Avoiding Individual Liability: Navigating Whistleblower, Corruption, and Financial Reporting Matters May 5, 2016

Transcription

1 Avoiding Individual Liability: Navigating Whistleblower, Corruption, and Financial Reporting Matters May 5, 2016

2 Foreign Corrupt Practices Act

3 Foreign Corrupt Practices Act Enacted in 1977 to combat bribery of foreign officials by U.S. companies Contains two primary provisions (1) anti-bribery provision and (2) accounting and internal control provisions DOJ and SEC are agencies responsible for FCPA enforcement FCPA liability is concern for publicly-traded and private companies FCPA liability is concern for individual corporate actors working for a private company that conducts business outside the U.S 3

4 Foreign Corrupt Practices Act Anti-bribery provisions prohibit corruptly paying or offering to pay anything of value to foreign official directly or indirectly to secure improper advantage ; influence foreign official in order to obtain or retain business Criminal liability attaches for willful violation 4

5 Increased Focus on Individuals More prosecutions of individuals under FCPA Former DOJ FCPA Unit Chief Patrick Stokes (now head of DOJ Fraud Section) emphasized importance of prosecuting individuals Said DOJ was very focused on individuals Said DOJ was using all available law enforcement tools including electronic surveillance: Corporate executives should wonder who is listening in on their calls and conversations. 5

6 Increased Focus on Individuals On September 9, 2015, DOJ issued a memorandum entitled Individual Accountability for Corporate Wrongdoing outlining six steps that prosecutors should take in all future investigations 1. To qualify for any cooperation credit, corporations must provide the DOJ all relevant facts relating to the individuals responsible for the misconduct. 2. Both criminal and civil corporate investigations should focus on individuals from the outset of the investigation. 3. The criminal and civil attorneys handling a corporate investigation should routinely be in communication with each other. 4. Absent extraordinary circumstances or approved departmental policy, individuals will receive no release from civil or criminal liability as part of the DOJ s resolution of investigations involving corporate wrongdoing. 5. DOJ attorneys are admonished not to resolve corporate matters without a plan to resolve related individual matters and to memorialize any declinations as to individuals in such cases. 6. The Department s civil enforcement attorneys are directed to focus consistently on individuals in addition to the company and to evaluate whether to bring suit against an individual based on factors other than the individual s ability to pay. 6

7 Pointers for Avoiding Liability Conduct due diligence on contracting parties, particularly when venturing into new or high-risk foreign markets Conduct a background check on all parties involved agents, consultants, distributors, licensees, representatives search Office of Foreign Asset Control (OFAC) sanctions list Understand role of all parties and agents why are they involved? what do they actually do? what is relationship with government agencies and officials? Include provision in contract requiring compliance with FCPA and allowing termination if any anti-corruption law is violated Also consider limiting duration of contract in unfamiliar high-risk jurisdictions so that ties can be severed easily if corruption issues arise 7

8 Pointers for Avoiding Liability Avoiding liability in context of M&A and joint ventures Acquirer can be liable for FCPA violations committed by target Resource Guide affirms: [s]uccessor liability applies to all kinds of civil and criminal liabilities, and FCPA violations are no exception Conduct pre-acquisition due diligence Identify target company s international operations, including agents and distributors Audit selected transactions of target company Engage with target s general counsel and internal audit department regarding corruption risks and compliance programs; ask about corruption-related issues over past five years 8

9 Finanancial Reporting and Internal Controls

10 SEC enforcement trends Accounting enforcement actions up 46% in 2015 More claims against individuals Strong emphasis on companies that do not timely report material weaknesses in internal controls Increasingly willing to bring non-fraud-based claims Has obtained big penalties without proving fraud $80 million against Monsanto (Feb. 2016) $46.9 million against Life Partners (Jan. 2015) Deploying software to detect outliers and anomalies (similar to sophisticated short sellers) Targeting companies with frequent audit adjustments 10

