award, the Commission acknowledged that the whistleblower’s interactions with the SRO occurred prior to the SEC’s proposal or adoption of Rule 21F-4(a), which created incentives for whistleblowers to report original information to the SEC before they are approached by an SRO.

In determining the award amount, the Commission explained that the amount reflects the significance of the information that the whistleblower provided to the Commission, the efforts the whistleblower made to protect investors and report the violation internally, and the personal and professional injuries that the whistleblower suffered in raising the issues.

In a press release concerning the award, Sean McKessy, Chief of the SEC’s Office of the Whistleblower, recognized the whistleblower’s efforts to address the issue internally before reporting to the SEC, stating:

The whistleblower did everything feasible to correct the issue internally. When it became apparent that the company would not address the issue, the whistleblower came to the SEC in a final effort to correct the fraud and prevent investors from being harmed. This award recognizes the significance of the information that the whistleblower provided us and the balanced efforts made by the whistleblower to protect investors and report the violation internally.

This award and the Commission’s willingness to waive certain eligibility requirements to incentivize whistleblower claims send a strong message to companies about the importance of having robust internal reporting procedures and of properly investigating and taking necessary steps to address reported issues.


Corporate Compliance, Financial Regulation

Unpacking OFAC’s Revised Guidance Regarding its “50 Percent Rule”

On August 14, 2014, the Department of the Treasury’s Office of Foreign Assets Control (OFAC) published revised guidance regarding entities owned by persons whose property and interests in property are blocked pursuant to an Executive Order or regulations administered by OFAC (blocked persons). Fed. Reg. 47726 (August 14, 2014). Under the revised guidance, any entity that is owned “in the aggregate, directly or indirectly, 50 percent or more by one or more blocked persons is itself considered to be a blocked person.” This is true even if the entity is not itself listed in the annex to an Executive Order or otherwise placed on OFAC’s list of Specially Designated Nationals (SDNs). As with any blocked person, now a U.S. person generally may not engage in any transactions with an entity that is not formally blocked but is at least 50 percent owned by a blocked person or blocked persons, unless authorized by OFAC.

This announcement updates OFAC’s February 14, 2008, guidance establishing the so-called 50 Percent Rule, which stated that a blocked person is “considered to have an interest in all property and interests in property of an entity in which it owns, directly or indirectly, a 50% or greater interest.” While the 2008 guidance left open the question whether aggregate ownership resulted in automatic blocking of the non-blocked entity, OFAC issued the admonition that U.S. persons act with caution when considering a transaction with a non-blocked entity in which a blocked person has a significant ownership interest that is less than 50 percent or “which a blocked person may control by means other than a majority ownership interest.” OFAC repeated this admonition in the revised guidance, which is even more relevant in light of the recent sanctions targeting Russia, where oligarchs appear to have fractional ownership and potentially control interests in many entities that themselves may not be blocked.

When blocked persons own a significant, but still less than 50-percent ownership interest, or otherwise appear to exert control over an entity, U.S. persons considering a transaction with the entity face a difficult issue of risk tolerance. In the first instance, the original and revised guidance provide the practical advice that entities that are less than 50 percent owned by blocked persons “may be the subject of future designation or enforcement action by OFAC.” This designation is now automatic, should blocked persons obtain 50 percent ownership in the aggregate. Further, certain of OFAC’s sanctions programs, such as those regarding Cuba and Sudan, include the notion of “control” in key definitions and provisions, such that an entity that is minority owned by persons blocked under those programs, but still effectively controlled by them, could be considered blocked as well. However, the risk of transacting with entities potentially controlled by blocked persons is difficult to ascertain, given the relative dearth of guidance as to what level of control or influence need be demonstrated.

While the question of control remains murky, OFAC provided additional clarity on the revised guidance with frequently asked questions (FAQ) on the question of entities owned by blocked persons. See FAQ #398-402. Some key points from the FAQ include the following:

OFAC aggregates the ownership interests of persons blocked under different OFAC sanctions programs. See FAQ #399.

