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Government Investigations and White Collar Litigation Group
Financial Institution Regulation

CFPB Proposes New Rule Expanding Oversight to NonBank Auto Finance Companies

By Jodie Herrmann Lawson

In a move that should come as no surprise to anyone who has been following the Consumer Financial Protection Bureau (CFPB), the agency issued a proposed rule last week that would expand its oversight, supervision and enforcement jurisdiction to include nonbank automobile finance companies.

Established by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act), the CFPB has authority to oversee and regulate entities, such as banks and credit unions, that provide consumer financial products and services. The agency’s jurisdiction extends to certain nonbank entities that the CFPB defines through rulemaking as “larger participants” in a market for “other” consumer financial products or services. 12 U.S.C. § 5514.

On September 17, 2014, the CFPB issued a proposed rule that would allow it to begin regulating an estimated 38 nonbank auto finance companies that it considers to be “larger participants” (per the rule, companies that originate, acquire or refinance at least 10,000 loans per year) in the consumer “automobile financing market.”According to the CFPB, these 38 companies originate roughly 90 percent of nonbank auto loans and leases, and last year provided service to approximately 6.8 million borrowers.

Under the proposed rule, the “automobile financing market” encompasses entities that grant credit for automobile purchases, refinance such obligations, purchase or acquire such obligations, or issue or purchase automobile leases. Id. These entities include specialty finance companies, captive nonbanks (subsidiary finance companies owned by automobile manufacturers), and “buy here, pay here” finance companies. Id. The “automobile financing market” does not encompass title lending or the securitization of loans or leases.

The CFPB says its move to regulate and supervise nonbank auto finance companies is part of its larger effort to curtail discrimination in the auto-lending market. In a press release and report issued concurrently with the proposed rule, the CFPB stated that over the past two years, it discovered that a number of banks subject to agency regulation “had discretionary pricing policies that resulted in discrimination against African-American, Hispanic, and Asian and Pacific Island borrowers.”According to the agency, these discriminatory policies resulted in affected borrowers “paying more for their auto loans than similarly situated non-Hispanic white borrowers.” Id. The CFPB already supervises the auto lending practices of banks with more than $10 billion in assets. According to the CFPB, “[t]his proposal is needed to level the playing field for banks and nonbanks in the auto lending market,” because “every auto lender should be following the law and be subject to the same level of oversight.”

If the proposed rule becomes final, it will be the fifth rule to expand the CFPB’s oversight authority pursuant to the Dodd-Frank Act’s provisions concerning “larger participants” in markets for “other consumer financial products or services.” The four other rules include markets for consumer reporting, consumer debt collection, student loan servicing and international money transfers. It seems clear that the CFPB’s efforts to stretch the boundaries of its jurisdiction won’t be ending any time soon.

Fraud, Deception and False Claims, Securities and Commodities

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

By Government Investigations Group

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, Law360.com, http://www.law360.com/articles/574043/8th-circ-denies-appeal-on-dodd-frank-whistleblower-limits, (Sept. 4, 2014 4:03 PM ET).

Anti-Bribery and Corruption, Enforcement and Prosecution Policy and Trends, Financial Institution Regulation, Securities and Commodities

Going Inside for Insider Trading

By Government Investigations Group

It is always assumed that sentences in the US for any crime are significantly higher than they are in the UK, but nowhere is this more starkly exemplified than in white collar crime.  The recent sentence of 9 years in prison for Mathew Martoma for insider trading is the latest proof of the truth of this assumption.  Previous long sentences for this offence included 12 years in 2011 for Matthew Kluger, and 11 years in 2012 for Raj Rajaratnam in the notorious Galleon case.  Both Kluger, a corporate lawyer, and Rajaratnam, a hedge fund owner, were senior professionals who, like Martoma, were deemed to have been insiders in possession of explosive unpublished information, which they deliberately used to their own advantage.

