The SEC Uses an FCPA Case for Its First-Ever Deferred Prosecution Agreement

May 19, 2011

On May 17, 2011, the U.S. Securities and Exchange Commission ("SEC") announced its first deferred prosecution agreement ("DPA").  The DPA was with Luxembourg-based Tenaris S.A., a global steel pipe manufacturer and supplier for the energy industry, to resolve alleged violations of the Foreign Corrupt Practices Act ("FCPA").[1]  Tenaris, founded in Argentina, is a foreign private issuer with American Depository Shares ("ADSs") listed on the New York Stock Exchange.  Tenaris agreed to pay $4.79 million in disgorgement plus $641,900 in prejudgment interest.  Separately, Tenaris resolved a parallel investigation by the U.S. Department of Justice ("DOJ") by entering into a separate non-prosecution agreement ("NPA") and agreeing to pay $3.5 million in fines.  The settlement is significant because it is the SEC’s first use of a DPA since it announced its Cooperation Initiative last year.

I.  SEC’s Cooperation Initiative

In January 2010, the SEC implemented a formal process under which individuals and companies can cooperate to avoid a civil enforcement action or receive a lesser sanction.[2]  Drawing on the principles first articulated in the Seaboard Report,[3] the Division of Enforcement’s Enforcement Manual identifies four measures of a company’s cooperation: (1) self-policing prior to the company’s discovery of the misconduct; (2) self-reporting after discovering the misconduct; (3) remediation of the misconduct; and (4) cooperation with law enforcement.[4]  The Division identified a continuum of so-called cooperation tools, from proffer and cooperation agreements to DPAs and NPAs to criminal immunity requests, designed to reward cooperation. 

To date, the SEC has publicly announced only one prior example of such a cooperation tool–its December 20, 2010, NPA with Carter’s Inc. ("Carter’s NPA") to resolve alleged accounting fraud without any monetary penalty imposed by the SEC.[5]  In that case, the Director of the Division of Enforcement, Robert Khuzami, noted that "Carter’s did the right thing by promptly self-reporting the misconduct, taking thorough remedial action, and extensively cooperating" with his office.[6] 

II.  Tenaris’s Asserted FCPA Violation and Subsequent Investigation

According to the Statement of Facts in the Tenaris DPA, in 2006 and 2007, Tenaris’s sales personnel for the Caspian Sea region (which accounted for only 1% of its total global sales and services between 2003 and 2008) allegedly engaged in a bid-rigging scheme involving four contracts with OJSC O’ztashqineftgaz ("OAO"), a subsidiary of Uzbekistan’s state-owned oil and gas company.  The company admitted that it paid its bidding agent commissions of between 3.0% and 3.5% on contracts awarded by OAO to improperly obtain confidential bid information on Tenaris’s competitors’ bids from OAO personnel–the purported government official–and then secretly substitute its bids to undercut its competitors.  As a result of this alleged foreign bribery scheme in violation of the FCPA, Tenaris was awarded four contracts worth a total of nearly $20 million.

In the fall of 2007, Tenaris’s competitors complained to the Uzbekistani government that Tenaris was unfairly receiving contracts, and the government opened an investigation into the bidding process for the four contracts in question.  The company’s regional sales personnel agreed to funnel further payments to government officials to head-off an investigation and have them "close their eyes," but no evidence was found that any payments were actually made.  By the summer of 2008, OAO cancelled all outstanding portions of the contracts following the results of the government investigation.  Nevertheless, Tenaris earned a profit of $4.79 million from these four contracts. 

In March 2009, a customer informed Tenaris that some Tenaris sales agent payments may have improperly benefitted the customer’s employees.  In response to this information, the Audit Committee of Tenaris’s Board of Directors launched a worldwide investigation.  It appears that this customer was not OAO and the report addressed information unrelated to Tenaris’s Uzbekistani contracts.  Its annual report filed in June 2009 in Form 20-F disclosed the customer’s report and the ongoing investigation.  At about the same time, Tenaris reported the investigation’s preliminary findings to DOJ and SEC staff, which did not apparently include the Uzbekistani matter, and informed them that the company would conduct a deeper investigation.  A year later, in July 2010, Tenaris disclosed the Uzbekistani matter to DOJ and SEC staff.  It is clear from the SEC’s DPA that other conduct, possibly including the conduct underlying the original report, was not charged by the government. 

