Subject to Inquiry

Subject to Inquiry

THE LATEST ON GOVERNMENT INQUIRIES AND ENFORCEMENT ACTIONS

Government Investigations and White Collar Litigation Group
Enforcement and Prosecution Policy and Trends, Fraud, Deception and False Claims

With Record-Setting False Claims Act Recoveries, What Will DOJ Do for an Encore?

Last week, the Department of Justice (DOJ) announced that it had collected a record $5.69 billion in False Claims Act (FCA) settlements and
recoveries over the past year, marking the first time that recoveries have breached the $5 billion threshold. The DOJ press release announcing this accomplishment highlighted two key areas of recovery: healthcare and the financial sector.

While the healthcare field is likely to remain a fertile ground for future FCA litigation, many of the recoveries involving financial institutions arose from events leading up to the financial crisis. As a result, DOJ will likely be hard-pressed to replicate this value in the upcoming year. The Supreme Court may add further complications to DOJ’s recovery efforts when it decides Kellogg Brown & Root Services v. United States ex rel. Carter, which may limit the government’s efforts to toll the FCA’s statute of limitations. Despite its unprecedented success this year, DOJ is unlikely to declare victory and refocus its efforts elsewhere. To the contrary, it is highly likely that DOJ will redouble its efforts in pursuing FCA cases and up the stakes further by shifting from a focus on monetary recovery to a focus on seeking criminal penalties.

DOJ has already announced its intent to increase emphasis on criminal prosecutions in FCA cases. In remarks on September 17, 2014, Leslie Caldwell, assistant attorney general for the Criminal Division, announced that DOJ would be implementing new procedures regarding qui tam complaints. Caldwell stated that DOJ would be increasing the resources it devotes to FCA cases by bringing in the Criminal Division early and often. Going forward, the Criminal Division’s Fraud Section will review all qui tam actions as soon as they are filed to determine whether to open parallel criminal investigations. Caldwell suggested that even if criminal charges ultimately are not filed, the civil investigation will still benefit from criminal investigators’ expertise in uncovering fraud. She also encouraged prospective relators to contact criminal as well as civil authorities before filing a qui tam suit.

The upshot of these developments is that companies should expect an increase in criminal investigations that accompany FCA cases. In particular, they should expect DOJ to intensify efforts to hold individuals criminally responsible for FCA violations. In a particularly ominous statement, Caldwell highlighted the Criminal Division’s ability to freeze assets. While this power ostensibly is used for “preventing criminals from enjoying the proceeds of their schemes,” DOJ regularly freezes assets before trial as a tactical tool to impede individuals’ ability to defend themselves against the charges.

Increased criminal scrutiny makes it even more vital for companies to undertake a comprehensive internal investigation when first confronting an FCA investigation. As a criminal investigation likely will include individual employees becoming subjects or targets, the company should identify individuals with potential exposure to government scrutiny as early as possible. Companies also should ensure that they have sufficient D&O insurance coverage to withstand an investigation involving senior-level employees. On the preventative side, this only further underscores the importance of robust compliance programs that ensure employee concerns are addressed and resolved before they turn into whistleblower or FCA cases.

Financial Institution Regulation

CFPB Issues Sweeping Proposal to Regulate Prepaid Financial Products

On November 13, 2014, the CFPB proposed expansive federal regulations establishing requirements for prepaid financial products. The proposed regulations cover “traditional” prepaid cards that can be loaded with money and used to store funds, make payments, withdraw cash, receive direct deposits, and send funds to others. According to the CFPB , consumers are expected to load nearly $100 billion onto general purpose reloadable cards in 2014. In addition, the proposed new regulations also cover payroll cards; certain federal, state, and local government benefit cards; student financial aid disbursement cards; tax refund cards; peer-to-peer payment products; and even mobile and electronic accounts that store funds.

The proposed regulations come as no surprise, as the CFPB has made its intentions to regulate prepaid financial products clear since May 2012. CFPB Director Richard Cordray characterized the regulations as “clos[ing] the loopholes in this market and ensur[ing] prepaid consumers are protected whether they are swiping a card, scanning their smartphone, or sending a payment.”

Based on the proposal’s broad scope, however, it appears to do much more than simply close loopholes. The summary below discusses key provisions of the proposed regulations.

Disclosure Requirements

The CFPB proposal seeks to standardize disclosures by requiring that prepaid card issuers adopt two model disclosure forms: a short form and a long form. These forms are available here . The short form highlights basic account information, including disclosures about monthly fees, purchase fees, ATM fees, and fees to reload cash. The long form contains all the fees of the short form, plus any other fees that could be imposed.