The UK record over the last few years in insider dealing cases has been good, but the longest sentence any individual has received is the 4 years handed out to James Sanders of Blue Index in 2012.  It should be pointed out that the maximum sentence under section 52 Criminal Justice Act 1993 is 7 years, and also that the sums involved in the cases brought by the Financial Services Authority have been small by comparison with the US blockbusters, rarely exceeding £1m, and in most cases much less.  In Operation Tabernula, the FSA’s (now FCA) largest insider dealing investigation, the profits made by the two defendants who have so far pleaded guilty were £245,000 and £500,000.  Martoma’s actions in arranging for hedge fund SAC Capital, where he worked as a portfolio manager, to sell its entire position in drugs company Wyeth and Elan just ahead of bad news about a new counter-Alzheimer’s product, are said to have made a profit of $275m for SAC, and a bonus for him of $9.3m. His sentence included the disgorgement of his bonus and the loss of a house in Florida.  In addition, he will never work again in the financial services sector – or in any other professional capacity – in his lifetime. Preet Bharara, the US attorney responsible for the SAC convictions, and for about 80 other successful insider dealing convictions, had demanded that the sentence should be 15-20 years, but the judge rejected this claim as excessive.

As for SAC, it settled its differences with the SEC last November, paying a fine of $1.2bn.  Eight SAC employees were charged during an investigation that lasted several years.  Six pleaded guilty.  Martoma’s case, involving events in 2008, marks an end to the proceedings.  But one person who was not indicted was SAC’s owner, Steven A Cohen, in spite of the assertion by Bharara that “insider trading at SAC was substantial, pervasive and on a scale without precedent in the history of hedge funds”.  Cohen strongly denies this claim, and Bharara, in spite of pressurising Martoma to give evidence against his former boss, failed to get evidence to indict him.  SAC Capital continues to do business, albeit with some restrictions. Cohen is still at its helm.

The focus by the FSA since 2007 on insider dealing, and the successful prosecutions brought against more than 20 individuals, as well as civil market abuse cases, appear to have had an impact on market conduct.  Two civil market abuse cases in particular, against US hedge fund owner David Einhorn, who was fined £7.2m in 2012 in connection with trading in Punch Taverns stock ahead of a funding announcement, and Ian Hannam, a senior investment banker at J P Morgan Cazenove, who the Upper Tribunal found guilty of two counts of market abuse in 2014, have spooked the market. A Market Cleanliness report published by the FCA in 2013 stated that after remaining stable for the four years to 2009, the level of abnormal pre-announcement price movements declined to 21.2% in 2010, 19.8% in 2011 and to 14.9% in 2012. This is the lowest level since 2003. The fall took place in a year of weak takeover activity and against a backdrop of the Regulator’s ‘continuing focus on market abuse and enforcement activity in this area’.  Whether the US experience is the same is not known, but one might expect that the tough sentencing of senior market professionals will have had an impact.

Anti-Money Laundering, Fraud, Deception and False Claims

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

By Government Investigations Group

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

 

Anti-Bribery and Corruption, Enforcement and Prosecution Policy and Trends, Fraud, Deception and False Claims

Welcome to The Fraud Board, a new blog site for UK fraud and related regulatory issues

By Government Investigations Group

Welcome to the new McGuireWoods London LLP fraud blog: The Fraud Board, which has taken over from our highly rated Bribery Library site.  There are various reasons for the change, but the main rationale is that while the subject of Bribery remains very important in the economic crime landscape, and will continue to feature strongly in our blogs, other fraud and regulatory issues are increasing in significance.

The Serious Fraud Office is investigating a number of Bribery cases, some of them involving the Bribery Act 2010.  All fraud lawyers and other professionals, including ourselves, are watching this space on behalf of clients, to see how the SFO will deploy the new provisions in the Act, in particular sections 6 and 7.  How far will they go to prosecute corporations under the failure to prevent offence?  How will the defences play out in practice?  What level of detail will it be necessary to deploy to disprove an assertion that a corporation’s systems and controls were inadequate?  How will the section 9 Guidelines work?  How will the SFO use the new powers to negotiate Deferred Prosecution Agreements?  What is the future of internal investigations after the SFO Director’s recent criticism of practices adopted during investigations, in particular relating to privilege?