11 Fraudulent Intent Not Required for Many Violations Section 13(a) of Exchange Act prohibits companies from filing false or untimely Form 10-Ks and Form 10- Qs Section 13(b)(2)(A) requires companies to keep books, records, and accounts which in reasonable detail accurately and fairly reflect the company s transactions and dispositions of assets Section 13(b)(2)(B) requires companies to devise internal controls Rule 13a-14 requires Sarbanes-Oxley certifications Sections 17(a)(2) and 17(a)(3) of Securities Act prohibits obtainment of money or property by untrue statement or omissions 11

12 SEC Scrutinizing Internal Control Certifications CEOs and CFOs must certify internal controls were designed and that they personally evaluated effectiveness of ICFR A material weakness only requires a reasonable possibility that a material misstatement will not be detected SEC pursuing companies and individuals for: Not timely disclosing material weaknesses Not personally evaluating effectiveness of ICFR Not maintaining documentation to support evaluation Using incorrect standard for evaluating deficiencies Relying excessively on outside consultants Inadequate disclosure controls over investor presentations and other less formal communications 12

13 Recent Enforcement Actions QGSI: Penalty and D&O bar where executive unfamiliar with Treadway Commission standards and concealed inventory control deficiencies from auditors Saba Software: $2.5 million clawback against CEO where deficient controls did not detect time-entry scheme JDA Software: $750,000 penalty for nonfraudulent control deficiencies in not establishing VSOE PolyCom: $750,000 penalty for control deficiencies leading to $200,000 in fudged expenses going undetected 13

14 Recent Enforcement Actions (cont d) Stein Mart: $800,000 penalty for allowing marketing department to make accounting decisions about markdowns MuscleFarm: $700,000 penalty against company, $150,000 against CEO and $30,000 against CFO and audit chair for not reporting $500,000 in executive perks Trinity Capital: Fraud case against bank for manipulating loan loss disclosures, with non-fraud internal control charges against former VP of internal audit Magnum Hunter: $250,000 penalty after disclosing 14 MWs and terminating auditor; SEC alleged that MWs improperly classified as significant deficiencies and should have been disclosed earlier 14

15 Material Weaknesses as Basis for Class Action Liability Accounting restatements and internal control deficiencies are traditionally insufficient to support a strong inference of fraud for Rule 10b-5 liability But restatements and control deficiencies may support claims over IPO prospectus disclosures, which do not require plaintiffs to show fraud Everyone who signs Registration Statement can be individually liable under Section 11 15

16 Internal Controls Takeaways Certifying officers must adequately explain how they evaluated controls and must know the standards Companies should maintain contemporaneous documentation of internal control judgments For every deficiency, management and audit committees must ask whether it is a MW and be able to explain and document why it does not Accounting departments must be adequately staffed, with sufficient training and lines of responsibility 16

17 Non-GAAP Financial Measures Recent SEC Interest SEC Chair Mary Jo White in December 2015 on non-gaap financial measures: This area deserves close attention, both to make sure that our current rules are being followed and to ask whether they are sufficiently robust in light of current market practices. By some indications, such as analyst coverage and press commentary, non-gaap measures are used extensively and, in some instances, may be a source of confusion. 17

18 Advice from SEC Chair Ask the following: Why are you using the non-gaap measure, and how does it provide investors with useful information? Are you giving non-gaap measures no greater prominence than the GAAP measures, as required under the rules? Are your explanations of how you are using the non- GAAP measures and why they are useful for your investors accurate and complete, drafted without boilerplate? Are there appropriate controls over the calculation of non- GAAP measures? 18

19 Whistleblower Liability

20 Whistleblower Actions On The Rise Employee litigation top concern among GCs Explosive growth in retaliation/whistleblower actions SEC whistleblower actions increased drastically since 2010 More False Claims Act (FCA) claims filed in 2014 than in any year of the FCA s history (relators collected more than $435 million) IRS has an informant program providing whistleblowers 15 to 30% of taxes, penalties, and other amounts it collects Why? Easy to make, instant credibility, internal insight, visibility of Dodd-Frank bounties, and growing sophistication of plaintiff law firms 20

