SEC investigates sovereign wealth funds - International Law Office

International Law Office

White Collar Crime - USA

SEC investigates sovereign wealth funds

March 07 2011

Introduction
Background
Key points from current investigation
Appropriate responses


Introduction

In 2008 Steven Tyrrell, then chair of the Department of Justice Fraud Section, acknowledged heightened departmental interest in potential violations of the Foreign Corrupt Practices Act arising out of sovereign wealth fund investments in US companies, including financial institutions. Although he refused to confirm a specific ongoing investigation, Tyrrell stated that the "boom of sovereign wealth funds is an area at the top of the Justice Department's hit list". More recently, January 2011 media reports indicated that the Securities and Exchange Commission has initiated a Foreign Corrupt Practices Act investigation of US financial institutions related to interactions with sovereign wealth funds.

According to reports, a number of financial institutions (potentially up to 10) received letters from the SEC requesting that those institutions retain documents related to dealings with sovereign wealth funds and requesting information about those relationships. Reports also indicate that some institutions have received more formal subpoenas requesting similar documents and information. Specifically, the sovereign wealth fund investigation appears to focus on whether financial institutions used third-party agents to influence improperly sovereign wealth funds to invest with their companies. The letters may simply be the tip of the iceberg of a larger, industry-wide investigation examining the practices of financial institutions when attempting to obtain investments from sovereign wealth funds. Similar industry-wide investigations of potential Foreign Corrupt Practices Act conduct have led to large criminal and civil settlements in the pharmaceutical, medical devices and oil and gas industries.

Background

Basic provisions
The Foreign Corrupt Practices Act consists of two sets of provisions. First, the anti-bribery provisions prohibit payments, direct or indirect, to "foreign officials" in exchange for business or business advantages. These provisions apply to:

  • issuers(1) and all US companies, citizens or residents, whether or not they act within or outside the United States;
  • any company or individual that executes any part of a bribery scheme from within the United States; and
  • all officers, directors, employees or agents of the above.(2)

The statute does allow for 'facilitating' payments, which are payments made to secure "routine governmental action".

Second, under the books and records provisions, issuers must keep accurate books and records and maintain adequate internal controls.(3)

'Foreign official'
Under the statute, 'foreign official' includes any officer or employee of a non-US government, and any officer or employee of "any department, agency, or instrumentality" of a non-US government. The SEC and Department of Justice liberally construe the statutory definition and apply it to interactions with employees of state-owned enterprises. To determine whether employees of a state-owned enterprise are foreign officials, the enforcement agencies have considered the percentage of government ownership in the enterprise and the amount of control the non-US government exerts over the entity in question. Recent Foreign Corrupt Practices Act settlements indicate that even a minority government ownership may be sufficient for employees to be foreign officials. As a result, companies have reached Foreign Corrupt Practices Act settlements with the enforcement authorities, based on allegations of bribes paid to physicians at state-owned hospitals and employees at state-owned oil, steel and telecommunications companies. The SEC will likely take the position that sovereign wealth fund employees are foreign officials for the purposes of the act.(4)

Obtain or retain business
Similar to their construction of the 'foreign official' element, the SEC and Department of Justice liberally interpret the Foreign Corrupt Practices Act's requirement that to be deemed 'corrupt', a payment must assist the defendant in "obtaining or retaining business". According to the SEC and Department of Justice, 'corrupt' payments under the act may encompass more than those resulting in additional sales contracts and other forms of new business. In fact, the Department of Justice and the SEC have charged companies with act violations based on payments made to obtain other loosely defined business advantages, such as:

  • tax refunds and reductions;
  • government inspection reports and certifications;
  • customs clearance for improperly or illegally imported goods and equipment;
  • expedited government registration certifications; and
  • beneficial changes to laws and regulations.

This expansive interpretation suggests that the SEC and Department of Justice will consider gifts, entertainment or other payments of value to be outside the scope of that which may be allowed under the act to sovereign wealth fund employees by a company to secure an investment by the sovereign wealth fund that would be provided for the purpose of "obtaining or retaining business".

Penalties
For companies, criminal violations can result in a $2 million fine for an anti-bribery violation and a $25 million fine for a books and records violation. Individuals face up to five years in jail with a maximum fine of $250,000 for an anti-bribery violation, and up to 20 years in jail with a maximum fine of $5 million for a books and records violation. Under a federal alternative fine provision, companies and individuals may be fined up to twice the benefit sought or received.

In the civil context, the SEC and the Department of Justice can impose a $10,000 fine per violation on individuals and companies. Additionally, the SEC may impose further civil penalties ranging from $7,500 to $150,000 on individuals and $75,000 to $725,000 on companies. Alternatively, the SEC may impose a civil penalty equal to the gross pecuniary gain to an individual or company and equitable relief, such as disgorgement of profits.

Key points from current investigation

The rise in sovereign wealth fund investments in US financial institutions in 2008 sparked the Department of Justice's interest. As the investment arm of some foreign national governments, sovereign wealth funds have increased their presence as investors in US businesses and private equity funds over the years. In the past, foreign governments often invested surplus cash reserves in low-risk investments such as bank deposits and Treasury securities. However, on the heels of the global financial crisis many sovereign wealth funds seized the opportunity to make non-traditional, potentially higher-yield investments in the US market. Sovereign wealth funds based in China, Kuwait, Abu Dhabi and Dubai acquired significant stakes in many major US financial institutions, including private equity funds, banks and securities firms. In turn, US companies depended, at least in part, on sovereign wealth fund investments to raise capital.