Meanwhile, other economic crime issues have been grabbing the headlines.  The Attorney General, speaking at last week’s Cambridge International Economic Crime Symposium, restated the Government’s intention of introducing legislation to prosecute firms for failing to prevent fraud offences generally, and therefore we may expect to see large fines deployed against businesses for allowing economic crime to flourish.  This follows calls by the Director of the SFO for such an offence to be created, and is seen as a response to the allegations made in the Libor and Forex investigations, which will make it easier to take action against firms, at the same time as being an attempt to raise ethical standards.  However, given that there has been a similar offence in relation to money laundering (now regulation 45 of the Money Laundering Regulations 2007) since 1993 which has never been used, it will be interesting to see how the ‘failing to prevent’ offences work out in practice.

Other new initiatives include a reinvigorated push to take senior management to task for their part in corporate wrong-doing and failures.  Section 36 of the Financial Services (Banking Reform) Act 2013 is one sign of the impact that the work of the Treasury Select Committee is having in this area.  Whether the attempt to criminalise reckless banking will work out in practice is open to question, but there can be no doubting that the gloves are off.

Working equally hard to make management accountable is the Financial Conduct Authority, with the Senior Persons Regime and other measures such as attestations designed to ensure that there is clear liability at board level for all aspects of financial firms’ activities.  This will be given added impetus by the outcome of the enquiry into the FSA’s handling of the failure of HBOS between 2008 and 2012.  The FCA has promised to be more aggressive in pursuing regulatory offences generally, intervening early to prevent mis-selling of financial products, and generally working hard to protect consumers.  How will this work out in practice?  Firms may well continue to be relatively content to settle their disputes with the regulator, but individuals are likely to continue to tough it out.

Civil fraud actions occupy an equally important space in the economic crime landscape, either in conjunction with prosecutions, or as an alternative where law enforcement does not have the resources or the capability to take action.  Seeking redress for the victims of fraud, whether the wrong-doing is committed by financial institutions or criminal gangs or computer hackers, through litigation enables lawyers to take control of the process on behalf of their clients and to pursue remedies in increasingly imaginative ways.

The Fraud Board will examine all these issues, and others, bringing the experience of Vivian Robinson QC, David Kirk and Adam Greaves, and their supporting team both in McGuireWoods London LLP and across the firm’s US offices, to bear on the topics that matter.

Anti-Bribery and Corruption, Enforcement and Prosecution Policy and Trends, Fraud, Deception and False Claims

The Director of the SFO criticises corporations which commission internal investigations before self-reporting

By Government Investigations Group

Following an article published in Legal Week in August authored by Ben Morgan, the joint head of bribery and corruption at the SFO entitled “Coming Clean – the argument for cooperating with the SFO on corporate crime”, we commented on this in a blog dated 18 August 2014 setting out some of the issues which corporate clients have to consider when deciding whether or not to self-report possible criminal issues to the SFO.  We offered the view that: 

  • the SFO’s position as stated by Mr Morgan had perhaps been oversimplified; 
  • that a number of corporations and their lawyers were struggling with these issues and debating them privately with the SFO; and 
  • that the issues would benefit from a public debate. 

We concluded that blog by saying that these issues, when considered in depth, and if aired publicly, may reinforce the SFO’s arguments for self-reporting, rather than undermine them, so a public debate should be beneficial all round in order to dispel corporate anxieties and misunderstandings. 

On 27 August 2014 The Times newspaper published an article in its business section “Fraud Office attacks fraud crime reports” in which the director of the SFO, David Green CB QC, was quoted as saying that he is “against businesses commissioning their own reports into allegations of serious misbehaviour that often “cleared” the subject of any illicit activity”.  He complained that the SFO was often handed privately paid for investigations by expensive external lawyers that contained an “inherent conflict”…  The report itself may tend to minimise the problem one way or another.  Later claims of legal privilege on witness statements taken by the external lawyers can be questionable.  And, of course, the crime scene can be churned up by the investigation.  The SFO will never take such a report at face value and will drill down into its evidence and conclusions”. 