21 Key Laws False Claims Act Prohibits knowingly making or causing the submission of false claims for payment to the federal government or knowingly retaining money owed to the government Allows for private parties (qui tam relators) to bring suit on behalf of the government and participate in % of any recovery Dodd-Frank & Sarbanes-Oxley Protects employees who report violations of the Securities Exchange Act/rules/regulations, Commodity Exchange Act, Consumer Financial Protection Act, other federal statutes protecting shareholders Retaliation Affordable Care Act Protects employees who report violations of the Affordable Care Act Forbids retaliation against employees who benefit from the Act 21

22 Key Laws Title VII of the Civil Rights Act of 1964 Anti-retaliation provision protects employees who: Oppose any unlawful discrimination under Title VII Make an EEOC or other charge Assist, testify, or participate in any Title VII investigation, proceeding, or hearing Fair Labor Standards Act Anti-retaliation provision applies to any employee who: Files a complaint, or institutes a proceeding Testifies or is about to testify Serves on, or is about to serve on, an industry committee Occupational Safety and Health Act Similar protections for employees who report violations of the Act, or who exercise rights under the Act 22

23 Whistleblower Bounties About 20 bounties paid despite 4,000 tips/year 120-day window allows whistleblowers to report internally first Notable awards: $30 million to foreign whistleblower $14 million where substantial funds recovered $1.4 million to compliance professional $575,000 to former company officer 23

24 Individual Liability for Retaliation Federal court holds that individual directors could be liable for terminating whistleblower Wadler v. Bio-Rad Labs., 2015 WL (N.D. Cal. Oct. 23, 2015) Sarbanes-Oxley provides that an officer, employee, contractor, subcontractor, or agent can violate the Act Court concluded that although statutory language ambiguous, director may be held individually liable as an agent given broad purpose of Sarbanes-Oxley Dodd-Frank permits whistleblowers to sue an employer for retaliation but does not define employer Court concluded that Congress intended that Dodd-Frank provide for individual liability at least as extensive as Sarbanes-Oxley, thus directors may be held individually liable for retaliating against whistleblowers under Dodd-Frank 24

25 Retaliation Key Trends Less restrictive view of protected activity Wiest v. Lynch, 710 F.3d 121 (3d Cir. 2013) (protected activity found under SOX Section 806, even though the whistleblower (1) did not identify a violation of a particular law, (2) was unaware of any fraudulent intent, and (3) objected to potential, not existing violations) Wallace v. Tesoro (5th Cir. 2015): Whistleblower could bring SOX 806 claim if they had reasonable belief company violated accounting rules in public financial statements. Plaintiff adequately alleged reasonable belief even though he was not an accountant and did not cite specific accounting rules that were violated. Plaintiff, however, may face higher bar on summary judgment. Less restrictive view of adverse employment action Halliburton v. Admin. Rev. Bd. (5th Cir. 2015): Disclosure of whistleblower s identity to superiors and colleagues held sufficient to support anti-retaliation claim given negative consequences of disclosure. 25

26 Difficult Situations What if your trusted advisor blows the whistle (HR employee or in-house legal counsel)? What if whistleblower is a compliance officer whose job is to address employee misconduct? What if your whistleblowing employee won t cooperate during the investigation? What if you need to fire your whistleblower? When? Balance of Documentation Limited Release 26

27 Confidentiality Agreements: SEC Rule 21F-17(a) No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement... with respect to such communications. SEC has served subpoenas and has brought one enforcement action based on use of confidentiality agreements to stifle whistleblowers 27

28 Best Practices Handling Complaints Effectively Make written policies visible and relevant Designate dedicated personnel to handle whistleblower complaints Effective training, education, lines of communication Create a culture of compliance Train Management to Listen & Investigate Avoid hostility, belittling and defensiveness Take internal reports seriously Document all of the foregoing, and the result Remember Upjohn warnings and privilege considerations Make sure complaints and promptly reported to legal department 28

29 Best Practices (cont d) Ending Employment Termination Consider timing Documentation concerns Create and follow a standard termination checklist Exit Interviews Have a witness for key interviews Listen to the exiting employee; do not debate When possible, obtain a signed release, including certification or representation that employee knows of no claims 29

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