470 Search Results

December 15, 2011 |
‘Losing Ground’—In Search of a Remedy For The Overemphasis on Loss and Other Culbability Factors in the Sentencing Guidelines for Fraud and Theft

Washington, D.C. partner David Debold and New York associate Matthew Benjamin are authors of the essay "‘Losing Ground’—In Search of a Remedy For The Overemphasis on Loss and Other Culbability Factors in the Sentencing Guidelines for Fraud and Theft" [PDF] published in the December 2011 issue of the University of Pennsylvania Law Review PENNumbra (Vol. 160:141).

October 19, 2015 |
“Adoption Day” Marks Next Step for Iran Nuclear Deal

​ October 18, 2015 marked Adoption Day, the latest milestone in the implementation of the Joint Comprehensive Plan of Action ("JCPOA") between the E3/EU+3 (China, France, Germany, the Russian Federation, the United Kingdom, and the United States) and the Islamic Republic of Iran to ease sanctions on Iran in exchange for limitations on its nuclear program.   Adoption Day signaled the day on which the JCPOA became effective and when participants are to begin the necessary preparations for the eventual implementation of their full commitments under the JCPOA.  As President Obama explained in an official statement, Adoption Day officially starts the clock for Iran to take steps to remove thousands of centrifuges and related infrastructure, reduce its enriched uranium stockpile, and remove the core of the Arak heavy-water reactor.  In exchange for these measures, the other signatories will begin preparations to lift nuclear-related sanctions against Iran in accordance with the terms of the JCPOA.   In a Presidential Memorandum also issued on Adoption Day, President Obama directed the Secretaries of State, the Treasury, Commerce, and Energy "to take all necessary steps to give effect to the U.S. commitments with respect to sanctions" as described in the JCPOA.  Note, however, that Adoption Day itself does not bring any U.S. sanctions relief.  The Department of the Treasury’s Office of Foreign Assets Control (OFAC) was careful to issue a statement and FAQ that emphasized this point, cautioning that "[u]ntil Implementation Day is reached, the only changes to the Iran-related sanctions are those provided for in the Joint Plan of Action (JPOA) of November 24, 2013, as extended."  U.S. nuclear-related sanctions only begin to be lifted upon Implementation Day, which occurs when the International Atomic Energy Agency (IAEA) verifies that Iran has met its initial nuclear-related obligations under the JCPOA.  Most experts do not expect this to happen until sometime in early- to mid-2016. For further background on the JCPOA and a summary of the changes set to occur on Implementation Day, please see our July 14, 2015 client alert, "Landmark Nuclear Agreement with Iran Reached." ————— Adoption Day Statement by President Obama: https://www.whitehouse.gov/the-press-office/2015/10/18/statement-president-adoption-joint-comprehensive-plan-action Adoption Day Presidential Memorandum: https://www.whitehouse.gov/the-press-office/2015/10/18/presidential-memorandum-preparing-for-implementation-of-the-joint-comprehensive-plan-of-action OFAC Adoption Day Statement:  http://www.treasury.gov/resource-center/sanctions/Programs/Pages/iran.aspx OFAC Adoption Day FAQ: http://www.treasury.gov/resource-center/sanctions/Programs/Documents/jcpoa_adoption_faqs_20151018.pdf          Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding the above developments.  Please contact the Gibson Dunn lawyer with whom you usually work, or the authors in the firm’s Washington, D.C. office: Judith A. Lee (+1 202-887-3591, jalee@gibsondunn.com)Adam M. Smith (+1 202-887-3547, asmith@gibsondunn.com)David A. Wolber (+1 202-887-3727, dwolber@gibsondunn.com)Taylor J. Spragens (+1 202-887-3556, tspragens@gibsondunn.com) Please also feel free to contact any of the following leaders and members of the International Trade Group: United States:Ronald Kirk – Dallas (+1 214-698-3295, rkirk@gibsondunn.com)Jose W. Fernandez – New York (+1 212-351-2376, jfernandez@gibsondunn.com)Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com)Daniel P. Chung – Washington, D.C. (+1 202-887-3729, dchung@gibsondunn.com)Lindsay M. Paulin – Washington, D.C. (+1 202-887-3701, lpaulin@gibsondunn.com) Europe:Peter Alexiadis – Brussels (+32 2 554 72 00, palexiadis@gibsondunn.com)Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)Patrick Doris – London (+44 (0)207 071 4276, pdoris@gibsondunn.com)Penny Madden – London (+44 (0)20 7071 4226, pmadden@gibsondunn.com)Mark Handley – London (+44 (0)207 071 4277, mhandley@gibsondunn.com) © 2015 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.   

January 18, 2016 |
“Implementation Day” Arrives: Substantial Easing of Iran Sanctions alongside Continued Limitations and Risks

On January 16, 2016, the comprehensive international sanctions restricting dealings with Iran and Iranian entities were substantially eased.  Financial institutions and businesses hoping to access the Iranian market have new, immediate and substantial opportunities to do so; but this potential comes with continued complexities, ambiguities, and risks, particularly for U.S. companies.     The relief was triggered by the arrival of "Implementation Day," a major milestone set out in the Joint Comprehensive Plan of Action ("JCPOA") — the Iran nuclear deal that was finalized in July 2015 (discussed in detail in our Client Alerts of July 14, 2015 and October 19, 2015).    In accordance with the JCPOA, Implementation Day was announced following the International Atomic Energy Agency’s confirmation that Iran had successfully completed its initial agreed-upon JCPOA obligations with respect to dismantling and repurposing aspects of its nuclear program.  Implementation Day brings significant — and in parts comprehensive — sanctions relief by the international community and especially the European Union ("E.U.") and the United States.    Following Implementation Day, E.U. and United Nations ("UN") sanctions have all broadly been eased; U.S. sanctions have not been.  Consequently, U.S. companies will be at a significant disadvantage with respect to dealings with Iran compared to their global competitors.   However, the continuation of the bulk of U.S. sanctions — especially with respect to restricted dealings with the U.S. financial system and the provision of U.S. goods and services to Iran — means that international companies will still face daunting challenges and uncertainties with respect to Iranian business they may wish to pursue.  Indeed, given this continuing exposure under U.S. law, which in practice is more actively enforced than the sanctions laws of the E.U. and its member states, for companies with potential obligations under both U.S. and E.U. laws the most pressing priority in the short term may be to continue to ensure compliance with U.S. obligations, notwithstanding the apparent opportunities for European firms.   UN Sanctions Relief   Implementation Day has seen the termination of all existing UN Security Council resolutions that imposed sanctions on Iran, other than UN Security Council Resolution 2231 which implemented the JCPOA.  This resolution is subject only to snap-back (that is to say, expeditious re-institution) in the event of significant non-performance of Iran’s undertakings under the JCPOA commitments.  However, the United Nations arms embargo on Iran continues to be in force for another five years, though countries may petition the UN Security Council for authorization to sell certain weapons systems.  And UN sanctions on individuals previously designated for participating in Iran nuclear and ballistic missile programs will remain in place unless such persons are explicitly removed from the list by the UN Security Council.   From the perspective of financial institutions and businesses, the termination of UN Security Council Resolution 1929 is a critical development.  Under Resolution 1929, core elements of the Iranian economy were subject to significant restrictions including intrusive inspections of Iran Air and Iran’s state-owned shipping line ("IRISL"), as well as substantial limitations on the provision of insurance and reinsurance to Iranian parties, and the prohibition of the opening of new Iranian bank branches or subsidiaries outside Iran, and limiting UN member states from doing the same inside Iran.  These restrictions have all been terminated.    U.S. Sanctions Relief   U.S. sanctions on Iran have included the "blacklisting" of more than 700 individuals and entities on the U.S. Treasury Department’s Office of Foreign Assets Control’s ("OFAC’s") list of Specially Designated and Blocked Nationals ("SDN List"), as well as economic restrictions imposed on entities under U.S. jurisdiction ("primary sanctions") and restrictions on entities outside U.S. jurisdiction ("secondary sanctions").  While the sanctions relief that came into effect on Implementation Day includes relief to each of these three aspects of U.S. sanctions, the majority of the relief provided by the United States under the JCPOA concerns secondary sanctions.  OFAC has helpfully published a Frequently Asked Questions on its website.     In short, the U.S. domestic trade embargo on Iran remains in place with changes only at the margins.    On Implementation Day OFAC released several documents including: Guidance Relating to the Lifting of Certain Sanctions Pursuant to the Joint Comprehensive Plan of Action on Implementation Day; Frequently Asked Questions Relating to the Lifting of Certain U.S. Sanctions Under the JCPOA on Implementation Day; General License H: Authorizing Certain Transactions relating to Foreign Entities Owned or Controlled by a United States Person; and a Statement of Licensing Policy for Activities Related to the Export or Re-Export to Iran of Commercial Passenger Aircraft and Related Parts and Services.     These documents detail the specific elements of U.S. sanctions relief which include:   A.   Secondary Sanctions — Prohibitions on non-U.S. Entities Engaging with Iran   Until Implementation Day, non-U.S. financial institutions, corporations and individuals faced U.S. sanctions exposure if they engaged with certain Iranian persons or in transactions with specified Iranian sectors — even if the transactions had no connection to the United States, U.S. persons, or the U.S. Dollar.  The U.S. has now lifted secondary sanctions with respect to non-U.S. parties’ engaging with or providing associated services to:   certain Iranian financial and banking institutions — including the provision of U.S. bank notes to the Government of Iran; the purchase, subscription or facilitation or the issuance of Iranian sovereign debt, including government bonds; the provision of correspondent banking services; and the provision of financial messaging services (such as SWIFT);   the provision of insurance, reinsurance and underwriting services to Iran;   Iran’s energy and petrochemical sectors — including dealings with the National Iranian Oil Company ("NIOC"), the Naftiran Intertrade Company ("NICO"), and the National Iranian Tanker Company ("NITC");   Iran’s shipping, shipbuilding sectors and port operators — including calls at key Iranian trading facilities such as the Port of Bandar Abbas;   Iran’s trade in gold and other precious metals and software;    Iran’s trade in graphite, raw or semi-finished metals; and   Iran’s automotive sector.   In order to implement this relief, the United States revoked several sanctions-focused Executive Orders, waived portions of numerous pieces of sanctions legislation, and removed over 400 individuals and entities from the SDN List including most of Iran’s major financial institutions and oil and energy firms.    Limits to Secondary Sanctions Relief   Non-U.S. banks, companies and persons must be aware of two key limitations to the removal of secondary sanctions:   The risk of secondary sanctions continue to attach to significant transactions by non-U.S. parties with: Iranian persons who continue to be on the SDN List; the Islamic Revolutionary Guard Corps ("IRGC") and its designated agents or affiliates; and any other persons on the SDN List designated due to their association with Iran’s proliferation of weapons of mass destruction or Iran’s support for international terrorism.   The removal of secondary sanctions does not mean that parties can use or leverage U.S. services or institutions to engage with Iran.  With the exceptions described below, U.S. persons continue to be generally barred from exporting goods, services or technology directly or indirectly to Iran, or processing Iranian-related transactions in the U.S.  For example:   While dealings with certain Iranian financial institutions may be free of secondary sanctions risks, any newly-permitted transactions cannot be cleared by institutions under U.S. jurisdiction unless otherwise licensed to do so.  Transactions with Iran can use the U.S. dollar, but will not be able to leverage U.S. correspondent banks for clearing or settling of U.S. dollar dealings.    Though the provision of insurance, reinsurance and underwriting services to Iran is now possible by non-U.S. parties, U.S. primary sanctions continue to generally prohibit U.S. persons from participating in the provision of such services to Iran, including providing insurance coverage to, participating in reinsurance syndicates concerning, or paying claims involving Iranian entities; and,   While non-U.S. parties can now invest in and provide services to Iran’s automotive sector, neither U.S. car manufacturers nor non-U.S. parties can export or re-export U.S.-origin finished vehicles or U.S.-origin auto parts to Iran.   B.   Primary Sanctions — Prohibitions on U.S. Persons and those under U.S. Jurisdiction Engaging with Iran   The United States is only providing primary sanctions relief with respect to three defined categories of transactions involving (1) foreign subsidiaries of U.S. corporate parents; (2) commercial passenger aviation; and (3) the importation of Iranian foodstuffs and carpets.  Each category of relief is provided differently and has distinct limitations.   1)  Foreign Subsidiaries of U.S. Companies   On Implementation Day OFAC issued a regulatory exemption ("General License" or "GL") to foreign companies "owned or controlled" by U.S. persons to engage in activities with Iran "consistent with the JCPOA."  This General License, "GL ‘H’," allows such companies to transact in and with Iran.  However, GL H imposes several significant constraints on such transactions due to OFAC’s interpretation of what sort of dealings would be inconsistent with the JCPOA and/or contrary to other U.S. laws.    GL H does not, inter alia, permit foreign subsidiaries of U.S. parents to engage in Iran-related dealings involving:   the direct or indirect exportation or goods, technology, or services from the United States to Iran; the transfer of funds to, from, or through the U.S. financial system; or any entity on the SDN List.    Transactions undertaken by foreign subsidiaries that fall afoul of these prohibitions would not receive the benefit of the General License and could lead to U.S. sanctions liability for both the U.S. parent and its subsidiary.     A Firewall is Required between U.S. Parent and Subsidiaries   As a consequence, GL H implies that a significant firewall must be built between the U.S. parent and its foreign subsidiary with respect to the subsidiary’s Iran dealings.  OFAC, however, has provided two dispensations that allow some contact between the parent and subsidiary — these dispensations, amongst others, were lobbied for by major industry in the lead up to Implementation Day:   The U.S. parent — and U.S. persons at the parent company or U.S. persons outside the company retained by the parent — can establish or alter the parent’s operating policies and procedures to the extent necessary to allow the foreign subsidiary to engage in Iran activities without involving the parent or other U.S. persons; and   The U.S. parent can continue to make available to its foreign subsidiary any "automated and globally integrated computer, accounting, email, telecommunications, or other business support system, platform, database, application or server necessary to store, collect, transmit, generate or otherwise process documents or information related" to the foreign subsidiaries transactions with Iran.   We emphasize that both of these dispensations are drafted very broadly and OFAC does not clarify what sorts of policies or procedures are included, nor the full scope of the "automated" systems that a parent can share with its subsidiary.  We urge clients to carefully consider operations and strategies to ensure compliance.   While the exact contours of GL H remain unclear in the initial guidance, OFAC has noted that the goal of the license and the two dispensations are to allow U.S. persons, including senior management of U.S. corporate parents, to be involved in the initial determination to engage in activities with Iran, but not to be involved in the Iran-related day-to-day operations of their foreign subsidiaries.      2)  Commercial Passenger Aviation   Under the JCPOA, the United States pledged to allow the provision of commercial passenger aircraft and related parts and services to Iran, including goods with substantial U.S. content.  To implement this commitment, OFAC will consider granting individual exemptions ("Specific Licenses") to companies in the aviation sector.  Companies will need to apply to OFAC for such a license and, if granted, the license will also cover U.S. persons providing services "ordinarily incident and necessary" to transactions associated with the conveyance of civil aircraft to Iran.  Companies that receive an OFAC license will not need to apply for a second export license from the U.S. Department of Commerce’s Bureau of Industry and Security ("BIS").      The OFAC Specific Licenses will be broad with respect to the types of activities covered but limited in important ways.    In addition to airframes, engines and avionics, the licenses may also allow the provision of warranty, maintenance, repair services, safety-related inspections, spare parts, and training.  "Ordinarily incident and necessary" services could include transportation, legal, insurance, shipping, delivery and financial payment services, including the use of U.S. financial institutions for some of these services.  However, it is not yet clear if U.S. financial institutions will be able to deal directly with Iranian counterparts even in the context of Specifically Licensed transactions.     Further, there are two key limitations companies must keep in mind:   The "ordinarily incident and necessary" services are time- and transaction-limited and will only be licensed for specific conveyances.  For instance, a U.S. person’s provision of insurance to cover an aircraft or component during its transit to Iran would be covered; such insurance that covers the aircraft or the component for several years after its export would not be covered.  Similarly, OFAC will consider license requests from U.S. banks to finance the sale of particular aircraft to Iran, but not to provide aircraft financing in general for Iranian buyers.   Holders of these Specific Licenses must insist on strong end-use certifications, limitations, and perhaps even audits.  If the United States determines that any goods provided to Iran under these Specific Licenses are used for non-civil aviation purposes — or transferred to persons on the SDN List (which presently includes the largest Iranian airline, Mahan Air, which was not delisted) — the United States would view this as grounds to revoke these licenses.  In so doing there could be contractual and legal challenges for holders of the licenses both with respect to Iran and liability in the United States.       3)  Importation of Iranian Foodstuffs and Carpets   The United States’ ban on the importation of Iranian-origin foodstuffs and carpets was one of the last measures imposed by the United States on Iran as sanctions escalated prior to the start of the nuclear negotiations.  Though of comparatively limited economic weight compared with the other sanctions relief on offer, it was an important aspect of relief for the Iranian government to obtain and if successfully implemented could provide direct benefits to some of Iran’s most economically-vulnerable populations.    In order to implement this relief, OFAC will issue a General License to cover U.S. persons’ purchases of Iranian-origin food and carpets and services ordinarily incident and necessary to such transactions.  U.S. financial institutions will be able to be involved in these transactions, but OFAC will continue its restrictions on almost all direct connections between U.S. banks and Iranian counterparties which will usually mean that transactions between the U.S. and Iran for Iranian food or carpets will require intermediation by a third-country financial institution.  It remains to be seen how many third-country banks will be willing to serve in such a capacity.       E.U. Sanctions Relief   A.   Legislative Amendments Relevant to the E.U. Regime   Following the termination of all prior UN Security Council resolutions imposing sanctions of Iran, the restrictive measures imposed pursuant to those now-defunct U.N. Security Council resolutions were lifted on Implementation Day.   In particular, Council Decision (CFSP) 2015/1863 of 18 October 2015 amending Council Decision 2010/413/CFSP concerning restrictive measures against Iran:   suspends the provisions of Council Decision 2010/413/CFSP dealing with economic and financial sanctions consequent upon and simultaneously with Iran’s implementation of its JCPOA commitments, as verified by the IAEA;     suspends the related asset freeze (including the ban on making funds and economic resources available to listed persons) and visa ban applicable to individuals and legal entities; and   establishes an authorization regime regarding certain transfers of metals, software and nuclear-related matters.   CFSP 2015/1863 itself is implemented by two Regulations (see below), which are directly applicable in all Member States — that is to say, they can be relied on directly in the domestic legal order, without need for domestic implementing legislation; namely Council Regulation (EU) 2015/1861 of 18 October 2015 amending Regulation (EU) No 267/2012 concerning restrictive measures against Iran, and Council Implementing Regulation (EU) 2015/1862 of 18 October 2015, implementing Regulation (EU) No 267/2012 concerning restrictive measures against Iran.   The Council of the E.U. has also issued a Statement (Council Declaration 2015/C 345/01) specifying that the commitment to lift all nuclear-related sanctions is without prejudice, inter alia, to the reintroduction of E.U. sanctions in the case of significant non-performance by Iran of its JCPOA commitments.  The E.U. has also published a helpful Information Note on the lifting of the Iran sanctions.      B.   The Lifting of the E.U.’s Sectoral Sanctions   The E.U.’s sectoral sanctions against Iran, subject only to the few remaining prohibitions set out below, have been removed.   The E.U. sanctions related to all activities:   within the territories of the E.U.’s Member States including their airspace; anywhere in the world conducted by E.U. nationals and companies and other entities formed in E.U. Member States; on board E.U.-registered ships or aircraft.   The E.U.’s sanctions did not extend to foreign subsidiaries of E.U. companies, but there were broadly-phrased anti-circumvention provisions that went some way towards having this effect.   Lifting of Oil and Gas Restrictions   Critically, the terminated sanctions mean that the Iranian oil and gas sector is now sanctions-free from the perspective of the E.U. and its members.  All imports of Iranian oil, and all other hydrocarbon products, are now permitted — from any supplier.  Equally, exports of equipment, technology and services are now permitted to Iranian oil and gas producers, refiners and those involved in exploration and development.  (As discussed above, U.S. origin equipment, technology and services remain restricted, however, from export to Iran).   The country with the world’s fourth largest proven oil reserves has just re-entered the E.U. energy market.  While currently low oil prices reflect, in part, the expected rise in supply from Iran, the long-term prospect of capital expenditure, investment and modernization of Iran’s energy sector should remain the focus for participants in this space.   During the years of the E.U.’s Iran sanctions even non-E.U. customers for Iranian oil were limited in the extent to which they could receive oil because of the prohibitions on E.U. companies providing insurance for such shipments.  The exclusion of Iranian fuel shipments from the important insurance markets of London and elsewhere in Europe had the effect of extending the impact of the E.U.’s sanctions.   All restrictions of insurance related to Iran’s oil and gas market have also now been removed. This is also the case in relation to the other sectors benefitting from the removal of sanctions as part of Implementation Day.   Many of the Iranian companies that were listed under the E.U. sanctions were part of Iran’s shipping industry.  These had been sanctioned because of their role in exporting Iranian petroleum products.  The delisting of these companies, and the removal of broader sectoral sanctions against the Iranian shipping, ship building, and transport sectors again releases this whole industry from the constraints previously imposed upon it and those wishing to deal with it.   Lifting of Financial Restrictions   Public Financing The removal of all E.U. restrictions on the Iranian state and Iranian entities from entering the bond market is another of the more important developments as part of Implementation Day. The Iranian government appears to anticipate that this will enable large-scale financing to support investment and modernization across multiple sectors of the Iranian economy, as well as providing funding for government and state-owned enterprises, although the extent to which this is true will depend in large measure to the reaction of the global financial sector. Unfreezing of Assets In addition to these sectoral sanctions, the hundreds of individuals and companies named on the SDN on the basis of being involved in, or supporting, Iran’s nuclear program have been de-listed.  Billions of dollars held in E.U. accounts by these entities will now be unfrozen.  Transfers to and from these individuals and entities will now be unrestricted as a matter of E.U. law.  Debts long outstanding to listed entities can now lawfully be paid. The combined consequence of unfreezing accounts and allowing payments may have the effect of transforming the liquidity of many of the Iranian companies previously sanctioned.      Financial Transfers and Banking The provisions of perhaps broadest effect in preventing business with Iran were the prohibitions on financial transfers to and from all "Iranian Persons" (broadly defined) without either pre-notification to the relevant authority in each Member State or, where the transfer was above a certain threshold, pre-authorization from the relevant authority.  There were limited exceptions for humanitarian purposes, medical products, and foodstuffs, but even those could be restricted if an Iranian bank was involved.    In practice, while the E.U.’s Iran sanctions regime did nothing to prohibit trade with Iranian counterparties in many types of goods and services, but E.U. company could, in practice, neither pay, nor be paid.   The liabilities created by these prohibitions applied to both trading companies, and  E.U. financial institutions that facilitated the money transfers.  The practical effect of these rules was that many E.U. banks were reluctant to be involved in any way with handling money related to Iran, even if the authorization or notification process was potentially available.   The restrictions on financial transfers to/from Iranian persons have now been entirely removed.   The E.U. Regulation that had removed many Iranian banks from the SWIFT system has now also been repealed.  Alongside the lifting of prohibitions on E.U. banks establishing correspondent relationships with Iranian banks, and establishing offices in Iran, the result is to remove a whole series of E.U restrictions on the Iranian banking sector.   The sanctions had extended to cover a number of possible substitutes for cash.  These had been designed to prevent the ready circumvention of the prohibitions.  For instance the export of Iranian banknotes had been prevented, as were the exports of gold, other precious metals and precious stones.  The export and transfer of these proxies for cash are now also unrestricted by E.U. law.       C.    E.U.-Iran sanctions remaining in force after Implementation Day Even in the E.U., the sanctions relief triggered by Implementation day will not create a wholly sanctions-free zone in connection with Iran.  Certain E.U. sanctions regimes relating to Iran but unrelated to the sanctions aimed at nuclear proliferation will remain in full vigor and effect after Implementation Day.  These include the E.U. sanctions legislation relating to human rights violations and certain sanctions relating to terrorism (Council Decision 2011/235/CFSP (Apr. 12, 2011)), as well as the arms embargo, and certain limited restrictions on software and rare metals related to nuclear proliferation.     D.    Looking Forward in the E.U. — Continuing Risks   Businesses in the E.U. should be aware that a number of risks remain with respect to Iran sanctions, including the potential for liabilities for past violations of the EU’s Iran sanctions and the possibility of sanctions snap-back.   While contractual provisions can and should  be devised to protect businesses’ interests with respect to snap-back, addressing past violations is more challenging.    Sanctions relief will not absolve persons of violations of the E.U.’s Iran sanctions (or indeed the UK’s rules in relation to financial transfers to and from Iranian persons, which pre-dated the E.U.’s introduction of similar restrictions and were in force for around a year in late 2011 and 2012).  Those companies and individuals will, depending on the E.U. member state concerned, remain potentially subject to prosecution in connection with those violations.   Moreover, the anticipated wave of transactions with Iran would seem highly likely to lead to such past violations increasingly coming to the attention of the authorities.  This is because of reporting obligations and/or incentives for entities to make notifications to the authorities in connection with criminal offences they discover in connection with their business, for example under money laundering legislation such as the UK’s Proceeds of Crime Act 2002.     Consequently, businesses considering investment in Iran, or businesses which have carried out activities in Iran, must continue to give careful consideration to the question of whether there may be legacy liabilities, and whether there are grounds for suspicion that the investments contemplated may reveal the handling of the proceeds of such historic violations, or may risk facilitating the handling of such proceeds.   An additional risk for E.U. businesses arises from the facts that, first, while in some E.U. member states, E.U. sanctions laws automatically give rise to offences under existing domestic laws, in other member states, E.U. sanctions regimes only take effect upon separate implementation by means of national laws; and second, some member states are slow to respond to legislative changes at E.U. level.  As a result, some domestic criminal offences may remain in place notwithstanding the relief from sanctions at the E.U. level.  While enforcement of such offenses may be unlikely, or even illegal, in the circumstances, businesses should take care to ensure that full account is taken of any applicable transitional provisions in the E.U. member states.       Next Steps and the Way Ahead   Implementation Day does not mark the conclusion of the Iran sanctions story, but it is the end of an important chapter in economic restrictions on Iran.  It is unlikely that the globally comprehensive nature of sanctions on Iran will return even in the case of a "snap-back" of sanctions in the event of non-compliance.  While the United States could re-impose the full suite of its unilateral sanctions on Iran — and unlike the E.U. has made it clear that there will be no grandfathering of contracts signed before a snap-back — it is not certain that other members of the P5+1, including the E.U. (let alone states in Asia, Africa and Latin America) would be willing to return to a pre-JCPOA world.   In the coming weeks and months we expect to see five factors come into play which together will determine the success of the JCPOA’s sanctions relief.  While most of these elements focus on the United States they have potentially global implications for the ability and willingness of companies to take advantage of new Iranian opportunities.   First, we expect many companies in the U.S. and outside it — not just those in the civil aviation sector — to consider and apply for specific licenses from the U.S. government.  In an unprecedented move, OFAC has said that it will consider license requests from non-U.S. parties in certain cases.  Further the U.S. administration has made it clear that specific licenses covering activities outside the confines of the defined JCPOA relief — but in line with U.S. foreign policy interests — may be considered in light of the broader U.S. interest in effectuating real sanctions relief and further solidifying the deal.   Second, Implementation Day leaves untouched existing General Licenses available under U.S. Iran sanctions.  These include allowances for the exportation of agricultural goods, pharmaceuticals, medical devices, and certain services, software and hardware incident to personal communications (such as smart phones).  Before Implementation Day these licenses remained largely unused as potential exporters could not find insurers, financiers or others willing to engage in transactions with Iran.  With Implementation Day we expect more of these trade intermediaries to become willing to serve in such roles which will allow exporters to take greater advantage of existing permissions.    Third, a significant unknown that will be worked out in the months ahead concerns how and if non-U.S. international financial institutions will acclimate to eased sanctions.  It remains to be seen how major banks, many of which that have suffered significant fines and reputational damage over the past several years for violating U.S. sanctions — and in some cases remain under consent orders or other restrictions from state (rather than federal) authorities in the United States — will adjust to a new reality in which the federal legal prohibitions may have changed but state restrictions and potential reputational exposure remain.  Of note, OFAC makes clear in its guidance that even after Implementation Day, Iran remains a "Jurisdiction of Primary Money Laundering Concern" under section 311 of the USA PATRIOT Act — under which the U.S. Treasury has the authority to require U.S. financial institutions to take "special measures" with respect to such jurisdictions, financial institutions and/or international transactions related to such jurisdictions.        Fourth, OFAC and other sanctions authorities in the United States and in Europe will continue to maintain and enforce remaining sanctions.  The aggressiveness of such enforcement will be a factor in companies’ investment appetite for Iran.  For instance, in the U.S., Implementation Day also saw the addition of nearly a dozen new ballistic missile program-related sanctions to the SDN List.  In the E.U., the UK is launching its own OFAC-style body in April 2016 — the Office of Financial Sanctions Implementation which is forecast to have an enforcement focus.  Additionally, in mid-December 2015, the General Court of the E.U. (the E.U.’s lower court) dismissed the first challenges to sanctions listings brought by persons listed under the E.U.’s sanctions on Iran targeting violations of human rights — sanctions which remain even after Implementation Day.  This occurred in the Sarafraz and Emadi cases (Sarafraz v Council (Case T-273/13) [2015] (Dec. 4, 2015) and Emadi v Council (Case T-274/13) [2015] (Dec. 4, 2015)).   Continued and potentially increased enforcement and maintenance of remaining measures means that companies who wish to take advantage of any opening must make sure they stay compliant with continuing restrictions.     Fifth, prior to its issuance of JCPOA sanctions relief, OFAC conceded that the relief process will likely be iterative — that is, there was a realization that this first tranche of licenses and interpretative guidance may not be sufficient to fully implement the relief that the United States agreed to provide.  As such, we expect continued reassessments and potentially issuances of new licenses and interpretative guidance in the time ahead as the administration attempts to calibrate its relief in order to effectuate it as much as possible within the continuing constraints set by unchanging sanctions statutes passed by Congress.  On Congress’ part, the disquiet on behalf of Republicans with respect to the Iran deal and any sanctions relief remains and especially in an election year there continues to be a risk of additional Congressional action.  Though the President has underscored that he will veto any legislation that undercuts the JCPOA, Congressional creativity — and the potential of obtaining a veto-proof majority if Iranian behavior deteriorates — makes flux from the Congressional side as important to watch as that coming from the administration.  The following Gibson Dunn lawyers assisted in preparing this client alert: Judith Alison Lee, Adam Smith, Jose Fernandez, Patrick Doris, Mark Handley, David Wolber and Mehrnoosh Aryanpour.   Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the above developments.  Please contact the Gibson Dunn lawyer with whom you usually work, or any of the following members of the firm’s International Trade Group: United States:Judith A. Lee – Co-Chair, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)Ronald Kirk – Co-Chair, Dallas (+1 214-698-3295, rkirk@gibsondunn.com)Jose W. Fernandez – New York (+1 212-351-2376, jfernandez@gibsondunn.com)Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com)Daniel P. Chung – Washington, D.C. (+1 202-887-3729, dchung@gibsondunn.com)Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)David A. Wolber – Washington, D.C. (+1 202-887-3727, dwolber@gibsondunn.com) Mehrnoosh Aryanpour* – Washington, D.C. (+1 202-955-8619, maryanpour@gibsondunn.com)Lindsay M. Paulin – Washington, D.C. (+1 202-887-3701, lpaulin@gibsondunn.com) Europe and Asia:Peter Alexiadis – Brussels (+32 2 554 72 00, palexiadis@gibsondunn.com)Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)Patrick Doris – London (+44 (0)207 071 4276, pdoris@gibsondunn.com)Penny Madden – London (+44 (0)20 7071 4226, pmadden@gibsondunn.com)Mark Handley – London (+44 (0)207 071 4277, mhandley@gibsondunn.com) Robert S. Pé – Hong Kong (+852 2214 3768, rpe@gibsondunn.com) ** Ms. Aryanpour is not yet admitted to practice in the District of Columbia and currently practices under the supervision of the Principals of the Firm. © 2016 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 29, 2014 |
10th Annual Webcast Briefing on Challenges in Compliance and Corporate Governance

​Blockbuster fines and increasing regulatory requirements underscore the challenging environment facing today’s compliance professionals. Join our experienced securities law, corporate governance, white collar defense and investigations attorneys as they discuss practical approaches for developing strong compliance programs for the year ahead. This year’s presentation features new Gibson Dunn partner Scott Hammond, the former Deputy Assistant Attorney General for Criminal Enforcement of the U.S. Department of Justice’s Antitrust Division, and one of the nation’s leading experts on criminal antitrust and international cartel cases. Scott joins Joe Warin and Amy Goodman who now are in their 10th year of hosting ‘Challenges in Compliance and Corporate Governance.‘ Topics discussed include: The shrinking gap between "regulated" and "unregulated" entities A summary of the SEC and DOJ’s emerging enforcement and compliance policies U.S. enforcement trends; statistics from 2013 SEC, CFTC, antitrust, FCPA, FCA and FIRREA cases Lessons from 2013 SEC and DOJ cases and settlements Trends in international regulation and enforcement Building and overseeing effective compliance programs Voluntary disclosure programs The compliance function and the role of the Chief Compliance Officer, senior management, senior management and the Board in compliance Who should view this program: In-house counsel, directors, senior executives, finance and audit staff, corporate governance and compliance officers, corporate secretaries and others responsible for public company compliance. Panelists: F. Joseph Warin — Co-Chair of the firm’s White Collar Defense and Investigations Practice and former Assistant United States Attorney in Washington, D.C. Ranked as a leading white collar criminal defense, securities compliance and enforcement attorney by 2013 Chambers USA: America’s Leading Lawyers for Business, 2006 – 2013 Best Lawyers in America, and named a Top Lawyer for Criminal Defense by Washingtonian magazine and a White Collar Law MVP by Law360. Expertise includes white collar crime and securities enforcement and litigation—including Foreign Corrupt Practices Act investigations, False Claims Act cases, special committee representations, compliance counseling and complex civil litigation. Mr. Warin is the only person to have served as the FCPA compliance monitor, or U.S. counsel to the FCPA compliance monitor, in three different FCPA monitorships. Scott Hammond — Partner with the firm’s Antitrust and Trade Regulation Practice, with a focus on criminal antitrust and international cartel matters. Former Deputy Assistant Attorney General for Criminal Enforcement in the U.S. Department of Justice’s Antitrust Division. Recently joined Gibson Dunn following a 25-year tenure with the DOJ’s Antitrust Division. Supervised the Division’s domestic and international criminal investigations and prosecutions, including overseeing the Corporate and Individual Leniency Programs. Also worked to increase international cooperation in cartel enforcement with other jurisdictions, including the European Union, Australia, Brazil, Canada, Germany, India, Japan, Korea, Mexico, New Zealand, South Africa and the United Kingdom.

February 7, 2007 |
2006 Year-End FCPA Update

This client update provides an overview of Foreign Corrupt Practices Act ("FCPA") enforcement activities in 2006, a discussion of the trends we see from that activity, and practical guidance to help companies avoid or limit FCPA liability. FCPA Overview The FCPA’s anti-bribery provisions make it illegal to make payments of money or anything of value to any foreign government official or foreign political party in order to obtain or retain business or secure any improper advantage.  The anti-bribery provisions apply to "issuers," "domestic concerns," and "any person" that violates the FCPA while in the territory of the United States.  The term "issuer" covers any business entity that is registered under 15 U.S.C. § 78l or is required to file reports under 15 U.S.C. § 78o(d).  In this context, foreign issuers whose ADRs are traded on U.S. exchanges are "issuers" for purposes of this statute.  The term "domestic concern" is even broader and includes any U.S. citizen and any business entity that is organized under the laws of a U.S. state or that has a principal place of business in the United States.  In addition to the anti-bribery provisions, the FCPA’s books and records provision requires issuers to make and keep accurate books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the issuer’s transactions and disposition of assets.  Finally, the FCPA’s internal controls provision requires the issuer to devise and maintain reasonable internal accounting controls aimed at preventing and detecting FCPA violations.  2006 In Review 2006 marked one of the busiest years in FCPA enforcement and further evidenced the recent proliferation of FCPA enforcement activity.  Several high-profile FCPA enforcement actions, including charges against four companies and numerous individuals, were brought by either the Department of Justice ("DOJ") or Securities and Exchange Commission ("SEC").  Along with this explosion of enforcement activity comes warnings from the DOJ and the Federal Bureau of Investigation of "increased vigilance" in pursuing FCPA cases.  For example, in a speech on October 16, 2006, Assistant Attorney General Alice Fisher made clear that the FCPA is a "high priority": Do we care about the FCPA?  Is the FCPA relevant in today’s global business climate?  Is enforcing the FCPA a high priority?  The answer to all of those questions is yes.  Prosecuting corruption of all kinds is a high priority for the Justice Department and for me as head of the Criminal Division.  That includes public corruption, corruption in the procurement process, and the Foreign Corrupt Practices Act. Among the most important enforcement actions against corporations are: In the Matter of Oil States International, Inc. On April 27, 2006, the SEC announced that Oil States International, Inc., a Houston-based oil drilling service provider, had consented to the entry of an administrative order requiring the company to cease and desist from committing any future books and records or internal controls violations.  The SEC did not impose any financial penalties on Oil States. This case involved alleged improper payments made by a Venezuelan subsidiary of Oil States International to officials of Venezuela’s state-owned oil company, Petroleos de Venezuela, S.A. ("PDVSA").  The Venezuelan subsidiary had hired a consultant to interface with the PDVSA.  The consultant, together with three of the subsidiary’s employees, then engaged in a kickback scheme whereby the subsidiary paid approximately $348,000 in improper payments to PDVSA employees.  After discovering the kickback scheme, Oil States undertook extensive corrective and remedial measures and voluntarily reported its findings to the SEC and DOJ.  In declining to impose financial penalties, the SEC noted that it considered Oil States’ extensive remedial acts and its cooperation with the SEC staff. Schnitzer Steel Industries, Inc. On October 16, 2006, the DOJ and SEC announced a plea and settlement with Schnitzer Steel Industries, Inc., based in Portland, Oregon, and its foreign subsidiary, SSI Korea.  In the plea documents, SSI Korea admitted that it violated the FCPA’s anti-bribery provisions by making more than $1.8 million in corrupt payments over a five-year period to government-owned steel mill managers in China.  SSI Korea made the payments to induce the steel mill managers to purchase scrap metal from Schnitzer Steel.  The bribes, which took the form of commissions, refunds, and gratuities via off-book bank accounts, led to a substantial increase in business.  In addition, the SEC also alleged that Schnitzer Steel violated the FCPA’s books and records and internal controls provisions. To settle the criminal and administrative charges levied against it for violating the FCPA, Schnitzer Steel agreed to pay a total of $15.2 million.  In the criminal proceeding, the company’s wholly owned subsidiary, SSI Korea, pleaded guilty to violations of the FCPA’s anti-bribery and books and records provisions.  SSI Korea agreed to pay a $7.5 million criminal fine.  The DOJ deferred prosecution against Schnitzer Steel, the parent corporation.  In the deferred prosecution agreement, Schnitzer Steel accepted responsibility for the conduct of its employees and agreed to enhance its internal compliance measures.  The deferred prosecution agreement also provided for the appointment of an independent compliance consultant to review Schnitzer Steel’s compliance program and monitor the implementation of new internal controls related to the FCPA.  In the parallel SEC administrative proceeding, Schnitzer Steel consented to the entry of a cease-and-desist order and agreed to pay a $7.7 million civil penalty. Statoil, ASA On October 13, 2006, the DOJ and SEC announced that Statoil ASA, an international oil company in Norway whose ADRs are traded on the New York Stock Exchange, had agreed to pay a total of $21 million to settle criminal and administrative charges for violating the FCPA’s anti-bribery and accounting provisions.  Pursuant to a deferred prosecution agreement, Statoil agreed to a $10.5 million criminal penalty and the appointment of an independent compliance consultant who will review and report on Statoil’s FCPA compliance.  In the parallel SEC administrative proceeding, Statoil consented to the entry of an administrative order requiring the company to cease and desist from committing any future FCPA violations, and to pay disgorgement of an additional $10.5 million. Individual Enforcement Actions The DOJ and SEC also aggressively pursued individuals last year who were alleged to have violated the FCPA: U.S. v. Richard John Novak:  On March 20, 2006, Richard John Novak pleaded guilty to violating the FCPA, wire fraud, and mail fraud statutes.  Novak operated a "diploma mill" that issued fraudulent diplomas from falsely accredited universities.  Novak made payments to Liberian diplomats and officials to induce them to issue certificates of accreditation for Novak’s fictitious universities.  Novak’s sentencing was continued until December 2007 because he is offering ongoing assistance to the DOJ in criminal proceedings against Novak’s co-defendants, who are scheduled for trial in October 2007. U.S. v. Steven Lynwood Head<:  On June 23, 2006, Steven Lynwood Head, the former CEO of Titan Africa, Inc., pleaded guilty to falsifying the books and records of an issuer under the FCPA.  In the guise of "advanced social payments," Head authorized the payment of approximately $2 million to the President of Benin’s reelection campaign and then submitted false invoices to hide the payments.  Head is expected to be sentenced in March 2007.  Head’s former employer, Titan Africa, Inc., pleaded guilty in 2005 to FCPA violations in a well-publicized prosecution,  and paid $28.5 million in criminal penalties, disgorgement, and prejudgment interest. SEC v. John Samson, John Munro, Ian Campbell, and John Whelan:  On July 5, 2006, the SEC filed a complaint against four employees of ABB Ltd. for alleged violations of the FCPA.  The criminal and enforcement proceedings against ABB and its subsidiaries resulted in fines and penalties totaling more than $16 million.  The four employees allegedly participated in a scheme to bribe Nigerian government officials in furtherance of ABB’s bid to obtain a lucrative contract to supply oil drilling equipment in Nigeria. The four employees consented to the entry of final judgments that (1) permanently enjoined them from future FCPA violations, (2) ordered each to pay a civil penalty ($50,000 as to Samson, and $40,000 each for Munro, Campbell, and Whelan), and (3) ordered Samson to pay $64,675 in disgorgement and prejudgment interest. This action derived from another proceeding in 2004, in which ABB subsidiaries pleaded guilty to violating the anti-bribery provisions of the FCPA and ABB entered into a cease-and-desist order with the SEC.  U.S. v. Faheem Mousa Salam: On August 4, 2006, Faheem Mousa Salam pleaded guilty to one count of violating the FCPA’s anti-bribery provisions.  As a translator working in Iraq, Salam admitted offering a bribe to an Iraqi official to induce the official to purchase a printer and 1,000 armored vests.  On February 2, 2007, Salam was sentenced in the U.S. District Court for the District of Columbia to three years in prison.  This sentence, coupled with the sentences imposed on former American Rice executives David Kay and Douglas Murphy (discussed below), demonstrates that FCPA violations will be met with harsh, long prison sentences. SEC v. David M. Pillor:  David Pillor was the former Senior Vice President of Sales and Marketing for InVision Technologies, Inc.  In December 2004, InVision entered into a non-prosecution agreement with the DOJ, and in February 2005, InVision settled with the SEC.  On August 15, 2006, the SEC settled charges against Pillor for alleged violations of the FCPA for failing to maintain an adequate system of internal controls and for causing the falsification of the company’s books and records.  Pillor agreed to pay a $65,000 civil penalty and consented to a permanent injunction from future FCPA violations. U.S. v. Yaw Osei Amoako:  On September 6, 2006, Yaw Osei Amoako, a former regional manager of ITXC Corporation, pleaded guilty to one count of conspiring to violate the FCPA’s anti-bribery provisions.  Amoako pleaded guilty to paying approximately $266,000 in bribes to employees of foreign state-owned telecommunications carriers in various African countries.  Amoako is expected to be sentenced in February 2007. SEC v. Jim Bob Brown:  On September 14, 2006, the SEC settled a civil enforcement against Jim Bob "J.B." Brown, a former employee of a subsidiary of Willbros Group, Inc.  The SEC alleged violations of the FCPA’s anti-bribery, books and records, and internal controls provisions by Brown, who participated in a scheme to bribe foreign officials in Nigerian and Ecuadorian government-owned oil companies.  Brown consented to a permanent injunction against future FCPA violations.  Although Brown agreed to settle the SEC’s claim for injunctive relief, he has not settled the SEC’s claim for monetary penalties.  Those proceedings have been stayed pending the outcome of a parallel criminal proceeding. Reported Cases On December 8, 2006, the Second Circuit issued an opinion in U.S. v. James H. Giffen, 473 F.3d 30 (2d. Cir. 2006).  This case involved an interlocutory appeal by the DOJ from the district court’s order in the FCPA trial denying the government’s motion to preclude Giffen from raising a defense that he was authorized to act by public officials ("public authority defense").  Giffen had argued that he was a government informant, acting on behalf of "an agency of the U.S. government," and therefore he lacked the corrupt intent necessary to sustain an FCPA violation.  The district court had ruled previously that Giffen was entitled to review classified government documents to assess the viability of his public authority defense.  But when Giffen proffered the classified documents to use at trial in support of his public authority defense, the government objected and moved to preclude the defense.  The district court overruled the objection and permitted Giffen to present evidence of a public authority defense at trial.  The government appealed.  The Second Circuit refused to hear the appeal, however, after determining that the government’s interlocutory appeal was premature.  Nevertheless, in dicta, the Court opined that the district court may have misunderstood the requirements of the public authority defense.  According to the Second Circuit, the defense would not apply in this case because the evidence proffered by Giffen showed only that he may have been a government agent charged with "stay[ing] close to the President [of Kazakhstan]" and reporting possible criminal activity to U.S. authorities.  This authority did not authorize Giffen to violate the FCPA as alleged in the indictment. The 2007 Docket A review of FCPA actions pending in 2007 suggest that the trend of increasing enforcement will continue.  Following are several examples: U.S. v. Viktor Kozeny et al.:  On October 6, 2005, the DOJ announced that a federal grand jury in the Southern District of New York had indicted Viktor Kozeny, Frederic Bourke, Jr., and David Pinkerton for allegedly participating in a massive scheme to bribe government officials in Azerbaijan.  The three men allegedly bribed government officials to ensure that those officials would privatize Azerbaijan’s state-owned oil company, thus allowing Kozeny, Bourke, Pinkerton, and others to share in the anticipated profits arising from that privatization.  Although Bourke and Pinkerton have appeared in the case, Kozeny has refused to appear.  He has been arrested in the Bahamas and the United States is seeking his extradition.  A court in the Bahamas has ordered Kozeny’s extradition, but that ruling is pending on appeal.  SEC v. Steven Ott and Michael Young:  On September 6, 2006, the SEC sued Steven Ott and Michael Young, both former executives of ITXC Corporation, in the U.S. District Court for the District of New Jersey.  The SEC alleges that Ott and Young violated the FCPA by approving and negotiating bribes paid to foreign state-owned telecommunications carriers in various African countries.  The SEC seeks injunctions, disgorgement of ill-gotten gains, and civil penalties.  All discovery has been stayed pending conclusion of the DOJ’s parallel criminal prosecution, which is ongoing. SEC v. Osei Amoako:  The SEC also has another pending civil enforcement action against another former ITXC employee, Yaw Osei Amoako, which was filed on September 1, 2005 in the U.S. District Court for the District of New Jersey.  The SEC’s complaint alleges that Amoako bribed a senior official of the government-owned telephone company in Nigeria, in order to obtain a lucrative contract for ITXC.  The SEC is seeking an injunction, disgorgement of ill-gotten gains, and civil penalties.  This civil action has been stayed pending the final outcome of the criminal proceedings, mentioned above. United States v. Kay and Murphy: In 2002, the Justice Department indicted David Kay and Douglas Murphy, two former employees of American Rice, Inc., for violating the FCPA by making improper payments to Haitian government officials to reduce customs and sales taxes on rice imported by American Rice.  According to the indictment, Kay and Murphy bribed customs officials to understate the true amount of rice imported by American Rice, thereby subjecting American Rice to lower customs duties and sales taxes.  The original issue for the court was how broadly it should interpret the FCPA’s statutory prohibition on the making of payments to foreign officials to "obtain or retain business." The district court dismissed the indictment, holding that the statutory language "to obtain or retain business" applied only to payments that lead directly to the obtaining of new or the retaining of old business, which, the district court held, had not occurred here.  United States v. Kay, 200 F. Supp. 2d 681 (S.D. Tex. 2002).  The Fifth Circuit, however, reversed the district court’s decision.  United States v. Kay, 359 F.3d 738 (5th Cir. 2004).  Relying on the legislative history of the FCPA and its amendments, the court held that Congress intended the "obtain or retain business" language to apply to any payments to foreign officials intended to either directly or indirectly assist the payor in obtaining or retaining business.  The Fifth Circuit noted that bribes to foreign officials to secure illegally reduced customs and sales taxes, if intended to assist someone in obtaining or retaining business, could fall with the FCPA’s anti-bribery provisions. After remand, a jury found Kay and Murphy guilty of violating the anti-bribery provisions of the FCPA.  In June 2005, the Court sentenced Kay to 37 months imprisonment and Murphy to 63 months imprisonment.  Both defendants have appealed their convictions and sentences; the appeals are currently pending in the Fifth Circuit.  One of the issues before the Fifth Circuit will be whether the district court properly instructed the jury on the mens rea element of an offense under the FCPA.  The DOJ acknowledged that the district court failed to properly instruct the jury that the FCPA has both "willfulness" and "corruptly" elements.  Nevertheless, the parties disagree about the meaning of "willfulness" under the FCPA, and, specifically, whether the FCPA requires a showing by the government that the defendant acted with intent to violate the FCPA.  DOJ Opinion Procedure Release On October 16, 2006, the DOJ issued its first FCPA Opinion Procedure Release since September 3, 2004.  The DOJ stated that it would not take enforcement action against a company proposing to contribute $25,000 to the customs department of an African country.  In approving the transaction, the DOJ noted that there was no corrupt intent associated with the payment and that the payment was to the government and not to a foreign official.  In commenting on the release, Assistant Attorney General Alice Fisher remarked that "the FCPA opinion procedure has generally been under-utilized" and that she wants it "to be something that is useful as a guide to business." Trends With the increase in enforcement activity, we see several important trends developing in the arena of FCPA enforcement, many of which were directly addressed by Assistant Attorney General Fisher in her recent speech.  Voluntary Disclosures The number of voluntary disclosures continued to rise in 2006.  Seventeen of the twenty newly disclosed FCPA investigations during the past two years were voluntarily disclosed to the DOJ or SEC following internal investigations by the companies.  In the early 2000s, by contrast, the government initiated most of the reported investigations.  In encouraging companies to voluntarily disclose transgressions, Assistant Attorney General Fisher noted that, although the result of voluntary disclosure is uncertain, it will result "in a real, tangible benefit."  As explained below, there are various factors a company must consider when deciding whether to voluntary disclose an FCPA violation. Appointment of Monitors and Consultants In several of the most recent FCPA dispositions, the DOJ and SEC have required the company to appoint monitors or consultants to ensure FCPA compliance.  In addition to ABB, Diagnostic Products Corporation, DPC (Tianjin) Ltd., InVision, Micrus, Monsanto, and Titan, all of which were required to make such appointments in the past few years, in 2006 both Schnitzer Steel and Statoil were required to hire a compliance consultant to review the company’s system of FCPA internal controls.  Notwithstanding this recent trend, however, Assistant Attorney General Fisher explained that "there is no presumption that a compliance consultant is required in every FCPA disposition."  According to Ms. Fisher, when considering whether to require a compliance consultant, the DOJ will consider "the strength of the company’s existing management and compliance team, the pervasiveness of the problem, and the strength of the company’s existing FCPA policies and procedures." Increased Penalties Enforcement activity in 2006 continued the trend of increasing the severity of penalties.  Looking back, the SEC first required a company to disgorge the profits of its unlawful FCPA activities in 2004.  Today, the practice appears to have become standard fare.  In October 2006, for example, Statoil ASA agreed to a DOJ fine of $10.5 million and SEC disgorgement of an additional $10.5 million.  Schnitzer Steel’s Korean subsidiary agreed to a DOJ fine of $7.5 million while Schnitzer Steel agreed to pay the SEC $7.7 million in disgorgement and prejudgment interest.   Increasingly Broad Jurisdictional Nexus U.S. enforcement authorities have shown a willingness to reach far and wide outside traditional jurisdictional boundaries and think creatively when assessing the connection that the company or activity has with the United States.  The Statoil matter marked the first time that the DOJ has taken criminal enforcement action against a foreign issuer for violating the FCPA.  Assistant Attorney General Fisher noted that the criminal enforcement action against Statoil was intended as "a clear message" to foreign companies trading on the American exchanges that they must comply with U.S. laws.  Ms. Fisher added that "[t]his prosecution demonstrates the Justice Department’s commitment vigorously to enforce the FCPA against all international businesses whose conduct falls within its scope." Ongoing Civil Liability — Private Litigants/Shareholders Although the FCPA does not grant a private right of action, 2006 may have created a glimmer of promise for hopeful securities, class-action plaintiffs under the FCPA.  Following Immucor’s announcement of a formal SEC investigation into allegations of an improper payment under the FCPA, a shareholder class filed a complaint under §§ 10-b and 20(a) of the Exchange Act.  In re Immucor Inc., No. 1:05-CV-2276-WSD, 2006 WL 3000133 (N.D. Ga. Oct. 4, 2006).  The suit alleged that Immucor’s statements in securities filings, two of its press releases, and an analyst teleconference — all of which tended to underplay the severity of the potential FCPA violations — constituted material misstatements and omissions.  Notably, similar shareholder suits against InVision Technologies and Syncor International Corporation had been dismissed by district courts for failure to meet the pleading requirements of the Private Securities Litigation Reform Act ("PSLRA").  On October 4, 2006, the District Court for the Northern District of Georgia denied Immucor’s motion to dismiss the shareholder claim.  The court found that the plaintiffs had adequately alleged false or misleading statements, that the facts alleged regarding the various statements (notably an attribution of the payments’ costs to "bookkeeping" errors) did support the heightened pleading requirements as to scienter under the PSLRA.  In other words, for the first time, a federal court held that plaintiffs had met the heightened pleading requirement for fraud under the PSLRA in an FCPA case. Currently, more than 24 other major corporations are under SEC investigation for FCPA violations.  This landscape may provide fertile ground for plaintiffs’ counsel in search of a class to fashion FCPA-based suits.  Though corporate defendants historically have succeeded in challenging the standing of FCPA-based shareholder actions, cases like Immucor suggest that, especially in the current environment of heightened scrutiny, such claims may start to gain traction.  Regardless of outcome, however, one thing is clear: the legal road towards resolving an FCPA violation in the U.S. now stretches far beyond achieving peace with the SEC. Also of special note is the United Nations Convention Against Corruption, which requires member states to provide a private right of action for those who suffer damages as a result of an "act of corruption."  The U.S. Senate provided its Advice and Consent to the U.N. Convention on September 15, 2006, but in so doing, specifically made the reservation that U.S. law would remain unchanged and that no new private right of action was created in the U.S.  Nevertheless, to date 140 countries have become signatories to the U.N. Convention and it has been ratified by 80 countries.  Thus, although U.S. law remains unchanged, U.S. companies should be aware that other countries may provide for a private right of action, which could subject U.S. companies to increased litigation in foreign jurisdictions. Guidance In light of developments over the past year concerning the FCPA, we offer the following guidance to our clients and friends. Deciding Whether to Make a Voluntary Disclosure Although not mandated by the FCPA, voluntary disclosure of an FCPA violation to the DOJ and/or SEC, as appropriate, may help a company avoid prosecution or obtain partial mitigation of civil and criminal penalties.  Although there is no way to quantify the mitigation impact of a voluntary disclosure, a review of the Statoil, Schnitzer Steel, and Oil States International cases suggests strongly that voluntary disclosure and exceptional cooperation can result in relatively lenient criminal and administrative sanctions.  Schnitzer Steel, for instance, voluntarily disclosed its wrongdoing to the DOJ, conducted an extensive internal investigation, shared the results of the investigation promptly, cooperated extensively with the DOJ’s ongoing investigation, took appropriate disciplinary action against wrongdoers, replaced senior management, and took additional significant remedial actions, including the implementation of a robust compliance program.  Assistant Attorney General Fisher explained that Schnitzer’s "exceptional cooperation" … "was critical to its ability to obtain a deferred prosecution agreement" and a DOJ recommendation that it pay a fine "well below what it would otherwise have received."  Ms. Fisher added that "voluntary disclosure followed by extraordinary cooperation with the Department results in a real, tangible benefit to the company." Notwithstanding Ms. Fisher’s comments, however, the "credit" given for voluntary disclosure and cooperation in any particular case remains uncertain.  Perhaps disposition of cases pending in 2007 will enlighten this further.  In the meantime, however, corporations must weigh the potential benefits of a voluntary disclosure, including mitigation, against the costs of such disclosure, including the expense and resources required to cooperate with a government investigation, the uncertain scope of civil and criminal penalties, the risk and expense of private litigation, and the public relations and business consequences, both in the U.S. and overseas. Due Diligence is Necessary In the merger and acquisition context, and because of the substantial civil and criminal penalties possibly imposed for violations of the FCPA, corporations must remain focused on proper diligence before, during, and after the proposed acquisition.  Of note, three recent FCPA enforcement actions (ABB, GE/InVision, and Titan Corporation) came to light during M&A due diligence. Although the type and scope of FCPA due diligence required before an acquisition will vary depending on the particular risks involved, most pre-acquisition FCPA due diligence should contain the following elements: A determination of the risk that the target company has engaged in violations of the FCPA, based on the target company’s line of business and the countries where the target company is located or does business; A review of the effectiveness of the target company’s FCPA compliance program and policies and procedures for marketing-and-entertainment-related expenditures; Interviews with employees of the target company and other knowledgeable individuals regarding rumors of unethical or suspicious conduct by the target company, its employees, or its agents, consultants or representatives; A review of the target company’s books, records and accounts to determine whether such books, records and accounts accurately and fairly reflect all transactions and expenditures by the target company; An enhanced review of all contracts between the target company and any foreign government, foreign government-controlled entity, foreign government employee or foreign political candidate; An enhanced review of all contracts between the target company and any foreign agent, consultant or representative of the target company; and An enhanced review of any "red flags" indicating that violations of the FCPA may have occurred. Maintain Adequate Compliance Program and Internal Controls To minimize exposure to penalties under the FCPA, companies should establish, implement, and maintain an effective FCPA compliance program.  This program must be designed to deter violation of the FCPA and detect possible violations of the FCPA before they occur.  An effective FCPA compliance program also must be tailored to a company’s size, line of business, scope of international operations, and associated risk of violating the FCPA, among other factors.  At the very least, an effective compliance program should contain the following: Policy Statement: The company’s CEO or other member of senior management should issue a company-wide policy statement that clearly affirms the company’s commitment to comply fully with the FCPA and to maintain the highest level of ethical standards in the conduct of its business. Compliance Manual: The company should prepare and distribute an FCPA Compliance Manual containing written standards and guidelines to be followed by the company’s officers, directors, employees and agents to ensure their full compliance with the FCPA. Compliance Officer: The company should designate an individual from the company’s senior management or general counsel’s office to serve as the company’s FCPA Compliance Officer. Education and Training Programs: The company’s FCPA compliance program should include appropriate educational and training programs for all of the company’s directors, officers, employees and agents. Confidential Hotline: The company should establish a confidential telephone hotline that may be used by the company’s officers, directors, employees and agents to report any suspected or actual violation of the company’s FCPA Compliance Manual. Internal Audit: In addition to regular financial audits, the company should periodically review and test compliance with its FCPA compliance program. Miscellaneous: An effective compliance program should also (i) require annual certifications from employees that they have reviewed and agreed to comply with the FCPA Compliance Manual; (ii) help avoid unusual or extravagant payments or gifts; (iii) prohibit or require approval of gifts; (iv) provide FCPA guidance in all foreign languages where the company conducts business; (v) encourage employees to elevate FCPA issues; (vi) thoroughly screen third-party agents; and (vii) identify "red flags." Given the continued proliferation of FCPA enforcement activity in 2006, we expect U.S. authorities to initiate an increasing number of enforcement actions in the next few years and to seek more severe penalties for FCPA violators.  A company’s investment in an effective FCPA compliance program could help it avoid liability altogether or reduce the severity of penalties imposed against the company if it or one of its officers, directors, employees or agents violates the FCPA.   Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. We have more than ten attorneys with substantive FCPA expertise. Please contact the Gibson Dunn attorney with whom you work, or F. Joseph Warin (202-887-3609, jwarin@gibsondunn.com), Daniel J. Plaine (202-955-8286, dplaine@gibsondunn.com), Judith A. Lee (202-887-3591, jalee@gibsondunn.com), Jim Slear (202-955-8578, jslear@gibsondunn.com), Andrew S. Boutros (202-887-3727, aboutros@gibsondunn.com), or Jeremy A. Bell (202-887-3508, jbell@gibsondunn.com) in the firm’s Washington, D.C. office, Robert C. Blume (303-298-5758, rblume@gibsondunn.com) or J. Taylor McConkie (303-298-5795, tmcconkie@gibsondunn.com) in the Denver office, Nicola T. Hanna (949-451-4270, nhanna@gibsondunn.com) in the Orange County office, or Debra Wong Yang (213-229-7472, dwongyang@gibsondunn.com), the former United States Attorney for the Central District of California, in the Los Angeles office. © 2007 Gibson, Dunn & Crutcher LLP The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 4, 2008 |
2007 Year-End FCPA Update

2007 – A "Landmark Year" in FCPA Enforcement "2007 is by any measure a landmark year in the fight against foreign bribery." When Mark F. Mendelsohn, Deputy Chief of the Fraud Section in the Department of Justice’s Criminal Division ("DOJ") and the government’s top criminal Foreign Corrupt Practices Act ("FCPA") enforcer, opened the 2007 ACI FCPA Conference with this bold statement, not a single eyebrow rose across the ballroom filled with members of the ever-growing FCPA Bar. Nor was anyone surprised to hear Fredric D. Firestone, an Associate Director in the Securities and Exchange Commission’s Division of Enforcement ("SEC"), which shares enforcement responsibility under the FCPA with the DOJ, utter moments later "ditto from the SEC." For Messrs. Mendelsohn and Firestone spoke only what everyone in the room already knew: as the statute celebrated its thirtieth birthday, FCPA enforcement, already trending steeply upward in recent years, exploded in 2007. This client update provides an overview of the FCPA and other foreign bribery enforcement activities in 2007, a discussion of the trends we see from that activity, and practical guidance to help companies avoid or limit liability under these laws. A collection of Gibson, Dunn & Crutcher LLP ("Gibson Dunn") publications on the FCPA, including prior enforcement updates and more in-depth discussions of the statute’s complicated framework, may be found on Gibson Dunn’s FCPA website. FCPA Overview The FCPA’s anti-bribery provisions make it illegal to provide money or anything of value to officials of foreign governments or foreign political parties with the intent to obtain or retain business. The anti-bribery provisions apply to "issuers," "domestic concerns," and "any person" that violates the FCPA while in the territory of the United States. The term "issuer" covers any business entity that is registered under 15 U.S.C. § 78l or is required to file reports under 15 U.S.C. § 78o(d). In this context, foreign issuers whose American Depository Receipts ("ADRs") are traded on U.S. exchanges are "issuers" for purposes of this statute. The term "domestic concern" is even broader and includes any U.S. citizen, national, or resident, as well as any business entity that is organized under the laws of a U.S. state or that has a principal place of business in the United States.  In addition to the anti-bribery provisions, the FCPA’s books-and-records provision requires issuers to make and keep accurate books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the issuer’s transactions and disposition of assets. Finally, the FCPA’s internal controls provision requires that issuers devise and maintain reasonable internal accounting controls aimed at preventing and detecting FCPA violations. 2007 in Review The explosion of FCPA enforcement activity in 2007 is best captured in the following chart and graph, which each track the number of FCPA enforcement actions filed by the DOJ and SEC during the past five years: 2007   2006   2005   2004   2003 DOJ 18 SEC 20 DOJ 7 SEC 8 DOJ 7 SEC 5 DOJ 2 SEC 3 DOJ 2 SEC 0   FCPA Prosecutions 2003 — 2007 The thirty-eight FCPA enforcement actions brought by the DOJ and SEC in 2007 substantially more than doubled the fifteen governmental actions in 2006, which was until this year itself the busiest year ever in FCPA enforcement. And it is clear that the recent surge will not soon abate. Mr. Mendelsohn recently stated that the enforcement activity throughout the past few months represents "just the tip of the iceberg," noting that the DOJ has "many more matters under investigation." Mr. Firestone concurred, indicating that the SEC is engaging in "a full-court press on FCPA investigations." From our representation of corporations and individuals, our network of relationships, and our constant review of public disclosures, Gibson Dunn has identified approximately 100 companies that are the subject of open FCPA investigations.  2007 Enforcement Trends Record-Setting Resolutions  Not only did the DOJ and SEC bring record numbers of FCPA enforcement actions in 2007, they brought cases with record-setting penalties. In the largest criminal FCPA resolution to date, on February 6, 2007, three wholly owned subsidiaries of Vetco International pleaded guilty and a fourth entered into a deferred prosecution agreement. These four subsidiaries (collectively "Vetco Subsidiaries") agreed to pay a total of $26 million in criminal fines. According to the plea agreements, the Vetco Subsidiaries engaged in a scheme to authorize corrupt payments to officials in the Nigerian Customs Service. From 2001 through 2003, the Vetco Subsidiaries made at least 378 corrupt payments totaling approximately $2.1 million to customs officials in Nigeria through an "international freight forwarding and customs clearance company." The purpose of the payments was allegedly to gain preferential treatment in the customs clearance process and to secure an improper advantage in the importation of goods and equipment into Nigeria. Notably, the charges did not allege that the payments were to "obtain or retain business." The deferred prosecution agreement also requires that Vetco International hire an independent compliance monitor to oversee the formation and maintenance of a robust FCPA compliance program.  In the largest combined FCPA settlement to date, on April 26, 2007, the DOJ and SEC announced settlements with Texas-based oilfield services provider Baker Hughes, Inc. and its wholly owned subsidiary, Baker Hughes Services, International ("BHSI"), worth a combined $44 million. According to the settlement documents, between 2001 and 2003, Baker Hughes and BHSI paid approximately $5.2 million to two agents operating in Kazakhstan with the knowledge that some or all of that money would be funneled to officials of Kazakhstan’s state-owned oil company. Additionally, between 1998 and 2004, Baker Hughes and BHSI allegedly paid or authorized more than $15 million in commission payments to agents operating in Angola, Indonesia, Kazakhstan, Nigeria, Russia, and Uzbekistan "under circumstances in which the compan[ies] failed to adequately assure [themselves] that such payments were not being passed on, in part, to [government] officials."  To resolve the SEC’s complaint, which alleged violations of the FCPA’s anti-bribery, books-and-records, and internal controls provisions, Baker Hughes agreed to pay approximately $23 million in disgorgement and prejudgment interest and to pay a $10 million civil penalty for purportedly violating a 2001 SEC cease-and-desist order prohibiting future violations of the FCPA. This $10 million penalty, the first of its kind in FCPA enforcement, underscores that an injunction should never be entered into nonchalantly as it may form the basis for an increased penalty should the party become involved in a subsequent FCPA matter.  In the DOJ action, BHSI pleaded guilty to violating and conspiring to violate the FCPA’s anti-bribery provisions and aiding and abetting the falsification of Baker Hughes’s books and records, and it agreed to pay an $11 million criminal fine. Baker Hughes also entered into a deferred prosecution agreement alleging the same three violations to which BHSI pleaded guilty. Both the DOJ and SEC resolutions require the company to retain a compliance monitor for three years.  Commenting on the Baker Hughes settlements, Assistant Attorney General Alice S. Fisher, head of the DOJ’s Criminal Division, noted that "[t]he record penalties leveled in this case leave no doubt that foreign bribery is bad for business." And from the SEC side, Director of Enforcement Linda Thompson noted that the $10 million civil penalty for violating a prior cease-a-desist order "demonstrates that companies must adhere to Commission Orders and that recidivists will be punished."  Leveraging Isolated Cases into Worldwide & Industry-Wide Investigations Two other trends that emerged in FCPA enforcement in 2007 were investigations involving worldwide activities of single companies and industry-wide investigations of multiple companies. Traditionally, most FCPA investigations involved corrupt payments to government officials in a single country by a single company (and occasionally one or more of its employees). But today it is not uncommon for multinational companies that identify FCPA concerns in one locale to expand their internal inquiry to examine their operations around the globe. And where they do not, they can expect to receive the "So where else have you looked?" inquiry should they ever find themselves across the table from the DOJ or SEC. Prominent examples from 2007 of single-company FCPA resolutions spanning multiple countries include the following: York International Corp. — charged with making more than 870 improper payments, totaling more than $8.7 million, to obtain or retain more than 775 contracts in Bahrain, China, Egypt, India, Iraq, Nigeria, Turkey, the United Arab Emirates, and unspecified European countries;  Textron, Inc. — charged with making nearly $700,000 in improper payments to obtain or retain business in Bangladesh, Egypt, India, Indonesia, Iraq, and the United Arab Emirates; and  Paradigm B.V. — charged with providing foreign government officials with hundreds of thousands of dollars in cash and improper travel and entertainment benefits to obtain or retain business in China, Indonesia, Kazakhstan, Mexico, and Nigeria.  In 2007, the DOJ and SEC also took clear aim at leveraging single-company inquiries into industry-wide probes. The most recent example involves orthopedic implant manufacturers Biomet, Inc.; Medtronic, Inc.; Smith & Nephew plc; Stryker Corp.; and Zimmer Holding, Inc.; all of which publicly disclosed receiving letters from the DOJ or SEC requesting information concerning payments to government-employed physicians in various foreign countries, including Germany, Greece, and Poland. The letters followed on the heels of each of the companies, except Medtronic, entering into settlements with the New Jersey U.S. Attorney’s Office on September 27, 2007 alleging violations of the domestic anti-kickback statute relating to their sales of orthopedic implants to physicians in the United States. And in February 2007, Johnson & Johnson, the parent company of DePuy Orthopedics, which was also a party to the domestic physician anti-kickback settlement, publicly reported having voluntarily disclosed to the DOJ and SEC potential improper payments to government-employed physicians in foreign countries.  In another prominent example of an industry-wide probe from 2007, on July 2, the DOJ sent letters to eleven oil and oil services companies requesting information about their dealings with Panalpina Welttransport Holding AG, a Swiss logistics and freight forwarding company. Panalpina is widely believed to be the "major international forwarder and customs clearance agent" implicated in the February Vetco International FCPA settlement that allegedly made improper payments to officials of the Nigerian Customs Service. The DOJ is investigating Panalpina’s activities in Nigeria, Kazakhstan, and the Middle East. Most of the eleven companies that received the DOJ letter, as well as several other oil services companies, have publicly disclosed internal investigations concerning potential improper payments made through Panalpina and other agents to government officials in various countries, including Nigeria. Panalpina has announced that it is and will continue to cooperate with the DOJ’s investigation and that it has suspended its services in Nigeria. This investigation demonstrates the risks of doing business in countries where corruption is rampant, and it also emphasizes the need for companies to conduct adequate due diligence before hiring agents or consultants and to monitor the activities of those third parties post-retention to ensure FCPA compliance.  The mother of all 2007 industry-wide investigations has to be that arising from the Oil-for-Food Program ("OFFP"). Likely the largest international corruption investigation ever — involving a U.N.-commissioned international investigative body, four congressional committees, the DOJ, two U.S. Attorney’s Offices, the SEC, the Manhattan District Attorney’s Office, the Department of Treasury’s Office of Foreign Assets Control ("OFAC"), and at least six foreign governments — OFFP spawned six SEC and four DOJ FCPA enforcement actions in 2007. This all began when the U.N. Independent Inquiry Committee ("IIC"), commonly known as the Volcker Committee after its Chairman (and former Chairman of the Federal Reserve) Paul A. Volcker, published its final report detailing the results of its sixteen-month investigation into alleged corruption surrounding the OFFP. When the smoke cleared, the IIC had named 2,253 companies worldwide as having made more than $1.8 billion in "kickbacks" to the Iraqi government. More than two dozen companies have since publicly disclosed that they are under investigation by the DOJ and/or SEC, suggesting there may be more OFFP prosecutions to come in 2008.  First to settle FCPA-related OFFP charges was El Paso Corp., a Houston-based energy company. On February 7, 2007, El Paso agreed to settle with the SEC on charges that it violated the FCPA’s books-and-records and internal controls provisions, and at the same time entered into a non-prosecution agreement with the U.S. Attorney’s Office for the Southern District of New York ("SDNY") on non-FCPA (wire fraud and OFAC) charges. According to the SEC’s complaint, El Paso purchased oil from third parties while knowing that the third parties had themselves made approximately $5.5 million in illegal kickback payments in connection with their purchase of the oil from the Iraqi government. El Paso allegedly reimbursed the intermediary purchasers for their kickback payments through higher commission payments and then improperly recorded the whole of the commissions as "cost of goods sold." El Paso agreed to pay a $2.25 million civil penalty to the SEC and agreed to forfeit $5.48 million — the SEC refers to the forfeiture as disgorgement of "profits," while the SDNY refers to the figure as reflecting the value of the kickback payments — to the SDNY for ultimate transfer to the Development Fund for Iraq.  For the first half of 2007, El Paso remained the only company to settle FCPA charges arising from the OFFP. Then, on August 23, the DOJ and SEC announced FCPA books-and-records settlements (the SEC’s complaint also alleged internal controls violations) with Textron, Inc. According to the settlement documents, two relatively recently acquired French subsidiaries of Textron — which participated in the "Humanitarian" side of the OFFP, unlike El Paso, which was an "Oil" side participant — used a third-party agent to funnel $580,000 to ministries of the Iraqi government in connection with the sale of industrial pumps and related spare parts under the OFFP. Textron’s subsidiaries allegedly funded the payments, which equaled 10% of the contracts’ values, by inflating the value of their contracts by 10%, thereby receiving an extra 10% from the U.N.’s escrow account. Textron’s subsidiaries then increased the value of their agents’ commissions by 10%, reimbursing the agents for making the payments, and improperly recorded the whole of the payments to the agents as "commissions" and "consultation fees." To resolve the allegations concerning the OFFP, as well as other allegedly improper payments made in several countries outside the OFFP, Textron paid a $1.15 million fine to the DOJ as part of a non-prosecution agreement, and paid an $800,000 civil penalty to the SEC along with approximately $2.7 million in disgorgement with prejudgment interest. Both the DOJ and SEC acknowledged Textron’s early discovery and self-reporting of the improper payments, as well as the company’s remedial actions and significant cooperation in the government’s investigation of it and other companies.  Rounding out the ranks of companies to settle OFFP FCPA charges (thus far) are the following: York International Corp. — On October 1, settled FCPA books-and-records and internal controls charges with the SEC, and books-and-records and wire fraud charges with the DOJ, for its Dubai subsidiary allegedly funneling approximately $670,000 in kickbacks to the Iraqi government through third-party agents, funded by inflated contract price submissions to the United Nations. Also, as described above, York International’s subsidiaries in China, India, and the United Kingdom allegedly paid more than $8 million in bribes in Bahrain, China, Egypt, India, Nigeria, Turkey, the United Arab Emirates (SEC alleged FCPA anti-bribery violations in the UAE only), and unspecified European countries. York paid a $2 million civil penalty to the SEC and agreed to disgorge just over $10 million in profits plus prejudgment interest. As part of a deferred prosecution agreement with the DOJ, York paid a $10 million criminal fine and was required to retain an independent compliance consultant.  Ingersoll-Rand Co. Ltd. — On October 31, settled FCPA books-and-records and internal controls charges with the SEC, and books-and-records and wire fraud charges with the DOJ, for its subsidiaries in Belgium, Germany, Ireland, and Italy allegedly paying or promising to pay approximately $1.5 million in kickbacks to the Iraqi government through third-party agents, funded by inflated contract price submissions to the United Nations. Ingersoll-Rand paid a $2.5 million criminal fine to the DOJ in connection with a deferred prosecution agreement and paid a $1.95 million civil penalty to the SEC together with approximately $2.27 million in disgorgement plus prejudgment interest.  Chevron Corp. — On November 15, 2007, entered into a books-and-records and internal controls resolution with the SEC and agreed to pay a $3 million penalty to settle allegations that it purchased oil from third parties while knowing that the third parties had themselves made approximately $20 million in kickbacks in connection with their purchase of the oil from the Iraqi government.  Chevron’s SEC settlement required $20 million in disgorgement, but the disgorgement was deemed satisfied by the company’s payment of the same amount to the SDNY (to be transferred to the Development Fund for Iraq) as part of a non-prosecution agreement on non-FCPA charges.  The company also paid a $2 million civil penalty to OFAC and paid $5 million to the Manhattan District Attorney’s Office to reimburse it for investigative costs. Akzo Nobel N.V. — On December 20, settled FCPA books-and-records and internal controls charges with the SEC, and books-and-records charges with the DOJ, for its Dutch subsidiaries allegedly funneling nearly $280,000 in kickbacks to ministries of the Iraqi government through their third-party agents, funded by inflated contract price submissions to the United Nations. Akzo Nobel agreed to pay a $750,000 civil penalty to the SEC and to disgorge approximately $2.23 million in profits plus prejudgment interest. Its non-prosecution agreement with the DOJ does not require the payment of a fine, provided that one of Akzo Nobel’s subsidiaries reaches a criminal settlement with Dutch authorities by June 2008 and pays at least a EUR 381,602 ($549,419) fine in connection with that settlement. This is the first time that the DOJ has declined to impose a financial penalty altogether in an FCPA case in light of a foreign disposition, although it did credit a foreign government-imposed fine in the 2006 Statoil ASA FCPA prosecution.  The OFFP investigation has also highlighted another topic of great interest to those involved in FCPA matters: the increasingly inconsistent usage of non-prosecution and deferred prosecution agreements by the DOJ and the many United States Attorneys’ Offices. Thus far, Akzo Nobel, Chevron, El Paso, and Textron have received non-prosecution agreements from the DOJ and SDNY, while for essentially the same conduct, York International and Ingersoll-Rand received deferred prosecution agreements, widely believed (and for good reason) to be a more harsh sanction.  DOJ and SEC Target Individual Defendants This year, of thirty-one FCPA defendants, fifteen were individuals, by far the highest annual total in the statute’s thirty-year history. Asked at a recent American Bar Association event whether the prosecution of individuals in 2007 is a trend or an aberration, SEC Assistant Director Cheryl J. Scarboro said that the SEC will "continue to focus on individuals." Mr. Mendelsohn, also a panelist at this event, added that the trend of individual enforcement is "part of a very concerted effort" intended to "deter the conduct." And as if this were not disconcerting enough for individuals with potential FCPA liability, Donald W. Freese, the head of the Federal Bureau of Investigation’s new FCPA unit, recently expressed his view that the only way to deter FCPA conduct is to put people in jail.  Perhaps the highest profile FCPA prosecution of an individual in 2007 is that of sitting United States Congressman William J. Jefferson. On June 4, 2007, a grand jury in the Eastern District of Virginia returned a sixteen-count indictment charging Jefferson with violating the FCPA’s anti-bribery provisions, solicitation of a bribe by a public official, wire fraud, money laundering, obstruction of justice, and violating the Racketeer Influenced and Corrupt Organizations Act. The FCPA charges stem from Jefferson’s alleged promise to make a $500,000 "front-end payment" to a high-ranking Nigerian official, widely believed to be former Vice President Atiku Abubakar, to induce the official to assist Jefferson in obtaining regulatory approvals from the Nigerian state-owned telecommunications company for a joint venture between a Nigerian company and iGate, Inc., a Kentucky-based company for which Jefferson was acting as agent. Jefferson also allegedly offered the Nigerian official a "back-end payment" of 50% of the joint venture’s future profits. When the FBI raided Jefferson’s Washington, D.C. home, acting on the tip of a confidential informant, they discovered $90,000 cash in Jefferson’s freezer, which the indictment alleges was to be used in partial satisfaction of the $500,000 front-end payment. Jefferson has pleaded not guilty to all charges and is presently scheduled to go to trial in February 2008. Although lacking the media cachet of the Jefferson indictment, another particularly interesting 2007 FCPA individual enforcement action was the SEC’s settlement with Monty Fu, the founding Chairman of Syncor International Corp., a California-based provider of radiopharmaceutical products. Otherwise relatively standard FCPA fare, what makes this case truly significant is that the resolution was reached nearly five years after Syncor International and its foreign subsidiary Syncor Taiwan settled FCPA charges with the DOJ and SEC in December 2002. The SEC’s complaint charged Fu only with FCPA books-and-records and internal controls violations. According to the complaint, from 1985 through 2002, Syncor Taiwan made more than $1.1 million in improper commission payments to both private and state-employed physicians in Taiwan to influence them to purchase Syncor Taiwan’s products. The SEC alleged that Fu, as the Chairman of Syncor International, had the authority to implement a system of internal controls within Syncor Taiwan, yet failed to do so. Additionally, the SEC alleged that he either knew, or was reckless in not knowing, that the improper payments were being falsely recorded on Syncor Taiwan’s books and records, which were then incorporated into Syncor International’s books and records. Interestingly, given the nature of the charges and the lengthy time period to reach a settlement, it does not appear that Mr. Fu will be criminally prosecuted.  Other corporate officials to be charged in 2007 after their respective employers settled FCPA charges in prior years include Robert W. Philip (SEC) and Si Chan Wooh (DOJ and SEC), formerly the CEO and Executive Vice President, respectively, of Schnitzer Steel Industries, Inc., which together with its Korean subsidiary settled criminal and administrative FCPA charges with the DOJ and SEC in October 2006, and Charles M. Martin (SEC), formerly the Asian Governmental Affairs Director of Monsanto Co., which itself settled civil and administrative FCPA charges with the SEC in January 2005.  International Enforcement and Cooperation One can’t help but suspect that Mark Mendelsohn chose carefully his words featured at the outset of this Update — "2007 is by any measure a landmark year in the fight against foreign bribery." For not only did FCPA enforcement reach unprecedented levels in 2007, but this year also featured never-before-seen vigor among foreign prosecutors in at least investigating, if not yet prosecuting, international graft. Chiming in on this point, Alice Fisher recently described the DOJ’s efforts to work "more effectively with foreign authorities around the world to investigate and prosecute FCPA offenses," resulting in "an increase in the number of joint investigations." Representative of this increased multinational cooperation, on November 20 and 21, 2007, Ms. Fisher, Mr. Mendelsohn, and William B. Jacobson, Assistant Chief of the DOJ’s Fraud Section and the DOJ’s second-most senior FCPA prosecutor, participated in an international conference to celebrate the tenth anniversary of the OECD Anti-Bribery Convention. Together with the DOJ representatives, prosecutors from Brazil, Chile, France, Germany, Hong Kong, Hungary, Italy, South Africa, and Switzerland gave presentations on the status of international bribery enforcement in their own countries. This coordination between U.S. and foreign anti-bribery enforcement agencies may subject multinational companies to dual enforcement actions in the United States and foreign countries, much as we saw in the 2006 prosecutions of Statoil ASA and expect to soon see for Akzo Nobel N.V. Several recent cases highlight this trend toward more aggressive international enforcement of foreign anti-bribery laws. On October 5, 2007, German conglomerate Siemens AG announced that it had accepted a German court’s order to pay a EUR 201 million ($284 million) fine in connection with alleged bribes paid by Siemens’s telecommunications unit to win contracts in a number of countries, including Russia. Siemens also agreed to pay German tax authorities EUR 179 million ($253 million) in back taxes related to improper deductions taken for the unlawful payments. In addition, the German authorities indicted at least one executive from the telecommunications unit in connection with the alleged bribery, and press reports indicate that additional indictments are expected. These significant fines came on the heels of a EUR 38 million ($51 million) fine levied against Siemens’s power-generation unit in May 2007, and Siemens has confirmed that it is continuing to investigate suspicious payments made by several other units. Both the DOJ and SEC have open FCPA investigations related to the alleged bribery, which many speculate will lead to even more sizeable penalties than those imposed in Germany, which already dwarf the highest FCPA settlement on record, Baker Hughes, Inc. with $44 million. China, Greece, Hungary, Indonesia, Italy, Japan, Norway, and Switzerland also have reportedly launched investigations into the same conduct. In one of the most highly publicized and controversial international corruption investigations in recent memory, BAE Systems PLC, a major British defense contractor, is suspected of having paid billions of dollars to members of the Saudi royal family over several decades to secure lucrative contracts to provide fighter jets and other military equipment to Saudi Arabia. The British Serious Fraud Office ("SFO") had reportedly been investigating BAE for several years when then-Prime Minister Tony Blair intervened to halt the inquiry in December 2006, invoking national security concerns when Saudi Arabia threatened to withdraw from cooperative anti-terrorism efforts. But that would not be the end of BAE’s troubles, for on June 26, 2007, BAE announced that the DOJ had opened its own investigation into the Saudi payments. While British authorities have reportedly resisted cooperating with the DOJ, the Swiss authorities have agreed to provide relevant financial records to assist the DOJ’s investigation. And according to media reports, the DOJ recently flew a BAE employee to the United States for interviews, routing him through Paris so as to avoid attention. Accordingly, the BAE investigation highlights the fact that the level of international cooperation may vary greatly, depending on the particular countries involved. In early December, the SFO announced a new investigation of BAE, focusing on potentially improper payments made to secure contracts with the governments of Romania, South Africa, and Tanzania. In November 2007, the former chief legal officer for the Samsung Group, the largest conglomerate (chaebol) in South Korea, publicly reported that the company and its affiliates paid billions of dollars to various government officials to ensure that the son of Samsung’s current chairman would succeed his father as the head of the chaebol. The whistleblower claimed that the money was kept in slush funds that were concealed through unlawful bookkeeping practices. State prosecutors in South Korea are investigating the allegations, and President Roh Moo-hyun recently approved legislation mandating the launch of a separate, independent, investigation. Several commentators have speculated that the negative press arising from the bribery allegations may trigger changes in Samsung’s business practices, but skeptics have noted that the culture of bribery is deeply rooted in South Korea, where the chaebols wield significant political influence. The Only Way to (Sponsor) Travel  Company-sponsored travel by government officials was clearly an area of focus for the DOJ and SEC in 2007. The FCPA’s anti-bribery provisions provide for an affirmative defense permitting companies to pay for the "reasonable and bona fide" expenses of foreign government officials, "such as travel and lodging expenses," incurred in connection with either (1) the "promotion, demonstration, or explanation" of the payer’s products or services or (2) "the execution or performance of a contract with a foreign government or agency thereof." But as the DOJ and SEC made clear in 2007, there is a right way and a wrong way to go about sponsoring travel for foreign government officials.  The "right way" is exemplified in two very similar FCPA Opinion Procedure Releases issued by the DOJ in July and September, respectively (the FCPA Opinion Procedure Release process is described in greater detail below). In FCPA Op. Proc. Rel. 2007-01, the DOJ wrote that it would not take enforcement action against a company that wished to cover domestic travel expenses — including transportation, lodging, and meals — expected to be incurred by a six-person delegation of a foreign government in connection their visit to one of the requestor’s U.S. sites (the foreign government agreed to pay the officials’ international travel expenses). The Opinion highlighted the following facts as relevant to the DOJ’s conclusion that the requestor’s contemplated conduct would fall within the FCPA’s "promotional expenses" affirmative defense:  the foreign officials making the trip were selected by the foreign government, not the requestor; the foreign officials had no authority to make decisions that would affect the requestor’s planned operations in the foreign country; the requestor would pay all incurred expenses directly to the service providers, not to the officials, and would properly record such payments in its books and records; the air transportation to be provided by the requestor would be "economy class"; the requestor obtained a written legal opinion "that the requestor’s sponsorship of the visit and its payment of the expenses described in the request is not contrary to the law of the foreign country"; the requestor would not "fund, organize, or host any entertainment or leisure activities for the officials, nor [would] it provide the officials with any stipend or spending money"; any souvenirs to be provided to the foreign officials "would reflect the requestor’s name and/or logo and would be of nominal value"; and  the requestor would "not pay any expenses for spouses, family, or other guests of the officials."  In FCPA Op. Proc. Rel. 2007-02, the DOJ issued very similar advice to a requestor contemplating the payment of domestic travel and lodging expenses for foreign government officials already in the United States on business unrelated to the requestor. The only significant differences between FCPA Op. Proc. Rels. 2007-01 and 2007-02 are that the requestor in this instance additionally sought: to reimburse incidental expenses incurred by the visiting foreign officials "up to a modest daily minimum, upon presentation of a written receipt"; and  to provide a "modest four-hour city sightseeing tour" for the officials.  The DOJ again concluded that payment of the foreign officials’ travel expenses under these circumstances would fall within the FCPA’s "promotional expenses" affirmative defense.  On the "how not to" side of the government official travel sponsoring ledger, on December 21, 2007, the DOJ and SEC announced FCPA books-and-records and internal controls settlements with Lucent Technologies, Inc., a global telecommunications provider that merged with Alcatel SA in November 2006. The settlement documents allege that, between 2000 and 2003, Lucent spent more than $10 million sponsoring 315 trips for approximately 1,000 Chinese government officials. The majority of these trips were ostensibly designed to allow officials before whom Lucent had pending or expected tenders to inspect Lucent’s factories or to train Chinese officials with whom Lucent had ongoing contracts on how to use Lucent equipment. In fact, the Chinese government officials spent little to no time visiting Lucent’s facilities — indeed, for much of the relevant period Lucent had relocated its production facilities to countries, including China, other than where the travel was provided — and instead spent the majority of these trips visiting popular tourist destinations in Australia, Canada, Europe, and many locations within the United States, including Disney World, the Grand Canyon, Hawaii, Las Vegas, and Niagara Falls. Each trip typically lasted fourteen days and cost Lucent between $25,000 and $55,000. In connection with some of these trips, Lucent additionally provided between $500 and $1,000 per day to the traveling foreign officials as a "per diem," even though Lucent was already funding all of the officials’ travel expenses. And Lucent’s funding of these trips was so transparently gratuitous to at least one Chinese official, that he even requested (and Lucent agreed) that Lucent pay $21,000 to cover the costs of him obtaining his MBA in lieu of paying for him to attend one of the trips.  Although the conduct described in the settlement documents arguably implicates the FCPA’s anti-bribery provisions — the DOJ and SEC have previously charged corporate largesse through gratuitous travel sponsorship as anti-bribery violations — Lucent was only alleged to have improperly recorded the expenses and to have failed to maintain a system of internal controls. For example, Lucent allegedly booked many of the trips to a "Factory Inspection Account," even where the officials did not visit a Lucent factory at any time during the trip. With regard to Lucent’s internal controls, the settlement documents allege that Lucent "failed, for years, to properly train its officers and employees to understand and appreciate the nature and status of its customers in China in the context of the FCPA."  Lucent’s settlements, through which it will pay a $1.5 million civil penalty to the SEC and a $1 million fine to the DOJ, resolve a longstanding investigation into Lucent’s travel practices in China. According to Lucent’s public filings, the company nearly went to the mat on this investigation, receiving a "Wells" notice from SEC Staff in September 2006 and submitting a written response to the Commission in late 2006. Another interesting aspect of the settlement is that the DOJ’s non-prosecution agreement, which typically resolves all of a company’s outstanding FCPA liabilities, expressly provides that it does not cover the DOJ’s ongoing investigation of pre-merger Alcatel SA activities in "Costa Rica and elsewhere." Alcatel’s former Country Manager for Costa Rica, Edgar Acosta, was indicted on FCPA charges in March 2007, and its former Director of Latin American Sales, Christian Sapsizian, who was originally indicted on FCPA charges in 2006, pleaded guilty in June 2007.  Transactional Due Diligence With the recent upsurge in global M&A activity coinciding with that of FCPA enforcement, the FCPA has become a central issue in transactional due diligence. So much so that Alice Fisher made the topic a centerpiece of a recent speech she gave on the FCPA, advising that there are five questions that every acquirer will want to know, at a minimum, about a prospective target before it closes on an acquisition: "The extent to which the company’s customers are government entities, including state-owned companies; "Whether the company is involved in any joint ventures with government entities; "What government approvals and licenses the company needs to operate abroad, how it obtained them, and when they require renewal; "The company’s requirements relating to Customs in foreign countries and how it fulfills those requirements; and "The company’s relationships with third party agents or consultants who interact with foreign officials on the company’s behalf, including how those agents were chosen and vetted by the company."  Nearly half of the corporate FCPA enforcement actions of 2007 implicated some aspect of M&A activity. For example, Delta & Pine Land Co. and York International Corp. each settled FCPA enforcement actions in 2007 shortly after being acquired by, respectively, Monsanto Co. and Johnson Controls, Inc. Interestingly, Delta & Pine’s pre-merger SEC filings suggest that it had identified the FCPA issue forming the basis for the SEC’s administrative cease-and-desist order — the provision of approximately $43,000 in cash, travel expenditures, and office furniture, among other items, to Turkish Ministry of Agriculture officials to influence them in providing Delta & Pine with regulatory approvals — years prior the Monsanto acquisition. But Delta & Pine determined that the payments did not violate the FCPA, perhaps because it believed that they fit within the "facilitating payments" exception to the FCPA’s anti-bribery provisions, and accordingly did not report the conduct to the DOJ or SEC. But when Monsanto discovered these payments in the course of pre-acquisition due diligence, it required Delta & Pine to report the conduct to the DOJ and SEC, ultimately leading to a post-closing FCPA settlement.  Commenting on the York International settlement, Mark Mendelsohn recently noted that counsel for Johnson Controls actively participated in settlement negotiations with the DOJ and SEC, and that while there was "recognition around the table" that the matter would be settled, the "big issue was to ensure York was the settling party; not Johnson Controls." Mr. Firestone added that the SEC is likewise sensitive to issues such as who the settling party will be in the context of a merger.  For additional guidance on the topic of transactional due diligence, please see the article by F. Joseph Warin, et al., Acquisition Due Diligence: A Recipe to Avoid FCPA Enforcement, TEXAS STATE BAR OIL, GAS, & ENERGY RESOURCES LAW SECTION REPORT 2 (June 2006).  The Pain Continues — FCPA-Inspired Civil Litigation  Although the FCPA does not grant a private cause of action, several federal district courts have recently refused to dismiss § 10(b) actions based on allegedly false and misleading statements regarding FCPA violations made in companies’ financial statements. These courts have held that the plaintiffs met the heightened pleading requirement for fraud under the Private Securities Litigation Reform Act ("PSLRA").  Continuing this trend, on September 18, 2007, the U.S. District Court for the Middle District of Florida decided two motions to dismiss a securities class action arising, in part, from alleged FCPA violations by FARO Technologies, Inc. The class action complaint named as defendants FARO, several individual FARO employees, and FARO’s auditor, Grant Thornton ("GT"). The complaint made various allegations of fraud, including a claim that the company overstated income by including sales resulting from FCPA violations and a claim that the company falsely stated that its system of internal controls was adequate. In the court’s decision, it adopted a magistrate judge’s recommendation to deny FARO’s motion to dismiss the plaintiffs’ second amended complaint. The magistrate judge found that the complaint sufficiently alleged that the individual employees’ knowledge of unlawful payments should be imputed to FARO and that FARO and the individual defendants "knowingly or recklessly attested to the adequacy of the internal controls system, when they knew that the system was, in fact, seriously inadequate." In contrast, the magistrate judge recommended that the court grant GT’s motion to dismiss because GT did not actively participate in the fraudulent activities alleged against FARO, nor did GT have knowledge of FARO’s inadequate internal controls. In addition, despite the existence of some "red flags," the magistrate judge found that GT was not reckless in failing to detect FARO’s inadequate controls and fraudulent activity. Accordingly, the court granted GT’s motion to dismiss on the magistrate judge’s recommendation. In May 2007, following a denial of its motion to dismiss, Georgia-based medical equipment manufacturer Immucor, Inc. agreed to settle a similar class action for $2.5 million. In denying Immucor’s motion to dismiss, the district court held that the "weaknesses [in Immucor’s internal controls] could have lead [sic] . . . to liability under the FCPA and impacted the value of Immucor’s stock. The Court cannot rule as a matter of law that Immucor’s misstatement of those weaknesses was not material." Then on September 27, 2007, just one day after the district court approved the class action settlement, Immucor and its President, Gioacchino De Chirico, entered into administrative settlements with the SEC charging them with violating the FCPA’s anti-bribery, books-and-records, and internal controls provisions and ordering them to cease-and-desist from future violations of the same. There was no financial penalty imposed upon Immucor or De Chirico.  On September 19, 2007, in the U.S. District Court for the District of Columbia, a public pension system based in Michigan filed a derivative lawsuit related to alleged FCPA violations against BAE Systems PLC. The lawsuit claims that BAE’s officers and directors encouraged and permitted the company’s managers to make and authorize more than $2 billion in bribes and kickbacks to win lucrative contracts in violation of the FCPA and other foreign anti-corruption laws. The complaint alleges that this conduct constituted an intentional, reckless, and negligent breach of the directors’ and officers’ fiduciary duties to the company. In addition, the plaintiff shareholder claims that the defendants misrepresented the quality and effectiveness of the company’s compliance program.  Litigation continues in two shareholder derivative suits filed in May 2007 against certain of Baker Hughes, Inc.’s current and former directors and officers. The plaintiffs allege that the defendants failed to implement adequate internal controls, policies, and procedures to prevent the conduct that gave rise to the company’s April 2007 settlements with the DOJ and SEC.  Another recent civil case, one with a particularly peculiar fact pattern, demonstrates yet another way in which civil liability can follow from alleged FCPA violations. In March 2006, the Government of the Dominican Republic and the Secretariat of State for the Environment and Natural Resources of the Dominican Republic filed a lawsuit in the U.S. District Court for the Eastern District of Virginia against AES Corporation ("AES"), which is based in Virginia, several of its subsidiaries, and an independent contractor. The complaint alleges that the defendants conspired to dump hazardous coal ash on two beaches in the Dominican Republic, resulting in ecological destruction and undermining the physical and economic health of local communities. In addition to allegations that the defendants violated various environmental laws and the Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and Their Disposal, the Dominican Government asserted that the defendants violated the FCPA and the Racketeer Influenced and Corrupt Organizations Act by approving the payment of bribes to Dominican officials to allow the dumping to occur. Further, the complaint alleges that after a Dominican District Attorney attempted to halt the dumping, he was himself offered a bribe and, when he refused, subjected to an attempted physical assault, an attempted firebombing of his car, and death threats before ultimately being fired by corrupt Dominican officials. The complaint asserts that the defendants all knew about and ratified these activities. Interestingly, the Dominican government conceded that corruption was so problematic in its own judiciary that it sought relief in a U.S. court because of concerns that the defendants would purportedly resort to further bribery to win a case brought in its home country. In February 2007, one week before trial, AES settled the case for $6 million. In short, corporations and their directors and officers must not overlook the third member of the FCPA Trifecta: the DOJ, the SEC, and the civil litigant.  2007 DOJ Opinion Procedure Releases By statute, the DOJ is required to provide a written opinion at the request of an "issuer" or "domestic concern" as to whether the DOJ would prosecute the requestor under the FCPA’s anti-bribery provisions for prospective conduct that the requestor is considering taking. These opinions are published on the DOJ’s FCPA website, but only a party who joins in the request may officially rely upon the opinions.  In the FCPA’s thirty-year history, the DOJ has issued but forty-seven such written opinions, including three in 2007. In 2006, Alice Fisher commented that "the FCPA opinion procedure has generally been under-utilized" and noted she wants it "to be something that is useful as a guide to business." The three opinion releases issued in 2007 are the most issued in a single year since 2004, when the DOJ issued four releases. The first two of these releases were described above in the Sponsoring Travel Section; the third is described below.  FCPA Op. Proc. Rel. 2007-03 The DOJ issued its final FCPA Opinion Procedure Release of 2007 on December 21. In this Opinion, the requestor sought to make a $9,000 "advance payment" required by a family court judge in a foreign country to cover administrative costs expected to be incurred by the court in administering a dispute over the estate of a deceased relative of the requestor. The requestor represented that she had obtained a written opinion from a lawyer with law degrees in both the United States and the foreign country that the payment she sought to make was not only not contrary to, but explicitly provided for, under the foreign country’s laws. The requestor further represented that the payment would be made directly to the clerk’s office of the family court, not to the foreign judge presiding over the dispute. The DOJ concluded that the proposed payment would be lawful under two grounds: (1) the payment "will be made to a government entity, the court clerk’s office, rather than a foreign official" and "there is nothing to suggest that the presiding judge . . . will personally benefit from the funds after they are paid into the government account"; and (2) the payment is contemplated under the local law of the foreign country so it falls under the FCPA’s "lawful under the written laws and regulations" of the foreign country affirmative defense.  2007 FCPA Enforcement Litigation  United States v. Kay On October 24, 2007, the United States Court of Appeals for the Fifth Circuit issued a much awaited opinion concerning the scope of the FCPA. In United States v. Kay, the court held that payments to foreign officials made to reduce customs duties and taxes, thereby helping the payer gain a competitive advantage in the marketplace, may violate the FCPA’s prohibition on payments made to "obtain or retain business." During the 1990s, David Kay and Douglas Murphy, executives at American Rice, Inc. ("ARI"), paid bribes to various Haitian officials, allowing ARI to avoid paying certain customs duties and taxes on its rice imports. In 2002, following a disclosure to the SEC, Kay and Murphy were indicted, but the district court granted their motion to dismiss the indictment, "concluding that payments to foreign government officials made for the purpose of reducing customs duties and taxes do not fall under the scope of obtaining or retaining business pursuant to the text of the FCPA." In 2004, the Fifth Circuit reversed that decision, holding that "bribes paid to foreign officials in consideration for unlawful evasion of customs duties and sales taxes could fall within the purview of the FCPA’s proscription" provided that the "bribery was intended to produce an effect — here, through tax savings — that would assist in obtaining or retaining business." (Emphasis in original). After Kay and Murphy were found guilty at trial, they moved to dismiss and arrest judgment, renewing their argument based on lack of fair warning. The district court judge denied the motion, and Kay and Murphy appealed to the Fifth Circuit on the ground that application of the Fifth Circuit’s prior opinion on the scope of the FCPA violated the Due Process Clause by denying them fair notice that their conduct was illegal. The Fifth Circuit considered four standards for fair notice, ultimately concluding that Kay and Murphy’s convictions met each standard. First, the court noted that although the FCPA’s "obtain or retain business" provision was "imprecise general language," the FCPA did not violate the prohibition against vagueness because the defendants viewed their payments as measures necessary to keep up with competitors — i.e., to obtain or retain business — and thus a man of common intelligence would have understood that the defendants were "treading close to a reasonably-defined line of illegality." Second, the court explained that when the district court determined that the facts of the case fell within the FCPA’s prohibitions, it did not extend the FCPA beyond its explicit terms and thereby violate the prohibition on retroactive application of a novel interpretation of a statute, because "[t]he explicit terms of the FCPA do not include either language relating specifically to contracts or defining more general business practices that may fall under the [FCPA’s] business nexus test." Third, the court held that the mere fact that the FCPA "contained an ambiguous provision" did not mean that it was void for vagueness, and the relative dearth of prosecutions under the FCPA of individuals for the "narrow type of payment" at issue in the case did not permit Kay and Murphy to argue that they "were unaware of the boundaries of illegality under the [FCPA] in the 1990s." Finally, the court held that the rule of lenity, which "ensures fair warning by so resolving ambiguity in a criminal statute as to apply it only to conduct clearly covered," did not apply, because the rule permits use of legislative history to resolve ambiguity, and "the mere possibility of articulating a narrower construction of an act . . . does not by itself make the rule of lenity applicable."  The Fifth Circuit also held that the district court’s jury instructions, which required that the defendants have committed the act "voluntarily and intentionally" and "with a bad purpose or evil motive of accomplishing either an unlawful end or result, or a lawful end or result by some unlawful method or means," met the common law definition of "willfully," by requiring that a defendant know he is committing the act itself, and know that it is "in some way wrong." The court expressly declined to include a third requirement — that the defendant "knew that he was violating the specific provisions of a law" — thus agreeing with prior Second Circuit precedent in limiting the requirement of such specific knowledge to "highly technical exceptional statutes" such as federal tax laws, reiterating the traditional rule for criminal willfulness: "ignorance of the law is no excuse." The Fifth Circuit affirmed the convictions of both defendants. The Kozeny Cases On June 21, 2007, Judge Shira Scheindlin of the U.S. District Court for the Southern District of New York dismissed all FCPA counts pending against Frederic Bourke and David Pinkerton on statute-of-limitations grounds. Along with Viktor Kozeny, Bourke and Pinkerton were indicted on May 12, 2005 for allegedly participating in a massive scheme to bribe government officials in Azerbaijan. The three men allegedly bribed government officials to ensure that they would privatize Azerbaijan’s state-owned oil company, thus allowing Kozeny, Bourke, Pinkerton, and others to share in the anticipated profits arising from that privatization. Judge Scheindlin later reinstated several of the FCPA counts on July 16, 2007, though the reasoning for her opinion did not change.  Pinkerton and Bourke had moved to dismiss the FCPA counts as time-barred (Kozeny, who has thus far refused to submit to U.S. jurisdiction, did not join in the motion). The DOJ had previously sought and received a court order tolling the statute of limitations under 18 U.S.C. § 3292, which permits the United States to obtain such orders for up to three years while it pursues an official request to obtain evidence located in a foreign country. Although the DOJ filed the official request at issue in this case with the governments of the Netherlands and Switzerland within the five-year statute-of-limitations period, it did not obtain the § 3292 court order until after the statute of limitations had run. Judge Scheindlin held that it is the court order, not the application with the foreign government, that tolls the statute of limitations under 18 U.S.C. § 3292. The DOJ has appealed Judge Scheindlin’s decision to the Second Circuit, which has yet to schedule oral argument.  As noted above, Kozeny has thus far refused to appear in U.S. court to answer the charges against him. He was arrested in the Bahamas and the DOJ filed an extradition application with the Bahamian courts. On October 25, 2007, after a lower Bahamian court approved the application, an intermediate appellate court overturned the extradition order, basing its decision, in part, on the failure of the U.S. government to disclose Judge Scheindlin’s decision dismissing the FCPA charges against Kozeny’s co-defendants. Kozeny has been released on $300,000 bail as the prosecution appeals the intermediate court’s ruling to the highest court in the Bahamas.  In another related case from 2007, on July 6, following the district court’s dismissal of the FCPA charges against Bourke and Pinkerton, the DOJ and SDNY jointly announced a non-prosecution agreement with hedge fund Omega Advisors, Inc. to resolve allegations surrounding its participation in the Azeri oil privatization effort. According to the agreement, Omega invested more than $100 million in companies controlled by Kozeny while knowing that he had entered into corrupt arrangements with Azeri officials giving them a financial interest in the privatization effort. Omega agreed to forfeit $500,000 in connection with its FCPA settlement.  2007 Legislation Relevant to the FCPA Two pieces of legislation relevant to the FCPA are currently pending in Congress. If either bill passes, the implications for companies subject to the FCPA could be far-reaching. On August 3, 2007, Representative Gene Green (D-TX) introduced H.R. 3405, a bill that would require all government contractors to certify, before any Executive Agency may contract with it, that they, their employees, and their agents have not violated the FCPA or analogous foreign international corruption statutes. The legislation arises from a concern that U.S. companies are at a disadvantage when competing against foreign competitors who are not bound by the FCPA. The intent of H.R. 3405 is to level that playing field somewhat by requiring all companies to certify their compliance with the FCPA before bidding on contracts with the U.S. government. Several companies have criticized the bill because it would render them unable to make the requisite certification and bid on a U.S. government contract if they have ever violated the FCPA in the past, even if the past violations were voluntarily disclosed, fully investigated, and prosecuted by the government. The bill could also require all government contractors to notify the government of previously undisclosed past violations of the FCPA. H.R. 3405 remains in the House Subcommittee on Government Management, Organization, and Procurement, where it was referred in September 2007. On November 13, 2007, the House passed H.R. 3013, a bill that would prohibit federal prosecutors and agents from demanding, requesting, or conditioning treatment based on a company’s disclosure of, or refusal to disclose, privileged attorney-client communications or attorney work product. H.R. 3013 would also prohibit federal prosecutors and agents from conditioning a charging decision on such disclosures or using any such disclosures as a factor in determining whether a company has cooperated with the government. This legislation is a response to the "culture of waiver" that has been created by recent policy guidance issued by the DOJ that treats companies more harshly if they do not waive the attorney-client privilege and work product protections.  H.R. 3013 would apply in all situations in which the government investigates and prosecutes a company, but the issue of waiver arises frequently in the context of FCPA investigations. In many cases, a company that has voluntarily disclosed allegedly improper payments to the DOJ or the SEC will conduct its own internal inquiry of the conduct and then cooperate with the government’s investigation to receive favorable treatment. In the past, the government expected that companies in such a position would waive privilege to gain the full benefits of cooperating with the government. The House Report discussing H.R. 3013 discusses the importance of the attorney-client privilege and the work product doctrine, concluding that "[t]he clear thrust of [the DOJ’s] new policies is that waiver is required to get ‘cooperation’ credit, a crucial element in charging decisions." Accordingly, H.R. 3013 tries to "strike a balance between the promotion of effective law enforcement and compliance effort . . . and the preservation of essential legal protections."  On November 14, 2007, H.R. 3013 was referred to the Senate Judiciary Committee. In September 2007, the Senate Judiciary Committee held hearings on S. 186, a bill that is identical to the version of H.R. 3013 that was first introduced in the House, but there has been no further action.  2008 Litigation Docket A collateral consequence of the drastic upswing in the prosecution of individual defendants for alleged FCPA violations is almost certain to be an increase in litigated FCPA cases, of which there are but a handful in the statute’s thirty-year history. Without the same complex mix of public relations and other collateral concerns that pressure many corporate defendants to settle — call it the Arthur Andersen Effect — not to mention the motivation of literally fighting for their freedom, individual defendants have traditionally been more willing to put the government to its burden at trial. Look for at least one of the below pending cases to see a jury in 2008: United States v. William J. Jefferson — Allegations described above, the trial proceedings are presently scheduled to begin before Judge T.S. Elliot III in the U.S. District Court for the Eastern District of Virginia on February 25, 2008. A potential trial derailment factor may be the DOJ’s recent petition for certiorari from an adverse decision of the D.C. Circuit Court of Appeals suppressing certain evidence seized in a search of Jefferson’s congressional office on Speech or Debate Clause grounds.  United States v. Leo W. Smith — Smith, a co-founder of California-based military equipment manufacturer Pacific Consolidated Industries LP, was indicted on April 25, 2007 on FCPA anti-bribery, money laundering, and tax offenses stemming from an alleged ten-year conspiracy whereby Smith made more than $300,000 in bribe payments to an official of the United Kingdom’s Ministry of Defence in return for the award of U.K. Royal Air Force contracts collectively worth more than $11 million for his employer. Smith was arrested on June 18, 2007, has pleaded not guilty to all charges, and is presently scheduled to go to trial before Judge Andrew Guilford in the U.S. District Court for the Central District of California on April 1, 2008. United States v. Frederic Bourke and David Pinkerton — As described above, Judge Shira Scheindlin of the U.S. District Court for the Southern District of New York dismissed some, but not all, of the FCPA charges pending against Bourke and Pinkerton on statute-of-limitations grounds. The DOJ has appealed Judge Scheindlin’s ruling to the Second Circuit, but in a recent court filing, she nonetheless insisted on keeping a March 3, 2008 status hearing to discuss a trial date for the remaining counts. And, as noted above, Victor Kozeny’s indictment remains outstanding should the United States be successful in its extradition application.  United States v. Gerald and Patricia Green — Gerald Green, a Los Angeles film company executive, and Patricia Green, Gerald’s wife and business partner, were both arrested on December 18, 2007 on the basis of a criminal complaint charging them with conspiring to violate the FCPA’s anti-bribery provisions by paying more than $1.7 million to a Thailand Tourism Authority official to persuade the official to award the Green’s businesses contracts to run the annual Bangkok International Film Festival. A trial date has yet to be scheduled.  SEC v. Yaw O. Amoako, Steven J. Ott, Roger M. Young — Amoako, Ott, and Young all pleaded guilty to criminal FCPA anti-bribery violations in 2007 arising from their conduct while employed by ITXC Corp. But all additionally have pending civil FCPA actions that were brought by the SEC in 2005 and 2006 and stayed during the pendency of the criminal prosecutions. In a December 2007 status report, the DOJ advised the court that the SEC expected Commission action on a settlement proposal for Ott and Young by January 31, 2008. Amoako’s status is less certain, as his attorney recently successfully sought to be removed on the grounds that Amoako has refused to pay accrued legal fees.  SEC v. Roy Fearnley — When the SEC filed a settled civil action with Baker Hughes, Inc. in April 2007 (described above), it also filed a contested complaint against Fearnley, a former Baker Hughes Business Development Manager, charging him with FCPA anti-bribery violations and aiding and abetting his former employer’s violations of the FCPA’s books-and-records and internal controls provisions. Fearnley, a U.K. citizen last known to reside in Kazakhstan, has not answered the SEC’s complaint.  United States v. Edward V. Acosta — As noted above, Acosta, former Senior Costa Rican Country Manager for Alcatel SA, was indicted on criminal FCPA anti-bribery charges in March 2007. In June 2007, the U.S. District Court for the Southern District of Florida transferred Acosta to fugitive status.  Guidance China, China, China — The Perils of Doing Business China remains a high-risk environment for conducting business in compliance with the FCPA. In 2007 alone, the DOJ and SEC brought FCPA cases against Si Chan Wooh and Robert W. Philip, both formerly of Schnitzer Steel Industries, Inc. (which itself settled FCPA charges in 2006); Lucent Technologies, Inc.; York International Corp.; and Paradigm B.V.; all stemming from allegedly improper conduct in China. These five FCPA actions in 2007 nearly doubled the number involving China from the previous three years combined. Ranked seventy-second on Transparency International’s 2007 Corruption Perceptions Index, corruption is rampant in China, and Chinese government officials routinely seek free meals, gifts, entertainment, cash-equivalent vouchers, and sponsored travel opportunities. According to the U.S.-China Business Council, "[s]o tightly knit are corrupt practices into the fabric of modern Chinese society that they are almost invisible. . . . For businesspeople, corrupt practices have layered cost upon cost, as each government organization with any say over a given deal has to be negotiated with, cajoled, and managed in order to fend off the rent-seeking behavior."  China’s layered government enhances this already corrupt environment. Businesses seeking licenses are forced to deal with several layers of government and several agencies within each layer. Recent central government anti-corruption reforms have not affected local customary practice. Moreover, in China, the intersection of private and governmental business makes it difficult to identify foreign officials. For instance, many businesspeople also hold governmental positions; and many major businesses are state-owned or state-controlled. It is typical for an ex-government official who remains a Communist Party member and maintains continuing ties to the government to serve as a "consultant." Further, as a multitude of cases and settlements have made clear, the definition of "foreign official" is broad indeed, encompassing airport officials (InVision Technologies, Inc.), physicians and lab employees at government-owned hospitals (Diagnostic Products Corp.), and employees of China National Offshore Oil Company (Paradigm B.V.). China is especially dangerous because the line between bona fide business expenses and corruption is not well-defined. For instance, the network of connections built on personal relationships (guanxi) is essential for successful business in China. Yet, access to that network often requires providing gifts, meals, and entertainment. Additionally, gifts for Chinese holidays, like Chinese New Year and the Mid-Autumn Festival, can also blur the line. The difference between traditional gifts (e.g., mooncakes) and cash gifts — even those of lesser value — can mean the difference between a mere symbolic gesture and a bribe. Of more recent note, officials are increasingly requesting "good works" marketing, in which funds are redirected to community projects in exchange for business. These cultural and community pressures make doing business in China a precarious proposition. Conclusion As the mix of revenues for U.S. corporations increasingly shifts abroad, and as foreign corporations increasingly take advantage of U.S. securities markets, the challenges of navigating foreign environments in compliance with the FCPA continually increase. The pitfalls for even the most compliance conscious corporations are substantial. A quick "top-ten" checklist to bolster FCPA compliance should include: 1. Clearly articulated policy against violations of the FCPA and foreign anti-bribery laws; 2. Appropriate disciplinary procedures to address compliance violations;  3. Regular FCPA training for, with mandatory compliance certifications by, employees and third-party representatives;  4. Careful pre-retention scrutiny of all third-party representatives; 5. Senior management oversight of third-party representatives post-retention;  6. Inclusion of anti-corruption representations and undertakings, with audit and termination rights, in all third-party representative agreements; 7. Anonymous "Helpline" reporting system; 8. Centralization of accounting systems to achieve corporate headquarters-review of all financial transactions (i.e., follow the money);  9. Thorough pre-acquisition due diligence of prospective targets, with a particularized focus on the FCPA and analogous foreign anti-bribery laws; and  10. Immediate integration of recently acquired subsidiaries to assure that the new entity is effectively bathed in the compliance culture of the acquirer.    Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. We have more than 20 attorneys with substantive FCPA expertise. Joe Warin, a former federal prosecutor, currently serves as a compliance consultant pursuant to a DOJ and SEC enforcement action. The firm has 20 former Assistant U.S. Attorneys and DOJ attorneys. Please contact the Gibson Dunn attorney with whom you work, or any of the following: Washington, D.C. F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com)  Daniel J. Plaine (202-955-8286, dplaine@gibsondunn.com) Judith A. Lee (202-887-3591, jalee@gibsondunn.com) David P. Burns (202-887-3786, dburns@gibsondunn.com)  Jim Slear (202-955-8578, jslear@gibsondunn.com)Michael S. Diamant (202-887-3604, mdiamant@gibsondunn.com)John W.F. Chesley (202-887-3788, jchesley@gibsondunn.com)Patrick F. Speice, Jr. (202-887-3776, pspeicejr@gibsondunn.com) New YorkLee G. Dunst (212-351-3824, ldunst@gibsondunn.com)James A. Walden (212-351-2300, jwalden@gibsondunn.com)Alexander H. Southwell (212-351-3981, asouthwell@gibsondunn.com) DenverRobert C. Blume (303-298-5758, rblume@gibsondunn.com)J. Taylor McConkie (303-298-5795, tmcconkie@gibsondunn.com) Orange CountyNicola T. Hanna (949-451-4270, nhanna@gibsondunn.com) Los AngelesDebra Wong Yang (213-229-7472, dwongyang@gibsondunn.com), the former United States Attorney for the Central District of California.  © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice. 