There is no suggestion in The Times article that Mr Green is currently pushing for a change in the law in order to address his stated concerns. 

The Times article then goes on to cite a couple of apparent examples, one in the United States and one in the United Kingdom, of large professional service firms having produced reports following internal investigations which, the article intends the reader to infer, were not entirely candid in their conclusions, or had adopted too narrow a remit at the onset.  We make no comment on the fairness or accuracy of these cited examples. 

The article concludes that although more than 100 SFO staff are working full time on SFO investigations into LIBOR rigging and foreign exchange market (“FOREX”) manipulation, Mr Green warned that “…it was likely that the SFO was a long way from getting to the bottom of much of the criminality in the City…”  The size of the white collar criminal legal sector servicing the City of London suggests there is a lot more work out there that the SFO could be doing…” 

While one has some initial sympathy for the Director’s comments, when considered in further detail, a number of other issues come to mind: 

  • Encouraging corporations not to hire external solicitors to advise them on whether they have potential criminal issues within the company could lead to:
  • Corporations inadvertently (or otherwise) covering up their own wrong doings, having not had the benefit of objective, experienced external advice; 
  • Alternatively, because most corporations do not employ in-house lawyers with white collar defence experience, corporations failing to recognise at all that conduct within the organisation was criminal or should be reported to the SFO; 
  • And/or, in the absence of objective external advice, corporations (or at least individuals within the corporations) will themselves “contaminate the crime scene” (to use the Director’s phrase) and/or to destroy evidence such as deleting electronic data or destroying hard copy documents.  The external advisers would not be able to watch and ensure evidence is properly preserved. 
  • Many corporations would not even recognise or accept that self-reporting to the SFO was something that they should even consider, let alone act upon. 
  • Experience tells us (by which I mean white collar lawyers generally) that self-reporting by corporation is almost always done on the strong advice of reputable external law firms rather than from a corporation’s innate desire to “come clean” and confess to an investigating/prosecuting agency.  Corporations are already fearful that by self-reporting they will bring a huge amount of adverse publicity and incur significant costs, and therefore by discouraging corporations from taking external legal advice, we think that corporations are far less likely to self-report, not having any guidance as to the potential outcome, rather than more likely.  People (including legal persons) are far more likely to bury their head in the sand if they do not receive expert advice. 
  • Further, it should be remembered that the SFO’s nominal budget has been reduced drastically under the current coalition government, due to cutbacks in all government departments.  Although this has been addressed/reversed to some degree by so-called “blockbuster funding” from the Treasury in relation to specific investigations, the SFO is still seriously underfunded.  The current practice of corporations carrying out extensive internal investigations and handing over their report to the SFO is actually helping the SFO because a lot of the leg-work has been done by the company itself and this is very costly work.  Of course, every corporation accepts that the SFO will want to drill down further into the evidence later.  The suggestion that the SFO itself has the resources to undertake dozens (or perhaps a great deal more) of the initial investigations itself is unlikely to ever be supported by government funding as the SFO’s annual budget would need to double or treble.  The current system offloads huge costs on to the corporations. 
  • Further, given the slow pace of the SFO’s current investigations, which may take several years before charges are laid against any defendants and even longer before they conclude with a trial, this will make the process of justice even slower not faster, which is bad for justice and bad for business. See for example an article in the Financial Times of 28th August 2014 entitled “Regulatory Revenge Risks Scaring Investors Away”.
  • Although The Times article of 27 August 2014 cites a couple of examples where reports carried out by external advisers are thought to be flawed (in fact the American example is the only one of which there seems to be explicit criticism that the professional services firm is alleged to have “toned down some of its criticism”), no credit has been given by the article or by the SFO for the (probably) scores of cases of self-reporting that go on every year to the SFO that has been conducted in a perfectly acceptable and honest manner.  Perhaps there should be more clarity (albeit anonymised) of these statistics? 
  • Even if the SFO were much better funded, and let’s say its budget were trebled, that would still not be justification for saying that corporations should not able to take legal advice on activities that have been conducted within the organisation or by the organisation with third parties.  It remains a fundamental principle of our constitution that people and legal entities should be able to take legal advice and that that legal advice should remain legally privileged i.e. confidential to the client, unless the client waives his right to privilege.  If you had a client who had/may have committed some other type of crime, you would not send him off to the police to make a confession on their own, would you?  You would want to understand your client’s own story first. 