Prepaid card issuers also would be required to post their account agreements on their websites and submit their account agreements to the CFPB. In turn, the CFPB would create and maintain a public website housing all submitted account agreements.

Access to Account Information

Under the proposed regulations, prepaid card issuers must provide consumers with free access to account information. That information can be disclosed online or through sending periodic statements. When providing a statement or account information, the prepaid card issuer would need to disclose monthly and annual totals of all fees imposed on the account and the total of all deposits to, and debits from, the prepaid account.

Credit Features

The proposed regulations also impose a variety of limitations on extensions of credit, triggered when prepaid products “allow consumers to pay to spend more money than they have deposited in the account.” For example, the proposed regulations treat overdraft coverage as an extension of credit. This means that if prepaid card issuers provide overdraft coverage and charge for it, consumers receive the same protections as credit card holders.

In addition, the proposed regulations would require providers of prepaid products to assess the consumer’s ability to repay the debt. The proposed regulations also place limits on when prepaid card issuers can offer credit products and when they can move funds, requiring them to wait 30 days after a card is registered to offer a credit product. Prepaid card issuers also would be prohibited from automatically moving funds to pay a debt unless a consumer affirmatively opts in. Even if the consumer opts in, the prepaid card issuer cannot take funds more than once per month. Prepaid card issuers also must give each consumer 21 days to repay a debt before charging a late fee that is “reasonable and proportional” to the violation of the account terms in question.

Error Resolution and Fraud Protection

The CFPB’s proposed regulations also enhance consumer protections in cases of error or fraud. If there is a dispute − for example, where a consumer is double-charged − the prepaid card issuer has 10 days to investigate. If an investigation cannot be timely resolved, the issuer has up to 45 days to resolve the dispute but must deposit the disputed funds back into the consumer’s account in the interim. The proposed regulations also limit consumers’ liability for fraudulent activity. If a consumer timely reports that a prepaid card was lost or stolen, the consumer is only responsible for up to $50 in unauthorized charges.

The proposed regulations will be open for comment for 90 days, and prepaid card issuers also should expect a nine-month implementation period before the final rule becomes effective. If the proposed rule becomes final, it would mark the first set of comprehensive federal regulations over the prepaid financial product industry.

Enforcement and Prosecution Policy and Trends, Financial Institution Regulation

CFPB Supervision Exposes Violations by Service Providers

Last month, the CFPB released the fifth edition of its Supervisory Highlights report describing findings from recent examinations of consumer financial products and services providers.

The report highlighted regulatory violations − or unfair, abusive, or deceptive trade acts or practices (UDAAPs) − in the consumer reporting, debt collection, deposits, mortgage servicing, and student loan servicing industries. Key highlights include the following:

  • For the consumer reporting industry, the report primarily addressed agencies’ dispute-handling obligations, including their failure to provide certain information about reinvestigation of consumer disputes related to the completeness or accuracy of information contained in agency files.
  • Unsurprisingly, the CFPB maintained its focus on debt collectors and violations of the Fair Debt Collection Practices Act (FDCPA). It observed debt collectors (1) exceeding FDCPA limits on imposing convenience fees, (2) threatening litigation without intent to pursue, (3) permitting disclosure of an employer’s name before receiving a disclosure request, (4) overstating the annual percentage rates in documents provided to debt buyers, and (5) delaying forwarding of payments to appropriate debt buyers.
  • In the deposit area, the report noted several violations of Regulation E’s procedures on electronic funds transfers, including (1) violations of error resolution requirements, (2) violations regarding liability for unauthorized transfers, and (3) notice deficiencies.
  • With respect to student lending, the report highlighted a number of UDAAPs, including (1) allocation of partial payments to maximize late fees, (2) misrepresentation of minimum payments on billing statements, (3) improperly charged late fees, (4) failure to provide accurate tax information, (5) misrepresentation of rules on discharge through bankruptcy, and (6) improper telephone communications.

In addition, the report offered updated supervisory guidance and identified public enforcement actions addressing regulatory violations.