July 7, 2008 |
2008 Mid-Year FCPA Update

The frenetic pace of Foreign Corrupt Practices Act ("FCPA") enforcement set in 2007 has carried through the first half of 2008.  Mid-year prosecutions are up – substantially so – from last year’s record-setting totals.  And corporate disclosures and media reports of ongoing investigations evidence that this trend of continually increasing enforcement is here to stay for the near future.  This client update provides an overview of the FCPA and other foreign bribery enforcement activities during the first half of 2008, a discussion of the trends we see from that activity, and practical guidance to help companies avoid or limit liability under these laws.  A collection of Gibson Dunn’s publications on the FCPA, including prior enforcement updates and more in-depth discussions of the statute’s complicated framework, may be found on our FCPA website. FCPA Overview The FCPA’s anti-bribery provisions make it illegal to offer or provide money or anything of value to officials of foreign governments or foreign political parties with the intent to obtain or retain business.  The anti-bribery provisions apply to "issuers," "domestic concerns," and "any person" that violates the FCPA while in the territory of the United States.  The term "issuer" covers any business entity that is registered under 15 U.S.C. § 78l or that is required to file reports under 15 U.S.C. § 78o(d).  In this context, the approximately 1,500 foreign issuers whose American Depository Receipts ("ADRs") are traded on U.S. exchanges are "issuers" for purposes of this statute.  The term "domestic concern" is even broader and includes any U.S. citizen, national, or resident, as well as any business entity that is organized under the laws of a U.S. state or that has a principal place of business in the United States. In addition to the anti-bribery provisions, the FCPA’s books-and-records provision requires issuers to make and keep accurate books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the issuer’s transactions and disposition of assets.  Finally, the FCPA’s internal controls provision requires that issuers devise and maintain reasonable internal accounting controls aimed at preventing and detecting FCPA violations.  Regulators have frequently invoked these latter two sections – collectively known as the accounting provisions – in recent years when they cannot establish the elements of an anti-bribery prosecution.  Because there is no requirement that a false record or deficient control be linked to an improper payment, even a payment that does not constitute a violation of the anti-bribery provision can lead to prosecution under the accounting provisions if inaccurately recorded or attributable to an internal controls deficiency.  2008 Mid-Year Figures The continuing explosion of FCPA prosecutions during the first half of 2008 is best captured in the following chart and graph, which each track the number of FCPA enforcement actions filed by the DOJ and SEC during the past five years.  In these first six months, there have been more FCPA prosecutions than in any other full year prior to 2007.  And although the careful reader will notice that year-to-date numbers are less than half of 2007’s record numbers, by this point last year the DOJ and SEC had filed 5 and 4 enforcement actions, respectively, substantially fewer than we have seen thus far in 2008.  2008(through June 30) 2007 2006 2005 2004 DOJ7 SEC9 DOJ18 SEC20 DOJ7 SEC8 DOJ7 SEC5 DOJ2 SEC3   2008 Mid-Year Enforcement Docket Westinghouse Air Brake Technologies Corp. On February 14, the DOJ and SEC announced settlements with Westinghouse Air Brake Technologies Corp. ("Wabtec") resolving allegations that Wabtec violated the anti-bribery and accounting provisions of the FCPA.  The SEC’s complaint and administrative order allege that Wabtec’s Indian subsidiary, Pioneer Friction Ltd., made $137,400 in improper payments to officials of the Indian Railway Board.  Pioneer allegedly made these payments to influence the Board to award it new contracts to supply brake blocks and to approve Pioneer’s pricing proposals for existing contracts.  Pursuant to the SEC settlement, Wabtec agreed to pay an $87,000 civil penalty, to disgorge $288,351 in profits plus prejudgment interest, and to retain an independent compliance monitor to review and make recommendations concerning the company’s FCPA compliance program for two years.  The DOJ’s non-prosecution agreement with Wabtec additionally alleges that Pioneer made improper payments to various railway regulatory boards to facilitate the scheduling of product inspections and the issuance of compliance certificates and to the Central Board of Excise and Customs to put an end to excessively frequent audits.  Although these payments totaled more than $40,000 over the course of one year, individual payments were as miniscule as $67 per product inspection and $31.50 per month to lower the frequency of Pioneer’s audits.  To resolve these allegations, Wabtec agreed to pay a $300,000 fine and conduct an internal review of its FCPA compliance program.  The Wabtec case, in particular the non-prosecution agreement, paints a sobering picture of the DOJ’s view of the facilitating payments exception to the FCPA, arguably to the point of reading the exception out of the statute.  Companies that permit facilitating payments as a matter of corporate policy should carefully consider this settlement.  Flowserve Corp. On February 21, Flowserve Corp. became the seventh company to settle with the DOJ and SEC for its conduct under the United Nations Oil-for-Food Program.  Although we have described the Oil-for-Food scheme in greater detail in prior updates, the essential allegations (as they concern the "Humanitarian" side of the Program) are that the Iraqi government imposed a 10% "after sales service fee" ("ASSF") as a condition of sales under the Program.  To fund these mandatory payments, contractors typically increased the value of their contracts by 10%, thereby receiving an additional 10% from the United Nations escrow account, and passed the increase on to the Iraqi government through third-party agents and Iraqi-controlled bank accounts.   The SEC’s complaint alleges that Flowserve violated the FCPA’s books-and-records and internal controls provisions through the incorporation into its ledger of $646,487 in inaccurately recorded ASSF payments made (and $173,758 in additional ASSF payments agreed to but not paid) by its French and Dutch subsidiaries, Flowserve Pompes SAS and Flowserve B.V.  To settle these allegations, Flowserve agreed to pay a $3 million civil penalty and to disgorge $3,574,225 in profits plus prejudgment interest.  Flowserve’s settlement with the DOJ was limited to the conduct of its French subsidiary, Flowserve Pompes, as the DOJ (in a fascinating move described in greater detail below) declined prosecution of Flowserve B.V. in recognition of a pending home state prosecution of that subsidiary in the Netherlands.  Flowserve entered into a deferred prosecution agreement with the DOJ, paying a $4 million criminal penalty, and consented to the filing of a criminal information charging Flowserve Pompes with conspiracy to commit wire fraud and to violate the books-and-records provision.  Assuming Flowserve’s successful compliance with the deferred prosecution agreement’s terms, the DOJ will defer prosecution of Flowserve Pompes for the agreement’s three-year term and ultimately dismiss the charges.    AB Volvo One month later, on March 20, AB Volvo became the eighth company to settle with the DOJ and SEC on Oil-for-Food charges.  Alleging essentially the same scheme as with Flowserve, the SEC’s complaint charges AB Volvo with violations of the books-and-records and internal controls provisions through the incorporation into its ledger of $6,309,695 in inaccurately recorded payments made (and $2,388,419 in additional payments agreed to but not paid) by its French and Swedish subsidiaries, Renault Trucks and Volvo CE.  To settle these allegations, AB Volvo agreed to pay a $4 million civil penalty and to disgorge $8,602,649 in profits plus prejudgment interest.  To resolve the DOJ’s investigation, AB Volvo entered into a deferred prosecution agreement and agreed to pay a $7 million criminal fine.  It also consented to the filing of criminal informations against its two implicated subsidiaries, each alleging a conspiracy to commit wire fraud and to violate the books-and-records provision.  As with the Flowserve settlement, assuming AB Volvo successfully completes the three-year term of its deferred prosecution agreement, the DOJ will dismiss the charges against Renault Trucks and Volvo CE.  It is a virtual certainty that AB Volvo’s will not be the last of the Oil-for-Food settlements – likely not even the last of 2008.  At least a dozen other companies have publicly disclosed ongoing Oil-for-Food investigations by the DOJ and SEC in their securities filings.  And in announcing this most recent settlement, then-Assistant Attorney General Alice Fisher noted that the DOJ "will continue its pursuit of companies that abused the U.N. Oil for Food program."  Martin Self On May 2, Martin Self pleaded guilty to a two-count criminal information charging him with violating the anti-bribery provision of the FCPA.  Mr. Self was the President and a part owner of Pacific Consolidated Industries ("PCI").  According to the plea agreement, Mr. Self caused PCI to execute a "marketing agreement" with a relative of a United Kingdom Ministry of Defence ("UK-MOD") official and subsequently caused the payment of approximately $70,350 to the relative pursuant to the agreement.  The problem, according to the charging documents, was that Mr. Self was not aware of any genuine services that the relative provided for PCI and, in fact, Mr. Self believed that the payments were truly for the benefit of the UK-MOD official, who was in a position to influence the award of equipment contracts to PCI.  Holding these beliefs, Mr. Self purposely failed to investigate and deliberately avoided becoming aware of the full nature of PCI’s relationship with the UK-MOD official’s relative.  Mr. Self is not scheduled to be sentenced until September 29, 2008, but the DOJ has publicly announced that he has agreed to serve eight months in prison as part of the plea deal.  This case is the second prosecution of a former PCI executive, the first being the 2007 indictment of Leo Winston Smith.  Mr. Smith has not settled the charges against him and is presently set to go to trial on October 7, 2008.  Additionally, the U.K. government prosecuted the U.K.-MOD official, who is now serving a two-year prison term.  Willbros Group, Inc., Lloyd Biggers, Carlos Galvez, Gerald Jansen, and Jason Steph On May 14, Willbros Group, Inc. and four of its former employees entered into a joint civil settlement with the SEC, and Willbros additionally settled criminal charges with the DOJ.  According to the SEC’s complaint, Willbros, acting through various subsidiaries and employees, including the individual defendants: agreed to make more than $11 million in corrupt payments, at least $2,869,111 of which was actually paid, to senior Nigerian officials, the ruling Nigerian political party, and officials of a commercial joint venture operator to influence the award of several major pipeline contracts collectively worth more than $600 million; made at least $300,000 in corrupt payments to Nigerian revenue officials to lower tax assessments and judicial officials to obtain favorable treatment in litigation; agreed to make $405,000 in corrupt payments, at least $150,000 of which was actually paid, to officials of PetroEcuador, Ecuador’s state-owned oil and gas company, in order to obtain a $3.4 million pipeline modification contract; and paid $524,000 to commercial vendors in Bolivia to obtain dummy invoices that purported to increase Willbros’s subcontractor costs, thereby reducing its value-added tax ("VAT") liability to the Bolivian government by approximately $2.5 million. In summary, Willbros made approximately $3.8 million in corrupt payments, and agreed to make another $8 million in payments upon which it did not deliver, to influence the assessment of taxes, the judicial process, and the award of more than $630 million in pipeline contracts.  To settle the SEC’s complaint, which charged violations of the anti-bribery, books-and-records, and internal controls provisions of the FCPA in addition to violations of the antifraud provisions of § 10(b), Willbros agreed to disgorge $10.3 million in profits plus prejudgment interest.  Willbros additionally entered into a deferred prosecution agreement with the DOJ by which it agreed to pay a $22 million criminal penalty and consented to the filing of criminal informations against both it and its subsidiary, Willbros International, charging violations of the anti-bribery and books-and-records provisions.  Willbros will also retain an independent compliance monitor for the three-year term of the agreement.  Willbros’s combined $32.3 million settlement is thus far the largest of 2008, as well as the second largest in the FCPA’s thirty-one year history.  The SEC’s complaint also permanently enjoins the four Willbros employee defendants from future violations of the FCPA.  Additionally, Messrs. Galvez and Jansen agreed to pay civil penalties of $35,000 and $30,000, respectively.  Mr. Steph, who pleaded guilty to criminal FCPA violations arising from the same conduct in 2007, will have his civil penalty, if any, determined in conjunction with his sentencing for the criminal case later this year.  And in addition to these four Willbros defendants, a fifth, Jim Bob Brown, settled criminal and civil FCPA charges with the DOJ and SEC in 2006 and, like Mr. Steph, is awaiting sentencing.  One final noteworthy aspect of the Willbros settlement is that this case includes a criminal books-and-records prosecution unrelated to corrupt payments.  The allegations stemming from Willbros’s Bolivian tax fraud scheme are predicated on the company’s falsification of its accounts to avoid tax liability.  This potentially foreshadows a broad expansion of the DOJ’s FCPA enforcement practice.   AGA Medical Corp. On June 3, AGA Medical Corp. entered into a deferred prosecution agreement with the DOJ and consented to the filing of a two-count criminal information charging it with violating the anti-bribery provision of the FCPA as well as conspiring to violate the same.  According to the information, a high-ranking AGA officer authorized the company’s distributor to make corrupt payments to government-employed physicians in China to induce them to buy AGA products and Chinese patent officials to induce them to approve AGA patent applications.  AGA agreed to pay a $2 million criminal penalty and retain an independent compliance monitor for the three-year term of the agreement.   FARO Technologies, Inc. Exemplifying the perilous challenge of FCPA compliance in China, two days later, on June 5, the DOJ and SEC announced another China-based FCPA settlement, this one with FARO Technologies, Inc.  FARO consented to the filing of an administrative cease-and-desist order by the SEC and entered into a non-prosecution agreement with the DOJ alleging that FARO violated the anti-bribery, books-and-records, and internal controls provisions of the FCPA through the actions of its wholly owned Chinese subsidiary, FARO Shanghai Co., Ltd.  The settlement documents allege that FARO Shanghai’s country manager made $444,492 in corrupt payments, disguised as "referral fees," to various employees of Chinese state-owned or state-controlled businesses in order to obtain sales contracts.  FARO’s regional sales director for the Asia-Pacific region approved the payments, despite knowing that they were bribes and that they exposed FARO to liability, and despite explicit instruction from other FARO officers not to make such payments.  Pursuant to the non-prosecution agreement, FARO agreed to pay a $1.1 million criminal penalty and retain an independent compliance monitor for the two-year term of the agreement.  The SEC’s cease-and-desist order requires FARO to disgorge $1,850,943.32 in profits plus prejudgment interest. David Pinkerton Although not a 2008 enforcement action – David Pinkerton was indicted for his alleged role in an Azeri bribery scheme in 2005 – defense victories in FCPA cases must be celebrated when they come.  On June 30, the U.S. Attorney’s Office for the Southern District of New York moved to dismiss (which motion was granted on July 1) the charges against Mr. Pinkerton, advising, "further prosecution . . . in this case would not be in the interests of justice."  As we reported in our last update, Mr. Pinkerton and his co-defendant, Frederic Bourke, were successful in persuading Judge Shira Scheindlin to dismiss most of the charges in the indictment on statute-of-limitations grounds.  The DOJ appealed Judge Scheindlin’s decision to the Second Circuit, where the case has been briefed, argued, and is awaiting a decision, but ab initio elected to dismiss the remaining charges against Mr. Pinkerton in this motion.  The charges against Mr. Bourke, as well as his fugitive co-defendant, Victor Kozeny, are still pending.  2008 FCPA Opinion Procedure Releases (through June 30, 2008) By statute, the DOJ must provide a written opinion at the request of an "issuer" or "domestic concern" as to whether the DOJ would prosecute the Requestor under the FCPA’s anti-bribery provisions for prospective conduct that the Requestor is considering taking.  The DOJ publishes these opinions on its FCPA website, but only a party who joins in the request may authoritatively rely upon the opinions.  That said, opinion releases provide excellent – perhaps the best – insight into the DOJ’s views on the scope of the statute.  In the FCPA’s thirty-one year history, the DOJ has issued only forty-nine such opinions, including three in 2007 and two thus far in 2008.  In 2006, then-Assistant Attorney General Alice Fisher commented that "the FCPA opinion procedure has generally been under-utilized" and noted that she wants it "to be something that is useful as a guide to business."  FCPA Opinion Procedure Release 2008-01 On January 15, the DOJ issued its first FCPA opinion release of 2008.  This Opinion is unusually lengthy as compared to prior releases, and contains a myriad of details specific to the Requestor’s proposed transaction.  According to the Opinion, the Requestor sought to make an investment in a joint venture, majority-owned (56%) by an unnamed foreign government, that provides public services to foreign municipalities.  The foreign government wished to completely divest its interest in, and thereby privatize, the joint venture.  The Requestor agreed to purchase the government’s 56% interest in the joint venture, but only after the interest was first purchased by the private foreign entity that owned the minority (44%) share.  Thus, the private foreign entity would form a new company with the foreign government’s shares and then sell those shares to the Requestor. The Requestor conducted extensive pre-acquisition due diligence focused on FCPA compliance.  It considered the owner of the foreign private company to be a "foreign official" under the FCPA because he also served as general manager of the then still government-controlled joint venture.  This concerned the Requestor because it planned to purchase the shares from the general manager at a substantial premium over purchase price.  Accordingly, the Requestor sought an opinion from the DOJ that neither the projected payments to the owner of the private foreign entity nor any shares received by the owner from the divesting government entity would violate the FCPA.  It made certain representations to the DOJ, including that the foreign private company owner’s purchase of the foreign government’s shares would be lawful under the foreign country’s laws and that the owner will cease to be a "foreign official" once the private company purchased the government’s majority stake in the joint venture (i.e., before the Requestor would pay the premium purchase price). The DOJ concluded that it would not pursue an enforcement action with respect to this proposed transaction based on a number of factors.  First, the Requestor conducted reasonable due diligence of the anticipated seller of the privatized shares and would maintain the relevant documentation in the United States.  Second, the Requestor required complete transparency in the transaction and that adequate disclosures be made to the foreign government.  Third, the Requestor plans to obtain from the private foreign entity owner representations and warranties regarding past and future compliance with anti-corruption laws.  Fourth, the Requestor agreed to retain contractual rights to discontinue the business relationship if the joint venture agreement were breached for any reason, including for a violation of anti-corruption laws.  FCPA Opinion Procedure Release 2008-02  The DOJ’s second FCPA opinion release of 2008, issued on June 13, is a groundbreaking statement on an acquiror’s successor liability for FCPA violations by a target company.  The Opinion creates a framework through which U.S. acquirors might seek amnesty for pre- and even post-acquisition FCPA violations by the target, particularly in deals negotiated under the laws of foreign jurisdictions (such as the U.K.) where pre-acquisition due diligence is less open than in the United States.  The requestor, Halliburton Corp., sought to acquire Expro International Group, a publicly traded British oilfield services provider.  Halliburton’s principal competitor in the bidding, Umbrellastream, had made an unconditional bid to Expro (neither Expro nor Umbrellastream is identified in the Opinion, but both are named in numerous media accounts of the bidding war).  Halliburton represented to the DOJ that, "as a result of U.K. legal restrictions inherent in the bidding process for a public U.K. company, it has had insufficient time . . . to complete appropriate FCPA and anti-corruption due diligence."  Further, under the U.K. Takeover Code, an acquiror has no legal ability to insist upon a specified level of due diligence until after the acquisition is completed.  Accordingly, if Halliburton conditioned its bid upon satisfactory completion of pre-acquisition FCPA due diligence, Expro would be free to reject this conditional offer in favor of Umbrellastream’s unconditional bid, even if Umbrellastream offered a lower price.  Accepting the restrictive nature of U.K. due diligence procedures, the DOJ agreed to grant Halliburton a 180-day grace period post-closing during which Halliburton could self-report pre- and post-acquisition FCPA violations without itself being prosecuted, provided Halliburton adhered to a stringent post-acquisition due diligence and integration plan (described below).  Although reserving the right to proceed against Expro for any FCPA violations, the DOJ stated that it does not intend to pursue any enforcement action against Halliburton in connection with (1) the acquisition of Expro in and of itself; (2) any pre-acquisition unlawful conduct by Expro that Halliburton discloses to the DOJ within 180 days of closing; and (3) any post-acquisition unlawful conduct by Expro that Halliburton discloses to the DOJ within 180 days of closing (or within one year if, in the judgment of DOJ, the conduct cannot be fully investigated in 180 days). Five Key Takeaways from the First Half of 2008 FCPA Enforcement Beyond the frenzied nature of the prosecution environment, there are five developments in FCPA enforcement from the first half of 2008 that every general counsel of a business with international operations and every lawyer practicing in this area must key into.  They are: 1.      The outburst of civil litigation collateral to FCPA investigations; 2.      The introduction of legislation that would provide for a private right of action under the FCPA; 3.      The increasing number of foreign corruption investigations; 4.      The growing importance of FCPA due diligence in business transactions, particularly acquisitions; and 5.      Substantial jail terms for individual defendants convicted under the FCPA.   Civil Litigation Collateral to FCPA Investigations Like a broken record, our recurring advice to clients and friends has been to expect and prepare for "tag along" civil litigation when a governmental FCPA investigation becomes public.  In the first half of 2008, we have witnessed this admonition borne out as never before, with a new diversity of FCPA-inspired civil litigation theories.  Over the last few months we have seen four distinct types of collateral litigation emerge:  (1) § 10(b) securities fraud actions; (2) shareholder derivative suits; (3) lawsuits brought by foreign governments; and (4) lawsuits brought by business partners.  As we have previously reported, the first two categories – § 10(b) securities fraud and shareholder derivation actions – are not new to the FCPA world.  But FARO Technologies, Inc. has the unfortunate distinction of facing both arising from the same investigation – on top of criminal and administrative settlements with the U.S. government.  As noted previously, on June 5, FARO entered into dispositions with the DOJ and SEC through which it agreed to pay just over $2.95 million.  Only three days earlier, the U.S. District Court for the Middle District of Florida gave preliminary approval to a $6.875 million settlement resolving a § 10(b) suit filed on behalf of purchasers of FARO stock alleging that FARO "knowingly or recklessly attested to the accuracy of [its] internal controls system, when [it] knew that the system was, in fact, seriously inadequate."  And as if that were not enough, FARO is additionally in settlement negotiations with a plaintiff shareholder who filed a derivative suit on January 11, 2008.  Other companies currently engaged in shareholder derivative litigation stemming from FCPA investigations include BAE Systems PLC and Chevron Corp.  A Michigan public pension system filed suit in 2007 in federal district court in the District of Columbia against BAE’s officers and directors alleging that they breached their fiduciary duties by permitting the company’s managers to make and authorize more than $2 billion in bribes and kickbacks in violation of the FCPA and other foreign anti-corruption laws.  The defendants have moved to dismiss the complaint arguing that plaintiffs lack personal jurisdiction over the leadership of the British company and that, in any event, English law grants plaintiffs neither standing to sue nor a cause of action against BAE’s officers and directors.  The plaintiff shareholder in the Chevron matter filed suit in California state court in May 2007, just two weeks after the New York Times reported that Chevron was in settlement negotiations with the U.S. government concerning its conduct under the Oil-for-Food Program (Chevron would ultimately settle its U.S. government liability in November 2007 for $30 million).  The plaintiff ultimately converted his suit to a shareholder demand on Chevron’s Board of Directors, but a Special Committee of the Board recently declined, after investigation, to file suit against the directors.  The plaintiff shareholder has since refiled his lawsuit.     Chevron has also found itself part of a new wave of FCPA-inspired civil litigation:  one where foreign governments sue U.S. companies that allegedly corrupted the foreign government’s own officials.  On June 27, 2008, the Republic of Iraq filed suit in Manhattan federal district court against ninety-one companies and two individuals alleging that the defendants conspired with Saddam Hussein’s regime to corrupt the Oil-for-Food Program by diverting as much as $10 billion in funds intended for the humanitarian use of the Iraqi people to the illicit use of Hussein’s government.  Iraq claims, inter alia, that the defendants violated the Racketeering Influenced Corrupt Organizations ("RICO") Act, with mail fraud, wire fraud, money laundering, and violations of the Travel Act constituting the necessary predicate violations.  In addition to Chevron, ten other defendants named by the Republic of Iraq have already settled with U.S. government regulators for allegations arising from the Oil-for-Food Program.  Iraq’s Oil-for-Food lawsuit follows closely on the heels of another RICO action filed by a foreign government, that brought by the Kingdom of Bahrain against Alcoa, Inc.  Bahrain’s state-owned aluminum smelter, Aluminum Bahrain ("Alba"), filed suit in federal district court in Pittsburgh on February 27 alleging that Alcoa and its affiliates conspired to corrupt one or more of Alba’s senior officials, influencing the officials to cause Alba to pay inflated prices for Alcoa’s products and to favor the sale of a controlling interest in Alba to Alcoa.  Alba is seeking more than $1 billion in damages, including punitives, but the court has stayed the suit on motion of the DOJ as an intervener.  DOJ sought the stay of proceedings, which neither party opposed, so that it might conduct its own criminal investigation – which does not appear to have been open prior to the civil suit – without the ongoing distraction of civil litigation.  But the DOJ’s stay of Alba’s lawsuit did not stay all of the civil litigation arising from this matter, for on May 1, 2008 a Hawaiian pension fund filed a shareholder derivative action.  Interestingly, the DOJ has not (yet) moved to stay those proceedings, which are presently at the stage of defendants moving to dismiss for failure to make a pre-suit demand upon Alcoa’s Board of Directors.  The final category of FCPA-inspired civil litigation emerging in 2008 is commercial litigation brought by a private plaintiff against its business partners.  On February 21, 2008, Jack Grynberg filed a RICO suit against BP plc and StatoilHydro ASA alleging that they bribed Kazakh officials to win oil rights for joint ventures in which he had an interest, thereby diverting his share of the joint venture profits.  Bringing the classic aphorism "the best defense is a good offense" to the FCPA context, Mr. Grynberg recently told the Daily Telegraph that he brought this suit in an effort to head off a potential prosecution by the DOJ, stating, "Unless I assert that I am an unwilling participant in this, my neck could be on the line."   Another recent example of such a business partner lawsuit with FCPA connotations is that brought by Agro-Tech Corp. against its Japanese distributor, Yamada Corp.  Yamada is presently under investigation by Japanese government authorities for its dealings with Japan’s Ministry of Defense, an investigation that has led to the arrest of a senior Yamada executive as well as the former Vice Minster of Defense.  On March 24, 2008, Agro-Tech filed suit in the U.S. District Court for the Northern District of Ohio seeking a declaratory judgment that it may now lawfully terminate its distributor agreement with Yamada on the grounds that Yamada has breached its contractual obligations to use "ethical means" and to "obey the letter and spirit" of anti-bribery laws, including the FCPA.  Yamada has since counter-sued Agro-Tech, claiming that Agro-Tech’s lawsuit is just a ploy to terminate unlawfully the fifty-year exclusive distributorship arrangement Yamada has with Agro-Tech.    Foreign Business Bribery Prohibition Act of 2008 (H.R. 6188) In a pending development related to our collateral civil litigation discussion above – yet significant enough to warrant individual mention – on June 4, 2008 Rep. Ed Perlmutter (D. Colo.) introduced in the House of Representatives the Foreign Business Bribery Prohibition Act of 2008.  This bill would provide for a limited right of private action under the FCPA; such a right does not presently exist.  Rep. Perlmutter’s bill would amend the FCPA to permit issuers and domestic concerns to bring suit seeking treble damages against "foreign concerns" for FCPA violations that both assist the foreign concern in obtaining or retaining business and prevent the plaintiff from obtaining or retaining that business.  The bill would provide a right of action only against "foreign concerns," defined as any person other than an issuer or domestic concern, and even then only where the foreign concern’s actions violate the FCPA.  Therefore, the class of potential defendants under this bill would be limited to foreign persons and businesses unaffiliated with U.S. stock exchanges and who corruptly use instrumentalities of interstate commerce within the United States in furtherance of their bribes.  Still, this would be an important development in the effort to "level the playing field" of FCPA enforcement worldwide.  The bill is presently awaiting consideration in the House Judiciary and Energy and Commerce committees.  FCPA Acquisition Due Diligence and Post-Acquisition Compliance Integration One of the most pressing issues facing the FCPA bar right now is how to assess successor liability of an acquiror for pre-acquisition FCPA violations by a target company.  The government’s right to impose successor liability as a matter of law is difficult to challenge.  Yet as a policy matter, such prosecutions can have a perverse effect:  discouraging the "race to the top" created where companies with superior FCPA compliance programs acquire those with less thorough programs, inculcating the latter into the former’s culture of compliance.  At the end of the day, everyone, including the U.S. government, benefits when companies with superior compliance programs acquire companies with less effective programs, even when they come with warts.   The DOJ’s focus on this issue in the two FCPA opinion releases issued this year is encouraging.  Particularly so is the DOJ’s acknowledgement in FCPA Op. Proc. Rel. 2008-02 that providing Halliburton with a limited safe harbor in which to conduct post-acquisition due diligence without fear of prosecution "advances the interests of the Department in enforcing the FCPA and promoting FCPA due diligence in connection with corporate transactions."  In detailing the procedures that Halliburton must follow in order to avail itself of the protection afforded by 2008-02, the DOJ has set forth its view on "best practices" for post-acquisition compliance integration.  Halliburton agreed to take the following steps: Immediately upon closing, imposing Halliburton’s Code of Business Conduct on all Expro operations and meeting with the DOJ to discuss whether the information that Halliburton has learned to that point shows potential pre-acquisition FCPA violations; within 10 days of closing, preparing and presenting to the DOJ a comprehensive FCPA due diligence work plan that addresses and categorizes each of the following into high, medium, and low risk elements:  use of third-party representatives, commercial dealings with state-owned customers, joint ventures, teaming or consortium agreements, customs and immigration matters, tax matters, and government licenses and permits; utilizing in-house resources, outside counsel, and third-party consultants (e.g., forensic accountants) as appropriate to conduct post-acquisition due diligence, including a review of Expro e-mails and financial records and interviews of legacy-Expro employees; requiring legacy Expro third-party representatives that Halliburton intends to use post-acquisition to sign new contracts with Halliburton that incorporate audit rights and FCPA and other anti-corruption provisions; providing FCPA training to legacy Expro employees "whose positions or job responsibilities warrant such training on an expedited basis" within 60 days of closing and providing such training to all other employees within 90 days; and disclosing to the DOJ all "FCPA, corruption, and related internal controls and accounting issues that it uncovers during the course of its 180-day due diligence." Although not all of these measures will be practical in all acquisitions, companies should take note of these procedures and structure their integration measures in line with these steps where possible.  For additional guidance on the topic of transactional due diligence, please see the article by F. Joseph Warin, et al., Acquisition Due Diligence: A Recipe to Avoid FCPA Enforcement, TEXAS STATE BAR OIL, GAS, & ENERGY RESOURCES LAW SECTION REPORT 2 (June 2006).  Parallel Foreign Proceedings Another key trend that we have been following during the first half of 2008 is that the enforcement of foreign bribery statutes is increasingly becoming a global enterprise.  After years of not-too-subtle nudging by international anti-corruption watchdogs, most notably the Organization for Economic Cooperation and Development ("OECD") and Transparency International ("TI"), foreign jurisdictions are finally beginning to launch their own investigations that parallel those brought by U.S. enforcement agencies.  Although some jurisdictions have not pursued bribery investigations aggressively and none can claim to match the torrid pace set by the DOJ and SEC, we believe that the trend of parallel foreign enforcement actions and investigations will only intensify in the future.  Investigations arising out of the Oil-for-Food Program comprise a significant portion of the foreign parallel proceedings.  For example, the United Kingdom’s Serious Fraud Office (“SFO”) is actively pursuing Oil-for-Food investigations against several major companies, including at least one (GlaxoSmithKline plc) that has publicly disclosed being under investigation by the DOJ and SEC.  Other foreign countries with open Oil-for-Food investigations include Italy, which has initiated preliminary court proceedings against a number of companies and their employees, Ireland, and Switzerland, which has already imposed $17 million in fines against eight unnamed companies.    Although international anti-corruption activity is increasing overall, not all countries have been consistent in investigating and prosecuting corruption offenses.  As we have reported previously, in 2006 the SFO controversially dropped on national security grounds its investigation concerning allegedly corrupt payments made by BAE Systems plc to senior Saudi governmental officials.  On April 10, 2008, the High Court of London declared the SFO’s decision to close the investigation illegal and ordered the agency to reopen the investigation.  The British government is now appealing that decision to the House of Lords, the U.K.’s highest court.  A fascinating development in the interplay between foreign and domestic corruption investigations is the DOJ’s recent decision to forgo – in two Oil-for-Food cases – criminal sanctions against foreign businesses in light of pending actions against the companies in their home states.   In our last FCPA review, we reported that the DOJ elected not to impose a criminal fine in connection with its December 2007 non-prosecution agreement with Akzo Nobel provided that Akzo Nobel caused one its Dutch subsidiaries to enter into a criminal disposition with the Dutch Public Prosecutor and pay a fine of at least €381,602 ($549,419) within six months.  And during the current reporting period, on February 21, 2008, the DOJ completely declined prosecution of a Dutch subsidiary of Flowserve in return for Flowserve agreeing to cause that subsidiary to enter into a criminal disposition with the Dutch Public Prosecutor.  Although these prosecutions in the Netherlands are not publicly reported, a Dutch representative recently informed TI that Dutch prosecutors have filed seven Oil-for-Food cases.  It took the United States many years to reach its current state of enforcement and we expect that other nations will experience growing pains as well.  But with an enhanced commitment on the part of many nations, coupled with pressure from non-governmental organizations and a newfound willingness by the DOJ to defer to home state prosecution in appropriate circumstances, we expect anti-corruption enforcement to take on an increasingly global character in the future.  Substantial Jail Time for Individual Defendants As we have reported previously, efforts to prosecute individuals for violations of the FCPA have skyrocketed in the past few years.  Focusing on criminal prosecutions, we have identified forty-six individual defendants charged by the DOJ over the last ten years for allegedly participating in foreign bribery schemes, including many former senior executives and other high-ranking employees.  Approximately 91% of the individuals to resolve their charges – thirty-three of thirty-six – have pleaded guilty or been convicted at trial of at least one charge.  Only three defendants has been acquitted at trial or have had their charges dismissed.  Resolution of Criminal FCPA Anti-Bribery Cases Brought Against Individuals from 1998 to the Present. Of the thirty-three convicted individual defendants, only twenty have gone to sentencing.  This reflects the DOJ’s common practice in FCPA prosecutions of postponing sentencing for lengthy periods – even years – as the convicted defendant cooperates with the government’s investigation.  Of the twenty sentenced defendants, thirteen have received jail terms, ranging from several months to more than five years.  This figure includes sentences of incarceration for all four defendants to have been convicted at trial and sentenced. These figures are not trending more favorably to individual FCPA defendants.  In the past five years, eight out of ten individuals sentenced for their role in a foreign bribery scheme have been sentenced to a term of imprisonment.  Sentences for Individual Criminal Defendants Convicted in FCPA  Cases from 1998 to the Present.  Sentences for Individual Criminal Defendants Sentenced in FCPA Cases from 2003 to the Present. This trend is unmistakable:  incarceration is becoming a near certainty for individuals convicted of violating the FCPA.  One recent example is Ramendra Basu, a former World Bank official, who on April 22, 2008 was sentenced to 15 months incarceration for assisting consultants in bribing a Kenyan official.  Additionally, sentencing is pending for thirteen defendants, all of whom face the prospect of at least several months’ imprisonment.  We anticipate that many, if not all, of these individuals will receive jail time.  Given the zeal with which the DOJ has pursued FCPA cases in recent years, it does not appear that the trend toward aggressive prosecution of individuals and imposition of severe penalties will soon abate.  Conclusion As breathtaking as the pace of FCPA enforcement was in 2007, the first half of 2008 has proved a worthy successor.  With many large matters pending in the investigative stage, we expect more of the same for the second half.  Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. We have more than 20 attorneys with substantive FCPA expertise. Joe Warin, a former federal prosecutor, currently serves as a compliance consultant pursuant to a DOJ and SEC enforcement action. The firm has 20 former Assistant U.S. Attorneys and DOJ attorneys. Please contact the Gibson Dunn attorney with whom you work, or any of the following: Washington, D.C. F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com)  Daniel J. Plaine (202-955-8286, dplaine@gibsondunn.com) Judith A. Lee (202-887-3591, jalee@gibsondunn.com) David P. Burns (202-887-3786, dburns@gibsondunn.com)  Jim Slear (202-955-8578, jslear@gibsondunn.com)Michael S. Diamant (202-887-3604, mdiamant@gibsondunn.com)John W.F. Chesley (202-887-3788, jchesley@gibsondunn.com)Patrick F. Speice, Jr. (202-887-3776, pspeicejr@gibsondunn.com) New YorkLee G. Dunst (212-351-3824, ldunst@gibsondunn.com)James A. Walden (212-351-2300, jwalden@gibsondunn.com)Alexander H. Southwell (212-351-3981, asouthwell@gibsondunn.com) DenverRobert C. Blume (303-298-5758, rblume@gibsondunn.com)J. Taylor McConkie (303-298-5795, tmcconkie@gibsondunn.com) Orange CountyNicola T. Hanna (949-451-4270, nhanna@gibsondunn.com) Los Angeles Debra Wong Yang (213-229-7472, dwongyang@gibsondunn.com), the former United States Attorney for the Central District of California,Michael M. Farhang (213-229-7005, mfarhang@gibsondunn.com)Douglas M. Fuchs (213-229-7605, dfuchs@gibsondunn.com) © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 7, 2009 |
2008 Year-End Criminal Antitrust Update

Introduction The dramatic surge in worldwide criminal antitrust enforcement over the last decade continued at a remarkable pace in 2008, with no signs of ebbing on the horizon.  This update provides a summary overview of criminal antitrust enforcement in 2008 and a discussion of the trends we see from that activity over the next few years.  Gibson Dunn has been fortunate to have represented many clients in these matters.  Among the most notable developments and trends from the last couple years, and 2008 in particular, are: 1. The ever-increasing amount of fines imposed by the U.S. Department of Justice, Antitrust Division ("DOJ" or "Antitrust Division") – including fines of $400 million, $120 million, and $65 million imposed by the DOJ in November 2008 on LG Display, Sharp and Chunghwa Picture Tubes, respectively – and the world’s other leading antitrust enforcement authorities, particularly the European Commission ("EC" or "Commission")  which as become more agressive in seeking higher fines; 2. Individual foreign defendants are submitting to U.S. jurisdiction and receiving the longest criminal antitrust prison sentences in history, joining the significant upward trend of prison terms imposed on all criminal antitrust defendants; 3. A number of jurisdictions beyond the U.S. and Canada are imposing criminal antitrust sanctions on individuals and corporations, most notably the United Kingdom.  In Australia, a draft bill has been introduced that would create criminal penalties for cartel conduct.  Developments from 2008 demonstrate that criminal antitrust defendants involved in a single cartel may be criminally liable and subject to prison terms in multiple jurisdictions; 4. The first-ever attempted revocation of an amnesty applicant’s conditional amnesty by the DOJ and the continued fall-out from that decision; 5. The continued aggressive prosecution of non-antitrust charges by the Antitrust Division; and 6. The continued mixed record of the DOJ in obtaining convictions of individual defendants at trial in antitrust cases. 2008 also marked a year of notable changes that could have significant impact in the next year and beyond.  Obviously, in two weeks the United States will have a new President and new leadership at the DOJ.  The highly regarded Assistant Attorney General in charge of the Antitrust Division for the last three and one-half years, Thomas Barnett, has already resigned.  Given public statements made by President-elect Obama, and the success achieved by the Bush Administration in collecting record-setting fines and obtaining ever-higher prison sentences, the Obama Administration likely will continue the increasingly aggressive investigation and prosecution of criminal antitrust offenses.  Enforcement by the Numbers Dramatic Increases in Fines Continue Through FY 2008 (and beyond) When compared to the last eight years, the statistics for FY 2008 demonstrate the dramatic increase in the sanctions as a result of DOJ’s criminal enforcement actions.[1]  First, criminal antitrust fines continued to increase throughout FY 2008 with a clear likelihood that FY 2009 will set a staggering new record with respect to total fines levied.  In FY 2007, DOJ antitrust criminal enforcement resulted in approximately $630 million in fines imposed, and in FY 2008, the amount of criminal antitrust fines rose to approximately $686 million.  FY 2009 promises to be a record-setter.  As the chart below illustrates, for just the first quarter of FY 2009 (October-December 2008), the DOJ has already imposed criminal antitrust fines of approximately $592 million; this represents 86% of the fines imposed over the course of the entire prior year.  The bulk of this figure came from the agreed-upon fines imposed on the first three companies to enter guilty pleas in the DOJ’s TFT-LCD investigation (see more below); at least seven corporate subjects remain, some of which can be expected to pay comparable fines.  U.S.Criminal Antitrust Fines (2000-2009) Although these aggregate numbers present a striking illustration of the DOJ’s increased enforcement of the criminal antitrust statutes, they do not reflect adequately the enormity of each fine imposed.  The chart below breaks out the criminal fines imposed by the DOJ in FY 2008/2009 that exceeded $10 million.  Notably, four of the fines imposed in this time period exceeded $100 million, including the second and third largest criminal antitrust fines imposed by the DOJ in history (the LG and Air France-KLM fines, respectively): U.S. Fines of $10 million or more in FY 2008/2009   Amount Company Investigation $400 million LG Display/LG Display USA TFT-LCD $350 million Air France-KLM Air Cargo $120 million Sharp TFT-LCD $110 million Japan Airlines Air Cargo $65 million Chunghwa Picture Tubes TFT-LCD $61 million Qantas Air Cargo $60 million Cathay Pacific Air Cargo $52 million SAS Cargo Air Cargo $42 million Martinair Holland Air Cargo   The levels of and increases in fines levied by the European Commission are even more staggering.  In 2007, the EC collected more than €3.3 billion ($5.2 billion USD) in cartel fines – an 80% increase over the €1.8 billion imposed in 2006 and an incredible 388% increase over the €683 million imposed in 2005.  In 2008, there was a decline from 2007 with fines of approximately €2.3 billion ($3.2 billion USD), down €1 billion, but still a dramatic increase in penalties from just three years ago, as the chart below illustrates: European Commission Cartel Fines (2003-2008) The fines from 2008 include the largest penalties ever imposed by the Commission:  €1.4 billion ($1.95 billion USD) against participants in an information exchange conspiracy in the automobile glass industry, with one participant alone fined €896 million ($1.25 billion USD). Prison Terms for Foreign Defendants Also Increased Substantially One of the more notable developments of criminal antitrust enforcement over the last several of years (and 2008 was no exception) is the length of prison sentences that the DOJ is requiring for individual foreign defendants who wish to enter into plea agreements.  The DOJ has stated that foreign nationals "are expected to serve jail sentences in order to resolve their criminal culpability."[3]  As the chart below illustrates, in FY 2000, the average agreed-upon jail sentence for a foreign defendant was a little more than two months.  In FY 2008, mainly as a result of multi-year terms imposed on foreign executives in the Marine Hose investigation (see more below), the average prison term was approximately 15 months; an increase in excess of 600%.  Most recently, in December 2008, a Japanese executive from Bridgestone Corporation pleaded guilty in the Marine Hose investigation and agreed to a prison term of 24 months. Average Jail Sentence for Foreign Defendants In International Cartel Cases This increase in average jail sentences for foreign defendants is in line with the overall trend of increased prison terms for all defendants over the last eight years.  At the halfway point of FY 2008, the average prison term for all antitrust defendants was 31 months, which was the same as FY 2007.  Since that time, however, the DOJ has obtained lengthy prison sentences against numerous other individuals, including a defendant in its E-Rate bid-rigging investigation that led to a sentence of 7.5 years.  However, as discussed in more detail below, the aggressive prosecution and sentencing of foreign defendants, particularly in the last two years, has been a notable recent development that should serve as an increased warning to foreign companies and their executives to be wary of violating U.S. antitrust laws.  The DOJ has observed that long jail terms for foreign nationals "should carry a strong deterrent message to members of international cartels that victimize businesses and customers in the United States and abroad."[4] Significant Antitrust Investigations in 2008 Thin Film Transistor-Liquid Crystal Display ("TFT-LCD") Panels One of the most significant criminal investigations in 2008 involved price-fixing in the TFT-LCD panel industry.  TFT-LCD panels are the principal component for LCD televisions and computer monitors, among other LCD displays.  In December 2006, producers of LCD panels in Korea, Taiwan, Japan, and Europe received subpoenas or were the subject of raids by the DOJ, the Japan Fair Trade Commission ("JFTC"), the Korean Fair Trade Commission ("KFTC"), the Canadian Bureau of Competition ("CBC"), and the EC Directorate of Competition ("DG Comp").  Among those who have acknowledged receiving subpoenas are:  Samsung, LG Philips (now LG Display), Sanyo Epson, Sharp, Toshiba Matsushita, Hannstar, NEC, Chi Mei Optoelectronics, AU Optronics, and Chunghwa Picture Tubes.  The investigation is focused on price-fixing by all major producers of TFT-LCD panels during the period 1998–2006. In November 2008, the DOJ announced that LG and Chunghwa had entered into  agreements to plead guilty and pay substantial fines for conspiring with their competitors to fix the prices of TFT-LCD panels at regular "crystal meetings" that occurred from 2001 to 2006.  Sharp agreed to plead guilty to separate conspiracies to fix prices to Dell (for monitors and laptops), Motorola (for screens for RAZR cellular phones), and Apple (for displays for its iPod music players).  Combined, these defendants agreed to pay fines of $585 million:  LG agreed to pay $400 million – the second-largest criminal fine ever imposed by the Antitrust Division, while Sharp and Chunghwa agreed to pay $120 million and $65 million, respectively.  LG and Sharp were formally sentenced in December; Chunghwa will be sentenced in mid-January 2009.  Additionally, LG and Sharp each had four individual executives carved out from the plea agreements and therefore still subject to criminal prosecution.  Thomas Barnett, the then-Assistant Attorney General in charge of the Antitrust Division, noted, however, the significance of the cooperation these corporate defendants provided to the DOJ’s investigation: "The Board of Directors for LG Display, Sharp and Chunghwa deserve credit for making a timely decision to accept responsibility and cooperate.  Today’s fines would have been significantly higher were it not for their cooperation."[5]  These pleas, and the DOJ’s statements in connection with them, indicate that 2009 will bring both additional pleas by and indictments of other companies and individuals who were a party to these conspiracies with further very large fines, as well as numerous significant prison sentences. Finally, in December 2008, the JFTC fined Sharp 251 million Yen ($2.9 million USD) for its participation in a price-fixing scheme with Hitachi Displays for TFT-LCD panels sold to Nintendo for its DS Lite hand-held games consoles.  It is unknown at this time whether Hitachi also has been fined for its participation in the conspiracy. Cathode Ray Tubes ("CRT") Investigation There also has been an active investigation in the cathode ray tubes industry, which is related to TFT-LCD.  In November 2007, U.S., European, Canadian, Japanese, and Korean enforcers served subpoenas and raided numerous makers of CRTs around the globe, which includes several companies that are also the subject of investigations in the TFT-LCD industry.  To date, no formal actions have been taken by the DOJ or any other enforcement authority, although the DOJ sought and obtained a lengthy stay of related civil litigation to permit its investigation to move forward unimpeded.  The discovery stay is set to be lifted in March 2009, so it is possible that there will be pleas and indictments before or just after that time. Marine Hose Investigation The investigation that became public in May 2007, with the simultaneous arrests in Houston and San Francisco of eight executives from the U.K., France, Italy and Japan for conspiring to rig bids, fix prices and allocate markets of marine hose, was active throughout 2008 and will no doubt continue into 2009.  At the time of their arrests in 2007, seven of the eight individuals – executives from Dunlop Oil & Marine Ltd ("Dunlop"), Trelleborg Industrie S.A. ("Trelleborg"), Bridgestone Corporation ("Bridgestone"), Parker ITR slr ("Parker), and PW Consulting – were taken into custody after, according to the government, engaging in a cartel meeting (which the DOJ covertly videotaped), during the time they were attending a trade conference in Houston.  Simultaneously, search warrants were executed at locations across the U.S., as well as in the U.K. by the Office of Fair Trading and in Europe by the EC.  Marine hose is a flexible rubber hose used to transport oil between tankers and oil storage facilities.  To date, nine individuals have agreed to plead guilty for their participation in the cartel.  In what may prove to be a harbinger of future coordination between the Antitrust Division and DOJ’s Fraud Section unit that is responsible for enforcing the Foreign Corrupt Practices Act ("FCPA"), in December 2008 Misao Hioki, a Japanese national and the former general manager of Bridgestone’s International Engineered Products Department, pleaded guilty to his role in the marine hose cartel as well as his role in a conspiracy to pay bribes to government officials in Latin America and elsewhere in violation of the FCPA.  He was sentenced to serve 24 months in prison and pay a fine of $80,000.  Other sentences imposed in this investigation have ranged from as low as 6 months of house arrest for Giovanni Scodeggio, an Italian citizen who is the manager of Parker’s Oil & Gas Business Unit, to as high as 30 months of imprisonment for Peter Whittle, a former Dunlop executive and now the proprietor of PW Consulting.  Two former Manuli managers, Robert Furness and Charles Gillespie, pleaded guilty and have agreed to serve prison terms of 14 months and 12 months, respectively.  Whittle, together with Bryan Allison and David Brammar of Dunlop, U.K. citizens who pleaded guilty and were sentenced in the U.S. for their roles in the marine hose cartel, also were arrested and criminally charged with cartel offenses by U.K. antitrust authorities.  (More on this below) Not all of the individuals charged with participating in the cartel have agreed to plead guilty.  Indeed, in November 2008 Francesco Scaglia and Val Northcutt, two sales managers from Manuli’s Oil & Marine Division, were acquitted of marine hose cartel charges after a four-week jury trial in Houston.  The jury deliberated for two hours before reaching its verdict.  Ewe Bangert, a German national and former executive of Dunlop, has pleaded not guilty to charges that he was involved in the cartel.  His case is pending in the Southern District of Florida in Fort Lauderdale, and a trial date has not yet been set.      In addition to the convictions of individuals, the DOJ has been investigating and prosecuting the companies involved in the cartel.  In December 2008, Manuli pleaded guilty and was ordered to pay a fine of $4.54 million, and Dunlop agreed to plead guilty and pay a fine of $2 million.  Outside the U.S., the JFTC issued cease and desist orders against Bridgestone, Dunlop, Trelleborg, Manuli and Parker for their roles in the marine hose cartel.  The JFTC also announced that it had determined that Japan-based Yokohama Rubber Co. had joined the cartel, but it was not included in the order because the company voluntarily had admitted its conduct.  The EC and the Competition Division of the Secretariat of Economic Law in Brazil also reportedly are investigating the marine hose cartel.    International Air Cargo Investigation The DOJ’s investigation into air cargo transportation price fixing, which had its first guilty pleas in late 2007, reached a climax in 2008.  The Antitrust Division obtained several jail sentences for corporate executives and the largest criminal fines against corporations ever obtained in a single investigation. The conspiracies alleged by the DOJ involved items such as fuel surcharges and post-September 11 security charges imposed by several major international airlines.  The initial wave of guilty pleas began in late 2007, when British Airways and Korean Air pleaded guilty.  British Airways and Korean Air paid $300 million each.  (A portion of the British Airways criminal fine was for fixing passenger fuel surcharges.) Additional corporate guilty pleas started in January this year and continued through June.  Companies pleading this year (and their criminal fines) were: Air France-KLM Royal Dutch Airlines ($350 million); Japan Airlines ($110 million); Qantas ($61 million); Cathay Pacific Airways ($60 million); SAS Cargo Group ($52 million); Martinair Holland ($42 million). According to Associate Attorney General Kevin O’Connor, this brought the total fines in the air cargo investigation to $1.2 billion, the highest fines ever imposed in a single criminal antitrust investigation.  Several of the airlines’ executives also separately agreed to plead guilty and serve jail sentences.  These were Bruce McCaffrey of Qantas (eight months plus a $20,000 criminal fine); Timothy Pfeil of SAS Cargo Group (six months); and Keith Packer of British Airways (eight months plus a $20,000 criminal fine).  Internationally, Qantas and British Airways each agreed to pay additional criminal fines in Australia (AU$20 million and AU$5 million, respectively).  In December, New Zealand’s Commerce Commission announced an investigation of these and other airlines (13 in all) plus a total of 7 executives.  Airlines reportedly subject to the New Zealand investigation include United, Lufthansa, and El Al.  The European Union antitrust enforcement officials also continue their investigation into the air cargo sector. According to the DOJ’s press release in late September 2008, the investigation is ongoing. DRAM Investigation The DOJ’s investigation into price-fixing in the dynamic random access memory ("DRAM") market, which began in 2002, has been among the most significant ever.  The DRAM investigation has yielded criminal charges against 18 current and former executives from multiple companies, in addition to guilty pleas from those companies (including Samsung, Hynix, and Elpida) that required them to pay fines that collectively exceeded $730 million.  Of particular note to illustrate the DOJ’s increasingly aggressive position with respect to foreign defendants, one Samsung executive, Il Ung Kim, agreed to plead guilty last year and serve 14 months in prison and pay a $250,000 fine. The overall success of the DOJ’s investigation into and prosecution of price-fixing in DRAM, however, suffered a notable setback in 2008.  In February 2008, the Antitrust Division tried a Hynix executive, Gary Swanson, on a criminal charge of conspiring to fix DRAM prices.  The Swanson trial was the only prosecution in the DRAM case that went to trial.  After a nearly three-week trial, the jury deadlocked 10-2 in favor of acquittal and a mistrial was entered.  The DOJ declined to re-try Swanson and there are no further prosecutions expected.  Given the number of guilty pleas, the cooperation of an amnesty applicant, and the significant fines and prison sentences imposed, the Swanson mistrial represented a somewhat surprising and negative coda to the DRAM investigation, although the fines and jail sentences meted out should continue to give companies and their employees pause in engaging in potentially anticompetitive conduct. New York Marine Plastic Pilings Investigation The DOJ obtained two guilty pleas in 2008 relating to a scheme to rig bids in the New York Pier 86 reconstruction project.  Between 1999 and 2003, two firms were involved in bribing a city engineer, Charles Kriss, to ensure that the firms were chosen for city contracts.  In 2007, Robert Taylor, the president of a contracting firm, pleaded guilty to multiple felonies, including conspiring to bribe Kriss.  Taylor was sentenced in early 2008 to 24 months in prison and a criminal fine of $300,000.  Kriss himself pleaded guilty in mid-2008 to conspiracy to commit bribery and was sentenced to 12 months in prison and $36,380 in restitution.  Finally, American Composite Timbers (ACT), which sold plastic marine pilings to be used in the project, pleaded guilty to conspiracy to commit bribery and agreed to pay a criminal fine that has yet to be determined by the court. E-Rate Bid Rigging Investigation This year saw several jury convictions, guilty pleas, and sentences in the E-Rate bid rigging investigation, which has resulted in convictions of 7 companies and 13 individuals to date, plus over $40 million in criminal fines and restitution.  The E-Rate program funds schools’ purchases of internet backbone equipment and is operated by the FCC.  Among the notable convictions, guilty pleas, and sentences entered in the E-Rate case this year are the following:  Judy Green was convicted in 2007 by a jury in San Francisco of rigging bids and defrauding the program, and was sentenced in early 2008 to 7.5 years in prison.  Benjamin Rowner and Jay Soled pleaded guilty to conspiracy to defraud the program from 1999 through 2003; they agreed to assist the investigation and apparently have not yet been sentenced.  Howe Electric, Inc., a California electrical contractor, agreed to plead guilty to bid rigging and pay a total of $3.3 million in restitution, criminal fines, and civil settlement.  A federal court in South Carolina sentenced a school district official, Cynthia Ayer, who was convicted of mail fraud, to two years in prison and was ordered to pay restitution of $486,000.  And in Atlanta, R. Clay Harris was convicted by a jury of bribing E-Rate administrators to receive contracts for his company.  Domestic Ocean Shipping Investigation In October 2008, four U.S. shipping company executives agreed to plead guilty and serve jail sentences for their roles in an alleged conspiracy to rig bids, fix prices and allocate market shares for customers transporting goods between the continental United States and Puerto Rico by ocean vessel.  Peter Baci, an executive with Sea Star, and Kevin Gill, Gregory Glova, and Gabriel Sura (all executives from Horizon Lines) each agreed to serve a jail term that will be determined by the court on January 31, 2009, and pay a $20,000 criminal fine. A one-count felony obstruction of justice charge was filed against a fifth shipping executive, Alexander Chisholm, also of Sea Star, who agreed to plead guilty and serve jail time, to be determined by the court. The DOJ noted in announcing these pleas that they were "the first charges in the Antitrust Division’s ongoing investigation into collusion in the coastal shipping industry."[6]  Indeed, the DOJ’s investigation includes all domestic ocean shipping trade lanes. Department of Defense Military Tie-Down Equipment Contracts The DOJ continued its investigation into Defense Department contracts for military tie-down equipment.  Last year saw five bid-rigging charges and three guilty pleas.  This year there were more individual and corporate guilty pleas.  Peck & Hale LLC, a defense contractor, pleaded guilty to bid rigging and agreed to pay a criminal fine of $275,000.  Ransom Soper, another former Peck & Hale employee, pleaded guilty to bid rigging and fraud.  Wilson Freire, a former Peck & Hale executive, pleaded guilty to bid rigging and soliciting and accepting a kickback.  He agreed to serve 12 months in jail and pay a $10,000 fine.  Finally, Frank Granizo, president of a freight forwarding company pleaded guilty to fraud in connection with paying kickbacks. Iraq, Kuwait & Afghanistan Investigations The DOJ investigated and prosecuted several military officers and defense contractors doing business in or providing support to military operations in Iraq, Kuwait, and Afghanistan.  A Canadian night vision device contractor was indicted for fraud in attempted bid rigging.  At least three military officers pleaded guilty to bribery.  One defense contractor also pleaded guilty to bribery and agreed to pay over $800,000 in criminal fines and restitution.  Several other companies and individuals targeted by the DOJ in this investigation were also indicted for bribery, money laundering, and filing false tax returns. Other Notable Prosecutions There were several other notable investigations of varying scope, including the following: Defense Department fuel contracts:  an employee of Avcard (a division of Kropp Holdings LLC), Matthew Bittenbender, pleaded guilty to a conspiracy to steal trade secrets.  The trade secrets were to be sold to Avcard’s competitors, Far East Russia Aircraft Services, Inc., and Aerocontrol LTD.  Paul Wilkinson and Christopher Cartwright, employees of the competitors, also pleaded guilty to fraud. Bid-rigging of GICs:  Several major financial services institutions have recently disclosed that they had been subpoenaed in a federal and multi-state investigation of bid rigging in guaranteed investment contracts (GICs) and other municipal bond derivatives. Processed tomatoes:  Late in 2008, the DOJ obtained its first guilty plea into an investigation related to the sale of processed tomatoes.  Randall Rahal pleaded guilty in federal court in Sacramento, California to price fixing, racketeering, and other charges, and agreed to pay $600,000 in criminal fines and to cooperate in the investigation.  Previously-filed FBI affidavits allege that major national food companies including Agusa Inc., Safeway Inc., B&G Foods Inc., ConAgra Foods Inc., and Frito-Lay each had buyers acting as co-conspirators.[7] There was also action in Antitrust Division investigations of more limited scope: Kwik-Chek Food Stores, Inc. and Jarrod Thomas were indicted for conspiring to fix the price of gasoline in Oklahoma.  Other representative examples included guilty pleas related to bid rigging and market division in the door hardware market in El Paso; a market division guilty plea related to Cincinnati ice manufacture; and a bribery guilty plea related to the New York power authority. Non-Title 15 Prosecutions The Antitrust Division, in addition to its continued vigor in enforcing criminal antitrust laws, also continued its aggressive pursuit of non-Title 15 charges, including fraud, bribery, obstruction of justice, and false statements.  Examples of fraud prosecutions include charges relating to construction contracting in New Orleans for Katrina recovery, and the E-Rate investigation discussed above.  Bribery examples include the overseas military investigations, the tomato processing investigation, and the New York investigation into marine plastic pilings discussed above. Former Assistant Attorney General Barnett, commenting on the Kriss indictment in the marine plastic pilings investigation, explained the Antitrust Division’s stance on bribery: "Bribery undermines the benefits afforded by competition, which lies at the heart of the Antitrust Division’s mission.  We prosecute such violations to the full extent of the law."[8] The end of the year brought the first ever joint antitrust/Foreign Corrupt Practices Act ("FCPA") guilty plea in the Marine Hose case.  As discussed in more detail above, Misao Hioki, the former general manager of Bridgestone Corporation’s Japanese marine hose business, pleaded guilty to a two-count criminal information charging him with conspiracy to violate the Sherman Act and conspiracy to violate the FCPA.    Notable Foreign Prosecutions and Developments Marine Hose As described above, the Marine Hose case has been a source of interesting developments in the past year.  One of the notable events was the prosecution of three marine hose executives for price-fixing by the U.K.’s Office of Fair Trade ("OFT"), the first criminal antitrust case it has ever prosecuted under a 2002 law that permitted OFT to pursue criminal penalties for cartel conduct.  As part of their plea agreements in the U.S., the executives were allowed to go to the U.K. to face the OFT’s separate charges against them there and serve in the U.K. any term of imprisonment imposed by the U.K. court.  The U.S. plea agreement deferred sentencing in the United States pending the resolution of the OFT’s prosecution, but it required the defendants not to seek from the U.K. court a prison sentence less than the sentences set out in each of their plea agreements, respectively:  Whittle (30 months), Allison (24 months), and Brammar (20 months).  The fact that DOJ permitted the executives to face charges in the U.K. and serve a prison sentence there concurrently with their U.S. sentences, and the OFT successfully obtained guilty pleas and prison sentences, suggests a new trend of coordinated, successive criminal prosecutions and potentially successive jail sentences in international cartel cases.  The deal these defendants struck with the DOJ, however, likely caused them to serve longer sentences than they otherwise might have under U.K. law.  Although the three were originally given sentences greater than the terms agreed to in their U.S. plea agreements, in November 2008, the U.K. Court of Appeals reduced each of these defendant’s sentences to match their sentence in the U.S.  The court made it clear that it would almost certainly have reduced their sentences even further but for the U.S. plea agreements.  Had Whittle, Allison, and Brammar been given sentences less than the periods agreed to in the U.S., they would have had to serve the balance in the U.S.  As one of the jurists on the panel noted to the media, "We have considerable misgivings about disposing of these applications in the way we intend, but, if we are to avoid injustice, we feel we have no alternative."[9] This is an important issue that will confront executives subject to criminal antitrust liability in several jurisdictions and will undoubtedly be the subject of increasing debate and clarification in the next several years. Extradition of U.K. Citizen To U.S. To Face Antitrust Charges Temporarily Blocked By House of Lords One of the DOJ’s disappointments in 2008 was the blocked (at least temporarily) extradition of Ian Norris, a U.K. citizen and former carbon parts executive, to face criminal antitrust claims in the U.S. for allegedly participating in an 11-year conspiracy to fix the price of carbon parts from 1989 to 2000.  Norris was indicted and arrested in London in 2005, and his extradition to the U.S. was originally approved by the U.K. government.  Norris resisted extradition, however, on the ground that his actions were not criminal under U.K. law at the time, thus it would be unjust to subject him to criminal prosecution in the U.S.  (Price-fixing only became a crime in the U.K. under the Enterprise Act of 2002, which postdated Norris’ conduct).  In a ruling in March 2008, the House of Lords agreed and halted Norris’ extradition, remanding the case to a district judge to determine whether Norris could be extradited on obstruction of justice charges.  The judge ruled in July that he should be extradited; Norris’s attorneys promised to seek review with the Home Secretary and to appeal to the House of Lords if necessary on the grounds that the criminal sentence in the U.S. could rely upon uncharged conduct – such as, apparently, the alleged price fixing.[10]  Nevertheless, the Norris case serves as an important precedent for foreign executives who face criminal liability in the U.S. for conduct that is not criminal in their own country and could limit the DOJ’s potential reach beyond the U.S. border in international cartel cases. French Metal Producers Hit With Record Fine In December 2008, the French Competition Authority levied a €575.4 million ($797.7 million USD) penalty against 10 steel brokers and sellers that conspired to fix prices in the French steel market through regular meetings of a sham trade association between 1999 and 2004.  The single largest fine – and the largest ever imposed by the French Competition Authority – of €301.8 million ($424 million USD) was imposed on Arcelor Mittal’s French subsidiaries.  Co-defendant Klockner Distribution Industrielle SA was hit with the second-largest single fine in French history of €169.3 million. China Adopts First Antitrust Law in Its History In August 2008, China’s Anti-Monopoly Law, which was first adopted in 2007, became effective.  Though the law is a major step in establishing a system of commercial law consistent with international norms, the text and the system that will interpret and apply it raise serious concerns about whether the law will, in practice, be used primarily to protect competition and consumer welfare in China, or whether it will be used as a protectionist device to favor State Owned Enterprises and privatized indigenous companies in Chinese markets.  Article 3 of the law seeks to provide a general list of the broad types of conduct proscribed by the statute.  "Monopolistic Conduct" is defined as the following activities that eliminate or restrict competition or are likely to have the effects to eliminate or restrict competition: Monopoly agreements between undertakings; Abuse of dominant market position by undertakings; and Concentrations conducted by undertakings that may have the effect of eliminating or restricting competition. Initial analysis suggests that the only criminal components to the law relate to obstruction of investigations and official corruption.  Australia Criminal Cartel Legislation In October, Australia’s Department of Treasury proposed new legislation that would criminalize "serious" cartel conduct.  The maximum penalty for a cartel violation under the new law is 10 years in prison plus a AU$220,000 fine for individuals and the greater of AU$10 million, three times the benefit gained by the corporation, or ten percent of the corporation’s annual turnover.  Chris Bowen, the minister responsible for drafting the legislation, said, "Together with the United States the 10-year jail term puts Australia at the forefront in fighting illegal cartels."[11] Other Significant Developments Stolt-Nielsen One of the most significant recent setbacks for the DOJ resulted from its decision to revoke the conditional amnesty of Stolt-Nielsen, a London-based parcel tanker shipper, in its investigation into bid rigging and price fixing in the industry.  After the DOJ revoked Stolt-Nielsen’s amnesty for alleged continued anticompetitive conduct, it secured an indictment against the company in 2006.  In late 2007, a federal court dismissed the indictment, finding that Stolt-Nielsen did not breach its conditional amnesty agreement with the DOJ and the government could not prosecute Stolt-Nielsen under that agreement.  In December 2007, the DOJ declined to appeal the ruling. In related litigation, Stolt-Nielsen brought suit against the United States to compel production of all of the Antitrust Division’s amnesty agreements with other parties under the Freedom of Information Act ("FOIA").  In July 2008, the D.C. Circuit reversed summary judgment in favor of the government on the ground that the district court did not make any findings as to whether materials that were protected from disclosure could be segregated from those that could.  Although the district court has not ruled on remand, this decision raises the unsettling prospect that an amnesty applicant’s agreement with the DOJ to cooperate in an antitrust investigation will not remain confidential, thereby potentially compromising investigations and exposing applicants to enhanced exposure in civil litigation. Finally, in reaction in part to Stolt-Nielsen, the DOJ has revised its Corporate Leniency Agreement for the first time since 1993.  As Scott Hammond, the Deputy Assistant Attorney General for criminal enforcement in the Antitrust Division, commented, "The point was bought home many times during the Stolt litigation that, as the authors of the conditional leniency letter, any ambiguities in the language would be held against the government.  Therefore, we will tighten up some of the language in our model letter to avoid any uncertainty in the future."[12] One of the more notable conditions is that a company must waive its right to seek pre-indictment adjudication of the DOJ’s revocation of the amnesty agreement; Stolt-Nielsen initially sought to win a pre-indictment judgment in court.  Hammond has stated, however, that the changes were merely "clarifications" to provide "additional guidance and transparency in addressing issues relating to the implementation of the division’s voluntary disclosure programs."[13] Trial Losses for the DOJ Although the last year has been mostly marked by the continued successes of the DOJ in increased investigations, fines, and jail sentences, it has also been marked by some notable trial losses: In July 2007, a federal jury in Hartford, Conn., acquitted coated-paper maker Stora Enso North America Corp. of charges in a rare price-fixing trial against a corporation.  In December 2006, the DOJ indicted Stora Enso for conspiring with one or more competitors to fix coated magazine paper prices in the United States from August 2002 through June 2003.  The jury returned a not guilty verdict, even though the DOJ had the cooperation of an amnesty applicant; In February 2008, a mistrial was declared in the trial of a former Hynix executive, Gary Swanson, for participation in the DRAM conspiracy after the jury returned hung 10-2 in favor of acquittal, and the charges were later dismissed (also discussed above); and In November 2008, a federal jury in Florida acquitted Scaglia and Northcutt, executives charged with participating in the marine hose conspiracy (also discussed above). Although these losses are noteworthy, one should be careful not to read too much into them.  Trying cases is always unpredictable.  As the rest of this update illustrates, the DOJ is bringing numerous criminal antitrust cases to trial and securing long sentences (see, e.g., the E-Rate cases).  Plainly, the Antitrust Division is not afraid to try cases it  believes are merited.  Additionally, the individual defendants in price-fixing cases that go to trial are the hardest cases for the DOJ; most culpable executives plead guilty and only those with the most circumstantial cases against them risk trial.  Moreover, juries often identify strongly with individuals engaged in marginally prohibitive conduct and appear to be put off by cases that rest heavily on testimony from witnesses who have received amnesty from prosecution.  While these losses may seem consistent with the Antitrust Division’s uneven trial record against individuals over the last decade,[14] they followed a remarkable string of 18 straight trial victories for the Antitrust Division.  In any event, these recent losses will likely cause the Division to reevaluate factors in its charging decisions and may well give the Division pause in its decisions to pursue close cases.  Thomas Barnett’s Resignation  On November 7, 2008, Thomas Barnett, an extremely bright and capable attorney, announced that he would resign as Assistant Attorney General in charge of the Antitrust Division, effective November 19.  Barnett had served in that position since February 2006 and had served as a Deputy Assistant Attorney General prior to that.  In his speech announcing Barnett’s resignation, Attorney General Mukasey said that "[u]nder Barnett’s leadership, the Division obtained $1.8 billion in criminal fines against 50 corporations and 91 individuals.  The average prison sentence for incarcerated defendants charged by the Division reached an all-time high of 31 months in FY 2007 with an overall average of 23 months during Barnett’s 3-1/2 years as head of the Division.  Foreign executives in international cartel cases also faced longer jail sentences, averaging 12 months in FY 2007."[15] The Obama administration appears primed to continue this aggressive enforcement of the criminal antitrust laws.  Indeed, President-elect Obama said repeatedly during the campaign that he would direct his administration to reinvigorate antitrust enforcement.  These comments may have been focused more on merger enforcement, but obviously demonstrate that the DOJ will not flag in its aggressive prosecution of price-fixing cases in the next administration. Conclusion By any measure, 2008 was an active year for the Antitrust Division, as well as its counterparts around the globe.  The year was marked with significant DOJ successes, including: record criminal fines; higher and higher prison sentences (including numerous significant sentences for foreign individuals); myriad guilty pleas; and the conviction of an individual for antitrust and FCPA offenses in a single enforcement action.  At the same time, 2008 saw the acquittal (or dismissal after mistrial) of several defendants at trial and several other disappointments, including the House of Lords ruling in the Norris case. In international cartel enforcement, the U.K. brought its first ever criminal case against individuals in the Marine Hose investigation, and imposed significant prison terms matching those agreed to in the U.S.  Numerous other foreign enforcement authorities actively investigated and prosecuted both companies and individuals for antitrust violations.  And if the close of 2008 – marked among other things by the $585 million in fines levied in the TFT-LCD investigation – is any indication, 2009 promises to be another active year.  Indeed, the ongoing nature of the TFT-LCD investigation, as well as Air Cargo, Marine Hose, and other investigations, virtually guarantees that the trend of increased criminal antitrust enforcement defining the last several years will not end anytime soon.     [1]      Unless otherwise indicated, all statistics are based on the DOJ’s fiscal year, which  runs from October 1 through September 30.     [2]      The number for FY 2009 is for the first quarter (October 2008–December 2008) only.     [3]      Scott D. Hammond, Deputy Asst. Attorney General, Recent Developments, Trends, and Milestones In The Antitrust Division’s Criminal Enforcement Program, address before the ABA Section of Antitrust Law (Nov. 16, 2007), at 5.     [4]      Press Release, Statement of Thomas O. Barnett, Asst. Attorney General for the Antitrust Division, on U.K. Crown Court Sentencing of Marine Hose Executives and Independent Consultant for Bid-Rigging Conspiracy (June 11, 2008).     [5]      Remarks Prepared For Delivery By Asst. Attorney General Thomas O. Barnett at a Press Conference Regarding LG, Sharp, and Chunghwa’s Agreements to Plead Guilty in LCD Price-Fixing Conspiracies (Nov. 12, 2008) (emphasis added).     [6]      Press Release, Four Shipping Executives Agree to Plead Guilty to Conspiracy to Eliminate Competition and Raise Prices for Moving Freight to and from the Continental U.S. and Puerto Rico (Oct. 1, 2008), http://www.usdoj.gov/atr/public/press_releases/2008/237849.htm.     [7]      See, e.g., Associated Press, Man Agrees to Plead Guilty to Tomato Price-Fixing, Dec. 10, 2008, http://cbs13.com/local/tomato.price.fixing.2.884623.html.     [8]      Press Release, U.S. Department of Justice, Former New York City Employee Indicted in Conspiracy to Commit Bribery (June 5, 2008), http://www.usdoj.gov/atr/public/press_releases/2008/233850.htm.     [9]      Jesse Greenspan, UK Court Cuts Sentences for Marine Hose Defendants, Law360, Nov. 17, 2008, http://competition.law360.com/articles/77000.    [10]      Sean Farrell, Norris loses US extradition battle but says he will appeal, The Independent, July 26, 2008, http://www.independent.co.uk/news/business/news/norris-loses-us-extradition-battle-but-says-he-will-appeal-877866.html.    [11]      Press Release, Treasurer of the Commonwealth of Australia, Rudd Government to Introduce Legislation Criminalising Cartels (Oct. 27, 2008), http://assistant.treasurer.gov.au/DisplayDocs.aspx?doc=pressreleases/2008/087.htm&pageID=003&min=ceb&Year=&DocType=.    [12]      Interview of Scott D. Hammond, Deputy Asst. Attorney General (May 1, 2008) http://www.usdoj.gov/atr/public/speeches/234840.htm.    [13]      Id.    [14]      See "To Plead or Not to Plead?  Reviewing a Decade of Criminal Antitrust Trials" The Antitrust Source (July 2006) (exploring the reasons that the conviction rate in criminal antitrust trials at trial is lower than the DOJ’s overall success rate).    [15]      Press Release, Statement of Attorney General Michael B. Mukasey on the Resignation of Assistant Attorney General Thomas O. Barnett (Nov. 7, 2008) (emphasis added).   Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or any of the following: Washington, D.C.F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com)D. Jarrett Arp (202-955-8678, jarp@gibsondunn.com)David P. Burns (202-887-3786, dburns@gibsondunn.com)  John W.F. Chesley (202-887-3788, jchesley@gibsondunn.com) New YorkRandy M. Mastro (212-351-3825, rmastro@gibsondunn.com)James A. Walden (212-351-2300, jwalden@gibsondunn.com)Peter Sullivan (212-351-5370, psullivan@gibsondunn.com)John A. Herfort (212-351-3832, jherfort@gibsondunn.com) DenverRobert C. Blume (303-298-5758, rblume@gibsondunn.com)Stephen C. McKenna (303-298-5963, smckenna@gibsondunn.com) DallasM. Sean Royall (214-698-3256, sroyall@gibsondunn.com) San FranciscoGary R. Spratling (415-393-8222, gspratling@gibsondunn.com)Joel S. Sanders (415-393-8268, jsanders@gibsondunn.com)Trey Nicoud (415-393-8308, tnicoud@gibsondunn.com)Joshua D. Hess (415-393-8276, jhess@gibsondunn.com)Rachel S. Brass (415-393-8293, rbrass@gibsondunn.com) Los AngelesDaniel G. Swanson (213-229-7430, dswanson@gibsondunn.com)  BrusselsDavid Wood (+32 2 554 7210, dwood@gibsondunn.com) LondonJames Ashe-Taylor (+44 20 7071 4221, jashetaylor@gibsondunn.com) © 2009 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice. 

