U.S. prosecutors don’t typically bring charges of Foreign Corrupt Practices Act violations against individuals of publicly traded companies without bringing charges against the company itself. Defense contractor Harris Corp. has just been added to that list of the fortunate few.
The U.S. Department of Justice and the Securities and Exchange Commission decided not to take any action against Harris over violations of the FCPA, citing several reasons as to why the company didn’t deserve to face an enforcement action. Compliance officers should refer to this case as yet another example highlighting the merits of swift and thorough post-acquisition due diligence and robust compliance measures.
The government investigations against Harris followed the company’s 2011 acquisition of Carefx and its subsidiaries, including its China subsidiary, Carefx China. “Following the closing, we became aware that certain entertainment, travel, and other expenses in connection with the Carefx China operations may have been incurred or recorded improperly,” Harris told the SEC.
“In response, we initiated an internal investigation and learned that certain employees of the Carefx China operations had provided pre-paid gift cards and other gifts and payments to certain customers, potential customers, consultants, and government regulators,” Harris added.
From at least April 2011 through April 2012, Carefx China’s Chairman and CEO Jun Ping Zhang directly authorized or indirectly allowed Carefx China sales staff to make between $200,000 and $1 million in improper gifts to government officials at Chinese state-owned hospitals and regional departments of health in exchange for over $9.6 million in contracts. Furthermore, Ping knew the bogus expenses were improperly recorded in Carefx China’s books and records as legitimate sales expenses or consulting fees and that, as a result, their true nature would not be disclosed to Harris, the SEC said.
As the top manager of Carefx China, Ping was responsible for maintaining and ensuring compliance with Harris’s internal accounting controls. Instead, he circumvented these controls by consistently allowing the submission of Carefx China’s monthly expense summary reports that he knew contained false information. “By doing so, Ping enabled Carefx China to cloak its illicit gifts to government officials in the guise of legitimate business expenses and, thereby, hide the practice from Harris,” the SEC said.
“In previous years, that sort of conduct would have resulted in a costly enforcement action against Harris, regardless of whether the scheme had been actively concealed.”
Robert Kent, Partner, Baker & McKenzie
Moreover, Ping did not disclose to Harris’s attorneys during the pre-acquisition due diligence process any information about the improper gifts or bogus expense invoices used to pay for them. In fact, he cautioned employees not to give gifts that were too large and told them not to get caught. Despite Ping’s evasion of internal controls, Harris discovered the illicit conduct at Carefx within a few months of the acquisition.
The SEC’s order finds that Ping violated the anti-bribery, books and records, and internal accounting controls provisions of the Securities Exchange Act. Ping consented to the entry of the cease-and-desist order and agreed to pay a $46,000 civil penalty.
During the second quarter of fiscal year 2016, the Department of Justice notified Harris that it would not be taking any action against the company. In a quarterly filing, Harris said the Justice Department based its decision off the company’s level of acquisition due diligence and integration efforts, voluntary disclosure, remediation efforts, and cooperation throughout the investigation.
The SEC reached a similar conclusion. In its administrative proceeding, the SEC said it “determined not to bring charges against Harris, taking into consideration the company’s efforts at self-policing that led to the discovery of Ping’s misconduct shortly after the acquisition, prompt self-reporting, thorough remediation, and exemplary cooperation with the SEC’s investigation.”
Some people argue that if the Justice Department or SEC opens an investigation and no enforcement action results, that’s a declination.
Below is an excerpt from the case SEC case, In the Matter of Jun Ping Zhang.
On October 18, 2011, Ping received an e-mail from a CareFx China sales manager regarding a potential upcoming project for the Nansha District Health Bureau (“Nansha District”). The sales manager had just purchased meals for several of the Nansha District government officials’ responsible for awarding the Nansha District project. He was told that the Nansha District’s Deputy Director “made a promise [to] let [CareFx China] have the project.” On October 21, 2011, the CareFx China sales manager requested approval of approximately $2,300 for three iPhones because “the Nan’sha project has currently entered its bidding stage” ” and “we will need strong cooperation and support from [the Nansha District officials].” On January 2, 2012, Ping responded to an email regarding the sales staff’s plan to use government officials to manipulate the Nansha Project bidding process by noting the “great significance of Nansha District Project for our business.” On January 12, 2012, CareFx China won the Nansha District contract, which was worth $93,000.
On November 17, 2011, Ping authorizeda sales manager’s request to “overspend by several thousand yuan this month” to purchase gifts for “leaders in the Health Department” and “hospital leaders.”
On December 25, 2011, Ping received a request from a CareFx China sales member for approval of approximately $2,600 to pay for gifts, shopping cards, and entertainment for government officials at the Yuelu District Health Bureau. On December 26, 2011, Ping instructed his second in command, CareFx China’s Executive Deputy Manager, to “please solve this problem.”