III.  Tenaris’s DPA

The SEC resolved the matter using its first-ever DPA.  In announcing the DPA, Mr. Khuzami noted Tenaris’s "high levels of corporate accountability and cooperation," including its "immediate self-reporting, thorough internal investigation, full cooperation with SEC staff, enhanced anti-corruption procedures, and enhanced training made it an appropriate candidate for the Enforcement Division’s first Deferred Prosecution Agreement."  Mr. Khuzami continued, "Effective enforcement of the securities laws includes acknowledging and providing credit to those who fully and completely support our investigations and who display an exemplary commitment to compliance, cooperation, and remediation."

The DPA, which has a two-year term, requires Tenaris to disgorge profits plus prejudgment interest totaling more than $5.43 million; provide the SEC with a written compliance certification in advance of the DPA’s expiration; review and, if appropriate, update its Code of Conduct on an annual basis; require each director, officer, and management-level employee to certify annually his or her compliance with the Code of Conduct; and conduct FCPA training for all officers and managers, employees in Finance, Accounting, Internal Audit, Sales, and Government Relations, plus any other employees in positions Tenaris determines involve FCPA risk, and for all such future employees within 90 days of their hiring.  The DPA noted that Tenaris had already undertaken substantial remedial measures, including strengthening the anti-corruption controls in its Code of Conduct, Business Conduct Policy, and Agent Retention Procedures, and providing for enhanced due diligence procedures related to the retention of third-party agents and review of payments to third-party agents.[7] 

If Tenaris breaches the DPA, the Division retains the right to seek authority from the Commission to institute an enforcement action against Tenaris.  In the event of a lawsuit, Tenaris agrees not to contest or contradict the factual statements contained in the DPA as admissions.  However, Tenaris may contest those facts in any other legal proceeding with any other party.  In addition, the agreement recites that the Division’s statement of facts is made pursuant to settlement negotiations is not binding on Tenaris in any other proceeding, and is not binding on any other party or entity.  The DPA also provides that the statute of limitations is tolled for the duration of the DPA. 

Separately, Tenaris also entered into a two-year NPA with the DOJ, agreeing to a $3.5 million criminal penalty.[8]  The DOJ press release noted that this was a "substantially reduced monetary penalty" that reflected DOJ’s "commitment to providing meaningful credit [for] extraordinary cooperation."  The DOJ NPA had additional compliance requirements, such as assigning oversight of its compliance program to one or more senior corporate executive(s). 

IV.  Comparing the SEC’s NPAs and DPAs

In the past, DPAs and NPAs have been used by federal criminal prosecutors to resolve criminal matters.  In the criminal context, DPAs typically involve the government filing a formal charging document, usually an information, as well as the DPA with the appropriate court; NPAs typically do not involve the courts and the agreements are maintained by the parties.[9] 

Historically, the SEC resolved settled enforcement actions by filing consent judgments based on civil complaints in a United States District Court or an administrative order instituting proceedings and imposing sanctions to which the respondent consented.  In both types of actions, the defendants (or respondents) neither admitted nor denied the Commission’s allegations or findings.[10]

The SEC’s new resolution methods differ from its historic practices and from the DOJ’s methods in several ways.  Procedurally, the SEC does not file a civil case or institute an administrative action as part of the NPA or DPA.

According to its Enforcement Manual, the SEC’s NPA imposes two basic requirements upon the defendant: to cooperate fully and truthfully in the SEC’s investigation, and to comply with any undertakings in the agreement.[11]  The Carter’s NPA noted that Carter’s agreed to "cooperate fully and truthfully . . . regardless of the time period in which the cooperation is required."  Unlike the Tenaris DPA, the Carter’s NPA did not have a time period for which it was valid.  Cooperation included producing non-privileged documents and securing cooperation by current and former directors and employees.  If Carter’s violates the NPA and the SEC takes responsive action, Carter’s agreed that if the action "would not have been time-barred by the applicable statute of limitations if brought on the date of the execution" of the NPA, the SEC may bring the action "notwithstanding the expiration of the statute of limitations between the signing of [the NPA] and the commencement of such action." 