  • While an entity controlled but not owned 50 percent or more by blocked persons is not automatically blocked, persons should be cautious not to conduct business (e.g., enter into contracts) with a blocked person representing the non-blocked entity, which is generally prohibited by OFAC sanctions. See FAQ #398, 400.
  • Beware of the indirect ownership principle when applied to the aggregate ownership guidance. For example, if Blocked Person X owns 50 percent of Entity A, which in turn owns 50 percent of Entity B, Entity B is blocked because Blocked Person X indirectly owns 50 percent of Entity B. See FAQ #401 for additional examples.

OFAC’s common-sense expansion of the 2008 guidance provides a reminder to businesses that vigilance is required when vetting potential or existing counterparties, particularly when those counterparties have complex ownership structures and fractional shareholders. In short, it may not be sufficient simply to determine whether counterparties appear on OFAC’s SDN list. Instead, businesses should endeavor to conduct reasonable screening and due diligence designed to understand the ownership structure of counterparties (and the ownership structure of their related companies) and determine not only whether a counterparty is significantly owned by one or more blocked persons, but also whether blocked persons exert influence over the entity by some other mechanism. A business with exposure to SDNs should reevaluate its existing due diligence processes in light of this expanded guidance to ensure it is taking reasonable steps to avoid transactions with a blocked person or an entity deemed blocked through its association with blocked persons either through ownership interests or other forms of control.


False Claims Act, News, Qui Tam

Supreme Court Grants Certiorari on False Claims Act Case Addressing Wartime Tolling and First-to-File Bar

On July 1, the Supreme Court granted certiorari in Kellogg Brown & Root Services v. United States ex rel. Carter, a case from the Fourth Circuit raising two important questions under the False Claims Act (FCA) that together create the risk that FCA defendants may have to face continued qui tam lawsuits no matter how old the conduct in question.

First, the case raises the question of whether the Wartime Suspension of Limitations Act (WSLA), which tolls the statute of limitations for fraud offenses when the country is at war, applies to civil actions for fraud or when there has not been any formal declaration of war. The WSLA is located in the criminal title of the United States Code and does not expressly include civil claims. If wartime tolling applies to civil FCA claims and does not require a formal declaration of war, the FCA statute of limitation might conceivably become a dead letter because it is unlikely that a war that was not formally declared would ever be formally concluded.

FCA plaintiffs have been successful in numerous cases arguing that wartime tolling applies to civil FCA claims and currently applies because of the conflicts in Iraq and Afghanistan. As discussed on this blog, it was only last month that the District Court for the District of Columbia became the first court to reject that argument, in a case involving an FCA suit against Lance Armstrong related to monies he received from his sponsorship by the United States Post Office. As seen by that case, arguments for wartime tolling have not been limited to defense contracts or to events occurring in war zones, so wartime tolling is potentially of concern to any entity receiving federal government funds.

Second, Kellogg Brown & Root raises the issue of how broadly the first-to-file bar is to be interpreted. Under the FCA, “[w]hen a person brings an action under [the FCA], no person other than the Government may intervene or bring a related action based on the facts underlying the pending action.” As the Fourth Circuit noted in its decision, “the [FCA] seeks to prevent parasitic lawsuits based on previously disclosed fraud.” The Fourth Circuit held, however, that the first-to-file bar applied only when the earlier lawsuit was actually pending, and that the first-to-file bar no longer applied if that lawsuit was dismissed, although depending on the resolution of the first case, another doctrine such as claim preclusion might prevent the filing of subsequent qui tam actions. The court held that a subsequently filed lawsuit must be dismissed without prejudice, with the potential to bring the lawsuit again after conclusion of the first-filed lawsuit. This decision, which followed previous decisions from the Seventh and Tenth Circuits, is of potentially great concern to FCA defendants, who may face the prospect of defending repeated qui tam complaints brought by different relators as long as each suit is sequential instead of concurrent.

Unusually, the Supreme Court granted certiorari on both issues in the case, despite opposition by the solicitor general. The solicitor general recommended that the Court not grant certiorari regardless of a circuit split on the first-to-file bar issue.

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.