  • On the mortgage front, the report noted the CFPB’s new mortgage servicing rules that went into effect on January 10, 2014. These rules require servicers to maintain certain oversight policies and procedures, but the CFPB observed deficient or, in some cases, nonexistent procedures. The report also addressed misrepresentations and deceptive acts relating to loan modifications and short sales.
  • In addition, in January 2014, the CFPB announced a different resubmission standard for any institution reporting 1,000 or more loans on its Home Mortgage Disclosure Act Loan Application Register. The CFPB will continue to follow previous standards in reviewing 2013 and earlier HMDA data, which will allow larger reporters an opportunity to comply with the new standards.
  • For larger nonbank participants, the CFPB discussed a final rule in the international money transfer market and a proposed rule expanding supervisory authority in the automobile financing market.
  • The report also described CFPB guidance on (1) marketing credit card promotional APR offers, (2) FFIEC credit practices, (3) mortgage servicing transfers, and (4) mortgage transactions involving “mini-correspondent” lenders.
Enforcement and Prosecution Policy and Trends

DOJ Wields Financial Institutions Reform, Recovery, and Enforcement Act Against Financial Institutions

In 2012 and 2013, the Department of Justice brought a slew of actions against several financial institutions under a rarely used and little-known statute from the late 1980s for conduct related to the mortgage crisis. Outcomes in these cases in recent months show the statute’s potency and likely indicate that the government will continue to use this statute in the future.

The statute involved is the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). Originally passed by Congress in response to the savings-and-loan crisis of the late 1980s, FIRREA was enacted as a tool to protect financial institutions and others from fraud and insider actions by allowing the government to bring civil actions when certain criminal statutes (including mail and wire fraud) have been violated, as long as the violation “affected a federally insured financial institution.” Essentially, FIRREA allows the government to prosecute alleged criminal conduct while taking advantage of the lower burden of proof used in civil cases. In addition, the Act comes with a 10-year statute of limitations, as opposed to the typical five- year limitation common in criminal statutes.

Courts have strengthened the government’s ability to bring FIRREA cases in the future by declining to limit the scope of the law. The Act allows the government to bring an action for civil penalties against anyone who violates certain criminal statutes when the conduct “affects[s] a federally insured financial institution.” District Courts faced with the issue have ruled that the defendant financial institution can, in the same case, be both the defendant and the financial institution “affected” by the conduct (as opposed to frauds by third parties that affect the bank). The Courts of Appeals have not yet been afforded the opportunity of limiting the statute’s use.

In addition, Attorney General Eric Holder recently proposed raising FIRREA’s whistleblower payment from the current $1.6 million cap, yet another indication that the government plans on bringing additional FIRREA actions in the future.

 

Enforcement and Prosecution Policy and Trends, Financial Institution Regulation, Fraud, Deception and False Claims

FCA Enforcement Performance: Part 2 – The Forex Effect

Only a couple of weeks ago I was commenting on a NERA report that had found that in the period between April 2012 and October 2014 the FCA had imposed fines of over £1bn, in sharp contrast to the preceding decade during which a paltry £320m had been levied.

Now, on 12 November 2014, the FCA has set another UK record: in one day it has exceeded the previous 30 month record, by fining 5 banks, Citibank, HSBC, JPMorgan Chase, RBS and UBS for gross and persistent misconduct in their Forex trading rooms more than £200m each, totaling £1,114,918,000.  Other banks, including Lloyds and Barclays, have yet to reach a settlement of the FCA claims, and therefore the final tally is likely to exceed £1.5bn.  While this pales into insignificance compared with the $56.5bn penalties imposed by US regulators, it marks a step change in attitude.  

Citibank, JPMC and UBS have also faced huge fines from their home regulators, including the CFTC and Finma.  Other regulators, including the infamous Department of Financial Services and the EU, are carving out their own settlements, and there is much more pain to come.

The FCA’s current slice of the action is, nevertheless, sizeable, and since the fines go to the Exchequer, the Chancellor may be thinking that the recent surprise £1.7bn levy from Brussels is not looking quite so problematic, but that ignoble thought apart, what is the point of such massive fines?

Fines imposed by the financial regulator on firms are designed to punish, to deter, and to express public outrage.  The size of the fines perhaps reflects a need to punish more harshly than before, because it is clear that the banks were not deterred from continuing the kind of bad behavior they had indulged in over Libor.  Knowing that such misconduct had been uncovered and was in the process of being punished, some major banks continued with Forex mismanagement for many months, only finally stopping in October 2013. 

The concept of punishing a business is slightly artificial, and the problem with imposing a fine is that those who feel the effects may include the shareholders and the employees, who are innocent of wrong-doing.  As it happens, the banks’ share prices were not greatly affected by the news of the fines, but the impact may be longer term, perpetuating the losses made since the global financial crisis and leading to further shareholder pain.  Shareholders can, of course, seek to ensure that the firm is deterred from misbehaving again by exerting pressure on the Board, and in any event are not, according to some, to be much pitied as they enjoyed the profits of the boom years during which so much misconduct boosted profits. 