January 8, 2009 |
2008 Year-End False Claims Act Update

I.  Introduction Today’s headlines are riddled with allegations of fraud and fraudulent schemes–against investors, markets, homeowners, individuals, corporations, and the government.  To combat the latter, the government calls upon its primary weapon – the False Claims Act, 31 U.S.C. §§ 3729-33 (“FCA” or the “Act”).  The Act, as amended in 1986, provides for treble damages and substantial civil penalties from any person or entity that knowingly submits or causes another to submit a false or fraudulent claim to the United States.  Unique “qui tam” provisions of the Act empower private individual whistleblowers, called “Relators,” to file suit in federal court on behalf of the government and to share in anyrecovery.  Recently, the Department of Justice (“DOJ”) reported that in fiscal year 2008 alone, it recovered approximately $1.34 billion in FCA settlements and judgments.[1] While our nation engages in unprecedented amounts of federal spending,[2] legislation with bipartisan support is likely to be reintroduced in the current Congress, which would expand the scope of the Act and relax restrictions on those who may initiate lawsuits.  Meanwhile, industries that did not receive federal funding in the past may soon receive, directly or indirectly, a portion of billions of dollars in federal “bailouts” recently announced.  Unwary companies, therefore, could find themselves the target of federal or state FCA investigations and lawsuits for allegedly misusing or fraudulently obtaining federal funds.  For these and other reasons, Gibson Dunn predicts continued (if not unprecedented) growth in FCA investigation, enforcement, and litigation. This year-end update provides: (1)  A brief overview of the federal statute, including its unique damages, penalty, and private enforcement provisions. (2)  A review of significant activities in 2008, including substantial recoveries by industry, including healthcare, defense, public works, government contracts, and education. (3)  Information regarding Government intervention and the importance of early involvement of qualified FCA counsel and appropriate cooperation with the government to limit exposure to FCA claims.[3] (4)  A summary of important federal court decisions in 2008 and certain legal trends that the FCA lawyers at Gibson Dunn observed this past year. (5)  An overview of legislation, proposed in late-2007, passed out of Committee in 2008, and which may be re-introduced and enacted in 2009, that would broaden the scope of the Act and reverse many of the judicial limitations that have recently emerged. (6)  An overview of state false claims acts.  Because many federal programs, contracts, and grants are jointly funded and/or administered by the states (such as Medicaid), companies are increasingly likely to face simultaneous state and federal enforcement actions. (7)  An overview of new rules for government contractors (effective December 12, 2008) that require internal controls and self-disclosure of suspected FCA violations. We conclude our review with some predictions for the year ahead. II.   FCA – An Overview A.  Liability Under The Statute The FCA provides for recovery of civil penalties and treble damages from any person who knowingly submits or causes the submission of false or fraudulent claims to the United States for money or property.[4]  Under the most commonly-enforced provisions of the statute, a person is liable for “knowingly” (1) presenting or causing the presentment of a claim for payment or approval; (2) making a “false record or statement to get a false or fraudulent claim paid or approved by the Government;” or (3) conspiring to defraud the government “by getting a false or fraudulent claim allowed or paid.”  The FCA also penalizes so-called “reverse false claims,” in which a person “knowingly makes, uses, or causes to be made or used, a false record or statement to conceal, avoid, or decrease an obligation to pay or transmit money or property to the Government.”  The FCA defines “knowingly” as having “actual knowledge” of falsity or acting in “deliberate ignorance” or “reckless disregard” of the truth or falsity of the information.  “No proof of specific intent to defraud is required.”  31 U.S.C. §3729(b). The FCA’s qui tam provisions empower private individuals to file litigation in federal court on behalf of the government and to share in any subsequent recovery.  Qui tam complaints are filed under seal for at least 60 days, to allow the government to investigate the allegations and determine whether to intervene.  After review, the DOJ, on the government’s behalf, decides whether to:  (1) intervene and dismiss the action, (2) intervene and assume primary responsibility for prosecuting the action; or, (3) decline intervention and permit the alleged whistleblower to proceed with the lawsuit on his or her own.  Even if the government initially declines to intervene, it may later intervene in a qui tam action at any time upon a showing of good cause.  31 U.S.C. § 3730(c)(3).  Moreover, because the alleged whistleblower ostensibly brings the action on behalf of the government, the government always retains the right to approve or reject any settlement, even in those cases where the government initially opted out.  See 31 U.S.C. §§ 3730(b)(1) (a qui tam action “may be dismissed only if the court and the Attorney General give written consent to the dismissal”); 31 U.S.C. § 3730(c)(3). B.   Damages And Penalties FCA civil damages and penalties are harsh.  A defendant may be liable for up to three times actual damages plus penalties between $5,500 and $11,000 per claim.[5]  Depending on the manner in which the number of “claims” is calculated, civil penalties may far exceed any actual damages the government sustained.  The DOJ and plaintiffs’ bar have recently pursued expansive theories of liability, seeking the maximum possible damages.  For example, under a “fraudulent inducement” theory (discussed further below under current trends), plaintiffs contend that if a government contractor makes a misrepresentation to obtain a government contract, then every single claim or invoice submitted to the government pursuant to that contract is “false” (and thus subject to a civil penalty).  Under that theory, therefore, all monies paid by the government to the contractor would be recoverable as damages, as the government would have paid nothing had it known of the falsity.  This expansive theory of damages persists regardless of whether the government actually received a valuable product, service, or benefit.  Some courts, it appears, have been receptive to such arguments.  See, e.g., United States v. Rogan, 517 F.3d 449 (7th Cir. 2008).[6] Voluntary disclosure of an FCA violation and full cooperation with the government may help reduce damage exposure to double, instead of triple, recovery.  31 U.S. C. § 3729(a).  Accordingly, companies that do business with the federal government, or receive federal monies, should implement and maintain robust internal compliance programs and take any related employee complaints seriously.  In fact, as discussed further below, Federal Acquisition Regulations (“FARs”) now require certain federal government contractors to create business ethics awareness and compliance programs, an internal control system, and to voluntarily disclose suspected FCA violations to the federal government.  See FAR Case 2007–006; Contractor Business Ethics Compliance Program and Disclosure Requirements. C.  Qui Tam Provisions The FCA’s qui tam provision provides enormous incentives for qui tam Relators to expose fraud against the government.[7]  Successful Relators may receive 15-30% of settlement or judgment proceeds, and may be entitled to reasonable attorney fees’ and costs, which can be substantial.  31 U.S.C. § 3730(d). In FY 2008 (ending September 30, 2008), Relators received approximately $198 million of the federal government’s recoveries, which is an increase from approximately $180 million in FY 2007.[8]  On a dollar for dollar basis, Relators recover significantly more money when the government actually intervenes in their FCA whistleblower actions, despite the fact that Relators receive a greater percentage of any recovery when the government declines to intervene.  In FY 2008, for example, Relators recovered only $197,438,998 (approximately 1% of total relator share awards) in cases where the government declined to intervene.  Id.  The statistics are similar for FY 2007 (approximately 3% of Relator share awards derived from cases in which the government declined to intervene).  Id. Although the FCA authorizes private qui tam enforcement actions, the FCA limits an individual’s ability to file suit to avoid multiple actions against the same defendants and/or about the same conduct.  For example, the FCA’s “first-to-file” bar would prohibit any private action “based upon allegations or transactions which are the subject of a civil suit or an administrative civil money penalty proceeding in which the Government is already a party,” 31 U.S. C. § 3730(e)(3), but the provision has created significant debate about how closely related the suits must be to trigger the limitation.  Another limitation, and the one most frequently litigated, is the “public disclosure bar,” 31 U.S.C. § 3730(e)(4), which divests a court of jurisdiction over any action “based upon the public disclosure of allegations or transactions in a criminal, civil, or administrative hearing, in a congressional, administrative, or Government Accounting Office report, hearing, audit, or investigation, or from the news media,” unless the action is brought by an “original source” of the information.  Id.  To qualify as an “original source,” and thereby avoid dismissal based on the “public disclosure,” the Relator must (1) have “direct and independent knowledge” of the information on which the allegations in his or her complaint are based, and (2) must voluntarily provide the information to the Government before bringing suit.  Id. D.  Statute Of Limitations An FCA action must be brought within six years of the date on which a violation was committed, 31 U.S.C. § 3731(b)(1), or within three years of the date on which the government knew or should have known that a violation was committed, and in no event more than 10 years after the date on which the violation was committed.  31 U.S.C. § 3731(b)(2).  Courts are divided about whether the limitations period begins to run from the date a false claim is submitted to the government or from the date a false claim is paid by the government.  Additionally, courts are split over whether a qui tam Relator is entitled to take advantage of the three-year tolling provision, or whether that provision only applies to the government.  Finally, there is also debate as to whether government claims first asserted in a complaint-in-intervention beyond the limitations period may nevertheless survive by “relating back” to the time of filing the original qui tam complaint under seal. III.  2008 In Review Total federal recoveries under the FCA have exceeded $21.6 billion since 1986.[9]  For FY 2008, the federal government obtained more than $1.34 billion in FCA settlements and judgments.[10]  While the $1.34 billion recovered in FY 2008 is a staggering number, it is a decline from the last two fiscal years.  The government reportedly recovered almost $2 billion in settlements and judgments in FY 2007, and a record $3.2 billion in settlements and judgments in FY 2006.[11]  Commentators (largely from the plaintiffs’ bar) generally attribute the recent decline in recoveries to a substantial backlog of whistleblower cases awaiting DOJ action.  But Gibson Dunn attributes the decline, at least in part, to significant legal developments in the federal courts that have limited the scope of the Act and made it more difficult for private individuals to sustain claims. Significantly, virtually all monies recovered by the government under the FCA arose in cases where the government intervened.  For example, in FY 2008, of the $1.34 billion recovered, only $5,956,644 (less than ½ of 1%) resulted from actions in which the government elected not to intervene, continuing a consistent trend from previous years (see chart immediately below).  Without question, early involvement of qualified FCA defense counsel and effective communication with the government are essential to dissuading the government from intervening and otherwise minimizing exposure to FCA claims. Settlements or Judgments in Cases Where the Government Declines Intervention as a Percentage of Total Annual FCA Recoveries A.  Federal Recoveries By Industry The government uses the FCA to combat fraud in connection with any federal contract or program, and has enforced the Act within virtually every federal agency, from the Department of Agriculture to the Department of Veterans Affairs (essentially all but federal tax fraud is included).  The overwhelming majority of FY 2008 FCA recoveries (nearly 90% or more than $1.11 billion) came from the health care industry, including pharmaceutical companies and related entities in particular.  The following summarizes some of the significant recoveries in 2008 within certain industries frequently targeted for FCA enforcement and litigation activity. 1.  Healthcare As the foregoing chart demonstrates, recoveries from the healthcare industry represent the vast majority of FCA recoveries in every year since 2000.  Gibson Dunn expects this trend to continue into 2009 in part because Congress has allocated more than $25 million to combat fraud and abuse in the Medicaid Program under the Supplemental Appropriations Act of 2008 and Section 6035 of the Deficit Reduction Act.[12]  Already, the fiscal year 2009 Work Plan for the U.S. Department of Health & Human Services (“DHHS”), Office of Inspector General (“OIG”), identifies as its primary area of investigative focus, the Durable Medical Equipment supplier business and targets “potentially illegal practices by suppliers and manufacturers who do not directly bill [federal healthcare] programs,” and “business arrangements that allegedly violate the Federal health care anti-kickback and anti-referral statutes.”[13]  Accordingly, Gibson Dunn looks for these enforcement initiatives to spark an increase in FCA litigation in 2009 and beyond. In 2008, significant healthcare recoveries included the following: a.  Prescription Drugs In February 2008, Merck & Company agreed to pay $650 million to resolve allegations that it knowingly failed to pay proper rebates to Medicaid and other government health care programs and paid kickbacks to health care providers to induce them to prescribe the company’s products.  The settlement resulted from two qui tam lawsuits.  In the first lawsuit, a former Merck employee alleged that the company violated the Medicaid Rebate Statute by providing discounts to hospitals that used its drugs Zocor and Vioxx in place of competitors’ brands, without reporting those discounts and other cost information to reflect its “best price,” as the statute requires.  The suit also alleged that Merck paid kickbacks to physicians to induce them to prescribe its drugs.  In the second lawsuit, a physician alleged that Merck provided discounts to hospitals to induce them to administer its antacid, Pepcid.  Under the two settlement agreements, the federal government received more than $360 million, and forty-nine states and the District of Columbia received over $290 million. In March 2008, CVS Caremark Corporation agreed to pay $36.7 million ($21.1 million to the federal government and $15.6 million to 23 states) to settle claims that from 2000-2006, the company illegally switched patients from the tablet form of the drug Ranitidine (generic Zantac) to a capsule form in order to increase Medicaid reimbursement.  A whistleblower initiated the lawsuit in 2003 and received more than $4.3 million as his share of the settlement.[14]  In its press release, the Government announced,  “[s]witching medication from tablets to capsules might seem harmless, but when that is done solely to increase profit and in violation of federal and state regulations that are designed to protect patients, pharmacies must know that they are subjecting themselves to the possibility of triple damages, civil penalties and attorney fees. . . .  These penalties, coupled with the willingness of insiders to report fraud, should deter such misconduct, but when it doesn’t, the result in this case and others serve notice that we will aggressively pursue all available legal remedies.”[15] Walgreen Co. settled multiple qui tam actions this year for nearly $45 million.  In June 2008, Walgreens agreed to pay $35 million (federal share $18.6 million with remainder to 46 states and Puerto Rico) to settle claims that it switched patients to different prescription drugs in order to increase Medicaid reimbursement.  In September 2008, Walgreens agreed to a $9.9 million settlement to resolve allegations that the company over-billed four state Medicaid agencies for prescription drugs provided to beneficiaries covered both by Medicaid and by private third-party insurance.  Although pharmacies may bill Medicaid for prescription drug costs not covered by private insurers, which typically amounts to a co-payment alone, DOJ alleged that Walgreens knowingly submitted claims to the Medicaid programs in excess of the co-pay amount. In September 2008, Cephalon Inc. agreed to pay a total of $425 million to resolve criminal and civil claims arising from allegations that the company marketed three drugs for off-label uses in violation of FDA rules resulting in false claims to Medicaid, Medicare and other programs for unapproved uses of the drugs the programs did not cover.  $375 million was paid to resolve the civil FCA allegations, $116 million of which was paid to several states.  The settlement resolved four qui tam lawsuits, three of which were brought by former Cephalon sales representatives.  The Relators received over $46 million of the federal share of the settlement. In September 2008, Abbott Laboratories, Inc. agreed to pay a total of $28 million to resolve false claims allegations stemming in part from a qui tam lawsuit alleging that the company falsely reported drug prices to state and federal Medicaid programs, which are used to calculate reimbursement rates, causing the federal and state governments to overpay for prescription medications. b.  Outlier Payments Under certain conditions, Medicaid and Medicare disburse  “outlier payments,” in addition to standard reimbursement rates, to compensate providers when the length of stay or cost of treating a beneficiary is exceptionally high relative to the average length of stay or average cost of treating comparable conditions.  Following a record-breaking $900 million settlement in July 2006 with Tenet Healthcare Corporation resolving fraudulent outlier payment allegations (among other alleged violations), this type of fraud continued to be a focus in FY 2008. On December 10, 2007, Warren Hospital agreed to pay $7.5 million to resolve claims from two separate qui tam actions alleging the hospital fraudulently claimed outlier payments.  In March 2008, Cathedral Healthcare Systems settled three separate qui tam actions for $5.3 million to resolve allegations that it fraudulently obtained outlier payments.  In August 2008, BlueCross BlueShield of Tennessee settled outlier fraud claims for $2.1 million, and in September 2008, Cooper University Hospital (in New Jersey) agreed to pay $3.85 million to resolve allegations that it defrauded Medicare by increasing charges and fraudulently obtaining outlier payments. c.  Illegal Kickbacks and Referrals[16] In December 2007, HealthSouth Corporation and two physicians agreed to pay $14.9 million to settle allegations that the company submitted false Medicaid and Medicare claims to the government and paid illegal kickbacks to physicians in violation of the Anti-Kickback Statute and the Stark Law.  Notably, the settlement resulted from company disclosures to the government following a change in management and an internal investigation. In April 2008, a Florida radiologist, his imaging center, and related entities agreed to pay $7 million to resolve allegations of fraudulent billing and violations of the Stark law and Anti-Kickback statute.  Memorial Health, Inc. also agreed to pay $5.08 million to resolve a qui tam lawsuit alleging Medicare fraud and violations of the Stark Law. In May 2008, Baptist Health South paid nearly $7.8 million to settle claims that it violated the FCA and Stark laws. In July 2008, Lester E. Cox Medical Centers agreed to pay $60 million to settle claims that it violated the FCA, the Anti-Kickback Statute, and the Stark Law.  The United States alleged that Cox entered into illegal financial relationships with referring physicians at a local physician group and engaged in improper billing practices with respect to Medicare.  The settlement also resolved claims that Cox included non-reimbursable costs on its Medicare cost reports and improperly billed for dialysis services. In November 2008 (FY 2009) Bayer Healthcare LLC agreed to pay $97.5 million to settle FCA allegations that it had paid illegal kickbacks to diabetic suppliers. d.    Fraudulent Healthcare Billing In November 2007, Stryker Corporation and its former outpatient therapy division, Physiotherapy Associates Inc. agreed to pay $16.6 million to settle allegations that Physiotherapy submitted false claims to Medicare and other federal and state health care programs.  Former Physiotherapy employees brought the lawsuit alleging that Physiotherapy falsely billed services as one-on-one services and improperly retained excess or duplicate payments. In March 2008, HealthEssentials Solutions, Inc. agreed to pay $117 million to resolve claims that it committed health care fraud against Medicare, Medicaid, and other federally subsidized health care programs by “upcoding” claims.  The settlement resulted from three different whistleblower lawsuits. In May 2008, Medtronic Spine, LLC (formerly Kyphon Inc.) agreed to pay $75 million to settle claims that it violated the FCA by knowingly causing the submission of false claims to Medicare in connection with its kyphoplasty spinal procedure (allegedly performed on an inpatient basis rather than the less costly outpatient basis).  The settlement resolved a qui tam lawsuit filed by two former Kyphon employees. In August 2008, Amerigroup Corporation agreed to pay $225 million to settle federal and state FCA charges that the corporation systematically avoided enrolling pregnant women and other high-cost patients in the company’s managed care program in Illinois in violation of Medicaid regulations.  In October 2006, a federal district court entered judgment for $334 million.  Amerigroup appealed the decision to the Seventh Circuit, but ultimately settled.  A former employee filed the lawsuit and received approximately $55 million as his share of the settlement proceeds. In September 2008, Staten Island University Hospital (SIUH) agreed to pay $74 million to settle two FCA qui tam actions and two other matters for alleged fraudulent Medicare and Medicaid billing.  In addition, SIUH  agreed to pay the State of New York more than $14.8 million. 2.    Procurement Fraud In October 2006, the government announced a new National Procurement Fraud Task Force “to promote the early detection, prevention and prosecution of procurement fraud associated with increased contracting activity for national security and other government programs.”  The task force includes members from the DOJ Criminal and Civil Divisions, U.S. Attorneys’ Offices, and other federal law enforcement agencies, such as the FBI, the Special Inspector General for Iraq Reconstruction, the Offices of Inspectors General for the Department of Defense, the Central Intelligence Agency, the General Services Administration, and the Department of Homeland Security, among others.  One of the Task Force’s primary objectives is to “[i]ncrease and accelerate civil and criminal prosecutions and administrative actions to recover ill-gotten gains resulting from procurement fraud.”[17]  In its December 2008 Progress Report, the Task Force reported that in the two years since its formation, it had recovered more than $362 million in civil settlements or judgments arising from procurement fraud claims.  Id.  The Task Force credits some of the significant recoveries in 2008 set forth below to its coordinated investigation and prosecution efforts. a.    Department of Defense[18] There were several multimillion dollar settlements in connection with the manufacture and supply of defective Zylon bulletproof vests purchased and paid for by the government.  In October 2007, for example, Hexcel Corporation agreed to pay $15 million.  In October 2008 (FY 2009), Armor Holdings Products LLC agreed to pay $30 million.  On June 5, 2008, the government sued Honeywell International, Inc. under the FCA for allegedly failing to inform Armor Holdings or the government of known defects in the Zylon Shield vests.  The National Procurement Fraud Task Force’s 2008 Progress Report also notes that the government has brought FCA causes of action against Second Chance Body Armor and Toyobo Corporation for making similar false claims. In March 2008, National Air Cargo agreed to pay $28 million in a global settlement to resolve criminal and civil FCA allegations of fraudulently billing the DOD for the shipment of freight by surface rather than air transportation as DOD regulations require.  Of the total payment, National Air Cargo paid $11.75 million to settle civil FCA claims brought by a whistleblower. In May 2008, the Pasha Group agreed to pay $13 million to resolve allegations that the company participated in a conspiracy to rig bids and fix prices for transportation of household goods belonging to U.S. military and DOD personnel, which allegedly caused the government to overpay for transportation claims, in violation of the FCA. In August 2008, Pratt & Whitney agreed to pay $53 million to resolve allegations that the companies knowingly submitted false claims for defective turbine blades the Air Force purchased.  The government pursued the case as part of the National Procurement Fraud Initiative.  Gibson Dunn believes that the wars in Iraq and Afghanistan likely will give rise to a surge in FCA enforcement actions and new claims against government defense contractors in the near future.  Indeed, just last month, on December 8, 2008, the DOJ announced that a subsidiary of L-3 Communications Holdings Inc. paid the government $4 million to settle allegations that its employees falsified time cards for services to the Army between March 2004 and August 2005.  A former L-3 employee brought the action.  Further, the National Procurement Fraud Task Force in 2008 identified contracts related to the wars in Iraq and Afghanistan, and the rebuilding of those countries, as a “major focus of the Civil Division’s procurement fraud efforts.”[19] b.    Public Works In January 2008, Bechtel Infrastructure Corp. and PB Americas Inc. agreed to pay $458 million to settle federal and state claims (which included $23 million to the United States and over $40 million to the Commonwealth of Massachusetts to settle state FCA allegations).  The claims arose in connection with a major public transportation infrastructure project in Boston known as the “Big Dig.”  The government alleged the firms submitted false claims for federal highway funds by failing to provide adequate management and quality assurance services during construction.  The settlement also resolved claims brought in a qui tam action filed in the United States District Court for the District of Massachusetts. Of note, President-elect Obama recently announced plans for enormous infusions of federal funds to the states for the purpose of infrastructure and public works projects.[20]  Accordingly, Gibson Dunn expects to see enhanced federal and state FCA activity in this area. c.  Government Contracts; GSA In May 2008, Computer Sciences Corporation (“CSC”) agreed to pay $1.37 million to settle allegations that it solicited and received improper payments and failed to disclose conflicts of interest in connection with government agency technology contracts.  The settlement is significant because the action against CSC is part of a larger investigation of government technology vendors and consultants, which also resulted in FCA actions filed in 2007 against Accenture, LLP, Hewlett-Packard Company, and Sun Microsystems Inc.[21] 3.    Education In addition to university teaching hospitals, which are frequent targets of FCA actions alleging Medicaid and Medicare fraud, many universities and institutions of higher learning apply for and receive federal student aid and research grants from agencies such as the NIH or CDC.  In exchange, they must adhere to federal regulations, such as the Higher Education Act (HEA).  Some of the nation’s most prominent universities have settled FCA allegations in the past few years, including Harvard ($31 million in 2005; $2.4 million in 2004), Weill Medical College of Cornell University ($4.4 million in 2005), John Hopkins ($2.6 million in 2004), the Mayo Clinic ($6.5 million in 2005), and Northwestern ($5.5 million in 2003).  In July 2007, Oakland City University paid $5.3 million to resolve a qui tam action alleging false certification of compliance with HEA provisions. This trend continued in 2008.  In February 2008, the Puerto Rico Department of Education paid more than $19 million to resolve allegations that it falsely certified its eligibility to receive federal funds under the Migrant Education Program.  In July 2008, St. Louis University agreed to pay $1 million to settle a lawsuit filed by a former Dean of the school alleging that it improperly supplemented faculty pay by misusing federal (CDC) grant funds. On December 23, 2008, the DOJ announced that Yale University had agreed to pay $7.6 million to resolve allegations that it violated the FCA by misusing and mismanaging federally-funded research grants.  The government alleged that researchers transferred non-allocable costs to certain grant accounts in order to obtain unspent grant funds near the expiration dates of the grants.  In addition, the settlement resolved allegations that certain researchers improperly charged federal grant accounts for time spent on unrelated work, in order to obtain salaries over the summer months.  Yale cooperated with the government during its investigation, and DOJ reports that as a result of such cooperation and the settlement, there will be no lawsuit filed against the university regarding more than 6,000 federally-funded grants covered by the agreement.  The DOJ stated that the settlement should “send a clear message that the regulations applicable to federally-funded research grants must be strictly adhered to.”[22] A significant qui tam action remains pending in California federal court against the University of Phoenix, alleging the university defrauded the federal government out of millions of dollars in federal education loans by paying unlawful bonuses and other gifts to recruiters.  The government declined to intervene.  Although the district court dismissed the action, the Ninth Circuit reversed.  The case is in the midst of discovery and is presently scheduled for trial in 2010. B.   Hot Topics, Significant Legal Trends, and Key Cases in 2008 There were several significant legal developments in the FCA arena during 2008.  These developments include, among others: (1) the Supreme Court’s ruling in Allison Engine Co. v. United States ex rel. Sanders, 128 S.Ct. 2123 (2008), which significantly curtailed the potential reach of the FCA; (2) further development regarding the nature of the public disclosure bar including a growing trend of dismissing cases on public disclosure grounds; (3) further narrowing of false certification and fraudulent inducement theories of liability which relators and DOJ have used in an attempt to expand potential FCA liability; (4) courts insisting on a greater level of specificity in a Relator’s pleadings to avoid dismissal under Rule 9(b); and, (5) an increased willingness of courts to grant summary judgment for lack of evidence of a “knowing” violation of the FCA.  Each of these trends is discussed in further detail below. 1.    The U.S. Supreme Court Curtails the Reach of the FCA and Warns Against “transform[ing] the FCA into an all-purpose antifraud statute” In Allison Engine Co. v. United States ex rel., Sanders, 128 S.Ct. 2123 (2008) the Supreme Court addressed the issues of whether a plaintiff asserting a claim under Section 3729(a)(2) (using a false record or statement to get a false or fraudulent claim paid) and Section 3729(a)(3) (conspiracy) “must show regarding the relationship between the making of a ‘false record or statement’ and the payment or approval of ‘a false or fraudulent claim . . . by the Government.'”  The Court unanimously held that a Relator must prove “that the defendant intended that the false record or statement be material to the Government’s decision to pay or approve” a false claim. The facts:  The United States Navy procured missile destroyers from two prime-contractor shipbuilders.  The two prime contractors contracted with Petitioner Allison Engine, which subcontracted with Petitioner General Tool Company, which subcontracted with Petitioner Southern Ohio Fabricators, Inc., to manufacture the generator sets (“Gen-Sets”) which supplied the electrical power to the destroyers.  Each Gen-Set had to be manufactured according to Navy specifications, and each subcontractor invoice had to be accompanied by a Certificate of Conformance (“COC”).  Relators introduced evidence that the Gen-Sets were not manufactured according to Navy specifications and that the Petitioners’ invoices were accompanied by false COCs, but “did not, however, introduce the invoices submitted by the shipyards to the Navy.” The Supreme Court, for the first time, addressed the requisite proof of an offense under 31 U.S.C. § 3729(a)(2).  The Court held, “If a subcontractor or another defendant makes a false statement to a private entity and does not intend the Government to rely on that false statement as a condition of payment, the statement is not made with the purpose of inducing payment of a false claim ‘by the Government.’  In such a situation, the direct link between the false statement and the Government’s decision to pay or approve a false claim is too attenuated to establish liability.” Allison Engine increases the burden on plaintiffs when bringing an FCA false record and/or conspiracy claim against subcontractors and others who deal only indirectly with the federal government.  Specifically, the Supreme Court confirmed that Relators must demonstrate that the subcontractor made a false statement to a private entity intending that the Government would rely upon the statement in order to make payment.  To prevail on an FCA conspiracy claim, Allison Engine instructs that “it is not enough for a plaintiff to show that the alleged conspirators agreed upon a fraud scheme that had the effect of causing a private entity to make payments using money obtained from the Government.  Instead, it must be shown that the conspirators intended to ‘defraud the Government.’” The lower courts in 2008 have only just begun considering the ramifications of Allison Engine.  However, several decisions suggest that Allison Engine has already curtailed the reach of the Act.  For example, following the Allison Engine decision, a district court in Iowa entered summary judgment sua sponte dismissing Section 3729(a)(2) and (3) claims in connection with allegedly false crop insurance claims.  See United States v. Hawley, 566 F. Supp. 2d 918 (N.D. Iowa 2008).  In Hawley, the government alleged that Mr. Hawley engaged in improper conduct that allowed certain ineligible farmers to obtain and make claims against multi-peril crop insurance policies that were sold by Hawley, issued by North Central Crop Insurance, and reinsured by the Federal Crop Insurance Corporation.  The court dismissed the “false statement” and conspiracy claims because the alleged fraud was too attenuated.  Id. at 927-28 (“the allegedly false crop insurance claims themselves were never forwarded to or approved by the government, nor was the payment of the crop insurance claims conditioned on review or approval by the government, and there is no showing that the defendant intended that the false records or statements would be material to the government’s decision to pay or approve the false claim.”) Similarly, in United States ex rel. Sterling v. Health Ins. Plan of Greater N.Y., Inc., 2008 U.S. Dist. LEXIS 76874 (S.D.N.Y. Sept. 30, 2008), the Relator alleged that defendant Health Insurance Plan of Greater New York, Inc. (“HIP”) defrauded the federal government and the City of New York by fraudulently altering statistical data about its treatment procedures in order to obtain accreditation needed to maintain a contract to provide health benefits and health management services to federal employees, recipients of Medicaid, and federal beneficiaries of various programs, including Child Health Insurance Plus.  Following Allison Engine, the district court dismissed the complaint because the allegedly false statements to the accreditation agency (the National Committee for Quality Assurance) were too far removed from any actual claims.  Id. at *14 (the “Relator’s claim does not show a substantial connection between HIP’s alleged fraud and the Government’s payment to HIP.  Relator attempts to draw such a connection by stating that HIP had a contractual requirement to maintain accreditation, that the strep-throat testing statistics would have affected its accreditation, that HIP therefore falsified the results that it gave to NCQA to maintain good ratings, and then, finally, that the Government relied on this fraudulently obtained positive NCQA rating to award HIP continuing contracts. …  This line of argument stretches the narrow boundaries that Allison Engine created.”). By contrast, in United States v. Eghbal, 548 F.3d 1281 (9th Cir. 2008), the court determined that under the standards set forth in Allison Engine, FCA liability could attach to false statements in loan applications for federally-insured loans that have a “”material effect’ on the Government’s eventual decision to pay a claim.”  Id. at *6.  The defendants in Eghbal purchased HUD-foreclosed homes and resold them for profit to buyers with mortgage secured loans insured by HUD.  Defendants sold the loans to buyers who lacked sufficient assets to cover the down payment on the properties, and provided the down payment for the buyers in violation of HUD rules (HUD would not insure a loan for a home for which the down payment was paid by the seller).  Defendants signed documents falsely certifying that they provided no funds towards the down payment.  Defendants argued that “they sought only to fraudulently induce HUD to insure the mortgage, not to have the buyers default or cause the mortgage holders to make claims on HUD.”  Id. at *5.  The court rejected their claims and held “liability under the FCA nevertheless attaches, because the false statements were ‘relevant to the government’s decision to confer a benefit,'” and the “plain language of the FCA contemplates liability not only for fraudulently causing the Government to pay a claim, but also for causing the Government to approve a claim.”  Id. at *5-6. Some have speculated that Allison Engine may restrict actions in the Medicaid arena, because claims are presented to state agencies and paid with state funds (which the federal government then reimburses to the state on a percentage basis).[23]  It is too soon to make any generalizations about the precise effect of Allison Engine, but litigation of the issue is sure to surface in the year ahead. 2.    The Federal Courts Interpret the Public Disclosure Bar As noted above, a district court does not have jurisdiction over a private individual’s FCA action if the claim is based on publicly disclosed information unless the Relator qualifies as an “original source” of the information upon which his/her action is based.  31 U.S.C. §3730(e)(4).  Congress enacted the provision to balance competing desires to encourage private citizens to expose fraud on the government, but also to discourage opportunistic or “parasitic” plaintiffs from capitalizing on publicly disclosed information. In determining whether a court has jurisdiction over an FCA claim, in the first instance, courts must answer three questions – (1) Was there a public disclosure?  If so, (2) Is the qui tam action based upon the public disclosure?  If so, (3) Is each Relator an original source of the information underlying each of the allegations of the complaint?  Each of those three questions has given rise to considerable litigation and has divided the Federal Circuit Courts.  Indeed, plaintiff lawyers (and, consequently, the courts) have subjected every word of the statute to varied interpretation, making the search for clarity and guidance elusive.  In 2007 the Supreme Court resolved a circuit split about the third question in Rockwell  Int’l Corp. v. United States, 549 U.S. 457 (2007), thereby restricting the interpretation of the “original source” requirement. a.    Do State Reports Qualify as A Source of Public Disclosure?   U.S. Supreme Court May Resolve Issue Shortly With respect to the first question, whether there was a public disclosure of the information, the FCA enumerates several sources of public disclosure, including disclosure in a “Congressional, administrative, or Government Accounting Office report, hearing, audit, or investigation.”  A common point of debate, however, is whether a state administrative report constitutes a public disclosure.  On June 9, 2008, the Fourth Circuit held “the public disclosure bar applies to federal administrative audits, reports, hearings or investigations, but not to those conducted or issued by a state or local governmental entity.”  United States ex rel. Wilson v. Graham County Soil & Water Conservation Dist., 528 F.3d 292, 296 (4th Cir. 2008) (emphasis added). The defendant in that case has petitioned the U.S. Supreme Court for review, and, in December 2008, the Supreme Court invited the United States Solicitor General to file a brief expressing its views whether administrative reports or audits issued by state or local governments constitute “public disclosures” within the meaning of the FCA.  Several states’ Attorney Generals and representatives of the pharmaceutical and biotechnology industries have filed amicus briefs in the case, as those non-parties are vitally concerned that the Supreme Court hear the issue and resolve the Circuit split in favor of a decision that a state audit or report is a “public disclosure” within the meaning of the FCA.  States regularly administer programs involving federal funds (such as Medicaid, which is jointly administered and funded), during the course of which they routinely investigate improper or fraudulent claims. b.    A Stricter Interpretation of the Original Source Requirement With respect to the third question, that is, proof required to demonstrate “original source” status, the FCA defines an original source as an “an individual who has direct and independent knowledge of the information on which the allegations are based and has voluntarily provided the information to the Government before filing an action . . . which is based on the information.”  31 U.S.C. § 3730(e)(4)(A) and (B).  In March 2007, the Supreme Court decided Rockwell Int’l Corp. v. United States, 549 U.S. 457 (2007), which resolved a split among the circuits and narrowly construed the “original source” requirement. First, Rockwell clarified that the “original source” issue is a jurisdictional issue, which cannot be conceded or waived, may be raised, and must be satisfied, at all stages of the litigation, even post-trial.[24]  Second, Rockwell held that a Relator must possess “direct and independent knowledge” of the information on which the allegations of his or her complaint are based, as opposed to the information on which the publicly disclosed allegations are based (this particular holding resolved the split in the Circuits).  Third, Rockwell prohibits “claim smuggling;” a Relator must qualify as an original source as to all claims raised, and some claims may be severed and dismissed even if the Relator is an original source as to other claims in the same litigation.  Fourth, Rockwell held that a qui tam Relator’s “prediction” or suspicion of wrongdoing is not first hand knowledge sufficient to satisfy the “original source” requirement. Following Rockwell, and throughout late-2007 and 2008, Gibson Dunn identified a trend in which courts appear far more willing to dismiss claims for lack of jurisdiction under the public disclosure bar.  See, e.g., United States ex rel. Hockett v. Columbia/HCA Healthcare Corp., 498 F. Supp. 2d 25 (D.D.C. 2007); United States ex rel. Boothe v. Sun Healthcare Group, Inc., 496 F.3d 1169 (10th Cir. 2007); United States ex rel. Fried v. West Independent School Dist., 527 F.3d 439 (5th Cir. 2008) (“The burden was on [Relator] to show that the information and allegations he discovered were qualitatively different information than what had already been discovered and not merely the product and outgrowth of publicly disclosed information.”) (internal quotations omitted); United States ex rel. Duxbury v. Ortho Biotech Products, 551 F. Supp. 2d 100 (D. Mass. 2008). 3.    The Rise of False Certification and Fraudulent Inducement Theories of Liability and Federal Courts’ Efforts To Restrict Such Theories The DOJ and Relators have taken ever expansive views of liability under the FCA.  For example, allegations of promissory fraud continue to percolate in the federal courts, with plaintiffs taking the position that if an FCA defendant lied to obtain a contract at the outset, then liability attaches to all claims submitted under that contract because all claims are “tainted” by the alleged fraudulent inducement and all monies paid under the fraudulently obtained contract must be re-paid to the government.  Additionally, Relators frequently attempt to bring claims under implied or express “false certification” theories of liability, arguing that a defendant may be liable for falsely certifying compliance with a broad range of federal statutes, regulations, or guidelines at the time of seeking payment on a claim, whether or not the regulations directly relate to the actual claim for government funds.  In other words, private individuals who would not otherwise have standing to enforce myriad laws (e.g., healthcare or environmental regulations) because those regulations contain no private enforcement mechanisms like the FCA’s qui tam provisions, seek to use the FCA as a back-door to enforce compliance with those laws and to severely penalize non-compliance, even if the noncompliance itself resulted in little or no monetary loss.  Some of the most prevalent FCA actions in 2008 involved allegations that healthcare providers falsely certified compliance with anti-kickback and self-referral legislation, or that government contractors fraudulently obtained contracts in violation of government procurement regulations and/or fraudulently certified compliance with regulations at the time of claim submission. a.    False Certification The Tenth Circuit this year in United States ex rel. Conner v. Salina Regional Health Center, Inc., 543 F.3d 1211 (10th Cir. 2008) addressed “whether a qui tam plaintiff, proceeding under the FCA, can maintain a cause of action against a Medicare provider based on an allegation that the provider’s certification of compliance with Medicare statutes and regulations, contained in the annual cost report, render[ed] all claims submitted for reimbursement by that provider false within the meaning of the FCA.”  In other words, can FCA liability arise if the Medicare provider is not in complete compliance with all Medicare statutes and regulations? The facts:  Dr. Brian E. Conner was an ophthalmologist and eye surgeon who worked as a member of the medical staff for Salina Regional Health Center, Inc. (“SRHC”) at its Salina, Kansas facility.  When SRHC provided a Medicare service, it submitted individual Medicare reimbursement requests to an intermediary of the Government, which then calculated and dispensed estimated periodic payments.  Final payments were calculated based on actual costs, as set forth in annual cost reports the Medicare provider submits.  As part of its annual cost reports, an SHRC representative certified, among other things, that “the services identified in this cost report were provided in compliance with [Medicare] laws and regulations.”  Conner asserted that at the time SRHC made this representation, it was not in compliance with all Medicare laws and regulations. Conner filed a qui tam complaint after SHRC refused to reappoint him to its medical staff and alleged that SHRC had “presented false claims because it was in violation of various regulations and statutes establishing Medicare conditions of participation at all times from 1987 until the present day.”  The district court granted SHRC’s Rule 12(b)(6) motion to dismiss, holding that “the government’s payment for services rendered was not conditioned on” compliance with Medicare statutes and regulations, and Conner appealed. The Tenth Circuit affirmed because although the certification represented “compliance with underlying laws and regulations, it contain[ed] only general sweeping language and d[id] not contain language stating that payment [was] conditioned on perfect compliance with any particular law or regulation.”  In reaching its holding the Tenth Circuit distinguished between “[c]onditions of participation, as well as provider’s certification that it has complied with those conditions, [which] are enforced through administrative mechanisms,” from “[c]onditions of payment . . . which, if the government knew they were not being followed, might cause it to actually refuse payment.  Conner is representative of the growing trend of cases rejecting false certification claims based on boilerplate certifications of compliance with federal regulations. By contrast, plaintiffs may prevail where they identify a false certification of compliance with a specific regulation that is a condition of payment.  Compare United States ex rel. Roberts v. Aging Care Home Health, Inc., 2008 U.S. Dist. LEXIS 56846, *28-34 & n.13 (W.D. La. July 25, 2008) (holding Medicare conditions payment of a claim upon a certification of compliance with the Stark Laws, but also noting that “[v]iolations of Stark II or any other law, without more, do not create liability under the FCA.”) with Abner v. Jewish Hosp. Health Care Servs., 2008 U.S. Dist. LEXIS 61985, *22-25 & n.3 (S.D. Ind. Aug. 13, 2008) (noting the Circuit split regarding the viability of express or implied false certification theories of liability; dismissing false certification claims for failure to plead with particularity where “relators pointed the court generally to 42 C.F.R. parts 482 and 493 but did not point to any specific regulation requiring certification before dispensation of payment, let alone point to one that defendants allegedly violated;” and warning, “[i]f relators file a second amended complaint that alleges false certification with particularity, they must direct the court to a specific regulation conditioning payment on certification of compliance.”) (emphasis added). b.    Fraudulent Inducement The Fourth Circuit in United States ex rel. Wilson v. Kellogg Brown & Root, Inc., 525 F.3d 370 (4th Cir. 2008) addressed the issue of whether a fraudulent inducement theory of FCA liability can arise when a defendant fails to satisfy generic statements of contractual obligations.  The Facts:  Kellogg Brown & Root, Inc. (“KBR”) entered into a Logistics Civil Augmentation Program contract with the Department of Defense (“DOD”) to provide operational support to the United States military in wartime situations.  Under the general contract, the Army requested specific services pursuant to Task Orders.  The Task Orders also contained Statements of Work that further delineated KBR’s responsibilities.  Pursuant to Task Order 43, KBR agreed to provide transport services for the army.  Task Order 43 required KBR, among other things, to maintain vehicles “in a safe operating condition and good appearance.”  Relators Wilson and Warren, KBR employees who drove supply trucks in Iraq, brought suit under the FCA using a “fraudulent inducement” theory.  They argued that KBR fraudulently induced the United States into issuing Task Order 43 by knowingly misrepresenting that KBR would comply with the Task Order’s maintenance requirements.  The Relators asserted that KBR had signed a DOD form accepting the task order subject to its terms and conditions, which was required to be signed before payment could be made, knowing that KBR had not fulfilled its maintenance obligations in the past and would not do so in the future.  The district court granted KBR’s rule 12(b)(6) motion to dismiss because the DOD form did not constitute a “false statement or fraudulent course of conduct.” The Fourth Circuit affirmed the district court’s dismissal of the claims, holding that Relators’ assertions that KBR did not fulfill its maintenance obligations were mere “allegations of poor and inefficient management of contractual duties,” insufficient to create a cause of action under the FCA   Furthermore the “imprecise nature of the general maintenance provisions at issue” made it difficult to determine what qualified as adequate or inadequate maintenance under Task Order 43.  The Fourth Circuit also noted that the DOD form in question had been signed more than five months after KBR began performance under the Task Order so, as a matter of law, even if the DOD form contained a misstatement, such misstatement could not explain how Task Order 43 had been “obtained originally” through fraudulent inducement as the FCA requires. KBR confirms that Relators pursuing fraudulent inducement theories of recovery under the FCA must identify specific false statements made while negotiating a contract that induced the government to contract with, or pay, the contractor. 4.    Requiring Increased Particularity In Pleading Pursuant To Rule 9(b) FCA actions are subject to the Federal Rules of Civil Procedure, including special pleading requirements applicable to fraud actions.  Specifically, Rule 9(b) requires a plaintiff to plead with particularity the who, what, when, where, and how of the alleged fraud.  When facing Motions to Dismiss, court often struggle to determine the appropriate level of specificity required in a complaint, particularly where the plaintiff alleges a fraudulent scheme occurring over many years and/or in multiple programs or locations. Gibson Dunn has identified a trend in which courts appear to demand an increasing level of specificity in complaints to withstand dismissal.  For example, plaintiffs frequently allege an underlying “scheme to defraud” the government in detail, but courts nevertheless seem more apt to dismiss such complaints unless at least some representative examples of specific false claims resulting from the alleged fraudulent schemes are identified in, or attached to, the complaint.  See, e.g., United States ex rel. Fowler v. Caremark, R.X., LLC, 496 F.3d 730, 740 (7th Cir. 2007), cert. denied, 128 S. Ct. 1246, 170 L. Ed. 2d 66 (2008); United States ex rel. Wilson v. Kellogg Brown & Root, Inc., 525 F.3d 370, 379-80 (4th Cir. 2008) (agreeing with district court that the third amended complaint failed to satisfy Rule 9(b) in part because the “complaint lacks any specific facts about several important elements of the alleged scheme”); United States ex rel. Marlar v. BWXT Y-12, L.L.C., 525 F.3d 439 (6th Cir. 2008) (affirming dismissal of substantive FCA claims for failing to comply with Rule 9(b)); Barys v. Vitas Healthcare Corp., 2008 U.S. App. LEXIS 22619 (11th Cir. 2008) (district court did not err in refusing to relax pleading requirements nor in dismissing amended complaint for failure to satisfy the requirements of Rule 9(b)); United States ex rel. Hebert v. Dizney, 2008 U.S. App. LEXIS 21413, *13-14 (5th Cir. Oct. 10, 2008) (“While we agree that Rule 9(b) does not require a qui tam plaintiff alleging a long-running scheme involving many false claims to list every false claim, its dates, [and] the individuals responsible, . . . the allegedly great extent and complexity of a fraudulent scheme does not excuse a failure to plead at least  one false claim with the requisite specificity.”) (internal quotations omitted); United States ex rel. Serrano v. Oaks Diagnostics, Inc., 568 F. Supp. 2d 1136, 1143 (C.D. Cal. 2008) (“The general allegations that all claims submitted during an almost four year period were fraudulently submitted is insufficient particularity to satisfy the 9(b) pleading standard.  While the Court is not suggesting that Rule 9(b) requires precise details  pertaining to each of the allegedly 1393 claims submitted, the Ninth Circuit requires some specifics, such as the time, place, nature of the false statement, as well as the identities of the parties to the misrepresentation be present to comply with Rule 9(b) pleading standards. . . .  [B]ecause not a single allegedly false claim is stated with those particularities, the FCA claims must be [dismissed].”).[25] Defendants served with FCA complaints should carefully consider challenging the complaint on the basis of Rule 9(b) at the outset.  Even if dismissal is granted with leave to file an amended complaint, defendants are far better prepared to defend against detailed and specific allegations and may even be successful in narrowing the scope of discovery, which can be expensive, intrusive, and time consuming. 5.    Granting Summary Judgment For Lack Of Evidence Of a “Knowing” Violation The FCA penalizes only “knowing” violations, defined as actual knowledge, or a deliberate ignorance of, or reckless disregard for, the truth or falsity of information.  31 U.S.C. §3729(b).  Repeatedly, courts have held that negligent or innocent billing mistakes are not actionable under the statute.  See, e.g., United States ex rel. Farmer v. City of Houston, 523 F.3d 333, 338-39 (5th Cir. 2008) (“Though the FCA is plain that “proof of specific intent to defraud” is not necessary, . . . that mens rea requirement is not met by mere negligence or even gross negligence. . . . Given [the FCA’s] definition of ‘knowingly,’ courts have found that the mismanagement-alone-of programs that receive federal dollars is not enough to create FCA liability.”) Predictably, plaintiffs almost invariably argue that “scienter” or state-of-mind element is a factual issue, inappropriate for summary disposition prior to trial.  Recently, however, federal courts appear far more willing to dispose of FCA cases on summary judgment where plaintiffs fail to submit evidence to support a reasonable inference of knowledge or reckless disregard, particularly in areas where there is evidence that governing regulations or contract terms are ambiguous and the defendant’s interpretation was reasonable.[26] IV.  Significant Proposed Legislation – The False Claims Correction Act of 2007 A.  Introduction For more than 100 years, since President Lincoln signed the FCA into law in 1863 to combat fraud perpetrated against the Union Army, the FCA remained virtually untouched by legislators.  In 1986, however, Representative Howard Berman (D-Cal) and Senator Chuck Grassley (R-Iowa) reinvigorated the century-old law by adding provisions that allow citizens to act as “private attorneys general” and sue for government fraud.  Then, in late 2007, these lawmakers introduced bills in the U.S. House of Representatives and Senate to amend the False Claims Act.  Both bills are entitled the False Claims Correction Act of 2007. Specifically, on September 12, 2007, Senator Grassley introduced the Senate’s amended bill, S. 2041, 110th Cong., which was intended to “modernize and strengthen” the False Claims Act, expanding the government’s ability to protect treasury assets and fight fraud.  Senator Grassley has long been a champion of the False Claims Act, and the bill’s other sponsors show that it has enjoyed bi-partisan support.  On December 19, 2007, Representative Berman introduced a companion bill in the House, H.R. 4854, 110th Cong., which includes substantially the same provisions.  The House bill also has bipartisan support.  Both bills were debated and passed out of Committee in 2008, but were not voted on by either chamber or signed into law.[27] With the end of the 110th Congress on January 3, 2009, the bills will not automatically carry over to the 111th Congress.  However, Gibson Dunn anticipates that Senator Grassley and Representative Berman will submit materially identical versions of these bills for consideration by the 111th Congress. B.   Important Proposed Changes To The Current Act The congressional bills seek to affect crucial changes on the structure and operation of the False Claims Act.  Most notably, the bills expand the availability of lawsuits under the Act. 1.    The Public Disclosure Bar Possibly the most significant change to the FCA under the proposed amendments seeks to confer on private individuals the right to bring FCA claims without exposing any fraud.  The amendments circumscribe the public disclosure bar by defining “public information” narrowly to encompass only information “on the public record” or “broadly disseminated to the general public.”  Thus, the amendments would allow individuals to bring qui tam actions even if the government already knew about an alleged fraud but failed to disclose that fraud through the public channels previously articulated in the statute.  The amendments further constrict the public disclosure bar by limiting the bar to situations where “all essential elements” of the plaintiff’s claim are publicly available.   This would effectively eliminate the public disclosure bar in all but the most egregious of cases because plaintiffs would need only show one non-public source of information to escape the bar–a substantially lower standard than currently required: “direct and independent” knowledge of the fraud.  And finally, and perhaps most significantly, only the U.S. Attorney General–not the court–would have the power to dismiss a qui tam Relator’s claims for violating the public disclosure bar. 2.    Expanded Definition of “Claim” The proposed legislation also expands the definition of a “claim.”  Indeed, the amendments would broaden the availability of FCA suits by allowing suits against any person who knowingly presents a false or fraudulent claim for government money or property. The amendments effectively repeal any “presentment” requirement by tying FCA claims directly to federal money and property, regardless of to whom the claim is presented.  Similarly, the amendments would expand the definition of “government property” to encompass third-party property that is merely administered by the government.  If passed, this amendment would permit FCA suits arising out of a purely private transaction and would greatly expand the reach of the Act.  It remains to be seen whether the verbiage of any proposed amendment in this regard will change following the Supreme Court’s decision in Allison Engine providing that the link between a false statement and the federal government’s decision to pay or approve a false claim must not be “too attenuated” (discussed above). 3.    Qui Tam Actions by Government Employees One of the amendments’ most controversial provisions would allow government employees to bring qui tam actions themselves after exhausting internal procedures and administrative remedies.  Historically, courts have restricted government employees from bringing FCA claims as a matter of strong public policy.  See United States ex rel. Fine v. Chevron U.S.A., Inc., 72 F.3d 740 (9th Cir. 1996).  The proposed amendments would create increased incentives for exposing fraud, but also may create conflicts of interest among public employees and encourage opportunistic behavior. For example, federal employees may owe a duty of loyalty and candor to the government to report fraud, and many (such as auditors, investigators and attorneys) are specifically employed in part to identify fraud.  Opportunity for personal financial gain may create at least the appearance of investigative and/or enforcement decisions motivated by such personal gain rather than the public interest.  Further, if the government has determined not to act upon information disclosed by a government employee, then that employee should not be able to file a private action based on such information.  Indeed, the amendments create incentives for government employees to withhold critical information from the government.  In addition, if an active government employee files a qui tam action, his or her financial incentive may give rise to a conflict of interest which impairs his or her (and possibly other government employees’) ability to work on the matter or to serve as a witness in any trial.[28] 4.    Procedural Changes The amendments also seek to drastically alter the procedural requirements of the Act.  Indeed, in a significant departure from current law, the amendments would permit the Attorney General to delegate his broad investigatory powers under the FCA to third parties, including private entities.  Presently, only the Attorney General may issue civil investigative demands (CIDs), before commencing a civil proceeding, which may require the target to produce documents and answer oral or written questions regarding such documents.  31 U.S.C. § 3733(a).  The “Attorney General may not delegate [that] authority.”  Id.  By expanding the power to issue CIDs to private parties, the congressional amendments would eliminate what has been a powerful check on investigative fishing expeditions. The bills also affect procedural changes by requiring the government, if it elects to intervene and proceed with an action, to file its own complaint, or to amend the complaint of a person who brought a civil action.  Further, the amendments seek to lengthen the statute of limitations from six years under the current statute (31 U.S.C. § 3731(b)) to ten years.  Of note, the House committee shortened this time to eight years. 5.    Whistleblower Protections Finally, the amendments strengthen the Act’s prohibition against retaliatory actions taken by employers against whistleblowers by prohibiting employers from taking actions that materially hinder a whistleblower in obtaining new employment or other business opportunities.  Similarly, the Senate bill authorizes relief for government employees and contractors from retaliatory actions taken against them because of lawful acts done in furtherance of efforts to stop violations of the Act. C.  Support For The Amendments The amendments’ supporters argue that the legislation is needed because recent judicial decisions have weakened the FCA.  Indeed, on February 20, 2008, Senator Grassley criticized the courts for doing “their best to undo the most effective tool of the federal government in rooting out fraud and abuse.”[29]  Senator Grassley observed that “[o]ur bill works to make sure recent court decisions won’t weaken the government’s ability to recover taxpayer dollars lost to fraud, whether it’s in health care, defense, or another area of spending.”  Id. Plaintiffs’ attorneys and members of the “Relators’ bar” have argued that recent Supreme Court cases such as Rockwell were wrongly decided, and that the public disclosure bar has routinely, and incorrectly, been utilized to avoid liability.  They argue that the amendments are necessary to effectuate the original purposes of the legislation. D.  Opposition To The Amendments Opponents argue that the amendments greatly expand liability under the Act and will make it more difficult for companies to defend themselves against costly litigation.  Indeed, although the House and Senate bills both enjoy bipartisan support, some skepticism has emerged.  Not surprisingly, some of the most vehement criticism has been lodged against the bills’ amendments to the public disclosure bar. The business community has given both bills a cold reception.  The U.S. Chamber of Commerce opposes the legislation on the ground that it is unnecessary and that it could harm small businesses that do not have the resources to defend themselves in court.[30]  The bills have also been criticized for benefiting plaintiffs’ attorneys and not the federal government.  The DOJ has also expressed “significant concerns” with the bills as written, particularly with respect to provisions that would allow government employees to act as Relators and virtually eliminate the public disclosure bar.[31]  The DOJ has echoed others’ complaints, arguing that these provisions would spawn frivolous, costly litigation and hinder the DOJ’s efforts to combat fraud. V.  State False Claims Acts More than 20 states and the District of Columbia (and even some cities) have now enacted their own civil False Claims Acts modeled after the federal statute, and more are sure to follow.  In fact, the federal government provides an incentive to states that enact such legislation:  Section 6031 of the Deficit Reduction Act of 2005 provides that if a state has qualifying false claims act in effect, then the state will get ten percent more of any amount recovered in any false claims action brought under the state’s act.  See Section 1909(b) of the Social Security Act, 42 U.S.C. § 1396h(b). In a recently, highly-publicized case, thought to be the largest recovery ever against a utility for overcharging customers, a California Superior Court ruled in June 2007 that the Los Angeles Department of Water & Power deliberately overcharged Los Angeles County, the school district and other plaintiffs in the case for nearly 10 years and ordered the agency to pay a total of $223.8 million.  In October 2008, DWP announced that it had decided not to appeal the verdict and instead settled for a total of $160 million.  The lawsuit was initiated by an energy consultant under the California False Claims Act whistleblower provisions.  Similarly, in September 2008, Boehringer Ingelheim Roxane, Inc., a drug manufacturer, paid the Commonwealth of Massachusetts $1.8 million to settle an FCA lawsuit alleging that it falsely inflated the prices of certain drugs that it reported to the national pharmaceutical price reporting services, which states (including Massachusetts) use to determine the reimbursement amounts for drugs dispensed to Medicaid recipients.  The state sued 13 drug manufacturers and had already settled similar claims against four other drug companies for nearly $6 million. Those doing business with the government should be aware that many programs are jointly funded by the federal and state governments (such as Medicaid),[32] and many government contracts are similarly funded by the federal and state governments (such as infrastructure improvement).  Accordingly, companies may face concurrent allegations of liability under federal and state versions of the FCA.  And qui tam plaintiffs may be able to convince state regulators to intervene and pursue state claims, even if the federal government declines intervention. VI.  Increased FCA Activity in the Future?  A.  The Federal Bailout The federal government’s recent and expanding bailout places substantial federal funds into the hands of a stunning variety of entities.  And with the growing demand for oversight, it is possible that a new form of FCA claims will emerge–claims alleging that the entity receiving federal funds defrauded the government based on misrepresentations to receive the federal monies in the first instance, or false statements made to continue to receive the monies.  FCA claims could also be brought by whistleblowers claiming that the federal funds that have been received were not appropriately applied to their intended uses. B.   New Rules For Government Contractors A final rule issued on November 12, 2008, and effective on December 12, 2008, amends the Federal Acquisition Regulation (“FAR”) to require the disclosure of violations of the FCA and “significant” overpayments on a contract, and a knowing failure by a federal government contractor to timely disclose “credible evidence” of these violations or overpayments may result in suspension or debarment, in addition to FCA damages and penalties.  The new rule also mandates that certain federal government contractors create a business ethics awareness and compliance program, as well as an internal control system.  For more information on the FAR, please see Gibson Dunn client alert, “New Federal Regulation Requires Mandatory Disclosure and Amplified Compliance Programs for Government Contractors,” November 13, 2008. Although the full effect of the new rule remains to be seen, it clearly signals an attempt to significantly change the relationship between contractors and the federal government regarding the disclosure of certain criminal and ethical violations, including violations of the FCA, as well as instances of significant overpayment.  Key terms such as “significant overpayments” are not clearly defined in the rule, so questions remain as to how broadly the new disclosure requirements will be interpreted and applied.  Additionally, the requirements regarding compliance and control programs are complex and are likely to present significant business and legal challenges to contractors in the near future.[33] C.  Proposed Legislative Changes Passage of the proposed legislative changes would certainly lead to expanded FCA activity.  As previously described, the proposed changes would undermine the “public disclosure” bar likely resulting in an increase of the number of private individuals that could bring FCA suits even if they have only indirectly witnessed alleged fraud.  A broader definition of a “claim,” opening the FCA to government employees, extending the statute of limitations, and enhancing whistleblower protections are all steps that will likely increase the number of FCA suits brought by the public.  Indeed the legislative changes likely would undo many of the judicial trends previously noted in this update that point towards a narrower interpretation of the FCA. VII.  Conclusion Based on recent events, Gibson Dunn predicts that 2009 will be an active and interesting time for False Claims Act activity.  In Rockwell and Allison Engine, the U.S. Supreme Court restricted the class of persons able to bring FCA actions, narrowed the application of the Act, and expressly warned against “transform[ing] the FCA into an all-purpose antifraud statute.”  And lower federal courts have applied these requirements, which make it more difficult to pursue FCA claims.  But legislation with bipartisan support is likely to be reintroduced and enacted in the current Congress that would essentially reverse those decisions, expand the scope of the Act, and increase penalties.  Government agencies (such as DHHS OIG) have increased budgets and issued marching orders to strengthen oversight and enforcement activities to prevent fraud and abuse.  Task forces among various government agencies (notably, in the healthcare and procurement areas) have recently been formed with specific goals of combining and leveraging their investigative and prosecutorial resources to more efficiently and effectively recoup federal funds obtained by fraud.  And all of this at a time when the federal government has infused, and has announced plans to further infuse, unprecedented amounts of money into many sectors of the economy.  The year ahead is sure to present a robust level of enforcement activity.    [1]  See DOJ Press Releases available at http://www.usdoj.gov/criminal/npftf/pr/press_releases/2008/nov/11-10-08_frd-fls-clam-fy08.pdf and http://www.usdoj.gov/opa/pr/2008/November/fraud-statistics1986-2008.htm.  [2]  According to the U.S. Census Bureau’s September 2008 Consolidated Federal Funds Report for Fiscal Year 2007, the federal government allocated $2.56 trillion in domestic spending for FY 2007, which was up 4.4% from the prior year, and nearly half of all spending (over $1.3 trillion) went to Social Security, Medicare, and Medicaid.  Defense spending accounted for approximately 16% ($430.5 billion).  See http://www.census.gov/prod/2008pubs/cffr-07.pdf; http://www.census.gov/Press-Release/www/releases/archives/governments/012743.html.  FY 2008 figures are not yet final and available.   [3]  Companies that do business with the federal government or receive federal funds should implement and maintain robust internal compliance programs and take employee complaints seriously.  Because FCA lawsuits are most frequently initiated by present or former employees, and because the employee’s investigation and participation in an FCA action constitutes protected activity under the Act, companies should also engage qualified FCA counsel before making any employment decisions regarding an individual who has complained of potentially fraudulent activity.   [4]  18 U.S.C. § 287 makes it a crime to knowingly present a “false, fictitious, or fraudulent” claim to the government punishable by up to five years imprisonment and/or a fine.  Id.  This year-end summary focuses on the civil False Claims Act, but the government can, and often will, pursue both criminal and civil remedies.   [5]  The Act defines “claim” as “any request or demand, whether under a contract, or otherwise, for money or property which is made to a contractor, grantee, or other recipient if the United Sates Government provides any portion of the money or property which is requested or demanded, or if the Government will reimburse such contractor, grantee, or other recipient for any portion of the money or property which is requested or demanded.”  31 U.S.C. § 3729(c).   [6]  In Rogan, an individual was liable under the FCA for conspiring to defraud the government by concealing illegal referrals and kickbacks and for otherwise inflating Medicaid and Medicare claims.  Following a bench trial, the court awarded damages equal to three times the entire amount that the medical facility (Edgewater) received from the government plus penalties.  The court refused to discount damages based on any actual services or treatment provided at the medical facility.  Id. at 451-52 (court did not “think it important that most of the patients for which claims were submitted received some medical care–perhaps all the care reflected in the claim forms. …  Edgewater did not furnish any medical service to the United States.  The government offers a subsidy (from the patients’ perspective, a form of insurance), with conditions.  When the conditions are not satisfied, nothing is due.  . . .  Now it may be that, if the patients had gone elsewhere, the United States would have paid for their care.  Or perhaps the patients, or a private insurer, would have paid for care at Edgewater had it refrained from billing the United States.  But neither possibility allows Rogan to keep money obtained from the Treasury by false pretenses, or avoid the penalty for deceit.”)   [7]  The FCA protects whistleblowers from retaliation by their employers as a result of the whistleblower’s investigative activities.  31 U.S.C. §3730(h).   [8]  See http://www.usdoj.gov/opa/pr/2008/November/fraud-statistics1986-2008.htm.     [9]  See supra, note 1.    [10]  DOJ statistics confirm that the government depends heavily on whistleblowers to expose fraud.  Of the 542 new FCA matters opened in FY 2008 (including referrals, investigations and qui tam actions), 375 (70%) of those were qui tam actions.  This represents a slight decline in the percentage of actions initiated by private individuals (in FY 2007, of the 472 new FCA investigations, 364 (77%) were qui tam actions; similarly, in FY 2006, of the 455 new investigations, 384 (84%) were qui tam actions).  Of the total amount of recoveries in 2008, 78% (approximately $1.04 billion) resulted from investigations or actions originally initiated by whistleblowers.   [11]  See supra, note 1. [12]  See http://www.oig.hhs.gov/publications/docs/workplan/2009/WorkPlanFY2009.pdf.   [13]  The OIG also intends to focus on Medicare Part D drug benefits,” as well as “enrollment and marketing schemes,” “prescription shorting,” quality-of-care and substandard care issues and will “expand [its] focus on these issues to additional institutions and community-based settings.”  Further, the OIG intends “to conduct investigations related to false claims submitted to Medicaid for services not rendered, claims that manipulate payment codes in an effort to inflate reimbursement amounts, claims for substandard care provided to nursing home residents, and claims submitted to obtain program funds.”  Id.   [14]  Notably, the relator in the CVS action (a pharmacist) initiated similar claims (switching from tablets to more expensive capsule versions of certain prescription drugs) against Omnicare, Inc, which resulted in a $49.5 million settlement in FY 2007.  The whistleblower received over $6.4 million of that award, bringing his total qui tam share recovery to more than $10 million.   [15]  See http://www.usdoj.gov/opa/pr/2008/March/08_crt_214.html.   [16]  The Anti-Kickback Statute, 42 U.S.C.S. § 1320a-7b, imposes liability on anyone who knowingly and willfully offers or pays any remuneration directly or indirectly, to any person to induce that person to refer an individual for the provision of any item or service for which payment may be made under a Federal health care program.  The Stark Law, 42 U.S.C.S. § 1395nn, generally prohibits physicians having a financial relationship with an entity from making a referral to the entity for the provision of health services.  Some courts have held that violations of the Anti-Kickback Statute and the Stark Law are actionable under the FCA if the government conditioned payment upon compliance therewith.   [17]  See http://www.usdoj.gov/criminal/npftf/resource/Dec08progress_report.pdf.   [18]  The U.S. Census Bureau reports that federal government procurement contracts accounted for $440 billion (17 percent) of total federal spending in FY 2007.  Of that spending, defense contracts compromised 67% percent.  FY 2008 figures are not yet available.   [19]  The National Procurement Fraud Task Force 2008 Progress Report noted that in 2007, the FBI launched a project “to scan approximately seven million DOD payment vouchers totaling over $10 billion dollars in expenditures/payments . . . to aid in retention, retrieval, and proactive review for fraud indicators and red flags.  . . . . Several cases have been referred to [federal] agencies as a result of red flags and anomalies discovered during the review of these vouchers.” http://www.usdoj.gov/criminal/npftf/resource/Dec08progress_report.pdf.  Litigation is sure to follow.   [20]  See, e.g., Scott Horsley, Can Infrastructure Spending Rev Up The Economy?, Nat’l Pub. Radio, Dec. 8, 2008 (available at http://www.npr.org/templates/story/story.php?storyId=97973470), reporting that President-elect Obama voiced his intention to “lead the biggest government infrastructure investment since the interstate highway system was launched in the 1950s.”   [21]  In August 2007, IBM Corporation and PricewaterhouseCoopers agreed to pay more than $5.2 million to settle allegations stemming from that investigation.  In FY 2007, Oracle Corporation paid the government $98.5 million to resolve allegations that PeopleSoft, Inc. (acquired by Oracle in 2005) engaged in defective pricing of its software and services under the company’s multiple award schedule with GSA.   [22]  See http://www.usdoj.gov/usao/ct/Press2008/20081223-1.html.   [23]  See, e.g., CRS Report for Congress, “The False Claims Act, the Allison Engine Decision, and Possible Effects on Health Care Fraud Enforcement,” Nov. 6, 2008, available at http://assets.opencrs.com/rpts/RS22982_20081106.pdf.  [24]  This holding should greatly interest companies that are presently defendants in FCA actions.  As a jurisdictional inquiry, even if the case has progressed beyond motions to dismiss or for summary judgment, the “public disclosure” bar may be a viable defense to claims, regardless of whether it was raised at an earlier stage of the litigation.   [25]  District court cases dismissing FCA complaints for failure to satisfy Rule 9(b) pleading requirements have been published on a weekly, if not daily basis, over the past few months.  See, e.g., United States ex rel. Kennedy v. Aventis Pharmaceuticals, Inc., 2008 U.S. Dist. LEXIS 100444 (N.D. Ill. Dec. 10, 2008); United States ex rel. Radcliffe v. Purdue Pharma L.P., 2008 U.S. Dist. LEXIS 81688 (W.D. Va. Oct. 14, 2008); Unterschuetz v. In Home Pers. Care, Inc., 2008 U.S. Dist. LEXIS 81914 (D. Minn. Oct. 14, 2008); United States ex rel. Sterling v. Health Ins. Plan of Greater N.Y., Inc., 2008 U.S. Dist. LEXIS 76874 (S.D.N.Y. Sept. 30, 2008); United States ex rel. Lacy v. New Horizons, Inc., 2008 U.S. Dist. LEXIS 73814 (W.D. Okla. Sept. 25, 2008).   [26]  Some of the Circuit Court decisions in 2008 that affirmed summary judgment for lack of evidence of scienter include:  United States ex rel. K & R Ltd. P’ship v. Mass. Hous. Fin. Agency, 530 F.3d 980, 981 (D. C. Cir. 2008); United States ex rel. Hefner v. Hackensack Univ. Medical Ctr., 495 F.3d 103, 110 (3d Cir. 2007); United States ex rel. Farmer v. City of Houston, 523 F.3d 333, 339 (5th Cir. 2008); United States ex rel. Taylor-Vick v. Smith, 513 F.3d 228, 232 (5th Cir. 2008); United States ex rel. Gudur v. Deloitte & Touche, 2008 U.S. App. LEXIS 17038, *4-5 (5th Cir. Aug. 7, 2008); United States ex rel. Bustamante v. Orenduff, 2008 U.S. App. LEXIS 24303, *49 (10th Cir. Nov. 28, 2008).   [27]  S. 2041 was referred to the Committee on the Judiciary, which held hearings on the measure on February, 27, 2008.  After debating the bill, the committee passed the bill in early April 2008 without a single dissenting vote.  H.R. 4854 bill was referred to the House Committee on the Judiciary, which held hearings in June 2008.  The bill was also referred to the Subcommittee on Commercial and Administrative Law and the Subcommittee on Courts, the Internet, and Intellectual Property.  On July 16, 2008, the Committee voted to report the bill to the full chamber.   [28]  For these and other policy reasons, the DOJ “strongly opposes the proposed amendment” in this regard and “believes there should be a complete ban on any qui tam suit that utilizes information acquired during the course of Government employment.”  See http://www.usdoj.gov/ola/views-letters/110-2/07-15-08-hr4854-false-claims-act-correction-act.pdf. [29]  Geof Koss, Senate Judiciary to Weigh Changes to Key Whistleblower Law, CongressNow (Feb. 21, 2008).   [30]  Brendan Brown, Chamber of Commerce Argues Against Update of False Claims Act, CongressNow (June 19, 2008).   [31]  See http://www.usdoj.gov/ola/views-letters/110-2/07-15-08-hr4854-false-claims-act-correction-act.pdf and http://www.usdoj.gov/ola/views-letters/110-2/02-21-08-s2041-false-claims-correction-act.pdf.    [32]  On October 28, 2008, the Department of Health & Human Services Centers For Medicare & Medicaid Services (CMS) issued a letter to the states setting forth CMS policy on refunding the federal share of Medicaid overpayments recovered under state false claims act statutes.  See SHO #08-004 (“this letter explains what amounts must be returned to the Federal Government on any recovery, the proper accounting of the relator’s share and litigation”).    [33]  Many critics of the proposed rule argued that FCA violations are difficult to define, and contractors are likely to have an honest disagreement about whether a violation of the FCA has occurred sufficient to warrant self-disclosure.  In enacting the Rule, the Civilian Agency Acquisition Council and the Defense Acquisition Regulations Council stated, “the disclosure requirement applies only where the contractor has ‘credible evidence’ that a violation of the civil FCA has occurred. . . . Genuine disputes over the proper application of the civil FCA may be considered in evaluating whether the contractor knowingly failed to disclose a violation of the civil FCA.”  Further, “the mere filing of a qui tam action under the civil FCA is not sufficient to establish a violation under the statute, nor does it represent, standing alone, credible evidence of a violation.  Similarly, the decision by the Government to decline intervention in a qui tam action is not dispositive of whether the civil FCA has been violated, nor conclusive of whether the contractor has credible evidence of a violation of the civil FCA.” Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues.  Gibson Dunn successfully argued the Allison Engine case in the Supreme Court, which resulted in a unanimous decision by the Court.  Our attorneys have handled more than 100 FCA investigations and have a long track record of litigation success.  The firm has more than 30 attorneys with substantive FCA expertise and 20 former Assistant U.S. Attorneys and DOJ attorneys.  Please contact the Gibson Dunn attorney with whom you work, or any of the following: Washington, D.C. F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com) Andrew Tulumello (202-955-8657, atulumello@gibsondunn.com) Karen L. Manos (202-955-8536, kmanos@gibsondunn.com) Joseph D. West (202-955-8658, jwest@gibsondunn.com),    New York Randy Mastro (212-351-3825, rmastro@gibsondunn.com) James A. Walden (212-351-2300, jwalden@gibsondunn.com) Denver Robert C. Blume (303-298-5758, rblume@gibsondunn.com) Jessica H. Sanderson (303-298-5928, jsanderson@gibsondunn.com) Laura Sturges (303-298-5929, lsturges@gibsondunn.com) Dallas Evan S. Tilton (214-698-3156, etilton@gibsondunn.com) Orange County Nick Hanna (949-451-4270, nhanna@gibsondunn.com) Los Angeles Timothy Hatch (213-229-7368, thatch@gibsondunn.com)    © 2009 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 5, 2009 |
2008 Year-End FCPA Update