The engagement of external lawyers by corporations is still the safest and best option as those external law firms not only have their own firm’s professional brand reputation to protect in giving full honest and fair reports, but the lawyers who form those organisations all owe personal duties to the court not to mislead it. Their report would have been prepared in the knowledge that, if disclosed to the SFO as part of a self-reporting procedure, it could end up being scrutinised by the court.  

Whilst there is a “crime scene” it is mostly consisting of paper and electronic documents, and witness evidence, and not the forensic DNA evidence seen on television dramas.  “Contamination” will therefore be different, but the deletion or alteration of documents mostly itself leaves an evidential trail, so it is not clear whether there is really a serious problem here.  We would have been interested to have seen some examples cited in The Times article as to Mr Green’s specific concerns.  Further discussion is required, publicly, if this suggestion is to be considered seriously. 

Perhaps the Director’s real gripe concerns an inequality of arms i.e. that large corporations are usually much better funded than the SFO itself.  That may be true, but that is a question for the government to address in terms of how serious it is in pursuing serious economic crime in the UK.  Removing corporation’s rights to take external legal advice on any perceived problems within the corporation would be throwing the baby out with the bath water.  The Government should perhaps allow the SFO to keep more of the money it recovers through civil settlements, criminal fines levied by the Court as a result of the SFO’s prosecutions and monies disgorged by defendants under the Proceeds of Crime Act.

Compliance, Financial Institution Regulation

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

By Alex J. Brackett, Jeffrey M. Hanna and Patrick Rowan

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.

 

Anti-Bribery and Corruption, Enforcement and Prosecution Policy and Trends, Financial Institution Regulation

The Long Arm of British Anti-Corruption Laws and the impact on individual defendants

By Government Investigations Group

Bruce Hall, the former Chief Executive Office of Aluminium Bahrain Bsc (“ABLA”) was sentenced on 22 July 2014 to 16 months in prison for conspiracy to corrupt in relation to contracts for the supply of goods and services to ALBA during the period September 2001 to June 2005.  The Serious Fraud Office (“SFO”) press release is here.

Followers of this blog will remember that the SFO also prosecuted Victor Dahdaleh, a British/Canadian billionaire, whose trial collapsed at the end of 2013.  We blogged previously here , here and here.

Bruce Hall decided in 2012 to plead guilty to the charges laid by the SFO in 2012.  He accepted that he had received £2.9 million in corrupt payments between 2002 and 2005 including 10,000 Bahraini Dinars in cash from Sheikh Isa Bin Ali Al Khalifa, a member of the Bahraini Royal Family and, at the time, Bahrain’s Minister of Finance and ALBA’s Chairman.  The payments were made in exchange for Mr Hall agreeing to and allowing corrupt payments that Sheikh Isa had been involved in before Mr Hall’s appointment as CEO to continue as a result of the corrupt payments received.  Mr Hall was ordered to pay: 

  • £3,070,106.03 within seven days, or face serving an additional term of imprisonment of 10 years; 
  • compensation to ALBA in the amount of £500,010; 
  • £100,000 as a contribution to the prosecution costs. 

The Judge presiding over the hearing, Judge Loraine-Smith said: 

“In any view, this was an extremely serious use of corruption…you breached the trust that was placed in you as the CEO of ALBA…corruption has been described as an insidious plague that has corrosive effects across communities…there was a reluctance by you to accept that what was done by you was as corrupt as it so obviously was…” 

Judge Loraine-Smith also noted that Mr Hall had cooperated with numerous authorities throughout the investigation.  The Judge held that if he had not been so cooperative, he could have faced around six years in prison, close to the maximum sentence for conspiracy to corrupt (under the old, pre-Bribery Act 2010 laws).  As a result of his cooperation Mr Hall was entitled to a 66% reduction in his sentence and a further one third reduction due to entering a guilty plea.  In addition to which, the 119 days that Mr Hall spent in prison in Australia awaiting extradition to the United Kingdom would be taken off his sentence. 