The public may feel that some sort of justice has been done, although they will also want to ask, as happened in the Libor investigations, whether the individuals within the banks who cooked up the deception are going to be called to account.  Many headlines since the fines were imposed quote politicians and others calling for prison for the wrong-doers, and they are asking why management did not step in.  And if so, how far up the executive ladder are the guilty parties going to be found?  

The traders who developed stratagem to fix the market in their favour can be relatively easily identified, and therefore prosecuted (although that process is unlikely to be simple in spite of the childish bragging in on-line banter already uncovered by investigators).  But did their line managers know about this, and who at board level was responsible for ensuring that the traders were behaving honestly and ethically?  What was the tone at the top?  Did senior management, in the wake of the Libor scandals, take the time to check out conduct in similar markets? The Serious Fraud Office is already looking at all this, and while considering whether criminal charges should be brought in relation to Forex in much the same way as charges have been brought for Libor rate fixing, they will be carefully considering line responsibility.

The timing of the publication of the Final Notices consequent on the settlements reached with the banks is interesting.  This has been achieved with commendable speed, given the significant hurdles that FCA Enforcement will have had to get over.  Some have complained that the FCA must have cut corners and wrapped up the deals ‘on the hoof’, but by any standards, this is an impressive performance.  It may, of course, be the case that the banks, still reeling from Libor, just wanted to get the bad news out of the way at the earliest opportunity, and to move on, and were therefore eager to settle.  It may also be that the investigation teams will have learned lessons from Libor that enabled them to proceed more efficiently. In addition, the banks themselves were forced to undertake much of the investigating work, thus reducing the FCA’s burden.  But as Tracey McDermott, FCA Director of Enforcement pointed out, even with the bank’s help it took her team 45 man years to get the case to this stage, and the outcome is surely one the FCA can be hugely proud of.

One subject on which there may have been discussion is the extent to which the final results of the Enforcement investigations into the failings by the banks could be published in advance of any criminal action.  There must have been a risk that the SFO would insist that any such publication might prejudice a criminal trial.  However, since no criminal proceedings are yet before the courts, it could be argued that there was nothing to prevent publication. While, therefore, the FCA will be as keen as anyone to ensure that there is no possible prejudice to any criminal process, the regulator will have wanted to perform its duties to the market, and get its message across, at the earliest opportunity.  The FCA is very keen to show that it has got a grip on banking misconduct, and that the UK banking market is moving on from the mistakes of the past.  Any delay in publishing a Final Notice diminishes the impact of the publication, and any possible prejudice to a trial that is unlikely to take place for some years was rightly ignored. 

So, a very good day for the FCA, but, of course, not the end of the Forex saga.  There will be more FCA fines against firms, and individuals are likely to face regulatory action. This will now be relatively straightforward.  A more difficult challenge will face the SFO, and it is likely to be some time before the fraud prosecutor can reach any conclusions about criminal charges, and much longer before any cases get to trial.  The Libor trials are due to get under way in 2015, and will probably still be going (in the absence of guilty pleas) in 2016.  It might well be 2017 before Forex hits the courts.

 

 

 

Enforcement and Prosecution Policy and Trends, Financial Institution Regulation, Securities and Commodities

Law Enforcement Bliss: The SEC As Policeman, Judge and Jury

New York’s Southern District Court Judge Jed Rakoff is always worth listening to.  He expresses trenchant views about the rule of law elegantly and politely.  He is fearlessly independent. Prosecutors in the US, who are normally prone to swagger just a bit, probably find his comments and rulings rather irritating.

In a speech to the Practicing Law Institute on 5 November the Judge directed a passing swipe at the Security and Exchange Commission’s in-house administrative court, complaining that increasing enforcement powers granted by Congress have led to the SEC bringing more and more cases before this court.  Rakoff is concerned that this policy risks hindering the development of the law, because ‘it would not be good for the impartial development of the law in an area of immense practical importance’ without providing the opportunity for evidence and law to be tested by ‘impartial jurists’.

The Judge makes the point that the SEC’s record of success in front of its own administrative court is 100%, whereas it has suffered a number of defeats in recent insider dealing jury trials.  Any prosecutor will acknowledge that although he or she might give their right hand to win every case, such a high success rate is unhealthy.  It suggests either that they are only taking on the low hanging fruit, or that their system is artificially skewed against the defendant.