By any measure, 2008 was a monster year in Foreign Corrupt Practices Act ("FCPA") enforcement.  With thirty-three enforcement actions between the Department of Justice ("DOJ") and Securities and Exchange Commission ("SEC"), the statute’s dual enforcers, 2008 was the second busiest numerical year on the books, trailing only 2007.  But beyond the numbers (after all, with the massive Siemens resolution, 2008 dwarfs all other years combined in fines and disgorgement), 2008 saw the FCPA’s enforcement regime mature like never before.  There were no unimportant FCPA enforcement actions this year.  Whether the trend was increasingly aggressive enforcement against individuals, ramped up international coordination, the joining of FCPA prosecutions with prosecutions for distinct federal crimes, or others trends discussed herein, every case fits an important trend in foreign bribery enforcement that we expect to continue into 2009 and beyond. This client update provides an overview of FCPA and other anti-corruption enforcement activity from the past year and a discussion of the trends that we see emerging from that activity.  A collection of Gibson Dunn’s publications concerning the FCPA, including prior enforcement updates and more in-depth discussions of the statute’s complicated framework, may be found on Gibson Dunn’s FCPA website.   FCPA Overview The FCPA’s anti-bribery provisions make it illegal to offer or provide money or anything of value to officials of foreign governments or foreign political parties with the intent to obtain or retain business.  The anti-bribery provisions apply to "issuers," "domestic concerns," and "any person" that violates the FCPA while in the territory of the United States.  The term "issuer" covers any business entity that is registered under 15 U.S.C. § 78l or that is required to file reports under 15 U.S.C. § 78o(d).  In this context, the approximately 1,500 foreign issuers whose American Depository Receipts ("ADRs") are traded on U.S. exchanges are "issuers" for purposes of this statute.  The term "domestic concern" is even broader and includes any U.S. citizen, national, or resident, as well as any business entity that is organized under the laws of a U.S. state or that has a principal place of business in the United States. In addition to the anti-bribery provisions, the FCPA’s books-and-records provision requires issuers to make and keep accurate books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the issuer’s transactions and disposition of assets.  Finally, the FCPA’s internal controls provision requires that issuers devise and maintain reasonable internal accounting controls aimed at preventing and detecting FCPA violations.  Regulators have frequently invoked these latter two sections – collectively known as the accounting provisions – in recent years when they cannot establish the elements for an anti-bribery prosecution or as a mechanism for compromise in settlement negotiations.  Because there is no requirement that a false record or deficient control be linked to an improper payment, even a payment that does not constitute a violation of the anti-bribery provisions can lead to prosecution under the accounting provisions if inaccurately recorded or attributable to an internal controls deficiency. 2008 in Review The recent trend of increased FCPA enforcement activity is best captured in the following chart and graph, which each track the number of FCPA enforcement actions filed by DOJ and the SEC during the past five years:  2008 2007 2006 2005 2004 DOJ20 SEC13 DOJ18 SEC20 DOJ7 SEC8 DOJ7 SEC5 DOJ2 SEC3 For some time, we have been reporting – based on our representation of corporations and individuals, our network of relationships, and our constant review of public disclosures – that there are approximately 100 companies that are the subject of open FCPA investigations.  This figure was recently confirmed by Mark Mendelsohn, the Deputy Chief of the Fraud Section in DOJ’s Criminal Division and DOJ’s top-FCPA enforcer, at an FCPA enforcement conference.  With so many active matters in the pipeline, we expect that U.S. enforcement agencies will continue their aggressive pursuit of companies and executives suspected of international bribery for the foreseeable future. Top Five Trends in FCPA Enforcement The past year in FCPA enforcement activity bore out many of the key enforcement themes that we have observed in recent years.  Although there are many important trends that can be drawn from last year’s prosecutions, we have identified below the top five that we believe best highlight the myriad risks facing companies and their employees doing business internationally.  These significant trends are: 1.  Escalating corporate financial penalties; 2.   Increasing focus on individual prosecutions; 3.   Internationalization of foreign anti-corruption enforcement; 4.   DOJ’s coupling of FCPA prosecutions with other charges; and 5.   Continuing upswing in FCPA litigation. Escalating Corporate Financial Penalties Scott Friestad, Deputy Director of Enforcement for the SEC, recently forewarned the FCPA community, "The dollar amounts in the [FCPA] cases that will be coming within the next short while will dwarf the disgorgement and penalty amounts that have been obtained in prior cases."  When Friestad made this statement, Baker Hughes, Inc.’s 2007 joint DOJ/SEC resolution of approximately $44.1 million held the record for the largest FCPA settlement.  But, on December 15, 2008, DOJ and the SEC eclipsed this record by nearly twenty times in announcing their long-anticipated resolution with Siemens AG.  Siemens pleaded guilty to FCPA books-and-records and internal controls charges brought by DOJ and consented to the filing of a civil complaint by the SEC charging Siemens with anti-bribery, books-and-records, and internal controls violations.  Three of Siemens’s "regional operating companies" also pleaded guilty to conspiring to violate various provisions of the FCPA.  Under the plea agreement and civil settlement, Siemens and its subsidiaries agreed to pay a total criminal fine of $450 million to DOJ and to disgorge $350 million in illicit profits to the SEC.  Siemens consented to an SEC injunction against future violations of the FCPA and agreed to retain an FCPA compliance monitor for up to four years.  In addition to the U.S. settlements, Siemens on the same day settled the balance of its liabilities in the long-running Munich Public Prosecutor’s corruption probe (Siemens’s communications business reached a settlement with that office in 2007).  Siemens agreed to pay €395 million (~ $569 million), consisting of €394.75 million in profit disgorgement and €250,000 in administrative penalties, to resolve this investigation.  If you add to these settlements the roughly $287 million in fines and disgorgement imposed in connection with the 2007 Munich Public Prosecutor settlement with the company’s communications business, and Siemens’s approximately $255 million settlement with German tax authorities in 2007, Siemens has paid well over $1.9 billion to resolve the U.S. and German corruption probes.  The scope of illicit conduct alleged by DOJ and the SEC covers thousands of corrupt payments, totaling approximately $1.4 billion, to foreign government officials in ten countries in connection with hundreds of individual projects or sales.  At the press conference announcing the settlement, DOJ’s Acting Assistant Attorney General, Matthew Friedrich, went so far as to say that bribery was, for Siemens, "nothing less than standard operating procedure."  SEC Director of Enforcement Linda Thomsen described Siemens’s "pattern of bribery" as "unprecedented in scale and geographic reach."  The DOJ and SEC settlements allege that Siemens corruptly influenced contracts and tenders in Argentina, Bangladesh, China, Iraq, Israel, Mexico, Nigeria, Russia, Venezuela, and Vietnam. The DOJ and SEC settlements detail "systematic efforts" to falsify Siemens’s books and records and circumvent Siemens’s system of internal controls, including the use of off-book accounts as pools of money for corrupt payments, signing approval forms for corrupt payments with removable Post-It notes, thereby concealing the identity of the signors, and operating "cash desks" where employees could withdraw up to €1 million at a time for use in corrupt payments.  Siemens’s internal controls failures were substantial and widespread enough to merit the first ever criminal FCPA internal controls charge filed by DOJ.  But the settlement papers also tell a remarkable story of corporate remediation and an internal investigation of unparalleled magnitude.  Papers filed by both sides in support of the agreed-upon sentence in the criminal case detail more than $1 billion in investigative and remediation costs incurred by Siemens in the just over two years since German authorities raided Siemens in late 2006.  Some of the eye-popping figures include: 1.6 million billable hours logged by Siemens’s Audit Committee counsel and the company’s forensic auditor at a cost of over $850 million; 1,750 interviews and 800 informational meetings concerning the company’s operations in 34 countries; administration, with approval from DOJ and the SEC, of two employee amnesty programs, which led to 100 employees coming forward with useful information; over 100 million documents preserved and 80 million documents stored in an electronic database at a cost to Siemens of more than $100 million; analysis of 38 million transactions from Siemens’s "Finavigate" accounting system and a review of 127 million accounting records related to those transactions; more than $5.2 million in document translation costs; and more than $150 million spent on the creation of an anti-corruption kit for 162 distinct operating entities, including six weeks of auditors "on the ground" at each of the fifty-six entities determined to be a "high risk."  DOJ concluded in its sentencing memorandum that the "reorganization and remediation efforts of Siemens have been extraordinary and have set a high standard for multi-national companies to follow."  DOJ’s Friedrich succinctly summarized this point at the press conference announcing the Siemens resolution, referring to Siemens’s cooperation as, "in a word, . . . exceptional."  Not only does the Siemens FCPA resolution dwarf the prior record FCPA settlement, but the combined U.S. settlements (not to mention the German settlements) substantially exceed the aggregate of every dollar ever collected by the U.S. government in connection with FCPA settlements over the statute’s thirty-one year history.  Still, the fact remains that Siemens’s settlement figures could have been much higher.  For example, DOJ’s sentencing guideline calculation called for a criminal fine of between $1.35 and $2.7 billion.  Clearly, DOJ and the SEC gave Siemens significant credit for its remediation efforts and for the substantial settlements it paid abroad.  Although many orders of magnitude smaller than the Siemens resolution, in May 2008, Willbros Group, Inc., agreed to pay the then-second (now third) highest combined fine/disgorgement figure to DOJ and the SEC to settle FCPA charges arising out of Willbros’s operations in Bolivia, Ecuador, and Nigeria.  The allegations against Willbros Group, which are described in greater detail in our 2008 Mid-Year FCPA Update, involve claims that the company, acting through various subsidiaries and employees, made $3.8 million in corrupt payments, and agreed to make another $8 million in payments, to influence the assessment of taxes, judicial processes, and the award of more than $630 million in pipeline contracts.  To settle the SEC’s complaint, Willbros agreed to pay $10.3 million in disgorgement plus prejudgment interest.  To resolve the criminal charges, Willbros entered into a deferred prosecution agreement with DOJ, agreeing to pay a $22 million fine, to have a criminal information filed against its subsidiary Willbros International, Inc., and to retain an independent compliance monitor for three years. The Willbros settlement underscores the difficulty of conducting business in Nigeria, which as we note below was the most frequent locale for FCPA violations alleged in 2008 settlements.  Some companies have found it so difficult to operate in this nation without running afoul of the FCPA that they have withdrawn their business operations altogether.  And demonstrating that enormous foreign bribery settlements are certain not to be a fluke of 2008, ABB Ltd. recently announced that it has reserved $850 million for "potential costs related to the . . . investigations by the U.S. and European authorities into suspect payments and alleged anti-competitive practices" and business restructuring costs.  Market analysts have pegged the expected legal share of this reserve at between $650 and $700 million, although it is not clear how much is attributable to the anticipated corruption settlement(s) vis-à-vis the anticipated antitrust settlement(s).  The corruption investigations reportedly stem from ABB’s operations in Iraq, Kazakhstan, and Nigeria.  This would be ABB’s second brush with the FCPA, its now-divested Vetco Gray business having been the subject of a $16.4 million settlement in 2004.  Increasing Focus on Individual Prosecutions Although the FCPA is commonly perceived – and perhaps, historically speaking, with good reason – to be a statute of predominantly corporate enforcement, 60% of the FCPA defendants in 2008 were individuals.  DOJ’s Mendelsohn recently said of the continuing trend of holding individuals to answer for foreign bribery, "The number of individual prosecutions has risen – and that’s not an accident. . . .  It is our view that to have a credible deterrent effect, people have to go to jail."  SEC Associate Director Fredric Firestone, speaking at a separate engagement, expressed a similar sentiment:  "The Commission very clearly has stated to us that enforcement actions against individuals as well as companies is a priority."  The landmark case in individual FCPA prosecutions in 2008 has to be the joint DOJ/SEC prosecution of Albert Stanley, the former Chairman and Chief Executive Officer of former Halliburton subsidiary Kellogg, Brown & Root, Inc. ("KBR").  On September 3, 2008, Stanley pleaded guilty to criminal charges of conspiring to violate the FCPA’s anti-bribery provisions and of conspiring to violate the mail and wire fraud statutes in a separate kickback scheme.  Stanley also entered into a civil settlement with the SEC charging him with violating the FCPA’s anti-bribery provisions and enjoining him from future violations of the FCPA.  The charging documents allege that Stanley was KBR’s senior representative on the steering committee of a four-company joint venture formed to obtain and administer more than $6 billion in contracts to build liquefied natural gas production facilities in Bonny Island, Nigeria.  Stanley and his co-conspirators allegedly authorized more than $182 million in payments to third-party agents with the expectation that the agents would pass most of those payments on to senior officials of a Nigerian state-controlled oil company.  In connection with the kickback scheme, Stanley pleaded guilty to a mail and wire fraud conspiracy premised on his receipt of approximately $10.8 million in kickbacks from a former KBR employee to whom Stanley directed as much as $65 million in KBR consulting contracts.  Although he has not yet been sentenced, Stanley has agreed to serve seven years in prison and to pay $10.8 million in restitution to KBR.  Stanley is cooperating with DOJ in its continuing investigation in hopes that DOJ will file a motion to reduce his sentence pursuant to § 5K1.1 of the U.S. Sentencing Guidelines.  Announcing Stanley’s guilty plea, DOJ’s Friedrich commented, "Today’s plea demonstrates that corporate executives who bribe foreign officials in return for lucrative business deals can expect to face prosecution." In another significant development in individual FCPA prosecutions in 2008, on December 19, DOJ unsealed the January 2008 indictment of James Tillery, the former President of Willbros International, Inc., and Paul Novak, a former Willbros International consultant.  DOJ made the indictment public after arresting Novak when he arrived at Houston’s George Bush Intercontinental Airport on a flight from South Africa.  Novak returned to the United States after the revocation of his U.S. passport.  Tillery remains a fugitive with a warrant outstanding for his arrest.  Tillery and Novak are each charged with violating the anti-bribery provisions of the FCPA, conspiring to do the same, and conspiring to commit money laundering.  The indictment alleges that Tillery and Novak conspired with other Willbros International employees, including Jim Brown and Jason Steph, who themselves pleaded guilty to FCPA charges in 2006 and 2007, respectively, to pay more than $6 million in bribes to Nigerian government officials in return for the award of more than $380 million in gas pipeline contracts.  The co-conspirators allegedly delivered approximately $2 million of these bribes to employees of various Nigerian state-owned gas companies, to a senior official in the executive branch of the Nigerian government, and to officials of the dominant political party in Nigeria.  The indictment further alleges that Tillery and Novak agreed to make approximately $300,000 in corrupt payments, and delivered $150,000 of this amount, to officials of the Ecuadorian state oil company in return for the award of a $3 million gas pipeline project.  Finally, Tillery and Novak are alleged to have conspired with other Willbros International employees to transmit money from within the United States to places outside of the United States with the intent to promote violations of the FCPA, a "specified unlawful activity" within the money laundering statutes.  The Tillery/Novak indictment makes seven former Willbros employees and representatives, in addition to the company, who have been charged with FCPA violations by either or both DOJ and the SEC.  As noted above, Brown and Steph pleaded guilty to criminal FCPA charges in 2006 and 2007.  Brown also consented to an SEC injunction from future FCPA violations in 2006.  Then, on May 14, 2008, Jason Steph and three other former Willbros International employees – Lloyd Biggers, Carlos Galvez, and Gerald Jansen – settled civil FCPA charges with the SEC and agreed to permanent injunctions from future FCPA violations.  Additionally, Galvez and Jansen agreed to pay civil penalties of $35,000 and $30,000, respectively.    Another 2008 corporate FCPA prosecution in which DOJ charged multiple individuals is the Nexus Technologies, Inc. matter.  On September 4, 2008, DOJ filed an indictment charging Nexus Technologies and four employees – An Nguyen, Kim Nguyen, Nam Nguyen and Joseph Lukas – with one count of conspiring to violate the FCPA and multiple substantive FCPA counts, in connection with alleged corrupt payments to officials of various Vietnamese government agencies.  According to the indictment, over a ten-year period the defendants paid at least $150,000 in bribes, styled as "commissions," to Vietnamese government officials in order to secure contracts for the supply of a wide variety of equipment, ranging from helicopter parts to underwater mapping equipment to chemical detectors.  Federal agents arrested the four individual defendants on September 5, 2008, and both they and their employer are presently awaiting trial.  Rounding out the cadre of individual FCPA defendants in 2008 are Misao Hioki, Shu Quan-Sheng, Martin Self, and Mario Covino.  We discuss the Hioki and Quan-Sheng prosecutions below as evidence of DOJ’s movement towards charging FCPA crimes in conjunction with violations of unrelated criminal statutes.  Self, the former President and part owner of Pacific Consolidated Industries ("PCI"), pleaded guilty to two counts of violating the anti-bribery provisions of the FCPA on May 8, 2008, and was subsequently sentenced to pay a $20,000 fine and serve a probationary sentence.  Self was alleged to have executed a "marketing agreement" with a relative of a United Kingdom Ministry of Defence ("UK-MOD") official and subsequently causing the payment of approximately $70,350 to the relative pursuant to the agreement.  According to the charging documents, Self was not aware of any genuine services that the relative provided to PCI and, in fact, Self believed that the payments were truly for the benefit of the UK-MOD official, who was in a position to influence the award of equipment contracts to PCI.  Holding these beliefs, Self purposely failed to investigate and deliberately avoided becoming aware of the full nature of PCI’s relationship with the UK-MOD official’s relative.  Another former PCI executive, Leo Winston Smith, was indicted on FCPA charges in 2007 and is currently awaiting a May 2009 trial date. Covino was the Director of Worldwide Factory Sales for an unnamed Rancho Santa Margarita, California-based manufacturer of service control valves for the nuclear, oil and gas, and power generation industries.  On December 17, 2008, DOJ filed a plea agreement by which Covino agreed to plead guilty to charges of conspiring to violate the FCPA’s anti-bribery provisions.   The plea agreement and accompanying criminal information allege that Covino conspired with his former colleagues to implement a sales approach that encouraged the company’s salespeople to cultivate "friends-in-camp" at the company’s government customers.  Covino and his co-conspirators allegedly made more than $1 million in corrupt payments to friends-in-camp employed by state-owned entities in Brazil, China, India, Korea, Malaysia, and the United Arab Emirates so that the foreign officials would either award Covino’s employer contracts or influence the technical specifications of competitive tenders in a manner that would favor Covino’s employer.  Covino’s plea agreement does not specify an agreed upon sentence, but does include a Sentencing Guidelines calculation that calls for a sentence of five-years imprisonment, the statutory maximum for conspiracy.  Internationalization of Foreign Anti-Corruption Enforcement Speaking at an FCPA conference, DOJ’s Mendelsohn called 2008 the year of "foreign coordination."  Similarly, in connection with the Siemens settlement described above, in which DOJ, the SEC, and the Munich Public Prosecutor coordinated announcement of their resolutions, DOJ’s Friedrich echoed this sentiment:  "We are now working with our foreign law enforcement colleagues in bribery investigations to a degree that we never have previously."  And, as reported in the Wall Street Journal, anti-bribery prosecutors from around the globe gathered in Paris during the summer of 2008 for an "informal, roll-up-your sleeves meeting" as part of a first-of-its kind effort to increase collaboration in international investigations.  Mendelsohn, in his speech, leveraged this increased international collaboration into advice on self-reporting violations to foreign regulators, noting that if DOJ speaks with prosecutors in a foreign country, companies under investigation by DOJ for conduct in that country should consider disclosing the conduct to the foreign regulator as well.  Putting some statistical meat on the bone, Mendelsohn reported that DOJ sent out at least forty-five letters rogatory invoking Mutual Legal Assistance Treaties in 2008.  DOJ’s prosecutors also took at least sixteen international trips to locations including Greece, Hungary, Panama, Romania, and the United Kingdom.  And DOJ is now involved in at least twenty-three multi-jurisdictional investigations, including matters with anti-corruption authorities in the Czech Republic, Finland, Germany, Greece, Japan, Norway, Sweden, Switzerland, and the United Kingdom. Not only have anti-corruption prosecutors from around the globe been assisting U.S. authorities, they are now beginning to increase their own enforcement efforts.  The combined 2007 and 2008 Siemens resolutions with the Munich Public Prosecutor, at $856 million, topped the $800 million combined DOJ and SEC resolutions with Siemens.  And, pursuant to a new multinational cooperation initiative known as Eurojustice, Munich prosecutors invited their Greek counterparts to question Siemens officials in Munich about Greek transactions.  The Munich authorities also gave their Greek counterparts broad access to Swiss financial records in their possession.  Moving to the United Kingdom, prosecutors there obtained their first foreign bribery conviction with the guilty plea of Niels Tobiasen, the Managing Director of CBRN Team Ltd., a U.K. security-consulting firm, for bribing two Ugandan officials to obtain a security-consulting contract with the Ugandan Presidential Guard.  And when one of these two Ugandan officials, Ananais Tumukunde, happened to fly into Heathrow Airport, U.K. authorities were waiting to arrest him.  Using the authority under U.K. law to prosecute foreign government officials who receive bribes – a power that does not exist under the FCPA – U.K. authorities successfully prosecuted Tumukunde and obtained a twelve-month jail sentence as well as forfeiture of the corrupt payment.  In another significant U.K. case, borrowing from the now widespread U.S. model of deferred and non-prosecution agreements, the U.K.’s Serious Fraud Office ("SFO") sought and obtained judicial authorization to employ a Civil Recovery Order ("CRO") against Balfour Beatty plc in connection with Balfour Beatty’s self-reported admission to payment irregularities in connection with a $130 million contract to rebuild the Alexandria Library in Egypt.  The CRO, the first of its kind in U.K. foreign bribery prosecutions, allows authorities to recover a monetary penalty without a corresponding criminal prosecution and represents a powerful new tool for U.K. anti-corruption regulators.  That Balfour Beatty self-reported its conduct to the SFO is itself quite noteworthy.  Historically, the U.K. criminal law regime has given prosecutors little discretion in charging decisions once they discover a violation of law, which in turn has limited the motivation of companies to turn themselves in.  The Balfour Beatty non-prosecution agreement might begin to change this calculus.  In other anti-corruption news out of the United Kingdom, the SFO has created a new position for Head of Anti-Corruption, filled by Keith McCarthy, and reallocated resources within the office to increase the number of anti-corruption investigators from sixty-five to one hundred.  And in a fascinating "reverse-FCPA" prosecution, the SFO obtained several guilty pleas for conspiracy to commit corruption from U.K. nationals who conspired to bribe the U.S. Attorney General in an attempt to persuade him to unfreeze assets seized by the SEC in a Ponzi scheme investigation.  Of course, the story of foreign corruption prosecutions in the United Kingdom was not all pro-enforcement in 2008.  On July 30, the U.K. House of Lords reversed the decision of the High Court of London, which had ordered the SFO to reopen its investigation of allegedly corrupt payments by BAE Systems plc to senior Saudi government officials.  The SFO terminated its investigation of BAE’s Saudi operations, citing national security concerns, after the Saudi government threatened to stop sharing counter-terrorism intelligence.  The House of Lords declared the SFO’s decision to terminate its investigation to be within the anti-corruption agency’s authority.  Nonetheless, U.S. enforcers continue to pursue the BAE investigation, including by, according to press reports, briefly detaining senior BAE executives at a U.S. airport until they could be served with grand jury subpoenas.  In other 2008 foreign anti-corruption prosecutions of note, Japanese prosecutors obtained guilty pleas from Pacific Consultants International and four of its senior executives under that nation’s Unfair Competition Prevention Law.  The defendants admitted bribing senior Vietnamese government officials to obtain infrastructure development contracts in Ho Chi Minh City.  Elsewhere in Asia, Chinese authorities are currently investigating two American law firms with offices in Hong Kong and Beijing for alleged corrupt payments tied to business and investment licenses granted to foreign businesses seeking to operate in China.  It has been reported that this investigation is linked to an October 2008 disclosure by cosmetic retailer Avon Products, Inc., in which Avon announced an internal investigation into possible FCPA violations in China.  Finally, the Dutch, Italian, and Swiss governments all filed foreign corruption cases in 2008 against corporations relating to their participation in the United Nations Oil-for-Food Program.  This uptick in international anti-corruption enforcement activity makes clear that, as DOJ’s Friedrich put it when announcing the Siemens settlement, the "United States is not the only player at the table" when it comes to "fighting global corruption."  But just what this increased anti-corruption enforcement abroad will mean for companies under investigation by DOJ and the SEC remains to be seen.  Both DOJ and SEC officials have said that they will pay heed to the foreign investigations of those also under investigation in the United States.  For example, the SEC’s Firestone, speaking at an FCPA conference, said that, although the SEC might not decline an enforcement action simply because a company is subject to prosecution in a foreign jurisdiction, neither will the SEC "turn a blind eye" to any foreign action:  "We certainly will take that into account in terms of what we are going to do."  And DOJ’s Mendelsohn, speaking at an American Bar Association event, said that although the United States does not recognize the concept of "international double jeopardy," DOJ’s resolutions will "reflect . . . what’s going on in [the foreign] jurisdiction in some way."  Mendelsohn cited the 2006 Statoil and 2007 Akzo Nobel prosecutions as examples in which DOJ has credited penalties paid in foreign jurisdiction against those to be paid in the United States.  And he further noted: There are other cases that are not public where we have elected to do nothing in deference to ongoing foreign investigations – or to sit back and wait to see what the outcome of that foreign investigation will be. . . .  If that foreign investigation results in some enforcement action, we may elect to do nothing.  On the other hand, if . . . that foreign prosecution never gets off the ground, we may step in and proceed with our investigation. International coordination and non-U.S. enforcement will be a hugely important part of the global fight against corruption in 2009 and beyond.  DOJ’s Coupling of FCPA Prosecutions with Other Charges DOJ has long charged FCPA defendants with other crimes incidental to the improper payments (e.g., wire fraud, mail fraud, money laundering, tax evasion, violations of the Travel Act, etc.).  But 2008 saw DOJ join FCPA charges with prosecutions for violations of federal statutes that have distinct patterns of conduct and criminal elements in a way that it has seldom done before.  In 1999, then-Deputy Assistant Attorney General of DOJ’s Antitrust Division (and now Gibson Dunn partner) Gary Spratling gave a speech at an FCPA conference in which he noted that "in today’s global economy there is a recurring intersection of conduct that violates both the Sherman Antitrust Act and the Foreign Corrupt Practices Act.  A payment to a foreign official in violation of the FCPA may also be an act by an international bid-rigging, price-fixing, or market allocation cartel . . . ."  Spratling went on to observe that an improper payment detected by a corporate FCPA compliance program can lead to the discovery and report of related antitrust violations, potentially allowing the company to take advantage of the Antitrust Division’s Corporate Leniency Policy. It took some time, but on December 10, 2008, DOJ’s Antitrust and Criminal Divisions announced the first ever joint FCPA/antitrust prosecution.  Misao Hioki, the former General Manager of Bridgestone Corporation’s Japanese marine hose business, pleaded guilty to one count of conspiracy to rig bids in violation of the Sherman Act and one count of conspiracy to violate the FCPA’s anti-bribery provisions.  According to the charging documents, Hioki authorized and approved contracts with government agencies throughout Latin America, in particular in Mexico, that included commissions for third-party agents, which commissions included a percentage to be given to officials of those government agencies.  Hioki was sentenced to serve two years in prison and pay an $80,000 criminal fine. Hioki is the ninth individual to plead guilty in the Antitrust Division’s long-running marine hose investigation (which began in May 2007 with a headline-grabbing sweep of arrests coinciding with an alleged cartel meeting), but the first to be charged with FCPA violations.  His former employer, Bridgestone, has publicly announced that it too is under investigation for potential violations of both the FCPA and antitrust laws.  Bridgestone announced that it discovered the improper payments during its internal investigation into the alleged antitrust violations and reported these payments to U.S. and Japanese authorities.  Other ongoing, publicly announced joint FCPA/antitrust investigations include those of ABB Ltd., Innospec, Inc., and Halliburton, Inc.  In another example of a case involving alleged violations of both the FCPA and of a distinct criminal regime, on September 24, 2008, DOJ announced the arrest of Shu Quan-Sheng, a renowned physicist and naturalized U.S. citizen who was born in China.  Quan-Sheng was charged with two counts of exporting defense services and articles to China without a license in violation of the Arms Export Control Act and one count of offering bribes to Chinese government officials in violation of the FCPA.  According to the charging documents, Quan-Sheng offered to pay three bribes, totaling $189,300, to officials of a Chinese space research agency in connection with a $4 million procurement for the development of a liquid hydrogen tank system.  Quan-Sheng was acting as an agent of an unnamed French company in offering to make these payments, which do not appear to have ever been delivered.  On November 17, 2008, Quan-Sheng pleaded guilty to all three counts of the criminal information and is scheduled to be sentenced in April 2009.  Continuing Upswing in FCPA Litigation For a statute now in its fourth decade, the dearth of FCPA litigation is remarkable.  But two trends that we have noted in this and past FCPA updates – the rise of private litigation collateral to government enforcement actions and the increase in individual prosecutions – are slowly adding to the body of judicial precedent.  This is a welcome addition to private practitioners who still oftentimes find themselves arguing precedent from settled enforcement actions drafted by the government and untested before neutral judicial bodies.  Although there is no private right of action under the FCPA, enterprising plaintiffs’ lawyers have been creative in parlaying alleged FCPA violations into alleged violations of securities laws that do allow for private redress.  As a result, and as described in more detail in our 2008 Mid-Year FCPA Update, FCPA investigations have increasingly spurred a variety of collateral civil suits, including securities fraud actions, shareholder derivative suits, and lawsuits initiated by foreign governments or business partners.  Accordingly, companies can no longer assume that making peace with DOJ and the SEC will end the pain associated with their alleged FCPA violations. To date, the most common type of collateral civil litigation has come in the form of securities fraud class actions or derivative shareholder suits against publicly traded corporations.  Such cases typically involve claims that the defendant issuer misled investors by understating the risks associated with an FCPA investigation or overstating the quality of its bookkeeping policies and internal controls, which ultimately caused financial losses for the company.  In recent years, courts have been trending towards finding that plaintiffs adequately alleged false or misleading statements, thereby meeting the heightened scienter pleading requirements under the Private Securities Litigation Reform Act ("PSLRA") and enabling plaintiffs to survive the motion to dismiss.  But a recent decision by the U.S. Court of Appeals for the Ninth Circuit makes clear that there are limits on the types of allegations that will meet this threshold. On November 26, 2008, the Ninth Circuit affirmed the dismissal of a securities fraud class action filed against InVision Technologies, Inc.  The plaintiff shareholders claimed that InVision misled investors by making three misstatements in a merger agreement that the company filed in conjunction with its March 2004 annual report.  In particular, the plaintiffs alleged that InVision misstated in its regulatory filing announcing its proposed merger with the General Electric Company that InVision was in compliance with all applicable laws, that the company was in compliance with the books-and-records provision of the FCPA, and that neither the company nor its employees knew of any violations of the FCPA’s anti-bribery provisions.  This report was filed just a few months before InVision announced that it had uncovered potential FCPA violations and reported those violations to DOJ and the SEC, ultimately resulting in InVision settling FCPA charges with both enforcement agencies.  The announcement of the FCPA investigation caused InVision’s stock price to drop significantly and nearly undermined the pending merger.   In early 2006, the district court dismissed the shareholders’ complaint, triggering the appeal to the Ninth Circuit.  The Ninth Circuit upheld the district court’s dismissal, holding that plaintiffs must plead that the senior officials who prepared the company’s allegedly misleading disclosures were aware of the unlawful conduct – and therefore knew that the statements at issue were false – in order to survive a motion to dismiss under the PSLRA.  Because the plaintiffs had not pled that InVision’s Chief Executive Officer or Chief Financial Officer, who prepared the statements at issue in the merger agreement, knew about the improper payments in March 2004, the scienter pleading requirements of the PSLRA were not met. Three other recently filed cases demonstrate new categories of collateral civil litigation arising in conjunction with potential FCPA violations.  On June 27, 2008, eLandia International, Inc. filed an action in Florida state court against Jorge Granados, the former Chief Executive Officer of Latin Node, Inc., and others relating to eLandia’s acquisition of the Latin Node business in 2007.  The complaint, which asserts claims for, among other things, breach of contract, breach of the obligation of good faith and fair dealing, and fraudulent inducement, alleges that Granados and others failed to disclose during the acquisition process that Latin Node had made payments to various governmental parties in violation of the FCPA.  eLandia discovered the potentially corrupt payments by Latin Node employees after completing the acquisition and reported the same to DOJ and the SEC.  eLandia noted in a recent quarterly filing that it has offered $2 million to DOJ in an effort to settle the successor liability claims arising from the Latin Node business.  Next, on October 21, 2008, Supreme Fuels Trading FZE filed a complaint in Miami federal court against its competitor, International Oil Trading Co. ("IOTC"), alleging that IOTC bribed Jordanian government officials to ensure that only IOTC would receive a letter of authorization from the Jordanian government allowing IOTC to transport fuel through Jordan into Iraq.  Contractors that do not have such a letter are ineligible to win certain U.S. government contracts.  The complaint asserts that, but for IOTC’s bribes, Supreme Fuels Trading would have been able to obtain the necessary letter of authorization from Jordan and would have won certain U.S. government contracts.  Supreme Fuels Trading claims that IOTC’s conduct tortuously interfered with Supreme Fuels Trading’s business relations and violated the Racketeer Influenced and Corrupt Organizations Act, the Sherman Act, and the Florida state law equivalents of those federal acts.  And on December 23, 2008, Willbros International filed suit against its former executive James Tillery and several of its former consultants, including Paul Novak and Hydrodive International, Ltd., some of the parties allegedly responsible for Willbros International’s own guilty plea to FCPA charges in May 2008.  Willbros International alleges that Tillery purchased an approximately 30% interest in Hydrodive International four months before causing Willbros International to enter into a consulting agreement with Hydrodive and without disclosing this ownership interest to Willbros.  Tillery and Novak, who themselves were indicted on FCPA charges in 2008 (Willbros International’s complaint was filed only four days after the Tillery/Novak indictment was unsealed), allegedly then used Hydrodive International and other consulting entities "as a conduit to make corrupt payments to foreign officials in Nigeria" in violation of the Racketeer Influenced and Corrupt Organizations Act.  Moving to the criminal litigation front, on October 6, 2008, the U.S. Supreme Court denied David Kay and Douglas Murphy’s petition for certiorari, leaving the Fifth Circuit’s 2007 decision in place and finally bringing to a conclusion one of the FCPA’s longest-running and highest-profile cases.  The underlying decision of the Fifth Circuit, as well as the protracted and winding history of this case, is described in detail in our 2007 Year-End FCPA Update.  Speaking shortly after the Supreme Court’s cert denial, DOJ’s Mendelsohn proclaimed that this action confirms DOJ’s long-held interpretation of the FCPA as more than "just a procurement fraud statute."  2008 also saw significant judicial decisions in what is perhaps now the FCPA’s longest running prosecution: that of Frederic Bourke, David Pinkerton, and Victor Kozeny.  The three were indicted in 2005 on charges of bribing senior Azeri government officials to influence the officials’ decision to privatize Azerbaijan’s state-owned oil company.  As reported in our 2007 Year-End FCPA Update, Bourke and Pinkerton (Kozeny has never appeared to answer his charges and is still a fugitive living in the Bahamas) moved to dismiss their charges on statute-of-limitations grounds.  Their argument turned on whether 18 U.S.C. § 3292, which permits DOJ to toll the statute-of-limitations in FCPA cases for up to three years while it pursues an official inter-governmental request to obtain evidence located in a foreign jurisdiction, requires DOJ to file the § 3292 tolling application within the five-year statue-of-limitations period.  DOJ argued that it was sufficient for it to simply file the foreign legal assistance request within the statute-of-limitations period, as it had in this case, and then file the § 3292 tolling order after the limitations period expired.  Judge Shira Scheindlin of the U.S. District Court for the Southern District of New York granted Bourke and Pinkerton’s motion to dismiss on most of the FCPA counts, leading DOJ to seek review in the U.S. Court of Appeals for the Second Circuit.  On August 29, 2008, the Second Circuit affirmed Judge Sheindlin’s decision, holding that "the plain language of [18 U.S.C. § 3292], and the structure and content of the law by which it was enacted, require the government to apply [to the district court] for a suspension of the running of the statute of limitations before the limitations period expires."  DOJ had voluntarily dismissed the charges against Pinkerton after the case was argued in the Second Circuit but before the decision had been rendered, and the Second Circuit’s decision removed all but one FCPA count against Bourke.  The single remaining FCPA count against Bourke was then the subject of a second opinion by Judge Scheindlin, issued on October 21, 2008.  Bourke filed a motion to dismiss his remaining FCPA charge on the ground that the alleged payments were lawful under the written laws of Azerbaijan, and thus fell within the FCPA’s "local law" affirmative defense.  Bourke argued that Azeri law relieves from criminal liability those who pay bribes under duress of extortionate demands as well as those who self-report their bribes to Azeri authorities, both of which Bourke claimed applied to him.  Following a hearing at which Judge Scheindlin heard from dueling Azeri law experts testifying pursuant to Rule 26.1 of the Federal Rules of Criminal Procedure, the Court rejected Bourke’s argument, reasoning that the FCPA focuses on the legality of the payment, not the foreign government’s ability to prosecute the payer.  So with respect to Azeri law’s absolution for bribes self-reported to the government, the payments are never themselves lawful, they are simply barred from prosecution, much as the majority of Bourke’s alleged improper payments were barred from prosecution by the U.S. statute of limitations.  Similarly, Judge Scheindlin held that with respect to Bourke’s extortion argument, a "payment to an Azeri official that is made under threat to the payer’s legal interests is still an illegal payment, though the payer cannot be prosecuted for the payment."  Because the FCPA is not meant to apply to cases of "true extortion" (e.g., payments to prevent the dynamiting of an oil rig), which generally do not meet the statute’s corrupt intent requirement in any event, Judge Scheindlin instructed Bourke to prepare jury instructions on extortion that he may present to the jury if he can lay an evidentiary foundation that the alleged extortion was "true extortion" and not merely economic coercion (e.g., payments to gain entry to a market).  Bourke’s trial is currently scheduled for March 2009.  Two other FCPA cases went up to the circuit courts of appeal in 2008 on non-FCPA issues.  In the high-profile prosecution of U.S. congressman William Jefferson, described in detail in our 2007 Year-End FCPA Update, a three-judge panel of the United States Court of Appeals for the Fourth Circuit affirmed the district court’s denial of Rep. Jefferson’s motion to dismiss his indictment on Speech or Debates Clause grounds on November 12, 2008.  Rep. Jefferson had argued that the grand jury’s consideration of evidence unlawfully seized from his congressional office tainted his indictment.  The Panel observed that "there are limits to the protection afforded to legislators by the Speech or Debate Clause" and concluded that the district court properly decided that the evidence in question was not properly Speech or Debate Clause material protected by the Constitution.  The full Fourth Circuit then denied Rep. Jefferson’s petition for rehearing en banc on December 12, 2008.  There is presently no trial date set and Rep. Jefferson may still seek certiorari on the Speech or Debate Clause issue from the U.S. Supreme Court.   The other FCPA case to find its way into the federal appellate courts on non-FCPA grounds is the prosecution of husband and wife film producers Gerald and Patricia Green.  We first profiled this case in our 2007 Year-End FCPA Update, after the Greens were arrested in December 2007 on charges of conspiring to pay more than $1.7 million in bribes to the former governor of the Tourism Authority of Thailand in return for lucrative contracts to administer the annual Bangkok International Film Festival.  But on October 1, 2008, the grand jury returned a superseding indictment adding new charges alleging bribery of the same Thai official in return for contracts related to the introduction of an "elite privilege card" service marketed to wealthy foreigners.  Additionally, the superseding indictment added money laundering charges and allegations that Mrs. Green knowingly subscribed two false corporate income tax returns that included deductions for "commissions" as business expenses while Mrs. Green knew that these commissions represented "a false and overstated amount including bribes to a foreign official . . . ."  Collectively, the Greens now face twenty-one counts on the superseding indictment.  The Greens’ docket sheet is shrouded in a veil of "under seal" filings.  But the publicly available entries show that the Greens have sought interlocutory review by the Ninth Circuit of a district court order for the production of grand jury testimony and documents that the Greens argue is protected by the attorney-client privilege.  The district court ruled that the documents and testimony were subject to the "crime fraud" exception to the attorney-client privilege and therefore are not protected.  The case appears to have been argued in front of the Ninth Circuit, though a decision has not yet been released.  Other Significant Enforcement Developments Four More Oil-for-Food Prosecutions Make Ten In 2008’s final FCPA enforcement action, DOJ and the SEC jointly announced that Fiat S.p.A. had agreed to a settled FCPA resolution in connection with the company’s participation in the Oil-for-Food Program.  This made Fiat the fourth company of 2008 – Flowserve Corp., AB Volvo, and Siemens AG being the first three – and the tenth company overall to settle FCPA charges with DOJ and/or the SEC arising out of this United Nations program.  We described the Oil-for-Food scheme in greater detail in our 2007 Year-End FCPA Update, but the essential allegations (as they concern the "Humanitarian" side of the Program) are that the Iraqi government imposed a 10% "after sales service fee" ("ASSF") as a condition of sales under the Program.  To fund these mandatory payments, contractors typically increased the value of their contracts by 10%, thereby receiving an additional 10% from the United Nations escrow account, and passed the increase on to the Iraqi government through third-party agents and Iraqi-controlled bank accounts.   The settlement documents allege that Fiat violated the FCPA’s books-and-records and internal controls provisions through the incorporation into its ledger of $4,379,657 in inaccurately recorded ASSF payments made (and $312,198 in additional ASSF payments agreed to but not paid) by the company’s Dutch, French, and Italian subsidiaries.  To settle these allegations, Fiat agreed to pay a $7 million criminal penalty to DOJ and more than $10.8 million in civil penalties, disgorgement, and prejudgment interest to the SEC.  Fiat also (i) entered into a deferred prosecution agreement with DOJ, (ii) consented to the filing of criminal informations charging the three implicated subsidiaries with various FCPA books-and-records and wire fraud conspiracy charges (which will be dismissed in three years assuming compliance with the deferred prosecution agreement’s terms), and (iii) consented to the filing of an SEC injunction permanently enjoining it from future violations of the FCPA.  Aibel Group’s Deferred Prosecution Agreement Revoked On November 21, 2008, DOJ for the first time ever revoked a deferred prosecution agreement and filed criminal charges against the previously protected party.  As reported in our 2007 Year-End FCPA Update, in February 2007, Aibel Group entered into a deferred prosecution agreement with DOJ in connection with the payment of approximately $2.1 million in alleged bribes to Nigerian customs officials in return for preferential treatment in customs clearance matters.  But twenty-one months later, DOJ announced that Aibel Group had breached its deferred prosecution agreement and had agreed to plead guilty to a two-count superseding information re-alleging the same conduct underlying the deferred prosecution agreement.  DOJ did not specify the reason for its revocation of the 2007 agreement, except to say in the plea agreement that despite Aibel’s commitment of "substantial time, personnel, and resources to meeting the obligations of its DPA," Aibel "failed to meet its obligations."  Pursuant to the plea agreement, Aibel Group paid a $4.2 million criminal fine and will serve a two-year term of organizational probation requiring the company to submit annual reports on the implementation of anti-bribery compliance measures within the business.  This revocation and prosecution demonstrate DOJ’s willingness to hold companies accountable for violations of deferred and non-prosecution agreements, which should grab the attention of every corporation now serving a term of DOJ probation pursuant to one of these agreements.                Trouble Spots Still Troubled Compliance professionals know that a select number of foreign locales have historically proven especially difficult to navigate for U.S.-based multinationals and others subject to the FCPA’s reach.  2008 was no exception in this regard, with Nigeria, Iraq, and China pulling down to the "top" three slots for the dubious distinction of being the most-referenced setting for FCPA allegations.  What Facilitating Payments Exception? For years, we have advised our clients on the pitfalls of the "facilitating payments" exception to the FCPA’s anti-bribery provisions.  Pursuant to this exception, payments to "expedite or to secure the performance of a routine government action" are not considered bribes within the scope of the anti-bribery provisions.  But DOJ and the SEC have long been openly skeptical of the reach of this exception.  For example, speaking at an FCPA conference, DOJ’s Mendelsohn advised that simply because the statute contains the exception does not mean that DOJ encourages such payments as a good business practice.  In the first FCPA settlement of 2008, DOJ took perhaps its strongest stance yet against facilitating payments in a non-prosecution agreement with Westinghouse Air Brake Technologies Corp. ("Wabtec").  On February 14, Wabtec entered into a joint resolution with DOJ and the SEC whereby it consented to the filing of an SEC complaint and entered into a non-prosecution agreement with DOJ, both alleging that the company violated the FCPA’s anti-bribery and accounting provisions.  The SEC’s complaint focused on $137,400 in improper payments made by Wabtec’s Indian subsidiary, Pioneer Friction, Ltd., to officials of the Indian Railway Board in order to influence the Board to award it new contracts for the supply of brake blocks and to approve Pioneer’s pricing proposals for existing contracts.  Pursuant to the SEC settlement, Wabtec agreed to pay an $87,000 civil penalty, to disgorge $288,351 in profits plus prejudgment interest, and to retain an independent compliance monitor to review and make recommendations concerning the company’s FCPA compliance program for two years.  But DOJ’s non-prosecution agreement is of particular interest.  There, DOJ alleged that Pioneer made improper payments to various regulatory boards to facilitate the scheduling of product inspections and the issuance of compliance certificates and to the Central Board of Excise and Customs to put an end to excessively frequent audits.  Although these payments totaled more than $40,000 over the course of one year, individual payments were as miniscule as $67 per product inspection and $31.50 per month to lower the frequency of Pioneer’s audits.  To resolve these allegations, Wabtec agreed to pay a $300,000 fine and conduct an internal review of its FCPA compliance program.  DOJ’s non-prosecution agreement paints a sobering picture of DOJ’s view of the facilitating payments exception to the FCPA, arguably to the point of reading the exception out of the statute.  Companies that permit facilitating payments as a matter of corporate policy should carefully consider the lessons to be drawn from this settlement.  2008 DOJ FCPA Opinion Procedure Releases By statute, DOJ is required to provide a written opinion at the request of an "issuer" or "domestic concern" as to whether DOJ would prosecute the requestor under the FCPA’s anti-bribery provisions for prospective conduct that the requestor is considering taking. These opinions are published on DOJ’s FCPA website, but only a party who joins in the request may officially rely upon the opinions.  The SEC does not itself issue FCPA opinion procedure releases, but has opted as a matter of policy not to prosecute issuers that obtain clean opinions from DOJ.  DOJ has issued fifty such written opinions in the statute’s thirty-one years, including three in 2008.  In 2006, then-Assistant Attorney General Alice Fisher commented that "the FCPA opinion procedure has generally been under-utilized" and noted she wants it "to be something that is useful as a guide to business." The three opinion releases issued in 2008 equal the number of releases issued in 2007 and continues a slight upward trend.  We detailed the first two FCPA Opinion Procedure Releases of 2008, including the landmark 2008-02 opinion that is a must read for any company undertaking an international acquisition, in our 2008 Mid-Year FCPA Update.  Here we will tackle the third release.  FCPA Opinion Procedure Release 2008-03 The third DOJ opinion procedure release of 2008 involves the FCPA’s second affirmative defense (in addition to the "local law" defense discussed above in connection with the Bourke prosecution) – that for "reasonable and bona fide expenditures" related to "the promotion, demonstration, or explanation of products or services" or "the execution or performance of a contract with a foreign government or agency thereof."  Global anti-corruption watchdog TRACE International, a domestic concern under the FCPA, submitted the request in advance of an FCPA conference held in Shanghai, China.  TRACE sought clearance to pay travel-related expenditures for Chinese journalists (most media outlets in China are state-owned, rendering the journalists foreign officials under the FCPA) to attend a TRACE press conference timed to coincide with the FCPA conference.  TRACE represented that it would provide the journalists with modest cash stipends – approximately $28 for in-town journalists and $62 for out-of-town journalists – to cover meals, local transportation costs, and, in the case of the out-of-town journalists, would reimburse the journalists for economy rate inter-city travel and pay directly for their overnight lodging in the hotel where the conference was to take place.  TRACE further represented, among other things, that members of the state-owned media in China are not typically reimbursed for work-related travel expenses, that TRACE would not condition the stipends and expense reimbursements on the journalists’ coverage of TRACE’s press conference, that TRACE would send letters to the journalists’ employers advising them of the proposed stipends and expense reimbursements, and that TRACE had obtained "written assurance from an established international law firm that TRACE’s payment of the stipends is not contrary to [Chinese] law." Based on these representations, DOJ concluded that the proposed payments would "fall within the FCPA[’]s promotional expenses affirmative defense in that the expenses are reasonable under the circumstances and directly relate to ‘the promotion, demonstration, or explanation of [TRACE’s] products or services.’"  DOJ explicitly disclaimed any reliance on TRACE’s representations "that it may be a common practice for companies in [China] to provide such benefits to journalists attending a press conference."  Legislative Developments 2008 also saw the introduction of several pieces of legislation that, if passed, could have substantial ramifications for companies subject to the FCPA. As reported in our 2008 Mid-Year FCPA Update, on June 4, 2008, Rep. Ed Perlmutter (D. Colo.) introduced H.R. 6188, the Foreign Business Bribery Prohibition Act of 2008.  This bill would provide for a limited right of private action under the FCPA; such a right does not presently exist.  Rep. Perlmutter’s bill would amend the FCPA to permit issuers and domestic concerns to bring suit seeking treble damages against "foreign concerns" for FCPA violations that both assist the foreign concern in obtaining or retaining business and prevent the plaintiff from obtaining or retaining that business.  The bill would provide a right of action only against "foreign concerns," defined as any person other than an issuer or domestic concern, and even then only where the foreign concern’s actions violate the FCPA.  Therefore, the class of potential defendants under this bill would be limited to foreign persons and businesses unaffiliated with U.S. stock exchanges and who corruptly use instrumentalities of interstate commerce within the United States in furtherance of their bribes.  Still, this would be an important development in efforts to "level the playing field" of FCPA enforcement worldwide.  The bill was referred to the House Judiciary and Energy and Commerce committees, but no action was taken in the 110th Congress. On May 16 2008, Rep. Barney Frank (D. Mass.) introduced H.R. 6066, the Extractive Industries Transparency Disclosure Act, in the House.  This bill would amend the ’34 Exchange Act to require issuers to disclose in their annual SEC filings all payments to foreign governments, including their agencies and instrumentalities, in connection with the extraction of natural resources.  Long advocated by human rights groups, the purpose of this legislation is to increase the transparency of funds flowing into the coffers of oppressive Third World regimes that sit on great natural wealth while their citizens live in poverty.  Of course, a side effect of the law would be mandatory disclosures of certain payments that may implicate the FCPA.  Unlike the Foreign Business Bribery Prohibition Act, this bill has seen movement.  The House Financial Services Committee held hearings on the bill in June 2008 and then, in July, Sen. Charles Schumer (D. N.Y.) introduced a companion bill (S. 3389) in the Senate.  The Senate and House bills have collectively gathered forty co-sponsors and, according to a recent article in the Houston Chronicle, additional committee hearings are scheduled for 2009 with a goal of passing the law in 2010.    Finally, although technically neither legislation nor relating specifically to the FCPA, we would be remiss not to mention this year’s major compliance development in the Federal Acquisition Regulation ("FAR").  On November 12, 2008, the FAR Council amended the FAR with FAR Case 2007-006, which requires mandatory disclosure by federal government contractors of certain violations of federal criminal law and the civil False Claims Act and requires many government contractors to create a business ethics awareness and compliance program.  The push for this rule originated with DOJ’s Criminal Division, which has long criticized what it sees as a lack of voluntary disclosure by federal contractors of legal and ethical violations. FAR Case 2007-006 requires government contractors to disclose all violations of criminal law involving fraud, conflict of interest, bribery, and gratuities connected to any aspect of a federal government contract or subcontract, as well as violations of the civil False Claims Act and "significant" overpayments on a contract.  A knowing failure to timely disclose "credible evidence" of such violations may result in suspension or debarment.  The rule also requires contractors, other than those classified as small business concerns or contracting solely for commercial items, to implement a business ethics awareness and compliance program as well as a system of internal controls.  And even small business concerns are covered to the extent that they work on federal government contracts valued in excess of $5 million and with performance periods longer than 120 days.  These compliance and control systems must be reasonably calculated to, among other things, facilitate timely discovery of improper conduct related to a federal government contract and guarantee that effective corrective measures are taken once such conduct has been discovered.  Although FAR Case 2007-006 applies only to U.S. government contracts, and its criminal disclosure obligations do not on their face apply to the FCPA (the criminal law disclosure obligations are limited to Title 18 of the U.S. Code whereas the FCPA is contained in Title 15), one could easily spin a hypothetical in which this development becomes very relevant to companies with FCPA concerns.  For more on FAR Case 2006-007, please see Gibson Dunn’s November 13, 2008 Client Alert, New Federal Regulation Requires Mandatory Disclosure and Amplified Compliance Programs for Government Contractors.  Conclusion Although the number of FCPA enforcement actions brought in 2008 was slightly down from 2007’s record pace, the FCPA enforcement agencies have continued to prosecute violators aggressively.  In doing so, DOJ and the SEC have taken an expansive view of the scope of the FCPA’s prohibitions and continue to seek increasingly large penalties against both corporate and individual defendants. With approximately 100 pending FCPA investigations, we expect this trend of aggressive enforcement to continue in 2009 Washington, D.C. F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com)  Daniel J. Plaine (202-955-8286, dplaine@gibsondunn.com) Judith A. Lee (202-887-3591, jalee@gibsondunn.com) David P. Burns (202-887-3786, dburns@gibsondunn.com)  Jim Slear (202-955-8578, jslear@gibsondunn.com)Michael S. Diamant (202-887-3604, mdiamant@gibsondunn.com)John W.F. Chesley (202-887-3788, jchesley@gibsondunn.com)Patrick F. Speice, Jr. (202-887-3776, pspeicejr@gibsondunn.com) New YorkLee G. Dunst (212-351-3824, ldunst@gibsondunn.com)James A. Walden (212-351-2300, jwalden@gibsondunn.com)Alexander H. Southwell (212-351-3981, asouthwell@gibsondunn.com) DenverRobert C. Blume (303-298-5758, rblume@gibsondunn.com)J. Taylor McConkie (303-298-5795, tmcconkie@gibsondunn.com) Orange CountyNicola T. Hanna (949-451-4270, nhanna@gibsondunn.com) Los Angeles Debra Wong Yang (213-229-7472, dwongyang@gibsondunn.com), the former United States Attorney for the Central District of California,Michael M. Farhang (213-229-7005, mfarhang@gibsondunn.com)Douglas M. Fuchs (213-229-7605, dfuchs@gibsondunn.com) MunichMichael Walther (+49 89 189 33-180, mwalther@gibsondunn.com)Mark Zimmer (+49 89 189 33-130, mzimmer@gibsondunn.com) © 2009 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 9, 2009 |
2008 Year-End Hedge Fund Update: Enforcement and Regulatory Developments and Compliance Considerations