As part of Mr Hall’s mitigation, he also agreed to divest himself of other corrupt payments which he had received during his time as the CEO of ALBA.  These payments were not part of the indictment as the SFO did not have jurisdiction to prosecute for the conduct acknowledged by Mr Hall.  In order to recover the other payments received by Mr Hall, which amounted to US$900,000, the director of the SFO launched proceedings under Part 5 of the Proceeds of Crime Act 2002 in the High Court. 

Although the SFO had a fairly spectacular failure during the ALBA case in its prosecution of Victor Dahdaleh (on which we have blogged previously – links above), the prosecution of Bruce Hall is another SFO success story and should properly be regarded as such.  Even though the prosecution took place under the pre 1 July 2011 (the date the Bribery Act came into force) corruption laws, which pre-date the Bribery Act 2010 and which are still being used to prosecute for offences which took place prior to that date, nevertheless this case amply demonstrates: 

  • That British anticorruption laws can affect foreign individuals living outside of the UK, and that extradition treaties can be utilised to force those individuals to face trial in the UK; 
  • That the SFO and the British courts will use the Proceeds of Crime Act 2002 to force individuals to disgorge the profits made from corruption. 
  • The investigations/prosecutions can hang over an individual (or indeed a corporate defendant) for many years – in this case the SFO formally opened its investigation in 2009.  For most people that may mean their lives are in limbo during the whole period, and they may be unable to obtain employment during that time, or at least at the same level or in the same industry.
  • Practices of corruption which are regarded as almost de rigeur in many countries around the world will be viewed very differently indeed if they come before the English courts which have repeatedly stated that defendants are no better than “common criminals”.

The inference to be made from this court order is that  the crime of corruption really doesn’t pay, especially for board level directors, and that individuals who get involved in (or permit existing arrangements to continue unabated) international corruption are at risk of being prosecuted in one or more jurisdictions around the world and are liable to lengthy terms of imprisonment as well as very substantial penalties and orders for disgorgement of payments.  That said, one one view, for wealthy defendants like Victor Dahdaleh, there is still an argument for aggressively defending these prosecutions because Mr Dahdaleh’s trial collapsed (the SFO’s statement on the collapse is here) and he is no longer being prosecuted, whereas Bruce Hall pleaded guilty at an early stage for the very same allegations, and Mr Hall by contrast has suffered all the penalties set out above.  As with all prosecutions, the way a defendant pleads to them is ultimately his/her own decision and often a complete gamble, but the orders made by Judge Loraine-Smith on 22 July 2014 show that the courts will make substantial discounts in sentencing as a result of a guilty plea and cooperation with the prosecution, and this should encourage defendants to work out for themselves the benefits of cooperation.

Anti-Bribery and Corruption, Compliance, Enforcement and Prosecution Policy and Trends, Fraud, Deception and False Claims

Coming clean – the argument for cooperating with the SFO on corporate crime*

By Government Investigations Group

*This title is taken from an article published in Legal Week last week which we quote in full below.

Following the recent sentencing of four individual defendants in the Innospec corruption investigation by the SFO, Ben Morgan, the joint head of bribery and corruption at the SFO wrote the following in Legal Week last week, as follows:

“4 August was the day that four men were sentenced for their part in the Innospec leaded fuel corruption case.

There was a real spread of sentences – four years’ imprisonment, two years’ imprisonment, 18 months’ imprisonment and 16 months’ imprisonment, suspended. Two had pleaded guilty to corruption, and two had been found guilty by unanimous jury verdict after a three-month trial. In his sentencing remarks, His Honour Judge Goymer made very clear the seriousness of offending of that nature, and the sentences reflect that.