In the UK, the Financial Conduct Authority and its predecessor, the Financial Services  Authority, have had a similar internal ‘court’ since 2000, the Regulatory Decisions Committee.  The RDC receives proposals from Enforcement, with supporting evidence, which seek to impose penalties on individuals and firms which are alleged to have breached regulations.  The matters before the RDC can range from a defaulting IFA, resulting in a £50,000 fine and prohibition, to a Libor settlement with UBS of £160m. In regulatory cases, the Committee decides whether to issue a Warning Notice, and then hears representations from both sides before deciding whether to issue Decision and Final Notices.  Many cases settle and the Final Notice is an agreed document.  Those who want to contest a Final Notice published after a contested hearing can appeal to the Upper Tribunal, where the appeal will be heard by a Judge.  The members of the RDC are employees of the FCA, but are, in my experience, strongly independent – some within the FCA would say, too independent!  The Committee’s existence has been challenged over the years, not least by the Regulator itself, and consideration was given to abolishing it when the FCA was set up in 2013.  However, no better system for arbitrating and disposing of the majority of regulatory cases could be found, and the work of the RDC continues.

Some, but by no means all, of the cases that come before the RDC might amount to criminal offences as well as regulatory breaches.  The most obvious example of this is insider dealing/market abuse, but there are other borderline cases where, for example, an allegation of lack of integrity – a breach of Principle 1 of the FCA Principles for Business – might equally be viewed as dishonesty.

Because insider dealing is both a regulatory (section 118 Financial Services Act 2000) and a criminal (section 52 Criminal Justice Act 1993) offence, a decision by the FCA to litigate a case in front of the RDC is one which most people accused of such activity in the UK will usually welcome.  The prospect of a criminal conviction and a prison sentence (maximum 7 years) is removed.  The worst that can happen – and it is bad enough – is a fine, disgorgement of profit, and, if the individual concerned is an approved person in the financial services regime, a prohibition from being involved in financial services for a fixed or indefinite period.  If an individual wants to face criminal charges, and chance his luck in front of a jury, he can probably engineer that result simply by being obstructive and uncooperative, but no one has so far chosen this option.

In a market abuse case in 2012, David Einhorn, President of a US hedge fund, Greenlight Capital, was fined £3.5m, with Greenlight being fined a similar amount, in connection with the sale of its holding in Punch Taverns.  Although Einhorn hotly denied that he had done anything wrong, he decided not to challenge the RDC’s decision.  In that case, which involved questions of wall-crossing, it might be said that there were some unresolved issues at the conclusion of the case.  The RDC, in effect, exonerated Einhorn of deliberate misconduct, finding only that he ought to have known that what he did was wrong.

In another recent and high profile case, Ian Hannam, who had been Chairman of Capital Markets at J P Morgan Cazenove, challenged a decision by the RDC that he had committed market abuse.  He appealed to the Upper Tribunal which, in May this year, upheld the RDC’s decision.  The ruling runs to 130 pages, and no one reading it will think that it has in any way restricted ‘the impartial development’ of financial services law.  To the contrary, the ruling clarifies the law in a number of important respects.  The fact that a jury was not faced with the legal and factual complexities, leading to guilty or not guilty verdicts which are entirely unexplained, does not strike one as a disservice to justice.

There is, however, a problem which mirrors a theme which Judge Rakoff has frequently articulated.  Libor was originally treated as an administrative breach, with Barclays being fined by both the FSA and the SEC in June 2012. This sparked a public outcry – why was no one being prosecuted in the criminal courts for such outrageous misconduct?  A cosy settlement with the firm, with no senior person being brought to account, came nowhere near slaking the public thirst for revenge.  There was a hasty reassessment of the position, prompting the Serious Fraud Office to open an investigation, which has now led to 13 individuals being charged with criminal offences, and awaiting jury trial in 2015.  One individual has pleaded guilty.

At the same time, the FCA is being asked questions about its failure to take action, either regulatory or criminal, against senior bankers in the wake of the global financial crisis.  Recent legislation and public criticism are ramping up the pressure to take criminal proceedings against unethical banking practices.  The fact that such cases, whether criminal or regulatory, are immensely difficult to investigate and prosecute does not deter those who are baying for blood.

Interestingly, however, when such cases do come to court, the results, like the SEC’s criminal insider dealing trials, are mixed.  Juries, when they hear the facts in court, as opposed to the newspaper headlines and the posturing of politicians, do not always convict.  On the 3 November 2014 a jury in a federal court in Fort Launderdale took just two hours to bring in not guilty verdicts against a senior UBS executive, Raoul Weil, in connection with off-shore tax havens sheltering the wealth of 20,000 US citizens.  No doubt the US Internal Revenue Service, which prosecuted Weil, would have welcomed the opportunity to try the case in its own administrative court.