I.  Hedge Fund Enforcement Update   A.  Introduction 1.  2008–A Watershed Year in Hedge Fund Enforcement By virtually any measure, 2008 was a watershed year on the hedge fund enforcement front.  Driven by the turmoil that has reshaped our capital and credit markets, enforcement efforts soared to new heights.  Regulators and prosecutors redefined their enforcement priorities, commenced an unprecedented number of investigations and enforcement actions, and, according to a senior Securities and Exchange Commission ("SEC" or "Commission") insider, reached out to and cooperated with domestic and foreign agencies in a manner that has not been seen in at least thirty years.  Explaining the unusually intense scrutiny that regulators placed upon hedge funds in 2008, Bruce Karpati, who coordinates the SEC’s Hedge Fund Working Group out of the New York Regional Office, suggested that, given the economic climate, "half to two-thirds of hedge funds might go out of business"–and, as the aphorism goes, desperate times may lead hedge funds to take desperate measures. According to Linda Thomsen, Director of the SEC’s Division of Enforcement, since 2000, the SEC has brought 145 actions involving hedge funds; and since 2003, the number of actions involving hedge funds each year has been in the teens or twenties.  In 2008, that trend continued with the filing of twenty-two hedge-fund-related enforcement matters.  In addition, the Department of Justice brought five hedge-fund-related criminal actions.  While these numbers may seem unexceptional given the unprecedented scrutiny that hedge funds faced, the figures should be considered in light of the fact that 2008 saw: (a) the filing of a significant number of large, complex, or novel cases; (b) the culmination of similarly large, complex, or novel previously filed actions; and (c) the commencement of several broad industry-wide sweep investigations focusing on the activities of hedge funds and other market participants–all of which likely required the deployment of significant regulatory and prosecutorial resources.  One need look no further than the highly publicized civil and criminal actions brought against Bernard L. Madoff for allegedly defrauding his advisory clients (hedge funds and others) out of billions of dollars in what might be the largest financial fraud in history.  Investor losses from the fraud could reach $50 billion. Importantly, hedge fund enforcement activities in 2008 were part of a broader wave of general enforcement-related efforts that set new records.  For example, in fiscal year 2008, the SEC reportedly brought the highest number of insider trading cases in the agency’s history and a record high number of enforcement actions against market manipulation–including a precedent-setting case against a former hedge fund trader for spreading false rumors.  Further, the SEC reportedly completed the highest number of enforcement investigations in any year to date, by far, and initiated the second highest number of enforcement actions in agency history.  Adding to these records, SEC Chairman Christopher Cox noted that the Commission devoted more than one-third of the entire agency staff to the enforcement program–a higher percentage of the SEC’s total staff than at any time in the past twenty years–and the internal allocation of funds for enforcement was the highest in agency history.  The level of interaction and cooperation among enforcement agencies similarly rose to new heights.  Thomas Biolsi, Associate Regional Director for Examinations at the SEC’s New York Regional Office, recently observed that he has never seen–in thirty years–the type of multi-agency interaction now taking place.  Not only are U.S. regulators increasingly working with each other in more sophisticated ways, they are also doing so with their foreign counterparts.  According to Chairman Cox, "[t]he Commission’s international work was more significant in FY 2008 than ever before."  During that time, the SEC reportedly made more than 550 requests of foreign regulators for assistance with SEC investigations–more than one a day on average, and far higher than any previous year–and cooperated with more than 450 requests from foreign regulators for enforcement assistance.  A significant amount of this "international work" likely involved hedge funds.  Indeed, Bruce Karpati recently stated that, given the "global nature" of the hedge fund industry and the fact that "such a big component of what hedge funds do is in the overseas markets," the Hedge Fund Working Group is "increasingly working with foreign regulators." The take-away is clear: hedge funds were under extraordinary regulatory scrutiny in 2008–particularly so once the economic crisis came to dominate the daily news–and that level of scrutiny is expected to continue, if not intensify, in 2009. Gibson Dunn has been counsel to hedge funds during this time, and we have written extensively on an array of enforcement and regulatory developments affecting hedge funds.  This section of the client update provides an overview of hedge fund enforcement activities in 2008 and the priorities that emerged as the year progressed, as well as practical guidance to help hedge funds avoid or limit liability.  Much of the information presented in this section is based on our review of cases filed and public sources describing enforcement initiatives and investigations.  In addition, we have incorporated salient comments and observations made by senior regulators and prosecutors at a November 24, 2008 Practising Law Institute Conference in New York on Hedge Fund Enforcement and Regulatory Concerns.  We follow this section of the client update with an overview of hedge-fund-related regulatory developments and compliance considerations.  We discuss actions taken by the SEC and others in response to the economic crisis, and we present best practices and related guidance.  At the end of the client update, we provide an addendum containing a compilation of hedge fund enforcement actions and developments in 2008. 2.  Hedge Fund Enforcement Priorities Senior regulators and prosecutors from the SEC, the Financial Industry Regulatory Authority ("FINRA"), the New York Stock Exchange ("NYSE"), and the New York Attorney General’s Office recently identified their top hedge fund enforcement priorities in 2008–all of which are expected to remain priorities in 2009.  They are: Rumor mongering; Insider trading; Private investment in public equity ("PIPE") transactions; Portfolio pumping; Valuation/Risk of investment; Allocation; and Predatory short selling and illegal short selling in connection with Regulation M. B.  Rumor Mongering Rumor mongering–the act of knowingly creating, spreading, or using false or misleading information with the intent to manipulate securities prices–became a staple of the hedge fund enforcement vernacular in 2008.  Bruce Karpati of the SEC’s Hedge Fund Working Group explained why: "from an enforcement and examination perspective, jittery markets . . . can be taken advantage of" by false rumors, with particularly dangerous effects on our markets.  Echoing this sentiment, David Markowitz, Chief of New York Attorney General Andrew Cuomo’s Investor Protection Bureau, indicated that, in light of the financial market turmoil and economic crisis, short selling in conjunction with rumors became a hedge fund enforcement priority.  Regulators have recognized that, in this economic climate, rumor mongering can lead to the precipitous collapse of even our most venerable institutions.  Accordingly, 2008 saw unprecedented efforts to address this issue. First, the SEC initiated nationwide enforcement investigations into alleged intentional manipulation of securities prices through rumor mongering and abusive short selling.  In connection with these investigations, the SEC reportedly issued subpoenas to more than fifty hedge fund advisers and other participants in the securities markets, seeking various trading and communications data.  Supplementing these investigations, the SEC, FINRA, and NYSE launched coordinated examinations of broker-dealers and investment advisers, including unregistered hedge fund managers, aimed at preventing the intentional spreading of false rumors to manipulate securities prices. Only weeks later, the SEC announced a sweeping expansion of its ongoing investigations, stating that the Commission would require hedge fund managers and other investors with significant trading activity in financial issuers or positions in credit default swaps ("CDS") to disclose those positions under oath pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934 ("Exchange Act").  According to Bruce Karpati, the expansion of the investigation to include CDS should not have come as a surprise.  Mr. Karpati noted that it is appropriate to be "very much focused" on this area because false rumors can "affect a company’s credit quality," which in turn can affect trading in CDS.  Shortly after its announcement, the SEC issued orders under Section 21(a)(1) to more than two dozen hedge funds and sell-side firms.  The SEC’s use of this tool–one that had not been broadly used for several years–represented a significant escalation of its enforcement efforts in this area.  Notably, Linda Thomsen recently stated that, while she does not believe the SEC will use this tool "every week," "it’s one more tool," and "it’s something [the SEC] will use in the future." Enter the New York Attorney General’s Office, which similarly launched a wide-ranging investigation into rumor mongering and short selling on Wall Street.  Attorney General Andrew Cuomo has said he will use New York’s Martin Act to prosecute any short sellers engaging in any improper conduct, including the spreading of false rumors.  (The Martin Act empowers the Attorney General to investigate fraud in the purchase or sale of securities and to bring civil and criminal charges where appropriate.)  Following the trajectory of the SEC’s investigation, David Markowitz recently stated that a "new focus" of the Attorney General’s investigation is CDS.  According to Mr. Markowitz, CDS "contributed greatly to the economic situation we’re facing today," and it is a "ripe area for regulatory action" or "at least inquiry."  As such, the office is taking a "very comprehensive," "broad-based look" at CDS.  In particular, the Investor Protection Bureau is looking at potential manipulation of the CDS market as a way of manipulating the equity market.  And the Attorney General’s Office is not working alone: it has partnered with the U.S. Attorney’s Office in Manhattan–a partnership that signals just how comprehensive this investigation is.  Thus far, the Attorney General’s Office has sent subpoenas to multiple hedge funds in a wide range of locales, including New York, Texas, and London, among others. Significantly, these ongoing investigations appear to be international in scope.  Bruce Karpati recently observed that many rumors appear to come from overseas trading desks, and the SEC is increasingly working with foreign regulators to combat rumor mongering.  The New York Attorney General’s Office and the U.S. Attorney’s Office in Manhattan may similarly be working with foreign authorities.  Indeed, it is believed that Attorney General Cuomo partnered with federal prosecutors in recognition of the fact that a comprehensive investigation of these issues requires substantial coordination with foreign sources–a function that the U.S. Attorney’s Office is particularly well suited to perform. 1.  SEC v. Berliner In April 2008, the SEC filed its first ever (and, to date, only) styled rumor mongering case–SEC v. Berliner–which was brought against a former trader with the Schottenfeld Group, a hedge fund.  After the Blackstone Group had entered into an agreement to acquire Alliance Data Systems ("ADS") for $81.75 per share, Paul S. Berliner allegedly disseminated a false rumor that read: ADS getting pounded–hearing the board is now meeting on a revised proposal from Blackstone to acquire the company at $70/share, down from $81.50.  Blackstone is negotiating a lower price due to weakness in World Financial Network–part of ADS’ Credit Services unit, as evidence [sic] by awful master trust data this month from the World Financial Network Holdings off-balance-sheet credit vehicle. Berliner allegedly spread this false rumor through instant messages to thirty-one traders at hedge funds and brokerage firms.  According to the complaint, Berliner profited by short selling ADS stock and covering those sales as the false rumor caused the price of ADS stock to fall. The SEC brought an action in the U.S. District Court for the Southern District of New York, charging Berliner with securities fraud and market manipulation for intentionally disseminating a false rumor.  Without admitting or denying the allegations in the complaint, Berliner agreed to settle the charges, and the court entered a judgment that (among other things) ordered him to disgorge $26,129 and pay a civil penalty of $130,000.  The SEC separately barred him from associating with any broker or dealer.  Commenting on Berliner, Chairman Cox stated: "The message of this case is simple and direct.  The Commission will vigorously investigate and prosecute those who manipulate markets with this witch’s brew of damaging rumors and short sales." 2.  Comment While Chairman Cox has acknowledged that it is difficult to pin down the source of market-moving rumors and to prove that rumors are "knowingly false," these enforcement hurdles apparently have not deterred regulators from aiming their collective sights on rumor mongering.  Shedding light on what may trigger a rumor mongering enforcement action by the Hedge Fund Working Group, Bruce Karpati said it "comes down to knowledge" and "falsity of information."  That is, did the individual have actual knowledge of the information’s falsity?  Or did he or she recklessly disregard the falsity of the information?  Linda Thomsen suggested that contrived defenses such as, "it’s true that he or she told me [substance of rumor]," would fall into this "recklessness" category and should not be attempted. The Berliner case is also instructive.  Notably, the rumor in Berliner was highly specific and completely (as opposed to partly) false.  If Berliner is the SEC’s model for future rumor mongering cases–and Bruce Karpati has suggested that it is–then a rumor’s degree of specificity and falsity may also be a significant factor in whether the Commission brings an enforcement action. If a client finds himself or herself under investigation for rumor mongering, and if an assessment of these or other pertinent factors shows that a rumor mongering investigation or case is unfounded, Linda Thomsen and Bruce Karpati stated that a presentation should be given to the SEC.  According to Mr. Karpati, a presentation in a rumor mongering matter would be "especially . . . beneficial." C.  Insider Trading Not only was insider trading by hedge funds an enforcement priority in 2008, but, according to Linda Thomsen, it was an issue on which the Hedge Fund Working Group (and other regulators) put a "particular emphasis."  Director Thomsen elaborated: "it is clear that there is a widespread public perception of insider trading by hedge funds ahead of the public announcement of significant corporate transactions.  This perception, in and of itself, is harmful to the reputation of our markets for fairness and integrity and therefore warranted further investigation–which has been undertaken by our Hedge Fund Working Group." Two areas of focus that have emerged in connection with insider trading are CDS and PIPE transactions.  Bruce Karpati has said that CDS are "ripe for insider trading" because they can be used to "bet on the future outlook of companies"; accordingly, the Hedge Fund Working Group has recognized CDS as a priority.  So, too, has the New York Attorney General’s Office, in partnership with the U.S. Attorney’s Office in Manhattan.  It should be noted that, as with the rumor mongering enforcement efforts discussed above, the SEC, the New York Attorney General’s Office, and the U.S. Attorney’s Office appear to be working with foreign regulators to combat insider trading in increasingly vigorous ways.  The SEC has also brought insider trading cases in connection with PIPE transactions; however, because regulators have identified PIPE transactions as a standalone priority, we discuss this topic separately below. Apart from these specific focus areas, regulators and prosecutors have continued to name hedge funds and persons associated with them in more traditional insider trading cases.  In 2008, there were a number of significant developments on this front. 1.  SEC v. Tom In May 2008, a Massachusetts federal district court entered final judgments by consent against former hedge fund manager Michael K.C. Tom, former investment adviser Global Time Capital Management, and former hedge fund GTC Growth Fund.  As alleged in the complaint, this insider trading case arose out of Citizens Bank’s May 2004 announcement that it was acquiring Charter One Financial.  A then-Citizens employee allegedly conveyed certain material, nonpublic information relating to this acquisition to Tom, who purchased numerous Charter One call options for his personal account and for the GTC Growth Fund and tipped his brother about Citizens’ acquisition plan.  The final judgment permanently enjoined Tom and Global Time Capital Management from future violations of the federal securities laws.  In addition, Tom agreed to pay disgorgement of $543,875.07, plus pre-judgment interest of $107,381.63, and a civil penalty of $150,000.  Global Time Capital Management agreed to pay a civil penalty of $39,056.93, and GTC Growth Fund agreed to pay disgorgement of $189,868.39, plus pre-judgment interest of $23,145.67. 2.  In the Matter of Rubin Chen In July 2008, the SEC issued an order barring Rubin Chen, a former vice president and head of relative value hedge fund strategies at ING Investment Management Services in New York, from associating with any investment adviser.  The order stemmed from actions taken earlier in the month by the U.S. District Court for the Southern District of New York, which entered a final judgment by consent against Chen and his wife, Jennifer Xujia Wang, permanently enjoining them from future violations of the federal securities laws, ordering them to pay disgorgement and pre-judgment interest totaling $784,829, and assessing a civil penalty of $50,000 each.  The SEC’s complaint alleged that they obtained illegal profits of $727,733 by trading on the basis of material, nonpublic information concerning various proposed corporate acquisition transactions.  The complaint further alleged that Wang, in her position as a vice president of Morgan Stanley, was privy to material, nonpublic information concerning each of the pending acquisitions, which she unlawfully disclosed to Chen.  Chen had pleaded guilty to four felony counts, including one count of conspiracy to commit securities fraud, in September 2007. 3.  The Mitchel S. Guttenberg Matter Several significant developments also occurred in connection with SEC v. Guttenberg–billed as the most significant insider trading case since the late 1980s.  Alleging two insider trading schemes involving several hedge funds and over $15 million in illicit profits, the SEC brought this civil enforcement action against fourteen defendants in the so-called Wall Street Insider Trading Ring.  As part of the scheme, the SEC alleged that Mitchel S. Guttenberg, an executive director in the equity research department of UBS and one of the key participants in the scheme, illegally passed inside information regarding upcoming UBS research reports to others, including Erik R. Franklin, in exchange for sharing in the illicit profits from their trading on that information.  Franklin allegedly used the information to make trades for the two hedge funds that he managed.  The SEC also alleged that Randi E. Collotta, an attorney who worked in the global compliance department of Morgan Stanley, passed inside information regarding the upcoming corporate acquisitions of Morgan Stanley’s investment banking clients to Marc R. Jurman, a registered representative, in exchange for sharing in Jurman’s profits from trading on that information.  The complaint further alleged that Jurman illegally traded on this inside information and passed the information to several downstream tippees who also traded on it, both for themselves and for hedge funds under their management. In September 2008, a number of the defendants settled the SEC’s insider trading charges.  These defendants were permanently enjoined from violating the federal securities laws and ordered to pay various disgorgement amounts ranging from $4,500 to approximately $2.7 million.  Many of them were also barred from associating with any broker, dealer, or investment adviser.  With respect to Collotta, the SEC separately issued an order suspending her from appearing or practicing before the Commission as an attorney. Also, in November 2008, in connection with the parallel criminal case brought by the U.S. Attorney’s Office for the Southern District of New York, Guttenberg was sentenced to six-and-a-half years in prison after pleading guilty to six counts of conspiracy and securities fraud. 4.  Efforts by Foreign Regulators to Combat Insider Trading a.  The Steven Harrison Matter In September 2008, a settlement was reached in what the U.K. Financial Services Authority ("FSA") has called its first ever credit market abuse case.  The FSA alleged that Steven Harrison, a former hedge fund manager at Moore Europe Capital Management, was provided with inside information about the refinancing plans of Rhodia, which he illicitly passed onto a colleague with instructions to buy.  Under the settlement, Harrison agreed not to act as a fund manager or trader for twelve months and to pay a $92,500 fine.  In setting this penalty, the FSA considered several notable factors.  The FSA found that Harrison’s conduct was not deliberate, he made no direct personal profit from these activities, and he cooperated with the FSA’s investigation.  The FSA also took into account the impact of the twelve-month restriction to which Harrison agreed.  Significantly, the FSA sanctioned the former hedge fund manager even though it apparently could not prove that he knew he possessed inside information when trading took place and even though he did not appear to profit from the trades. b.  The Porsche Matter In October 2008, Germany’s financial regulator, BaFin, announced that it will investigate whether the dramatic price moves seen in Volkswagen’s share price were due to market manipulation in general or insider dealing in particular.  As reported in the press, Volkswagen’s share price more than quadrupled after it was revealed that Porsche had built up a much larger stake in Volkswagen than had previously been thought.  This reportedly caused hedge funds that believed its price would fall to close out their short positions and scramble to buy up the small amount of free-float shares available.  As a result, news reports noted, Volkswagen’s share price surged, briefly making it the world’s largest company by market capitalization.  Shortly thereafter, its price fell dramatically, reportedly losing forty-five percent on October 29, 2008.  BaFin has not yet identified any targets of its investigation. 5.  Comment In addition to being an enforcement priority, insider trading by hedge funds is a key examination priority.  From an examination perspective, the SEC has said it will focus on "the adequacy of policies and procedures, information barriers, and controls to prevent insider trading and leakage of information including the identification of sources of material non-public information, surveillance, physical separation, and written procedures."  Thomas Biolsi of the SEC recently emphasized that, in addition to these factors, he and his team will check to see whether a company has a code of ethics, and whether the policies and procedures in place are actually being followed.  Clients are encouraged to review carefully their insider trading policies and procedures, paying particular (but not exclusive) attention to these express focus areas. D.  PIPE Transactions For the past few years, the SEC has focused significant attention on the use of shares acquired in PIPE offerings to cover short sales of the publicly traded stock, and Linda Thomsen has made clear that PIPE transactions will remain a hedge fund enforcement priority going forward. In a PIPE offering, a public company issues unregistered securities to private investors, including hedge funds.  The public company commits to investors that, within a short time following their investment, it will file a registration statement and register the shares that were sold in the PIPE with the SEC.  Absent effective SEC registration, investors’ public resales of shares generally must be effected in accordance with Rule 144 under the Securities Act of 1933 ("Securities Act"). When the issuance of restricted shares in a PIPE offering is publicly announced, the price of the PIPE issuer’s publicly traded stock typically declines.  Given this dynamic, PIPE investors often attempt to reduce their risk by selling short the PIPE issuer’s publicly traded securities.  To cover their short positions, certain investors choose to wait until the SEC declares a PIPE resale registration statement effective and then use their previously restricted PIPE shares to close out their short positions. The SEC has taken the position that this strategy violates the federal securities laws.  Specifically, the SEC has advanced two legal theories in response to this conduct.  First, the SEC has claimed that these short sales constitute insider trading violations.  This argument is premised on the view that the public announcement of a PIPE offering will cause a decline in the market price of the issuer’s publicly traded stock, thereby permitting the investor to profit wrongfully from confidential, pre-announcement information about the PIPE offering.  Second, when investors cover their pre-effective date short positions with the actual shares received in the PIPE, the SEC has claimed that investors have engaged in the sale of unregistered securities in violation of Section 5 of the Securities Act.  This contention is based on the view that shares used to cover a short position are deemed to have been sold when the short sale was made (i.e., when they were still unregistered). 1.  The Commission’s Section 5 Theory Sees Defeat–For Now In January 2008, two federal district courts weighed in on the SEC’s legal theories.  Both courts ruled that the SEC’s insider trading theory constituted a plausible legal basis upon which the SEC could continue to litigate its case.  But the SEC’s Section 5 theory met a different fate, with both courts rejecting and dismissing the theory as legally deficient.  In a subsequent action, the SEC advanced only its insider trading theory.  Notwithstanding these adverse rulings and the SEC’s recent decision to press only its insider trading theory, the SEC has indicated that it does not plan to abandon its Section 5 theory. a.  SEC v. Lyon In SEC v. Lyon, the Commission filed an enforcement action in the U.S. District Court for the Southern District of New York against Edwin Buchanan Lyon, a hedge fund manager, and seven hedge funds for short sales involving thirty-five PIPE offerings.  The SEC brought insider trading claims, arguing that the defendants were selling short the securities of certain PIPE issuers prior to the public announcement of the PIPE while using nonpublic information they received when being solicited to invest in the PIPE, notwithstanding their agreement to keep such information confidential or refrain from trading prior to the public announcement of the PIPE.  The SEC also pressed its Section 5 claim, contending that the defendants caused an unregistered distribution of securities when they covered their short sales with shares purchased in the PIPE offerings. In a January 2008 opinion, the court declined to dismiss the SEC’s insider trading claims.  The court first observed that the complaint appeared to be based on the misappropriation theory of insider trading, which states that a person commits securities fraud "when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information."  The court then held that the complaint "alleged facts with the requisite specificity that plausibly support its claim that a confidential relationship arose between defendants and [the] PIPE issuers."  The court reasoned that, by selling short the PIPE issuers’ securities, the defendants may have breached this confidential relationship.  Thus, the court concluded, the SEC had set forth a plausible claim for insider trading. But the court rejected as "logical[ly] implausibl[e]" the SEC’s Section 5 theory that delivering the previously restricted PIPE shares to close a short position transforms the short sale into a sale of the unregistered securities.  This position, the court observed, is "inaccurate and not reflective of what occurs in the market."  The court concluded that "a short sale of a security constitutes a sale of that security" and "[h]ow an investor subsequently chooses to satisfy the corresponding deficit in his trading account does not alter the nature of that sale." b.  SEC v. Berlacher In SEC v. Berlacher, the SEC filed suit in the U.S. District Court for the Eastern District of Pennsylvania against a hedge fund operator, Robert A. Berlacher, and his group of funds, known as the Lancaster Funds.  The allegations in Berlacher materially reflect those in Lyon, and the SEC likewise advanced its insider trading and Section 5 theories.  The court in Berlacher, following Lyon‘s reasoning, similarly allowed the SEC’s insider trading claims to proceed but dismissed its Section 5 claim. c.  SEC v. Ladin In October 2008–following these adverse rulings on the SEC’s Section 5 theory–the Commission filed a settled enforcement action in the U.S. District Court for the District of Columbia, charging Brian D. Ladin, a former analyst for Bonanza Master Fund, a Dallas-based hedge fund, with improper PIPE-related trading.  The allegations are similar to those in Lyon and Berlacher, yet the SEC alleged only that Ladin engaged in unlawful insider trading in connection with a 2004 PIPE offering.  Ladin agreed to settle the matter, and the court entered a final judgment permanently enjoining him from future violations of the federal securities laws, ordering him to pay $10,895 in disgorgement, along with $2,532 in pre-judgment interest thereon, and assessing a $317,000 civil penalty.  Bonanza and its investment adviser consented to the entry of a final judgment ordering them to pay a total of $371,429 in ill-gotten gains. 2.  Comment Including SEC v. Mangan–a 2007 case that fits the mold of Lyon and Berlacher–the SEC’s Section 5 theory has seen defeat in three different federal district courts.  Given this adverse case law, Linda Thomsen recently conceded that the SEC’s Section 5 theory is "not doing well in the courts."  Director Thomsen quickly added, however, that the Commission’s insider trading theories "still work."  Consistent with that assessment, the SEC in Ladin appeared to advance only its insider trading theory.  Recently, however, Gibson Dunn learned through its network of relationships that the SEC does not plan to give up on its Section 5 theory, though the SEC did not specify what it intends to do or when it intends to act.  The SEC could appeal the dismissal of its Section 5 claim once its insider trading claims are resolved in the ongoing Mangan, Lyon, or Berlacher litigation.  The SEC, rather than its staff, could also issue clarification or guidance on this issue.  What is clear, however, is that regulators will continue to scrutinize hedge funds’ trading practices in PIPE offerings, and hedge funds therefore should be particularly attentive to the substantial risks that are presented by the conduct at issue in these cases. 3.  The Hilary L. Shane Matter–Use of a Deferred Prosecution Agreement Although the federal litigation involving the SEC’s insider trading and Section 5 theories received much attention in 2008, a less noticed but significant development occurred in August 2008 when the U.S. Attorney’s Office for the Southern District of New York struck a deferred prosecution deal with Hilary L. Shane, a former hedge fund manager, who had been indicted in 2006 on five counts of insider trading in connection with a PIPE transaction.  This appears to be the first use of a deferred prosecution agreement in the PIPE context.  The criminal case stemmed from a settled SEC civil action against Shane for entering into short sales, both for herself and the hedge fund she managed, while also taking part in a PIPE offering.  Among other things, the SEC claimed that Shane engaged in insider trading by entering into short sales ahead of the issuer’s public announcement of the PIPE transaction after agreeing to keep the information confidential.  In pertinent part, the 2008 deferred prosecution agreement reads: "after a thorough investigation it has been determined that the interest of the United States and your own interest will best be served by deferring prosecution in this District.  Prosecution will be deferred during the term of your good behavior and satisfactory compliance with the terms of this agreement for a period of six months . . . ."  Under the terms of the agreement, Shane must (among other things) refrain from associating with an investment adviser and pay a $50,000 fine.  If Shane complies, the government is expected to dismiss her 2006 indictment on insider trading charges.  Shane, who had pleaded not guilty, had faced up to one hundred years in prison if convicted on all five counts. E.  Portfolio Pumping According to Bruce Karpati, the Hedge Fund Working Group has focused on attempts by hedge fund personnel to "inflat[e] performance during a desperate situation."  In particular, the SEC has brought enforcement actions based on portfolio pumping or "marking the close"–where a hedge fund buys large quantities of thinly traded securities to boost fund asset values at the end of a reporting period.  In 2008, portfolio pumping firmly established itself as a priority on the SEC’s hedge fund enforcement agenda based on the view (articulated by Lori Richards, Director of the SEC’s Office of Compliance Inspections and Examinations) that, "in times of financial strain, people may act in uncharacteristic ways–in order to conceal losses, [or] inflate revenues or profits, to stay in business or just to avoid delivering bad news." 1.  SEC v. Lauer In September 2008, a federal district judge in Florida granted the SEC’s motion for summary judgment against the architect of a massive billion dollar hedge fund fraud involving portfolio pumping.  According to the SEC’s complaint, Michael Lauer lied about the performance and net asset value of three hedge funds that he created.  As alleged in the complaint, Lauer systematically manipulated the month-end closing prices of certain securities held by the funds to overstate the value of their holdings in virtually worthless companies.  For example, in December 2002, at the end of the last trading day of the year, Lauer allegedly placed two orders for Fidelity First stock, which artificially raised the price of the stock to $5.00 a share.  Lauer then valued all of the funds’ Fidelity First stock holdings at $5.00 per share.  Among other things, the summary judgment order found that Lauer manipulated the prices of several securities and materially overstated the hedge funds’ valuations for a number of years.  The court permanently enjoined Lauer from future violations of the federal securities laws but reserved ruling on the SEC’s claim for disgorgement and similar matters.  The Commission is seeking disgorgement and penalties totaling more than $50 million. Earlier, the U.S. Attorney’s Office for the Southern District of Florida indicted Lauer on one count of conspiracy to commit mail, wire, and securities fraud and six counts of wire fraud.  If convicted, Lauer reportedly could face a maximum sentence of twenty years and a $250,000 fine for each count of wire fraud, and five years and a $250,000 fine for the conspiracy count. 2.  The MedCap Matter In October 2008, the SEC charged San Francisco investment adviser MedCap Management & Research ("MMR") and its principal, Charles Frederick Toney, Jr., with reporting misleading results to hedge fund investors by engaging in portfolio pumping.  Toney, through MMR, is the manager of MedCap Partners ("MedCap"), a hedge fund that reportedly suffered dramatic losses throughout 2006.  In an effort to report favorable news to the fund’s investors, Toney–through a separate fund he managed–allegedly placed large orders for a thinly traded stock in which MedCap was heavily invested.  According to the administrative complaint, because the stock represented over a third of MedCap’s holdings, the brief boost in its price inflated the reported value of the MedCap fund from approximately $9 million to $38 million.  Toney allegedly reported to MedCap’s investors that the fund’s performance was improving without disclosing the reason for this bounce.  Without admitting or denying the Commission’s findings, MMR and Toney agreed to cease and desist from violating the federal securities laws.  MMR disgorged $70,633.69 and received a Commission censure.  Toney was also ordered to pay a $100,000 penalty and was barred from associating with any investment adviser, with the right to reapply after one year. 3.  Comment Given the heightened regulatory concern that portfolio managers may engage in portfolio pumping to boost fund performance or enhance their fees, clients are encouraged to review their written policies and procedures that pertain to conflicts of interest.  In particular, those policies that relate to self-dealing conflicts should specifically identify portfolio pumping as a concern and clearly prohibit it.  In addition, clients should ensure that they have systems in place to capture and evaluate trading data that could be construed to constitute portfolio pumping. F.  Valuation/Risk of Investment According to Bruce Karpati, another enforcement priority for the Hedge Fund Working Group is valuation, with a particular focus on how the risk of underlying investments is disclosed to investors.  Mr. Karpati indicated that the "trend" is to look for instances where "hedge fund managers l[ie] about value."  Linda Thomsen and Mr. Karpati recently suggested that the following matters illustrate the kinds of cases that the SEC is looking to bring in this area. 1.  SEC v. Lauer As discussed above, in September 2008, a Florida federal court granted the SEC’s motion for summary judgment against Michael Lauer.  The SEC alleged, among other things, that Lauer lied about the net asset value of three hedge funds that he created and provided unfounded and unrealistic valuation opinions to the auditor of one of the funds.  Lauer’s groundless valuations were allegedly designed to attract new investors to invest and induce actual investors to forgo redemptions and continue investing in the funds–with the objective of generating increased management fees.  The summary judgment order found that Lauer materially overstated the hedge funds’ valuations for a number of years and failed to provide any basis to substantiate or explain his exorbitant valuations.  The order permanently enjoined Lauer from future violations of the federal securities laws.  The SEC’s claim for disgorgement and penalties remains pending, as do criminal charges brought earlier in the year by the U.S. Attorney’s Office for the Southern District of Florida. 2.  In the Matter of Don Warner Reinhard In October 2008, the SEC initiated administrative proceedings against Don Warner Reinhard, the sole owner and president of Magnolia Capital Advisors, a registered investment adviser, charging Reinhard with making false and misleading statements and omissions of material fact to investors in connection with the offer and sale of collateralized mortgage obligations.  According to the SEC’s complaint, Reinhard misrepresented the investment risk associated with the mortgage obligations that he purchased for his clients and for Magnolia Capital Partners, a hedge fund he controlled.  The complaint also alleges that Reinhard provided clients with false quarterly account statements that materially inflated their account valuations.  The action is currently pending. 3.  Comment Not only is valuation an enforcement priority, it is also an examination priority.  Lori Richards has said this is an "important area," and she and Thomas Biolsi recently made clear that SEC examiners will continue to focus on firms’ valuation controls.  Clients should therefore take proactive measures in this area, including (among other things): Ensuring that their valuation policies and procedures are well designed and effective; Confirming that the individuals involved in valuing products have the requisite seniority and expertise; and Verifying that the process used to value products is marked by independence and objectivity. G.  Allocation Bruce Karpati recently stated that "favoritism in allocations" is an enforcement priority of the Hedge Fund Working Group.  With respect to this issue, Mr. Karpati indicated that the SEC is focused on the following questions: "How are investors treated?"  "Are hedge fund principals given an advantage over other hedge fund investors?"  "Is preferred status given?"  Mr. Karpati added that, at bottom, allocation "is a matter of disclosure." 1.  SEC v. Dawson In September 2008, the SEC filed a complaint in the U.S. District Court for the Southern District of New York against James C. Dawson, an investment adviser to a hedge fund, Victoria Investors, and to individual clients.  The Commission’s complaint alleges that Dawson cherry-picked profitable trades for his own account, thereby harming his clients and unjustly enriching himself at their expense.  Dawson allegedly conducted this scheme by purchasing securities throughout the day in a single account and delaying the allocation of the purchases until later in the day, after he saw whether the securities appreciated in value.  According to the complaint, Dawson allocated approximately 400 trades to his personal account, approximately 393 of which were profitable on the first day, for a success rate of approximately ninety-eight percent; in contrast, of the 2,880 trades Dawson allocated to his clients during the same time, only 1,489 were profitable on the first day, for a success rate of approximately fifty-two percent.  Dawson allegedly did not tell Victoria Investors or his individual clients about this allocation process.  The complaint further alleges that Dawson used his hedge fund clients’ assets to pay for personal expenses without the clients’ knowledge.  Among other things, the Commission is seeking disgorgement and an order permanently enjoining Dawson from violations of the federal securities laws. 2.  Comment Although only one allocation case appears to have been brought in 2008, investigations may very well be underway.  Equally important, fund allocation is an examination priority.  Calling this a "focus area," Lori Richards has indicated that "[e]xaminers are looking for cherry-picking and favoritism in allocations to, for example, relatives, high profile clients, clients with performance-fee accounts, or other clients that the adviser may have an incentive to benefit."  Accordingly, hedge fund advisers are encouraged to review their fund allocation policies and procedures to ensure that the full range of potential conflicts is addressed.  Among other things, hedge fund advisers should also confirm that those policies and procedures are designed to ensure–and actually produce–equitable allocation among different funds and managed accounts. H.  Predatory Short Selling and Illegal Short Selling in Connection with Regulation M Recently, Linda Thomsen of the SEC and David Markowitz of the New York Attorney General’s Office stated that "predatory short selling" and "illegal short selling in connection with Regulation M" are top hedge fund enforcement priorities.  In September 2008, the SEC brought two enforcement actions in this area. 1.  In the Matter of Moon Capital Management The SEC initiated administrative proceedings against Moon Capital Management, a registered investment adviser, alleging that it violated Rule 105 of Regulation M when it sold securities short on behalf of one of the hedge funds it advises during the five business days before the pricing of an offering and then covered the short positions with securities purchased in the offering.  According to the SEC, this resulted in $88,100 in illicit profits for the hedge fund.  The Commission censured Moon Capital, required it to cease and desist from committing or causing any violations of Rule 105 of Regulation M, and directed it to disgorge $88,100 (plus pre-judgment interest of $20,971.67) and pay a $30,000 civil penalty. 2.  SEC v. Victoire Finance Capital The SEC brought administrative proceedings against Victoire Finance Capital, alleging that the hedge fund adviser violated Rule 105 of Regulation M on eighteen occasions by selling securities short within five business days before the pricing of the offering and covering the short sale, in whole or in part, with shares purchased in the offering.  The SEC alleged that these violations generated profits of $168,139.50 for Victoire Finance et Gestion, B.V., the offshore hedge fund that Victoire Finance Capital advises.  The Commission censured Victoire Finance Capital, required it to cease and desist from committing or causing any violations of Rule 105 of Regulation M, and directed it to disgorge $168,139.50 (plus pre-judgment interest of $47,491.53) and pay a $85,000 civil penalty. I.  A Shift in Focus–Soft Dollars and Late Trading/Market Timing As the SEC and other regulators grappled with the economic crisis and the enforcement issues flowing from it, previous front-and-center issues affecting money managers became less of a focus.  Two such issues were (1) soft dollar practices and (2) late trading/market timing.  At the November 24, 2008 Practising Law Institute conference on hedge fund enforcement, neither issue was identified by senior regulators or prosecutors as a top priority going forward.  While these issues may have abated somewhat as enforcement priorities, clients should nonetheless remain mindful of them and review their policies and practices to prevent potentially problematic activities. 1.  Soft Dollars Among other things, the term "soft dollars" generally refers to an arrangement by which a discretionary investment manager, including a hedge fund manager, receives brokerage or research services in addition to trade executions from a broker-dealer in exchange for brokerage commissions.  Congress established a conditional safe harbor pursuant to Section 28(e) of the Exchange Act, which, in general, protects money managers from charges of breach of fiduciary duty that might be alleged because the manager paid more than the lowest possible commission on a client transaction in order to receive certain brokerage and research services from the executing broker-dealer.  A number of issues can arise for hedge fund managers who participate in soft dollar arrangements, including whether adequate disclosure has been made to investors, whether the services received are consistent with such disclosures and whether they are expenses of the manager or the funds, and any quid pro quo or conflicts with the manager’s duty of best execution. FINRA–Proceedings Against SMH Capital In January 2008, FINRA announced that it had fined Texas-based SMH Capital $450,000 for inadequate supervisory procedures and systems that allowed improper payments of $325,000 in soft dollars to a hedge fund manager.  In pertinent part, FINRA found that SMH sent two improper soft dollar payments to a hedge fund manager, who had submitted facially suspicious invoices requesting one check for $75,000 to an individual for "consulting services" and a second check for just under $250,000 to the manager for "research expense reimbursement"–all without any additional detail or documentary support.  In addition to the fine, FINRA ordered SMH to retain an independent consultant to review the firm’s policies and procedures with regard to its hedge fund operations. 2.  Late Trading/Market Timing In previous years, the SEC focused much of its enforcement attention on late trading and market timing by and on behalf of hedge funds.  But in 2008, these issues appeared to fade somewhat, particularly as the year progressed and the economic crisis deepened. a.  SEC v. Chronos Asset Management In January 2008, the SEC issued an order instituting administrative and cease-and-desist proceedings against hedge fund adviser Chronos and its principal Mitchell L. Dong, finding that they engaged in a fraudulent market timing and late trading scheme.  The SEC found that they used deceptive means to continue market timing in mutual funds that had previously attempted to detect and restrict Chronos’s trading.  The SEC also found that Chronos late traded through two broker-dealers, which routinely allowed Chronos to communicate orders to purchase and sell mutual fund shares after mutual fund companies calculated their daily net asset value.  Chronos’s late trading arrangements thus allowed the traders to purchase or sell mutual fund shares at prices set as of the market close with the benefit of after-market information, thereby giving Chronos a competitive advantage.  The SEC’s order, among other things, censured Chronos, suspended Dong from associating with an investment adviser or investment company for twelve months, and directed Chronos and Dong to pay disgorgement in the amount of $303,000, plus $73,915.80 in pre-judgment interest, and a civil money penalty in the amount of $1,800,000. b.  In the Matter of Ritchie Capital Management Following on an investigation by New York Attorney General Andrew Cuomo, the SEC initiated administrative proceedings against a hedge fund, Ritchie Multi-Strategy Global Trading, its investment adviser, Ritchie Capital Management, and the firm’s founder and two employees.  In its February 2008 order settling the proceedings, the SEC found that Ritchie Capital engaged in an illegal late trading scheme in which it placed thousands of trades in mutual fund shares after the markets had closed, allowing it to trade in mutual funds at pre-close prices based on post-close information.  The Commission ordered the hedge fund and adviser firm to pay approximately $40 million in disgorgement, interest, and penalties.  In a related action, the SEC settled administrative proceedings against Michael Mauriello, the Ritchie Capital employee who was primarily responsible for placing late trades on behalf of the hedge fund adviser. c.  SEC v. Pentagon Capital Management In April 2008, the SEC filed a civil action in the U.S. District Court for the Southern District of New York against a U.K.-based hedge fund adviser, Pentagon Capital Management ("PCM"), and its chief executive officer, Lewis Chester, for allegedly defrauding U.S. mutual funds through late trading and deceptive market timing.  As alleged in the SEC’s complaint, PCM and Chester routinely engaged in late trading of U.S. mutual funds.  PCM allegedly placed orders to buy, redeem, or exchange mutual fund shares after the market close while still receiving the current day’s mutual fund price, thereby generating unlawful profits–at the expense of other shareholders in the U.S. mutual funds–from after-market events that were not reflected in the price that was paid for the mutual fund shares.  In addition, PCM and Chester also allegedly used deceptive techniques to market time U.S. mutual funds.  For example, PCM allegedly used multiple accounts so that, when a U.S. mutual fund detected market timing and attempted to stop it, PCM would simply transfer funds to a different brokerage account of which the U.S. mutual fund was unaware, and market timing the same mutual fund would then resume.  This matter is currently pending. d.  SEC v. Headstart Advisers; SEC v. Gabelli and Alpert In April 2008, the SEC brought a civil action in the U.S. District Court for the Southern District of New York against a U.K.-based hedge fund adviser, Headstart Advisers, and its "Chief Investment Adviser," Najy Nasser, for allegedly defrauding U.S. mutual funds through late trading and deceptive market timing.  The allegations are strikingly similar to those in SEC v. Pentagon Capital Management, above.  This matter is currently pending. In a related action, the SEC sued Marc J. Gabelli, the former portfolio manager of the Gabelli Global Growth Fund ("GGGF"), currently known as GAMCO Global Growth Fund, and Bruce Alpert, chief operating officer of GGGF’s adviser, Gabelli Funds, in connection with an undisclosed market timing arrangement with Headstart Advisers.  The SEC’s complaint alleges that Gabelli authorized Headstart to place market timing trades in GGGF in exchange for a "sticky asset" investment in a hedge fund that he also managed.  This action is currently pending in the U.S. District Court for the Southern District of New York. The Commission simultaneously instituted and settled administrative and cease-and-desist proceedings against Gabelli Funds, a registered investment adviser.  Gabelli Funds was censured, ordered to cease and desist its securities law violations, and ordered to pay $9.7 million in disgorgement, $1.3 million in pre-judgment interest, and a penalty of $5 million, for a total payment of $16 million.  Gabelli Funds’ payment will be distributed to shareholders harmed by the market timing activity during the relevant period. e.  SEC v. Gann In 2005, the SEC filed a civil action against Scott B. Gann, a former vice president and stockbroker with Southwest Securities, in the U.S. District Court for the Northern District of Texas.  The complaint alleged that Gann took part in a scheme to defraud hundreds of mutual funds and their shareholders by engaging in deceptive market timing practices on behalf of a hedge fund client, for whom he opened multiple accounts and used multiple registered representative numbers to place trades.  Following a recent three-day trial, the court concluded that Gann’s actions were "intentionally geared toward evading detection by the mutual fund managers" and constituted "material misrepresentations made in the course of buying securities."  In April 2008, the court permanently enjoined Gann from future violations of the securities laws and ordered him to pay disgorgement and pre-judgment interest of $70,209.35, plus a $50,000 civil penalty.  The SEC subsequently issued an order instituting administrative proceedings, resulting in a September 2008 order barring Gann from associating with any broker, dealer, or investment adviser. f.  United States v. Beacon Rock Capital and Gerbasio In May 2008–in connection with the first U.S. criminal case brought against a hedge fund for deceptive market timing–the U.S. District Court for the Eastern District of Pennsylvania sentenced Beacon Rock Capital, a hedge fund located in Oregon, to three years of probation, and entered an order requiring the hedge fund to forfeit $475,905 and pay a fine of $600,000.  In addition, Thomas J. Gerbasio, a former registered representative, was sentenced to one year and one day in prison and two years of supervised release, and was ordered to pay a fine of $7,500.  According to the information, Gerbasio provided brokerage services to Beacon Rock in order to assist it in evading and circumventing controls implemented by mutual funds seeking to restrict market timing trading.  Gerbasio allegedly engaged in a number of deceptive and fraudulent practices designed to conceal the identity of Beacon Rock and the nature of its trading activity, resulting in more than 26,000 Beacon Rock market timing trades.  Both Beacon Rock and Gerbasio pleaded guilty to securities fraud. g.  United States and SEC v. Ficken In September 2008, Justin F. Ficken of Massachusetts pleaded guilty to one count of conspiracy, three counts of wire fraud, and two counts of securities fraud in a market timing case brought by the U.S. Attorney’s Office in Boston.  The indictment charged that Ficken and others at Prudential Securities disguised their own and their hedge fund customers’ identities to execute market timing trades that mutual funds were trying to prohibit.  The SEC earlier filed a civil injunctive action against Ficken and others based on similar conduct.  As alleged in the SEC’s complaint, Ficken was part of a three-person group of registered representatives, known as the Druffner Group, that defrauded mutual fund companies and the funds’ shareholders by placing thousands of market timing trades worth more than $1 billion for five hedge fund customers.  In September 2007, the U.S. District Court for the District of Massachusetts entered a final judgment against Ficken after granting the Commission’s motion for summary judgment (which was recently upheld on appeal).  The final judgment enjoined Ficken from future violations of the federal securities laws and ordered him to pay $589,854 in disgorgement and pre-judgment interest. Also, in February 2008, an administrative law judge issued an initial decision barring Ficken from associating with any broker, dealer, or investment adviser.  Ficken has appealed that decision to the Commission, and that appeal is pending. J.  Conclusion At this time, the hedge fund enforcement landscape appears relatively clear.  Regulators and prosecutors have been transparent in identifying their priorities.  Still, there are questions concerning the specific ways in which regulators will move forward in pursuing them.  For example, will regulators bring rumor mongering cases with facts that are less compelling than those in Berliner–perhaps one where the rumor at issue is general or vague?  Will the SEC reinvigorate its Section 5 PIPE theory?  If so, what specific form will the Commission’s efforts take?  Questions abide.  In navigating these and similar issues, regulators will need to ensure that the specific enforcement positions they take do not unduly chill appropriate and important hedge fund (and other) activities that constitute a key component to the sound and efficient functioning of our securities markets. And while regulators’ enforcement priorities seem clear now, those priorities can change suddenly and dramatically.  Consider the Bernard L. Madoff scandal.  In December 2008, the SEC and the U.S. Attorney’s Office in Manhattan brought concurrent civil and criminal actions against Madoff and his investment firm, charging Madoff with orchestrating a Ponzi scheme through which he defrauded his hedge fund clients and other investors out of billions of dollars.  For years, Madoff’s scheme apparently escaped the attention of regulators, including the SEC and FINRA.  The SEC has come under fire for not uncovering the Madoff scandal until his sons went to authorities and told them he had confessed to the fraud.  Indeed, on January 5, 2009, the House Committee on Financial Services held a hearing to examine how a scheme of this magnitude could have gone undetected for so long, whether the SEC has the resources to police the markets effectively, and what new safeguards may be needed to protect investors.  From an enforcement and examination perspective, the fallout from the Madoff scheme and regulators’ failure to detect it will almost certainly cause the Commission to step up and revamp its examination of investment advisers and oversight of those that are unregistered.  Whether, and to what extent, these expected efforts detract from or augment the SEC’s identified enforcement priorities should be a compelling story line in 2009. II.  Regulatory Developments and Compliance Considerations A.  Introduction The significant regulatory developments affecting hedge funds in 2008 were largely actions by the SEC and other authorities in response to the financial markets crisis.  Other developments, such as the best practices developed by the Asset Managers’ Committee ("AMC") of the President’s Working Group on Financial Markets ("PWG") and statements on "group" determinations following the CSX Corporation v. The Children’s Investment Fund Management decision, should also be considered when reviewing compliance programs and procedures.  Summarized below are: The SEC’s rulemakings relating to curbing abusive short selling activities; FINRA’s proposed new Rule 2030 relating to the circulation of rumors, which if adopted in its current form would significantly curtail the flow of information between broker-dealers and their customers; The SEC’s exemptive orders to facilitate the development of central counterparties ("CCPs") for CDS; Potential changes to beneficial ownership and group determinations; Proposed disclosure obligations pursuant to Form ADV relating to, among other things, use of commissions by hedge fund managers who are registered investment advisers; and The AMC’s suggested best practices for hedge funds. B.  Short Sales 1.  Initial SEC Response to the Evolving Financial Crisis From July 15, 2008 through October 15, 2008, the SEC issued an unprecedented six emergency orders pursuant to Section 12(k)(2) of the Exchange Act relating to short selling.  In July, the SEC issued its first order, which banned short selling in the specified securities of nineteen financial firms absent pre-borrowing or arranging to borrow.  See Exchange Act Release No. 58166 (July 15, 2008), available here.  In September, the SEC banned short sales in the publicly traded securities of 799 financial firms, and that number increased to nearly 1000 public companies as the SEC delegated responsibility for determining "financial firms" to the primary listing exchanges.  See Exchange Act Release No. 58592 (Sept. 18, 2008), available here. In addition, the SEC adopted two rules of particular significance to hedge funds: New interim final temporary Rule 10a-3T and Form SH, which requires certain institutional investment managers to report certain information concerning their short sales of and short positions in Exchange Act Section 13(f) securities (other than options).  See Exchange Act Release No. 58785 (Oct. 15, 2008), available here; and Previously proposed Exchange Act Rule 10b-21, which is intended to address abusive "naked" short selling.  See Exchange Act Release No. 58774 (Oct. 14, 2008), available here. The SEC also adopted new interim final temporary Rule 204T of Regulation SHO, which imposes hard close-out requirements for fails to deliver on long and short sale transactions, see Exchange Act Release No. 58773 (Oct. 14, 2008), available here, and an amendment to Rule 203 of Regulation SHO to eliminate the options market maker exception from the close-out requirement for failures to deliver resulting from short sales to hedge options positions established before the underlying securities became threshold securities, see Exchange Act Release No. 58572 (Sept. 17, 2008), available here. 2.  Reporting Requirements: Interim Final Temporary Rule 10a-3T and Form SH Interim final temporary Rule 10a-3T requires certain "institutional investment managers" to report on temporary Form SH certain information concerning their short sales of and short positions in Exchange Act Section 13(f) securities (other than options).  Rule 10a-3T and Form SH were effective from October 18, 2008 and are effective until August 1, 2009, unless extended.  The key elements of the reporting requirements are as follows: a.  Institutional Investment Managers Required to Report An institutional investment manager who exercises investment discretion with respect to accounts holding Section 13(f) securities is required to file Form SH if: (i) at the end of the most recent calendar quarter it was required to file a Form 13F for the quarter (i.e., the manager exercised investment discretion with respect to accounts holding Section 13(f) securities having an aggregate fair market value on the last trading day of any month of the prior calendar year of at least $100,000,000), and (ii) it effected a short sale in a Section 13(f) security (other than options) during a Sunday to Saturday calendar week. b.  Definitions of "Short Sales" and "Short Positions" For purposes of Rule 10a-3T, "short sale" has the same meaning as under Rule 200 of Regulation SHO: "any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller."  A "short position" for purposes of Form SH is the aggregate gross short sales of an issuer’s Section 13(f) securities (other than options), less purchases to close out a short sale in the securities of the same issuer.  Short positions are not net of long positions.  If a manager sells a security that was loaned to another person, and a bona fide recall is initiated within two business days of trade date (T+2), the sale should be treated as "long" for purposes of Form SH.  Options and short sales of options are not reported on Form SH, except that the manager will have Form SH short sales if it: (i) exercises a put option and is net short for purposes of Regulation SHO, or (ii) effects a short sale as a result of assignment to it as a call writer, upon exercise. c.  Public Availability of Information The SEC has stated that it remains sensitive to concerns about additional, imitative short selling and will treat Form SH as nonpublic "to the extent permitted by law."  Filers are not required to submit a Freedom of Information Act confidential treatment request, but should instead label their reports as "non-public" pursuant to the Form SH instructions (i.e., in bold, capitalized letters). d.  Exceptions to the Reporting Requirements An institutional investment manager is not required to report short sales and short positions if: (i) it has not effected any short sales of Section 13(f) securities during the relevant reporting period; or (ii) its short positions or short sales are de minimis.  In the first case, this means that even if an institutional investment manager reported for prior periods, it does not need to file a Form SH for any week in which it effected no short sales even if it has short positions.  In the second case, for purposes of Form SH reporting requirements, de minimis means that (i) during the reporting period, the start of day short position, the gross number of securities sold short during the day, and the end of day short position constitute less than 0.25 percent of the class of the issuer’s Section 13(f) securities issued and outstanding, and (ii) the fair market value of the start of day, the gross number of securities sold short during the day, and the end of day short position is less than $10,000,000.  The analysis is made on a per column and per day basis, and the manager may report "N/A" for any data element where the exception is available.  Managers are no longer able to exclude short positions attributable to short sales effected before September 22, 2008.  e.  Required Information; Formatting Requirements Managers required to file Form SH must report for each 13(f) security and for each calendar day of the reporting period: (i) the gross quantity of shares sold short, (ii) the start of day short position, and (iii) the end of day short position. Certain information must be submitted in XML tagged data format with additional identification within the data file; i.e., the date, the filer’s Central Index Key, the identity and CUSIP number of the issuer, the short position at the start of the day, the number of securities sold short on that day and the short position at the end of the day.  The formatting requirements are intended to facilitate data analysis by the SEC staff.  The report must contain a signature block for the person signing on behalf of the manager and additional information about the report type (see below) and managers covered. f.  Three Form SH Reports Similar to Form 13F, there are three Form SH report types: (i) a Form SH Entries Report, used if all of the information an institutional investment manager is required to report is included in the Form SH filing; (ii) a Form SH Notice, used if all of the information a manager is required to include is reported in another manager’s report; and (iii) a Form SH Combination Report, used if a portion of the manager’s entries is filed in the manager’s report and a portion is reported by another manager.  A manager that files a Form SH Combination must identify the other manager whose reports cover a portion of the filing manager’s entries. g.  Timing Each Form SH is due on the last business day of the calendar week subsequent to a week in which reportable short sales were effected.  h.  Request for Comment Although adopted on a final, albeit interim temporary, basis, Rule 10a-3T and Form SH were published for comments, which were due December 16, 2008.  To date, approximately fifty commenters have submitted their views to the SEC.  Naturally, the comments vary based on the particular perspectives of those commenting on behalf of persons who are deemed "institutional investment managers" and required to report, and those commenting on behalf of issuers, but key themes are: Public Availability of Information.  Not surprisingly, comments on behalf of issuers continue to press for public availability of short sale information, at least on a delayed basis.  On the other hand, those commenting on behalf of broker-dealers and hedge funds have expressed concern that disclosure of short sale and short position information could, among other things, (i) cause competitive harm, including through front-running and short squeezes, to market participants required to disclose their short positions and possibly their trading strategies; (ii) shift trading to less transparent markets; (iii) confuse investors who will have only partial information and no way to distinguish between short selling effected for hedging purposes and short selling related to a negative view on an issuer’s outlook; and (iv) encourage short selling by those who trade by imitating others’ positions. Scope of Covered Securities.  Generally, there has been no push to expand the scope of reporting requirements beyond Section 13(f) securities, despite discussion in the press about extending the rule to require reporting of derivatives. Harmonization of Various Rules.  Several commenters recommended that the SEC attempt to harmonize its new short selling rules with foreign jurisdictions to eliminate the burdens of overlapping and inconsistent disclosure burdens. Frequency of Reporting.  Comment letters from institutional investment managers have argued that weekly reporting is time-consuming, and quarterly reporting would be less burdensome on investors while still providing the SEC with the information it is seeking. 3.  The "Naked" Short Selling Antifraud Rule–Exchange Act Rule 10b-21 Following its proposal in March 2008, see Exchange Act Release No. 57511 (Mar. 17, 2008), available here, the SEC adopted new Rule 10b-21, effective October 17, 2008, to address abusive "naked" short selling.  Naked short selling is deemed to occur when a seller of equity securities deceives its broker about its intention or ability to deliver the relevant securities on or before settlement date and fails to deliver securities on or before settlement date.  Rule 10b-21 provides that sellers who knowingly or recklessly misrepresent to their broker that they own the securities being sold "long" or have obtained a locate for securities sold "short" expose themselves to liability for engaging in a "manipulative or deceptive device or contrivance" in violation of Exchange Act Section 10(b).  Although the SEC emphasized that, prior to the adoption of Rule 10b-21, it had authority under the Exchange Act over short sellers who are not broker-dealers, and that the rule does not impose any additional liability or requirements, the new rule further evidences the SEC’s direct authority.  Rule 10b-21 poses numerous potential risks for investment managers.  For example, a manager’s reckless inaccurate calculations of long and short positions could create liability.  Also, recklessly identifying locate brokers to executing brokers (e.g., by programming an execution management system to populate automatically the locate field with the market participant identifier of a prime broker without taking appropriate steps to obtain the required locate from the broker) could expose an investment manager to liability.  Rule 10b-21 is not violated, however, by a seller’s good faith reliance on a broker’s "easy to borrow" list to satisfy Regulation SHO’s locate requirements.  Finally, the SEC confirmed that a private right of action exists under Section 10(b) and Rule 10b-5, and that if a plaintiff is able to prove the elements of a Rule 10b-21 violation, an actor in violation of Rule 10b-21 may face private litigation in addition to regulatory sanctions.  C.  Controlling and Reporting the Spread of False Rumors 1.  Introduction As described above in Section I.B, "Hedge Fund Enforcement Update–Rumor Mongering," the SEC and Justice Department investigations and examinations of rumor mongering have increased hedge funds’ focus on practices relating to the circulation of false rumors.  The dissemination of a false rumor about a security, particularly when accompanied by trading, can result in liability under Section 17(a) of the Securities Act and Sections 9(a)(4) and 10(b) of the Exchange Act, and Rule 10b-5 promulgated thereunder.  In addition, broker-dealers are subject to self-regulatory organization ("SRO") rules prohibiting the spreading of false and sensational rumors, including National Association of Securities Dealers ("NASD") Rule 6140(e) and NYSE Rule 435(5).  On November 18, 2008, FINRA issued Regulatory Notice 08-68 and requested comment on proposed FINRA Rule 2030, which would replace the NASD and NYSE rules as part of its consolidated rulebook initiative.  Comments on proposed Rule 2030 were due to FINRA by December 18, 2008, and after processing these comments, FINRA will file its proposed rule with the SEC for approval. Although proposed Rule 2030 is an SRO rule and directly applicable only to FINRA’s broker-dealer members and their associated persons, it is significant to hedge funds and other industry participants because, as proposed, it requires FINRA members to "promptly report to FINRA any circumstances which reasonably would lead the member to believe that [a prohibited] rumor might have been originated or circulated."  The key components of the proposed rule are summarized below. 2.  Proposed Rule 2030 a.  Scope Proposed Rule 2030 would prohibit the "originat[ion] or circulat[ion] . . . [of] a rumor concerning any security which the member knows or has reasonable grounds for believing is false or misleading or would improperly influence the market price of such security." (emphasis added).  Accordingly, proposed Rule 2030 can be violated when a party circulates an unfounded rumor even if there is no expectation that the rumor would have market impact.  b.  Securities Covered Proposed Rule 2030 would apply to all securities, not just securities reported to the Consolidated Tape. c.  No Safe Harbor for Information Published by Widely Circulated Public Media FINRA does not propose to include the safe harbor in NYSE Rule 435(5) for unsubstantiated information published by a widely circulated public media even when its source and unsubstantiated nature are disclosed.  Whether a media report is considered a rumor under the proposed rule would depend on the degree to which a member may regard the report as substantiated or as likely to be substantiated; however, this uncertainty is of concern to market participants. Not surprisingly, this proposed change from the existing NYSE rule has drawn considerable criticism.  For example, it would seem to eliminate the possibility of a broker being able to point to an article in a mass media publication as a possible explanation for a stock’s price movement or spike in trading volume, even if the broker were to disclaim any knowledge as to the accuracy of the article.  At least informally, FINRA has acknowledged the unintended consequences of not allowing references to information contained in widely circulated public media.  According to William Jannace, managing director in FINRA’s Member Regulation Group, if information is available in the public market through newspapers or other media, FINRA "probably wouldn’t look to circumscribe that and limit communication."  More of Mr. Jannace’s remarks are available here. d.  Reporting Proposed Rule 2030 would require members promptly to report to FINRA any circumstance that might lead the member to believe that a prohibited rumor might have been originated or circulated.  Although many broker-dealers’ procedures currently call for reporting of rumors, the specific requirement in the rule, coupled with the increased regulatory focus, may lead to an increase in the number of rumors reported.  Presumably, in circumstances when FINRA does not have jurisdiction over the persons named by the broker-dealer, the information would be relayed by FINRA to the SEC. 3.  U.K. Financial Services Authority Approach The Markets Division of the FSA recently published a Market Watch report, available here, on its findings of the review of the policies for handling rumors of fifty firms, ranging from small funds to large investment banks.  While the Market Watch report is specifically disclaimed from being FSA guidance, it does reflect the Markets Division’s views as to good and bad practices for handling rumors and summarizes industry best practices. In contrast to FINRA’s proposal, the Market Division recognized that legitimate business reasons can exist for disseminating a rumor, such as if a client seeks an explanation for the behavior of a security or the market.  Accordingly, the U.K. construct allows broker-dealers to point to news articles, even if unsubstantiated, as a possible explanation for a price change or increased trading volume, provided that (i) the client is also provided, where possible, with the source of the information, (ii) the broker-dealer gives no additional credibility or embellishment to the information, (iii) the broker-dealer makes clear that the information is a rumor, and (iv) the broker-dealer makes clear that the information has not been verified. 4.  Compliance Considerations Among the compliance controls relating to rumors that we have recommended that clients consider, depending on their particular activities and circumstances, are: Reviewing existing compliance policies to make sure they clearly prohibit the initiation and circulation of rumors, and require the inclusion of attribution, if appropriate; Reminding personnel of the firm’s policies; training them on how to handle the receipt of rumors and other potentially problematic information and encouraging them to notify the appropriate managers on receipt of such information.  Bruce Karpati recently commented that personnel should consider phrasing language that potentially could be construed as a rumor as a question (as opposed to a declarative sentence); Encouraging personnel to ask supervisors for assistance in handling rumors; Considering the use of rumor lists for names that are the subject of rumors, and using such lists as a spot check for any suspicious trading in proprietary, customer, or employee accounts in names on the list; Spot checking relevant emails, instant messages, chat rooms, bulletin boards, and other communications for suspicious terms; Reviewing lexicons to determine if additional words or terminology should be included; Reviewing trading surveillance protocols for inclusion of the securities of issuers who are the subject of rumors to catch potentially manipulative trading; Updating compliance policies and supervisory procedures to reflect any changes made; and Making and keeping records of how and when any of these steps are taken. D.  Credit Default Swaps 1.  Introduction On November 14, 2008, the PWG announced "a series of initiatives to strengthen oversight and the infrastructure of the over-the-counter ("OTC") derivatives market."  The press release is available here.A key component of the PWG‘s initiatives is addressing any regulatory impediments to the development of CDS CCPs, which are viewed as beneficial to reducing the systemic risks associated with counterparty credit exposures in the CDS market. One challenge has been that each of the Board of Governors of the Federal Reserve System ("Federal Reserve"), the SEC, and the Commodity Futures Trading Commission ("CFTC") have prescribed regulatory responsibilities with respect to CDS.  Section 3A of the Exchange Act excludes non-security-based and security-based swap agreements from the definition of "security" in Exchange Act Section 3(a)(10).  A "swap agreement" is "any agreement, contract, or transaction between eligible contract participants (as defined in Section 1a(12)(c) of the Commodity Exchange Act . . .) . . . the material terms of which (other than price and quantity) are subject to individual negotiation."  15 U.S.C. § 78c note.  Accordingly, the SEC has regulatory authority over CDS that are "non-excluded" products, e.g., products whose terms are standardized to facilitate exchange trading or central clearing and are not individually negotiated.  To address impediments to the development of clearing agencies for CDS in order to increase transparency and reduce systemic risk, on November 14, 2008, the three regulators entered into a Memorandum of Understanding ("MOU") regarding CDS CCPs. The MOU, which is available here, is intended to facilitate the regulatory approval process for CCPs and to promote more consistent regulatory oversight among the three regulators by establishing a framework for consultation and information sharing on issues related to CDS CCPs.   2.  SEC’s Temporary Conditional Exemptions for LCH.Clearnet Ltd. On December 23, 2008, the SEC issued a press release announcing that it had approved, on a seriatim basis, temporary and conditional exemptions allowing LCH.Clearnet Ltd. ("LCH.Clearnet") to operate as a CCP to clear "Cleared Index CDS" (i.e., CDS that (i) are submitted to LCH.Clearnet; (ii) are offered only to, purchased only by, and sold only to eligible contract participants; and (iii) have a reference index in which eighty percent or more of the index’s weighting consists of certain specified entities or securities).  See the press release here, and the SEC order here.  As a result of these exemptions, LIFFE, the global derivatives business of NYSE Euronext, became the first exchange eligible to offer clearing of CDS contracts.  The SEC stated that it developed the temporary exemptions in "close consultation with the [Federal Reserve, the Federal Bank of New York, the CFTC, and the U.K. FSA]" and it is expected that the exemptions will further PWG‘s Policy Objectives for the OTC Derivatives Market.  The press release is available here. The exemptions, which were granted pursuant to Section 36(a) of the Exchange Act until September 25, 2009, consist of: A temporary, conditional exemption from the requirement that LCH.Clearnet register as a clearing agency under Exchange Act Section 17A solely to perform the functions of a clearing agency for Cleared Index CDS.  Among other things, LCH.Clearnet is required to (i) post on its Web site and provide to the SEC annual audited financial statements, (ii) comply with certain recordkeeping requirements for five years, (iii) supply information about its Cleared Index CDS clearance and settlement services to the SEC, (iv) provide access to the SEC to conduct on-site inspections of its facilities, records, and personnel, subject to coordination with the FSA; (v) provide monthly notice to the SEC of material disciplinary actions, including any denials of services, relating to its Cleared Index CDS clearance and settlement services, (vi) provide the SEC with notice of all changes to its default rules, (vii) provide the SEC with reports relating to its automated systems used in connection with Cleared Index CDS clearance and settlement services, (viii) provide notice to the SEC regarding any suspension of services or inability to operate its facilities for clearance and settlement of Cleared Index CDS; and (ix) make available to the public, on terms that are fair, reasonable, and not discriminatory, all end of day settlement prices and other prices relating to Cleared Index CDS that are established to calculate mark-to-market margin requirements and other pricing or valuation information; Broad temporary exemptions from the Exchange Actto encourage market participants to use CCPs to clear CDS transactions, provided that they do not receive or hold funds or securities for the purpose of purchasing, selling, clearing, settling, or holding Cleared Index CDS positions.  Generally, this temporary exemption essentially treats Cleared Index CDS as OTC (i.e., excluded) CDS.  This exemption does not extend to the antifraud rules, or Sections 5, 6, 12, 13, 14, 15(d), or 16 of the Exchange Act; A temporary exemption from broker-dealer registration requirements for certain clearing and non-clearing members of LIFFE Administration and Management ("LIFFE A&M") and LCH.Clearnet without regard to whether they receive or hold funds or securities for the purpose of purchasing, selling, clearing, settling, or holding Cleared Index CDS.  Among other things, eligibility for this exemption depends on the LIFFE A&M member complying with the rules of LIFFE A&M and LCH.Clearnet.  Notwithstanding the application of "mutual recognition" in this context, the SEC’s proposal to amend Exchange Act Rule 15a-6, which exempts certain foreign broker-dealers from SEC registration is still pending with the SEC.  See Exchange Act Release No. 58047 (Jun. 27, 2008), available here; A temporary exemption for registered broker-dealers from Exchange Act provisions and rules and regulations thereunder that do not apply to security-based swap agreements.  In particular, this means that a broker-dealer will not be exempt from the antifraud provisions of the Exchange Act of Sections 5, 6, 12(a) and (g), 13, 14, 15(b)(4), 15(b)(6), 15(d), 16, and 17A.  In addition, the SEC noted that exemptions are not being granted from Exchange Act provisions relating to margin and unlawful extensions of credit, books and records requirements, net capital requirements, the customer protection rule, or quarterly security count requirements; and Separate exemptions from the exchange registration requirements of Sections 5 and 6 of the Exchange Act for exchanges that effect or report transactions in non-excluded CDS and are not otherwise subject to these provisions, and for any broker or dealer that effects or reports transactions in non-excluded CDS on such an exempt exchange.  See Exchange Act Release No. 59165 (Dec. 21, 2008), available here. During the temporary exemptions, i.e., until September 25, 2009, the SEC is seeking public comment on what action it should take with respect to the CDS market in the future, including, among other things, whether the exemptions should be extended or allowed to expire, and whether registration with the SEC as a clearing agency should be required. 3.  SEC Approval Pending for Other CCP Initiatives Two other proposals to operate CDS CCPs have cleared regulatory approvals, but are awaiting SEC approval.  CMDX, a joint venture company of the CME Group and Citadel Investment Group, has completed regulatory reviews by the CFTC and Federal Reserve Bank of New York; however, SEC review and approval is still pending.  The CFTC’s press release is available here.  In addition, the New York State Banking Board has approved an initiative by the IntercontinentalExchange, Inc. ("ICE") and The Clearing Corporation, together with nine global investment banks, to create a New York-charted trust company, ICE US Trust LLC, to serve as a central clearing facility for CDS.  The press release is available here.  Federal approval for ICE to operate a CCP is still pending with the Federal Reserve as well as the SEC. 4.  Open Issues The January 8, 2009 report to Congress by the U.S. General Accountability Office ("GAO") on Financial Regulation: A Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory System ("GAO Report on Financial Regulation"), available here, includes recommendations that gaps in federal oversight of CDS and other complex financial products be closed, but does not reference the recent combined regulatory efforts to foster the development of CCPs.  Other issues still to be addressed are: the extent to which cross margining will be permitted, if at all; the development of risk management protocols regarding market participants‘ positions, exposures, and collateral requirements and needs; a CCP guaranty fund; additional recordkeeping requirements, including transaction reporting requirements to facilitate creation of audit trails; and information sharing protocols among the Federal Reserve, SEC, and CFTC concerning CCPs‘ financial condition, risk management systems, internal controls, liquidity and financial resources, operations, and governance as well as results and reports of examinations of CCPs. E.  Determination of "Group" Under Section 13(D) of The Exchange Act On June 11, 2008, Judge Lewis A. Kaplan of the U.S. District Court for the Southern District of New York issued a decision in CSX Corporation v. The Children‘s Investment Fund Management (UK) L.L.P. et al., available here, holding that The Children’s Investment Fund ("TCI") and 3G Capital Partners ("3G"), two large hedge funds, violated Section 13(d) of the Exchange Act.  Specifically, Judge Kaplan’s decision stated that TCI should be deemed to beneficially own the shares referenced in its cash-settled equity total return swaps pursuant to the anti-avoidance provisions of Rule 13d-3(b) under the Exchange Act.  Accordingly, TCI violated Section 13(d) by not filing a Schedule 13D within ten days of acquiring beneficial ownership of more than five percent of CSX shares.  Further, TCI and 3G were found to have formed a group and to have violated Section 13(d) by not making the required filing within ten days of forming the group.  Although TCI and 3G were found to have violated Section 13(d), the Court did not enjoin them from voting their shares at the 2008 annual shareholders’ meeting, leaving the question of penalties to the SEC or Department of Justice.  On September 15, 2008, the Second Circuit issued a summary order, available here, affirming Judge Kaplan’s ruling not to enjoin TCI from voting its shares, and CSX subsequently agreed to seat all four of TCI’s slate of nominees to the CSX board.  Although the Second Circuit has stated that it will issue an opinion (in addition to the summary order), the expectation is that any guidance or requirement to reflect the reference securities related to equity derivatives will need to come from the SEC.  To date, the SEC’s statements have been limited to a June 4, 2008 amicus letter to the district court signed by Brian Breheny, Deputy Director of the SEC’s Division of Corporation Finance.  In his letter, Mr. Breheny wrote that "a person who entered into a swap would be a beneficial owner under Rule 13d-3(b) if it were determined that the person did so with the intent to create the false appearance of non-ownership of a security."  The letter is available here. Beyond this letter, the SEC has indicated that it plans to address the issues raised by the case in 2009.  In the meantime, the compliance focus in this area should remain on external communications to avoid at least the inadvertent formation of a group.  Judge Kaplan’s statements are a reminder that incriminating communications coupled with parallel behavior, such as directional trading or activist shareholder activities, can create the risk that a shareholder will be deemed to have formed a group with other shareholders. F.  Disclosure–Amendments to Form ADV 1.  Introduction On March 3, 2008, the SEC re-proposed amendments (the "Proposed Amendments") to Part 2 of Form ADV and its related rules under the Investment Advisers Act of 1940.  See SEC Release No. IA-2711, available here.  The proposed amendments are intended to improve the quality of information that registered investment advisers provide their clients about business practices, conflicts of interest, and the background of the adviser and its personnel. Currently, Part 2 of Form ADV is a "check-the-box" and "fill-in-the-blank" form that is not required to be filed with the SEC.  The Proposed Amendments would replace this form with Part 2B, a narrative disclosure written in plain English in a prospectus-like brochure that would be filed electronically with the SEC’s Investment Adviser Registration Depository and, therefore, publicly available.  Proposed Part 2A, the firm brochure, contains nineteen items of disclosure about the adviser firm and its senior management.  Part 2A would be augmented by proposed Part 2B, the brochure supplement, which contains six items of disclosure about the firm’s advisory personnel.  Part 2B would not need to be filed with the SEC, but copies, including any amendments, would need to be preserved in accordance with applicable recordkeeping requirements. 2.  Summary of the Proposed Amendments a.  Part 2A: Brochure As proposed, Part 2A will require disclosure about the adviser’s services, fees, compensation, disciplinary history, and related conflicts of interest.  An adviser would need to respond only to the items applicable to its business.  In addition to an increased emphasis on how advisers address conflicts of interest that arise during the course of business, below are some of the major disclosure items that generally would affect registered hedge fund managers: Types of services the adviser provides, including specialized services, as well as the methods of analysis, investment strategies, and general and/or specialized areas of risks in its investment approach; Total amount of client assets that the adviser manages; Adviser compensation for services, including brokerage commissions and custody fees, client referral compensation, or any other compensation attributable to the sale of a security or investment product and the circumstances in which the adviser charges performance fees and manages accounts side-by-side; Selection of brokers and determination of reasonableness of commissions and other fees; Soft dollar arrangements, including products and services received, and related conflicts of interest; All legal or disciplinary events that are material to a client’s assessment of the integrity of the adviser or its management; Information about conflicts of interest associated with the use of affiliated portfolio managers; and A summary of any material changes since the last brochure update. b.  Part 2B: Brochure Supplement While Part 2A pertains to the investment adviser and its senior management, Part 2B is intended to provide an adviser’s clients with information about the advisory personnel responsible for servicing their particular accounts.  Neither Part 2, nor Part 2B, would be required to be delivered to certain clients receiving only impersonal investment advice.  In addition, investment advisers would not be required to provide Part 2B to clients who are qualified purchasers or certain "qualified clients" who also are officers, directors, employees or other persons related to the manager. If an adviser is required to deliver Part 2B, it is proposed that each advisory client would be required to receive a supplement for each "supervised person" employed by the adviser who either (i) has direct contact with and formulates investment advice for such client, or (ii) has discretionary authority over such client’s investment needs.  A "supervised person" is defined as any officer, partner, director, employee, or other person who provides investment advice on the adviser’s behalf and is subject to the control of the adviser.  The supplement for each supervised person contains information regarding: His or her education and business experience for the last five years;  Legal or disciplinary events material to a client’s evaluation of such person’s integrity;  Other investment-related business activities (non-investment-related activities included only if such activities constitute a "substantial" portion of income or time);  Any arrangement under which someone other than the client compensates the supervised person for providing advisory services; and  An explanation of how the person is supervised at the firm and the supervisor’s contact information. c.  Delivery An adviser would be required to deliver a copy of Part 2A to relevant clients before or at the time it enters into an advisory agreement with them, and annually thereafter within 120 days of the end of its fiscal year.  The annual delivery would also include a summary of any material changes since the last brochure–either on the brochure cover or via a separate communication accompanying the brochure.  Interim brochures would be delivered only if a material change or disciplinary event occurs.  Part 2B would need to be delivered to relevant clients before or at the time the applicable supervised person begins to provide advisory services to the client and would need to be updated only if a material change occurs.  All deliveries may be made electronically by complying with the SEC’s 1996 interpretative guidance on electronic deliveries, available at here.  d.  Compliance If the Proposed Amendments are adopted, beginning six months after their effective date, registered advisers will need to be in compliance by the date of their next annual Form ADV. 3.  Most Frequently Raised Comments Sixty-nine comment letters were filed with the SEC regarding the proposed amendments by the close of the comment period on May 16, 2008.  Below are the issues that were most frequently raised: Delivery.  A number of larger advisers expressed concern over the annual delivery requirement due to the increased costs and labor that would be required, and instead proposed an "access equals delivery" model to meet the requirement.  Under such a model, the adviser would (i) post the brochure on the SEC website and its own website, (ii) provide notification of the postings, and (iii) offer to deliver a paper copy of the brochure at a client’s request. Supplements.  The proposed addition of Part 2B has been met with a fair amount of opposition.  Some commenters asserted that the operational and cost burdens of producing the supplements outweigh their additive value because such information is available from FINRA’s free online system, BrokerCheck.  Soft Dollars.  Some commenters expressed concern over the disclosure of broker selection based on soft dollar benefits and argued that consideration of such benefits does not necessarily conflict with an adviser’s fiduciary duty to obtain best execution of client transactions.  These commenters requested guidance on how execution should be evaluated in this context. Definition of "Material Change."  Because an interim brochure and separate summary are required if any "material change" occurs, several commenters requested that the SEC provide a definition of "material change" for uniform disclosure among advisers.  Definition of "Substantial."  Commenters requested that the SEC provide a definition for "substantial" in connection with the requirement that a supervised person’s outside business activities be disclosed if such activities constitute a "substantial" portion of income or time.  The comment period ended on May 16, 2008, and the SEC has taken no further action with respect to the amendments.  In an October 28, 2008 letter to the Investment Adviser Association, SEC Chairman Christopher Cox stated that, tentatively, the SEC would consider the final amendments in early December 2008, but he appears to have left this issue to the next Commission. G.  Hedge Fund Best Practices In response to the growth of hedge funds, and the increased calls for hedge funds to demonstrate appropriate controls in managing their activities, the PWG formed a private sector committee, the AMC, to develop best practices for the hedge fund industry based on the PWG’s earlier "Agreement among PWG and U.S. Agency Principals on Principles and Guidelines regarding Private Pools of Capital."  The AMC released its best practices (the "Report") in April 2008.  The Report is available here. The proposed best practices favor increased voluntary action by hedge fund managers rather than greater mandatory regulation.  Of course, considering the complexity of the industry, there is no "one size fits all" solution to best practices, risk management, and compliance processes and controls.  The overarching principle of the Report, however, is the hope that promotion of industry standards will assist in reducing systemic risk and promote investor protection.  To foster this expectation, the AMC contemplates that managers explain to investors how they have implemented the best practices, and if they have not, why not. The Report calls on hedge funds to adopt comprehensive best practices in all aspects of their business and specifically identifies and addresses five key areas: (i) disclosure, (ii) valuation, (iii) risk management, (iv) trading and business operations, and (v) compliance, conflicts, and business practices–each of which is discussed below. 1.  Disclosure The authors of the Report believe strong disclosure practices will provide investors with the information needed to determine whether to invest in a fund, better monitor an investment,  or redeem an investment.  The framework for disclosing information should include: Deciding when and what information will be provided to investors; Guidelines for disclosure regarding potential conflicts of interest; Guidelines relating to disclosure of information to counterparties; and Guidelines for the qualifications of investors in the fund (to assist the fund in complying with safe harbors). Effective disclosure of information to investors can occur in various forms, including (i) a private placement memorandum that can be updated upon material changes or upon new investments, (ii) quarterly annual audited, GAAP-compliant financial statements, and/or (iii) regular investor letters and risk reports.  The Report outlines what should be included in each document.  For example, an offering memorandum would include descriptions of the fund’s investment philosophy, strategies, products, and risks, while GAAP financial statements would contain estimates of the fund’s performance. Hedge funds and managers are also encouraged to (i) disclose, to the extent possible, information regarding parallel managed accounts and side letters, (ii) outline their valuation policies (including any non-GAAP measures), and (iii) provide periodic performance information on the value of fund assets and profits at least quarterly.  The Report further recommends that managers address the disclosures that will be made to counterparties, such as banks and broker-dealers.  Reflecting concerns about the collapse of prime brokers such as Bear Stearns & Co. Inc. and Lehman Brothers Inc., the AMC noted that stable relationships between hedge funds and counterparties will be enhanced if they agree at the outset on what information will be provided to each other. 2.  Valuation The AMC recommends that funds maintain documented and consistent valuations of all investment positions while also minimizing potential conflicts that may arise in the valuation process.  Where relevant, a framework for valuation might include: A governance mechanism, such as a valuation committee, that has the ultimate responsibility for establishing compliance with any valuation policy and for providing consistent oversight; The development by the manager of well-documented valuation policies, together with guidelines to evaluate exceptions and to test and review compliance; and Sufficiently knowledgeable and independent personnel who are separate from and do not report to the trading or portfolio management personnel and who are responsible for the valuation of the fund’s investment positions and for implementing the policies. The valuation committee, in addition to establishing compliance, should be tasked with approving the manager’s policies for classification of the fund’s assets (as described below), reviewing the fairness of valuation policies and their consistent application, selecting and supervising third-party service providers who are involved in the valuation process, reviewing any material exceptions made to the policies, and approving final valuations.  The AMC further recommended that assets be classified according to Statement of Financial Accounting Standards No. 157 (categorized as Level 1, 2, and 3 investments), and that the percentage of assets in each level, along with the percentage of realized and unrealized profit and loss derived from assets in Levels 2 and 3, be disclosed to investors at least quarterly. The Report notes that, in addition to providing for the valuation of assets, valuation policies should address conflicts of interest (such as those that can arise when a manager receives an incentive fee or performance allocation).  Where appropriate and practical, the AMC recommended the establishment of a system of segregated responsibilities of personnel and the appropriate use of advisers.  This can be particularly important in situations where the potential conflict may be more pronounced, such as when pricing information is available only from brokers dealing in certain OTC derivatives.  While third-party service providers can be useful in eliminating valuation conflicts, the Report noted that managers should remain involved and not take "undue comfort" from an administrator’s independence. Finally, the Report outlines suggested procedures for using "side pockets" to segregate illiquid or other difficult to value investments, including determining whether to move an asset in or out of a side pocket, and setting fees and investment restrictions. 3.  Risk Management The AMC recommends that funds establish and carry out a comprehensive risk management framework that emphasizes the measuring, monitoring, and managing of risk.  The framework set out in the Report includes the following elements: Identification of portfolio risk by a member of senior management, such as a chief risk officer (including liquidity risk, leverage, market risk, counterparty credit risk, and operational risk); Measurement of the principal categories of risk; Adoption of policies that establish monitoring and measurement criteria; Maintenance of a regular process of risk monitoring appropriate for the fund, including risks that are not quantifiable; and Retention of knowledgeable personnel to measure and monitor risk (with very limited outsourcing). Specific recommendations include: (i) preparing risk reports describing the portfolio’s exposures and distributing those reports to the senior management responsible for the portfolio, and (ii) appointing a member of senior management or establishing a risk committee to supervise risk analysis (including when risk measurement is outsourced) and to take responsibility for the creation of policies covering risk management. The Report also emphasizes stress-testing of portfolios for market and liquidity risk.  In addition, because the failure of a counterparty could have serious implications for a fund’s liquidity and success, the AMC recommends that managers assess the creditworthiness of counterparties and consider taking steps to increase access to liquidity in the event of market stress, along with fully understanding the complex legal relationships at issue with counterparties.  Managers are also encouraged to disclose material risk information to investors quarterly (taking into account confidentiality obligations), including qualitative and quantitative analyses. 4.  Trading and Business Operations To the extent that hedge funds have grown into complex organizations, their operations and infrastructure should mirror such growth.  Suggested best practices for trading and business operations might include, if appropriate: Checks and balances in operations and systems; Sufficient infrastructure, automation, and resources; Policies and procedures that address segregation of duties and reconciliation; Senior management (e.g., a chief operating officer) responsibility for operations, and adequate resources to perform this duty; and Continual assessment of effectiveness of operational and internal controls. The checks and balances policies should address the appropriate management of counterparty relationships; adequate management of cash, margin, and collateral requirements; careful selection of key service providers; adequate infrastructure and operational practices; adequate operation and accounting processes (including appropriate segregation of business operations and portfolio management personnel); and a disaster recovery process. Regular systems reviews, most likely by the chief operating officer, are another suggested tool for assessing operational risks arising from changes.  In the case of counterparties and service providers, managers should review the terms of the agreements with such parties to understand the risks that could affect the parties’ rights and obligations and the service providers and counterparties’ suitability for providing the relevant service. 5.  Compliance, Conflicts, and Business Practices The AMC emphasizes the importance of a continued commitment to the highest standards of integrity and professionalism.  The Report therefore outlines a framework to address conflicts of interest and to promote high standards of conduct.  This framework should include: A written code of ethics containing guidelines that will foster integrity and professionalism; A written compliance manual that addresses the various rules and regulations governing the manager’s operations, potential conflicts of interest, and the maintenance and preservation of adequate records; A process for handling conflicts, such as a formally constituted conflicts committee, particularly for those conflicts that are not anticipated by the manager’s policies; Regular and robust training of personnel regarding the material elements of the compliance program; and A compliance function that includes a chief compliance officer, appropriate discipline, and an annual review of the framework that will account for any legislative or regulatory developments, changes in business practices, and employee conduct. The Report emphasizes that the success of this framework depends upon creating a top down culture of compliance that is grounded in the commitment and active involvement of the senior leaders of the firm and fostered throughout the organization.  The Report also identifies potential conflicts relevant to the hedge fund industry to help managers evaluate where conflicts might arise based on their own structure and operations.  However, because it is possible some conflicts will not be anticipated, the Report recommends that managers establish a conflicts committee to address issues as they arise. H.  Conclusion With a new administration, a Congress focused on financial markets reform, and multiple governmental authorities pursuing a variety of investigations and actions that directly or indirectly affect hedge funds, we expect 2009 to be a busy year.   The GAO Report on Financial Regulation, available here, recommends, among other things, that regulators address problems in financial markets, particularly potential systemic and counterparty credit risks resulting from hedge funds and other "large and sometimes less-regulated market participants." In addition, with the new Congress having convened this week, Senator Charles E. Grassley (R-IA) is expected to introduce a bill modeled after S.1402, the Hedge Fund Registration Act that he introduced in May 2007.  Sen. Grassley’s new bill is expected to require hedge funds to register with the SEC.  The 2007 legislation was referred to the Senate Committee on Banking but was never brought up for consideration.  In particular, Sen. Grassley has expressed concern about the increasingly large investments by public pension funds in hedge funds and has stated that transparency of hedge funds is necessary to protect those investments.  Sen. Grassley’s press release is available here.  In anticipation of the ever increasing likelihood of some form of federal registration or charter, hedge funds may want to begin considering the implications of such action for their business and operations. A further challenge for hedge funds will be dealing with increased compliance and regulatory scrutiny, often with reduced compliance staff.  Addendum–A Compilation of Hedge Fund Enforcement Actions and Developments in 2008 Rumor Mongering/Market Manipulation   SEC v. Paul S. Berliner (May 2008) The SEC filed a civil action against Paul S. Berliner, a Wall Street trader previously associated with the Schottenfeld Group, charging him with securities fraud and market manipulation for intentionally disseminating a false rumor concerning The Blackstone Group’s acquisition of ADS.  The complaint alleged that on November 29, 2007–approximately six months after Blackstone agreed to acquire ADS at $81.75 per share–Berliner disseminated a false rumor, through instant messages to traders at brokerage firms and hedge funds, that ADS’s board of directors was meeting to consider a revised proposal from Blackstone to acquire ADS at $70 per share, a substantially lower price than the agreed-to $81.75 price.  According to the SEC’s complaint, this rumor caused the price of ADS stock to plummet, with Berliner profiting by short selling ADS stock and covering those sales as the stock price fell.  Berliner consented to a judgment enjoining him from future violations of the federal securities laws and ordering him to pay over $26,000 in disgorgement and $130,000 in civil penalties. Insider Trading   SEC v. Mitchel S. Guttenberg et al.; United States v. Jurman et al. (November 2008) In November 2008, Mitchel S. Guttenberg, former executive director of UBS Securities LLC and one of the key participants in what many call the most significant insider trading case in history, was sentenced to seventy-eight months in prison and ordered to forfeit approximately $15.8 million in fraudulent profits.  From 2001 to August 2006, Guttenberg tipped material, nonpublic information to Erik R. Franklin, a hedge fund manager at Bear Stearns, and David M. Tavdy, a trader at Assent LLC and Andover Brokerage LLC, in exchange for a share in the illicit profits that they generated on behalf of their hedge fund clients and brokerage accounts.  The inside information was also used by a number of other individuals to trade for their personal accounts and for other entities.  Both civil and criminal charges have been settled with respect to Franklin, Tavdy, and the other defendants.   SEC v. Brian D. Ladin et al. (October 2008) The SEC filed a civil action against Brian D. Ladin, a former analyst for Dallas-based hedge fund Bonanza Master Fund Ltd., charging him with insider trading in connection with a 2004 PIPE offering conducted by Radyne Comstream, Inc.  The complaint alleged that Ladin, on the basis of material, nonpublic PIPE information, presented an investment in Radyne to Bonanza, resulting in Bonanza establishing a 100,000 share short position in Radyne stock.  According to the complaint, Ladin, in signing the offering’s stock purchase agreement on behalf of Bonanza, represented that Bonanza did not hold a short position in Radyne common stock when he knew, or was reckless in not knowing, that the fund did hold such a position. Ladin consented to an injunction and an order requiring him to pay approximately $331,000 in disgorgement, interest, and penalties.  Bonanza and its investment adviser, Bonanza Capital Ltd., consented to the entry of a final judgment ordering them to pay approximately $370,000 in disgorgement.   FSA–Proceedings Against Steven Harrison (September 2008) The U.K. FSA brought proceedings against Steven Harrison, a senior portfolio manager at the London unit of American hedge fund Moore Europe Capital Management, alleging that he received inside information that a company in which Harrison’s fund held bonds was about to refinance its debt and used the information to direct the purchase of two million of the company’s senior bonds on the eve of the refinance.  The FSA fined Harrison $92,500 and excluded him from employment in the hedge fund market for twelve months.   United States v. Hilary L. Shane (August 2008) In August 2008, the U.S. Attorney’s Office for the Southern District of New York struck a deferred prosecution deal with Hilary L. Shane, a former hedge fund manager, who had been indicted in 2006 on five counts of insider trading in connection with a PIPE transaction.  This appears to be the first use of a deferred prosecution agreement in the PIPE context.   In the Matter of Rubin Chen (July 2008) In July 2008, the SEC issued an order barring Rubin Chen, a former vice president and head of relative value hedge fund strategies at ING Investment Management Services in New York, from associating with any investment adviser.  The order stemmed from actions taken earlier in the month by the federal court in Manhattan, which entered a final judgment by consent against Chen and his wife, Jennifer Xujia Wang, permanently enjoining them from future violations of the federal securities laws and ordering them to pay roughly $885,000 in disgorgement, interest, and penalties.  The SEC’s complaint alleged that they obtained illegal profits of $727,733 by trading on the basis of material, nonpublic information concerning various proposed corporate acquisition transactions.  The complaint further alleged that Wang, in her position as a vice president of Morgan Stanley, was privy to material, nonpublic information concerning each of the pending acquisitions, which she unlawfully disclosed to Chen.  Chen had pleaded guilty to four felony counts, including one count of conspiracy to commit securities fraud, in September 2007.   SEC v. Michael K.C. Tom et al. (May 2008) In May 2008, the SEC announced that the U.S. District Court for the District of Massachusetts entered final judgments by consent against the remaining defendants in an insider trading case arising out of Rhode Island-based Citizens Bank’s May 4, 2004 announcement that it was acquiring Charter One Financial, Inc., a Cleveland-based bank.  The SEC’s complaint alleged that Global Time Capital Management ("GTCM") portfolio manger Michael K.C. Tom, a former Citizens employee who managed the GTC Growth Fund, obtained over $740,000 in illicit profits by purchasing numerous Charter One call options for his personal account and for the hedge fund after receiving material, nonpublic information relating to Citizens acquisition of Charter One from a then-Citizens employee.  Both Tom and GTCM consented to judgments enjoining them from future violations of the federal securities laws.  Tom was ordered to pay disgorgement, interest, and penalties totaling over $800,000, and GTCM was ordered to pay a penalty of nearly $40,000.  The hedge fund was ordered to pay disgorgement and interest of over $210,000 as a relief defendant. Stock Registration Issues in Connection with PIPE Transactions   SEC v. Edwin B. Lyon et al. (January 2008) In December 2006, the SEC filed a civil action against Edwin B. Lyon and the collection of onshore and offshore hedge funds that he managed, alleging that he and his funds obtained over $6.5 million in unlawful profits by using PIPE offerings to cover short sales of the same issuer’s stock, thus causing unregistered shares to be distributed in violation of the registration provisions of Section 5 of the Securities Act.  The SEC also alleges that the defendants committed insider trading by trading ahead of the various companies’ announcements of PIPE offerings and committed securities fraud by attempting to hide their PIPE trading.  In January 2008, the New York district court, echoing the U.S. District Court for the Western District of North Carolina’s decision in SEC v. Mangan, dismissed the SEC’s unregistered distribution claim and its attendant fraud allegations, holding that Lyon did not cause an unregistered distribution of shares simply by covering short sales with shares purchased in the PIPE offerings.  The securities fraud and insider trading charges remain pending in the Southern District of New York.    SEC v. Robert A. Berlacher (January 2008) In late 2007, the SEC filed a civil action against hedge fund adviser Robert A. Berlacher, alleging that he pumped up his hedge funds’ performance–and his own compensation–through illegal trading in at least ten PIPE offerings.  According to the SEC’s complaint, Berlacher and his hedge funds employed a variety of techniques to conceal the funds’ trading in unregistered PIPE shares.  The SEC also alleged that Berlacher violated the Securities Act’s registration provisions by causing an unregistered distribution of shares in connection with the PIPE transactions, but, as in Lyon, the district court dismissed this claim.  The case is currently pending in the Eastern District of Pennsylvania. Portfolio Pumping/"Marking the Close"    In the Matter of MedCap Management & Research LLC and Charles Frederick Toney, Jr. (October 2008) The SEC initiated administrative proceedings against a Delaware investment adviser, MedCap Management & Research LLC, and its principal, Charles Frederick Toney, Jr., alleging that the defendants misled hedge fund investors about the fund’s performance by engaging in portfolio pumping.  According to the SEC’s order of settlement, in an attempt to save MedCap Partners, one of his hedge funds, Toney placed numerous buy orders for an OTC stock through MedCap Partners Offshore, his other hedge fund, pushing the share price for the stock from $0.85 per share to $3.72 per share and thereby quadrupling the value of the shares already held by MedCap.  The brief boost inflated the fund’s reported value by $29 million, masking what would otherwise have been a forty percent quarterly loss.  The defendants consented to an order enjoining them from future violations of the securities laws, barring Toney from associating with an investment adviser for one year, and requiring Toney to pay $100,000 in penalties and MedCap Management to pay roughly $70,000 in disgorgement and interest.   SEC v. Michael Lauer; United States v. Lauer (September 2008) In September 2008, the SEC announced that the U.S. District Court for the Southern District of Florida granted its motion for summary judgment against Michael Lauer, the principal and manager of a group of hedge funds called the Lancer Group.  The summary judgment order found that Lauer materially overstated the hedge funds’ valuations from 1999 to 2002, engaged in portfolio pumping to manipulate the prices of seven securities that were held by the Lancer Group funds, issued false portfolio statements to investors, and falsely represented the funds’ holdings in newsletters in an effort to hide the fraudulent scheme.  The court permanently enjoined Lauer from violating the federal securities laws but reserved ruling on the SEC’s claim for disgorgement and interest.  The Commission is seeking disgorgement and penalties totaling more than $50 million.  In a related criminal proceeding, the U.S. Attorney’s Office for the Southern District of Florida indicted Lauer and four other individuals on charges of conspiracy and mail, wire, and securities fraud in connection with the above-described scheme.  Those charges remain pending. Valuation/Risk of Investment   In the Matter of Don Warner Reinhard (October 2008) The SEC initiated administrative proceedings against Don Warner Reinhard, the sole owner and president of Magnolia Capital Advisors, a registered investment adviser, charging Reinhard with making false and misleading statements and omissions of material fact to investors in connection with the sale of certain mortgage obligations.  According to the SEC’s complaint, Reinhard misrepresented the investment risk associated with mortgage obligations that he purchased for his clients and for Magnolia Capital Partners, a hedge fund that Reinhard controlled.  The SEC’s complaint also alleges that Reinhard provided his clients with false quarterly account statements as part of the fraud.  The action is currently pending.   SEC v. Michael Lauer; United States v. Lauer (September 2008) Please see the summary of these parallel cases under the heading "Portfolio Pumping/"Marking the Close," above.  Allocation/"Cherry Picking"   SEC v. James C. Dawson (September 2008) The SEC filed a civil action against James C. Dawson, the investment adviser to Victoria Investors LP, charging him with "cherry picking" profitable trades for his own account between April 2003 and October 2005.  According to the complaint, Dawson orchestrated the scheme by purchasing securities throughout the day in a single account and then delaying the allocation of the shares until later in the day after he had determined whether the securities appreciated in value.  The complaint alleges that Dawson achieved a first-day success rate of ninety-eight percent on trades for his own account, while he achieved only a fifty-two percent first-day success rate on trades for his clients’ accounts.  The SEC also alleges that Dawson used hedge fund assets to pay for personal expenses.  The case remains pending in the Southern District of New York. Illegal Short Selling in Connection with Regulation M   In the Matter of Moon Capital Management, LP (September 2008) The SEC initiated administrative proceedings against Moon Capital Management, LP, a registered investment adviser, alleging that it violated Rule 105 of Regulation M when it sold securities short on behalf of one of the hedge funds it advises during the five business days before the pricing of an offering and then covered the short positions with securities purchased in the offering.  According to the SEC, this resulted in $88,100 in illicit profits for the hedge fund.  Moon Capital consented to a judgment ordering it to pay over $138,000 in disgorgement, interest, and penalties, and to cease and desist from future violations of Regulation M.   SEC v. Victoire Finance Capital, LLC (September 2008) The SEC brought administrative proceedings against Victoire Finance Capital, LLC, alleging that the hedge fund adviser violated Rule 105 of Regulation M on eighteen occasions by selling securities short within five business days before the pricing of the offering and covering the short sale, in whole or in part, with shares purchased in the offering.  The SEC alleged that these violations generated profits of nearly $170,000 for Victoire Finance et Gestion, B.V., the offshore hedge fund that Victoire Finance Capital advises.  The hedge fund adviser consented to a cease-and-desist order and agreed to disgorge the $170,000 in profits. Soft Dollar Practices   FINRA–Proceedings Against SMH Capital, Inc. (January 2008) FINRA fined SMH Capital, Inc., $450,000 for failing to adopt adequate supervisory procedures and systems designed to address its prime brokerage and soft dollar services to hedge funds.  As a result of this oversight, SMH made improper payments of $325,000 in soft dollars to a hedge fund manager. Late Trading/Market Timing   SEC v. Justin F. Ficken; United States v. Ficken (September 2008) In September 2008, the SEC announced that Justin Ficken, a former representative at Prudential Securities, pleaded guilty to one count of conspiracy, three counts of wire fraud, and two counts of securities fraud in connection with his role in a scheme to place deceptive market timing trades in mutual funds on behalf of some of Prudential’s hedge fund clients.  In the SEC’s earlier civil action arising from the matter, the district court entered an order enjoining Ficken from future violations of the federal securities laws and ordering him to pay nearly $590,000 in disgorgement and interest.  In related administrative proceedings, the SEC secured an order barring Ficken from associating with any broker, dealer, or investment adviser.  Ficken has appealed that decision to the Commission, and that appeal is pending.   United States v. Beacon Rock Capital and Thomas J. Gerbasio (May 2008) Following on an earlier civil action, the SEC announced in May that Thomas J. Gerbasio, a broker-dealer, and Beacon Rock Capital, a hedge fund, were sentenced in the first U.S. criminal case brought against a hedge fund for deceptive market timing.  The information in the case alleged that, from at least August 2002 until October 2003, Gerbasio defrauded hundreds of mutual funds and their shareholders by engaging in deceptive market timing practices through trades on behalf of Beacon Rock.  According to the government’s allegations, Gerbasio structured trades on behalf of Beacon Rock in a number of ways to evade detection by the mutual funds.  Gerbasio was sentenced to one year and one day in prison and ordered to pay a fine of $7,500.  Beacon Rock was sentenced to two years of probation and ordered to forfeit $475,500 and pay a fine of $600,000. Earlier, the SEC obtained a permanent injunction against Gerbasio and disgorgement of $540,000, which was decreased to $100,000 due to his financial condition.   SEC v. Headstart Advisers, Ltd.; SEC v. Marc J. Gabelli and Bruce Alpert; In the Matter of Gabelli Funds, Inc. (April 2008) The SEC filed a civil action against U.K.-based hedge fund adviser Headstart Advisers, Ltd. and its chief investment adviser, Majy N. Nasser, charging the defendants with devising a scheme to defraud U.S. mutual funds and their shareholders through late trading and deceptive market timing on behalf of the adviser’s hedge fund client, Headstart Fund, Ltd.  The SEC’s complaint alleges that the defendants split trades on behalf of the hedge fund across multiple accounts to avoid detection and that the hedge fund obtained approximately $198 million in fraudulent profits through this scheme.  The SEC seeks an injunction, disgorgement of profits, and civil penalties.  The action remains pending in the Southern District of New York.  In a related action, the SEC filed a civil complaint against Marc J. Gabelli, the former portfolio manager of the Gabelli Global Growth Fund, and Bruce Alpert, chief operating officer of the fund’s adviser, Gabelli Funds, LLC, in connection with an undisclosed market timing arrangement with Headstart Advisers.  The complaint alleges that, from September 1999 until August 2002, Gabelli permitted Headstart Advisers to place market timing trades in the Gabelli Global Growth Fund while prohibiting other investment advisers from doing so.  This action also remains pending in the New York court. The SEC settled administrative proceedings against Gabelli Funds, LLC, ordering it to cease and desist from securities violations and to pay approximately $16 million in disgorgement, interest, and penalties.   SEC v. Pentagon Capital Management PLC (April 2008) The SEC filed a civil action against U.K.-based hedge fund adviser Pentagon Capital Management PLC and its chief executive officer, Lewis Chester, alleging that, from June 1999 through September 2003, the defendants routinely engaged in late trading and market timing of U.S. mutual funds on behalf of Pentagon Special Purpose Fund, Ltd., an international business company incorporated in the British Virgin Islands that served as the master fund in a master-feeder fund structure.  According to the complaint, the Pentagon fund obtained approximately $62 million in illicit profits through the scheme.  The SEC seeks an injunction, disgorgement of profits, and monetary penalties.  The action remains pending in the Southern District of New York.   SEC v. Scott B. Gann (April 2008; September 2008) In 2005, the SEC filed a civil action against Scott B. Gann, a former vice president and stockbroker with Southwest Securities, in the U.S. District Court for the Northern District of Texas.  The complaint alleged that Gann took part in a scheme to defraud hundreds of mutual funds and their shareholders by engaging in deceptive market timing practices on behalf of a hedge fund client, for whom he opened multiple accounts and used multiple registered representative numbers to place trades.  In April 2008, following a three-day trial, the court permanently enjoined Gann from future violations of the securities laws and ordered him to pay disgorgement and pre-judgment interest of $70,209.35, plus a $50,000 civil penalty.  The SEC subsequently issued an order instituting administrative proceedings, resulting in a September 2008 order barring Gann from associating with any broker, dealer, or investment adviser.   In the Matter of Chronos Asset Management, Inc. and Mitchell L. Dong (January 2008) The SEC brought settled administrative proceedings against Chronos Asset Management, Inc., a hedge fund adviser, and its principal, Mitchell L. Dong.  The Commission alleged that, from January 2001 to September 2003, the respondents used deceptive means to continue market timing in mutual funds despite earlier attempts by the mutual funds to restrict such trading.  The SEC also alleged that the respondents engaged in late trading from May 2003 to September 2003.  As part of the settlement, the SEC ordered Chronos and Dong to cease and desist from future violations of the federal securities laws and to pay disgorgement and interest of over $375,000 and a civil penalty of $1.8 million.   In the Matter of Ritchie Capital Management LLC, Ritchie Multi-Strategy Global Trading, Ltd., A.R. Thane Ritchie, and Warren Louis Demaio; In the Matter of Michael Mauriello (January 2008; February 2008) Following on an investigation by New York Attorney General Andrew Cuomo, the SEC initiated administrative proceedings against a hedge fund, Ritchie Multi-Strategy Global Trading, Ltd., its investment adviser, Ritchie Capital Management LLC, and the firm’s founder and two employees.  In its order settling the proceedings, the SEC found that, between January 2001 and September 2003, Ritchie Capital engaged in an illegal late trading scheme in which it placed thousands of trades in mutual fund shares after the markets had closed, allowing it to trade in mutual funds at pre-close prices based on post-close information.  The Commission ordered the hedge fund and adviser firm to pay approximately $40 million in disgorgement, interest, and penalties. In a related action, the SEC settled administrative proceedings against Michael Mauriello, the Ritchie Capital employee who was primarily responsible for placing late trades on behalf of the hedge fund adviser. Fraud   SEC v. Bernard L. Madoff; United States v. Madoff (December 2008) On December 11, 2008, the SEC and the U.S. Attorney’s Office for the Southern District of New York brought concurrent civil and criminal actions against Bernard L. Madoff and his investment firm, Bernard L. Madoff Investment Securities LLC ("BMIS"), charging Madoff with orchestrating a Ponzi scheme through which he defrauded his hedge fund clients out of billions of dollars.  According to the charging documents, Madoff admitted to two of his employees that his hedge fund business "was a fraud" and that, for years, he had paid returns to BMIS hedge fund investors out of the principal received from other investors in the funds.  He allegedly estimated the losses from the fraud to approach $50 billion.  In an emergency measure, the U.S. District Court for the Southern District of New York entered an order freezing all of Madoff’s and BMIS’s assets.  The civil and criminal actions remain pending. Following Madoff’s arrest, investors have raised questions and concerns about the role of hedge funds in the scheme.  Investors have alleged that their hedge fund managers handed over billions of dollars to Madoff without giving him much scrutiny, or that fund managers missed red flags that might have put investors on alert that their assets were not safe.  For example, commenters have noted that money managers should have been concerned with Madoff’s outside auditor, which reportedly is not a nationally recognized auditing firm specializing in financial service clients but a relatively unknown three-person shop.  These commenters have further noted that managers should have been troubled by the lack of transparency of BMIS’s operations, including the investment process that produced consistently high positive returns irrespective of market conditions.  Based on these types of allegations, a number of private lawsuits have been filed against hedge funds.  Even the SEC has been sued for allegedly missing red flags in what appears to be the first attempt by an investor to recover investment losses from the Commission.    SEC v. Marc S. Dreier; United States v. Dreier (December 2008) The SEC and Department of Justice filed concurrent civil and criminal actions against Marc S. Dreier, a high profile New York lawyer and founding partner of the Dreier LLP law firm, charging him with defrauding a number of hedge funds and other private investment funds out of nearly $113 million through the sale of bogus promissory notes.  According to the complaints in the actions, Dreier created an elaborate scheme to convince investors that the promissory notes were genuine: he allegedly prepared phony financial statements and audit opinion letters in the name of a reputable accounting firm and recruited others to play the parts of representatives of legitimate companies involved in the transactions, even creating dummy email addresses and telephone numbers.  The SEC has charged Dreier with multiple civil violations of the federal securities laws, and the Justice Department has charged him with securities and wire fraud.  The cases are pending in the Southern District of New York.   SEC v. William H. Eichengreen and David L. Myatt (September 2008) The SEC brought a civil action against William H. Eichengreen and David L. Myatt, charging them with violating the antifraud provisions of the federal securities laws based on their conduct related to a now-defunct hedge fund, Directors Performance Fund, LLC ("DPF").  According to the complaint, Myatt defrauded DPF by convincing the fund’s investment adviser, Directors Financial Group, Ltd. ("DFG"), through a series of false disclosures to invest $25 million in a fraudulent "prime bank" scheme concocted by Myatt and Richard E. Warren, the purported trader who was to handle DPF’s investments in the bank.  The complaint alleges that Eichengreen, DPF’s chief compliance officer, defrauded the fund by falsifying the fund’s financial statements and misrepresenting the fund’s trading strategy and investment performance to investors.  The SEC previously settled charges against DFG and its president, Sharon Vaughn, in connection with this matter.  The civil action against Myatt and Eichengreen remains pending in the Northern District of Illinois. In related criminal proceedings, a jury convicted Warren on eleven counts of wire fraud, and Myatt pleaded guilty to obstruction of justice.  Myatt has been sentenced to sixteen months in prison.   SEC v. Michael Lauer; United States v. Lauer (September 2008) Please see the summary of these parallel cases under the heading "Portfolio Pumping/"Marking the Close," above.    SEC v. Ralph R. Cioffi and Matthew M. Tannin; United States v. Cioffi (June 2008) The SEC charged Ralph R. Cioffi and Matthew M. Tannin, two former Bear Stearns asset management portfolio managers, with fraudulently misleading investors about the financial state of the firm’s two largest hedge funds and about the funds’ exposure to subprime mortgage-backed securities before the collapse of the funds in late 2007.  In a related criminal action, the U.S. Attorney’s Office for the Eastern District of New York indicted Cioffi and Tannin on conspiracy and fraud charges.  Both the civil and criminal actions remain pending in the Eastern District of New York.   SEC v. Plus Money, Inc. and Matthew La Madrid et al. (May 2008) The SEC charged a San Diego-based investment adviser, Plus Money, Inc., and its principal, Matthew La Madrid, with orchestrating a $30 million hedge fund fraud.  The SEC’s complaint alleges that, beginning in 2004, the defendants raised more than $30 million from investors by telling them that they would engage in a covered call options trading strategy; however, the defendants allegedly abandoned the covered call trading strategy in the fall of 2007 and distributed the monies in the fund’s brokerage accounts to La Madrid and the relief defendants through a series of illicit transfers.  The district court has frozen the assets of all defendants.  The action remains pending in the Southern District of California.   SEC v. Peter Krieger, Sheldon Krieger, and John Madey (February 2008) The SEC announced that, on February 6, 2008, the U.S. District Court for the Southern District of Florida entered final judgments against Peter Krieger, Sheldon Krieger, and John Madey in connection with the Commission’s civil action against the defendants.  According to the SEC’s complaint, the Kriegers and Madey raised approximately $7.5 million from approximately forty-five investors for the KFSI Equity Fund, L.P., a Florida-based hedge fund, and then diverted roughly half of the fund’s assets to pay for the operation of the brokerage firm that the defendants controlled.  The complaint also alleged that the defendants concealed their misappropriation of KFSI’s assets by issuing false account statements.  The district court enjoined the defendants from future violations of the federal securities laws and ordered the Kriegers to pay $110,000 each in penalties and Madey to pay over $270,000 in disgorgement and interest. Misrepresentations of Fund Performance or Investment Strategy   SEC v. Lydia Capital, LLC et al. (September 2008) In September 2008, the Massachusetts federal district court entered a consent judgment against Evan K. Andersen, one of the principals of Boston-based hedge fund adviser Lydia Capital, in connection with the SEC’s civil action against Andersen, Lydia Capital, and Glenn Manterfield, a U.K. citizen and resident of Sheffield, England.  According to the SEC’s complaint, the defendants engaged in a scheme to defraud more than sixty investors who invested approximately $34 million in a hedge fund managed by Lydia Capital by making numerous material misrepresentations regarding the fund’s performance.  The SEC previously obtained an order from the Massachusetts court freezing Andersen’s assets and an order from the High Court of Justice in London freezing Manterfield’s assets.  As part of the consent judgment, the district court enjoined Andersen from future violations of the federal securities laws and ordered disgorgement and interest totaling over $2.5 million.  The case against Lydia Capital and Manterfield remains pending.   SEC v. Daniel N. Jones and Azure Bay Management, LLC; United States v. Jones (September 2008) The SEC brought a civil action against an investment adviser, Azure Bay Management, LLC, and one of its investment managers, Daniel N. Jones, alleging that the defendants defrauded their hedge fund client, The Addington Fund, by issuing false account statements and reports to investors for nearly two years in an effort to hide the fund’s poor performance.  According to the SEC’s complaint, Azure Bay continued to take excessive fees of at least $135,000 based on the fund’s "performance."  The Michigan federal court found that the defendants had violated the federal securities laws, issued an injunction, and ordered the defendants to pay nearly $3 million in disgorgement and interest.  In a related criminal action, Jones pleaded guilty to one count of wire fraud and was sentenced to twenty-one months in prison.   SEC v. Northshore Asset Management et al. (July 2008) In July 2008, the U.S. District Court for the Southern District of New York entered a final judgment against Francis J. Saldutti in connection with the Commission’s earlier complaint against Northshore Asset Management, the former investment adviser to a number of hedge funds that became defunct in early 2005.  The SEC alleged, among other things, that Saldutti sold his investment adviser firm to the other Northshore defendants–thereby granting them control over the now-defunct hedge funds–without disclosing to his investors material facts about multiple conflicts of interest raised by the sale of the firm.  Once in control of the hedge funds, Saldutti’s codefendants allegedly diverted millions of dollars from the hedge funds to their personal use.  The court enjoined Saldutti from future violations of the federal securities laws and ordered him to pay over $5 million in disgorgement and interest.   SEC v. James G. Marquez (May 2008) In a civil action, the SEC charged James G. Marquez, the portfolio manager and principal for the now-defunct Bayou Fund, LLC, with concealing from investors and prospective investors the hedge fund’s mounting trading losses by materially misrepresenting the fund’s performance in account statements, promotional materials, and correspondence.  The complaint also alleged that, with Marquez’s knowledge, Bayou Fund created a sham accounting firm to issue annual false audits of the hedge fund.  Marquez consented to an order enjoining him from future violations of the securities laws. In an earlier criminal action, Marquez pleaded guilty to one count of conspiracy.  He was sentenced to fifty-one months in prison and was ordered to pay over $6.2 million in restitution.   SEC v. Alexander James Trabulse et al.; In the Matter of Alexander James Trabuls (April 2008) The SEC charged Alexander James Trabulse, a San Francisco hedge fund manager, with defrauding investors in the fund by dramatically overstating the fund’s profitability and misusing the fund’s assets.  The complaint alleged that Trabulse sent account statements to investors in his Fahey Fund that inflated the fund’s returns by as much as 200 percent and that he used investors’ monies to finance personal purchases and shopping sprees for his family.  Trabulse entered into a consent judgment with the SEC.  The Commission enjoined Trabulse from future violations of the federal securities laws and ordered that he pay $250,001 in disgorgement and penalties.  In a related administrative proceeding, the SEC barred Trabulse from associating with any investment adviser for five years.   SEC v. Thompson Consulting et al. (March 2008) The SEC brought a civil action against a Salt Lake City investment adviser, Thompson Consulting, and three of its principals–Kyle J. Thompson, David C. Condie, and E. Sherman Warner–for making undisclosed subprime and other high risk investments that resulted in near total asset losses for two hedge funds managed by the investment adviser.  According to the complaint, Thompson Consulting deviated significantly from its stated investment policy from March through August 2007, writing options on the stock of a subprime lender and making other high risk investments.  The complaint also alleges that the defendants transferred money from the hedge funds to individual client accounts to make up for losses.  The SEC seeks an injunction, disgorgement of profits, interest, and monetary penalties.  The action remains pending in the District of Utah.   SEC v. Justin M. Paperny; United States v. Paperny (January 2008) The SEC brought a settled enforcement action against Justin M. Paperny, a former UBS broker, in connection with his role in a fraudulent hedge fund offering.  The Commission alleged that Paperny raised $14.1 million from forty-two investors on behalf of a hedge fund by falsely representing that the fund had special access to sought-after initial public offerings and that the fund had previously achieved high annual returns.  Paperny consented to a permanent injunction. The SEC’s action followed on the heels of a related criminal action against Paperny in which he pleaded guilty to one count of conspiracy to commit mail fraud, wire fraud, and securities fraud.  Paperny was sentenced to eighteen months in prison and ordered to pay over $510,000 in restitution.   SEC v. Coadum Advisors, Inc. (January 2008) The SEC obtained a permanent injunction, disgorgement, and civil penalties against three hedge funds, their two principals, and two other associated firms for engaging in a fraudulent scheme by which they raised approximately $30 million from at least 150 investors over the course of four securities offerings in early 2006.  According to the SEC’s complaint, the defendants falsely told investors that they would receive a return of three to six percent per month when in fact the defendants transferred investments into accounts and funds that either were not yet in operation or did not produce any return on investment.  The complaint also alleged that the defendants failed to disclose to investors that they made loans to themselves from investor proceeds, created and distributed false monthly account statements to mask their failure to produce the results promised to investors, and disbursed $5 million to various third parties without investor knowledge or approval. Improper Transfer of Assets   In the Matter of Thomas C. Palmer and Aeneas Capital Management, L.P. (July 2008) The SEC brought a settled administrative action against a hedge fund adviser, Aeneas Capital Management, L.P., and its former director of operations, Thomas C. Palmer, for improperly transferring $13.4 million from two hedge funds to a third in order to satisfy the third fund’s margin calls.  The SEC found that Palmer had violated the Investment Advisers Act of 1940 through the transfers and that Aeneas Capital had failed reasonably to supervise him.  The Commission ordered both respondents to cease and desist from future violations of the Act, suspended Palmer for twelve months from associating with any investment adviser, and fined Aeneas Capital and Palmer $150,000 and $65,000, respectively. Gibson, Dunn & Crutcher attorneys are available to assist with any questions you may have regarding these issues.  Please contact the attorney with whom you work or Washington, D.C.Barry R. Goldsmith (202-955-8580, bgoldsmith@gibsondunn.com)K. Susan Grafton (202-887-3554, sgrafton@gibsondunn.com) John H. Sturc (202-955-8243, jsturc@gibsondunn.com), F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com)   New YorkJonathan C. Dickey (212-351-2399, jdickey@gibsondunn.com)Mark K. Schonfeld (212-351-2433,  mschonfeld@gibsondunn.com)James A. Walden (212-351-2300, jwalden@gibsondunn.com) Lawrence J. Zweifach (212-351-2625, lzweifach@gibsondunn.com) DenverRobert C. Blume (303-298-5758, rblume@gibsondunn.com) Los AngelesGareth T. Evans (213-229-7734, gevans@gibsondunn.com)Debra Wong Yang (213-229-7472, dwongyang@gibsondunn.com) Douglas M. Fuchs (213-229-7605, dfuchs@gibsondunn.com) © 2009 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 6, 2009 |
2008 Year-End Update on Corporate Deferred Prosecution and Non-Prosecution Agreements