Typical investor entertainment and giftgiving may present problems
Media reports indicate that the SEC is focusing on financial institutions in which sovereign wealth funds have invested. It is likely that the SEC is examining whether the financial institutions made improper payments, either directly or through third parties, to sovereign wealth fund employees to influence their decisionmaking in connection with the sovereign wealth fund's investments. Specifically, the SEC is most likely focusing on whether improper payments were made so that the sovereign wealth fund would invest in the financial institutions being scrutinised. Because US financial sector entities view sovereign wealth funds as investors, they may be likely to engage in industry-accepted entertainment of investors or prospective investors. While client development perks (eg, paid-for travel expenses, high-priced or repetitive tickets to sporting events and complimentary 'big-ticket' dinners) may be appropriate ways to entice traditional investors, such attempts to attract or maintain sovereign wealth fund investors may have far-reaching Foreign Corrupt Practices Act implications when dealing with employees of sovereign wealth funds.

Additionally, previous Foreign Corrupt Practices Act investigations and dispositions indicate that the investigation could impact on financial services companies not currently under investigation because:

  • the current inquiries may be the initial steps of a larger investigation; and
  • even those firms without apparent Foreign Corrupt Practices Act exposure could be vulnerable to act-related charges under other criminal statutes.

Potential industry-wide investigation
The SEC and Department of Justice have initiated industry-wide Foreign Corrupt Practices Act investigations in the past. Those investigations may start with a request for information from a small number of sources. Then, based on the information received, the authorities may expand the investigation to include a number of companies in the same industry. For example, the SEC and Department of Justice coordinated an industry-wide investigation of gas and oil companies related to their use of freight forwarders. The investigation resulted in simultaneous settlements with seven different companies for more than $200 million in criminal fines and civil penalties. Based on media reports, the SEC's letter to some US financial institutions appears to be the beginning of another industry-wide investigation. The investigation may eventually encompass other financial institutions and address other Foreign Corrupt Practices Act issues in the industry, and could lead to multiple settlements.

Other crimes applied in act-related charges
Foreign Corrupt Practices Act-related charges could be brought against individuals or entities in the financial services industry, even if they did not have direct contact with sovereign wealth funds. Although the act's jurisdictional provisions limit the individuals and companies that may be directly liable for act violations, the Department of Justice has applied generally applicable criminal statutes, such as conspiracy or aiding and abetting, to individuals or companies who fall outside of those jurisdictional limitations. The Department of Justice has also charged companies with violations of other criminal statutes, such as mail and wire fraud, for conduct related to act violations.

Appropriate responses

Robust anti-corruption compliance programme
As described in plea agreements and civil settlements, the enforcement authorities expect companies with Foreign Corrupt Practices Act risk to have in place a rigorous anti-corruption compliance programme that includes policies and procedures designed to detect and deter violations of the Foreign Corrupt Practices Act and other applicable anti-corruption laws. Such a compliance programme should include:

  • a clearly articulated and visible corporate policy against act violations that includes specific standards and procedures regarding key Foreign Corrupt Practices Act risk areas (eg, interactions with foreign officials, gifts, meals and entertainment, and facilitating payments);
  • provisions for regular audits and testing of the compliance programme;
  • a system of financial and accounting procedures designed to ensure the maintenance of fair and accurate books, records and accounts;
  • a reporting system that allows for anonymous complaints; and
  • policies to mitigate the risk that third parties may expose a company to Foreign Corrupt Practices Act liability.

Companies with specific or heightened Foreign Corrupt Practices Act risks may need additional policies and procedures to address those risks.

Investigation readiness
Based on prior Department of Justice statements and the reports of the SEC's letters and subpoenas, financial services companies should be prepared to handle an industry-wide Foreign Corrupt Practices Act investigation. Steps to ensure that the institution is ready in the unfortunate event that it were to receive an inquiry may include:

  • an anti-corruption risk assessment of the institution's business model;
  • review of the entity's current anti-corruption compliance programme, including policy and procedures;
  • enhancement of the company's programme to protect against future risk;
  • identification of individuals, if any, who may be relevant to a sovereign wealth fund inquiry (ie, those with some involvement or activity related to sovereign wealth fund investments);
  • general identification of locations at which data related to sovereign wealth fund investments may reside; and
  • training of employees to mitigate anti-corruption risks properly.

Finally, any identified potential Foreign Corrupt Practices Act issue should be handled aggressively and appropriately. In light of the public nature of the SEC's investigation, enforcement authorities will expect that financial services companies diligently assess their current act compliance and swiftly remedy any compliance failures.

For further information on this topic please contact Richard Craig Smith, Marsha Z Gerber, Paul E Sumilas or Tracy Stewart DeMarco at Fulbright & Jaworski LLP by telephone (+1 202 662 0200), fax (+1 202 662 4643) or email (rcsmith@fulbright.com, mgerber@fulbright.com, psumilas@fulbright.com or tdemarco@fulbright.com).

Endnotes

(1) Issuers are companies with securities registered in the United States or that file periodic reports with the SEC.

(2) US parent companies may also be liable for the acts of non-US subsidiaries where the parent authorised, directed or controlled the activity in question.

(3) Non-US subsidiaries of issuers are not bound directly by these provisions, but a parent company must generally, in good faith, use its influence to cause its subsidiary to devise and maintain effective accounting controls.

(4) An additional, and perhaps surprising, risk may occur when a sovereign wealth fund acquires a meaningful stake in a US company. As the SEC and the Department of Justice continue to expand their interpretation of 'foreign official' to include employees of companies in which a foreign government maintains only a minority stake, a risk arises that the government could deem employees of US companies in which sovereign wealth funds have invested to be foreign officials for the purposes of the Foreign Corrupt Practices Act. In such a scenario, companies unaware of the sovereign wealth fund's stake in the company could conceivably violate the Foreign Corrupt Practices Act, in addition to other laws which prohibit bribery, by improperly dealing with employees of what they assumed was a US company.


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