Anti-Bribery and Corruption, Compliance, Enforcement and Prosecution Policy and Trends

Update on Brazil: Embraer SA and Anti-Corruption Progress

Imagine you are a compliance officer for a multinational company with securities listed on a U.S. stock market. The Foreign Corrupt Practices Act (FCPA) falls squarely within your purview, but other anti-corruption regimes seem less relevant because of a lack of enforcement (with the exception, perhaps, of the UK Bribery Act). Until recently, Brazil may have fallen into the category of countries about which you had lesser concerns in terms of vigorous anti-corruption enforcement. However, new enforcement efforts may be tilting the scale. Just ask Embraer SA, which finds itself dealing with criminal prosecutions of employees in Brazil, while facing parallel bribery-related investigations of the company in the United States and Brazil.

On September 23, 2014, The Wall Street Journal reported that Brazilian authorities had filed a criminal complaint alleging that eight Embraer employees bribed government officials in the Dominican Republic to secure a $92 million military procurement contract. According to the report, the U.S. Department of Justice and Securities and Exchange Commission provided evidence to the Brazilian authorities and are assisting in the investigation. The complaint alleges that Embraer vice presidents, regional directors and sales managers agreed to pay $3.5 million to a retired Dominican Air Force colonel who was serving as the director of special projects for the Dominican military, in exchange for his influence over the legislature to approve the contract with Embraer. The money was paid through three shell companies owned by the colonel and allegedly was intended for a Dominican senator. After Embraer’s compliance department prevented the employees from completing the transactions, the employees allegedly concealed the remaining payments as consulting fees in connection with a deal to sell aircraft to the Kingdom of Jordan. The employees are charged with corruption in international transactions and money laundering, and each faces eight years in prison if convicted.

It initially was reported in November 2013 that U.S. and Brazilian authorities were investigating whether Embraer had bribed a government official in the Dominican Republic in exchange for a contract to provide military aircraft. At the time, it was one of the first known investigations by Brazilian authorities into a Brazilian company for bribing government officials outside Brazil, and an indicator that the then-recently passed Brazil Clean Companies Act was in action. It is unknown whether the Brazilian investigation has ended with the criminal indictments. There are no indications that U.S. authorities have ended their investigations into Embraer or that Brazilian authorities have chosen not to pursue the company under the Clean Companies Act. Accordingly, more trouble may still be coming Embraer’s way.

The Organization for Economic Cooperation and Development (OECD), which recently published its Phase 3 report on Brazil’s implementation of the OECD Anti-Bribery Convention, has commended Brazil for enacting its Clean Companies Act and for the indictments handed down in the Embraer case. However, the OECD remains generally critical of Brazil’s anti-bribery enforcement efforts to date. The Phase 3 report cites several contributing factors for OECD’s ongoing concerns, including Brazil’s failure so far to issue the decree necessary to fully enforce the Clean Companies Act, a statute of limitation issue, and the lack of private-sector whistleblower protections.

Compliance officers whose companies have operations in, or do business in, Brazil should continue to monitor the legal developments in that country − and all should view the Embraer case as a cautionary tale. The apparent cooperation between U.S. and Brazilian authorities in that case highlights the importance for compliance departments to be mindful of the other anti-corruption laws that can impact businesses in non-U.S. jurisdictions. Brazil is just one example of several countries that recently have focused on combating bribery and corruption, especially that perpetrated by multinational companies and their employees.

 

Anti-Bribery and Corruption, Fraud, Deception and False Claims

Civil fraud damages claims begin in the UK following a corruption prosecution by the SFO and the DOJ against Innospec and others

In a recent decision of Mr Justice Flaux in the case Jalal Bezee Mejel Al-Gaood & Partner v Innospec Limited and Others, the Claimants sued for damages which they claimed arose as a result of the Defendants having bribed the Iraqi Ministry of Oil (“MOO”) to purchase their chemical products, TEL.  The claim for damages was for losses which the Claimants alleged they have suffered as a consequence of the unlawful means conspiracy on the basis that, but for the bribery and corruption, the MOO would have started to purchase the chemical additives distributed in Iraq by the Claimants, MMT.  The loss claimed, as quantified by the Claimants’ quantum expert, was US $26,572,603.

Reliance was placed by the Claimants on the fact that the Second Defendant and others had been charged by the United States Department of Justice and had pleaded guilty to criminal offences principally under the Foreign Corrupt Practices Act 1977 in relation to bribery and corruption in Iraqi and Indonesia.  In addition, civil proceedings were brought by the United States Securities and Exchange Commission against the Second Defendant and certain others as well as criminal proceedings pursued in England by the Serious Fraud Office against the First Defendant and certain others in relation to which various Defendants either pleaded guilty or were found guilty after a jury trial. We have blogged previously on the long running Innospec case including here for example.