2008 – A Dynamic Year in Corporate Deferred Prosecution Agreements In the post-Enron and WorldCom era, the U.S. Department of Justice ("DOJ") often uses corporate deferred prosecution agreements ("DPAs") to resolve federal criminal investigations.[1]   Although corporate DPAs play an important role in limiting the collateral consequences of corporate indictment, their dramatically increased use has prompted considerable debate.  The DPA debate hit a high point in 2008 with several DPAs drawing media and legislative attention, culminating in new DOJ guidance.   Gibson Dunn has been counsel to corporations in some of the earliest DPAs, and we have written extensively on DPA policy considerations.  This client update provides an overview of the corporate DPAs entered into in 2008 and discusses the legislative, judicial, and executive activity surrounding DPAs.  It also provides practical guidance to help companies navigate the DPA process. Deferred Prosecution Agreements and Non-Prosecution Agreements Although a conviction establishes legal culpability, the simple indictment of a corporation—particularly a public, regulated corporation—can have massive collateral consequences for the company and third parties.  The fallout from the Arthur Andersen prosecution is a textbook example.  Prior to its indictment in 2002, Arthur Andersen was a worldwide institution with over $9.3 billion in annual revenues and over 85,000 worldwide employees.  By the time the Supreme Court unanimously reversed Arthur Andersen’s conviction in 2005, the employees were virtually all gone, partnership value had vanished, and the few remaining assets were being divvied up by litigants.  Contemporaneous newspaper reports say Arthur Andersen and the DOJ discussed a DPA but failed to come to an agreement.  To mitigate some of these unintended consequences, the DOJ has relied more frequently on DPAs to resolve corporate criminal investigations.  The practice of corporate deferred prosecution is based loosely on the individual pretrial diversion principles set forth in section 9-22.010 of the United States Attorney’s Manual, and Chapter Eight of the United States Sentencing Guidelines, which addresses organizational sentencing considerations.  In a DPA, the DOJ typically files charges against a corporation, often through a criminal complaint, but agrees to dismiss those charges after a period of time, so long as the corporation does not breach the agreement.  In exchange, the corporation generally accepts responsibility for criminal wrongdoing; pays a combination of a criminal fine, civil penalty, and restitution; complies with the ongoing investigations; and takes remedial measures, such as revamped compliance programs with independent monitors overseeing compliance improvements.  Most DPAs also require the corporation to admit to a statement of facts, which the DOJ may use to prosecute the corporation if the corporation breaches the agreement.  Many DPAs prohibit the corporation from denying the facts in any context, including civil litigation, press releases, or investor conferences.  Because a DPA takes place at the pre-indictment stage, there is typically no judicial oversight of the agreement, though many are filed with the court.  Non-Prosecution Agreements are similar to DPAs, but these agreements do not involve the filing of charges.  Instead, the DOJ simply agrees, typically in a letter agreement, not to prosecute so long as the corporation complies with the terms of the agreement.  Although DPAs and NPAs have very similar characteristics—requiring a corporation to accept responsibility, cooperate with the government, and adopt remedial measures—NPAs are generally less detailed than DPAs.  Additionally, NPAs generally do not include provisions for corporate monitors. Despite the obvious advantages of a DPA over a criminal indictment for companies under investigation, one central problem with DPAs has been the lack of DOJ guidance.  Before 2008, the DOJ had no formal—and little informal—guidance for individual prosecutors regarding when DPAs should be offered and what terms should be included in an agreement.  The lack of DOJ internal guidance resulted in differing treatment for corporations with similar conduct.  For example, one corporation that violates a law but reports it to the DOJ and cooperates fully with the investigation may receive a DPA—still paying millions of dollars in fines and undertaking costly compliance programs.  Another corporation that violates the same law and equally cooperates with the DOJ investigation may receive a total pass.  This inconsistent application of DPAs raises concerns of inequity and makes it more difficult for a corporation to manage criminal investigations and predictability of the result.  Simply put, absent consistent and uniform guidance, a corporation has no way of measuring the consequences of coming forward and self-reporting potential criminal activity.    A History of Deferred Prosecution Agreements The DOJ has a long tradition of granting pretrial diversions to appropriate individuals accused of criminal wrongdoing as an alternative to prosecution.  Only recently have corporate DPAs become widely utilized.  The DOJ entered into its first corporate DPA in 1992, but they were relatively rare until 2003.  Following the Arthur Andersen indictment and the formation of the DOJ Corporate Fraud Task Force, their use began to steadily increase.  In 2007, the use of DPAs increased substantially, more than doubling to 37 that year, from 14 in 2006.  This past year saw the first decline in the number of corporate DPAs, with only 14 reported DPAs and three reported NPAs.  The below chart tracks the modern history of the DOJ DPA agreements.     Who Gives DPAs and Who Receives Them Not all DPAs are equal.  Indeed, some divisions of the DOJ are more likely to enter into corporate DPAs, and some types of corporations are more likely to receive a DPA arrangement.  Historically, the DOJ’s Fraud Section has been the clear leader in corporate DPAs, entering into 26 agreements since 2003.  The Fraud Section accounts for 28 percent of the total agreements entered into during the last five years.  Similarly, a handful of United States Attorney’s Offices account for the vast majority of DPAs.  The Southern District of New York entered into 21 DPAs since 2001, more than any other office.  The Eastern District of New York, the District of New Jersey, and the District of Massachusetts round out the top five offices entering into DPAs over the previous decade.  The vast majority of U.S. Attorney’s Offices have never entered—or at least publicly announced—a DPA.  From our experience, some U.S. Attorney’s Offices have entered into DPAs that have never been publicly announced.  Corporate recipients of DPAs also tend to share certain characteristics.  For example, large, publicly-held corporations historically receive DPAs.  Previous DPA recipients include: American Express Bank International (a former subsidiary of American Express Company), Boeing, Bristol-Myers Squibb, British Petroleum, Chevron, Health South, Lucent Technologies, Monsanto, Pfizer, and Sears.  This list of DPA recipients is not surprising given the DPAs’ implicit purpose of limiting the collateral consequences of corporate convictions.  These consequences can be especially harsh for corporations that operate in highly regulated industries.  For example, a conviction for certain violations could result in a corporation losing its broker-dealer license, banking license, charter, or deposit insurance; being stripped of eligibility to be a government contractor; or being prohibited from participation in government healthcare programs.  Although it is little consolation to a small corporation, the indictment of a publicly-held corporation that operates in a regulated industry is likely to have more significant collateral consequences, placing more employees at risk of losing their jobs and affecting greater shareholder value.  Interestingly, and contrary to the banner headlines, DOJ’s prosecution of corporations has not increased substantially over the last ten years; 2000 was the high mark with 296 convictions, and the low was 2004 with 130.  For the remaining years, the number of convictions fluctuated between approximately 185 and 260.  The vast majority of corporations actually prosecuted are small, closely-held, non-public corporations with less than 200 employees.  Despite the substantial emphasis regulators place on compliance programs, from 2003 to 2007 only one corporation received sentencing credit for having an effective compliance program.  Our perception is that the corporations prosecuted are small entities that do not have robust compliance programs, which are the best antidote against criminal indictment.   Deferred Prosecution Agreements Entered in 2008 The 17 DPAs entered into in 2008 are approximately half the number entered in 2007.  This downturn may result from the normal ups-and-downs of corporate investigations and prosecutions.  It may also reflect the debate surrounding the use of DPAs and the cautious approach that the DOJ took in entering into DPAs while awaiting further legislative and internal guidance.  For example, the use of DPAs by individual U.S. Attorney’s Offices dropped in 2008, making up only approximately one-half of the DPAs in 2008, as opposed to two-thirds of DPAs in 2007.  The DOJ Fraud Section remained the leader in entering into DPAs in 2008, handling 6 of the 17—approximately 35 percent of the total.   Consistent with increased DOJ interest in Foreign Corrupt Practices Act ("FCPA") investigations, 40 percent of the DPAs in 2008 involved FCPA violations.  DPAs involving immigration fraud—hiring illegal aliens— also increased resulting in three DPAs.  The DOJ entered two DPAs for money laundering, and two DPAs for accounting irregularities and securities violations.  Finally, there was one DPA each for the following: internet gambling operations; mail fraud for providing illegal purchasing incentives to a customer; and False Claims Act violations.  Numerous DPAs in 2007 involved health care and food and drug fraud actions; 2008 saw no DPAs in these areas.  Overall, the mix of allegations in the 2008 DPAs is consistent with DOJ prosecution trends, and does not demonstrate any tendency by DOJ to enter DPAs for specific criminal violations.    This past year saw a noticeable and important trend toward uniformity in the terms and conditions of the 17 DPAs entered into in 2008.  Although the time frames of the 2008 DPAs ranged from January to December, almost every agreement contained broad language requiring that: (1) the corporation cooperate with ongoing government investigations; (2) the corporation bind any successor in the event of a sale or merger; (3) the corporation refrain from making statements that contradict the facts set forth in the agreement; and (4) the DOJ had sole discretion to determine whether a breach occurred.  Several DPAs give the DOJ the option to extend the agreement for a year in case of a breach.  None of the DPAs entered in 2008 provided for "extraordinary restitution"—a widely critiqued practice whereby an uninjured third party receives a benefit.  As in previous years, DPAs were more prominent in 2008 than NPAs.  Two of the four reported NPAs in 2008 were entered by the U.S. Attorney’s Office for the Northern District of New York.  The U.S. Attorney’s Office for the Southern District of New York and the U.S. Attorney’s Office for the Southern District of Texas entered the other two NPAs.  The below chart shows the reported DPAs and NPAs entered in 2008.  An explanation of these DPAs and NPAs is found in Appendix A.        Revocation of a Deferred Prosecution Agreement Before 2008, DPAs were rarely, if ever, revoked due to non-compliance.  The prospect of a DPA revocation arose in 2007 after FirstEnergy Corp. paid $28 million pursuant to a DPA for alleged misrepresentations to the Nuclear Regulatory Commission. When the corporation submitted a $200 million insurance claim arguing that it did not intentionally cause the corrosion damage at its nuclear plant, there were reports that DOJ thought the insurance claim violated the terms of the company’s DPA.  FirstEnergy subsequently dropped the insurance claim.  November 28, 2008, however, brought the first reported case where the DOJ actually revoked a DPA.  In January 2007, Aibel Group Ltd. entered into a DPA with the DOJ Fraud Section.  Aibel was charged with violating the FCPA by making illegal payments to Nigerian customs officials.  The DPA required Aibel to (1) establish a Compliance Committee of its Board of Directors, (2) engage outside compliance counsel to monitor its duties and obligations under the DPA, and (3) establish and effectively implement an FCPA compliance program.  On November 21, 2008, the DOJ announced that, although Aibel "committed substantial time, personnel, and resources to meeting the obligations of the DPA," it was not in compliance with the DPA.  Because Aibel self-reported the non-compliance and agreed to plead guilty to the underlying FCPA charges, it avoided the more complicated question, raised in FirstCorp, of how to determine if a corporation has, in fact, violated a DPA.  Under the terms of the guilty plea Aibel agreed to pay a fine of $4.2 million and receive two years of corporate probation, during which time it must periodically report on its progress implementing anti-bribery measures.  Although the terms of the DPA will no longer be enforceable upon sentencing, the terms of the plea agreement are quite similar.  Ironically, unlike the prior requirement of its DPA, under the terms of the plea agreement, Aibel is no longer required to have an outside compliance monitor.   2008 Changes Related to DPAs In 2008 several DPAs drew media and Congressional attention.  In one instance, a company agreed to endow an ethics chair to the prosecutor’s alma mater as part of the corporation’s agreement to avoid indictment.  In a second instance, a prosecutor selected a former U.S. Attorney General to be a monitor as part of a DPA, leading to concerns regarding the selection process.  Following Congressional hearings on DPAs, New Jersey Congressman Frank Pallone introduced legislation (H.R. 5086) aimed at providing oversight to the DPA process.  This bill would require the Attorney General to issue guidelines regarding when DPAs should be entered; require a federal judge to approve all DPAs, determine breach, and appoint monitors; and require the courts to set fee schedules for monitors.  Senator Arlen Specter also re-introduced legislation (S. 3217) that would prohibit any government prosecutor or any agency from requesting information protected by the attorney-client privilege in exchange for leniency.  Neither bill, however, made it out of committee.  Following the media publicity and legislative activity, in 2008 the DOJ issued its first formal remedial guidance relating to DPAs.  The Department issued a memo addressing the use of monitors and also revised the United States Attorney’s Manual to prohibit "restitution" to uninjured third-parties.  Although the DOJ did not issue guidance on when a prosecutor should offer a corporation a DPA, it amended its internal policy regarding a corporation’s cooperation and waiver of attorney-client and work product privilege; two factors relevant to the DOJ’s decision making process.  Morford Memorandum – Monitors On March 10, 2008, the DOJ issued its first formal guidance with respect to the remedial provisions in DPAs.  Acting Deputy Attorney General Craig S. Morford issued a memorandum ("Morford Memo") setting forth the principles that federal prosecutors must follow in the selection and use of monitors in DPA agreements.  Previously, there had been no specific guidance on the use of monitors, or any other aspect of DPAs.  Deputy Attorney General Morford, an experienced and talented veteran DOJ prosecutor, brought a line-attorney’s perspective to the DPA process.  The Morford Memo standardizes common practices involving monitors by addressing, inter alia, the criteria for selecting a monitor, the need for a monitor’s independence, restrictions on the scope of a monitor’s duties, and the need for procedures to resolve disputes over the monitor’s suggestions.  In determining whether to appoint a monitor, the Morford Memo instructs prosecutors to consider not only the benefits of a monitor but also the cost to the corporation, as well as the impact on its operations.  Prosecutors now must notify the United States Attorney or the DOJ Component Head before they execute a DPA that requires a monitor.   In addition to guidance on whether to use a monitor, the Morford Memo creates guidelines for selecting a corporate monitor.  The selection process should "be designed to: (1) select a highly qualified and respected person or entity based on suitability for the assignment and all of the circumstances; (2) avoid potential and actual conflicts of interests; and (3) otherwise instill public confidence by implementing the steps set forth in this Principle."   Traditionally, the selection process of monitors varied widely, with the prosecutor often holding veto power.  The Morford Memo, however, requires the creation of a "standing or ad hoc committee in the Department component or office where the case originated to consider monitor candidates."  Individual prosecutors are no longer allowed to make, accept, or veto monitor candidates unilaterally, and the Office of the Deputy Attorney General must approve all monitors.  Furthermore, the Morford Memo directs prosecutors not to accept a monitor that "has an interest in, or relationship with, the corporation or its employees, officers or directors that would cause a reasonable person to question the monitor’s impartiality."  Monitors are prohibited from employment or affiliation, presumably including representation, with the corporation for one year from the date of the end of the monitorship.  In addition to guidance on choosing a monitor, the Morford Memo also defines the scope of the monitor’s duties.  First, the Memorandum makes clear that the monitor is "an independent third-party, not an employee or agent of the corporation or of the Government."  Even though the corporation pays the monitor’s fees and costs, a corporation may not seek or obtain legal advice from its monitor.  Second, the Morford Memo makes clear the common understanding of the monitor’s purposes to "assess and monitor a corporation’s compliance with the terms of the deferred prosecution agreement designed to address and reduce the risk of reoccurrence of the corporation’s misconduct."  The responsibility for designing and maintaining a compliance program lies with the corporation, "subject to the monitor’s input, evaluation and recommendations."  The Morford Memo also makes clear that the monitor’s role is to evaluate ongoing compliance, not to "investigate historical misconduct."  Corporations may not always wish to accept the suggestions of their compliance monitors, nor, under the DOJ guidance, are they required to follow the monitor’s recommendations.  However, if a corporation "chooses not to adopt recommendations made by the monitor within a reasonable time, either the monitor or the corporation, or both, should report that fact to the Government, along with the corporation’s reasons.  The Government may consider this conduct when evaluating whether the corporation has fulfilled its obligations under the agreement."  Further, the Morford Memo directs that a DPA clearly identify what, if any, previously undisclosed or new misconduct a monitor is required to report to the Government.  The Morford Memo does not establish a set duration for monitors, but directs prosecutors to provide for extension or early termination of the monitor of the DPA should the circumstances so require. The Willbros Group was the first corporation to enter a DPA after the issuance of the Morford Memo.  Consistent with the Memo’s guidance, the DPA required the monitor to "have, at a minimum . . . demonstrated expertise with respect to the FCPA . . . experience designing and/or reviewing corporate compliance policies, procedures and internal controls, including FCPA-specific policies, procedures and internal controls . . . and sufficient independence from [Willbros] to ensure effective and impartial performance of the Monitor’s duties . . . ." The agreement also included a provision governing Willbros’ relationship with the monitor, reiterating the principles set out in the Morford Memo.  AGA Medical’s DPA one month later contained similar provisions.  Although not all of the subsequent DPAs contained provisions as detailed as these two DPAs, the Morford Memo is likely to contribute to a standardization of these provisions. Although the Morford Memo is a welcome development for practitioners seeking guidance and uniformity in the selection and use of monitors in DPAs, it may only be the first step.  Senator Leahy, chairman of the Senate Judiciary Committee, recently expressed disappointment that the Morford Memo does not address the potentially excessive compensation of monitors or other issues such as a monitor’s reporting requirements.  For corporations worried about predictability in DPAs, the Morford Memo is a positive development, providing some guidance and uniformity in DPA agreements. Extraordinary Restitution  Following the public and Congressional reaction to DPAs that included extraordinary restitution, the DOJ prohibited DPA provisions granting money to uninjured third-parties.  On May 14, 2008, Deputy Attorney General Mark Filip added Section 9-16.325 to the Unites States Attorney’s Manual to make clear that "[p]lea agreements, deferred prosecution agreements and non-prosecution agreements should not include terms requiring the defendant to pay funds to a charitable, educational, community, or other organization or individual that is not a victim of the criminal activity or is not providing services to redress the harm caused by the defendant’s criminal conduct."  The DOJ prohibited the practice because it could "create actual or perceived conflicts of interest and/or other ethical issues."  Defining Cooperation On August 28, 2008, Deputy Attorney General Mark Filip published revisions to the Principles of Federal Prosecution of Business Organizations, which substantially modified the DOJ’s policy defining cooperation—one of the main factors the DOJ considers in determining whether to prosecute a corporation.  The Filip Memo[2] departs from previous guidance by expressly stating that "[e]ligibility for cooperation credit is not predicated upon the waiver of attorney-client privilege or work product protection," and that prosecutors "should not ask for such waivers and are directed not to do so."  However, the Filip Memo emphasizes that in order to obtain cooperation credit a corporation may need to provide factual information, even if that information is obtained in an internal investigation.  Producing factual information from an internal corporate investigation may still have adverse consequences for corporations as the production of factual information to the DOJ may create a subject matter waiver of a corporation’s attorney-client or work product privilege in subsequent civil litigation. The Filip Memo also directs prosecutors not to consider whether a corporation advances or reimburses legal fees for its employees and prohibits prosecutors from requesting that a corporation refrain from advancing attorneys’ fees.  In addition, prosecutors will not consider whether a corporation has retained or sanctioned employees in evaluating cooperation.  However, the DOJ may look at a corporation’s disciple of culpable employees in evaluating its remedial measures and compliance program.  Importantly, the Filip Memo makes clear that only discipline of employees deemed culpable by the company—not the prosecutor—may be considered in evaluating a company’s remedial measures.  As a result, DOJ’s focus will be on appropriate disciplinary processes, including any efforts to implement effective compliance programs, replace responsible management, and discipline or terminate culpable employees.        On the same day that the DOJ published the Flip Memo, the Second Circuit decided a case that further defines the proper boundaries of corporate cooperation.  In United States v. Stein, No. 07-3042 (2nd Cir. Aug. 28, 2008), the Second Circuit held that a company’s decision not to pay legal fees to certain employees, in response to pressure from the DOJ to obtain a DPA, violates the employees’ Sixth Amendment rights.  The Court found the company’s decision not to pay legal fees amounted to government action, because absent DOJ’s pressure, the company would have paid the fees, even in the absence of a legal requirement to do so.  The Stein decision, along with the Filip Memo, are important developments which will define the outer limits on the type of "cooperation" the DOJ can seek from corporations in exchange for a DPA. The majority of the DPAs entered in 2008 before the issuance of the Filip Memo explicitly allow the DOJ to consider a company’s decision to withhold information based upon the attorney-client privilege or the attorney work-product doctrine in determining whether the company has fully cooperated with the DOJ.  True to the guidance in the Filip Memo, none of the DPAs entered after the Memo contain this explicit provision. Predictions for the Future Although 2008 saw a marked decrease in the number of DPAs, the slowdown is not likely to continue in the future.  The large number of government investigations borne out of the current financial crisis and the DOJ’s increased sensitivity to collateral consequences of corporate indictment are likely to lead to a further resurgence in DPAs.  Indeed, we are aware of a large number of currently ongoing investigations likely to be resolved in 2009, which will likely include DPAs.   The average length of the DPAs—three years in 2008—is not likely to drop, given the complexity of the compliance programs likely to be pursued as a result of investigations growing out of the current financial crisis.  Several of the 2008 DPAs include an option allowing the DOJ, in its discretion, to extend the terms of a DPA for a year or more to monitor compliance.  This option is likely to be included in future DPAs. It is uncertain whether more DPAs will be revoked in the future.  Because Aibel self-reported its non-compliance with the DPA, the revocation of their DPA adds little to the ongoing potential dispute over how to determine whether a corporation breaches a DPA.  For the first time since corporate DPAs came into existence, 2008 brought several legislative, executive, and judicial reforms concerning DPAs.  However, questions remain as to how the prospect of pending legislation, the Stein decision, and internal DOJ policy changes will effect DPA agreements.  A new administration may take steps to clarify internal DOJ guidelines and provide corporations with some guidance on what conduct warrants a DPA, as well as the appropriate terms and conditions that should be standard in a DPA agreement.  Furthermore, it is likely that the new Justice Department leadership will seek to harmonize the varied practices among the various DOJ divisions and the U.S. Attorney’s Offices.  Practical Guidance No corporation welcomes the prospect of a criminal indictment.  Yet due to the increasingly complex regulatory and criminal law environment, and the reality of respondeat superior liability, even the most conscientious corporation may find itself on the wrong side of a DOJ investigation.  Given the severe ramifications of a corporate indictment, most corporations facing possible indictment will prefer to seek a DPA or NPA from the DOJ.  A corporation should consider the following critical factors when seeking to secure a DPA.    Self-Reporting and Cooperation The DOJ has consistently maintained that corporations that self-report wrongdoing are likely to receive cooperation credit from the DOJ.  Nonetheless, a corporation should carefully weigh the benefits of cooperation credit against the detriment of reporting when considering if, and when, to report suspected wrongdoing to the DOJ.  Before making any decision to report potential wrongdoing, a corporation should consult with experienced and knowledgeable counsel who are familiar with the DOJ and can help the company decide if, when, and how it should self-report. Once the DOJ has begun a criminal investigation (initially through self-reporting or otherwise), a corporation needs to carefully plan its approach to cooperation.  Deputy Attorney General Filip stated in a press conference announcing the new guidelines, that "[n]o corporation is obligated to cooperate or to seek cooperation credit by disclosing information to the government.  Refusal by a corporation to cooperate . . . does not, in itself, support or require the filing of charges in any way."  Notwithstanding that guidance, corporations may feel pressure to cooperate and may choose to "voluntarily" waive attorney-client and work-product privilege in order to obtain cooperation credit.  The ramifications of this should be discussed with counsel before such a waiver is given. Similarly, although new DOJ guidance prohibits prosecutors from considering whether a corporation pays its employees’ legal fees in evaluating the corporation’s cooperation, a prosecutor may still consider a corporation’s discipline of the employees the company finds culpable.  Although corporations should take measures to protect their employees’ rights, they must be careful not to deliberately shield wrongdoers.  As Stein illustrates, this balance can be exceedingly difficult to achieve and requires careful planning and execution.  Determining how best to cooperate with the DOJ, including a determination of whether to waive applicable privileges, is a crucial decision for any corporation.  This decision is made even more important because the majority of courts hold that once a privilege is waived, it is waived for all purposes, including future civil litigation.  Although corporations will want to continue to conduct detailed legal investigations into corporate wrongdoing for their board of directors and auditors, they may also want to explore alternative arrangements with the DOJ, which enable a corporation to disclose relevant facts without compromising the privileged information. Remedial Measures Instituting a compliance program, or modifying an existing one, is a nearly universal component of a DPA.  The DOJ consistently considers compliance programs a central factor in evaluating a corporation’s remedial measures.  Corporations should move swiftly to institute change as the DOJ gives consideration to "quick recognition of the flaws in the program and its efforts to improve."  The complexity and depth of the compliance program (and the corresponding cost) will vary widely depending on the type and extent of the violation alleged.  Corporations implementing or revising a compliance program should take special care to tailor their compliance program to incorporate the practices and procedures that will be viewed most favorably by the DOJ. Monitors A corporation seeking a DPA should assess early in the process whether a monitor is likely to be necessary.  The standard in the 2008 DPAs was to allow the corporation to choose the monitor, with veto power held by the individual prosecutor.  The Morford Memo no longer allows a single prosecutor to veto a monitor choice.  Instead, the Deputy Attorney General must approve or disapprove all monitors.  If a monitor is deemed necessary or prudent, a corporation should consider multiple qualified candidates, and make a selection early.  Although the Morford Memo affords corporations more protection against arbitrary vetoes by individual prosecutors, the centralized approval process may subject the monitor to greater scrutiny and lengthen the approval process.  A corporation can, and may desire to, put its own monitor in place before entering into a DPA.   The Morford Memo also recognizes that the monitor’s purpose is to assess compliance with the DPA.  In negotiating the terms of a DPA, a corporation should seek to explicitly define up-front the monitor’s duties in assessing compliance, the information a monitor will have access to, how often and to whom the monitor will report, and what form the reports will take.  Conclusion  Corporations and prosecutors have been advocating changes to DPAs and corporate prosecution for years. Although it is too early to measure the significance of these changes on the DOJ’s practice with DPAs, the coming year is likely to bring an increased focus on corporate wrongdoing.  These recent modifications are an important first step in recognizing the crucial role for DPAs and the need for additional guidance in order to ensure consistency and uniformity in their use and implementation.  The changes in 2008 are a welcome development, which should create a framework that shapes corporate DPAs in future years.   [1]   Deferred Prosecution Agreements are referred to in practice as "DPs" or "DPAs" and Non-Prosecution Agreements as "NPAs."  For purposes of this update, we refer collectively to these agreements as DPAs unless otherwise noted.  The DOJ is not the only law enforcement agency that utilizes deferred prosecution agreements in conjunction with corporate investigations.  State Attorneys General, the SEC, the FTC, as well as other government agencies also utilize corporate DPAs or equivalents.  This client update addresses only DPAs entered into by the DOJ, with the exception of DOJ’s Antitrust Division, which has an official policy of leniency—non-prosecution—often afforded to the first cooperative corporation in an industry, and which is not addressed here.   [2]  These revisions were incorporated in the U.S. Attorney’s Manual in order to ensure their uniform application across the Department, but are still referred to as the Filip Memo.    Appendix A:  DPAs Entered in 2008 Aktiebolaget (AB) Volvo                                                                              March 18, 2008 DOJ Office Department of Justice, Criminal Division, Fraud Section Allegations Wholly-owned subsidiaries of AB Volvo violated the FCPA by paying, through the Oil For Food Program, approximately $1.3 million in alleged kickbacks to the Iraqi government in order to obtain contracts to sell construction equipment Internal accounting records were falsified to conceal the nature of the payments The subsidiaries committed wire fraud violations by inflating the price of each piece of equipment before submitting contracts to the U.N. for approval, then drawing on a U.N. line of credit, issued via international wire, in order to fulfill payment Length of DPA Three years Penalties Criminal Fine – $7 million Civil Penalty – $12.6 million to SEC Revised Compliance Program AB Volvo and its subsidiaries and affiliates will conduct a review of existing policies and procedures Maintain a system of internal accounting controls designed to ensure fair and accurate books, records, and accounts Institute an anti-corruption compliance code applicable to all directors, officers and employees, and where appropriate outside parties acting on the company’s behalf Assign a senior official to oversee compliance with the FCPA and anti-corruption laws Institute periodic training and annual certification on compliance for all directors, officers, employees, and where appropriate, agents and business partners Institute a system for reporting criminal conduct and appropriately disciplining non-compliant employees Insert standard provisions into contracts and agreements that are reasonably calculated to ensure business partners and agents are compliant with the FCPA and other anti-corruption laws No monitor  AGA Medical Corp.                                                              June 2, 2008 DOJ Office Department of Justice, Criminal Division, Fraud Section Allegations AGA violated the FCPA by making payments to Chinese physicians employed by the government, in order to entice them to use their products AGA violated the FCPA by making payments to Chinese government officials in order to obtain a patent on their products Length of DPA Three years Penalties Criminal Fine – $2 million Revised Compliance Program AGA Medical will conduct a review of existing policies and procedures Maintain a system of internal accounting controls designed to ensure fair and accurate books, records, and accounts Institute an anti-corruption compliance code applicable to all directors, officers and employees, and, where appropriate, outside parties acting on the company’s behalf Assign a senior official to oversee compliance with the FCPA and anti-corruption laws Institute periodic training and annual certification on compliance for all directors, officers, employees, and, where appropriate, agents and business partners Institute a system for reporting criminal conduct and appropriately disciplining non-compliant employees Insert standard provisions into contracts and agreements that are reasonably calculated to ensure business partners and agents are compliant with the FCPA and other anti-corruption laws Monitor Company chooses monitor, with DOJ veto Monitor must have expertise with FCPA counseling and compliance program design; have the resources necessary to discharge duties; and independence from the company Scope of monitors duties is to review and evaluate the effectiveness of internal controls, record-keeping, and financial reporting policies and procedures as they relate to anti-corruption laws Monitor is to have access to all documents, records, facilities, and employees that fall within the scope of responsibilities Monitor is to conduct an initial review and report, followed by two follow-up reviews and reports to be submitted to the company and the DOJ Company has 120 days to adopt the monitor’s recommendations, or 60 days to advise the monitor and the DOJ why it will not adopt them If monitor discovers other corrupt payments, company has 10 days to self-report, or monitor is to report the payments to the DOJ   American Italian Pasta Company                                       September 15, 2008  DOJ Office United States Attorney’s Office for the Western District of Missouri Allegations Misrepresenting the company’s income to the SEC and the investing public through the use of accounting irregularities such as understating expenses, overstating inventory, and inappropriate amortization Length of DPA Two years Penalties Criminal Fine – $7.5 million Revised Compliance Program Replaced CEO and CFO Completed a restatement of its financial statements Established an independent chairman of the Board of Directors Employed a General Counsel, Chief Compliance Officer and a Director of Internal Audit Revised Board governance documents Revised the Code of Conduct and initiated employee training No monitor   Entertainment Systems Inc.                                                 June 3, 2008 DOJ Office United States Attorney’s Office for the Southern District of New York Allegations Citadel, a wholly-owned subsidiary, committed wire fraud due to its payment processing  services being used for internet gambling by U.S. persons Conducting an illegal gambling business Conducting international monetary transactions for the purpose of promoting illegal gambling Conducting an unlicensed money transmitting business Length of DPA Three years Penalties Criminal Forfeiture – $9.1 million Revised Compliance Program Implemented controls to prevent member accounts from being used to conduct or process illegal transactions between internet gambling merchants and U.S. persons Regularly monitor effectiveness of its procedures and controls, and revise and update them when necessary Monitor Monitor will provide a "Controls Report" within 45 days of the DPA Monitor will provide an initial compliance report within 90 days of the DPA Company has 60 days to cure defects detected in the monitor’s report, and 15 more days  for monitor to report on the cure All information, documents, or other records necessary for the monitor to prepare the  reports should be provided by the company     Faro Technologies                                                                 June 3, 2008 DOJ Office Department of Justice, Criminal Division, Fraud Section Allegations Faro China, a wholly-owned subsidiary, violated the FCPA by making payments of approximately $450,000 to Chinese government officials or employees of government run entities in order to obtain and retain business Internal records and books were falsified to conceal the nature of the illegal payments Internal controls and procedures were inadequate to detect or prevent anti-corruption violations Length of DPA Two years Penalties Criminal Fine – $1.1 million Civil Penalty – $1.8 million Revised Compliance Program Faro will conduct a review of existing policies and procedures Maintain a system of internal accounting controls designed to ensure fair and accurate books, records, and accounts Institute an anti-corruption compliance code applicable to all directors, officers and employees, and, where appropriate, outside parties acting on the company’s behalf Assign a senior official to oversee compliance with the FCPA and anti-corruption laws Institute periodic training and annual certification on compliance for all directors, officers, employees, and where appropriate, agents and business partners Institute a system for reporting criminal conduct and appropriately disciplining non-compliant employees Insert standard provisions into contracts and agreements that are reasonably calculated to ensure business partners and agents are compliant with the FCPA and other anti-corruption laws Institute appropriate due diligence requirements pertaining to the retention and oversight of agents and business partners Monitor Company chooses monitor, with DOJ veto Monitor must have expertise with FCPA counseling and compliance program design; have the resources necessary to discharge duties; and independence from the company Scope of monitors duties is to review and evaluate the effectiveness of internal controls, record-keeping, and financial reporting policies and procedures as they relate to anti-corruption laws Monitor is to have access to all documents, records, facilities, and employees that fall within the scope of responsibilities Monitor is to conduct an initial review and report, followed by two follow-up reviews and reports to be submitted to the company and the DOJ Company has 120 days to adopt the monitor’s recommendations, or 60 days to advise the monitor and the DOJ why it will not adopt them If monitor discovers other corrupt payments, company has 10 days to self-report, or monitor is to report the payments to the DOJ Fiat                                                                             December 22, 2008 DOJ Office Department of Justice, Criminal Division, Fraud Section Allegations Iveco, CNH Italia, and CNH France, wholly-owned subsidiaries of Fiat, violated the FCPA by paying, through the Oil For Food Program, approximately $5.26 million in kickbacks to the Iraqi government in order to obtain contracts to sell trucks, tractors, and spare parts Internal accounting records were falsified to conceal the nature of the payments The subsidiaries committed wire fraud violations by inflating the price of each truck, tractor, or spare part before submitting contracts to the U.N. for approval, then drawing on a U.N. line of credit, issued via international wire, in order to fulfill payment Length of DPA Three years Penalties Criminal Fine – $7 million Revised Compliance Program Fiat and its subsidiaries and affiliates will conduct a review of existing policies and procedures Maintain a system of internal accounting controls designed to ensure fair and accurate books, records, and accounts Institute an anti-corruption compliance code applicable to all directors, officers and employees, and where appropriate outside parties acting on the company’s behalf Assign a senior official to oversee compliance with the FCPA and anti-corruption laws Institute periodic training and annual certification on compliance for all directors, officers, employees, and where appropriate, agents and business partners Institute a system for reporting criminal conduct and appropriately disciplining non-compliant employees Insert standard provisions into contracts and agreements that are reasonably calculated to ensure business partners and agents are compliant with the FCPA and other anti-corruption laws No monitor   Fine Host Corp.                                                                     December 16, 2008 DOJ Office United States Attorney’s Office for the Southern District of New York Allegations Billed school districts for inflated supplier invoices Length of NPA No set term Penalties Civil Fine – $5.3 million Restitution – $4.3 million to the schools serviced by Fine Host’s Ronkonkoma, Long Island office Revised Compliance Program None reported No monitor   Flowserve Corp.                                                                    February 21, 2008 DOJ Office Department of Justice, Criminal Division, Fraud Section Allegations A wholly-owned French subsidiary violated the FCPA by paying, through the Oil For Food Program, approximately $778,000 in kickbacks to the Iraqi government in order to obtain contracts to sell large scale water pumps Internal accounting records were falsified to conceal the nature of the payments The French subsidiary committed wire fraud violations by inflating the price of each pump before submitting contracts to the U.N. for approval, then drawing on a U.N. line of credit, issued via international wire, in order to fulfill payment Length of DPA Three years Penalties Criminal Fine – $4 million Civil Penalty – $6.5 million to SEC Revised Compliance Program Flowserve and its subsidiaries and affiliates will conduct a review of existing policies and procedures Maintain a system of internal accounting controls designed to ensure fair and accurate books, records, and accounts Institute an anti-corruption compliance code applicable to all directors, officers and employees, and, where appropriate, outside parties acting on the company’s behalf Assign a senior official to oversee compliance with the FCPA and anti-corruption laws Institute periodic training and annual certification on compliance for all directors, officers, employees, and where appropriate, agents and business partners Institute a system for reporting criminal conduct and appropriately disciplining non-compliant employees Insert standard provisions into contracts and agreements that are reasonably calculated to ensure business partners and agents are compliant with the FCPA and other anti-corruption laws No monitor   IFCO Systems                                                                        December 19, 2008 DOJ Office United States Attorney’s Office for the Northern District of New York Allegations Hired 1,182 illegal alien workers at over 40 plants in 26 states Length of NPA Three years Penalties Civil Forfeiture – $18.1 million to the Department of the Treasury Fund for law enforcement purposes Civil Penalty – $2.6 million for violations of the Fair Labor Standards Act Revised Compliance Program Designation of a full-time compliance officer Establishment of an employee hotline in order to report violations of law Institute annual employee certifications with regard to the Compliance Manual and the Code of Conduct Use Department of Homeland Security’s "E-Verify" Program for all hires Use the Social Security Number Verification Service to verify all current employees, resolving any negative results on or before April 30, 2009 Ensure all employees complete a form I-9, including using the Spanish instructions were appropriate Establish an internal training program with annual updates regarding hiring procedures and immigration verification Annual external audit of program designed to deal with Social Security Administration "no-match" letters Require subcontractors to swear under oath that they comply with good hiring procedures and immigration verification No monitor   Jackson Country Club                                                         February 6, 2008 DOJ Office United States Attorney’s Office for the Southern District of Mississippi Allegations Hiring and continuing to employ illegal aliens Furnishing false information to the Social Security Administration Length of DPA Two years Penalties Criminal Fine – $214,500 Revised Compliance Program Submit to an I-9 audit by ICE to verify Social Security numbers of existing workforce Use Basic Pilot Employment Verification Program for all hires Establish internal training program on completing I-9 and detecting fraudulent documents Conduct I-9 form audits every 180 days, either by an outside company or by an employee who doe not complete the forms Create a confidential tip-line for employees or members to report possible illegal aliens Require contractors to swear by affidavit that they adhere to ICE Best Practices Report to ICE every 180 days regarding the effect of compliance with ICE Best Practices No monitor Additional Requirements Conduct a once quarterly workshop for the public, at no charge, based upon the Country Club’s internal training program, in order to educate employers on how to comply with the immigration laws  Lawson Products                                                                  August 11, 2008 DOJ Office United States Attorney’s Office for the Northern District of Illinois Allegations Mail fraud for providing illegal purchasing incentives of about $9.7 million to the employees of its customers so that they would buy higher priced tools, hardware, and chemicals Length of DPA Three years Penalties Criminal Forfeiture – $29.1 million Restitution – $820,000 Revised Compliance Program Will not re-employ any officer or director who formerly served in either position and left the company before the DPA Implement a compliance and ethics program designed to prevent and detect violations of federal and state anti-corruption laws Immediately notify the DOJ of any violations or suspected violations of anti-corruption laws No monitor Additional 19 individuals charged, 12 convicted to date   Milberg Weiss                                                                                    June 16, 2008 DOJ Office United States Attorney’s Office for the Central District of California Allegations Mail fraud, money laundering, and obstruction of justice for its scheme to pay named plaintiffs a portion of attorneys’ fees in class actions the firm wished to prosecute Paying kickbacks to stockbrokers to refer their clients to the firm Retaining an expert witness on a contingent basis Length of DPA Two years Penalties Criminal Fine – $60 million, plus interest Civil Fine – $15 million, plus interest, to the United States Postal Service Consumer Fraud Fund Revised Compliance Program Comply with all legal and ethical rules regarding fee division or fee sharing, expert witnesses, and political or charitable contributions Require all attorneys, before entering a fee sharing arrangement, to submit to the monitor a description of the arrangement, a statement from the referrer that the arrangement comports with all legal and ethical rules, and a statement from referring counsel and client that the client has consented to the fee and will not have pecuniary benefit from the arrangement Hold any fee sharing payments until the monitor has approved them Disclose to the monitor any expert witness payments that are contingent on success in litigation Disclose to the monitor and the court any fee arrangement between the firm and a client in any case in which the firm moves to become lead class counsel Monitor Previous monitor since 2006 required to be retained two years Monitor to have an office and facilities in the firm’s New York office Monitor is to report to the DOJ within 45 days whether company is in compliance with "best practices program" Monitor is to report to the DOJ every three months regarding companies compliance Monitor may conduct employee interviews, and is to have access to all company documents and information necessary to reviewing compliance Monitor must promptly report any failures in compliance to the DOJ Additional Can appeal a finding of breach to a higher authority within the DOJ Penn Traffic Company                                                        October 28, 2008 DOJ Office United States Attorney’s Office for the Northern District of New York Allegations One or more employees violated federal law with regard to disclosures to the SEC, financial statements, press releases, and investor calls related to promotional allowances Length of NPA No set term Revised Compliance Program Assure internal controls are in place to account for promotional allowances, rebates and discounts from vendors in accordance with GAAP Institute a hot-line or secure post office box whereby employees or vendors may confidentially notify Penn Traffic if they believe its promotional allowance policies are not in accordance with GAAP Monitor Imposed by the civil judgment entered with the SEC Must maintain monitor for three years Charged with annually reviewing Company policies regarding promotional allowances and reporting to the SEC, U.S. Attorney’s Office for the Northern District of New York, and the Board of Directors   Republic Services Inc.                                                           October 1, 2008 DOJ Office United States Attorney’s Office for the Southern District of Texas Allegations Hiring undocumented alien workers Dumping non-city waste at a city landfill, thereby causing the landfill to over-bill the city for waste Length of NPA 18 months Penalties Criminal Penalty – $1 million Restitution – $2 million to the City of Houston to benefit a recycling program Revised Compliance Program Terminated or disciplined responsible individuals Formal training on I-9 procedures Issuing I-9 self audit guidelines Continued retention of immigration counsel Implementing payroll software that included I-9 compliance measures Appointing a Chief Compliance Officer No monitor Sigue Corporation and Sigue, L.L.C.                                             January 24, 2008 DOJ Office United States Attorney’s Office for the Eastern District of Missouri Allegations Charged with failure to maintain an effective anti-money laundering program under the Bank Secrecy Act Fifty-nine agents transmitted funds represented by law enforcement officers to be the proceeds of drug trafficking;  forty-seven of these agents assisted remitters in structuring transactions to avoid the reporting requirements of the Bank Secrecy Act. Sigue filed suspicious transaction reports with the government on the obviously structured transactions but failed to report and prevent the broader money laundering activity.             Length of DPA One year Penalties Criminal Fine – $15 million forfeiture Civil Penalty – $12 million (satisfied by the $15 million criminal forfeiture) Revised Compliance Program Committed to spend additional $9.7 million to update its anti-money laundering program Employ a Global Compliance Officer who reports to the Audit and Finance Committee of the Board of Directors and provide adequate resources Authorized delegates will be subject to credit and criminal background checks, and periodic checks in certain circumstances Maintain improved transaction monitoring, including implementing enhanced identification and due diligence requirements that exceed current regulatory requirements Implement a transaction interdiction system to block future suspicious transactions                        No monitor   Westinghouse Air Brake Technologies Corp.                    February 8, 2008 DOJ Office Department of Justice, Criminal Division, Fraud Section Allegations A wholly owned Indian subsidiary violated the FCPA by making approximately $170,000 in cash payments to Indian government officials in order to obtaining business, schedule pre-shipping product inspections, have certificates of product delivery issued and curb excise tax audits Internal accounting records were falsified to conceal the nature of the payments Length of DPA Three years Penalties Criminal Fine – $300,000 Civil Penalty – $375,000 Revised Compliance Program Conduct an internal review of existing policies and procedures Adopt or modify policies and procedures in order to maintain a comprehensive anti-corruption program Ensure a system of accounting procedures that will ensure accurate books, records and accounts Promulgate a compliance code in order to avoid FCPA or other anti-corruption violations Assign a senior executive, to report to the Audit Committee, to oversee the compliance program Institute periodic training and annual certification on compliance for all directors, officers, employees, and where appropriate, agents and business partners Institute a system for reporting criminal conduct and appropriately disciplining non-compliant employees Insert standard provisions into contracts and agreements that are reasonably calculated to ensure business partners and agents are compliant with the FCPA and other anti-corruption laws No monitor   Willbros Group Inc.                                                              May 14, 2008 DOJ Office Department of Justice, Criminal Division, Fraud Section Allegations Willbros International, a wholly-owned subsidiary, through three Nigerian Subsidiaries, violated the FCPA by making payments of over $6 million to Nigerian government officials in order to obtain contracts to work on a natural gas pipeline project Willbros International, through another subsidiary, violated the FCPA by making payments of approximately $300,000 to Ecuadorian government officials in order to obtain business Internal records and books were falsified to conceal the nature of the illegal payments Length of DPA Three years Penalties Criminal Fine – $22 million Civil Disgorgement – $8.9 million plus $1.4 million pre-judgment interest to SEC Revised Compliance Program Implement a compliance and ethics program designed to detect and prevent violations of the FCPA and other anti-corruption laws applicable to subsidiaries, affiliates, joint ventures, contractors, and subcontractors Review existing internal policies and procedures Maintain a system of internal accounting controls designed to ensure fair and accurate books, records, and accounts Assign a senior official to oversee compliance with the FCPA and anti-corruption laws Institute periodic training and annual certification on compliance for all directors, officers, employees, and where appropriate, agents and business partners Institute a system for reporting criminal conduct and appropriately disciplining non-compliant employees Insert standard provisions into contracts and agreements that are reasonably calculated to ensure business partners and agents are compliant with the FCPA and other anti-corruption laws Monitor Company chooses monitor, with DOJ veto Monitor must have expertise with FCPA counseling and compliance program design, have the resources necessary to discharge duties, and independence from the company Scope of monitors duties is to review and evaluate the effectiveness of internal controls, record-keeping, and financial reporting policies and procedures as they relate to anti-corruption laws Monitor is to have access to all documents, records, facilities, and employees that fall within the scope of responsibilities Monitor is to conduct an initial review and report, followed by two follow up reviews and reports to be submitted to the company and the DOJ Company has 120 days to adopt the monitor’s recommendations, or 60 days to advise the monitor and the DOJ why it will not adopt them If monitor discovers other corrupt payments, company has 10 days to self-report, or monitor is to report the payments to the DOJ Additional Culpable employees had to pay civil penalties to the SEC Company fired one senior executive and disciplined 18 other employees      The White Collar Defense and Investigations Practice Group of Gibson, Dunn & Crutcher LLP successfully defends corporations, senior corporate executives, and public officials in a wide range of federal and state investigations and prosecutions, and conducts sensitive internal investigations for leading companies in almost every business sector.  The Group has members in every domestic office of the Firm and draws on more than 75 attorneys with deep government experience, including numerous former federal and state prosecutors and officials, many of whom served at high levels within the Department of Justice and the Securities and Exchange Commission.  Joe Warin, a former federal prosecutor, currently serves as a monitor pursuant to a DOJ and SEC enforcement action, and recently has been selected as the U.S. counsel for the compliance monitor for Siemens.  Debra Wong Yang is the former United States Attorney for the Central District of California, and currently serves as a monitor pursuant to a DOJ enforcement action.     Washington, D.C.F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com) John H. Sturc (202-955-8243, jsturc@gibsondunn.com)Barry Goldsmith (202-955-8580, bgoldsmith@gibsondunn.com) David P. Burns (202-887-3786, dburns@gibsondunn.com)David Debold (202-955-8551, ddebold@gibsondunn.com)Brian C. Baldrate (202-887-3717, bbaldrate@gibsondunn.com) New YorkJim Walden (212-351-2300, jwalden@gibsondunn.com)Lee G. Dunst (212-351-3824, ldunst@gibsondunn.com)Randy M. Mastro (213-351-3825, rmastro@gibsondunn.com)Marc K. Schonfeld (212-351-2433, mschonfeld@gibsondunn.com)Orin Snyder (212-351-2400, osnyder@gibsondunn.com)Lawrence J. Zweifach (212-351-2625, lzweifach@gibsondunn.com)Alexander H. Southwell (212-351-3981, asouthwell@gibsondunn.com) DenverRobert C. Blume (303-298-5758, rblume@gibsondunn.com) Orange CountyNicola T. Hanna (949-451-4270, nhanna@gibsondunn.com) Los Angeles Debra Wong Yang (213-229-7472, dwongyang@gibsondunn.com)Thomas E. Holliday (213-229-7370, tholliday@gibsondunn.com)Marcellus McRae (213-229-7675, mmcrae@gibsondunn.com)Robert C. Bonner (213-229-7321, rbonner@gibsondunn.com)Michael M. Farhang (213-229-7005, mfarhang@gibsondunn.com)Douglas Fuchs (213-229-7605, dfuchs@gibsondunn.com)     © 2009 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 6, 2009 |
2009 Mid-Year Criminal Antitrust Update

At the mid-point of 2009, the dominant trends in criminal antitrust have been dramatically increased fines and prison terms, both in the United States and abroad, particularly for cartel conduct.  Highlights of 2009 include: U.S. criminal antitrust fines for FY 2009 already exceed $950 million, surpassing the total amount of fines collected in each full fiscal year in the past nine years; Significant guilty pleas, fines, and prison sentences in various enforcement authorities’ prosecutions of price-fixing conduct in Air Cargo, Marine Hose, Thin Film Transistor-Liquid Crystal Display (TFT-LCD) panels, Cathode Ray Tubes (CRT), and Dynamic Random Access Memory (DRAM), which are in addition to record-breaking fines and sentences already imposed in those cases; The longest prison term imposed on an individual in the United States for a single antitrust charge–48 months; The Obama Administration’s announcement of new leadership at the Antitrust Division, and continued vigorous enforcement of criminal antitrust laws, including proactive measures relating to economic stimulus funds; and New and enhanced criminal antitrust laws in Australia and Japan, accompanied by tough rhetoric. These are just a few indications of the continued and increasingly vigorous criminal enforcement of antitrust laws around the world.  The following is a more detailed discussion of the year-to-date highlights of 2009.  U.S. Criminal Antitrust Fines for 2009 at Record-Breaking Pace With four months to go in the U.S. Department of Justice’s fiscal year, the Antitrust Division has already imposed criminal antitrust fines that exceed $950 million.  By comparison, for all of FY 2008, the DOJ imposed $701 million in criminal antitrust fines, which had been more than in any previous year since 1999.  The following chart puts FY 2009 to date in context of the last decade:   By March 2009, the DOJ announced that it had already imposed $745 million in fines, but in the next month alone it imposed an additional $214 million in additional fines on three international airlines in the ongoing Air Cargo Investigation (see below).  There remain numerous corporate and individual targets in the DOJ’s investigation into price-fixing in, among others, the TFT-LCD and CRT markets, which themselves are still at early stages.  As a result, the astronomically high aggregate fines in FY 2009 will only climb higher.  Significant Prosecutions International Air Cargo Investigation The worldwide investigation into air cargo transportation price-fixing continued to produce substantial fines around the world.  The conspiracies alleged by the various enforcement authorities involved fees such as fuel surcharges and post-September 11 security charges imposed by several major international airlines. The DOJ has obtained numerous additional corporate guilty pleas resulting in substantial fines.  In addition to the more than $1.2 billion in fines previously imposed on nine international carriers, the DOJ has obtained hundreds of millions of dollars in fines from an additional six carriers, totaling over $338 million for FY 2009 to date.  In January, the DOJ announced that LAN Cargo S.A., Aerolinhas Brasileiras S.A. (ABSA) (which is substantially owned by LAN) and El Al Israel Airlines each agreed to plead guilty to criminal price-fixing and collectively pay more than $124 million.  (LAN and ABSA jointly paid $109 million; El Al paid $15.7 million.)  Additionally, in April, the DOJ announced that Cargolux Airlines International S.A., Nippon Cargo Airlines Co. Ltd., and Asiana Airlines Inc., each also agreed to enter guilty pleas and pay fines totaling over $214 million:  Cargolux ($119 million); Nippon ($45 million); Asiana ($50 million).  This brings the total number of corporate defendants that have entered guilty pleas in the U.S. to 15, with collective fines of more than $1.6 billion, the highest fines ever imposed in a single criminal antitrust investigation. What is more, the DOJ obtained a guilty plea from a fourth executive in its Air Cargo Investigation.  A former vice president of Martinair Holland NV, Franciscus Johannes de Jong, agreed to serve eight months in prison and pay $20,000 in fines for his participation in price-fixing in the air cargo industry.  In 2008, three executives (one each from Qantas, British Airways, and SAS) entered guilty pleas, with sentences ranging from six to eight months and $20,000 in fines (except for the SAS executive, who only received a jail sentence). The DOJ is not alone in obtaining criminal fines in 2009 related to cartel conduct in the air cargo market.  In February, the Australian Competition and Consumer Commission (“ACCC”) announced that Martinair and Cargolux had each consented to pay $5 million (US) and Air France-KLM had also agreed to pay $6 million (US)–a total of $16 million (US).  The ACCC had already obtained $25 million (US) in its investigation into air cargo price-fixing. Most recently, on June 26, the Canadian Competition Bureau announced that Air France, KLM and Martinair pleaded guilty and were fined a total of $10 million (US) in Canada’s investigation into the air cargo cartel.  The fines imposed on the companies were as follows: Air France ($4 million (US)); KLM ($5 million (US)); and Martinair ($1 million (US)). The investigations in all jurisdictions remain ongoing. Marine Hose Investigation The global investigation into price-fixing in the marine hose industry that went overt in May 2007 with arrests in Houston and San Francisco and simultaneous search warrants executed at locations across the U.S., as well as in the U.K. by the Office of Fair Trading and in Europe by the European Commission, has remained active in 2009.  In January, the European Commission announced that it had fined five marine hose manufacturers for a total of $173 million for their part in the conduct.  The companies receiving fines were Bridgestone Corporation ($76.8 million), Parker ITR slr ($33.5 million), Trelleborg Industrie S.A. ($32.1 million), Dunlop Oil & Marine Ltd. ($23.6 million), and Manuli Rubber Industries SPA ($6.4 million).  The Commission also announced that Yokohama Rubber Co. had received immunity as the first conspirator to come forward to cooperate.  The Commission levied harsher fines on Bridgestone and Parker because it found that they were the leaders of the conspiracy, whereas Manuli received a 30% reduction in its fine in exchange for its cooperation in the Commission’s investigation. In April, the DOJ obtained additional guilty pleas in its own Marine Hose investigation, this time from two subsidiaries of Trelleborg (Virginia Harbor Services, Inc. and Trelleborg Industrie SAS).  The subsidiaries agreed to pay a total fine of $11 million in exchange for pleading guilty to two separate conspiracies involving price-fixing of marine hose and bid-rigging and allocating customers in contracts to sell plastic marine pilings.  In December 2008, Manuli pleaded guilty and was ordered to pay a fine of $4.54 million, and Dunlop agreed to plead guilty and pay a fine of $2 million.  Additionally, nine individuals have pleaded guilty in the U.S. to participation in the marine hose cartel. The Korea Fair Trade Commission (“KFTC”) has also been active in 2009 in its Marine Hose investigation.  In May, the KFTC imposed fines on Bridgestone, Dunlop, Trelleborg, and Parker.  These fines were substantially lower, however, than the fines those companies received in the U.S. and Europe:  Bridgestone ($256,600); Dunlop ($117,400); Trelleborg ($40,200); Parker ($33,700).  Manuli was also implicated in the conduct, but did not receive a fine.  Yokohama escaped sanction because of its amnesty status in Korea. TFT-LCD & Cathode Ray Tube Investigations The TFT-LCD panel price-fixing investigation–which began in 2006 and was extremely active in 2008–has brought additional guilty pleas, fines, and indictments in 2009.  There also has been an active investigation in the cathode ray tubes (“CRT”) industry, which is related to TFT-LCD.  Last year, the DOJ had secured guilty pleas from three companies–LG Philips (now LG Displays), Chunghwa Picture Tubes Ltd., and Sharp Corporation–totaling $585 million in the TFT-LCD investigation.  This year to date, the DOJ has also secured a guilty plea from Hitachi Displays Ltd.  Hitachi agreed to pay a $31 million fine for its participation in a conspiracy to fix the prices for TFT-LCD panel sales to Dell from April 2001 through March 2004.  The DOJ has also obtained indictments or guilty pleas from nine executives from all of the four companies that entered guilty pleas.  In January, four executives from LG Displays and Chunghwa entered pleas.  Chang Suk Chung, an LG executive, agreed to serve a seven-month prison sentence and pay $25,000 in criminal fines.  The Chunghwa executives–Chieng-Hon Lin, Chih-Chun Liu, and Hsueh-Lung Lee–agreed to serve nine, seven, and six-month prison terms, respectively, plus fines of $50,000, $30,000, and $20,000.  These executives pled guilty to participating in a conspiracy to fix TFT-LCD prices worldwide from September 2001 to December 2006.  All of these individuals who entered guilty pleas were foreign nationals, based abroad, and for whom extradition would have been difficult.  These guilty pleas continue the trend of the DOJ forcing foreign executives who participated in price-fixing to serve U.S. jail sentences. The following month, in February, two more executives from Chunghwa and another executive from LG Displays were indicted.  The Chunghwa executives were Cheng Yuan Lin (a former CEO) and Wen Jun Cheng; the LG executive was Duk Mo Koo.  Then in March an executive from Hitachi–Sakae Someya–was also indicted.  Finally, in April, another LG executive, Bock Kwon, entered a guilty plea and agreed to serve a sentence of a year and one day in prison, plus pay a $30,000 criminal fine.  Several other TFT-LCD competitors still remain uncharged and further indictments and guilty pleas can be expected in the months to come. Additionally, the DOJ’s CRT investigation has begun to yield criminal charges in 2009.  The DOJ was in the nascent stages of its CRT investigation in 2008, but in February 2009, the grand jury issued its first indictment in the CRT investigation for Cheng Yuan Lin, a former CEO of Chunghwa, who was also indicted in the TFT-LCD investigation.  To date, this is the only indictment in this investigation, but this remains a case to continue to watch in 2009 as more are expected, if the TFT-LCD investigation is any guide. Longest Sentence for Single Charge Ever Imposed in Criminal Antitrust Case In January, the DOJ secured a 48 month jail sentence in its investigation into collusion in shipping freight services between the continental United States and Puerto Rico.  Peter Baci, a shipping executive, agreed to plead guilty to participating in a conspiracy to suppress and eliminate competition in the U.S.-Puerto Rico shipping lane.  The 48-month sentence is the longest jail sentence ever imposed for a single antitrust charge.  The maximum sentence for antitrust crimes is 10 years.  Antitrust and obstruction of justice charges remain against three other executives in that case.  This case further illustrates that the DOJ is seeking longer jail sentences and will seek multi-year sentences against individuals even when they agree to enter into guilty pleas.  The average jail sentence for antitrust crimes was 9 months in 2006, 31 months in 2007, and 25 months in 2008.  Other Developments in the United States New Leadership at the Antitrust Division The most notable development of 2009 at the DOJ has been the arrival of new senior leadership at the Antitrust Division, principally the appointment of Christine Varney as Assistant Attorney General.  However, as a sign of the DOJ’s continued focus on the enforcement of criminal antitrust laws, Scott Hammond has remained as the Deputy Assistant Attorney General for Criminal Enforcement at the Antitrust Division.  Hammond is the only Deputy Assistant Attorney General to remain in place at the Antitrust Division with the change of administrations. Announcement of Citizen Complaint Center On April 13, 2009, the DOJ announced an unprecedented effort proactively to enforce criminal antitrust laws by establishing a new “Citizen Complaint Center” to accept reports of potential collusive conduct and fraud in procurement and grant awards under the American Recovery and Reinvestment Act of 2009 (“the Recovery Act”).  In addition to creating a center to accept complaints of such conduct by telephone and e-mail, the DOJ also published on its website “Red Flags of Collusion” that provide guidance as to what types of conduct the DOJ regards as potentially collusive and which markets are most likely to foster collusive activity.  The DOJ also stated that it will be providing training to federal agency procurement and grant officers, as well as agency auditors and investigators to identify collusive conduct. These efforts underscore the DOJ’s increasingly aggressive enforcement of criminal antitrust laws and illustrate that companies submitting bids or accepting funds under the Recovery Act (or any other stimulus programs instituted by the government) will be the subject of increased scrutiny.  The Recovery Act authorizes over $500 billion in stimulus spending for projects, such as for infrastructure and renewable energy, in addition to the hundreds of billions of dollars authorized to provide liquidity to the financial markets and stabilize the automotive, insurance, and financial services industries.  In announcing this new initiative, the DOJ noted that “[t]he potential risk of fraud and collusion increases dramatically when large blocks of funds, such as those associated with the Recovery Act, are quickly disbursed.” This is the first time the DOJ has preemptively issued a warning regarding conduct that would violate criminal antitrust laws and established a “hotline” to receive reports of such conduct.  This announcement emphasizes the DOJ’s particular concern regarding illegal activity related to stimulus funds, but it is also in line with its increasingly vigorous enforcement of criminal antitrust laws.  International Developments Australia Passes Criminal Antitrust Statute On June 16, the Australian Parliament passed legislation that would enact new civil and criminal prohibitions on cartel activities.  The law comes into effect upon Royal Assent, a formality that is expected to occur around the time of print, and will go into effect 28 days thereafter.  This new anti-cartel law provides for criminal sanctions, including up to 10 years of imprisonment, as well as substantial monetary penalties.  An overview of the law can be found athttp://minister.innovation.gov.au/Emerson/Pages/UPTO10YEARS.aspx. Japan Approves Higher Criminal Sanctions for Cartelists and Bid-Riggers On June 3, Japan passed increased criminal sanctions for collusive market conduct.  In an amendment to its Anti-Monopoly Act, the maximum prison sentence for engaging in cartel conduct or bid-rigging has increased from three to five years.  Monetary fines were also increased by 50%.  Additionally, the statute of limitations for cartel conduct and bid-rigging was increased from three to five years.   Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or any of the following: Washington, D.C.F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com)D. Jarrett Arp (202-955-8678, jarp@gibsondunn.com)David P. Burns (202-887-3786, dburns@gibsondunn.com)  John W.F. Chesley (202-887-3788, jchesley@gibsondunn.com) New YorkRandy M. Mastro (212-351-3825, rmastro@gibsondunn.com)James A. Walden (212-351-2300, jwalden@gibsondunn.com)Peter Sullivan (212-351-5370, psullivan@gibsondunn.com)John A. Herfort (212-351-3832, jherfort@gibsondunn.com)Lawrence J. Zweifach (212-351-2625, lzweifach@gibsondunn.com) DenverRobert C. Blume (303-298-5758, rblume@gibsondunn.com)Stephen C. McKenna (303-298-5963, smckenna@gibsondunn.com) DallasM. Sean Royall (214-698-3256, sroyall@gibsondunn.com) San FranciscoGary R. Spratling (415-393-8222, gspratling@gibsondunn.com)Joel S. Sanders (415-393-8268, jsanders@gibsondunn.com)Trey Nicoud (415-393-8308, tnicoud@gibsondunn.com)Joshua D. Hess (415-393-8276, jhess@gibsondunn.com)Rachel S. Brass (415-393-8293, rbrass@gibsondunn.com) Los AngelesDaniel G. Swanson (213-229-7430, dswanson@gibsondunn.com)  BrusselsDavid Wood (+32 2 554 7210, dwood@gibsondunn.com) LondonJames Ashe-Taylor (+44 20 7071 4221, jashetaylor@gibsondunn.com) © 2009 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 13, 2009 |
2009 Mid-Year False Claims Act Update

The frenetic pace of False Claims Act (“FCA”) activity in 2008 has continued into the first half of 2009.  In addition to record-breaking FCA settlements in several industries, we have witnessed substantial amendments to the federal statute itself. Most significantly, on May 20, 2009, President Obama signed into law the Fraud Enforcement and Recovery Act of 2009 (“FERA”), which amends the FCA in a manner that will increase the exposure of every company that does business with the federal government and of every person or entity that supplies goods or services that are reimbursed by federal government dollars.  FERA overturns important judicial precedent, including the Supreme Court’s unanimous ruling last term in Allison Engine Co. v. United States ex rel. Sanders, 128 S. Ct. 2123 (2008), and could reverse many judicial trends that curtailed private whistleblowers’ ability to prosecute FCA actions.  And other legislation remains pending in Congress that would further expand the scope of the Act and possibly eliminate key FCA claim defenses. Regarding the trend of increasing settlements, in fiscal year 2008, the federal government recovered approximately $1.34 billion in FCA settlements and judgments.  During the first six months of 2009, the federal government already has recovered far more than that amount.  Indeed, three FCA settlements alone exceed the total recoveries for FY 2008 ($800 million from Eli Lilly in January 2009, $262 million from Quest Diagnostics in April 2009, and $325 million from Northrop Grumman Corp. in April 2009). This client update provides first a summary of important amendments to the FCA (including amendments recently signed into law and others still pending before Congress), next a brief overview of FCA enforcement activities and judicial decisions during the first half of 2009, and finally some practical guidance to help companies avoid or limit liability under the current version of the FCA.  A collection of Gibson Dunn’s publications on the FCA, including prior client alerts and more in-depth discussions of the statute’s framework and operation, may be found on our website. I.  Legislative Action In 2009 A.  FERA Significantly Amends The False Claims Act In our May 26, 2009 client alert, “President Obama Signs Legislation Significantly Expanding the Scope of the False Claims Act,” we provided a detailed summary of important changes to the FCA embodied within FERA.  FERA, among other things: Overturns, legislatively, the Supreme Court’s unanimous decision last term in Allison Engine and imposes FCA liability even if the company that submitted a false claim to a non-government entity did not specifically intend to defraud the federal government. Expands liability to indirect recipients of federal funds by eliminating what had been called the “presentment” requirement and effectively overruling a D.C. Circuit decision (authored by then Judge John Roberts) in United States ex rel. Totten v. Bombardier Corp., 380 F.3d 488 (D.C. Cir. 2004).  The Totten court held that the FCA did not apply to a suit alleging fraud against a federal grantee (Amtrak), because the underlying false statements were submitted to a recipient of federal dollars and not to the federal government itself.  After FERA, the FCA appears to apply to any fraud committed against any federal grantee. Amends the definition of “claim,” thus extending FCA liability to any false claim made to any recipient of federal money so long as that money is used to “advance a Government program or interest,” a phrase the amendments fail to define. Penalizes the knowing “retention of any overpayment” as a reverse false claim, thus expanding exposure against federal contractors or grantees for retaining “overpayments” that may not have been obtained through any false statement or record in the first instance.[1] Resolves a Circuit split and defines “materiality” as “having a natural tendency to influence, or be capable of influencing, the payment or receipt of money or property,” which was the more liberal standard applied by some courts. B.  Pending Legislation (S. 458 And H.R. 1788) On February 24, 2009, Senator Charles Grassley (R-IA) introduced S. 458, the “False Claims Act Clarification Act of 2009.”  The bill was read twice on that date and referred to the Judiciary Committee.  On March 30, 2009, Representative Howard Berman (D-CA) introduced H.R. 1788, entitled the “False Claims Act Correction Act of 2009.”  The bill was reported out of the House Judiciary Committee on April 28, 2009.  Both bills seek to expand the definition of a claim under the FCA, eliminate the “presentment” requirement, and overrule Allison Engine in a manner that (arguably) has already been accomplished by FERA.  In addition, these bills look to expand the class of individuals permitted to bring private qui tam actions and effectively eliminate potent FCA defenses.  Indeed, the pending legislation would reverse many of the judicial trends we discuss below at Section III. 1.  Bidding Farewell To The Public Disclosure Bar? Presently, under the FCA, a defendant may move to dismiss a qui tam action for lack of subject matter jurisdiction at any stage of the litigation – even post-verdict – if the allegations are based upon public disclosures and the relator is not an “original source.”  31 U.S.C. § 3730(e)(4)(A); see also Rockwell Int’l. Corp. v. United States, 549 U.S. 457 (2007).  The pending legislation in both the Senate and the House, however, would amend the FCA to allow only the government to seek dismissal of a qui tam action based upon public disclosures.  See S. 458, § 4(b); H.R. 1788, § 3(d).  Further, the bills would redefine what constitutes a “public disclosure” and more narrowly define the “based upon” standard, thereby breathing new life into lawsuits that otherwise would die under the FCA’s current interpretation. For example, H.R. 1788 includes as a “public disclosure” only disclosures “that are made on the public record or have otherwise been disseminated broadly to the general public.”  Id. at § 3(d) (proposing amendments to 31 U.S.C. § 3730(e)(4)).  Further, the bill provides that an action or claim is “‘based on’ a public disclosure only if the person bringing the action derived the person’s knowledge of all essential elements of liability of the action or claim alleged in the complaint from the public disclosure.”  Id. (emphasis added).  Finally, the bill permits a court to dismiss a qui tam action or claim only if the “allegations relating to all essential elements of liability of the action or claim are based exclusively on the public disclosure of allegations or transactions . . . .”  Id. (emphasis added).  All of these definitions significantly narrow the standards most courts presently apply. 2.  Deputizing Government Employees Although the current statute does not expressly forbid it, many courts have held that government employees, particularly those who are charged with investigating fraud, are precluded from bringing qui tam actions.  See, e.g., United States ex rel. Fine v. Chevron U.S.A., Inc., 72 F.3d 740 (9th Cir. 1996).  Proposed legislation would expressly authorize federal employees to bring a qui tam action based upon information discovered during his or her employment under certain circumstances.  The bills would permit the government to seek dismissal when a government employee fails to satisfy the statutory prerequisites, but strikingly, the bills are unclear whether a private defendant could similarly move to dismiss. 3.  Relaxing Substantially Rule 9(b) Pleading Requirements Currently, courts demand that relators plead FCA allegations with heightened particularity as set forth in Federal Rule of Civil Procedure 9(b).  H.R. 1788, however, would effectively eliminate the Rule 9(b) pleading requirements, providing instead: “In pleading an action, a person shall not be required to identify specific claims that result from an alleged course of misconduct if the facts alleged in the complaint, if ultimately proven true, would provide a reasonable indication that one or more violations of section 3729 are likely to have occurred, and if the allegations in the pleading provide adequate notice of the specific nature of the alleged misconduct to permit the Government effectively to investigate and defendants fairly to defend the allegations made.”  H.R. 1788, § 4(c) (proposing a new subsection (e) to 31 U.S.C. § 3731).  Although supporters of the amendments argue that courts dismiss meritorious lawsuits based on an overly-strict interpretation of Rule 9(b), relaxation of Rule 9(b)’s pleading requirements – as the proposed legislation suggests – will likely encourage general allegations of wrongdoing that could only be evaluated after participation in the costly civil discovery process. C.   State Legislative Action In April and May 2009, respectively, Kansas and Minnesota enacted their own civil False Claims Acts modeled after the federal statute.  Those doing business with the government should be aware that many programs are jointly funded by the federal and state governments (such as Medicaid), and many government contracts are similarly funded by the federal and state governments (such as infrastructure improvement).  Accordingly, companies may face concurrent allegations of liability under federal and state versions of the FCA. II.  FCA Trends And Enforcement Activities During The First Half Of 2009 A.  The FCA As An All-Purpose Anti-Fraud Statute In Allison Engine the Supreme Court narrowed the application of the FCA and warned against “transform[ing] the FCA into an all-purpose antifraud statute.”  128 S. Ct. at 2130.  Federal appellate and district courts almost universally agreed.  For example, in United States ex rel. Bledsoe v. Community Health Sys., Inc., the Sixth Circuit stated that the FCA “imposes liability not for defrauding the government generally; it instead only prohibits a narrow species of fraudulent activity:  present[ing] or caus[ing] to be presented, . . . a false or fraudulent claim for payment or approval.”  Id. at 501 F.3d 493, 504 (6th Cir. 2007) (internal quotations omitted). Yet, in practice, the DOJ and qui tam relators have pursued, and will no doubt continue to pursue, FCA actions based on alleged regulatory noncompliance and generalized fraud.  For example, as discussed in our 2008 year-end FCA update, relators consistently bring claims under implied or express “false certification” theories of liability, arguing that a defendant violates the FCA by falsely certifying compliance with a broad range of federal statutes, regulations, or guidelines at the time claims were filed, whether or not the regulations directly relate to the actual claim for government funds.  Thus, private individuals who would not otherwise have standing to enforce the myriad of federal laws that lack private enforcement mechanisms (e.g., healthcare or environmental regulations), use the FCA to enforce compliance with those laws and to severely penalize noncompliance, even if the end result of a defendant’s conduct yielded little or no monetary loss. In pursuit of this principle, the DOJ recently intervened in an FCA action filed by the Humane Society against two meat distribution companies stemming from their purportedly inhumane treatment and slaughter of cattle.  See http://www.usdoj.gov/opa/pr/2009/May/09-civ-426.html.  The complaint alleged that the companies falsely represented to the U.S. Department of Agriculture that ground beef ultimately supplied to the National School Lunch Program came from cattle that was humanely handled in accordance with federal regulations and that no meat from disabled, non-ambulatory cattle was included in the supply.  Id.  The DOJ intervened in part over ‘concern for the health of our nations’ schoolchildren.’  Id. Similarly, the federal government pursued a case against an aircraft company that installed an untested component part of military helicopters.  See http://www.usdoj.gov/opa/pr/2009/March/09-civ-273.html.  In announcing the settlement, the DOJ did not allege that the untested parts were substandard or defective, or that any injuries resulted.  Yet, DOJ warned, “[t]his settlement sends a message that fraud, especially when it concerns the safety of our men and women in uniform, cannot and will not be tolerated in Government contracts.”  Id.  Although everyone applauded the government’s effort to protect the health and safety of our military, many questioned whether the FCA was the proper enforcement mechanism for doing so, especially when specific regulatory and/or statutory schemes existed to punish the same wrongdoing. The FCA has extended to the sales and marketing of medical devices and drugs.  For example, because Medicaid, Medicare, and other programs generally do not pay for off-label uses of drugs and devises, DOJ and relators have alleged that all claims for off-label uses are ineligible for reimbursement, such that the entire amount of the claim should be awarded as damages (and then trebled), regardless of the actual administration of the drug/device for medical purposes and any benefit actually conferred on the patient.  Relators typically proceed under the FCA using an express or implied certification theory, contending that compliance with restrictions on off-label marketing is a condition precedent to reimbursement.  See, e.g., United States ex rel. Kennedy v. Aventis Pharms., Inc., 2009 U.S. Dist. LEXIS 34107 (N.D. Ill. Apr. 20, 2009) (relators alleged that the defendant marketed a certain prescription drug for off-label uses and thereby induced providers to submit fraudulent Medicare reimbursement claims).  The $302 million recent Quest settlement (discussed below) further suggests that healthcare companies may be liable under the FCA for knowingly misrepresenting product information in labeling, marketing, or selling devices known to be inaccurate, unreliable, or defective.  Again, the expansion of FCA liability in these situations parallels similar enforcement under other statutes and/or regulations written specifically to cover the practices at issue. In the procurement context, the FCA has similarly expanded For example, DOJ and relators argue that by misrepresenting facts to obtain a contract at the outset, defendants subject all claims submitted under that contract to FCA liability because those claims are “tainted” by the alleged fraudulent inducement.  See, e.g., United States ex rel. Wilson v. Kellogg Brown & Root, Inc., 525 F.3d 370 (4th Cir. 2008) (relators alleged that the defendant fraudulently induced the contract with the United States to provide military transport by knowingly misrepresenting that it would comply with certain maintenance requirements).  To make matter worse, relators then seek to treble all monies paid under the contract (and add penalties), regardless of any benefit conferred or the value of goods or services provided under the contract.  Id.  . Despite the judiciary’s efforts to prevent the FCA from morphing into an “all-purpose antifraud statute,” the DOJ and relators continue to push expansive theories of liability that often drive large settlements, and, if accepted by the courts, would transform the FCA into an “all-purpose antifraud statute.” B.  FCA Settlements During The First Half Of 2009 Virtually every area of industry supported, even in part, by federal spending has witnessed FCA activity over these past few months.  By way of example only, the federal government recently settled civil FCA claims with: A Chicago advertising firm that allegedly over-billed the government while developing the “Army of One” recruiting campaign; A GSA contractor who allegedly sold furniture in violation of the Trade Agreement Act (the action was initiated by a competitor); Texas school districts who allegedly provided false information in connection with the Federal Communications Commission’s E-Rate program (which provides funding for school districts to access the internet and other critical technology); Colleges that allegedly submitted false claims for student aid funds by purportedly deceiving a state licensing agency to obtain a state license that served as a prerequisite to federal funding; A State Department of Education that allegedly falsely certified its eligibility to receive funds under the Migrant Education Program; and, Companies that allegedly made false statements to Federal Emergency Management Agency in connection with Hurricane Katrina Relief Funds. With federal spending on the rise and increased enforcement budgets and resources, we expect settlements to increase in every sector of our economy.  Three areas of industry merit separate attention, below. 1.   Healthcare As with all years for which statistics are available, most recoveries in the first half of 2009 stemmed from the healthcare industry.  To assure this trend continues, on May 29, 2009, the DOJ and the Department of Health and Human Services (“HHS”) announced a joint task force comprised of law-enforcement agents and prosecutors aimed at preventing fraud and enforcing anti-fraud laws known as the Health Care Fraud Prevention & Enforcement Action Team (“HEAT”).  HHS Secretary Kathleen Sebelius announced that the taskforce is “turning up the heat on perpetrators who steal from the taxpayers and threaten the future of Medicare and Medicaid.”  See http://www.hhs.gov/news/press/2009pres/05/20090520a.html. The following are three significant recoveries in the first half of this year: On January 15, 2009, the DOJ announced that Eli Lilly and Company had agreed to pay $1.415 billion to resolve criminal and civil allegations that it promoted its antipsychotic drug Zyprexa for uses not approved by the FDA.  See http://www.usdoj.gov/opa/pr/2009/January/09-civ-038.html.  The reported $515 million criminal fine was “the largest ever in a health care case, and the largest criminal fine for an individual corporation ever imposed in a United States criminal prosecution of any kind.”  Id. The civil settlement between Eli Lilly, the United States and various States of up to $800 million also resolved FCA claims and related state claims raised in four related qui tam lawsuits (all filed by former Eli Lilly sales representatives), alleging that Eli Lilly marketed and promoted Zyprexa for off-label uses, causing providers to submit false claims for payment to federal insurance programs.  The qui tam relators will receive more than $78 million from the federal share of the settlement amount.  On April 15, 2009, the DOJ announced a $302 million global settlement with Quest Diagnostics and its subsidiary, Nichols Institute Diagnostics (NID), resolving criminal and civil claims concerning various types of diagnostic test kits that NID manufactured, marketed, and sold to laboratories throughout the country.  See http://www.usdoj.gov/opa/pr/2009/April/09-civ-350.html.  The payment “represents one of the largest recoveries ever in a case involving a medical device.”  Id. The civil settlement resolved allegations that NID manufactured, marketed, and sold test kits knowing that some of these kits produced results that were materially inaccurate and unreliable, thereby causing laboratories and providers that used the test kits to submit false claims for reimbursement to federal health programs.  Quest and NID paid the United States $262 million plus interest to resolve the civil FCA allegations, and paid various state Medicaid programs approximately $6.2 million to resolve similar civil claims.  The qui tam relator will receive approximately $45 million from the federal share of the settlement amount. In May 2009, Sanofi-Aventis reportedly agreed to pay $95.5 million to settle allegations that it violated Medicaid’s “best prices” requirement.  Of the total settlement amount, $49 million will go to the federal government and more than $40 million will go to the various state Medicaid programs.  According to the DOJ, “Aventis entered into ‘private label’ agreements with the HMO Kaiser Permanente that simply repackaged Aventis’s drugs under a new label,” leading them to allegedly underpay drug rebates to Medicaid and overcharge public health services for the products.  See http://www.usdoj.gov/opa/pr/2009/May/09-civ-520.html.  The Civil Division, the U.S. Attorney’s Office for the District of Massachusetts, HHS’s Office of Inspector General and Office of Counsel to the Inspector General, and the National Association of Medicaid Fraud Control Units handled the investigation. 2.  Department of Defense The federal government is infusing unprecedented amounts of money into every sector of the economy, while simultaneously outsourcing more and more government functions to the private sector.  Perhaps nowhere is this more prevalent than the defense industry.  The Comptroller General of the United States recently testified before Congress regarding Department of Defense spending as follows: The government is relying on contractors to perform many tasks that closely support inherently governmental functions, such as contracting support, intelligence analysis, security services, program management, and engineering and technical support for program offices.[2] The following are significant recoveries in the defense industry the first half of this year: In April 2009, the DOJ announced that Northrop Grumman Corp., one of its subsidiaries, and a predecessor company agreed to settle FCA claims in connection with the sale of allegedly defective satellite parts.  The DOJ valued the settlement at $325 million, which was used to offset claims Northrop had asserted against the government in an earlier, unrelated contract dispute action.  See http://www.usdoj.gov/opa/pr/2009/April/09-ag-305.html.  A former employee whistleblower will receive more than $48 million as his share of the recovery under the qui tam provisions of the FCA. In February 2009, APL Limited agreed to settle FCA claims for more than $26 million stemming from allegations that it submitted inflated invoices for shipping containers to troops in Iraq and Afghanistan.  See http://www.usdoj.gov/opa/pr/2009/February/09-civ-120.html. 3.  Government Contracting And Financial Fraud In the wake of the economic crisis and the American Recovery and Reinvestment Act of 2009 (signed into law February 17, 2009), the federal government has shown a marked interest in contract and procurement cases and financial fraud.  In April 2009, the DOJ reported “the largest contract fraud settlement the General Services Administration (GSA) has obtained to date.”  See http://www.usdoj.gov/opa/pr/2009/April/09-civ-353.html.  And, when announcing a recently filed FCA action against a mortgage lender in connection with federally-insured loans, DOJ warned, “Mortgage fraud is a top priority for this Administration.”  See http://www.usdoj.gov/opa/pr/2009/June/09-civ-570.html.  Indeed, the main goal of FERA was to extend the reach of the FCA to financial frauds and provide the federal government with sufficient law enforcement staff and budget to prosecute those frauds. On May 12, 2009, the DOJ’s Antitrust Division announced a new initiative to help protect stimulus funds from fraud, waste, and abuse.  The Antitrust Division will train officials to recognize and report possible collusion, fraud, or waste in procurement, grant, and funding programs and will assist in investigations and prosecutions.  Moreover, the DOJ’s budget request for fiscal year 2010 includes $62.6 million to combat financial fraud and protect the federal fisc.  See http://www.usdoj.gov/opa/pr/2009/May/09-ag-451.html. The following are significant recoveries in the first half of this year in this area: In April 2009, GSA Contractor NetApp Inc. and NetApp U.S. Public Sector Inc. agreed to pay $128 million to resolve claims that they violated the FCA during contract negotiations and administration by knowingly failing to provide GSA with current, accurate, and complete information about its commercial sales practices and discounts for hardware, software, and storage management services for computer networks sold to government entities through the GSA program.  See http://www.usdoj.gov/opa/pr/2009/April/09-civ-353.html  A former NetApp employee whistleblower will receive more than $19 million as his share of the recovery.  Notably, on March 2, 2009, the federal government intervened in an FCA action against EMC Corp. similarly questioning its commercial pricing practices during negotiation of GSA contracts to provide information technology hardware and services to federal agencies. In February 2009, the federal government recovered $19 million from AMEC Construction Management, settling FCA litigation involving allegations of fraud, false claims, and kickbacks on four GSA construction contracts and litigation over claims for excess re-procurement costs incurred by GSA after it terminated the company’s contract to build a courthouse in St. Louis, Missouri.  See http://www.usdoj.gov/opa/pr/2009/February/09-civ-085.html. III.  Important Judicial Decisions And Continuing Legal Trends During The First Half Of 2009 In our 2008 year-end FCA update, we identified several legal trends in the FCA arena.  Those trends continue into 2009.  Since the last update, the Supreme Court has addressed the timeliness of an appeal under the FCA, and several lower courts (and the Supreme Court in a rare grant of certiorari), addressed the public disclosure bar, the original source requirements, and the FCA pleading requirements under Rule 9(b).  Finally, in a significant development, the Fourth Circuit recently held that fraudulent claims submitted to the Coalition Authority in Iraq and paid for with Coalition Authority funds, are subject to the FCA even if the actual source of the funds is someone other than the United States government. A.  The Supreme Court Limits The Time Relators Have To File An Appeal On June 8, 2009, the Supreme Court issued its unanimous decision in United States ex rel. Eisenstein v. City of New York, 129 S. Ct. 2230 (2009).  The Court considered “whether the 30-day time limit to file a notice of appeal in Federal Rule of Appellate Procedure 4(a)(1)(A) or the 60-day time limit in rule 4(a)(1)(B) applies when the United States declines to formally intervene in a qui tam action brought under the False Claims Act.”  Slip Op. at 1.  The Court held that because the United States declined intervention it could not be considered a “party” despite its status as a “real party in interest.”  Slip Op. at 9.  Because relators filed their notice of appeal 54 days after the district court dismissed their complaint and entered final judgment, the Court held that the appeal was not timely filed.  The decision resolved a previous split in the circuits regarding the amount of time for a relator to appeal in cases where the federal government had not intervened. B.  The Supreme Court Grants Certiorari To Resolve A Circuit Split Regarding The Scope Of The Public Disclosure Bar To determine, in the first instance, whether a court has jurisdiction over an FCA claim, the court must answer three questions – (1) Was there a public disclosure?  If so, (2) Is the qui tam action based upon the public disclosure?  If so, (3) Is each relator an original source of the information underlying each of the allegations of the complaint?  With respect to the first question, the FCA enumerates several sources of public disclosure, including disclosure in a “Congressional, administrative, or Government Accounting Office report, hearing, audit, or investigation.”  31 U.S.C. 3730(e)(4)(A).  The circuit courts are currently divided on whether a state administrative report constitutes a public disclosure.  On June 9, 2008, the Fourth Circuit held “the public disclosure bar applies to federal administrative audits, reports, hearings or investigations, but not to those conducted or issued by a state or local governmental entity.”  United States ex rel. Wilson v. Graham County Soil & Water Conservation Dist., 528 F.3d 292, 296 (4th Cir. 2008) (emphasis added).  Thus, disclosures in a county audit report and a State (North Carolina) Department of Environment, Health and Natural Resources report did not constitute “public disclosures” within the meaning of the FCA.  Id. The defendant in that case petitioned the U.S. Supreme Court for review, and, after briefing from the United States Solicitor General, several  states’ Attorneys General, and representatives of the pharmaceutical and biotechnology industries, the Supreme Court granted certiorari in June.  Should the Supreme Court resolve the circuit split and hold that state and local government reports constitute public disclosures, then the public disclosure bar would strengthen and serve to eliminate qui tam complaints “based upon” state administrative reports.  As discussed above, however, pending legislation – S. 458 and H.R. 1788 – would redefine “public disclosures.” C.  Courts Continue To Dismiss Claims Under The Public Disclosure Bar Circuit courts have continued to construe the public disclosure bar more broadly, thus leading to the dismissal of FCA claims for lack of jurisdiction.  For example, the Tenth Circuit recently held that “allegations of industry wide gas mismeasurement” disclosed in a previous lawsuit and in Senate Committee documents constituted a “public disclosure” of all types of mismeasurement techniques (even those not disclosed previously) by all gas companies that produced gas on Indian lands (even companies that were not identified in the public disclosures).  In re Natural Gas Royalties Qui Tam Litig., 562 F.3d 1032, 1040-43 (10th Cir. 2009). The Sixth Circuit recently held that prior litigation constituted a public disclosure even though the previous lawsuit contained no allegation of fraud because the prior lawsuit ‘”presented enough facts to create an inference of wrongdoing.'”  United States ex rel. Poteet v. Medtronic, Inc., 552 F.3d 503, 513 (6th Cir. 2009). Similarly, the Ninth Circuit recently rejected a relator’s claim that the public disclosure bar should not apply because the public disclosure came three months after the relator had presented evidence of the fraudulent activity to the federal government, but had not yet filed suit.  United States ex rel. Meyer v. Horizon Health Corp., 565 F.3d 1195, 1199-1200 (N.D. Cal. 2009).  The court reasoned that the relator’s disclosure to the government was a private disclosure that could not serve as a shield against a public disclosure that occurred three months later when the unrelated litigation commenced.  Id.   District courts have followed suit.  First the Southern District of New York recently followed the majority of circuits and held that information obtained through a FOIA request constitutes a public disclosure even though a FOIA request is not a specifically enumerated public disclosure in Section 3730(e)(4)(A).  United States ex rel. Kirk v. Schindler Elevator Corp., 606 F. Supp. 2d 448, 461-62 (S.D.N.Y. 2009) (following Third, Sixth, and Tenth Circuits).   And recently the Northern District of Illinois held that an OIG report identifying common practices of fraud by chiropractors generally was sufficient to constitute a public disclosure as to allegations against specific chiropractors who allegedly participated in similar practices.  United States ex rel. Baltazar v. Warden, 2009 U.S. Dist LEXIS 28639, *20-21 (N.D. Ill. Apr. 2, 2009). D.  Courts Continue To Strictly Interpret “Original Source” Requirements As discussed in our 2008 year-end FCA update, Courts have strictly interpreted the “original source” requirement of jurisdiction.  This trend continues. To qualify as an original source, a relator must demonstrate that (1) he or she has direct and independent knowledge of the information upon which the allegations are based and (2) voluntarily provided that information to the government prior to filing a qui tam action.  The Ninth Circuit recently confirmed that simply knowing about an alleged fraud is not equivalent to possessing “direct and independent knowledge of the alleged fraud.”  United States ex rel. Meyer v. Horizon Health Corp., 565 F.3d 1195, 1201 (9th Cir. May 14, 2009).  The circuit courts continue to deny original source status as to claims that occurred after a relator has left the defendant’s employ.  See, e.g., United States ex rel. Vuyyuru, 555 F.3d 337, 355 (4th Cir. 2009).  And the Sixth Circuit recently held that even relators who possess “direct and independent knowledge” do not qualify as original sources if they fail “to provide this information to the government before filing [their] complaint.”  United States ex rel. Poteet v. Medtronic, Inc., 552 F.3d 503, 515 (6th Cir. 2009); see also In re Natural Gas Royalties Qui Tam Litig., 562 F.3d 1032, 1044 (10th Cir. 2009). In addition, courts continue to reject relators’ efforts to secure discovery in an attempt to demonstrate independent source status.  As the Fourth Circuit succinctly observed “[o]ne also wonders why [the relator] would have even needed discovery regarding, for example, how he gained direct and independent knowledge of the alleged false billings submitted by Defendants, because such information should be within his own custody and control.”  Vuyyuru, 555 F.3d at 355. E.  Courts Continue To Dismiss Cases Based On Relators’ Failures To Plead FCA Claims With The Heightened Particularity That Rule 9(b) Requires FCA actions are subject to the special pleading requirements applicable to fraud actions under Rule 9(b).  When facing motions to dismiss, court often struggle to determine the appropriate level of specificity required in a complaint, particularly where the plaintiff alleges a fraudulent scheme occurring over many years and/or in multiple programs or locations.  Courts continue to demand an increasing level of specificity in complaints to withstand dismissal. Both the First and the Eighth Circuits recently affirmed dismissal of relators’ complaints for failure to plead with sufficient particularity as required by Rule 9(b).  See United States ex rel. Gagne v. City of Worcester, 565 F.3d 40, 48 (1st Cir. 2009); United States ex rel. Roop v. Hypoguard USA, Inc., 559 F.3d 818, 824-25 (8th Cir. 2009).  A number of district courts have also rejected FCA claims on 9(b) grounds within the past several months.[3]  As discussed above, pending legislation, H.R. 1788, would effectively eliminate the Rule 9(b) pleading requirements applied by these courts. On the other hand, the Fifth Circuit recently relaxed Rule 9(b)’s requirements where the relators could not allege the details of an actually submitted false claim.  United States ex rel. Grubbs v. Kanneganti, 565 F.3d 180, 189-190 (5th Cir. 2009).  In Grubbs, the relator alleged that other doctors with whom he worked “instructed him that during weekend on-call shifts doctors meet with the nursing staff to get updates on current patients.  The doctors then saw the patients only ‘as needed’ or when ‘something acute’s going on,’ but billed every day as a regular ‘face-to-face’ hospital visit.”  Id. at 184.  Relator further alleged that nurses “indeed attempted to assist him in recording face-to-face physician visits that had not occurred and that were based solely on information obtained through nursing contacts with the patients.”  Id.  Relator’s compliant laid out the allegations of wrongdoing with specificity, and averred at least one overt act of billing for each defendant doctor, which contained identifying information regarding a specific, individual claim.  Id. Defendants moved to dismiss arguing that Rule 9(b) demanded that the “contents of the presented bill itself . . . must be pled with particular detail and not inferred from the circumstances.”  Id. at 190.  The Fifth Circuit rejected this argument and held: [T]he ‘time, place, contents, and identity’ standard is not a straitjacket for Rule 9(b).  Rather the rule is context specific and flexible and must remain so to achieve the remedial purpose of the False Claim[s] Act.  . . .  We hold that to plead with particularity the circumstances constituting fraud for a False Claims Act § 3729(a)(1) claim, a Relator’s complaint, if it cannot allege the details of an actually submitted false claim, may nevertheless survive by alleging particular details of a scheme to submit false claims paired with reliable indicia that lead to a strong inference that claims were actually submitted. Id. (emphasis added). Although Grubbs appears to be a measured retreat from a requirement that actual false claims be particularly identified in the pleadings to survive a Rule 9(b) motion to dismiss, the court cautioned that in addition to alleging a scheme to submit false claims, relators must raise a “strong inference that . . . claims were submitted” by providing some specific allegations that the false claims were likely submitted “such as dates and descriptions of recorded, but unprovided, services and a description of the billing system that the records were likely entered into.”  Id. at 191.  Moreover, the Fifth Circuit rejected relator’s conspiracy claim against the hospital on Rule 9(b) grounds because allegations that “various doctors over a period of years each submitted certain false claims” only pointed “to a possibility of an agreement among” the doctors and the hospital.  Id. at 194.  Thus, the Fifth Circuit determined that general allegations of potential wrongdoing alone remain insufficient. F.  Fraudulent Claims Submitted To The Coalition Authority In Iraq Can Create FCA Liability The Fourth Circuit recently held that the FCA covered fraudulent claims submitted to the Coalition Authority in Iraq.  United States ex rel. DRC, Inc. v. Custer Battles, LLC, 562 F.3d 295, 303-08 (4th Cir. 2009).  Custer Battles contracted with the Coalition Authority of Iraq to replace currency that bore Saddam Hussein’s portrait with new currency.  Id. at 298.  “Although the Coalition Authority was funded from multiple sources,” including sources other that the United States Government, the Coalition Authority issued an advance of three million dollars to Custer Battles paid by a U.S. Treasury check that was funded by assets seized from the Iraqi government as part of the war effort.  Id. at 298-99.  Subsequent invoices were submitted “to U.S. personnel who were detailed to work with the Coalition Authority,” and were paid from the Coalition’s Development Fund for Iraq, which included funds from various non-U.S. sources as well as “$210 million confiscated by the United States from Iraqi bank accounts and transferred to the Development Fund, as well as funds appropriated by Congress.”  Id. at 299.  The district court limited Custer Battles’ damages under the Dinar Exchange Contract to a maximum of $3 million after “conducting a thorough source-of-funds analysis, concluding that of the approximately $15 million paid on the Dinar Exchange Contract, only the $3-million advance came from U.S. government funds.”  Id. at 301.  After the jury returned a verdict for the maximum damages of $3 million, the district court considered Custer Battles’ Rule 50(a) motion for judgment as a matter of law.  Because the “Relators did not prove that the invoices were presented to U.S. government employees or officers,” rather than to the Coalition Authority, the district court entered judgment for Custer Battles on relators’ 3729(a)(1) and 3729(a)(2) claims.  Id. at 301. The Fourth Circuit reversed.  First the Fourth Circuit held that “[s]o long as ‘any portion“ of the claim is or will be funded by U.S. money given to the grantee, the full claim satisfies the definition of [a false claim] as used in § 3729(a)(1) or (a)(2).”  Id. at 303 (emphasis in original).  Thus, the district court erred when it conducted a source of funds analysis.  Second, the Fourth Circuit rejected the district court’s requirement that the United States control the funds from which payment comes, finding a control of funds requirement inconsistent with the FCA’s inclusion of claims “made to . . . a grantee, or other recipient,” of U.S. funds, so long as the United States “provides any portion” of the funds that the grantees or recipients would use to pay the claim.”  Id. at 304 (citing 31 U.S.C. § 3729(c)) (emphasis in original).  Finally, the Fourth Circuit rejected the district court’s assumption that U.S. government personnel detailed to the Coalition Authority “could not be working in their official capacities as U.S. government employees,” as Section 3729(a)(1) requires.  Id. at 306. Notably, the Fourth Circuit’s ruling in Custer Battles, if accepted by other circuits, together with FERA’s recent amendments to the FCA, will most significantly broaden the types of FCA claims that relators may bring in the next few years. IV.  Practical Guidance and Concluding Thoughts In a recent Deloitte poll of more than 1,500 business professionals from multiple industries, a staggering 79.8% responded that they were unfamiliar with the FCA.  See http://www.deloitte.com/dtt/press_release/0,1014,sid%253D2007%2526cid%253D258357,00.html.  It is imperative, therefore, that all companies who do business with the federal government and/or receive federal funds directly or indirectly, educate their employees about the FCA’s provisions and the ramifications of violations. In that same Deloitte poll, more than half (58.2 %) of the respondents stated that the level of transparency demanded by the Obama administration in connection with bailout spending is not possible.  Id.  Nevertheless, all recipients of federal funds should strive for transparency, carefully document claims, and actively monitor compliance with federal regulations and contract specifications.  From the outset, companies that receive directly or indirectly stimulus funds under the American Recovery and Reinvestment Act must understand the FCA and implement controls to avoid fraudulent procurement or inducement claims that might taint every future claim for payment.  Companies should then closely monitor their activities to prevent fraud, waste, or abuse.  Not only will false certifications of compliance with contract specifications or federal regulations expose companies to sweeping FCA liability, but a failure to promptly detect and disclose overpayments may lead to FCA liability and disbarment under FAR Rules. In sum, the sweeping changes to the FCA brought by FERA is sure to spur increased activity in the FCA arena.  The scope of FCA claims is likely to expand, while the courts grapple with interpreting the FCA’s most recent amendments.  And as the federal government continues to increase its spending in all areas of the economy, more companies will find themselves subject to the FCA’s provisions.  The remainder of this year is sure to present a robust level of enforcement activity.  [1]  In our November 13, 2008 client alert, “New Federal Regulation Requires Mandatory Disclosure and Amplified Compliance Programs for Government Contractors,” we discussed rules requiring mandatory disclosure by federal government contractors of “credible evidence” of certain violations of the FCA and “significant” overpayments on a contract.  Although failure to comply with the FAR disclosure provisions may result in disbarment, the FCA carries treble damages and civil penalties.  [2]  See GAO Report, “DOD’s Increased Reliance on Service Contractors Exacerbates Long-standing Challenges,” GAO-08-621T, available at http://www.gao.gov/new.items/d08621t.pdf.  Notably, in recommending the fiscal year 2010 defense budget, requesting “a nearly $11 billion increase” above the prior year’s budget level, Secretary of Defense Robert M. Gates stated, “we must reform how and what we buy, meaning a fundamental overhaul of our approach to procurement, acquisition, and contracting.”  See April 6, 2009, “Defense Budget Recommendation Statement (Arlington, VA),” available at http://www.defenselink.mil/speeches/speech.aspx?speechid=1341.  [3]  See, e.g., United States ex rel. Carter v. Halliburton Co., 2009 U.S. Dist. LEXIS 1936, *11-16 (E.D. Va. Jan. 13, 2009); United States ex rel. Smart v. Christus Health, 2009 U.S. Dist. LEXIS 4143, *22 (S.D. Tex. Jan. 22, 2009); United States ex rel. Sharp v. Eastern Oklahoma Orthopedic Ctr., 2009 U.S. Dist. LEXIS 15988, *29-78 (N.D. Okla. Feb 27, 2009); United States ex rel. Snapp, Inc. v. Ford Motor Co., 2009 U.S. Dist. LEXIS 30393, *20-21 (E.D. Mich. Apr. 7, 2009); United States ex rel. Poteet v. Lenke, 604 F. Supp. 2d 313, 324 (D. Mass. 2009); United States ex rel. Westfall v. Axiom Worldwide, Inc., 2009 U.S. Dist. LEXIS 45809, *12-17 (M.D. Fla. May 20, 2009); United States ex. rel. Polansky v. Pfizer, Inc., 2009 U.S. Dist. LEXIS 43438, *11-14 (E.D.N.Y. May 22, 2009); Mason v. Medline Indus., Inc., 2009 U.S. Dist. LEXIS 43500, *9 (N.D. Ill. May 22, 2009). Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues.  Gibson Dunn successfully argued the Allison Engine case in the Supreme Court, which resulted in a unanimous decision by the Court.  Our attorneys have handled more than 100 FCA investigations and have a long track record of litigation success.  The firm has more than 30 attorneys with substantive FCA expertise and 20 former Assistant U.S. Attorneys and DOJ attorneys.  Please contact the Gibson Dunn attorney with whom you work, or any of the following: Washington, D.C. F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com) Andrew Tulumello (202-955-8657, atulumello@gibsondunn.com) Joseph D. West (202-955-8658, jwest@gibsondunn.com) Karen Manos (202-955-8536, kmanos@gibsondunn.com) New York Randy Mastro (212-351-3825, rmastro@gibsondunn.com) Jim Walden (212-351-2300, jwalden@gibsondunn.com) Denver Robert C. Blume (303-298-5758, rblume@gibsondunn.com) Jessica H. Sanderson (303-298-5928, jsanderson@gibsondunn.com) Laura Sturges (303-298-5929, lsturges@gibsondunn.com) Dallas Evan S. Tilton (214-698-3156, etilton@gibsondunn.com) Orange County Nick Hanna (949-451-4270, nhanna@gibsondunn.com) Los Angeles Timothy Hatch (213-229-7368, thatch@gibsondunn.com)   © 2009 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 7, 2009 |
2009 Mid-Year FCPA Update