After the years of investigation, legal challenge and the trial, the moment had finally come for those given custodial sentences to be taken from the dock. So what can we take from this?

1. ‘White collar’ crime will be treated no differently to any other crime

In his remarks, the judge said: “None of [these defendants], I expect, would consider themselves in the same category as common criminals who commit crimes that involve dishonesty or violence” – a sentiment widely shared across the senior ranks of the City. But it is obvious that that is a dangerous belief to hold if the temptation arises to commit, go along with or turn a blind eye to corruption.

The truth is that those who breach the criminal law in any forum will be treated equally, and I would be surprised if anyone seriously argued that should not be the case. The comfort, distance and apparent safety of the boardroom is indistinguishable from any other environment in which crime is committed, and is just as capable of resulting in a custodial sentence. Corporate crime is not a special category of crime-lite, to be treated less seriously than real crime. Surely the opposite is true when one takes into account the potential harm a senior individual can cause through the misuse of their privileged position.

As His Honour Judge Goymer said when dealing with the issue of human accountability for corporate crime: “[i]t follows that those who have a high level role in the organisation or management and by their own pleas or by the jury’s verdict are shown to have been knowingly involved in corruption must bear a heavy responsibility in the criminal law”. That is a view that I suspect resonates more comfortably with the public perception of those who commit highly impactful institutional crime.

2. In overseas corruption cases, the defence of ‘it’s just the way things are done’ is no defence at all

This is a short point, probably uncontroversial but worth revisiting. Few would put the positive case that just because people in a particular jurisdiction are known to tolerate corruption, it is acceptable to participate in that behaviour, particularly if they see less scrupulous competitors achieving an advantage.

A linked concern from the perspective of an individual is where they join or are promoted into the senior echelons of a company and find that questionable conduct is taking place or expected; it’s just the way things are done in that company. It can, I imagine, be immensely hard to stand up to that as the new person, but the risks of failing to do so are clear.

The trial judge commented during sentencing: “[t]he corruption in this company was ingrained, it was endemic and it was institutionalised. It is no excuse to say that things had always been done in what the jury and I came to know during the trial as “the Indonesian way”, and he went on to describe another economic argument said to mitigate the conduct in question as “a convenient and cynical excuse for the corruption”.

The lesson here is that whatever the prevailing context, the courts in England and Wales will view corrupt conduct with clarity and precision, uncluttered by whatever concession an individual may have made to themselves to justify their act or omission.

3. There is a clear incentive to co-operate with the SFO, both as an individual and as a company

The key point here is the suspended sentence one of the defendants received. It is entirely a matter for the court what sentence it imposes, and the SFO can make no guarantee about that, nor should it. But we know that in this case the two suspects who pleaded not guilty received a four-year and an 18-month sentence respectively, and a suspect who pleaded guilty immediately received two years’ imprisonment, but the suspect who pleaded guilty immediately and cooperated with the SFO’s investigation – including giving evidence for the Crown at trial – did not go to prison.

There is an overwhelming imperative on executives who suspect corruption in their organisation to speak up. There has always been a moral driver for that, but now there is a tangible, practical one too. If you know of something and you are not implicated yourself, then covering it up or passively going along with it can create its own legal risk. And if it is too late for that and you are already implicated, it seems your options are quite clear: fight and risk prison, or come clean and cooperate and, hopefully, don’t.

For now there is one final significant point to all of this. I have spoken publically about the decision a company itself has to make when it suspects it has a corruption issue, which is to choose its fork in the road. Does it want to keep the matter from the SFO, and run all the risks that entails, or does it choose to cooperate with the SFO in the hope of, effectively, a more lenient outcome if it turns out there has been criminal conduct?

I have given my reasons before about why I say the latter position is the obvious legal, commercial and moral choice, and since deferred prosecution agreements became available, numerous companies have come to talk to us. Notwithstanding that, I continue to encounter forceful opposition in the legal community, if not the business community, to the suggestion that a company would choose to speak to us, one of the reasons for which being, apparently, the difficulty the board members might have if they themselves are potentially exposed.