On December 30, 2011, CareFx China’s sales director requested $6,500 to provide “bonuses” to government officials at several hospitals and health offices in the Hubei Province.
On December 31, 2011, Ping instructed the sales director to discuss the amounts with Ping’s second in command.
On January 9, 2012, Ping authorized$775 in gifts to the Director and Vice Director of the Shanghai Shenkang Hospital Development Center, who were “responsible for the government’s major projects in 2012.”
In total, CareFx China employees made approximately $200,000 to $1 million in improper gifts to Chinese government officials between April 2011 and April 2012. These payments were incorrectly recorded in CareFx China’s books as legitimate sales expenses and consulting fees and were subsequently consolidated into Harris’s financial statements. CareFx China sales staff made these gifts to Chinese government officials who ultimately awarded CareFx China over $9.6 million in contracts with state-owned entities.
Source: In the Matter of Jun Ping Zhang
Mike Koehler, associate professor of law at Southern Illinois University School of Law, argues that a real “declination” is when U.S. prosecutors “could—based on the law, based on the facts—bring an FCPA enforcement action, but for whatever policy reason—perhaps due to voluntary disclosure or cooperation—they decline.” In the Harris case, based on the facts stated in the SEC’s administrative order, some could argue that prosecutors didn’t have a case to decline in the first place.
Robert Kent, a partner with law firm Baker & McKenzie who represented Harris, notes that evidence in this case points to the contrary: Because of Ping’s fraudulent activity, the company was able to obtain over $9.6 million in contracts.
“In previous years, that sort of conduct would have resulted in a costly enforcement action against Harris, regardless of whether the scheme had been actively concealed,” Kent says. That Harris was able to obtain a declination in this case without any allegation that Ping himself embezzled from Harris is “a significant development that changes the voluntary disclosure calculus,” he says.
In 2012, Morgan Stanley similarly dodged FCPA liability after prosecutors determined that Morgan Stanley had been duped by one of its managing directors, Garth Peterson. In that case, Peterson circumvented the company’s internal controls when he convinced Morgan Stanley to sell real-estate interest to Chinese state-owned entity Shanghai Yongye Enterprise. Unbeknownst to Morgan Stanley, Yongye was a shell company owned by Peterson and Yongye’s chairman.
Kent says the distinction between Harris and Morgan Stanley is that Morgan Stanley’s case “involved self-dealing by the employee,” a factor not present in the Harris case. In that aspect, Kent describes Harris as a “first-of-its-kind” case, because it “represents the first time in a ‘pure’ FCPA investigation that a multinational corporation has avoided prosecution entirely while one of its former employees was sanctioned for FCPA violations that created clear potential FCPA liability for the company.”
But even that might be open to interpretation. According to Koehler, Harris is hardly precedent-setting, as it is the 20th example since 2000 in which both the Department of Justice and SEC charged an individual with FCPA violations but not the company.
To be clear, most of those cases Koehler is referring to involved charges brought against individuals affiliated with small- to mid-size privately held organizations, not large, multinational publicly held companies.
The central message for legal and compliance executives to take from the Harris case is the value-add of conducting thorough pre- and post-acquisition due diligence.
Although Carefx China represented less than 0.1 percent of Harris’ total revenue, Harris engaged in substantial due diligence prior to closing on the acquisition, including conducting interviews of the relevant executives, Kent says. Ultimately, that level of pre-acquisition due diligence, in part, made up its “strong and compelling presentation to the government,” he says.
Its swift post-acquisition measures also won points with the SEC. “Although only able to perform limited pre-acquisition due diligence on the subsidiary, Harris took immediate and significant steps after the acquisition to train staff in China and integrate the subsidiary into Harris’ system of internal accounting controls,” the SEC said.
Kent adds that “within a month of acquisition, Harris did in-person training in China, conducted by one of its top anti-corruption in-house attorneys, set up an anonymous complaint hotline, and otherwise moved forward to integrate the company into its compliance process,” he says.
As a direct result of these post-acquisition measures, the SEC said, Harris discovered the misconduct at the subsidiary within five months of the acquisition.
The case also highlights the benefits of “exemplary cooperation.” For other companies undergoing an FCPA investigation, “exemplary cooperation” in the eyes of prosecutors typically involves producing witnesses, including those from overseas, producing and translating key documents, and generally responding to government inquiries.
In a post-Yates Memo regulatory environment, at a time when regulators have reinvigorated their focus on individual culpability, Kent says, the Harris case further signals that, where accounting violations are involved, companies also “need to be ready to produce evidence that relates to the accounting systems and the accounting issues that might arise in connection with any investigation.”
From a big-picture perspective, the Harris case is a positive development for the compliance community and offers at least a bit more perspective from prosecutors on the actual benefits of due diligence, compliance, and cooperation credit.