As the inauguration of Barack Obama in January 2009 ushered in a new U.S. presidential administration, things remained business-as-usual for regulators charged with enforcing the Foreign Corrupt Practices Act ("FCPA").  The number of FCPA prosecutions initiated by the Department of Justice ("DOJ") and the Securities and Exchange Commission ("SEC") during the past six months continued the recent explosion of FCPA enforcement activity, and the number of ongoing investigations suggests that this trend will not soon subside.  Beyond the overall trend of increased activity, the first half of 2009 has brought several other interesting FCPA enforcement developments.  In June 2009, two individual criminal defendants opted to try their cases before juries, rather than enter into plea agreements with DOJ, as has been the norm in FCPA cases.  Both trials are currently underway, and the defense bar will be watching closely to see how these defendants fare in the first FCPA trials in nearly five years.  Outside of traditional FCPA enforcement circles, interest in anti-corruption enforcement issues has also increased.  There is legislation pending in Congress that could alter the FCPA enforcement landscape, and the House Financial Services Committee recently held a hearing on combating global corruption.  In addition, the Financial Industry Regulatory Authority ("FINRA"), the self-regulatory organization of the U.S. securities industry, recently announced that FCPA compliance would be one of its primary areas of focus during 2009 examinations, and the New York State Insurance Department similarly indicated its intention to focus on FCPA compliance in future licensee examinations.  Overseas, a number of foreign regulators have recently stepped up their own anti-corruption enforcement activities.  This update provides an overview of the FCPA and a survey of U.S. and foreign anti-corruption enforcement activities during the first half of 2009, as well as a discussion of the trends that we see from that activity and practical guidance to help companies avoid or limit liability under these laws.  A collection of Gibson Dunn’s publications on the FCPA, including prior enforcement updates and more in-depth discussions of the statute’s complicated framework, may be found on our FCPA Website. FCPA Overview The FCPA’s anti-bribery provisions make it illegal to offer or provide money or anything of value to officials of foreign governments or foreign political parties with the intent to obtain or retain business.  The anti-bribery provisions apply to "issuers," "domestic concerns," and "any person" that violates the FCPA while in the territory of the United States.  The term "issuer" covers any business entity that is registered under 15 U.S.C. § 78l or that is required to file reports under 15 U.S.C. § 78o(d).  In this context, the approximately 1,500 foreign issuers whose American Depository Receipts ("ADRs") are traded on U.S. exchanges are "issuers" for purposes of this statute.  The term "domestic concern" is even broader and includes any U.S. citizen, national, or resident, as well as any business entity that is organized under the laws of a U.S. state or that has a principal place of business in the United States. In addition to the anti-bribery provisions, the FCPA’s books-and-records provision requires issuers to make and keep accurate books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the issuer’s transactions and disposition of assets.  Finally, the FCPA’s internal controls provision requires that issuers devise and maintain reasonable internal accounting controls aimed at preventing and detecting FCPA violations.  Regulators have frequently invoked these latter two sections – collectively known as the accounting provisions — in recent years when they cannot establish the elements for an anti-bribery prosecution or as a mechanism for compromise in settlement negotiations.  Because there is no requirement that a false record or deficient control be linked to an improper payment, even a payment that does not constitute a violation of the anti-bribery provisions can lead to prosecution under the accounting provisions if inaccurately recorded or attributable to an internal controls deficiency. 2009 Mid-Year Figures The continuing explosion of FCPA prosecutions is best captured in the following table and graph, which each track the number of FCPA enforcement actions filed by the DOJ and SEC during the past six years.  In just the first six months of 2009, more FCPA prosecutions were brought than in any other full year prior to 2007.  Moreover, the nineteen enforcement actions initiated to date in 2009 exceeds the enforcement activity undertaken during the first half of any prior year, including the sixteen enforcement actions filed during the first half of 2008 and the nine enforcement actions filed during the first six months of 2007.    2004 2005 2006 2007 2008 2009(through June 30) DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC 2 3 7 5 7 8 18 20 20 13 14 5 It is clear that this trend of heightened enforcement activity will not soon subside.  Mark F. Mendelsohn, the Deputy Chief of the Fraud Section in DOJ’s Criminal Division and the government’s top criminal FCPA enforcer, recently confirmed that at least 120 companies are the subject of ongoing FCPA investigations. 2009 Mid-Year Enforcement Docket United Industrial Corp. and Thomas Wurzel On May 29, 2009, United Industrial Corporation ("UIC"), an aerospace and defense systems contractor, settled administrative charges with the SEC alleging violations of the FCPA’s anti-bribery, books-and-records, and internal controls provisions.  The SEC claimed that, in 2001 and 2002, UIC subsidiary ACL Technologies, Inc. ("ACL"), made more $100,000 in payments to an agent with the expectation that the agent would pass portions of those payments to officials of the Egyptian Air Force in order to influence the award of a contract to construct and staff a military aircraft depot in Cairo.  The SEC noted the agent’s position as a retired Egyptian Air Force general, his friendship with a current high-level Air Force official, and the belief within ACL that "it’s a very small community of high-level military people" in Egypt.  The payments to the agent included $50,000 for "marketing services," which were unsupported by any marketing agreement, and $100,000 in "advance" payments to the agent that UIC later forgave through a fraudulent "repayment" plan involving inflated invoices.  Taking UIC’s remedial efforts into account, the SEC issued a cease-and-desist order that required UIC to pay $337,679.42 in disgorgement and prejudgment interest, but it did not assess a civil penalty.  On the same day, Thomas Wurzel, the former president of ACL, settled his own civil charges with the SEC.  Alleging violations of the anti-bribery, books-and-records, and internal controls provisions of the FCPA, the SEC cited numerous e-mails between Wurzel and ACL’s Egyptian agent to establish that Wurzel "knew or consciously disregarded the high probability that the agent would offer, provide or promise at least a portion of [his agency] payments to Egyptian Air Force officials" in order to influence the award of contracts to ACL.  Wurzel consented to the entry of a permanent injunction against future violations of the FCPA and agreed to pay a $35,000 civil penalty.  Juan Diaz and Antonio L. Perez On May 15, 2009, DOJ announced FCPA guilty pleas by the former controller of an unnamed Miami-based telecommunications company and the agent that it used as an intermediary for acquiring contracts with Telecommunications D’Haiti, the Haitian state-owned telephone company and sole provider of landline telephone service to and from the island nation.  The criminal informations charge that, between 2001 and 2003, the defendants authorized and paid bribes to officials of Telecommunications D’Haiti to reduce the amounts owed to the state-owned company, including by reducing per-minute rates and the number of minutes for which payment was owed. Antonio L. Perez, the former controller of the unnamed Miami telecommunications company, pleaded guilty to a one-count information charging him with conspiracy to violate the FCPA’s anti-bribery provision and to commit money laundering.  Perez admitted to personally authorizing more than $36,000 in bribes to Haitian officials, while his co-conspirators within the company, including the President and Executive Vice President, allegedly authorized approximately $675,000 in bribe payments.  Juan Diaz, the President of a shell company that served as an intermediary between the Haitian government and three unnamed Miami-based telecommunications companies, including Perez’s company, likewise pleaded guilty to a two-prong conspiracy count involving the FCPA and the money laundering statute.  Diaz admitted to collecting more than $1 million in "commissions" and "vendor payments" from these three companies, keeping $73,824 for himself and passing the balance to officials of Telecommunications D’Haiti.  As part of his scheme, Diaz structured his transactions to evade the obligation to file currency transaction reports on checks of more than $10,000.  Both Perez and Diaz face up to five years in prison at their respective sentencings, currently scheduled for later this year.  In addition, both have agreed to forfeit to the United States all funds traceable to their violations.  Novo Nordisk A/S In yet another prosecution stemming from the United Nations Oil-for-Food Program, Danish pharmaceutical company Novo Nordisk A/S settled civil and criminal FCPA charges on May 11, 2009.  According to the charging documents, Novo Nordisk paid approximately $1.4 million, and agreed to pay an additional $1.3 million, to the Iraqi government in connection with thirteen contracts that netted the company more than $4.3 million in profits.  The eleventh company to settle FCPA charges arising from the Oil-for-Food Program, Novo Nordisk admitted to inflating its contract submissions to the United Nations escrow account by 10% and to passing the difference to the Iraqi government as "after sales service fee" payments.  The SEC’s complaint alleges that Novo Nordisk violated the FCPA’s books-and-records and internal controls provisions.  To settle those allegations, Novo Nordisk agreed to pay a civil penalty of $3,025,066 and to disgorge $6,005,079 in profits plus prejudgment interest.  To resolve the criminal charges, Novo Nordisk entered into a deferred prosecution agreement with DOJ, agreeing to pay a $9 million criminal fine, and consented to the filing of a criminal information charging the company with conspiracy to commit wire fraud and to violate the books-and-records provision of the FCPA.  Assuming that Novo Nordisk successfully complies with the deferred prosecution agreement’s terms, DOJ will defer prosecution for the agreement’s three-year term and dismiss the charges in 2012.  Numerous Executives of Control Components, Inc. As part of its ongoing investigation of Control Components, Inc. ("CCI"), a California-based manufacturer of service control valves, on April 8, 2009, DOJ indicted six former CCI executives on charges of violating the FCPA’s anti-bribery provision and the Travel Act.  The indictment alleges a conspiracy to cultivate "friends-in-camp" at CCI’s government-owned and private customers worldwide by making corrupt payments to influence these individuals either to award CCI contracts or to influence the technical specifications of competitive tenders to favor CCI.  The defendants charged in this indictment include the following: Stuart Carson – former Chief Executive Officer; Hong "Rose" Carson – former Director of Sales for China and Taiwan; Paul Cosgrove – former Head of Worldwide Sales; David Edmonds – former President of Worldwide Customer Service; Flavio Ricotti – former Head of Sales for Europe, Africa, and the Middle East; and Han Yong Kim – former President of CCI’s Korean office.  The government’s allegations are far-ranging, claiming that the co-conspirators authorized and made 236 payments, totaling approximately $6.85 million, to customers in more than thirty countries to secure contracts for CCI that generated approximately $46.5 million in profits.  Indeed, so expansive are the government’s charges that Stuart Carson’s attorneys successfully moved the Court for a bill of particulars, resulting in DOJ filing a ten-page chart, with endnotes, ostensibly identifying, where known, the dates, beneficiaries, and recipients for each of the 236 allegedly unlawful payments.  Pre-trial litigation continues in this matter, and trial is set to begin on December 8, 2009. The April 2009 indictment followed a February 3, 2009 guilty plea by CCI’s former Finance Director, Richard Morlok, to charges of conspiring to violate the FCPA.  And, in December 2008, former Director of Worldwide Factory Sales Mario Covino also pleaded guilty to FCPA conspiracy charges.  Covino and Morlok are both presently scheduled to be sentenced in July 2009, but look for these dates to move as they continue to cooperate in DOJ’s ongoing investigation.  The company, CCI, has yet to be charged in this matter, although IMI plc, CCI’s parent company, announced on March 4, 2009, that it expects to "reach final agreement in the near future on a settlement with [DOJ] in respect of certain irregular payments by [CCI] that violated the [FCPA]."  IMI’s 2008 preliminary results announcement also noted that an investigation concerning other "possible incidental breaches of US trade law by CCI" has been completed and that the company will "have to deal with a number of collateral issues in other jurisdictions."  Latin Node, Inc. On April 7, 2009, Latin Node, Inc., a Miami-based telecommunications provider, pleaded guilty to criminal FCPA charges filed in connection with allegedly unlawful payments made to government officials in Honduras and Yemen in return for the award of new contracts and the negotiation of favorable terms on existing contracts, including reduced per-minute connectivity rates.  DOJ alleged that, between 2004 and 2007, Latin Node paid approximately $2.25 million in bribes, directly and through intermediaries, to officials at Hondutel and TeleYemen, the state-owned telecommunications companies in Honduras and Yemen, respectively.  Latin Node’s payments came to light after eLandia International, Inc. ("eLandia"), a public telecommunications provider that acquired Latin Node in June 2007, discovered irregularities during its post-acquisition financial integration review.  Within three months of uncovering the suspected misconduct, eLandia voluntarily disclosed the payments to the DOJ and SEC.  eLandia then conducted an extensive internal investigation and took substantial remedial actions, most notably shutting down Latin Node’s business operations at a cost to the company of millions of dollars.  DOJ’s sentencing memorandum makes clear that all of the alleged improper payments were made prior to eLandia’s acquisition, but it also implicitly suggests that eLandia conducted little, if any, FCPA due diligence in connection with its acquisition.  Latin Node, which eLandia maintained as a separate legal entity solely for purposes of resolving the criminal investigation, pleaded guilty to a one-count information charging it with violating the anti-bribery provisions of the FCPA and agreed to pay a $2 million fine.  A corporate guilty plea may well seem a harsh result in light of eLandia’s remediation and the presumed availability of the commonly employed deferred and non-prosecution agreements, but this might well have been eLandia’s choice resolution.  Although corporate entities with ongoing operations typically prefer a deferred or non-prosecution agreement to a guilty plea, eLandia had already ceased Latin Node’s business operations and therefore likely had lesser concerns relating to potential collateral actions, such as debarment proceedings.  Indeed, a deferred or non-prosecution agreement would have entailed substantial future reporting obligations that eLandia may have preferred to avoid.  Halliburton, KBR, Wojciech Chodan, and Jeffrey Tesler On February 11, 2009, Kellogg, Brown & Root LLC pleaded guilty to criminal violations of the FCPA, and Halliburton Co. and KBR, Inc., its former and current parent companies, respectively, settled related civil FCPA charges.  The road that led them there was long and winding, even by FCPA standards. In 1998, Halliburton acquired M.W. Kellogg Co. and merged it with an existing Halliburton subsidiary to form Kellogg, Brown & Root LLC.  At the time of the acquisition, M.W. Kellogg was a member of a four-party joint venture that had allegedly been engaged for several years in the practice of bribing Nigerian officials, through purported consulting payments to two different third-party agents, in return for the award of natural gas pipeline engineering, procurement, and construction ("EPC") contracts.  Halliburton conducted minimal due diligence on the agents, and the payments continued for another six years.  All told, between 1995 and 2004, the joint venture allegedly paid nearly $182 million in consulting fees to the two agents with the expectation that some or all of the payments would be passed along to Nigerian officials.  These unlawful payments allegedly led to the award of $6 billion in contracts to the joint venture, netting approximately $235.5 million in profits to Kellogg, Brown & Root.  To settle the charges, Kellogg, Brown & Root LLC pleaded guilty, paid a $402 million criminal fine, and agreed to retain an independent compliance monitor for a term of three years.  Both Halliburton and KBR settled civil FCPA charges filed by the SEC, agreeing to be held jointly liable for $177 million in disgorgement of ill-gotten gains.  This resolution, both individually at the DOJ and SEC, and in the aggregate, represents the second largest FCPA settlement in the statute’s history, behind only the record-shattering Siemens settlement of 2008.  On February 17, 2009, less than one week after finalizing the Halliburton/KBR settlements, DOJ filed a sealed indictment against two British citizens for their alleged roles in the bribery scheme.  The indictment charges Wojciech Chodan, a former sales vice president for M.W. Kellogg who was retained as a consultant after its acquisition by Halliburton, and Jeffrey Tesler, a U.K. solicitor and agent of the joint venture, with one count of conspiracy and ten substantive counts of violating the FCPA’s anti-bribery provision.  Chodan and Tesler allegedly participated in "cultural meetings" at which the joint venture members agreed to hire two agents to pay bribes to Nigerian officials in order to secure the EPC contracts.  Tesler was retained to bribe top-level officials in the Executive Branch of the Nigerian government, including three successive vice presidents, while a second, as yet uncharged Japanese agent was hired to bribe lower level Nigerian officials.   The Chodan/Tesler indictment was unsealed on March 6, 2009, after London police arrested Tesler at DOJ’s request.  Extradition proceedings have just begun, with Tesler "strongly den[ying] any wrongdoing" and promising a "hotly contested" fight.  Chodan has not yet been arrested, and press reports suggest that he has not been seen recently at his Somerset Village home.  The Halliburton, KBR, Chodan, and Tesler cases follow the 2008 guilty plea by former KBR Chairman and Chief Executive Officer Albert "Jack" Stanley.  Stanley’s sentencing has been delayed as he continues to cooperate in DOJ’s investigation with the hope that DOJ will file a pre-sentencing motion under § 5K1.1 of the U.S. Sentencing Guidelines requesting a reduced sentence due to Stanley’s "substantial assistance in the investigation or prosecution of another person."  Stanley is currently scheduled to be sentenced on August 27, 2009. ITT Corp. On February 11, 2009, the SEC filed a settled civil complaint against global conglomerate ITT Corporation, alleging violations of the FCPA’s books-and-records and internal controls provisions.  The SEC’s complaint alleges that, from 2001 to 2005, ITT’s Chinese subsidiary, Nanjing Goulds Pumps, Ltd. ("NGP"), paid approximately $200,000 to officials at Chinese state-owned entities that designed the specifications for large infrastructure projects on which NGP was a bidder.  The payments, which were allegedly transmitted directly by NGP and through NGP’s third-party agents, were tendered for the purpose of influencing the officials to formulate bid specifications that would favor NGP’s products.  NGP then allegedly improperly recorded the payments to the government officials as "commissions" in its corporate ledger, which was then consolidated into ITT’s financial statements at year end.  Upon discovering the potentially unlawful payments, ITT voluntarily disclosed the payments to the government.  Without admitting or denying the allegations, ITT agreed to pay a $250,000 civil penalty and to surrender $1,428,650 in disgorgement of profits and prejudgment interest.  DOJ has not yet filed any charges against ITT, and it remains unclear whether any criminal prosecution will be brought.  2009 Mid-Year Sentencing Docket In addition to the settlements described above, on April 7, 2009, Shu Quan-Sheng, who pleaded guilty to violating the FCPA and the Arms Export Control Act in November 2008, was sentenced to fifty-one months incarceration followed by two years of supervised release.  This sentence is demonstrative of the significant periods of incarceration that may follow from an FCPA conviction. Ongoing Criminal Litigation Throughout more than three decades of FCPA enforcement, only a handful of defendants charged with criminal violations of the statute have opted to take their cases before a jury rather than settle before trial with DOJ.  Indeed, coming into this year, the most recent FCPA trial occurred nearly five years ago, with the fall 2004 prosecution of David Kay and Douglas Murphy.  But, with the significant uptick in FCPA enforcement, trials are beginning to line up for the next several years.  DOJ’s recent focus on individual defendants, who face a much different calculus in weighing their settlement options due to the prospect of incarceration, appears to be driving this trend.  As we go to press with this publication, two FCPA cases are currently in trial, and verdicts will soon follow.  Frederic Bourke Trial For years, we have been reporting on the winding progress in the prosecution of Frederic Bourke.  First indicted in 2005 along with alleged co-conspirators Victor Kozeny and David Pinkerton, Bourke is presently on trial in the U.S. District Court for the Southern District of New York for conspiring to bribe senior Azeri government officials, including the nation’s former President, to influence these officials to privatize Azerbaijan’s state-owned oil company ("SOCAR").  Specifically, Bourke is alleged to have invested $8 million with Kozeny, while knowing that Kozeny was paying millions of dollars in bribes to Azeri officials and had promised these officials a two-thirds share of the profits from the privatization effort.  Bourke stands alone in this trial, with Pinkerton having been dismissed from the case in the wake of a significant statute-of-limitations decision in 2008 by Judge Shira Scheindlin and Kozeny remaining a fugitive in the Bahamas, which has refused U.S. extradition requests.  In the months leading up to the June 1, 2009 trial date, both DOJ and Bourke continued to aggressively litigate against each another.  On May 26, DOJ filed a second superseding indictment, dismissing the substantive FCPA count against Bourke and foreshadowing that the government would focus on Bourke’s knowledge of (or willful blindness to) the alleged corrupt payments, rather than his facilitation of the payments themselves.  Just three days later, Judge Scheindlin issued a significant evidentiary ruling permitting DOJ to introduce background evidence relating to corruption in Azerbaijan.  Judge Scheindlin held that evidence demonstrating that (i) Azerbaijan was widely known to be a corrupt nation, (ii) post-Communism privatization efforts in other states had been tainted by corrupt practices, and (iii) Kozeny was notoriously known as the "Pirate of Prague" due to alleged prior corrupt dealings arising from privatization efforts in the Czech Republic, all made it more probable that Bourke was aware that Azeri officials were being bribed in connection with the SOCAR privatization effort.  Further, Judge Scheindlin ruled that DOJ could present evidence that Bourke’s alleged co-conspirators, with whom he had substantial direct contacts, were aware of corruption in Azerbaijan in order to demonstrate that Bourke likely also had such knowledge.  On June 2, 2009, DOJ Attorney Robertson Park opened the government’s case before the jury by stating:  "This is a case about money – lots of it.  This is a case about bribes.  This is a case about lies."  As the opening statements for each side unfolded, it became clear that a central piece of evidence in the case would be a tape-recorded conversation between Bourke and his attorney in which Bourke can be heard to ask, if he learned that Kozeny was bribing government officials in Azerbaijan, "What are you going to do with that information? …  You got knowledge of it.  What do you do with that?"  DOJ characterized these statements as evidence that Bourke knew of, or was willfully blind to, the bribery scheme.  But the defense, which itself turned the tape over to DOJ during proffer negotiations, claimed that the tape is "the best piece of evidence in the case of Mr. Bourke’s innocence," because it shows that Bourke took his concerns about Kozeny to his attorneys so that he would not break the law.  After three weeks of testimony from more than a dozen witnesses, the prosecution rested its case on June 26.  The two star witnesses for the prosecution were Hans Bodmer and Thomas Farrell, a former attorney and aide to Kozeny, respectively, who each have pleaded guilty to their own FCPA violations and were testifying as cooperating witnesses for the government.  Bodmer and Farrell both testified that they told Bourke that Kozeny was using the investments he raised to bribe Azeri officials, but the defense countered with its own witnesses undercutting their recitation of events and affirmatively testifying that, although Bourke knew that Azeri officials had financial interests in the privatization scheme, Bourke had been told that the officials had paid for their stake and that the arrangement had been blessed by their lawyers.  The defense rested on June 30, electing not to call Bourke to testify on his own behalf.  One highlight of the defense was more than four hours of testimony from former Democratic Senate Majority Leader and current Special Envoy to the Middle East, George Mitchell.  Mitchell, a friend of Bourke’s, testified that he personally lost approximately $200,000 when the SOCAR privatization investment that Bourke had recommended to him failed, but that Bourke never suggested to him that bribes were being paid to ensure that the deal succeeded.  Closing arguments began on July 6, with DOJ concurrently putting forward two theories of its case.  First, relying principally on the testimony of Bodmer and Farrell, prosecutors argued that Bourke actually knew of the alleged conspiracy to bribe Azeri officials.  And second, as an alternative theory, the government argued that Bourke "stuck his head in the sand" and "consciously avoided" the "high probability" that his co-investors were paying bribes (the FCPA provides that knowledge of improper payments may be established by evidence that the defendant was "aware of a high probability of the existence of [the payments]").  Bourke’s defense team is scheduled to deliver its summation on July 7, and the jury should see the case before the week is out.  William Jefferson Trial On June 9, 2009, just one week after the first FCPA trial in nearly five years began, a second FCPA trial kicked off before U.S. District Court Judge T.S. Ellis in the Eastern District of Virginia with the long-awaited trial of former U.S. Congressman William Jefferson.  Jefferson faces a sixteen-count indictment alleging nearly a dozen distinct bribery schemes in which Jefferson variously plays the role of briber and bribee.  With respect to the FCPA, Jefferson is charged with substantive and conspiracy counts alleging that he attempted to bribe then-Nigerian Vice President Atiku Abubakar to induce favorable regulatory action for iGate, Inc., a Kentucky-based technology company for which Jefferson was acting as an agent.  A cooperating witness allegedly provided Jefferson with $100,000 in marked bills for ultimate delivery to Abubakar, $90,000 of which agents of the Federal Bureau of Investigation ("FBI") recovered from Jefferson’s freezer during a 2005 raid of his Virginia home.  Other evidence to come out at trial includes an allegation that Jefferson accepted $100,000 in bribes from Abubakar in return for introducing him to other congressmen so that Abubakar could build political contacts to support his bid for the Nigerian presidency.  As we go to publication, the government’s case continues with the fourth week of prosecution testimony.  Pre-trial litigation in the Jefferson case illustrates how it can be quite difficult for defendants to obtain foreign-based testimony and documentary evidence.  Several months before his trial began, Jefferson sought a court order requiring the U.S. government to invoke its Mutual Legal Assistance Treaty ("MLAT") with Nigeria to secure a deposition of Abubakar and Suleiman Yahyah, another alleged Nigerian co-conspirator.  Judge Ellis denied Jefferson’s request, holding that the MLAT process is available only to its signatories and cannot be invoked by private parties.  As an alternate route, Jefferson asked the Court to issue letters rogatory to secure deposition testimony from Abubakar and Yahyah.  Noting that such a request requires "exceptional circumstances" not present in this case due to the likelihood that the alleged co-conspirators would invoke their Fifth Amendment right not to testify, the Court instead issued only a preliminary letter rogatory seeking Nigerian judicial assistance in questioning Abubakar and Yahyah about their willingness to waive their Fifth Amendment rights.  After several months of silence from Nigerian judicial authorities, the Court ultimately directed the government to withdraw the preliminary letter rogatory, meaning that Jefferson will not have the testimony of either party available for his defense.  Other Ongoing Criminal Litigation Other post-indictment FCPA matters currently set for trial in 2009-2010 include the following:  Defendant(s) Allegations Mid-Year 2009 Developments Trial Date (Venue) Gerald Green Patricia Green The husband and wife film producers are accused of paying more than $1.7 million in bribes to a senior official with the Tourism Authority of Thailand in exchange for at least $14 million in contracts to administer a film festival and to market an "elite privilege card" to wealthy foreigners.   The 9th Circuit dismissed an appeal from the District Court ordering the Greens’ attorney to testify before a grand jury because the attorney had not yet submitted to a contempt citation, and, alternatively, in camera review provided a basis for concluding that the communications at issue were subject to the crime-fraud exception to the attorney-client privilege. DOJ filed a second superseding indictment, adding a 22nd count alleging that Gerald Green sought to alter and falsify business records to disguise the bribe payments after learning of the FBI’s investigation.  Aug. 4, 2009(C.D. Cal.) Paul Novak James Tillery The former President (Tillery) and consultant (Novak) of Willbros International are accused of conspiring to pay more than $6 million in bribes to Nigerian government officials in return for the award of more than $380 million in gas pipeline contracts and agreeing to make an additional $300,000 in corrupt payments to officials of the Ecuadorian state oil company in return for the award of a $3 million gas pipeline project.    Multiple continuances to facilitate discovery, including interviews in foreign jurisdictions, in the Novak prosecution.  Tillery remains a fugitive. Aug. 10, 2009(S.D. Tex.) Leo Winston Smith The former Director of Sales and Marketing of Pacific Consolidated Industries is accused of paying more than $300,000 to secure U.K. Ministry of Defense contracts.  Trial date continued. Sept. 29, 2009(C.D. Cal.) Nexus Technologies Joseph Lukas An Quoc Nguyen Kim Anh Nguyen Nam Quoc Nguyen   The export company and its executives are all accused of bribing Vietnamese officials to influence purchases of a wide variety of equipment and technology, including underwater mapping equipment, bomb containment equipment, helicopter parts, chemical detectors, satellite communication parts, and air tracking systems. Lukas pleaded guilty to FCPA conspiracy charges on June 29, 2009.  His sentencing is currently scheduled for April 2010.  The Court ordered DOJ to "work out the declassification and production of documents" to the remaining defendants by September 18, 2009. Mar. 1, 2010(E.D. Pa.) Collateral Civil Litigation Much as individuals implicated in foreign bribery schemes are increasingly finding themselves targeted for prosecution, companies unfortunate enough to find themselves under investigation by the DOJ and SEC are increasingly finding themselves embroiled in follow-on private civil litigation.  Although the FCPA does not provide for a private right of action, enterprising plaintiffs’ lawyers have not been deterred from shoehorning alleged FCPA violations into a variety of civil causes of actions that do provide for private redress, including securities fraud actions, shareholder derivative suits, contract claims, and tort claims.  On the other side of the coin, some corporate defendants in government enforcement actions have brought suit against the individuals responsible for those violations. Securities Fraud Actions The protracted securities fraud litigation initiated in 2004 against the former executives and the controlling shareholder of UTStarcom, Inc., gathered momentum in the early months of 2009.  Among the numerous claims, the plaintiff-shareholders allege that UTStarcom knowingly violated the FCPA by bribing officials in China, Mongolia, and India to secure contracts, ultimately forcing the company to restate its financial results and leading to joint DOJ/SEC investigations.  In March 2009, the U.S. District Court for the Central District of California denied the defendants’ motion to dismiss the plaintiffs’ fourth amended complaint, leading the Court to finally set a class certification hearing for September 21, 2009.  Additionally, the Court outlined a schedule for pre-trial motions and discovery continuing through the latter part of 2010. Shareholder Derivative Suits Perhaps no company better exemplifies the myriad pains that can accompany an FCPA investigation than FARO Technologies, Inc. ("FARO").  In 2009, FARO appears finally to have closed the book on the legal actions stemming from its alleged improper payments to Chinese government officials.  As originally reported in our 2008 Mid-Year FCPA Update, FARO settled FCPA charges in June 2008 with the DOJ and SEC, immediately after settling a § 10(b) suit with investors, who alleged that the company knowingly or recklessly attested to the adequacy of its internal controls, when it knew that they were inadequate.  As if this series of settlements was not enough, in April 2009, FARO settled a shareholder derivative lawsuit alleging that its officers and directors breached their fiduciary duties by failing to properly oversee the company’s internal activities.  The shareholder derivative settlement mandates the implementation of certain corporate governance changes at FARO and the payment of $400,000 in plaintiffs’ attorneys’ fees.  Personifying the axiom that crime doesn’t pay, FARO has now shelled out more than $10.2 million in criminal and civil settlements, not including its own attorneys’ fees or the costs of remedial measures, arising from roughly $450,000 in allegedly improper payments that netted it less than $1.9 million in profits.  The defendants in two other shareholder derivative lawsuits arising from settled FCPA enforcement actions fared somewhat better than FARO in 2009.  On May 26, 2009, Judge Vanessa Gilmore of the U.S. District Court for the Southern District of Texas dismissed a derivative claim filed by the Midwestern Teamster Pension Trust Fund on behalf of Baker Hughes, Inc., against twenty-five current and former directors.  Originally filed in June 2008, the lawsuit alleged that the company’s directors breached their fiduciary duties by not ensuring adequate oversight of Baker Hughes’s FCPA and Exchange Act compliance efforts.  Under Delaware law, a plaintiff filing a derivative claim must, with few exceptions, initially request that the Board of Directors bring the lawsuit on behalf of the corporation.  Judge Gilmore held that the exceptions did not apply in this case and that Baker Hughes’s Board was improperly denied the opportunity to decide whether the corporation should seek redress from its current and prior directors.  She therefore rejected the plaintiff’s demand futility argument and dismissed the claim because of the plaintiff’s failure to make an initial demand on the Board. Similarly, on March 10, 2009, Superior Court Judge David Flynn dismissed a 2007 derivative lawsuit filed in California state court on behalf of Chevron Corporation.  The plaintiffs originally filed the complaint after media reports described a then-pending FCPA settlement arising from Chevron’s participation in the United Nations Oil-for-Food Program.  But rather than dismiss the plaintiffs’ complaint, the Court instead treated the claim as a formal demand on Chevron’s Board of Directors to investigate whether a claim should be brought.  That challenge was accepted, with the Board appointing a special investigative committee to investigate the allegations, including by interviewing thirty-four witnesses and reviewing more than 150,000 pages of evidence.  After reviewing the results of the rigorous inquiry, the Board determined that a lawsuit would not be in Chevron’s best interest.  A board’s refusal to pursue a legal claim, after an initial demand is made, is protected by the business judgment rule under Delaware law.  A plaintiff can only overcome this obstacle in rare instances in which there is reasonable doubt about whether the board acted in good faith, with independence, or in a thorough manner.  Judge Flynn found that the plaintiffs offered little evidence that Chevron’s Board acted improperly in refusing to bring a lawsuit and therefore dismissed the derivative claim. Litigation surrounding two other recently filed derivative lawsuits arising from potential FCPA violations is ongoing.  On April 8, 2009, a shareholder filed a derivative action in the District of Massachusetts against BG Group P.L.C.’s current directors.  The complaint alleges that BG Group participated in a consortium of large oil companies that made at least $90 million in payments to Kazakh officials to secure oil and gas drilling opportunities in violation of the FCPA and other laws.  The plaintiff-shareholder further claims that BG’s Board wasted corporate assets when it later sold the company’s interest in this consortium for a fraction of its true market value.  And on May 14, 2009, three months after settling FCPA claims with the DOJ and SEC, numerous current and former directors of Halliburton and KBR found themselves named as defendants in a Texas state derivate suit filed by the Policemen and Firemen Retirement System of the City of Detroit.  The lawsuit alleges that the defendants breached their fiduciary duties by failing to oversee the companies’ operations, citing the FCPA settlement, alleged illegal exports to Libya, over-billing on government contracts in Iraq, hazardous waste dumping, and impermissible business with Iran.  The plaintiff further asserts that making a demand upon either company’s board of directors would be futile and, thus, should be excused.  On June 19, 2009, the defendants filed a notice of removal to the U.S. District Court for the Southern District of Texas. Lawsuits Brought by Foreign Governments and Business Partners As reported in our 2008 Mid-Year FCPA Update, on June 21, 2008, the Republic of Iraq filed suit in Manhattan federal district court against ninety-one companies and two individuals, alleging that the defendants conspired with Saddam Hussein’s regime to corrupt the United Nations Oil-for-Food Program by diverting as much as $10 billion in funds intended for the humanitarian use of the Iraqi people to the illicit use of Hussein’s government.  After a long period of stagnation, during which the Iraqi government sought and received continuances to effect service on the many defendants, this action picked up steam in February 2009, with Iraq applying to the Court to issue letters rogatory to courts in Austria, Jordan, Malaysia, South Africa, and the United Arab Emirates to effect services on numerous of the foreign defendants.  Since then, attorneys for more than fifty of the defendants have appeared in the case, and Judge Gerald Lynch has set a motion to dismiss briefing schedule that runs into February 2010.  Litigation continues in the previously reported civil dispute pitting Supreme Fuels Trading FZE ("Supreme Fuels") against its competitor, International Oil Trading Co. ("IOTC").  A civil claim filed by Supreme Fuels in October 2008 alleges that IOTC bribed Jordanian officials to receive the only license for transporting fuel through the country to Iraq.  IOTC filed a motion to dismiss the lawsuit on March 13, 2009, and Supreme Fuels has requested that the court schedule oral arguments on the motion.  The trial in this matter is tentatively set to begin on January 11, 2010, in the U.S. District Court for the Southern District of Florida. Discovery proceeded during the first half of 2009 in Argo-Tech Corporation’s civil case against Yamada Corporation and its subsidiary, Upsilon International Corporation.  Yamada served as an authorized distributor of Argo-Tech’s fuel pumps and related equipment, as well as the products of many other defense contractors.  A Japanese government investigation launched in 2007 uncovered evidence suggesting that Yamada bribed a Vice Defense Minister and fraudulently over-billed the Japanese Ministry of Defense for equipment.  Argo-Tech alleges that Yamada’s unlawful acts, including FCPA violations, breached its distributorship contract.  The complaint seeks damages resulting from the breach and attorneys’ fees.  The U.S. District Court for the Northern District of Ohio recently extended discovery into early 2010 and intends to refer the case to mediation during the summer of 2009. Lawsuits Filed by Companies That Have Settled FCPA Actions In a legal battle certain to be repeated in the coming years, given the government’s increasingly aggressive stance in successor liability FCPA actions (as discussed below), eLandia filed suit in June 2008 in Florida state court against Retail Americas VoIP, LLC, Latin Node’s former parent company, and Jorge Granados, the former Chief Executive Officer of Latin Node.  eLandia alleged breach of contract, breach of the obligation of good faith and fair dealing, and fraudulent inducement in connection with the defendants’ failure to disclose during acquisition due diligence information concerning the improper payments that ultimately led to Latin Node’s post-closing FCPA conviction.  On February 12, 2009, the defendants settled the matter, agreeing to return 375,000 of the 3.2 million shares of eLandia stock that they had received in connection with the acquisition.  There has been little movement thus far in 2009 on the December 2008 civil claim filed by Willbros International, Inc. ("Willbros"), in the U.S. District Court for the Southern District of Texas, against several former executives and consultants.  Willbros pleaded guilty to violating the FCPA in 2008 and now alleges that the defendants were responsible for the unlawful conduct.  Of the five defendants named in the lawsuit, only Paul Novak has responded, and he is currently embroiled in a parallel criminal proceeding stemming from the same acts.  The Court is currently considering Novak’s motion to dismiss.  No trial date has yet been scheduled. International Anti-Corruption Enforcement Activities As the DOJ and SEC have accelerated FCPA prosecutions, governmental authorities in a number of other countries have likewise stepped up their own anti-corruption enforcement efforts.  This internationalization of the fight against graft has resulted in an increasing pace of prosecutions for violations of foreign anti-corruption laws and further fostered cooperation between U.S. regulators and their foreign counterparts.  And yet, despite the increasingly global focus on combating corruption, international anti-corruption watchdog Transparency International is not prepared to rest.  In its fifth annual progress report on member states’ adherence to the Organisation for Economic Cooperation and Development Convention on Combating Bribery of Foreign Public Officials in International Business Transactions ("OECD Convention"), Transparency International makes the case that there is still much progress to be made in the fight against international graft.  Never afraid to name names, Transparency International categorized the enforcement efforts of thirty-six of the thirty-eight OECD member states, finding that twenty-one are engaged in "little or no enforcement."  Only four nations were classified as actively enforcing the OECD Convention, while eleven countries moderately enforce the Convention.    Developments Across the Pond On January 8, 2009, the British Financial Service Authority ("FSA") announced a settlement with London-based reinsurer Aon Ltd.  According to the FSA, between 2005 and 2007, Aon made nearly $7 million in payments to multiple firms and individuals as a consequence of the company’s alleged failure "to properly assess the risks involved in its dealings with overseas firms and individuals who helped it win business."  In announcing the £5.25 million fine, the highest ever imposed by the nongovernmental U.K. financial regulator, FSA Director Margaret Cole noted that the action "sends a clear message to the U.K. financial services industry that it is completely unacceptable for firms to conduct business overseas without having in place appropriate anti-bribery and corruption systems and controls."  But the FSA was also clear in commending Aon’s current management for identifying the past issues and substantially improving upon the firm’s systems and controls, an approach that the regulator called "a model of best practice that other firms may wish to adopt."  In accordance with FSA settlement procedures, the company’s substantial cooperation and early agreement to settle qualified it for a 30% discount on what would otherwise have been a £7.5 million fine.  Coupled with the U.K. Serious Fraud Office’s ("SFO") £2.25 million settlement with Balfour Beatty plc in 2008, described in our 2008 Year-End Update, the Aon settlement suggests that British authorities are seeking to put behind them their reputation for lax anti-corruption enforcement.  And they may receive some assistance from Parliament in the near future.  On March 25, 2009, the U.K. Ministry of Justice introduced draft legislation to modernize and tighten anti-bribery laws in the U.K.  The bill, offered in response to sharp criticism by the OECD, contains several important changes to the U.K.’s foreign and domestic anti-bribery laws, including the creation of a new, stand-alone offense for bribing foreign officials, the extension of British anti-bribery law to cover foreign nationals living and working in the U.K., and the creation of a corporate offense of negligently failing to prevent bribery.  Similar legislative reforms may be needed in France, according to a report published on March 12, 2009, by the Group of States Against Corruption ("GRECO").  GRECO, established in 1999 by the Council of Europe to monitor member states’ anti-corruption efforts, explained, "France has severely restricted its jurisdiction and its ability to prosecute cases with an international dimension, which, given the country’s importance in the international economy and the sale of many of its companies, is very regrettable."  According to the report, anti-corruption offenses committed outside of France can be investigated by French officials only "at the request of the state prosecution service and must be preceded by a complaint from the victim or his or her beneficiaries, or an official report by the authorities of the country where the offense was committed."  Moreover, French prosecutors also lack the power to prosecute foreign companies that have bribed French public officials abroad. The report stands in stark contrast to a decision handed down by the most senior French investigating judge, Françoise Desset, on May 7, 2009.  In his decision, Judge Desset ruled that a case brought by the French chapter of Transparency International could proceed, demanding that French authorities investigate how three African presidents acquired a large amount of expensive French real estate.  Transparency International hopes that the investigation "will uncover the truth about the origin of the contested assets, and eventually lead to the concrete implementation of the right to restitution – a fundamental principle of the United Nations Convention against Corruption," which France ratified in 2005.  Elsewhere in Europe, German authorities are following their blockbuster 2007 and 2008 settlements with Siemens AG, described in our 2008 Year-End Update, with another substantial corruption investigation concerning MAN AG.  The Munich Public Prosecutor’s Office is investigating allegations that MAN paid approximately €14 million in bribes to customers between 2002 and 2005 to secure business.  More than 300 police personnel are reported to be involved in the investigation of the company and more than 100 individuals.  MAN has announced that it is fully cooperating with prosecutors, and it has promised to terminate any employees involved in the corruption and to share the results of the internal investigation with prosecutors.  Rounding out European enforcement efforts, on June 26, Danish authorities announced settlements with seven different companies arising from their alleged payment of after-sales-service fees to the Government of Iraq in connection with the United Nations Oil-for-Food Program.  Collectively, the companies agreed to disgorge $8.4 million in profits.  Among the defendants was Novo Nordisk, which disgorged $5.6 million in profits to Danish authorities after settling the above-described joint DOJ/SEC enforcement actions filed earlier this year.  Developments in Asia Not to be outdone by their counterparts in Europe, anti-corruption enforcement authorities in Asia have also recently stepped up their fight against international graft.  On January 29, 2009, Tokyo-based consulting company, Pacific Consultants International, and three of its former executives, were convicted in a Japanese court of bribing a senior Vietnamese official to secure contracts for road projects backed by Japanese aid money.  The executives admitted at trial to paying $820,000 in bribes to a senior transport official in Ho Chi Minh City.  After the conviction and issuance of a ¥70 million fine, however, the judge suspended the sentences of all three convicted men, a common result for white-collar criminals in Japan who admit the allegations against them.  The convictions represent Japan’s first foreign bribery prosecution.  As a result of the Pacific Consultants investigation, Japan suspended all aid to Vietnam, including low-interest loans for infrastructure projects.  In response, Vietnamese officials arrested the alleged recipient of the bribes for "abuse of power" and asked Japan, the country’s largest source of aid, to resume the loan program.  The Japanese Ministry of Foreign Affairs has announced its intention to do so.  Prosecutors in Bahrain are in the midst of an investigation concerning $8.7 million in bribes allegedly paid by the Sojitz Group, a large Japanese commodities-trading firm, to two employees of Aluminum Bahrain BSC ("Alba"), Bahrain’s state-operated aluminum producer.  Affiliates of Sojitz Group and Swiss commodities trader Glencore International AG are alleged to have made the improper payments, between August 1998 and April 2004, in exchange for negotiated discounts on the purchase of aluminum.  State prosecutors filed money-laundering charges against the two Alba employees in March 2009.  And, according to news reports, Glencore has agreed to pay Alba more than $20 million in connection with a settlement of Alba’s internal probe into the payments. Legislative Anti-Corruption Developments In Congress, the first six months of 2009 have seen the reintroduction of legislation that would create a private right of action under the FCPA and a hearing before the Financial Services Committee of the U.S. House of Representatives that suggests that Congress may be interested in adopting stricter anti-corruption legislation. In an effort to level the playing field between firms subject to the FCPA and their foreign competitors not subject to the same stringent levels of anti-corruption scrutiny, Representative Ed Perlmutter (D. Colo.) reintroduced H.R. 2152, The Foreign Business Bribery Prohibition Act.  Similar to the proposed legislation of the same name that Representative Perlmutter introduced in 2008, the bill would create a private right of action enabling individuals and entities subject to the FCPA to sue foreign concerns not subject to the statute for actions that would be FCPA violations if the jurisdictional element of the statute were satisfied.  Successful plaintiffs would be awarded treble damages for the value of any contract that they had lost because of the defendants’ corrupt practices or for the value of any contract that the defendants thereby gained.  Because the bill implicates issues under the jurisdiction of both the House Judiciary Committee and the House Energy and Commerce Committee, portions of it were assigned to each committee in April 2009.  Although the 2008 bill never received much attention, the 2009 bill was mentioned during the House Financial Services Committee hearing described below as one possible way to discourage foreign corruption.  Neither committee has held any hearings specifically considering the bill, however, and no immediate action is expected.  Nevertheless, Representative Perlmutter’s Office continues to solicit comments and suggestions on the proposal. On May 19, 2009, the House Financial Services Committee held a hearing regarding "Capital Loss, Corruption and the Role of Western Financial Institutions."  During that hearing, the Committee members heard impassioned pleas for greater international anti-corruption cooperation from the representatives of nongovernmental organizations and former top-level law enforcement officials of Nigeria and Romania.  The witnesses’ chief concern was the huge transfer of wealth, which one witness claimed to be between $850 billion and $1 trillion per year, from developing nations to developed countries in the form of illicit money transfers, the use of tax havens, and graft by local officials invested in developed countries.  Nuhu Ribadu, the former Chief of Nigeria’s Economic and Financial Crimes Commission who obtained more than 275 corruption convictions and was the target of two assassination attempts, testified, "In a globalized and networked world, we all need to believe that the fight against corruption must assume a transborder dimension."  He then asked that Congress "push the boundaries of the [FCPA] to be expanded … to bite both givers and takers of bribes" and proposed "that Congress support civil society monitoring programs and direct support for programs building investigative journalism, which can support transparency and anti-corruption efforts."  Similarly, Anthea Lawson of Global Witness urged the Committee to consider legislation requiring banks to know the identity of the beneficial owners of accounts and to take steps to ensure that the funds that they accept are not the fruits of government corruption.  And Raymond Baker of Global Financial Integrity called for the creation of an international database of "Politically Exposed Persons," whose transactions would be subject to particular scrutiny because of their political power and opportunities for corrupt behavior. Although no formal legislative proposals have yet emerged from the hearing, it is clear that Committee Chairman Barney Frank (D. Mass.) intends to pursue concrete legislative action:  "I will reiterate that we have the entire legislative jurisdiction in this committee and it is our intention to move legislation, so I thank the witnesses.  You are helping us with a process that we think is going to result in better law." Regulatory Anti-Corruption Developments Complementing the heightened enforcement and legislative focus on the FCPA, on March 9, 2009, FINRA sent out its 2009 Examination Priorities Letter to broker-dealers and other financial services firms outlining the areas on which the self-regulatory organization intends to focus during its 2009 routine examinations, including FCPA compliance.  More generally, the letter suggests that the financial services industry may be the subject of increasingly FCPA scrutiny.  Accordingly, firms subject to FINRA’s examination authority should take steps to assess the effectiveness of their anti-corruption compliance programs and implement any required enhancements prior to undergoing a FINRA examination.  And, on June 29, 2009, New York’s then-Insurance Superintendent, Eric Dinallo, issued Circular Letter No. 11 (2009), admonishing all companies subject to his state’s insurance regulations to "assess their business models and circumstances to determine the extent to which they should formulate or revisit their policies to ensure proper compliance" with the FCPA and various other federal laws.  Dinallo warned that in future examinations, his Department "may make limited inquiry into a licensee’s compliance function to assess how well the licensee takes into consideration the risks of money laundering, bribery of foreign persons, and recognition of federal economic sanctions, … [including by] specifically ask[ing] the members of a licensee’s senior most governing body or senior management about those policies."  Avoiding Successor Liability through Acquisition Due Diligence For years now, we have consistently emphasized the perils associated with failure to conduct adequate pre-acquisition FCPA due diligence.  In recent years, the DOJ and SEC have frequently addressed this topic in public speeches and have initiated multiple enforcement actions against companies that merged with or acquired entities that had paid bribes.  Indeed, three of the five corporate FCPA enforcement actions filed during the first half of 2009 implicate successor liability issues.  The Latin Node case is the first FCPA enforcement action ever filed based entirely on pre-acquisition conduct that was unknown to the acquirer when the transaction closed.  As described above, eLandia appears to have conducted little, if any, FCPA due diligence in connection with its acquisition of Latin Node, discovering the alleged unlawful payments only after the acquisition closed.  Sufficient pre-acquisition due diligence could possibly have enabled eLandia to avoid purchasing an entity that it subsequently had to shut down, at great expense to the business, not to mention the attendant headache of the government enforcement action.    The Halliburton/KBR settlement further highlights the substantial penalties that companies may face if they fail to conduct adequate pre-acquisition due diligence and then follow up with targeted post-integration FCPA reviews (which, in the Latin Node case, at least prevented the problem from growing on eLandia’s watch).  As described above, Halliburton did not know about M.W. Kellogg’s participation in a joint venture that was making unlawful payments because it did not conduct FCPA due diligence prior to acquiring the company.  Subsequently, it did not implement an effective compliance program in the newly formed subsidiary or conduct sufficient due diligence on M.W. Kellogg’s legacy operations or agents.  Consequently, the unlawful conduct continued long after the acquisition, and both Halliburton and KBR were subjected to FCPA enforcement actions and more than $575 million in fines and disgorgement.  UIC‘s2009 civil settlement with the SEC also implicates the assessment of successor liability.  By the time of UIC’s settlement, the company had been acquired by Textron, Inc.  But Textron was on notice of the FCPA investigation due to UIC’s pre-acquisition public filings, and thus was able to factor any attendant liability into the purchase price.  Textron was then mentioned only as a footnote to the UIC settlement documents, making clear that the improper payments occurred entirely prior to the acquisition.  The topic of successor liability is one that U.S. authorities have often discussed publicly, providing some guidance to companies considering international mergers or acquisitions.  Most recently, in September 2008, Mendelsohn stated at an FCPA Conference in Washington, D.C. that the "nature and quality" of pre-acquisition due diligence is "one of the most critical factors" DOJ considers when making charging decisions in the context of a merger or acquisition.  If a company is unable to conduct effective pre-merger due diligence, Mendelsohn noted that DOJ expects the acquirer to move "aggressively and quickly" post-acquisition to investigate high-risk areas.  Although he declined to establish a specific timeline, he advised that waiting a full year to look for and remediate FCPA issues would be inadequate.  And in 2007, then-Assistant Attorney General Alice Fisher described the specific steps that DOJ expects companies to take when conducting effective pre-acquisition FCPA due diligence.  In prepared remarks delivered at a 2007 FCPA Conference, Fisher set forth the following five pieces of information that an acquirer should know, at a minimum, about a potential target: The extent to which the company’s customers are government entities, including state owned companies; Whether the company is involved in any joint ventures with government entities; What government approvals and licenses the company needs to operate abroad, how it obtained them, and when they require renewal; The company’s requirements relating to Customs in foreign countries and how it fulfills those requirements; and The company’s relationships with third party agents or consultants who interact with foreign officials on the company’s behalf, including how those agents were chosen and vetted by the company. Advising that "an acquiring company should be comfortable that it has assessed [these five] risks before closing a deal," Fisher further noted: If any of these due diligence exercises result in the discovery of a potential FCPA problem, we, of course, encourage the company to voluntarily disclose that problem to the Department.  If a company does not conduct some sort of due diligence, and it finds out a year later that the conduct has continued, the Department will want to know why there wasn’t any effort to assess whether there had been criminal conduct? Accordingly, the quality of an acquirer’s pre-acquisition due diligence efforts and voluntary disclosure of any potential FCPA issues uncovered during that process may influence the government’s position regarding successor liability in the FCPA context.  For additional guidance on the topic of acquisition due diligence, please see the article by F. Joseph Warin, et al., Acquisition Due Diligence: A Recipe to Avoid FCPA Enforcement, TEXAS STATE BAR OIL, GAS & ENERGY RESOURCES LAW SECTION REPORT 2 (June 2006). Conclusion The number of recent enforcement actions and ongoing investigations suggests that the heightened FCPA enforcement environment that we have observed over the past several years is here to stay.  This increased enforcement activity has created an ever-changing anti-corruption enforcement landscape, and we anticipate that new developments in enforcement and compliance will continue to emerge in the coming years.  It is essential that companies with international operations stay abreast of these developments to avoid running afoul of the FCPA and to address effectively any potential corruption issues.  Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. We have more than 20 attorneys with substantive FCPA expertise. Joe Warin, a former federal prosecutor, currently serves as a compliance consultant pursuant to a DOJ and SEC enforcement action and as FCPA counsel for the first non-U.S. compliance monitor. The firm has 20 former Assistant U.S. Attorneys and DOJ attorneys. Please contact the Gibson Dunn attorney with whom you work, or any of the following: Washington, D.C. F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com)  Daniel J. Plaine (202-955-8286, dplaine@gibsondunn.com) Judith A. Lee (202-887-3591, jalee@gibsondunn.com) David P. Burns (202-887-3786, dburns@gibsondunn.com)  Jim Slear (202-955-8578, jslear@gibsondunn.com)Michael S. Diamant (202-887-3604, mdiamant@gibsondunn.com)John W.F. Chesley (202-887-3788, jchesley@gibsondunn.com)Patrick F. Speice, Jr. (202-887-3776, pspeicejr@gibsondunn.com) New YorkJoel M. Cohen (212-351-2664, jcohen@gibsondunn.com) Lee G. Dunst (212-351-3824, ldunst@gibsondunn.com)Mark A. Kirsch (212-351-2662, mkirsch@gibsondunn.com)Jim Walden (212-351-2300, jwalden@gibsondunn.com)Alexander H. Southwell (212-351-3981, asouthwell@gibsondunn.com) DenverRobert C. Blume (303-298-5758, rblume@gibsondunn.com)J. Taylor McConkie (303-298-5795, tmcconkie@gibsondunn.com) Orange CountyNicola T. Hanna (949-451-4270, nhanna@gibsondunn.com) Los Angeles Debra Wong Yang (213-229-7472, dwongyang@gibsondunn.com), the former United States Attorney for the Central District of California,Michael M. Farhang (213-229-7005, mfarhang@gibsondunn.com)Douglas M. Fuchs (213-229-7605, dfuchs@gibsondunn.com) MunichBenno Schwarz (+49 89 189 33-110, bschwarz@gibsondunn.com)Michael Walther (+49 89 189 33-180, mwalther@gibsondunn.com) Mark Zimmer (+49 89 189 33-130, mzimmer@gibsondunn.com) © 2009 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 8, 2009 |
2009 Mid-Year Update on Corporate Deferred Prosecution and Non-Prosecution Agreements

DPAs and NPAs, Too Much of A Good Thing? Although virtually unheard of a decade ago, Deferred Prosecution Agreements ("DPAs") and Non-Prosecution Agreements ("NPAs") are a growing phenomenon in corporate prosecutions.  Essentially, DPAs and NPAs are agreements whereby the government agrees not to prosecute a corporation so long as the corporation abides by the terms of the agreement.  The key distinction between a DPA and an NPA is whether or not charges are filed against the corporation:  with a DPA the government files criminal charges with the court, while with an NPA nothing is filed with the court so long as the corporation completes the terms of the agreement–the agreement is strictly between the government and the corporation. Following the collapse of Arthur Andersen upon its indictment in 2003, the Department of Justice ("DOJ") began using DPAs and NPAs more frequently.  The idea behind DPAs and NPAs is to reform corporate behavior, while limiting the collateral consequences to innocent third parties–such as loss of jobs and shareholder value–that can result from the indictment or conviction of a corporation.  Despite the potential benefits of DPAs and NPAs, their increased use has led to some unintended consequences and complications for corporations. Gibson Dunn participated in some of the earliest DPAs with the government and has represented numerous corporations in negotiating and obtaining these agreements.  We have also written extensively regarding policy considerations related to DPAs and NPAs.  This client update provides an overview of the corporate DPAs and NPAs entered into by the DOJ during the first six months of 2009, identifies key trends in these agreements, and discusses unintended consequences resulting from the increased use of DPAs and NPAs.[1] Deferred Prosecution Agreements in 2009 There have been ten reported DPAs in the first half of 2009.  This number is in line with the eighteen total agreements entered into during 2008, but it represents a decrease from the record thirty-seven agreements reported in 2007.[2]  If the second half of 2009 is consistent with the first half, there will be only slightly more DPAs in 2009 than there were in 2008.  Although 2007 may have been the high water mark for DPAs, the ten agreements entered into during the first six months of 2009 is almost as many as the eleven total DPAs entered into during 2000-2003 combined.  The chart below summarizes the modern history of DPAs entered into by the DOJ. The ten DPAs entered into so far this year comprise a small sample set.  This limited data cautions against drawing many conclusions.  However, when comparing the DPAs to-date in 2009 to the trends observed in prior years, there is some basis for preliminary analysis. The DPAs entered into so far this year involve a variety of criminal offenses and violations.  The most obvious change from recent years is a drop in DPAs for violations of the Foreign Corrupt Practices Act ("FCPA").  In 2008 seven of the eighteen total DPAs–almost forty percent of the total–involved FCPA violations.  By contrast, thus far in 2009 only two of the ten DPAs–twenty percent of the total–have involved FCPA violations.  Of course, with over 120 active FCPA investigations by the DOJ, we expect to see more FCPA-related DPAs in the near future.  This year has seen a resurgence in DPAs for tax fraud, with two DPAs already on the books in 2009.  Although there were no DPAs for tax fraud in 2008, there were two tax fraud DPAs in 2007.  Similarly, there have been three DPAs this year involving health care-related crimes–one for illegal kickbacks, one for violations of the False Claims Act, and one for Medicare fraud.  The DOJ entered into only one health care-related DPA in 2008 but entered into multiple DPAs for health care fraud in 2007.  In 2008, there were multiple DPAs involving money laundering violations, securities violations, and immigration fraud.  None of those offenses, however, has led to DPAs thus far in 2009.  There was also one DPA for internet gambling in 2008.  This issue apparently remains on the DOJ’s radar as there has been one DPA for the same violation so far this year.  The first six months of 2009 also brought the first DPA related to mortgage fraud, which we expect will see increased criminal investigations and perhaps DPAs throughout the remainder of the year.  Overall, the data from the first half of 2009 reinforces the conclusion in our 2008 update that the DOJ’s use of DPAs is not tied to specific criminal violations, but rather, is in line with current prosecution trends.   Thus far in 2009, the proportion of DPAs entered into by U.S. Attorney’s Offices and Main Justice appears to be in line with 2008.  In 2008, approximately half of DPAs were entered into by a U.S. Attorney’s Office, and half by a division of Main Justice.  The first six months of 2009 have followed a similar pattern:  three DPAs were entered into solely by a U.S. Attorney’s Offices, four were entered into solely by Main Justice, and three were entered into by both a U.S. Attorney’s office and Main Justice.  Although the U.S. Attorney’s Offices and Main Justice did not enter into any joint DPAs in 2008, in previous years these joint DPAs were not uncommon.  For instance, in 2007 the DOJ entered into five DPAs in this manner. Within Main Justice, the Fraud Section has long been the leader in DPAs.  Although it entered into six DPAs in 2008, so far in 2009 it has only entered into two agreements.  In contrast, the Tax Division, which accounted for no DPAs in 2008, has entered into two agreements already in 2009.  The limited number of DPAs entered into by U.S. Attorney’s Offices does not lend itself to identifying trends.  It should be noted, however, that the historical leader in DPAs–the U.S. Attorney’s Office for the Southern District of New York–has only entered into one DPA thus far this year, while the U.S. Attorney’s Office for the Middle District of Florida–which has never previously entered into a DPA–entered into its first DPA this year.  Interestingly, one DPA, the WellCare Health Plans DPA, was entered into by both the U.S. Attorney’s Office for the Middle District of Florida and the Florida Attorney General’s Office.  Although State Attorneys General can, and often do, enter into DPAs, this is the first known instance in which both the DOJ and a State Attorney General entered into the same DPA. Thus far in 2009, NPAs appear to be on the rise as compared to DPAs.  In previous years reported DPAs have been much more prominent than NPAs, though the data may be skewed as a result of the fact that NPAs are not filed with a court, and therefore are not always publicly reported.  In 2008 only four NPAs were reported during the entire year, while there were fourteen DPAs.  In contrast, the DOJ has entered into four NPAs in just the first half of 2009:  one each by the Fraud Section, the U.S. Attorney’s Office for the Southern District of New York, the U.S. Attorney’s Office for the District of Massachusetts, and the U.S. Attorney’s Office for the Eastern District of New York and the DOJ Civil Division.  At first blush, the increase in NPAs may seem a significant victory for corporations, as they are able to successfully avoid prosecution.  However, as discussed further below, because the terms and conditions in NPAs increasingly mirror the terms and conditions in DPAs, the advantages in securing an NPA instead of a DPA are diminishing. The chart below summarizes the reported DPAs and NPAs thus far in 2009.  A further explanation of these DPAs and NPAs is found in Appendix A.   2009 Deferred and Non Prosecution Agreements Corporation Violation Total Monetary Penalty * Type Monitor Term Beazer Homes USA, Inc. Mortgage and Accounting Fraud $10 to 50 million DPA No 5 years Fisher Sand & Gravel Co. Tax Fraud $1,168,141 DPA Yes ** ~32 months Halliburton Company FCPA None NPA No 2 years Lloyds TSB International Emergency  Economic Powers Act $175 million DPA No 2 years NeuroMetrix, Inc. Kickbacks (Medicare) $1.2 million NPA Yes ** 3 years Novo Nordisk A/S Wire Fraud and FCPA $9 million DPA No 3 years PartyGaming PLC Wire Fraud (Internet Gambling) $105 million NPA No No set term Quest Diagnostics False Claims Act None NPA Yes ** Unconfirmed UBS AG Tax Fraud $780 million DPA Yes ** At least 18 months WellCare Health Plans Health Fraud $80 million DPA Yes 3 years *  Only includes monetary penalties included in the DPA itself, not all monetary penalties arising out of the same facts that gave rise to the DPA.  Information on all monetary penalties can be found in Appendix A.   **  Although these DPAs do not explicitly provide for a "monitor," they do provide for some form of de facto monitorship (either through the DPA or through a simultaneous agreement entered into by the corporation).  More information on these arrangements can be found in Appendix A.   GAO Report on DPAs In June 2009 the Government Accountability Office ("GAO") published a report entitled Preliminary Observations on DOJ’s Use and Oversight of Deferred Prosecution and Non-Prosecution Agreements.  This Report examined the factors the DOJ considers when deciding whether to enter into a DPA or NPA and the how the DOJ determines what terms and conditions to include in these agreements.  The Report also examined the DOJ’s methods of monitoring compliance with DPAs, including the use of corporate monitors. Consistent with what Gibson Dunn reported in its 2008 update and prior publications, the GAO Report concluded that the DOJ is not consistent in its use of DPAs.  The Report noted that different U.S. Attorney’s Offices and sections within Main Justice vary dramatically in their willingness to use DPAs and NPAs, and in the terms and conditions that are included in the agreements.  In fact, some U.S. Attorney’s Offices do not enter DPAs at all:  Linda Dale Hoffa, the chief of the Criminal Division at the U.S. Attorney’s office in Philadelphia, has stated that her office does not enter DPAs or NPAs because they "think it’s better to make a clear bright line decision that we are prosecuting or not prosecuting." Although it addressed many issues, the main focus of the GAO Report was the appointment of corporate monitors.  The GAO Report noted that there are significant disparities within the DOJ regarding the reasons for including a corporate monitor in a DPA, and the process used to select the monitor.  The Report recommended that the DOJ adopt internal procedures requiring prosecutors to document the reasons for requiring a monitor and the justification for the selection of a specific monitor. Corporate Monitors The debate surrounding corporate monitors in DPAs–discussed in detail in Gibson Dunn’s 2008 year-end update–has continued in 2009.  In June of this year, Congress held hearings on the role of monitors in DPAs and the need for additional legislation regulating monitors’ conduct.  Despite the continuing debate over corporate monitors, the DOJ continues to use them in conjunction with DPAs, though their use appears to be on the decline.  In 2008, six of the eighteen DPAs entered into required the appointment of a corporate monitor.  Thus far in 2009, only one of the ten DPAs, the agreement with WellCare Health Plans, has explicitly provided for a monitor.  The monitor for WellCare is tasked with reviewing and making recommendations regarding the efficacy of WellCare’s policies and procedures for reporting and accounting for health care expenditures that are reimbursed by the federal or state government.  Notably, the terms of the DPA state that the monitor is to have access to all non-privileged documents, and the monitor "will undertake to avoid the disruption of WellCare’s ordinary operations or the imposition of unnecessary costs or expenses to WellCare."  These terms may be a reaction to earlier scrutiny about the scope and expense of DOJ required monitorships. Although only one DPA in 2009 has explicitly provided for a monitor, four other DPAs have established terms that closely resemble the requirements of a monitorship.  As a part of its DPA, UBS agreed to exit, with some exceptions, the United States cross-border financial services business.  UBS also agreed to hire an "independent accounting or other appropriate firm" to conduct testing and issue reports on UBS’s exit from the cross-border business, and to implement internal controls related to cross-border business.  Much like the process involving a corporate monitor, the reports of the independent firm are to be submitted to the DOJ and the Audit Committee of USB. As a part of its DPA with the DOJ Tax Division and the U.S. Attorney’s Office for the District of North Dakota, Fisher Sand & Gravel agreed to designate a specific individual within the corporation as the Compliance Officer.  This individual will function much like a Compliance Officer in any corporation, evaluating and improving the effectiveness of the corporation’s compliance and ethics program, save for the fact that the Compliance Officer is to report to the DOJ in addition to corporate management. As in previous years, monitor-like terms were also established for health care violations.  Rather than appoint an independent monitor that reports to the DOJ, however, NeuroMetrix’s NPA requires the corporation to enter into a five-year Corporate Integrity Agreement with the Inspector General’s Office of the Department of Health and Human Services ("HHS-IGO").  The agreement with the HHS-IGO will require NeuroMetrix to undertake various compliance obligations, and the HHS-IGO will monitor compliance with the agreement and take action in response to any breaches.  Quest Diagnostics also entered into a similar agreement with the HHS-IGO as a part of its NPA with the U.S. Attorney’s Office for the Southern District of New York (and as a result of the guilty plea entered by its subsidiary, Nichols Institute Diagnostics).  Corporate Integrity Agreements with the HHS-IGO are common in False Claims Act cases in the health care industry.  However, a violation of the Corporate Integrity Agreements will not necessarily lead to a violation of the NPA–as is often the case with a violation in a traditional monitorship program. Standardization in the Terms and Conditions of DPAs As the GAO Report concluded, DOJ should demonstrate greater consistency in determining when a DPA or NPA is appropriate.  However, the trend toward uniformity in the terms and conditions of DPAs–as first noted in our 2008 year-end update–has continued in many respects.  Similar to 2008, almost every agreement in 2009 has included language specifying that: (1) the corporation must cooperate with ongoing government investigations; (2) the corporation must bind any successor in the event of a sale or merger; (3) the corporation must refrain from making any statements that contradict the facts set forth in the agreement; and (4) the DOJ has sole discretion to determine whether a breach of the agreement has occurred. It is no surprise that, as the use of DPAs increases, the terms and conditions used by the DOJ become more standardized.  Standardization of DPAs has occurred not only because of the DOJ’s increased familiarity with DPAs, but also in reaction to internal DOJ guidelines and proposed legislation.  Last year, the DOJ introduced guidance regarding the factors prosecutors should consider when entering into DPAs; the use of monitors; and prohibited specific practices such as extraordinary restitution (payments to parties not directly affected by the crime).  This year, Congressman Frank Pallone (D-NJ), a vocal critic of the DOJ’s use of DPAs, and three other Congressmen, re-introduced the Accountability in Deferred Prosecution Act, which was also introduced in 2008.  The Act would require the Attorney General to issue guidelines that describe when a DPA or NPA is appropriate; when the appointment of a corporate monitor is appropriate; what terms and conditions are appropriate to include in DPAs and NPAs; and the process that the DOJ must follow to determine whether a corporation has fully satisfied an agreement.  The proposed legislation also specifies terms and conditions for monitors, creates a list of pre-approved corporate monitors, and requires judicial oversight of DPAs and NPAs.  Although no legislative action has been taken, given this background, the DOJ’s self-regulation and standardization of DPA terms and conditions is unsurprising. Trends Toward Including DPA Terms and Conditions in NPAs What is surprising, however, is the fact that the standard terms and conditions used in DPAs are increasingly appearing in NPAs.  This trend has not gone unnoticed.  James B. Comey, former DOJ Deputy Attorney General, recently stated at a conference that "the lines [between NPAs and DPAs] blur.  Talking about DPAs separate from NPAs, . . . I’m not sure there is that meaningful [] a distinction."  In the past, the terms and conditions of an NPA–where the government agrees not to file charges against a corporation–have been much less demanding and cumbersome than the terms and conditions in a DPA.  With increasing frequency, NPAs have appeared that contain terms and conditions that are as comprehensive and restrictive as terms typically reserved for DPAs.  For example, both the PartyGaming and the NeuroMetrix NPAs contain terms (1) requiring continued cooperation on the part of the corporation; (2) regarding successor protection under the agreement; (3) waiving the statute of limitations for the stated violations; (4) waiving challenges to the admission of evidence related to the investigation and NPA; and (5) requiring the corporation to accept as true the statement of facts in the NPA.  These are standard terms used in the DPAs of past years, as well as those entered into in 2009. Given the increasing similarities between the terms and conditions of DPAs and NPAs, it is less surprising that even the DOJ occasionally fails to recognize the difference between DPAs and NPAs.  For example, the recent agreement between NeuroMetrix and the U.S. Attorney’s Office for the District of Massachusetts explicitly states that if NeuroMetrix violates the agreement, "the [U.S. Attorney’s Office] may file the attached criminal information in the United States District Court for the District of Massachusetts charging NeuroMetrix with a  violation of 42 U.S.C. § 1320-a-7b(b)(2)."  (emphasis added).  Because no criminal charges were filed, this agreement is clearly an NPA.  The DOJ press release describes the NeuroMetrix agreement as a DPA, however.  Additionally, the terms and conditions of the agreement are as detailed and restrictive as those typically found in a DPA.  In fact, the recent GAO Report on DPAs and NPAs notes that since March 2008, DOJ has improperly classified at least three DPAs and NPAs. Notable Terms and Conditions Even though there may be a trend toward standardizing the terms and conditions of DPAs and NPAs, there are some notable variations in the DPAs that have been entered into in 2009.  For instance, as a part of its DPA, WellCare Health Plans agreed to "prominently post on its website the Information, this DPA, and the Statement of Facts" for the duration of the agreement.  The company also agreed not to sell or transfer the corporation prior to full payment of the $80 million fine.  The DPA between Lloyds TSB Bank and the DOJ Money Laundering Section contains a term that deems a violation of a separate DPA that Lloyds entered into with the New York District Attorney to be a violation of the DOJ DPA, at the discretion of the DOJ.  A term in UBS’s DPA with the DOJ Tax Division and the U.S. Attorney’s Office for the Southern District of Florida explicitly allows UBS to challenge a "John Doe" subpoena issued by the U.S. District Court for the Southern District of Florida seeking records disclosing U.S. persons who maintain accounts with UBS in Switzerland.  The DPA allows UBS to use any defense, objection, or argument to resist enforcement of the subpoena, and to exhaust its appellate remedies should the corporation lose in the lower courts.  This is unusual as most DPAs require that the company not make any statement that contradicts the statement of facts in the DPA.  UBS has since resisted enforcement of the subpoena on the grounds it would force the corporation to violate Swiss privacy law.  The lawsuit between the DOJ and UBS is still pending. There is a similar, but more restrictive, provision in the Beazer Homes DPA that allows the corporation to dispute that the factual allegations in the criminal information or the DPA apply to a specific private civil litigant or class of litigants, but does not allow the company to dispute the factual allegations themselves.  This is a fine line, and it remains to be seen how this provision will be construed in practice.  Finally, there are terms in both the UBS and Beazer Homes DPAs that prohibit the corporation, with some exceptions, from re-entering the specific line of business that gave rise to the alleged violations. Attorney-Client Privilege A corporation’s waiver of attorney-client privilege and privileged attorney work product has long been an area of concern with regard to DPAs and NPAs.  In 2008, Deputy Attorney General Mark Filip issued guidance to DOJ prosecutors stating that "[e]ligibility for cooperation credit is not predicated upon the waiver of attorney-client privilege or work product protection," and prosecutors "should not ask for such waivers and are directed not to do so."  This was a departure from prior practice, wherein many DPAs and NPAs explicitly allowed the DOJ to extend cooperation credit to a corporation based on a company’s decision to produce attorney-client or attorney work-product information.  Consistent with this new DOJ guidance, not one of the DPAs entered into thus far this year contains provisions conditioning credit on waiver of privileged information.  In fact, three of the DPAs entered into–Fisher Sand & Gravel, Lloyds TSB Bank, and NeuroMetrix–contain provisions that explicitly state that nothing in the agreement shall require the corporation to waive attorney-client privilege or work product protection.  The DPAs with WellCare and Beazer Homes state that the corporations are required to turn over all non-privileged information the government requests.  The other DPAs and NPAs entered into in 2009 do not mention the attorney-client privilege or the work product doctrine. Even though the DOJ can no longer require a corporation to waive privilege in order to obtain cooperation credit, a corporation may still voluntarily decide to provide privileged information to the DOJ in particular situations.  Any corporation that considers providing information to the DOJ should carefully consider the collateral consequences it might face before it produces privileged material.  One potential consequence of producing privileged documents to the government pursuant to a DPA is that this information might be available to third-parties at a later date.  This is true even when the corporation has entered into a non-waiver, or selective waiver, agreement with the government, wherein the government agrees that production of the documents does not constitute waiver of the privilege or protection as to third-parties. DPAs and NPAs as Corporate Victories DPAs and NPAs have generally been viewed as significant victories for corporations, allowing a company to avoid prosecution and leave the allegations behind.  Given the harsh corporate consequences that result from an indictment, even when a company is later acquitted, companies are often predisposed to enter into these agreements.  Although a DPA or NPA is almost certainly preferable to criminal prosecution, the increasing costs, obligations, and continuing oversight associated with DPAs and NPAs can significantly impact a company’s bottom line.  One concern related to the growth and expansion of DPAs and NPAs is that their use may cause the DOJ to seek agreements in matters that it previously chose not to prosecute.  In the past, the DOJ often declined to prosecute cases in which the allegations involved low-level misconduct or there was a lack of sufficient evidence.  However, the increased use of DPAs and NPAs raises a question of whether this new prosecutorial tool may be encouraging the government to seek agreements with corporations in instances that previously resulted in declinations.  It is too soon to tell if there is any validity to this concern.  However, if the DOJ begins to use DPAs and NPAs in order to impose costly and cumbersome terms and conditions on companies for conduct that previously went unpunished, companies’ appetites for DPAs and NPAs may decrease.  This is particularly true as NPAs increase in complexity and require companies to comply with many terms previously reserved for DPAs or even corporate guilty pleas. Conclusion Although the number of DPAs and NPAs entered into in 2009 is off the record pace set in 2007, the number of agreements entered into this year remains very high.  The trend toward uniformity in the terms and conditions in DPAs is a welcome development, but the increasing cost and complexity of NPAs is troubling.  It remains to be seen what, if anything, the Obama administration under Attorney General Holder will do to modify the DPA process.  Assuredly, the DOJ will continue to use DPAs in some manner, which will require corporations to work closely with counsel to make appropriate decisions.  [1] Throughout the article, the term DPA will be used to refer to both DPAs and NPAs generally, unless specifically noted.  [2]  We reported a total of seventeen agreements in our 2008 year-end update on corporate deferred and non-prosecution agreements–fourteen DPAs and three NPAs.  Following publication, we became aware of a fourth NPA that was entered into during 2008, bringing the total number of agreements for that year to eighteen.  Because NPAs are not filed with a court and are not always publicly reported, the number of NPAs entered into by the DOJ is difficult to determine with precision.   The White Collar Defense and Investigations Practice Group of Gibson, Dunn & Crutcher LLP successfully defends corporations, senior corporate executives, and public officials in a wide range of federal and state investigations and prosecutions, and conducts sensitive internal investigations for leading companies in almost every business sector.  The Group has members in every domestic office of the Firm and draws on more than 75 attorneys with deep government experience, including numerous former federal and state prosecutors and officials, many of whom served at high levels within the Department of Justice and the Securities and Exchange Commission.  Joe Warin, a former federal prosecutor, currently serves as a monitor pursuant to a DOJ and SEC enforcement action, and currently serves as the U.S. counsel for the compliance monitor for Siemens.  Debra Wong Yang is the former United States Attorney for the Central District of California, and recently completed her role as a monitor pursuant to a DOJ enforcement action. Washington, D.C.F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com)John H. Sturc (202-955-8243, jsturc@gibsondunn.com)Barry Goldsmith (202-955-8580, bgoldsmith@gibsondunn.com) David P. Burns (202-887-3786, dburns@gibsondunn.com)David Debold (202-955-8551, ddebold@gibsondunn.com)Brian C. Baldrate (202-887-3717, bbaldrate@gibsondunn.com) New YorkJim Walden (212-351-2300, jwalden@gibsondunn.com)Lee G. Dunst (212-351-3824, ldunst@gibsondunn.com)Mark A. Kirsch (212-351-2662, mkirsch@gibsondunn.com)Joel M. Cohen (212-351-2664, jcohen@gibsondunn.com)Christopher M. Joralemon (212-351-2668, cjoralemon@gibsondunn.com)Randy M. Mastro (213-351-3825, rmastro@gibsondunn.com)Marc K. Schonfeld (212-351-2433, mschonfeld@gibsondunn.com)Orin Snyder (212-351-2400, osnyder@gibsondunn.com)Lawrence J. Zweifach (212-351-2625, lzweifach@gibsondunn.com)Alexander H. Southwell (212-351-3981, asouthwell@gibsondunn.com) DenverRobert C. Blume (303-298-5758, rblume@gibsondunn.com) Orange CountyNicola T. Hanna (949-451-4270, nhanna@gibsondunn.com) Los AngelesDebra Wong Yang (213-229-7472, dwongyang@gibsondunn.com)Marcellus McRae (213-229-7675, mmcrae@gibsondunn.com)Michael M. Farhang (213-229-7005, mfarhang@gibsondunn.com)Douglas Fuchs (213-229-7605, dfuchs@gibsondunn.com) __________________________________________________  Appendix A:  DPAs and NPAs Entered Into During the First Six Months of 2009   Beazer Homes USA, Inc. – July 1, 2009 DOJ Office United States Attorney’s Office for the Western District of North Carolina Allegations Beazer conspired to commit mortgage fraud by using fraudulent practices to originate loans insured by the Federal Housing Administration. These fraudulent practices included charging illegal fees, making improper gifts to purchasers to cover down payments, secretly raising home prices to offset expenses, conspiring to hide its default rates from the Department of Housing and Urban Development, and deliberately making loans to unqualified buyers. Beazer also conspired to commit accounting fraud by practicing "cookie jar accounting." Length of DPA 5 years or earlier if all of the following conditions are met: at least 3 years have passed (or a change of control of the company), payment of $50 million has been made to the restitution fund, and with the consent of the DOJ (which will "not be unreasonably withheld"). Penalties Restitution — $10 million to $50 million (creation of a restitution fund with an immediate contribution of $10 million, and contingent payments into the fund based on a specific formula, but with a cap of $50 million). Revised Compliance Program Beazer had previously exited the mortgage origination business, but agreed not to attempt to reenter the business. There is a "Claims Administer" who will administer the restitution fund. The administrator will be selected by Beazer in consultation with the DOJ, be subject to approval by the DOJ, and be subject to the approval of the court where the DPA is being filed. Additional A simultaneous settlement agreement was reached with the DOJ Criminal Division on False Claims Act allegations, for which Beazer paid the United States $5 million and agreed to contingent restitution payments of up to $48 million. A settlement agreement was reached with the SEC in September of 2008.  The settlement did not include any monetary penalties. The DPA is binding on all 93 U.S. Attorney’s Offices and the Criminal Division of Main Justice.  This provision most likely received the approval of the Criminal Division (since an individual U.S. Attorney’s Office is otherwise not permitted to bind those other entities), although the DPA does not state such explicitly. Fisher Sand & Gravel Co. – May 1, 2009 DOJ Office United States Attorney’s Office for the District of North Dakota Department of Justice, Tax Division Allegations FSG allowed the personal expenses of its owner (and his family members) to be paid by FSG as business expenses.  This caused FSG’s income to be artificially understated on its income tax returns. FSG also falsified payment entries in their business records, concealed these payments from their outside accountants, and filed false tax forms with the IRS. Length of DPA Approximately 32 months (until December 31, 2011) Penalties Restitution — $668,141 to the IRS (including interest) Criminal Fine  –  $500,000 Revised Compliance Program Implement a Code of Business Ethics and Conduct that prohibits the payment of personal expenses by FSG for any employee and prohibits false, misleading, and artificial entries on the books and records of FSG. The Code of Business Ethics and Conduct should be designed to monitor, detect, and prevent the payment of personal expenses and the deduction of those expenses from FSG’s federal income tax returns. Use reasonable efforts not to include within the substantial authority of the personnel of FSG anyone who FSG knows, or should know, has engaged in illegal activities or conduct that is inconsistent with an effective ethics and compliance program. No "monitor," but there is a "Compliance Officer" with similar responsibilities who reports to the DOJ. Compliance Officer Within thirty (30) days, the Company will choose a Compliance Officer and provide the officer’s name to the government. The Compliance Officer will be responsible for implementing the provisions of the Code of Business Ethics and Conduct. The Compliance Officer will take steps to detect any criminal conduct related to any aspect of the accounting function of FSG; to periodically evaluate the effectiveness of the ethics and compliance program; and to establish a system by which individuals can report possible criminal conduct without fear of retaliation. In order to carry out these responsibilities, the Compliance Officer will have adequate resources, appropriate authority, and direct access to high level personnel and the FSG Board of Directors. The Compliance Officer will report quarterly to high-level personnel and the FSG Board of Directors on the effectiveness of the compliance and ethics program.  During the term of the DPA, the Compliance Officer will also provide a quarterly report to the government that details the same. Additional The owner of FSG and two other officers of FSG pleaded guilty to individual charges of conspiracy to defraud the United States. Halliburton Company – February 10, 2009 DOJ Office Department of Justice, Criminal Division, Fraud Section Allegations Halliburton, through a former subsidiary, allegedly violated the FCPA by making improper and corrupt payments to Nigerian government officials in order to obtain contracts in connection with a natural gas liquefaction project in Nigeria. Length of NPA Two years Penalties None specifically in the NPA, but Halliburton will pay $382 million in criminal fines and $177 million in disgorgement of profits as part of the former subsidiary’s guilty plea. Revised Compliance Program None reported in the NPA No monitor Lloyds TSB – January 9, 2009 DOJ Office Department of Justice, Criminal Division, Asset Forfeiture and Money Laundering Section Allegations Lloyds violated the International Emergency Economic Powers Act and United States economic sanctions by stripping information from outgoing U.S. dollar wire transfer payment messages that would have revealed that the transactions involved countries, banks, or persons that were considered sanctioned parties under Iranian, Sudanese, and Libyan sanctions (the exportation of such services from the United States to those nations was prohibited by the sanctions). These actions also caused New York financial institutions to falsify records. Length of DPA Two years Penalties Civil Forfeiture — $175 million Revised Compliance Program The Company will demonstrate future good conduct and compliance with international Anti-Money Laundering and Combating Financing of Terrorism best practices and the Wolfsberg Anti-Money Laundering Principles for Correspondent Banking. Within 270 days and with the assistance of an outside consultant of Lloyd’s selection, the Company will conduct a historical transaction review of all available incoming and outgoing SWIFT MT 100 and MT 200 series USD payment messages from April 2002 through December 2007 that were processed through its UK processing centers and Dubai branch.  (Although this is part of the "cooperation" section of the DPA, some may consider it a penalty given the substantial costs involved with the review.) No monitor. Additional Lloyds also entered into a contemporaneous DPA with the Manhattan District Attorney’s Office, which included forfeiture of $175 million.  The DOJ DPA also requires adherence with the DPA of the Manhattan District Attorney’s Office. NeuroMetrix, Inc. – February 9, 2009 DOJ Office United States Attorney’s Office for the District of Massachusetts Allegations NeuroMetrix paid illegal remunerations to physicians in order to induce them to recommend to their colleagues the purchase of a NeuroMetrix medical system. These illegal remunerations were reimbursed in whole or in part by Medicare, in violation of the Medicare Anti-Kickback Act. Length of DPA Three years Penalties Criminal Fine — $1.2 million Revised Compliance Program NeuroMetrix will sign a five-year Corporate Integrity Agreement with the Inspector General’s Office of the Department of Health and Human Services. The Corporate Integrity Agreement will include various compliance obligations, as well as information regarding a de factor monitorship arrangement with the Inspector General’s Office that is meant to ensure NeuroMetrix’s adherence to those compliance obligations. A violation of the Corporate Integrity Agreement will not lead to a breach of the DPA. Additional NeuroMetrix also entered into a settlement agreement with the Inspector General’s Office of the Department of Health and Human Services, which included a payment of $2,498,337 and adherence to a Corporate Integrity Agreement. The Corporate Integrity Agreement contains many compliance-related requirements, including training obligations that require all NeuroMetrix employees to receive annual training on the proper methods of selling, marketing, and promoting medical devices, including information on relevant anti-kickback laws and regulations. Enforcement of the Corporate Integrity Agreement is the responsibility of the Inspector General’s Office, who will serve as de facto monitor of NeuroMetrix’s compliance with the Corporate Integrity Agreement.  The Inspector General’s Office also will have the authority to penalize NeuroMetrix for violations of the Corporate Integrity Agreement (despite the fact that the violations of provisions in the Corporate Integrity Agreement may not lead to a breach of either the DPA or the Settlement Agreement). Novo Nordisk A/S – May 6, 2009 DOJ Office Department of Justice, Criminal Division, Fraud Section Allegations Through the Oil For Food Program, the Company conspired to violate the FCPA by paying approximately $1.4 million in kickbacks to the Iraqi government in order to obtain contracts to provide them with insulin and other medicines.  Novo also inaccurately recorded the kickback payments as "commissions" in its books and records in violation of FCPA provisions. The Company conspired to commit wire fraud by inflating the price of the contracts by ten percent (10%) prior to submitting them for United Nations approval, concealing the fact that the price contained a kickback to the Iraqi government and drawing on a U.N. line of credit, issued via international wire, in order to fulfill payment. Length of DPA Three years Penalties Criminal Fine — $9 million Revised Compliance Program Implement a compliance and ethics program designed to detect and prevent violations of the FCPA and other applicable anti-corruption laws throughout its operations. Conduct a review and periodic testing of policies and procedures regarding compliance with the FCPA and other applicable anti-corruption laws. Maintain a system of internal accounting controls designed to ensure fair and accurate books, records, and accounts. Institute an anti-corruption compliance code that is applicable to all directors, officers, employees, and, when appropriate, outside parties acting on the company’s behalf. Assign a senior official to oversee compliance with the FCPA and anti-corruption laws. Institute periodic training and annual certification on compliance for all directors, officers, employees, and, where appropriate, agents and business partners. Institute a system for reporting criminal conduct and appropriately disciplining non-compliant employees. Insert standard provisions into contracts and agreements that are reasonably calculated in order to ensure that business partners and agents are complying with the FCPA and other anti-corruption laws. No monitor.  Additional Novo also reached a settlement with the SEC in connection with these facts, for which Novo paid $3,025,066 in civil penalties and $6,000,079 (including interest) in disgorgement of profits. PartyGaming PLC – April 6, 2009 DOJ Office United States Attorney’s Office for the Southern District of New York Allegations Conducted an illegal gambling business (for-money online games). Committed wire fraud and bank fraud by misrepresenting illegal gambling transactions on credit card statements. Length of NPA No set term Penalties Civil Forfeiture — $105 million Revised Compliance Program None reported No monitor Additional A founder and former officer of PartyGaming pleaded guilty to using wire transfers to transmit bets and wagering information in interstate commerce.  He also admitted to forfeiture allegations, which required him to forfeit $300 million to the United States. Quest Diagnostics – April 15, 2009 DOJ Office Department of Justice, Civil Division United States Attorney’s Office for the Eastern District of New York Allegations Violated the False Claims Act by allowing a subsidiary to fraudulently sell inaccurate and unreliable test kits. Length of NPA Not confirmed, but appears to be no set term  Penalties None in the NPA but as a part of a civil settlement Quest and its subsidiary will pay $262 million.  The subsidiary will also pay a criminal fine of $40 million. Revised Compliance Program Quest entered into a Corporate Integrity Agreement with the Inspector General’s Office of the Department of Health and Human Services (see below for more information on this agreement). No monitor. Additional Quest entered into a Corporate Integrity Agreement with the Office of the Inspector General for the Department of Health and Human Services. The Corporate Integrity Agreement contains many compliance-related requirements, including the establishment of a compliance program run by a Compliance Officer. Enforcement of the Corporate Integrity Agreement is the responsibility of the Inspector General’s Office, who will serve as de facto monitor of Quest’s compliance with the Corporate Integrity Agreement.  The Inspector General’s Office also will have the authority to penalize Quest for violations of the Corporate Integrity Agreement (despite the fact that the violations of provisions in the Corporate Integrity Agreement may not lead to a breach of either the DPA or the Settlement Agreement). UBS AG February 18, 2009 DOJ Office Department of Justice, Tax Division United States Attorney’s Office for the Southern District of Florida Allegations UBS participated in a scheme to defraud the United States by assisting a number of United States taxpayers to establish accounts with UBS in a manner designed to conceal the taxpayers’ interest in the accounts, which allowed the taxpayers to evade IRS reporting requirements, conceal assets from the IRS, and engage in financial transactions in which UBS did not withhold U.S. income taxes as required by law. False or misleading IRS forms were accepted and filed by UBS in order to conceal the identity of the owners of the above-referenced accounts.  These forms were required by law as a result of a Qualified Intermediary Agreement UBS voluntarily signed with the IRS. UBS bankers, managers and executives continued this cross-border business, despite the fact that they knew or should have known that their clients were evading U.S. taxes.  Length of DPA The longer of 18 months, the completion of UBS’s Exit Program (as described below), or the resolution of a "John Doe" summons enforcement action (which is an attempt to gain Swiss records of United States persons who maintained accounts with UBS). Penalties Civil Disgorgement — $380 million ($200 million of which is directly to the SEC) Restitution — $400 million (including restitution, interest, penalties and federal back-up withholding taxes that should have been withheld) Revised Compliance Program Engage in an "Exit Program," under which UBS will cease to operate in the United States cross-border business and provide banking or securities services only to United States private citizens residing in the United States through subsidiaries or affiliates registered to do business in the United States with the SEC. Provide the government with periodic reports on the progress of the Exit Program. Implement a revised governance structure under which Group General Counsel will have functional management responsibility and authority over the legal and compliance functions of all business divisions, as well as final authority over compensation and the promotion of division-level legal and compliance personnel. Appoint personnel with direct oversight authority of UBS’s performance under the Qualified Intermediary Agreement. Develop policies and procedures that are in compliance with the Qualified Intermediary Agreement (including the training of employees and an investigation into allegations of failure to comply). No "monitor," but there is an "external auditor" designated to monitor UBS’s Exit Program and particular internal controls. External Auditor Hire an external auditor, subject to the consent of the government, who will report on the Company’s progress within the Exit Program and implementation of internal controls with respect to the Qualified Intermediary Agreement. UBS will adopt any reasonable recommendations of the external auditor that will further comply with the Qualified Intermediary Agreement. Additional In addition to general cooperation, UBS shall disclose the identities and account information of certain United States clients and shall comply with the John Doe summons enforcement action if all objections to the action are denied (i.e., UBS would still retain all rights to defend itself against the summons; this provision only applies if those defenses are denied). WellCare Health Plans, Inc. – May 5, 2009 DOJ Office United States Attorney’s Office for the Middle District of Florida Allegations Two wholly-owned subsidiaries conspired to commit health fraud by fraudulently inflating medical expenditure information, all in an effort to reduce the amount of money they would be contractually obligated to pay back to two Florida health care benefit programs. Length of DPA Three years Penalties Restitution — $40 million plus interest Civil Forfeiture — $40 million plus interest Revised Compliance Program Within sixty (60) days of the agreement, the Company will implement updated policies and procedures that are designed to ensure complete and accurate reporting of all federal and state health care program information. Develop and operate adequate internal controls to prevent any of the improper and/or illegal activities that gave rise to the DPA. Evaluate and revise internal bid procedures in order to ensure fair and accurate submission of all data and information in response to any government bids and/or any government requests for proposals. Monitor A Monitor will be selected by the U.S. Attorney’s Office in accordance with DOJ guidelines and after consultation with WellCare. The monitorship will last for 18 months. Monitor will have access to all non-privileged documents, information, officers, employees, and agents of WellCare that he/she reasonably believes are necessary in the execution of his/her duties. The Monitor will immediately report to the DOJ any misconduct that: (a) poses a significant risk to public health and safety; (b) involves senior management of WellCare; (c) involves obstruction of justice; (d) involves a violation of any federal or state criminal statute, or otherwise involves criminal activity; and (e) otherwise poses a significant risk of harm to any person, state or federal entity, or government program.  The DOJ may choose to divulge this information to WellCare. The Monitor will review, evaluate, and make recommendations regarding policies which relate to: (a) the accounting and reporting of all revenues, expenditures, and costs incurred in providing any services to health care program beneficiaries; (b) the documentation of medical records pertinent to any health care services provided to health care program beneficiaries; (c) the submission of claims for payment to health care programs; (d) the preparation, certification, and submission of bids to health care programs; and (e) the training of WellCare employees in order to ensure that any information provided to health care programs is true, accurate, complete, and transparent. WellCare will adopt all recommendations submitted by the Monitor.  If WellCare objects to a recommendation made by the Monitor, the DOJ will issue a non-appealable decision resolving the dispute. The Monitor will review WellCare’s compliance with the DPA and all applicable federal and state health care laws, regulations, and programs. The Monitor will submit three written reports to the DOJ, WellCare senior management, and WellCare’s Board of Directors.  The reports will address: (a) WellCare’s compliance with the DPA and all applicable federal and state health care laws, regulations, and programs; (b) a summary of the Monitor’s recommendations to WellCare and WellCare’s responses to those recommendations; and (c) any other relevant information. WellCare will not employ or be affiliated with the Monitor for at least one year after the monitorship is terminated. © 2009 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 8, 2009 |
2009 Mid-Year Update on E-Discovery Cases