In his 78 page judgment Mr Justice Flaux said that by the end of the trial it was common ground between the parties that in order for the claim to succeed the Claimants had to establish three matters on a balance of probabilities:

  1. That there had been a decision by the MOO in October or November 2003 to replace the Defendant’s chemical product TEL with the Claimants’ chemical product MMT and to continue using TEL only until stocks were exhausted;
  2. That that decision was not implemented because the promise of bribes by a Mr Naaman procured the MOO to enter into the 2004 agreement and that prevented sales of MMT and;
  3. That, but for the promise of bribes, the decision would have been implemented and the MOO would have replaced TEL with MMT from early 2004 onwards so that the “counterfactual scenario on which the claim is based would have occurred…”.

After a four week trial, Mr Justice Flaux decided that the Claimants case was not made out on the facts and also failed on grounds of causation.  There was much technical evidence about the use of the various chemical products and their test results.  Mr Justice Flaux said

“Overall, although there clearly was criminal wrongdoing by Innospec and Dr Turner and, as is accepted on their behalf, their conduct was reprehensible, that wrongdoing did not prevent sales of MMT and was not causative of any loss.  ….there is no suggestion that MOO officials were bribed to place those orders: they were placed because the MOO needed TEL and, at least until refining equipment was replaced, the strategic decision within the MOO was to carry on using TEL, at least at Baiji and Basra…in the circumstances, the Claimants have failed to establish that the wrongdoing alleged against Innospec caused them loss and the claim fails on that basis as well…”

Although not strictly necessary, the judge went on explain that in relation to the claim for quantum, there were considerable risks and problems with the Claimants’ claim for loss because the Claimants themselves had engaged in corrupt practices in making payments to the government of Iraq and that, as a distributor, if their supplier, Ethyl, had discovered this earlier than they actually did discover it, they may have terminated the distributorship agreement at an earlier date and this would create additional uncertainty in relation to their loss calculation.  The last few pages of Mr Justice Flaux’s judgment are very interesting from the perspective of understanding the difficulties of valuing such claims when there are a number of variables and hypotheticals to take into consideration.  However, the considerations made by Mr Justice Flaux are all far too detailed to summarise in a blog post, but nonetheless they are interesting to practitioners who have a spare couple of hours to digest his very carefully reasoned judgment.

Nevertheless, this case demonstrates that the English court will seriously entertain civil damages claims which arise out of corruption prosecutions, even though in this particular case the claims failed.

Civil damages claims similar to this case already take place in the United States (indeed there was at least one in the US of which TheFraudBoard is aware which related to the same set of prosecutions), so we should expect a body of civil jurisprudence related to corruption investigations to grow steadily over the next few years in England, as the Serious Fraud Office begins to prosecute companies and individuals more frequently for corruption offences, both under the Bribery Act 2010 and the laws which predate this Act, which still cover offences occurring prior to 1st July 2011.

Financial Institution Regulation

Financial Conduct Authority Enforcement Performance

NERA Economic Consulting has recently published an analysis of the penalties imposed by the UK financial regulator since April 2012[1].  The startling headline is that the level of fines in the 18 months since April 2012 is over £1bn, whereas in the previous decade fines totaled less than £320m.  What is the reason behind this massive increase?  Has the FCA (which took over from the FSA in April 2013) just got tougher, or has it been easier to impose fines because the ‘accused’ have been major firms and High Street banks with long pockets and a propensity to settle, and because the issues under consideration since 2012, mainly the benchmark cases of Libor and Forex, have provided ample excuse for large fines?  In addition, has the even higher level of fines imposed in the US for similar misconduct prompted an escalation in both tariff and expectation?

It is tempting to see the high level of fines against firms set out in the NERA report as representing relatively easy pickings.  This is not to say that the investigations into Libor and Forex have been anything other than massively complex, or that fixing the level of penalty is easy, but there is an element of the domino effect – as soon as Barclays settled with the SEC and the FSA in June 2012, it was inevitable that the other major banks, and related financial businesses, who participated in Libor rate fixing would soon follow suit.  One may anticipate the same if it emerges, as expected, that there has been serious misconduct in the Forex market.