In light of the sentencing guidance this case offers, I wonder how credible that argument is. Is it now more or less likely that a conflicted board member would seek to cooperate with the SFO? If they do, is it more or less likely that the SFO will learn about and have evidence to demonstrate corporate offending? And what then for the company and the remaining directors who tried to bury it?”

First, credit where credit is due, the Innospec case is one of the SFO’s success stories, although the mass media is generally more inclined to knock the SFO when things go wrong than praise it when things go well. The SFO has had more than its fair share of failures over the years including in recent times but it has also had its successes which usually go unsung.

In relation to the points made by Mr Morgan about the risks of not self-reporting to the SFO when corruption has been discovered and cooperating with it from the outset, as opposed to the alternative of sweeping the discovery under the carpet, we are in substantial agreement with him, although we feel that there should be more public acknowledgment by the SFO of the difficulties practitioners and their corporate clients are facing with regard to other issues including:

  • If a corporation decides to self-report to the SFO, to which other investigating/prosecuting agencies around the world will the SFO send this information, in consequence of its international intelligence sharing agreements, thereby potentially multiplying the risks of several sets of legal costs and fines around the world. It is not just a question about reporting to the SFO but its like making a report to many foreign prosecutors, without knowing who they might be. The biggest fear for most defendants is that US prosecutors will crawl all over them and that the level of potential fines can be catastrophic to a company’s balance sheet. There are some current corruption investigations, well reported, where many jurisidictions are now involved and carrying out their own investigations.  Of course, that risk is still there whether or not a company self-reports, or is reported by a whistleblower, or comes to the attention of the SFO by other means, but what we do know from  our own experience and from discussioons with other law firms that this is a factor which really worries corporations when considering whether or not to self-report: that the investigation will run out of control, become extremely expensive, and could cause immense damage globally to the company.
  • An additional factor is the age-old question of legal privilege. The SFO’s position seems to be that when a company self-reports, it expects it to be as open as possible about its internal investigations and, for example, to disclose all witness statements prepared by the corporation’s external lawyers, effectively meaning that legal work that the client and the lawyers undertook, prior to entertaining any discussions with the SFO, and which was undertaken in the expectation that the work product was fully confidential/privileged, should be passed to the SFO and confidentiality/privilege waived. Apart from anything else, these statements may have been taken from employees who felt obliged to cooperate with the company because of their employment contracts, but who were not explicitly made aware that they could be implicating themselves in any criminal conduct. They may not have considered protecting their own interests at the time of giving the statement and may not have had their own counsel.
  • The current trend of corporate defendants coming to settlement arrangements with the SFO (approved by the court), whether in the form of “civil settlements” or whether through the newly enacted deferred prosecution agreements, places individual defendants in a much more difficult position to defend themselves in any subsequent prosecution, by reason of the corporate defendant having implicated the individual defendants when being forced to make its written plea as part of any “deal” to be approved by the court. As Ben Morgan acknowledges in his article, some of those people may have board positions and may have a personal conflict of interest (which may not be known to other board members, at least at the outset of the investigation).

These issues, and others, we dare say, are currently being considered by lawyers all over the UK (and abroad) in their dealings with the SFO, when considering whether or not to make a self-report, and are giving rise to considerable consternation in corporations at the highest level which are considering the SFO’s recommendation to self-report at the earliest opportunity. These are not easy issues to grapple with, and will differ from case to case, but we feel that there could be considerable benefits resulting from a more public debate with the SFO about how to confront and reconcile them. It is clear that even where there is no current US investigation, the fear of future prosecution by US prosecutors may be the driving force in corporate defendant’s decision-making processes whether to cooperate with UK prosecutors in a current investigation, and that these fears are a direct result of international cooperation agreements for the sharing of criminal intelligence (for example between the SFO and the US DOJ and SEC).

Funnily enough, these issues when considered in depth, may reinforce the SFO’s arguments for self-reporting, rather than undermine them, so a public debate should be beneficial all round.

Enforcement and Prosecution Policy and Trends, Fraud, Deception and False Claims

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

By Government Investigations Group

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.

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