Sanctions Cases Double Over 2008; Courts Continue to Press for Cooperation; E⁃discovery Trends in Criminal and Constitutional Law A comprehensive review of more than sixty federal and state court opinions addressing e-discovery issued during the first five months of 2009 reveals a dramatic increase in the frequency with which courts consider and apply sanctions.  In part, the increase in sanctions reflects solidifying legal standards governing when a potential litigant must preserve electronic evidence.  These opinions also reflect a continuing effort by the courts to urge litigants and their counsel to cooperate in e-discovery matters, and to sensibly and proportionately develop e-discovery protocols.   Highlights of 2009 to date include: More than half of the e-discovery opinions issued through May involved the consideration of sanctions, and sanctions were awarded in 36% of cases. Many of the e-discovery opinions provide greater clarity regarding the duty to preserve relevant data, and the consequences of failing to do so. Courts continue to urge transparency and cooperation among counsel in the e-discovery process. An increasing number of opinions are addressing the e-discovery obligations of governmental entities as civil litigants.  Some of the opinions address electronic discovery and data in the constitutional context, especially in relation to rights protected by the First, Fourth, Fifth and Fourteenth Amendments. These cases also provide guidance regarding the mechanics of e-discovery, such as the use of search terms, and the clawback of inadvertently produced privileged documents under Federal Rule of Evidence 502.  A notable decrease in the number of cases involving disputes over the format of e-discovery productions suggests that standards and uniformity are developing and becoming commonly understood and utilized.  The opinions to date also show courts continuing to address the role of electronic discovery in cases involving governmental entities.  Several recent decisions apply e-discovery rules to the government in its capacity as a litigant.  See, e.g., SEC v. Collins & Aikman Corp., 256 F.R.D. 403, 418 (S.D.N.Y. 2009) ("When a government agency initiates litigation, it must be prepared to follow the same discovery rules that govern private parties."); Washington v. Dingman, 202 P.3d 388 (Wash. 2009) (reversing criminal conviction where the state failed to provide the defendant with hard drive image in a file format his attorney could readily use).  The opinions also reflect how emerging technology continues to present novel questions of constitutional law under the First, Fourth and Fifth Amendments.  Selected significant decisions are discussed below. I.  E-Discovery and Private Litigants:  The Rise of Sanctions, Solidifying Legal Standards, and Ongoing Sources of Dispute One of the most striking themes of this year’s opinions addressing e-discovery is the increased frequency with which courts have imposed sanctions on litigants and counsel.  Making sense of this trend requires a careful review of the sanctions opinions and the issues about which litigants engaged in e-discovery most often argue. A.  A Proliferation of Sanctions Opinions Of the sixty-one reported electronic discovery opinions that courts issued during the first five months of 2009, more than half (52%) involved the consideration of sanctions.  In twenty-two (36%) of these opinions, courts imposed some form of sanction, almost always as a result of the spoliation of evidence.  Compared to a study of e-discovery opinions issued during the first ten months of 2008 by Kroll Ontrack, these figures represent a two-fold increase in the proportion of e-discovery opinions in which courts consider and a two-fold increase in the proportion of e-discovery opinions that impose sanctions.[1]  Fees and costs are the most common form of sanctions in these cases.  A recent series of orders in Keithley v. Homestore.com, Inc. illustrates that such fees and costs can impose substantial burdens even on litigants who win on the underlying merits.  Despite the Keithley defendants’ previous victory on a motion for summary judgment, Judge LaPorte (N.D. Cal.) ordered them to pay $283,000 in fees as a sanction for their systematic failure to preserve and produce relevant electronic evidence.  2009 WL 816429 (N.D. Cal. Jan. 7, 2009).  Added to previous similar awards, the Keithley defendants ultimately bore more than $650,000 of the plaintiffs’ legal expenses and costs.  In twelve other opinions, courts awarded costs and fees associated with bringing motions to compel or motions for sanctions, and, in some cases, the expenses of resolving problems caused by the responding party’s alleged conduct.  See Clearvalue Inc. v. Pearl River Polymers Inc., 560 F.3d 1291 (Fed. Cir. 2009) (awarding costs and fees of $121,107.38); Oz Optics v. Kakimoglu, 2009 WL 1017042 (Cal. Ct. App. Apr. 15, 2009) (upholding $90,000 award); Technical Sales Assoc. v. Ohio Star Forge Co., 2009 WL 728520 (E.D. Mich. Mar. 19, 2009) (awarding $17,786.25); Bank of Mongolia v. M&P Global Financial Services, 2009 WL 1117312 (S.D. Fla. Apr. 24, 2009) (awarding $3,400).[2]  In Bray & Gillespie, one of the more notable costs and fees opinions, the defendant bore the costs of additional discovery ordered by the court for its failure to properly disclose and produce relevant data.  The court went further and ordered the costs and fees associated with the plaintiff’s motion for sanctions to be born jointly and severally by the individual outside attorney and his law firm after it found the attorney acted in bad faith and misrepresented the circumstances surrounding the discovery failures to the court.  Bray & Gillespie at *22-*23.  In five cases through May 2009, courts awarded adverse inferences.  See Arista Records LLC v. Usenet.com, Inc., 608 F. Supp. 2d 409 (S.D.N.Y. 2009); Smith v. Slifer Smith & Frampton, 2009 WL 482603 (D. Colo. Feb. 25, 2009); Jones v. Hawley, 2009 WL 63000 (D.D.C. Jan. 12, 2009) (Facciola, J.); Beard Research, Inc. v. Kates, 2009 WL 1515625 (Del. Ch. May 29, 2009); Triton Construction Co. v. Eastern Shore Electrical Services, Inc., 2009 WL 1387115 (Del. Ch. May 18, 2009).  In one case a court declared a party’s patents unenforceable, the equivalent to a dismissal.  Micron Technology, Inc. v. Rambus, Inc., 255 F.R.D. 135, 151 (D. Del. Jan. 9, 2009). And, in one case the court dismissed the plaintiff’s claims, and awarded an adverse inference on the defendant’s cross claims.  Kvitka v. Puffin Co., 2009 WL 385582 (M.D. Pa. Feb. 13, 2009).   While dismissals and adverse inferences remain confined to cases in which a litigant’s discovery misconduct is so egregious that "the very integrity of the litigation process has been impugned," courts’ growing willingness to apply such sanctions seems to reflect a broadening judicial impatience with litigants who do not carefully fulfill their e-discovery obligations.  See Micron Technology, Inc., 255 F.R.D. at 151.  B.  Greater Clarity Regarding the Duty to Preserve. Sanctions are becoming more common as legal precedent coalesces around the point at which a duty to preserve electronic evidence is triggered.  One of the more common descriptions is "[a]s soon as a potential claim is . . . identified, a party is under a duty to preserve evidence which it knows, or reasonably should know, is relevant to the future litigation."  Micron Technology, Inc., 255 F.R.D. at 148.  In most e-discovery opinions, a party reasonably knows of litigation when a complaint is filed.  However, evaluating a party’s duty to preserve is intensely fact specific, and the triggering of that duty can fall along a time line up to the filing of a complaint (and in some cases, even beyond the filing of a complaint).[3]  Under certain circumstances, the duty to preserve might be triggered well before the filing of a complaint.  Phillip M. Adams & Assoc’s. is an infringement case regarding a patented solution to a problem with an NEC floppy disk controller.  The controller was widely used in most brands of personal computer.  Phillips at *1.  The plaintiff developed a software solution to the problem, patented it, licensed it widely, and aggressively pursued potential infringers.  Id at*1-*2.  The plaintiff sent a letter to the defendant in early 2005 claiming it was infringing on his patents.  Plaintiff then filed a complaint in January 2007.  It became clear through the discovery process that the defendant was unable to produce documents from a particularly relevant period (2000 – 2002) because it had failed to preserve them.  The defendant claimed it had no duty to preserve because it did not know if impending litigation until at least 2005 when it received plaintiff’s letter.  The court disagreed, stating that the problem with the NEC disk controller was widely known and discussed in the trade and popular press, and that in 1999 a large computer manufacturer, Toshiba, settled a class action lawsuit stemming from the defect for $2.1 billion.  Several other cases involving the controller were filed throughout 2000 and 2001.  "Throughout this entire time, computer and component manufacturers [such as the defendant] were sensitized to the [defect] issue."  Id at *11.  Because of this, the court found that the defendant should have known litigation was likely as far back as 1999, and sanctioned it for failing to preserve documents from that time.  Id at *16.  Other courts have also affirmed that a duty to preserve might attach before the filing of a complaint.  See, e.g., Beard Research v. Kates, 2009 WL 1515625 (Del. Ch. May 29, 2009) (finding that the duty to preserve certainly attached when the complaint was filed, but that "arguably" a former employee’s duty to preserve may have attached when he gave presentation to competitor while seeking employment disclosing confidential information);  Micron v. Rambus, 255 F.R.D. 135 (D. Del. 2009) (patent holder’s duty to preserve triggered when it developed litigation strategy against potential infringers well before filing complaint). In other circumstances, the duty to preserve may not attach, at least for certain kinds or sources of data, until the filing of discovery requests.  In Arista Records LLC v. Usenet.com, Inc. the Southern District of New York imposed substantial monetary sanctions and an adverse inference to punish the defendant’s manipulation of usage data needed to calculate damages. 608 F. Supp. 2d 409 (S.D.N.Y. 2009).  Arista Records concerned the presence of copyrighted music on Usenet’s servers, which users could download.  Data about users’ downloading activity on the Usenet site existed in server usage logs.  The data on these logs is ephemeral, because data regarding usage was kept for only a limited amount of time and then overwritten.  When the Arista plaintiffs served a discovery request seeking a series of one-hour "snap shots" from the logs reflecting the number of music downloads from the defendant’s servers, Usenet temporarily disabled public access to the servers, wiping out much of the usage data, and deleted music files so as to artificially deflate usage statistics.  These actions made any subsequent usage data collection efforts futile since the service disruptions induced many Usenet users to permanently switch to other sources of illegal music downloads.  Recognizing that Usenet "may not have had an obligation to preserve such evidence until placed on notice that Plaintiffs considered it relevant and were requesting it," the court nevertheless concluded that Usenet had a duty to preserve the data when it was put on notice through a discovery request that the ephemeral data was sought.  Id. at 431.  These opinions demonstrate that the analysis regarding when a duty to preserve attaches is fact specific.  The duty is most usually triggered upon the filing of a complaint, but may also trigger earlier.  In rarer cases, it may also attach after a complaint is filed, upon notice that a particular source or kind of data is being sought. One interesting theme emerging from the duty-to-preserve opinions is the use of e-discovery offensively.  Typically, a party establishes a data preservation protocol in order to defend or shield itself from accusations of discovery shortcomings and potential sanctions resulting from them.  However, a party that is conversant in e-discovery can also use it to assail an opposing party if it fails to meet its obligations.  A party that has its electronic house in order is a formidable opponent over the party that doesn’t.  In Micron Technology, Inc. v. Rambus, Inc., Rambus developed a valuable new technology and patented it.  It then developed an aggressive strategy against potential infringers, forcing them into licensing agreements or, failing that, facing litigation.  Rambus’ "document retention policy was discussed and adopted within the context of [this] litigation strategy." 255 F.R.D. at 150.  Micron, which suspected it would soon become the next target of a Rambus infringement action, carefully monitored the actions brought by Rambus, and discovered that there were potential inadequacies in Rambus’ document retention practices.  Going on the offensive, Micron sought a declaratory judgment that Rambus’ patents were not enforceable against it.  After considering a series of failures to preserve and produce evidence by Rambus, the Delaware District Court concluded that any sanction less than the invalidation of the patents would be "impractical, bordering on meaningless." Id. at 151.  The success of Micron’s offensive e-discovery strategy may prove a harbinger of cases to come.  A properly prepared litigant can use e-discovery as a sword, as well as a shield.   C.  Cooperation As courts continue to define the scope of preservation and production requirements, they increasingly urge parties to act "in a manner consistent with the spirit of cooperation, openness, and candor owed to fellow litigants and the court and called for in modern discovery."  Sentis Group, Inc. v. Shell Oil Co., 559 F.3d 888, 891 (8th Cir. 2009).  Citing the Sedona Conference Cooperation Proclamation, several courts have recently recognized that "the best solution in the entire area of electronic discovery is cooperation among counsel."  William A. Gross Construction Associates v. American Manufacturers Mutual Insurance Co., 256 F.R.D. 134, 136 (S.D.N.Y. 2009); see also SEC v. Collins & Aikman Corp., 256 F.R.D. 403, 415 (S.D.N.Y. 2009) (citing the Sedona Conference Cooperation Proclamation); Technical Sales Associates v. Ohio Star Forge Co., 2009 WL 728520 at *4 (E.D. Mich. March 19, 2009) (same).  D.  Privilege Disputes Clawing back documents inadvertently produced privileged documents is another common theme of 2009 e-discovery opinions.  Typically, when a party produces a privileged document, the privilege is waived.  But a court may determine that the privilege is not waived under certain circumstances.  The reasonableness of a party’s discovery conduct plays a significant role in the waiver determination.  When assessing reasonableness, the court will look to the precautions the producing party put in place to prevent the disclosure.  In SEC v. Badian, 2009 WL 222783 (S.D.N.Y. Jan. 26, 2009), the court denied the motion of a third party seeking the return of privileged documents stating, "there is no basis for me to conclude that there were precautions [to prevent the disclosure], let alone whether they were reasonable."  SEC at *3.  The party also has to act reasonably in seeking the return of the documents.  In Brookdale University Hospital & Medical Center v. Health Ins. Plan of Greater N.Y., 2009 WL 393644 (E.D.N.Y. Feb. 13, 2009) the court held that the party seeking return of the documents delayed an unreasonable length of time before seeking their return (more than a year).  The new Federal Rule of Evidence 502 that went into effect in September 2008, aims to resolve many of the longstanding disputes over how to handle the inadvertent disclosure of privileged documents, and courts have begun to consider how to apply it.  In Heriot v. Byrne, the Northern District of Illinois interpreted Rule 502 as a matter of first impression and developed a test for resolving issues of inadvertent production of privileged documents.  Under this test, when a court applies FRE 502(b) it is "free to consider any or all of the five Judson factors."  2009 WL 742769 at *7 (N.D. Ill. Mar. 20, 2009); see Judson Atkinson Candies, Inc. v. Latini-Hophberger Dhimantec, 529 F.3d 371, 388 (7th Cir. 2008) (listing relevant factors as "(1) the reasonableness of the precautions taken to prevent disclosure; (2) the time taken to rectify the error; (3) the scope of the discovery; (4) the extent of the disclosure; and (5) the overriding issue of fairness").  In passing Rule 502, Congress instructed that courts should apply it to then-pending cases insofar as doing so is "just and practicable." Pub. L. No. 110-322, § 1(c).  Surprisingly, relatively few litigants are taking advantage of a Rule 502(d) order.  Rule 502(b) protects a party from waiving privilege when it inadvertently produces privileged documents under certain circumstances.  When a court considers whether a privilege is waived, it will look to the reasonable of the producing party’s conduct to prevent and detect production.  However, under 502(d), the parties may agree to an inadvertent production protocol, or if they do not agree, a party may seek a protocol independently, which the court will enter as an order.  If a privileged document is produced, the privilege is not waived in the current or any other litigation if the producing party complies with the 502(d) order.  There is no requirement that the court evaluate the reasonableness of the producing party’s conduct.  This potentially provides a wider scope of protection than that of 502(b).  It is important to note that the parties’ agreement should be entered as an order to get the full protection of 502(d).  As 502(e) notes, an agreement absent an order provides waiver protection only for the current litigation.  As counsel becomes more proficient in working under the new Rule, it is likely that 502(d) orders will become more common. E.  Search Terms Search terms were also a source of dispute during the first five months of 2009, with Magistrate Judge Peck of the Southern District of New York issuing a "wake-up call to the Bar . . . about the need for careful thought, quality control, testing, and cooperation with opposing counsel."  William A. Gross Construction Associates v. American Manufacturers Mutual Insurance Co., 256 F.R.D. 134, 134 (S.D.N.Y. 2009).  Where litigants sought to search their opponent’s computer system using search terms that would have potentially returned virtually all documents, the court ordered them to develop a new set of search terms through collaboration with opposing counsel.  The William A. Gross court was harshly critical of the practice of "designing keyword searches in the dark, by the seat of the pants, without adequate . . . discussion with those who wrote the emails." Id. at 135.  Thus, Judge Peck has joined others, such as Magistrate Judges Paul Grimm of the District of Maryland and John Facciola of the District of D.C. in urging the bar to become more adept at formulating search terms.  And, as Judge Peck succinctly put, "Of course, the best solution in the entire area of electronic discovery is cooperation among counsel."  Id. at 136.   II.  What’s Good for the Goose is Good for the Government Gander … Several of the 2009 opinions discuss e-discovery obligations of governmental entities.  This theme is evident in the increasing number of criminal cases involving e-discovery issues.  See, e.g., State v. Dingman, 202 P.3d 388 (Wash. 2009) (reversing criminal conviction where the state failed to provide the defendant with hard drive image in a file format his attorney could readily use); State v. Rivas, 905 N.E. 2d 618 (Ohio 2009) (refusing to allow defendant to access police computer files where he could not make a prima facie showing that a copy of those files was not consistent with the original content).  But the most notable 2009 cases involving the government were when the government acted as a civil litigant.  A.  E-Discovery and Government as Civil Litigant Judge Shira Scheindlin held in SEC v. Collins & Aikman Corp. that "[w]hen a government agency initiates litigation, it must be prepared to follow the same discovery rules that govern private parties."  256 F.R.D. 403, 418 (S.D.N.Y. 2009).  The SEC argued that a government agency should be able to unilaterally restrict the scope of a search based on assertions of "undue burden" and limited public resources.  Judge Scheindlin characterized this argument as "patently unreasonable" and emphasized that the SEC "is not entitled to special consideration concerning the scope of discovery, especially when it voluntarily initiates an action."  Id. at 414.  Construing the government’s asserted deliberative process privilege narrowly, the Collins & Aikman court found that for purposes of electronic discovery courts should generally treat the SEC like any other civil litigant. The Massachusetts District Court will confront a similar set of issues when it decides Abbott Laboratories’ motion for a finding of spoliation in In re Pharmaceutical Industry Average Wholesale Price Litigation.  See Abbott Laboratories, Inc.’s Memorandum in Support of Its Motion for a Finding of Spoliation and for Sanctions, In re Pharmaceutical Industry Average Wholesale Price Litigation, No. 01-CV-12257-PBS (D. Mass. June 4, 2009).  Abbott’s motion alleges that the Department of Justice kept its investigation "under seal for more than eleven years, conducting one-sided discovery against Abbott, but did nothing to preserve evidence in its own possession or control."  Id. at 1.  Among the missing data, Abbott claims that the government failed to properly preserve relevant Centers for Medicare & Medicaid Services emails sent prior to September 2005.  According to Abbott’s motion, "CMS changed its email program, but made no effort to retain relevant emails.  The result was a massive destruction of potentially relevant emails."  Id. at 4.  To the extent that Abbott is able to substantiate these claims, the Massachusetts District Court’s opinion may become a companion to Collins & Aikman: where Collins & Aikman admonishes the government for its failure to produce, this opinion may very well admonish the government for its failure to preserve.  B.  E-Discovery and the Constitutional Scope of Government Power Emerging technologies and e-discovery rules continue to present novel questions about the scope of government power, and constitutional protections regarding electronic information.  As courts confront these questions they are adapting legal doctrines to reflect new realities even while protecting core constitutional principles.  Several cases involving the First, Fourth and Fifth Amendments are particularly noteworthy: In Independent Newspapers, Inc. v. Brodie, the Maryland Court of Appeals wrote about the importance of anonymous speech and the right of internet bloggers to remain anonymous pursuant to the First Amendment.  The court required a significant showing, holding that "before a defamation plaintiff can obtain the identity of an anonymous defendant through the compulsory discovery process he must support his defamation claim with facts sufficient to defeat a summary judgment motion."  966 A.2d 432, 445 (Md. 2009).  Because their complaint could not sufficiently plead that anonymous online forum posts were defamatory, plaintiffs could not compel a newspaper who controlled the online blog to reveal the identities of the authors.  The court observed that "anonymity or pseudonymity [is] a part of the Internet culture" and concluded that its approach best balanced the need for discovery with "the interest in having anonymous works enter the marketplace of ideas."  Id. at 425, 428-29. Maldonado v. Barceloneta examined, apparently for the first time, what kind of communication a message placed on someone’s social networking page is, and what constitutional protections the author should receive.  The court concluded this type of message is neither a blog (which is viewable by anyone who views the blog and thus is protected First Amendment speech) nor an e-mail (that is a private communication among the correspondents) but "a hybrid of the two."  2009 WL 636016 at *2 (D.P.R. Mar. 11, 2009).  The Maldonado court held that such messages are not entitled to First Amendment protection because, like emails, "messages sent to a user’s [social networking] inbox are not publicly viewable."  Id.  Thus the message was not in the public domain for constitutional purposes. In People v. Weaver, the New York Court of Appeals held that police violated the New York State Constitution (and suggested, without deciding, that they also violated the Fourth Amendment) when they placed a GPS device on the undercarriage of the defendant’s van and traced his movements for sixty-five days without a warrant.  12 N.Y. 3d 433, No. 53 (N.Y. May 12, 2009).  Noting that "the determinative issue remains open as a matter of federal constitutional law," the court emphasized that under the state constitution "the great popularity of GPS technology for its many useful applications, may not be taken simply as a massive, undifferentiated concession of personal privacy to agents of the state." Id. slip op. at 12, 15.  "GPS is a vastly different and exponentially more sophisticated" form of tracking technology than [other] courts have considered in the past.  Id. slip op. at 9.  Because the "[c]onstant, relentless tracking of anything is now not merely possible but entirely practicable," courts must confront "potentially doctrine-forcing" changes in surveillance technology.  Id. slip op. at 7, 9. In re Grand Jury Subpoena to Sebastien Boucher held that the Fifth Amendment’s Self-Incrimination Clause did not protect a grand jury target’s right to refuse to provide the password to an encrypted hard drive to which he had already briefly given the government access.  2009 WL 424718 (D. Vt. Feb. 19, 2009).  Because the suspect had shown government officials some of the child pornography on his computer when he was arrested, "the existence and location of the documents [were] known to the government."  Id. at *3.  Since the government was not seeking to offer the files for purposes of authentication, "’no constitutional rights [were] touched.’"  Id. at *3 (quoting Fisher v. United States, 425 U.S. 391, 411 (1976)). Conclusion From the upswing in sanctions to new constitutional questions, e-discovery continues to be an important and rapidly developing area of law.  While several major themes characterize this year’s opinions thus far, their enduring lesson is that litigants and their counsel need to adapt in a period of rapid technological and legal change.    [1]  Year In Review: Courts Unsympathetic To Electronic Discovery Ignorance Or Misconduct, Kroll Ontrack, Dec. 2, 2008 available at http://www.krollontrack.com/news-releases/?getPressRelease=61208  [2]  In each of the following cases, the amount of costs and fees awarded will be determined by later proceedings:  Covad Comm’s v. Revonet, 2009 WL 1472345 (D.D.C. May 29, 2009); Trustees of Chicago Plastering v. Elwood, 2009 WL 1444436 (N.D. Ill. May 20, 2009); Preferred Care Partners, Inc. v. Humana, Inc. 2009 WL 982460 (S.D. Fla. Apr. 9, 2009); Phillip M. Adams & Assocs. v. Dell, 2009 WL 910801 (D. Utah Mar. 30, 2009); Anthropologie v. Forever 21, 2009 WL 690239 (S.D.N.Y. Mar. 13, 2009); Bray & Gillespie Mgm’t., 2009 WL 546429 (M.D. Fla. Mar. 4, 2009); Smith v. Slifer Smith & Frampton, D. Colo. Feb. 25, 2009); Beard Research v. Kates, 2009 WL 1515625 (Del. Ch. May 29, 2009).   [3]  The Sedona Conference Commentary on Legal Holds: The Trigger & The Process is a useful guide to the duty to preserve.  Available athttp://www.thesedonaconference.com/dltForm?did=Legal_holds.pdf This article was prepared by Michael F. Flanagan, with special thanks to Brian W. Barnes for his significant assistance.   The Electronic Data Discovery Initiative ("EDDI") is a task force at Gibson, Dunn & Crutcher LLP dedicated to issues of e-discovery and records management.  If you have any questions regarding this material, or how to address e-discovery in one of your matters, please contact the Gibson Dunn attorney with whom you work, or any of the following: Gareth T. Evans – Los Angeles (213-229-7734, gevans@gibsondunn.com)Michael F. Flanagan – Washington, D.C. (202-887-3599, mflanagan@gibsondunn.com)Farrah Pepper – New York (212-351-2426, fpepper@gibsondunn.com)  © 2009 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 15, 2010 |
2009 Year-End Electronic Discovery and Information Law Update

Electronic discovery is one of the most rapidly developing and increasingly important areas of interest for our clients.  The past year featured the continued refinement of best practices in e-discovery law, as both courts and litigants continued their struggle to balance cost-effective approaches to discovery with the right to equitable access to discoverable information.  The coming year is poised to be another one of significant developments.  Our Electronic Discovery and Information Law Practice Group will be carefully watching and reporting these developments to you throughout the year. This 2009 year-end update provides an overview and analysis of the recent trends in e-discovery law, as well as a survey of case law developments.  For more in-depth treatment of these and other related topics, a collection of Gibson Dunn’s publications on electronic discovery and information law topics may be found on our website.   While sanctions continued to be a dominant theme in 2009, courts and litigants have become more knowledgeable about the fundamentals, and the general framework of e-discovery obligations is becoming more settled.  Likely as a result of this development, e-discovery disputes in 2009 tended to involve the application of e-discovery principles to more complex factual scenarios.  While courts have increasingly demanded that parties engage in reasonable e-discovery practices–and often impose sanctions when they fail to do so–courts in 2009 also frequently encouraged parties to anticipate and resolve potential issues through cooperation. Highlights of 2009 included: The number of e-discovery opinions almost doubled in 2009 over 2008. Almost half of the e-discovery opinions concerned sanctions, and sanctions were awarded in 70% of those cases, including 10 cases with terminating sanctions and five cases sanctioning counsel. E-discovery law is becoming more widespread and largely uniform, especially in federal jurisdictions; courts in every circuit issued e-discovery opinions in 2009. Courts are continuing to provide greater clarity on e-discovery requirements, including the duty to preserve, and the consequences of failing to do so. Courts increasingly are urging litigants to engage in cooperative and transparent discovery. Governmental entities are being held to the same e-discovery requirements as private litigants. As in prior years, there was an increase in e-discovery opinions in 2009.  Gibson Dunn has identified more than 200 such opinions issued by federal and state courts in the year, almost double the number issued in 2008.  As the number of cases has increased, the body of e-discovery law is becoming more evenly distributed among jurisdictions.  A similar growth of case law in state courts is also occurring (34 out of 208 cases), providing guidance in some key states.  The Delaware Chancery Court is a good example of this.  Before 2009, the Chancery Court had issued only a handful of e-discovery opinions (one in each of the years 2005 to 2008); and these cases addressed relatively minor e-discovery issues (e.g., form of production, access to a database, etc.).  In 2009, the Chancery Court issued four opinions that addressed fundamental e-discovery issues such as triggering the duty to preserve, the scope of that duty, litigation holds, and spoliation.  See Beard Research, Inc. v. Kates, 981 A.2d 1175 (Del. Ch. 2009); Omnicare, Inc. v. Mariner Health Care Mgmt. Co., No. 3087-VCN, 2009 WL 1515609 (Del. Ch. May 29, 2009); TR Investors, LLC v. Genger, No. 3994-VCS, 2009 WL 4696062 (Del. Ch. Dec. 9, 2009); Triton Constr. Co. v. Eastern Shore Elec. Servs., Inc., No. 3290-VCP, 2009 WL 1387115 (Del. Ch. May 18, 2009).  For more information about the Delaware Chancery Court opinions see Gibson Dunn‘s client alert, "Delaware Chancery Court Awards Sanctions for Spoliation; Issues Significant Guidance on Electronic Discovery." Last year’s opinions involved sanctions more than any other subject.  Of the 208 e-discovery opinions analyzed by Gibson Dunn, sanctions were sought in 88 of the cases (42%), and were awarded in 62 cases (70% of cases where sanctions were sought, and 30% of all e-discovery cases).  This is a significant increase over 2008, where 25% of the e-discovery cases sought sanctions.  Privilege waiver (13%), cooperation (10%), and form of production (10%) were also recurring issues in 2009. 2009 Trends in Sanctions The most common sanctions awarded in 2009 were the costs and fees associated with the discovery issue in dispute (33 out of 62 cases, or 53% of the sanctions cases identified).  In at least five cases, not only was a party sanctioned, but their counsel also was sanctioned.  See, e.g., Swofford v. Eslinger, No. 6:08-CV-00066-Orl-35DAB, 2009 WL 3818593 (M.D. Fla. Sept. 28, 2009); Green v. McClendon, No. 08 Civ. 8496, 2009 WL 2496275 (S.D.N.Y. Aug. 13, 2009); Bray & Gillespie Mgmt. LLC v. Lexington Ins. Co., 259 F.R.D. 568 (M.D. Fla. 2009), aff’d in part, rev’d in part by Bray & Gillespie Mgmt. LLC v. Lexington Ins. Co., No. 6:07-cv-0222-Orl-35KRS (M.D. Fla.  Jan. 5, 2010) (awarding additional sanction of dismissal of certain of plaintiff’s claims with prejudice); Steinbuch v. Cutler, No. 07-31459, 2009 WL 2370624 (Bankr. N.D.N.Y. June 5, 2009).    Swofford and Green illustrate how courts are holding both inside and outside counsel responsible for ensuring that their clients fulfill their e-discovery obligations.  In Swofford, inside counsel for a sheriff’s department failed to issue a litigation hold notice when litigation became foreseeable, and failed to undertake other meaningful actions to preserve relevant information.  The court stated that in-house counsel "professed not to have ever read the Federal Rules of Civil Procedure to ascertain on even a rudimentary level what his and his client’s obligations were in this regard."  2009 WL 3818593, at *4.  In addition to awarding adverse inference sanctions, the court ordered the defendants and inside counsel to pay fees and costs.  This is especially notable because the in-house counsel was not an attorney of record in the case, and each defendant had separate outside counsel. In Green, defendant’s counsel discussed with defendant the duty to preserve relevant data at the outset of the litigation, but the court concluded that counsel failed to provide enough detail or explicitly issue a written litigation hold notice.  Green, 2009 WL 2496275, at *5 (observing that "[u]nless [the defendant] brazenly ignored her attorney’s instructions, counsel apparently neglected to explain to her what types of information would be relevant and failed to institute a litigation hold to protect relevant information from destruction.")  When defendant reformatted her hard drive, resulting in the destruction of relevant evidence, the court awarded costs to be apportioned between defendant and outside counsel.  The court emphasized that "[t]he preservation obligation runs first to counsel, who has a duty to advise his client of the type of information potentially relevant to the lawsuit and of the necessity of preventing its destruction."  Id. (internal citations omitted).   While costs and fees were the most common sanction awarded in 2009, more severe sanctions also were imposed.  Courts awarded adverse inferences in 13 cases and evidence preclusion in five others.  The most noteworthy sanctions, however, were the 10 decisions that resulted in the termination of litigation due to discovery failures.  In five of these cases, the sanctioned party knowingly deleted or destroyed electronic data.  See Arista Records, LLC v. Usenet.com, Inc., 633 F. Supp. 2d 124 (S.D.N.Y. 2009); Elec. Funds Solutions LLC v. Murphy, No. 6040161, 2009 WL 1717383 (Cal. Ct. App. June 19, 2009); Grochocinski v. Schlossberg, 402 B.R. 825 (N.D. Ill. 2009); Kvitka v. Puffin Co., No. 1:06-CV-0858 2009 WL 385582 (M.D. Pa. Feb. 13, 2009); Gillett v. Mich. Farm Bureau, No. 286076, 2009 WL 4981193 (Mich. Ct. App. Dec. 22, 2009).  In four other cases, the sanctioned party repeatedly made knowing misrepresentations to opposing counsel and the court regarding the existence of relevant data or the party’s discovery conduct.  See 1100 West, LLC v. Red Spot Paint & Varnish Co., No. 1:05-CV-1670, 2009 WL 1605118 (S.D. Ind. June 5, 2009); Doppes v. Bentley Motors, Inc., 94 Cal. Rptr. 3d. 802 (Cal. App. 2009); Gamby v. First Nat’l Bank of Omaha, No. 06-11020,  2009 WL 127782 (E.D. Mich. Jan. 20, 2009); Magaña v. Hyundai Motor Am., 220 P.3d 191 (Wash. 2009). Finally, in Micron Technology, Inc. v. Rambus, Inc.,  255 F.R.D. 135 (D. Del. 2009), Micron, anticipating that Rambus would soon sue it for patent infringement as it had other computer chip makers, brought a preemptive declaratory relief action against Rambus seeking to have Rambus’s patents declared unenforceable.  By monitoring other cases involving Rambus, Micron became aware of potential deficiencies in Rambus’s preservation of relevant information.  Micron obtained a ruling that Rambus had failed to properly preserve relevant data such that the court could not determine whether the patents were proper, and as a sanction declared Rambus’s patents unenforceable against Micron, thus terminating the litigation in Micron’s favor.  Despite the increase in the number of cases awarding sanctions, courts tended to award them only for the most egregious conduct, and appeared to be carefully imposing them to offset the harm or burden suffered by the aggrieved party.  Generally, the harm suffered was the expenditure of resources to bring a motion to compel, or otherwise to seek the court’s intervention (resulting in the award of fees and costs).  Courts awarded more severe sanctions when a party willfully destroyed data or made misrepresentations to opposing counsel or the court. 2009 Trends in Document Preservation Document preservation remained an important e-discovery theme in 2009, and courts issued a steady stream of opinions providing guidance on best practices.  For more information on the 2009 case law developments in document preservation see Gibson Dunn attorney Farrah Pepper’s article, "To Have and to Hold: A Romantic Guide to Document Preservation." The 2009 cases reiterated that the duty to preserve relevant evidence commences when litigation is reasonably foreseeable.  See, e.g., Micron, 255 F.R.D. at 148.  Cases also emphasized that this duty can be triggered long before the filing of a complaint.  See, e.g., Phillip M. Adams & Assocs. v. Dell, Inc., 621 F. Supp. 2d. 1173 (D. Utah 2009) (holding that because patents at issue were well known to be problematic in the industry, litigation regarding them was foreseeable well before the filing of a complaint); Beard Research, 981 A.2d at 1195 (holding that former employee’s duty to preserve may have attached when he disclosed confidential information to a competitor while seeking employment); Micron, 255 F.R.D. 135 (holding that patent holder’s duty to preserve was triggered when it developed litigation strategy against potential infringers well before filing complaint); Scalera v. Electrograph Sys. Inc., No. CV 08-50, 2009 WL 3126637 (E.D.N.Y. Sept. 29, 2009) (holding that employer had a duty to preserve when it received a notice from the EEOC of a complaint by a former employee); Major Tours, Inc. v. Colorel, No. 05-3091, 2009 WL 2413631 (D.N.J. Aug. 4, 2009) (holding that the duty to preserve was triggered nearly two years before litigation commenced when the plaintiffs’ attorney sent a letter threatening suit).  Major Tours is also an example of courts requiring greater transparency regarding parties’ e-discovery compliance, as the court ordered the defendant to disclose its litigation hold notices and distribution lists after being presented with deposition testimony that witnesses were unaware of the company’s litigation hold. 2009 Trends in Search Methodology Courts generally are becoming more conversant and involved in e-discovery mechanics, as reflected in the increasing number of cases involving the use of search terms.  Some courts in 2009 declined to involve themselves in the minutiae of search terms–referring parties to experts (see Omnicare, 2009 WL 1515609) or requiring the parties to resolve the search term issues themselves (see, e.g., Smith v. Life Investors Ins. Co., No. 2:07-CV-681, 2009 WL 3364933 (W.D. Pa. Oct. 16, 2009)).  But others became involved in crafting search terms and made specific findings regarding the parties’ proposed terms.  See, e.g., Capitol Records, Inc. v. MP3Tunes, LLC, 261 F.R.D. 44 (S.D.N.Y. 2009) (ordering producing party to apply specified search terms across specified custodians’ data, but relieving the party from logging any privileged documents); Kay Beer Distrib., Inc. v. Energy Brands, Inc., No. 07-C-1068, 2009 WL 1649592 (E.D. Wisc. June 10, 2009) (ordering defendant to search for different variants of plaintiff’s name); In re Zurn Pex Plumbing Prods. Liab. Litig., MDL No. 08-1958 ADM/RLE, 2009 WL 1606653, at *3 (D. Minn. June 5, 2009) (ordering defendants to use certain search terms, although allowing the parties to "decide on a different set of fourteen terms if they choose to do so").  Although acknowledging that the producing party understands its own culture and lexicon better than the requesting party, some courts found that broader terms proposed by the requesting party should be used.  See Wixon v. Wyndham Resort Dev. Corp., No. C 07-02361-JSW, 2009 WL 3075649 (N.D. Cal. Sept. 21, 2009); In re Direct Southwest, Inc., No. 08-1984-MLCF-SS, 2009 WL 2461716 (E.D. La. Aug. 7, 2009).  Courts also required the parties to justify the search terms they requested.  See, e.g., Flying J Inc. v. Pilot Travel Ctrs., LLC, No. 1:06-CV-00030, 2009 WL 1834998 (D. Utah June 25, 2009) (requiring the requesting party to submit written justification for its proposed terms and allowing responding party to object). Search terms were increasingly used to sample data sets to identify key custodians and to inform what, if any, additional discovery was warranted.  See In re Zurn, 2009 WL 1606653, at *3 (requiring the parties to run fourteen terms initially and to review the documents identified by them to determine whether additional terms should be run); Dunkin’ Donuts Franchised Rests. LLC v. Grand Cent. Donuts, Inc., No. CV 2007-4027, 2009 WL 1750348 (E.D.N.Y. June 19, 2009) (requiring the parties to identify terms tailored to specific corporate divisions based upon their involvement in the subjects at issue as initial discovery step); Flying J, 2009 WL 1834998 (requiring the requesting party to identify 28 terms for initial search).  Using search terms to sample a data set can often be effective in controlling the cost and burden of discovery.  As Magistrate Judge Peck of the Southern District of New York noted, the skillful use of search terms requires "careful thought, quality control, testing, and cooperation with opposing counsel."  William A. Gross Constr. Assocs. v. American Mfrs. Mut. Ins. Co., 256 F.R.D. 134, 134 (S.D.N.Y. 2009). For a more detailed analysis of the Gross Construction opinion, see Gibson Dunn attorneys Jennifer H. Rearden and Farrah Pepper’s article, "Judge Issues a "Wake-Up Call" to New York Lawyers When It Comes to Search Terms, Play Nice and Plan Ahead." 2009 Trends in Cooperation and Proportionality Courts continued to emphasize the need for counsel to cooperate to avoid or resolve discovery disputes, often citing The Sedona Conference® Cooperation Proclamation.  The Cooperation Proclamation encouraged "a national drive to promote open and forthright information sharing, dialogue (internal and external), training, and the development of practical tools to facilitate cooperative, collaborative, transparent discovery," and set forth specific recommendations for achieving this goal. Since its publication, the Cooperation Proclamation has gained significant support among the judiciary.  As of January 2009, 44 judges had endorsed the Cooperation Proclamation.  At year end, that number increased to nearly 100.  Even Supreme Court Justice Stephen Breyer has written supportively of the principles of the Cooperation Proclamation, calling on litigants to "act cooperatively in the fact-finding process," noting that cooperation between parties will encourage resolution of cases, "and this will help ensure that the courts are not open only to the wealthy."  See 10 The Sedona Conference® Journal (Supp. 2009). Following the 2008 decision in Mancia v. Mayflower Textile Services. Co., 253 F.R.D. 354 (D. Md. 2008), a number of decisions in 2009 expressly adopted the Cooperation Proclamation as a roadmap for resolution of electronic discovery disputes.  Several courts ordered parties to cooperate and reach agreement regarding issues ranging from production of backup tapes to the form of production, specifically citing The Sedona Conference® Cooperation Proclamation as the basis for the order.  See, e.g., Dunkin’ Donuts, 2009 WL 1750348 (ordering parties to enter into an agreed-upon protocol to govern electronic discovery); Wells Fargo Bank, N.A. v. LaSalle Bank Nat’l Ass’n, No. 3:07-CV-449, 2009 WL 2243854 (S.D. Ohio July 24, 2009) (admonishing the parties for not engaging in an effective meet and confer process and denying any further discovery); Capitol Records, 261 F.R.D. at 50 (admonishing the parties for focusing efforts on "dueling epistles for submission," instead of cooperating on resolving discovery disputes); In re Direct Southwest, Inc., 2009 WL 2461716 (citing the Cooperation Proclamation, the court admonished the parties for submitting self-serving search terms); Oracle USA, Inc. v. SAP AG, No. C-07-01658, 2009 U.S. Dist. LEXIS 91432 (N.D. Cal. Sept. 17, 2009) (granting preclusion of evidence regarding damages because the claiming party had previously agreed that it would not seek damages on certain subjects and holding the party to its agreement); Newman v. Borders, 257 F.R.D. 1 (D.D.C. 2009) (ordering defendant to answer nine written questions in lieu of additional depositions, citing the Cooperation Proclamation and the court’s inherent duty to limit discovery costs and move litigation forward); Ford Motor Co. v. Edgewood Props. Inc., 257 F.R.D. 418 (D.N.J. 2009) (indicating the appropriateness of early discussion of the preferred format of production as encouraged by the Cooperation Proclamation and denying re-production of documents in native format).  For further discussion of the application and impact of The Sedona Conference® Cooperation Proclamation see Gibson Dunn attorneys Jennifer H. Rearden and Farrah Pepper’s article, "If The Sedona Conference Builds It, Will They Cooperate?  Year in Review." Even decisions that did not expressly adopt the Cooperation Proclamation emphasized the advantages of reaching agreed-upon resolutions to electronic discovery disputes.  See, e.g., Dahl v. Bain Capital Partners, LLC, No. 07-12388-EFH, 2009 WL 1748526, at *1 (D. Mass. June 22, 2009) ("The parties should cooperate as much as possible in exchanging information, for this collaboration helps to fulfill the overall goal of discovery: to focus on matters reasonably calculated to produce evidence admissible at trial."); In re Weekley Homes, L.P., 295 S.W.3d 309, 321 (Tex. 2009) ("[P]rior to promulgating requests for electronic information, parties and their attorneys should share relevant information concerning electronic systems and storage methodologies so that agreements regarding protocols may be reached or, if not, trial courts have the information necessary to craft discovery orders that are not unduly intrusive or overly burdensome.")  When parties reached agreement, courts often held them to their bargain.  See, e.g., Widevine Techs., Inc. v. Verimatrix, Inc., No. 2-07-CV-321, 2009 WL 4884397 (E.D. Tex. Dec. 10, 2009) (denying a motion to compel the production of documents outside of the date range agreed to by the parties, even though the documents might be responsive); In re Classicstar Mare Lease Litig., MDL No. 1877, 2009 WL 260954 (E.D. Ky. Feb 2. 2009) (denying a motion to compel the production of documents in a format different from the one agreed to initially by the parties).  Agreements were reached not only between parties of roughly equal resources or amounts of potentially relevant data, but also between parties with unequal resources.  See, e.g., Capitol Records, 261 F.R.D. 44; Oracle USA, 2009 U.S. Dist. LEXIS 91432; Widevine Techs., 2009 WL 4884397; Ford Motor Co. v. Edgewood Props. Inc., 257 F.R.D. 418; Newman, 257 F.R.D. 1.  By enforcing e-discovery protocols negotiated by the parties, courts rewarded cooperative conduct, just as sanctions punished uncooperative conduct. Courts were increasingly sensitive to the burden associated with e-discovery, and employed creative methods to proportionately and iteratively identify relevant data.  See, e.g., Rahman v. Smith & Wollensky Rest. Group, Inc., No. 06 Civ. 6198LAKJCF, 2009 WL 773344 (S.D.N.Y. Mar. 18, 2009) (holding that email was inaccessible because of undue burden or cost in proportion to its potential benefit though the email was on a live system and not backup tapes); In re Zurn, 2009 WL 1606653, at *2 (ordering a sampling of data using limited search terms to determine whether additional discovery was warranted).  The increased emphasis on cooperative, transparent, and proportional discovery appears to be bearing fruit, as evidenced by the number of cases where parties are negotiating discovery agreements, seeking to agree on search terms, and employing sampling or other iterative techniques.  It is likely that this trend will continue to develop in the coming year. 2009 Trends in Privilege Waiver Courts issued a number of decisions in 2009 applying and interpreting Federal Rule of Evidence 502, which was enacted in 2008 to provide uniformity and greater protection against waiver of the attorney-client privilege and work-product protection due to disclosure of privileged information.  Several decisions addressed Rule 502(b), which provides that an inadvertent disclosure is not a waiver if the holder "took reasonable steps to prevent disclosure" and "promptly took reasonable steps to rectify the error."  In determining whether a producing party’s production methodology was reasonably designed to prevent disclosure, courts considered the volume of privileged documents produced compared to the total volume of documents, the use of "sophisticated software" for the review, the extent, and quality of the training of the attorneys and/or paralegals conducting the review, and other factors.  See, e.g., Coburn Group, LLC v. White Cap Advisors, LLC, 640 F. Supp. 2d 1032 (N.D. Ill. 2009) (granting the claw back of email containing work product finding that steps to prevent disclosure were reasonable); United States v. Sensient Colors, Inc., No. 07-1275 (JHR/JS), 2009 WL 2905474 (D.N.J. Sept. 9, 2009) (holding that the first of three groups of privileged documents inadvertently produced could be clawed back, but second and third groups could not because producing party was on notice and did not rectify its error in producing them); Heriot v. Byrne, 257 F.R.D. 645 (N.D. Ill. 2009) (holding that inadvertent disclosure of privileged documents by a party’s e-discovery vendor did not waive the privilege because the steps to prevent disclosure were reasonable, even though not followed by vendor, and thus not attributable to the party).  Along with the increasing application of Rule 502(b), the use of Rule 502(d) protective orders also increased.  Rule 502(d) allows a court to issue an order–for example, a stipulated protective order–pursuant to which a disclosure of privileged or protected information, whether inadvertent or purposeful, will not constitute a waiver in any federal or state proceeding.  Some courts have even required parties to incorporate Rule 502(d) into their discovery plans to avoid burdensome, expensive, and time-consuming privilege reviews.  See, e.g., Spieker v. Quest Cherokee, LLC, No. 07-1225-EFM, 2009 WL 2168892 (D. Kan. July 21, 2009).  The advantage of a Rule 502(d) order is that it eliminates an inquiry into the reasonableness of the steps the producing party took to prevent disclosure, as required under Rule 502(b).  Rule 502(d) protective orders are being used not only to protect against waiver for inadvertent disclosure of privileged or protected information, but also to protect against waiver when a party purposefully discloses protected information–e.g., to the DOJ or a regulatory agency.  Although a Rule 502(d) order can be a powerful protective tool, the wording of the order must be carefully considered.  The Rule 502(d) order issued in SEC v. Bank of America Corp., No. 09 Civ. 6829, 2009 WL 3297493 (S.D.N.Y. Oct. 14, 2009), is instructive in this regard.  Judge Rakoff of the Southern District of New York entered the parties’ negotiated Rule 502(d) order, but indicated that the order would not preclude parties in private litigation from challenging the defendant’s claim of privilege.  Id., at *1.  In effect, the court appeared to suggest that despite the intention of Rule 502(d), the language of this particular stipulated order (which in part was phrased in terms of selective waiver) might be insufficient to prevent a waiver of the privilege.  For more detailed analysis of FRE 502 and its application in case law see Gibson Dunn attorneys Gareth Evans and Farrah Pepper’s article, "Federal Rule of Evidence 502: Getting to Know an Important E-Discovery Tool." 2009 Trends Where the Government Is a Party In 2009, courts continued to issue e-discovery decisions involving governmental entities as civil litigants, and the case law is more clearly defining the government’s e-discovery obligations.  Judge Shira Scheindlin held in SEC v. Collins & Aikman Corp. that "[w]hen a government agency initiates litigation, it must be prepared to follow the same discovery rules that govern private parties."  256 F.R.D. 403, 418 (S.D.N.Y. 2009).  In Collins & Aikman, the SEC argued that a government agency should be able to unilaterally restrict the scope of a search of email based on assertions of "undue burden" and limited public resources.  Judge Scheindlin characterized this argument as "patently unreasonable" and emphasized that the SEC "is not entitled to special consideration concerning the scope of discovery, especially when it voluntarily initiates an action."  Id. at 414.  Several other cases involved a governmental entity as a litigant, and their e-discovery obligations.  See Ford Motor Co. v. United States, No. 08-CV-12960, 2009 WL 2176657 (E.D. Mich. July 21, 2009) (ordering IRS to conduct search of employees’ email accounts over government objection that discovery should be limited due to its status); In re Fannie Mae Sec. Litig., 552 F.3d 814 (D.C. Cir. 2009) (ordering non-party regulator to provide allegedly privileged documents to litigants for a "quick peek" review because of significant and repeated delays in production); Chambers v. Dep’t of the Interior, 568 F.3d 998 (D.C. Cir. 2009) (granting summary judgment against DOI for spoliation); Ak-Chin Indian Cmty. v. United States, 85 Fed. Cl. 397 (2009) (granting motion to compel against the Department of Interior, requiring the organization and labeling of tribal records as held in the ordinary course); Neighborhood Alliance v. County of Spokane, No. 27184-6-III, 2009 WL 2456857 (Wash. Ct. App. Aug. 11, 2009) (granting motion to compel against county in FOIA request and ordering adequate search of computers); Sensient Colors, 2009 WL 2905474 (denying claw back request of privileged documents because of unreasonableness of plaintiff’s protocols to prevent disclosure). Conclusion In sum, 2009 featured a record number of reported e-discovery decisions.  While sanctions continued to be a major topic, many decisions also addressed document preservation, search methodologies, cooperation, the application of Federal Rule of Evidence 502 to privilege waiver issues, and the e-discovery duties of governmental entities.  We will continue to track these and other developments in the e-discovery field and report them to you in our 2010 Mid-Year Report. Gibson Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this article.  The Electronic Discovery and Information Law Practice Group brings together lawyers with extensive knowledge of electronic discovery and information law.  The group is comprised of seasoned litigators with a breadth of experience who have assisted clients in various industries and in jurisdictions around the world.  The group’s lawyers work closely with the firm’s technical specialists to provide cutting-edge legal advice and guidance in this complex and evolving area of law.  For further information, please contact the Gibson Dunn lawyer with whom you work or any of the following members of the Electronic Discovery and Information Law Group Steering Committee: Los Angeles/Orange CountyGareth T. Evans – Practice Co-Chair (213-229-7734, gevans@gibsondunn.com) New YorkJennifer H. Rearden – Practice Co-Chair (212-351-4057, jrearden@gibsondunn.com)Farrah Pepper – Practice Vice-Chair (212-351-2426, fpepper@gibsondunn.com) Washington, D.C.Michael F. Flanagan (202-887-3599, mflanagan@gibsondunn.com) San FranciscoG. Charles Nierlich – Practice Co-Chair (415-393-8239, gnierlich@gibsondunn.com)George A. Nicoud III ("Trey") (415-393-8308, tnicoud@gibsondunn.com) Palo AltoPaul J. Collins (650-849-5309, pcollins@gibsondunn.com) DallasM. Sean Royall – Practice Co-Chair (214-698-3256; sroyall@gibsondunn.com)Sarah Toraason (214-698-3226, storaason@gibsondunn.com) DenverRobert C. Blume (303-298-5758, rblume@gibsondunn.com) © 2010 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 8, 2010 |
2009 Year-End False Claims Act Update

In 2009, the United States government invested trillions of dollars into the economy.  Coupled with this unprecedented spending came increased demands for transparency and accountability.  Meanwhile, the False Claims Act (FCA)[1] underwent significant change in 2009, and we witnessed record-breaking settlements, statutory amendments, legislative proposals, and important judicial decisions.  In the end, these developments should encourage contractors, grantees, and other direct and indirect recipients of federal funds to reevaluate and, if necessary, strengthen their FCA compliance efforts. 1.  FCA Enforcement Activity in 2009 A.   Total Recovery Amounts 2009 was a monster year for FCA enforcement.  The Department of Justice (DOJ) announced $2.4 billion in civil settlements and judgments in FCA cases for the fiscal year ending September 30, 2009.[2]  This total represents the second largest annual recovery of civil fraud claims and only the third time recoveries have exceeded $2 billion in a single year.  The 2009 figures raise total federal FCA recoveries since 1986 to more than $24 billion.[3] The FCA’s enormous whistleblower incentives were most evident in 2009.  Nearly $2 billion of the FY 2009 settlements and judgments stemmed from actions initiated under the qui tam provisions of the FCA, and relators received more than $255 million in FY 2009 alone.  Moreover, recent legislative enactments have strengthened whistleblower protections, and pending legislation would strengthen them even further.[4]  The current political climate suggests ever increasing incentives for, and reliance upon, private qui tam enforcement of the FCA. B.  Industry Breakdown In 2009, health care and procurement fraud in connection with Department of Defense (DOD) contracts continued to dominate FCA recoveries.  The following chart depicts federal civil FCA recoveries within these industries over the last decade: FCA Recoveries By Industry   i.  Health Care Fraud As with all previous years for which statistics are available, the overwhelming majority of recoveries in FY 2009, nearly $1.6 billion, came from the health care industry.[5]  The statistics are not surprising given the massive amounts of federal health care spending.  In FY 2009 alone, assistance from the Department of Health and Human Services (HHS) exceeded $363 billion (30.7% of total federal grant dollars for the fiscal year).  And the National Health Care Anti-Fraud Association estimates that the United States government loses at least $60 billion to health care fraud every year. In its November 19, 2009 Press Release, the DOJ stated that fighting health care fraud is a “top priority,” and noted that its Civil Division “is pursuing allegations of a variety of schemes” within the health care industry.[6]  Earlier this year, on May 29, 2009, the DOJ and HHS announced a joint task force comprised of law-enforcement agents and prosecutors aimed at preventing fraud and enforcing anti-fraud laws known as the Health Care Fraud Prevention & Enforcement Action Team (HEAT).  HHS Secretary Kathleen Sebelius announced that the taskforce would “turn[] up the heat on perpetrators who steal from the taxpayers and threaten the future of Medicare and Medicaid.”[7]  DOJ credits much of its recent, significant health care recoveries to the work of HEAT and similar health care strike forces. ii.  Procurement Fraud FY 2009 procurement fraud settlements and judgments totaled more than $608 million and represented a quarter of all FY 2009 FCA recoveries.  $422 million of those recoveries were attributable to defense contracts ($59 million of which related to contracts in support of the wars in Iraq and Afghanistan).  Throughout 2009, President Obama and members of Congress repeatedly have called for increased oversight, accountability, and transparency in government contracting.  On March 4, 2009, President Obama observed, “Over the last eight years, government spending on contracts has doubled to over half a trillion dollars.  Far too often, the spending is plagued by massive cost overruns, outright fraud, and the absence of oversight and accountability.”[8] Not surprisingly, Assistant Attorney General Tony West proclaimed, “Addressing procurement fraud [remains] among [the] highest priorities at the [DOJ] and for the Civil Division . . . This includes everything from pursuing fraud in connection with the delivery of vital services to our men and women in uniform, to ensuring that the American taxpayers are not overcharged for what we purchase; ensuring that the equipment we deploy is built to specifications, tested, and properly performs, and enforcing the laws against bribery or other corruption that taints our contracts.”[9] In addition, Section 841 of the National Defense Authorization Act for Fiscal Year 2008 created the Commission on Wartime Contracting in Iraq and Afghanistan (CWCIA), tasked with, among other things, “assess[ing] a number of factors related to wartime contracting, including the extent of waste, fraud, abuse, and mismanagement of wartime contracts.”[10]  In its June 2009 Interim Report to Congress, the CWCIA stated, the “environment in Iraq and Afghanistan has been and continues to be susceptible to waste, fraud, and abuse.”[11]  The CWCIA continued: Without proper oversight, the government cannot confirm that contractors are performing in accordance with contract requirements, cannot support payment of award or incentive fees, cannot support the certification of invoices for services performed, and cannot ensure that services critical for the completion of our military and reconstruction missions are performed.  Any one of these conditions invites waste and abuse.  Taken together, they are a perfect storm for disaster.[12] While the CWCIA focuses on operations in Iraq and Afghanistan, in January 2009, Congress created an ad hoc subcommittee on contracting oversight to focus on all federal contracting.  The subcommittee held several hearings during 2009, including “Improving the Ability of Inspectors General to Detect, Prevent, and Prosecute Contracting Fraud,” in April 2009, and “Achieving the President’s Objectives: New OMB Guidance to Combat Waste, Inefficiency, and Misuse in Federal Government Contracting” in October 2009, which examined, among other things, “what additional controls and government oversight are needed to make sure that [government] contracts don’t result in the waste, fraud, and abuse we saw in Iraq.”[13] Given the government’s extensive and ever increasing reliance on private contractors and the cry for increased oversight, we expect a further increase in FCA enforcement activity within the procurement arena over the next several months. C.  Significant FCA Settlements and Judgments in FY 2009 DOJ press releases in 2009 announced several record-breaking recoveries, including, “the largest criminal fine ever imposed in the United States for any matter,”[14] the “largest civil fraud settlement in history against a pharmaceutical company,”[15] “one of the largest recoveries ever in a case involving a medical device,”[16] and “a record federal recovery by the Justice Department for the Medicaid Program.”[17]  Among the most substantial settlements in 2009 were: Pfizer:  In September 2009, the DOJ announced its settlement with pharmaceutical company Pfizer Inc. and its subsidiary Pharmacia & Upjohn Company Inc.[18]  Pfizer agreed to pay $1 billion to resolve FCA allegations regarding alleged illegal promotion of four drugs.  The federal share of the civil settlement exceeded $668.5 million and the state Medicaid share of the civil settlement exceeded $331 million.  Six whistleblowers will receive payments totaling more than $102 million from the federal share of the civil recovery.  Under the terms of the settlement, Pharmacia & Upjohn Company also pleaded guilty to a felony violation of the Food, Drug and Cosmetic Act and agreed to pay a criminal fine of nearly $1.2 billion.  Pharmacia & Upjohn also forfeited $105 million, for a total criminal resolution of $1.3 billion. New York State and New York City:  In July 2009, the DOJ announced a settlement that represented at the time “a record federal recovery by the Justice Department for the Medicaid Program” when New York State and New York City agreed to pay $540 million to settle allegations that they submitted or caused to be submitted false claims for reimbursement for school-based health care services provided to Medicaid eligible children.  The qui tam relator who initiated the FCA investigation and actions received $10 million.[19] Sanofi-Aventis:  In May 2009, Sanofi-Aventis agreed to pay $95.5 million to settle allegations that it violated Medicaid’s “best prices” requirement.  Under the Medicaid Drug Rebate Statute, Sanofi-Aventis was required to report to Medicaid the lowest, or “best” price that it charged commercial customers, and pay quarterly rebates to the states based on those reported prices.  Of the total settlement amount, $49 million went to the federal government, more than $40 million went to several states, and more than $6 million was awarded to certain public health services entities who allegedly paid inflated prices for the drugs.[20] Quest Diagnostics:  In April 2009, the DOJ announced a $302 million global settlement with Quest Diagnostics and its subsidiary, Nichols Institute Diagnostics (NID), resolving criminal and civil claims concerning various types of diagnostic test kits that NID manufactured, marketed, and sold to laboratories throughout the country.[21]  According to the DOJ, the payment “represents one of the largest recoveries ever in a case involving a medical device.”[22]  Quest and NID paid the United States $262 million plus interest to resolve the civil FCA allegations, and paid various state Medicaid programs approximately $6.2 million.  The qui tam relator received approximately $45 million from the federal share of the settlement amount. Northrop Grumman:  In April 2009, Northrop Grumman Corp., one of its subsidiaries, and a predecessor company agreed to settle FCA claims in connection with the sale of allegedly defective satellite parts.  The DOJ valued the settlement at $325 million, which was used to offset claims Northrop had asserted against the government in an earlier, unrelated contract dispute action.[23]  A former employee whistleblower was awarded more than $48 million as his share of the recovery under the qui tam provisions of the FCA. NetApp:  In April 2009, GSA Contractor NetApp Inc. and NetApp U.S. Public Sector Inc. agreed to pay $128 million to resolve claims that they violated the FCA during contract negotiations and administration by knowingly failing to provide GSA with current, accurate, and complete information about its commercial sales practices and discounts for hardware, software, and storage management services for computer networks sold to government entities through the GSA program.[24]  A former NetApp employee whistleblower was awarded more than $19 million as his share of the recovery. APL:  In February 2009, APL Limited agreed to settle FCA claims for more than $26 million stemming from allegations that it submitted inflated invoices for shipping containers to troops in Iraq and Afghanistan.[25] Eli Lilly:  On January 15, 2009, Eli Lilly and Company agreed to pay $1.415 billion to resolve criminal and civil allegations stemming from off-label promotion of prescription drugs.[26]  The federal share of the civil FCA settlement was $438 million.  At the time, the reported $515 million criminal fine was “the largest ever in a health care case, and the largest criminal fine for an individual corporation ever imposed in a United States criminal prosecution of any kind.”  In addition, the plea agreement provided for a $100 million forfeiture of assets.  The qui tam relators were awarded more than $78 million from the federal share of the civil settlement amount. 2.   Legislative Action in 2009 As we noted throughout the year in various other Client Alerts, for the first time in more than twenty years, Congress passed legislation in 2009 that amended essential provisions of the False Claims Act.  And more awaits, as pending legislation is poised to further amend the Act.  2009 also brought legislation, both passed and proposed, that will likely impact FCA investigation and enforcement activity. A.  Fraud Enforcement and Recovery Act of 2009 (FERA)[27] In our May 26, 2009 client alert, “President Obama Signs Legislation Significantly Expanding the Scope of the False Claims Act ,” we provided a detailed summary of important changes to the FCA embodied within FERA.  FERA provides substantial funding for federal fraud detection and enforcement, including appropriations of $165 million in 2010 and 2011 for “investigations and prosecutions and civil and administrative proceedings involving Federal assistance programs and financial institutions.”  What follows below is a recap of important procedural and substantive changes to the FCA embodied within FERA. i.  The Civil Investigative Demand (CID) The CID is a potent investigative device.  Whenever the Attorney General has reason to believe that a person may be in possession of documents or information relevant to an FCA investigation, the Attorney General may issue and serve a CID requiring the recipient to produce documents, answer written interrogatories, and/or provide oral testimony, even before litigation commences.  See 31 U.S.C. § 3733(a)(1).  Before FERA, the Attorney General was required to personally approve the issuance of all CIDs, and dissemination of information acquired through the CID process was limited.  FERA amended the FCA to provide that the Attorney General may now delegate his authority to issue a CID.  Further, investigators may share information obtained through the CID process with qui tam relators and other government agencies without demonstrating “substantial need” or obtaining prior approval from a district court, as was required under the prior version of the Act. In a briefing with reporters on November 19, 2009, Assistant Attorney General Tony West, the head of the Civil Division, said that Attorney General Eric Holder planned to give him authority to issue CIDs and that West was, “anxious to use that authority in appropriate ways.”[28]  Further, the DOJ reportedly is finalizing a policy that may authorize many lower-level government investigators to issue CIDs.  Senator Charles Grassley (R-IA) in particular is focused on CID authority implementation and “want[s] to hear about any problems the Justice Department is having implementing this powerful tool, and efforts to implement the new authority to share information obtained from CIDs with qui tam relators.”[29]  As a result, we expect to see a marked increase in the frequency of CIDs issued in FCA investigations over the coming months. ii.  Modification of Intent Requirement In Allison Engine Co. v. United States ex rel. Sanders, 128 S. Ct. 2123 (2008),[30] the Supreme Court held that Sections 3729(a)(2) and 3729(a)(3) of the FCA apply only to fraud directed against the federal government and not to frauds that subcontractors may commit against prime contractors working on projects funded with federal dollars.  The Court held that a defendant must “intend that a claim be paid . . . by the Government and not by another entity.”  Id. at 2129. FERA legislatively overruled Allison Engine.  The law now imposes FCA liability even if a company submits a false claim to a non-government entity and did not specifically intend to defraud the government directly.  Of particular note regarding this aspect of FERA, Congress made certain provisions of the new law retroactive to June 7, 2008–the date Allison Engine was decided.  As discussed below in Section 3, litigation has ensued over this retroactivity provision, and the majority of federal courts that have thus far addressed the issue, including the district court that received the Allison Engine case on remand, have refused to apply the amendment retroactively to the case at bar. iii.  Elimination of any Presentment Requirement Under FERA, the FCA now extends to any false or fraudulent claim for government money or property, whether or not the claim is presented to a government official or employee, and whether or not the government has title to, or physical custody of, the money or property.  FCA’s new definition of a “claim,” includes, “any request or demand . . . for money or property and whether or not the United States has title to the money or property, that . . . is made to a contractor, grantee, or other recipient, if the money or property is to be spent or used on the Government’s behalf or to advance a Government program or interest.”  31 U.S.C. § 3729(b)(2).  The implications of this change are profound.  So long as that money is used to “advance a Government program or interest,” a phrase the amendments do not define, then any false claim made to any recipient of federal money will trigger FCA liability.  Under a broad reading of the Act, the FCA could apply to nearly any fraud committed against any federal recipient or grantee. iv.  FCA Penalizes the Knowing Retention of “Overpayments” The FCA previously penalized any person who “knowingly makes, uses, or causes to be made or used, a false record or statement to conceal, avoid, or decrease an obligation to pay or transmit money or property to the Government.”  31 U.S.C. § 3729(a)(7).  FERA amended the FCA to specifically define an “obligation” to include “the retention of any overpayment.”  31 U.S.C. § 3729(b)(3).  This opens up new avenues of exposure for federal contractors or grantees who knowingly retain government “overpayments.”  As a result of the amendments, a contractor that innocently obtained government funds in the first place may become liable under the FCA if it later has reason to believe that it was overpaid.  This new provision raises many unanswered questions, such as when the statute of limitations begins to run (e.g. does the statute begin to run on the date of submitting the original claim, the date of payment, the date the recipient should have known it was overpaid, the date the government demands repayment, or some other date), and what will happen in situations where the contracting parties expect a “true up” or off-set under the contract. In our November 13, 2008 Client Alert, “New Federal Regulation Requires Mandatory Disclosure and Amplified Compliance Programs for Government Contractors,” we discussed rules effective December 12, 2008, that required mandatory disclosure by federal government contractors of “credible evidence” of certain violations of the FCA and “significant” overpayments on a contract.  According to Lynn McCormick, Manager, DOD Contractor Disclosure Program, as of October 13, 2009, DOD had received 80 disclosures since the Federal Acquisition Regulation (FAR) amendments took effect.[31]  FAR requires a “timely,” disclosure of overpayments, but does not define “timely.”  Of particular note, the FCA has a provision for “reduced damages” (double instead of treble) for cooperation and voluntary self-disclosure if “the person committing the violation of [the FCA] furnished officials of the United States responsible for investigating false claims violations with all information known to such person about the violation within 30 days after the date on which the defendant first obtained the information.”  31 U.S.C. § 3729(a)(2)(A).  Thus contractors subject to FAR and considering self-disclosure of an overpayment might consider reporting suspected overpayments or other potential FCA violations within thirty days to take advantage of the reduced damages provision under the FCA should the overpayment be deemed an FCA violation. v.  Definition of Materiality FERA resolved a circuit split by defining “materiality” as “having a natural tendency to influence, or be capable of influencing, the payment or receipt of money or property,” which was the more liberal standard previously applied by some courts.  31 U.S.C. § 3729(b)(4). vi.  Relation Back After FERA, the FCA now provides that when the government intervenes in a qui tam case it can expand the relator’s allegations and include new substantive claims, which will “relate back” to the filing date of the original qui tam complaint for statute of limitations purposes.  As a practical matter, the “relation-back” provision may operate to extend the statute of limitations in FCA suits. vii.  Expanded Whistleblower Protections The FCA previously afforded protection to any “employee” that suffered retaliation from his or her employer as a result of protected conduct.  Following FERA, whistleblower protections now extend beyond “employees” to any “contractor or agent” if that “employee, contractor, or agent is discharged, demoted, suspended, threatened, harassed, or in any other manner discriminated against in the terms and conditions of employment because of lawful acts done by the employee, contractor, or agent on behalf of the employee, contractor, or agent or associated others in furtherance of other efforts to stop 1 or more violations of” the FCA.  31 U.S.C. § 3730(h)(1). B.  American Recovery and Reinvestment Act of 2009[32] On February 17, 2009, President Barack Obama signed into law the American Recovery and Reinvestment Act of 2009 (ARRA).  ARRA’s combined spending and tax provisions are expected to cost $787 billion over 10 years.  More than two dozen federal agencies have been allocated a portion of the $787 billion in recovery funds, and each agency has awarded or will distribute those funds to state governments or directly to contractors and grantees. ARRA includes several provisions aimed at ensuring accountability and transparency.  Among other things, ARRA creates a Recovery Accountability and Transparency Board to “prevent and detect waste, fraud, and abuse” and to “provide transparent reporting of Recovery-related funds as they are distributed and used.”[33]  Awarding agencies are required to file weekly spending reports, and, starting in October 2009, recipients began filing quarterly reports on ARRA fund spending.  Further, all ARRA recipients and sub-recipients must promptly refer to the DOJ, Office of Inspector General (OIG) any credible evidence that a principal, employee, agent, contractor, subgrantee, subcontractor, or other person has submitted a false claim for ARRA funds under the FCA. Since the enactment of ARRA in February 2009, the DOJ OIG has trained more than 800 grant officials to recognize the specific fraud, waste, and abuse risks related to ARRA and other grant funding.  In addition, the OIG prepared a document, entitled “Improving the Grant Management Process,” which contained recommendations and best practices that OIG auditors and investigators have identified and that granting agencies should consider adopting to reduce waste, fraud, and abuse.[34]  As a result of this spending, reporting, and investigative efforts, we expect to see FCA activity in connection with ARRA funds in the coming months. C.  Emergency Economic Stabilization Act of 2008 (EESA) and the Troubled Asset Relief Program (TARP) According to the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP), as of September 30, 2009, the United States Treasury had announced commitments to spend $643.1 billion of the $699 billion maximum available for the purchase of troubled assets under TARP.  The following GAO graphic depicts spending through the end of FY 2009: SIGTARP, created by section 121 of the EESA, is responsible, among other things, to conduct, supervise, and coordinate audits and investigations of the purchase, management, and sale of assets under TARP.  One of SIGTARP’s oversight responsibilities is to prevent fraud, waste, and abuse.  To that end, SIGTARP reportedly has developed a close working relationship with the FBI, DOJ, SEC, and United States Attorney’s Offices.  According to SIGTARP’s October 2009 quarterly report to Congress, “[t]hrough September 30, 2009, SIGTARP has opened 61 and has 54 ongoing criminal and civil investigations.”[35]  In addition, “[s]ince its inception, the SIGTARP Hotline received and analyzed more than 7,000 contacts, running the gamut from expressions of concern over the economy to serious allegations of fraud.”[36]  With billions of dollars in government spending and significant investigative activity, increased FCA enforcement activity and qui tam litigation is sure to follow in connection with TARP funds. D.  Pending Legislation i.  S. 458 and H.R. 1788, the False Claims Act Clarification Act of 2009 On February 24, 2009, Senator Charles Grassley (R-IA) introduced S. 458, the “False Claims Act Clarification Act of 2009.”  On March 30, 2009, Representative Howard Berman (D-CA) introduced H.R. 1788, entitled the “False Claims Act Correction Act of 2009.”  Some of the proposed FCA amendments included within these bills were incorporated into FERA.  In addition, these bills look to expand the class of individuals permitted to bring qui tam actions and effectively eliminate potent FCA defenses.  For example, the amendments would (i) allow dismissal of a private action based upon the prior public disclosures only upon timely motion to dismiss by the Attorney General; (ii) narrowly redefine what constitutes a “public disclosure;” and (iii) amend the FCA to provide that private persons bringing qui tam actions shall not be required to identify specific claims that result from an alleged fraudulent scheme under certain circumstances, significantly curtailing a defendant’s ability to successfully move for dismissal under Rule 9(b) prior to costly discovery. ii.  S. 1959, the Health Care Fraud Enforcement Act of 2009 On October 28, 2009, S.1959, the Health Care Fraud Enforcement Act of 2009 (HCFEA), was read twice and referred to the Senate Judiciary Committee.  Senator Patrick Leahy (D-VT) joined with Senator Ted Kaufman (D-DE) to introduce the bill, which is cosponsored by Arlen Specter (D-Pa.), Herb Kohl (D-Wis.), Chuck Schumer (D-N.Y.), and Amy Klobuchar (D-Minn.).  In relevant part, the bill would amend the Social Security Act to provide that any claim submitted in violation of the Anti-Kickback Statute (AKS) “constitutes a false or fraudulent claim for purposes of” the FCA. In announcing the bill, Senator Kaufman noted, “By making all payments that stem from an illegal kickback subject to the False Claims Act, this bill leverages the private sector to help detect and recover money paid pursuant to these illegal practices.”[37]  The Senator also referred to a recent court decision that proved an “obstacle” to filing FCA actions in cases involving anti-kickback claims submitted by pharmacies and hospitals.  “This section remedies the problem,” he asserted, “by amending the AKS to ensure that all claims resulting from illegal kickbacks are false, even when the claims are not submitted directly by the wrongdoers themselves.”[38] On December 22, 2009, the Senate voted 60-39 on a manager’s amendment from Senate Majority Leader Harry Reid (D-Nev.) that would incorporate elements of the HCFEA into the Senate health care reform bill.  The manager’s amendment included the HCFEA provision that would amend the AKS to ensure that all claims resulting from illegal kickbacks are considered false claims for the purpose of civil action under the FCA. iii.  S. 2782 and H.R. 2349, Lieutenant Colonel Dominic “Rocky” Baragona Justice for American Heroes Harmed by Contractors Act On March 4, 2009, Senator Claire McCaskill (D-MO) introduced S. 526, entitled, Lieutenant Colonel Dominic “Rocky” Baragona Justice for American Heroes Harmed by Contractors Act.  On November 17, 2009, the bill was revised and reintroduced as S. 2782.[39]  The Committee on Homeland Security and Governmental Affairs Subcommittee on Contracting Oversight held hearings on the proposed legislation on November 18, 2009.[40]  On May 12, 2009, Representative Timothy Ryan (D-OH) introduced similar legislation in the House, H.R. 2349, which was referred to the Subcommittee on Government Management, Organization, and Procurement on June 26, 2009.[41]  For a detailed discussion of the proposed legislation, see our December 21, 2009 Client Alert “Proposed Legislation Would Allow Foreign Contractors to Be Sued in U.S. Courts.” Under the proposed legislation foreign contractors would be required, among other things, to consent to personal jurisdiction of the U.S. courts over civil or criminal actions brought by the government stemming from “wrongdoing associated with the performance of the covered contract.”[42]  The proposed legislation would also amend the FAR to provide that a foreign contractor may be debarred or suspended from contracting with the United States for evasion of service of process or failure to appear in U.S. court. During the Senate Hearings, Assistant Attorney General Tony West noted, “the Department has brought cases successfully against foreign contractors and subcontractors, and other nonresident defendants, for violations of the False Claims Act. . . . To date, [the government] ha[s] not yet faced a personal jurisdiction challenge in connection with a procurement fraud matter arising out of contracts related to the wars and reconstruction efforts in Iraq and Afghanistan.”[43]  Nevertheless, West remarked that he anticipated personal jurisdiction challenges in FCA cases in the future and, thus, “requiring contractors to consent to personal jurisdiction in U.S. courts as a condition of their contract with the United States should assist us in establishing personal jurisdiction over foreign contractors in procurement fraud cases.”[44] iv.  Additional Bills in the Current Congress with Potential FCA Application On January 6, 2009, H.R. 27, the Medicare Fraud Prevention and Enforcement Act of 2009, was introduced in the House. On February 9, 2009, the bill was referred to the Subcommittee on Crime, Terrorism, and Homeland Security.  Among other things, the bill would amend the Social Security Act to allow the government to exclude from participation in any federal health care program any billing agency or individual that knowingly submitted or caused to be submitted a claim for Medicare reimbursement that it knows or should know is false or fraudulent. On January 22, 2009, S. 301, the Physician Payments Sunshine Act of 2009, was read twice in the Senate and referred to the Senate Finance Committee.  On July 9, 2009, H.R. 3138 was introduced in the House and referred to the House Ways and Means Committee.  Both bills would require annual reporting, in electronic form, of specified information by any manufacturer of a covered drug, device, biological, or medical supply that makes a payment or another transfer of value to a physician, a physician medical practice, or a physician group practice.  Although we have witnessed little activity in the current session on these bills, the House and Senate actively are debating health care reform and the reform bills under consideration include provisions for public disclosure of payments to health care professionals.  It is unclear whether such reports would constitute “public disclosures,” sufficient to bar qui tam actions based upon the disclosures or whether the required public periodic reporting of all payments that could be construed as kickbacks may result in an increase in FCA litigation. On February 3, 2009, S. 372, the Whistleblower Protection Enhancement Act of 2009, was introduced in the Senate.  The bill was reported by the Senate Committee on Homeland Security and Governmental Affairs on July 29, 2009, and placed on the Senate Legislative Calendar on December 3, 2009.  On March 12, 2009, a similar bill was introduced in the House, H.R. 1507, also entitled the “Whistleblower Protection Enhancement Act of 2009,” and referred to the House Committee on Homeland Security.  Although the bills are not identical, both would amend the Whistleblower Protection Act, Chapter 23 of Title 5 of the United States Code, to clarify current law and give new protections to federal employees and contractors who report abuse, fraud, and waste involving government activities. On March 5, 2009, H.R. 1360, the Contractor Accountability Act, was introduced in the House.  On May 4, 2009, the bill was referred to the Subcommittee on Government Management, Organization, and Procurement.  Among other things, the bill would require the head of each federal agency to report to Congress annually on each covered contract or order awarded or issued by the agency during the year.  The report would be publicly available on the agency’s website, and would contain a list of the names of each contractor found to be in breach of its obligations.  Although potential relators may review such reports for evidence of FCA violations, those reports may constitute “public disclosures,” thereby barring qui tam actions based thereupon. On March 12, 2009, H.R. 1472, the TARP and ARRA Reporting and Waste Prevention Act, was introduced in the House and referred to the House Oversight and Government Reform Committee.  Among other things, the bill would establish additional reporting requirements each time funds from TARP or ARRA are received or redistributed, would establish a waste, fraud, and abuse hotline for such funds, and would provide additional whistleblower protections.  Again, increased reporting and transparency may lead to increased FCA activity. On October 1, 2009, S. 1745, the Non-Federal Employee Whistleblower Protection Act of 2009, was introduced in the Senate and referred to the Committee on Homeland Security and Governmental Affairs.  Among other things, the bill would expand whistleblower protections to non-federal employees of companies that receive funding from any government agency (in the form of either grants or contracts). E.  State Legislative Action In 2009, Kansas, Minnesota, and North Carolina enacted civil false claims statutes modeled after the federal FCA.  The Deficit Reduction Act of 2005 provided a financial incentive for states to pass their own qualified false claims acts by offering the states a 10% increased share in FCA recoveries.  Now, more than thirty states, some cities, and the District of Columbia have their own versions of the FCA, most of which include qui tam provisions and apply to all false claims (although a handful of state statutes are limited to Medicaid claims only).[45]  Companies doing business with the government should be aware that many programs are jointly funded by the federal and state governments (such as Medicaid), and many government contracts are similarly funded by the federal and state governments (such as infrastructure improvement).  The federal government has also distributed significant amounts of ARRA funds to the states for redistribution to private entities.  Accordingly, companies may face concurrent allegations of liability under federal and state versions of the FCA. 3.  Hot Topics and Key Cases in 2009 In our 2009 Mid-Year False Claims Act Update, we discussed several important judicial decisions during the first half of 2009 regarding the FCA.  Courts continued to be active in deciding FCA-related cases during the second half of 2009.  Most recently, on November 30, 2009, the U.S. Supreme Court heard oral argument in Graham County Soil & Water Conservation Dist. v. United States ex rel. Wilson, No. 08-304, to determine whether state and local government reports constitute “public disclosures” under the meaning of the FCA, which would preclude qui tam actions “based upon” those disclosures.  In addition, many lower courts have faced issues of first impression, including decisions interpreting FERA, the constitutionality of the FCA’s seal provisions, and the ability of FCA defendants to bring contractual indemnity and other independent claims against third parties. A.  Matters of First Impression i.   Interpreting FERA As discussed above in Section 2(A), the FCA was amended in 2009 through FERA.  Among other things, FERA legislatively overturned the Supreme Court’s unanimous ruling in Allison Engine Co. v. United States ex rel. Sanders, 128 S.Ct. 2123 (2008), and eliminated the former intent requirement under 31 U.S.C. § 3729(a)(2), which required a relator to show that a defendant had knowingly made or used a false record or statement “to get” a false or fraudulent claim “paid or approved by the Government.”  Although enacted on May 20, 2009, FERA contains a retroactivity clause: the amendments “shall take effect on the date of enactment and shall apply to conduct on or after the date of enactment, except that [the amendments to former 31 U.S.C. §3729(a)(2)] shall take effect as if enacted on June 7, 2008, and apply to all claims under the False Claims Act.”  Since FERA’s passage, a number of courts have addressed the retroactivity of FERA’s amendments to the FCA. Upon remand from the Supreme Court, the Southern District of Ohio held “[a] plain reading of the retroactivity clause results in the conclusion that the FCA as amended by FERA does not apply to this case,” because the amendments referred to “claims” that existed on June 7, 2008 rather than “cases.”  United States ex rel. Sanders v. Allison Engine Co, Inc., No. 1:95-CV-970, 2009 WL 3626773, at *10 (S.D. Ohio Oct. 27, 2009).  The court also held that the retroactive application of FERA to the defendants in Allison Engine “violates the Ex Post Facto Clause because Congress intended for the FCA to be punitive and because FCA sanctions are punitive in purpose and effect.”  Id. at *10.  Two other district courts have reached similar results.  United States v. Aguillon, 628 F. Supp. 2d 542, 550-51 (D. Del. 2009) (determining sua sponte that FERA’s amendments were not to be applied retroactively because it “would increase [a] defendant’s liability for past conduct.”); United States v. Sci. Applications Int’l Corp., No. 04-1543 (RWR), 2009 WL 2929250, at *14 (D.D.C. Sep. 14, 2009) (FERA did not retroactively apply because the amendments applied to “claims” pending on or before June 7, 2008 and not “cases.”).  Indeed, the majority of courts to have addressed the issue to date have refused to apply FERA re