It is also tempting to see all this against a backdrop of the fall-out from the global financial crisis.  Regulatory action against the banks for their failings leading up to October 2008 was relatively limited, and there has been a public thirst for some level of revenge.  The delayed response to PPI mis-selling, other mis-selling cases, the ‘London Whale’, and the benchmark fines, have given the regulator something to crow about, at a time when its response to the crisis in general, and to the RBS and HBOS failures in 2008 in particular, is under attack.

Another interesting headline is that, by contrast, the numbers and levels of fines against approved individuals have fallen ‘sharply’.  Is this because the FCA has found it easier to pursue firms which will, as stated above, seek to settle, both to take advantage of the discount, and to get the problem off the balance sheet?  And because individuals will tend to tough it out, and rarely settle?  The answer to these questions is a qualified ‘yes’, the qualification being that, as the NERA report makes clear, the fact of criminal proceedings for Libor misconduct, and other cases, has caused delays in finalizing regulatory cases against individuals.  Final notices against individuals cannot generally be published until related criminal proceedings have concluded.  There is therefore something of a log jam of penalties against individuals.

Nevertheless, the numbers and levels of fines against senior individuals for regulatory misconduct outside the benchmark arena remain relatively low.  This is partly because it has proved very difficult to pin the blame for large failings on specific members of the boards of financial firms, and partly, as stated, because individuals tend to contest allegations, often with a degree of success.  The regulator is, however, seeking to take more enforcement action against individuals, and has emphasised this ambition.  It has sought to reinforce its position by introducing ‘attestations’ and the senior persons’ regime, as well as new criminal offences such as section 36 Financial Services (Banking Reform) Act 2013 – reckless banking – which should make it easier to prove misconduct against individuals.  It will nevertheless be interesting to see whether these new powers will prove to be effective.

Over the next 18 months we may expect to see the levels of fines against firms remain high.  It is also likely that enforcement action against individuals will result in significant fines during this period, and that penalty levels will exceed those in recent years.  Both results will in large part be due to the benchmark cases, and therein lies a challenge for the FCA: there has been much comment about the extent to which the Libor and Forex cases have taken up Enforcement resources, to the possible detriment of other types of enquiry.  It is difficult to know whether this is true, and it will no doubt be hotly denied by FCA management, but the numbers to watch in the next year or so will be those that do not relate to benchmarks.

At the same time, the NERA report rightly stresses the extent to which the FCA views its consumer protection objective as a core value, and it is likely that statistics relating to this area of endeavour, in particular, for example, early intervention into the mis-selling of products, investigating Pay-Day loan providers, and restrictions on financial promotions, while not necessarily producing large penalties, will demonstrate that the FCA has teeth.

 

 

 

 

 

 

 

 


[1] ‘Trends in Regulatory Enforcement in Uk Financial Markets. 2014/15 Mid-Year Report, by Robert Patton.  Published 20 October 2014.

 

Fraud, Deception and False Claims

English Court grants worldwide freezing order in support of London arbitration where assets are outside the UK

A recent decision by the Commercial Court in the case of U&M Mining Zambia Limited v Konkola Copper Mines Plc [2014] All ER (D) 136 in which the Claimant’s application to continue a worldwide freezing order over the assets of the Respondent, Konkola, was granted, is significant for those conducting international arbitrations in London.

Worldwide freezing orders are, of course, normally granted on an ex parte basis in order to prevent the dissipation of assets by a defendant/respondent.  The defendant then has the opportunity to try to set it aside on a number of grounds.  The noteworthy ground which we consider in this blog post is that the Court considers it “just and convenient” to allow the freezing order to continue.

What is unusual about this case is that the Court upheld the freezing order even though there are no assets in the UK.  The Court held that where the seat of the arbitration is London, it would ordinarily be appropriate for the Court to issue orders in support of the arbitration, although there may be reasons why it is not appropriate from time to time, even though the seat of the arbitration is in England. So a worldwide freezing order will not necessarily be granted in every similar case.

In addition the Court decided that:

  • The fact that enforcement of the arbitral award would take place in Zambia was not sufficient to make it inappropriate for the Court to grant a worldwide freezing order;
  •  Even if the Zambian Court could also grant a freezing order, this would not make it inappropriate for the English Court to do so.

It is therefore possible for two courts to be appropriate forums in which to bring an application for a worldwide freezing order – in the case of London, because it was the seat of the arbitration, and in the case of Zambia because of the residency of the respondent, Konkola.

This decision should further encourage the choice of London as the seat of the arbitration in international contracts, where assets are not actually located in the UK.

We use cookies to enhance your experience of our website. By continuing to use this website, you agree to the use of these cookies. For more information and to learn how you can change your cookie settings, please see our policy.

Agree