The Enforcement Manual notes that an NPA is not appropriate if the defendant has previously violated the securities laws, if the investigation is in its early stages, or if the defendant’s role in the misconduct and/or the importance of the defendant’s cooperation are not yet clear.  As Mr. Khuzami noted in his press conference announcing the Cooperation Initiative, an NPA is "entered into under very limited and appropriate circumstances."[12]  Most important, from a collateral consequences perspective, the SEC’s first and only NPA to date, the Carter’s NPA, lacks a detailed statement of facts and any admission of liability, including lacking the stock statement that the company "neither admits nor denies" the allegations.[13]

In the case of both the NPA and DPA, if the defendant violates the agreement, the SEC reserves the right to pursue an enforcement action against the underlying conduct. 

V.  Observations and Analysis

One question raised by this case is where the SEC draws the line between use of a DPA and an NPA.  Based on comments by the Commission staff in announcing the DPA, Tenaris was a DPA candidate because of its immediate disclosure and exceptional cooperation.  However, it appears not to have been an NPA candidate because of the alleged underlying violation.  According to Cheryl Scarboro, Chief of the SEC Enforcement Division’s FCPA Unit, "Tenaris’s conduct was clearly in violation of the FCPA.  The company’s employees bribed government officials in Uzbekistan to obtain government contracts.  But when Tenaris discovered the illegal conduct, it took noteworthy steps to address the violations and significantly enhance its anti-corruption policies and practices to remediate weaknesses in its internal controls."  It appears that Tenaris’s Audit Committee’s robust response to the "red flag" information from its customer, and its "extensive, thorough, real-time cooperation" with DOJ and the SEC, and its willingness to undertake certain remedial measures led to the disposition.  Nevertheless, Tenaris still paid $8.93 million in monetary penalties and disgorgement–effectively double the profit it made off the allegedly improperly obtained contracts. 

The key question now is how a defendant benefits from receiving an NPA or DPA from the SEC over a traditional settled enforcement action.  Using the Carter’s NPA as a reference, the benefits of an NPA are clear: NPAs do not carry any financial penalties, i.e., no disgorgement of profits or civil money penalties.  With respect to alleged misconduct, the NPA makes no allegations of misconduct and contains no factual recitation.  Enforcement of any later-discovered wrongdoing may be barred by the statutes of limitations, so long as the defendant does not breach the agreement. 

Turning to a DPA, the defendant agrees to what appear to be remedies very similar to those historically obtained by the SEC in a settled enforcement action, but potential defendants need to consider the risks and benefits of a DPA more carefully.  Optically, for a company that does not go on to violate the agreement, a DPA can be favorably described as the SEC’s decision not to take an enforcement action against the defendant.  This distinction is meaningful for a defendant’s public image and reputation.  Moreover, in the Tenaris matter, the SEC staff went to great lengths to point out the company’s "extensive, thorough, real-time cooperation" with U.S. regulators, which can help a defendant show its constituents, investors and other regulators that it is an earnest, law-abiding entity.  A second potential advantage of a DPA is avoidance of the collateral consequences.  Some collateral consequences, such as disclosure obligations or disqualifications from participation in the securities industry, arise from the entry of an injunction, which a DPA avoids. 

On the other hand, the DPA’s model is untested.  One reason parties settle SEC proceedings is to avoid the collateral estoppel effect of adverse findings of fact and conclusions of law in contested litigation which an adversary may use in a claim for damages or other relief.  Generally, courts have concluded that they will not impose collateral estoppel based on factual recitations contained in settled SEC enforcement actions and that settled SEC complaints or administrative orders are not evidence.  Because DPAs are new, there is less precedent on how courts will view similar factual recitations.  Beyond their effect in courts, DPAs may carry other collateral effects, such as suspension or disbarment of companies that obtain government contracts in the U.S. or Europe, or companies that perform projects with funds from international development banks (e.g., the World Bank).  Such decisions are discretionary based on facts and circumstances, but the untested nature of the DPA carries some risk.  For example, under the Federal Acquisition Regulation, a U.S. government agency may have the discretion to suspend a company "on the basis of adequate evidence" and disbar a company "based upon a preponderance of the evidence." [14]  Companies considering a DPA resolution should consider how, if at all, the agreement and its statement of facts could affect these contractual relationships.  Similarly, companies considering a DPA may wish to consider confirming that their insurance carriers will not construe a DPA as an admission that could adversely affect coverage for a company and/or its directors and officers. 

On the whole, the SEC’s Cooperation Initiative and its NPA and DPA resolution methods provide additional means by which individuals and corporations may resolve SEC investigations on more favorable terms.  NPAs and DPAS are, however, new and untested, suggesting that their use requires careful consideration.