Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

In prior posts, I have examined the increasing importance of anticorruption efforts and their significance for purposes of corporate governance. But a recent report by a global watchdog group suggests that not all governments are actively enforcing their anticorruption commitments, with potentially serious consequences for the developing world.

Transparency International describes itself as a “global civil society organization leading the fight against corruption.” Among other things, the group issues an annual progress report on the enforcement of the OECD Convention on Combating Bribery of Foreign Officials.

On June 24, 2008, the group issued its 2008 Progress Report (here), which states that there has been a “dangerous stalemate on enforcement” and that “less than half” of the OECD Convention signatories “are living up to their commitments.” The report further states that while there has been “significant enforcement by 16 governments,” there is “little or no enforcement by 18 governments.”

The watchdog group is particularly worried about the “mixed message” that these uneven enforcement efforts may be sending. One commentator for the group is quoted as saying that “strong enforcement action against Siemens signaled to German business that foreign bribery will no longer be tolerated. But the backtracking of other countries, including the UK’s termination of an investigation into BAE Systems’ deals in Saudi Arabia, reinforces doubts about government commitment to enforce the Convention.”

The report leave no doubt about the importance of anticompetitive enforcement; as the report states, “compliance by signatory states is critical in draining the supply of bribe money that distorts public decision making in some of the world’s poorest states, with disastrous consequences for their citizens.”

My most recent post discussing the BAE Systems investigation can be found here, and my most recent post discussing the Siemens investigation can be found here.

Hat tip to the SOX First blog (here) for the link to the Transparency International report.

Siemens might not only have problems with the anticorruption laws, but also with its complexion, according to a June 24, 2008 Financial Times article reporting on comments from Siemens' current head, in an article entitled "Siemens is 'too white, German and male'" (here).

Another Options Backdating Securities Class Action Settlement: On June 24, 2008, Brooks Automation announced (here) that it had settled the securities class action lawsuit that was pending against the company and certain of its directors and officers. The defendants’ motion to dismiss the lawsuit had previously been denied, as I discussed in a prior post, here. The case settled for $7.75 million dollars, all of which is to be paid by the company’s liability insurance carrier.

In any event, I have added the Brooks Automation settlement to my table of options backdating-related lawsuit dismissals, denials and settlements, which can be accessed here.

“Aggregator” Standing: Ordinarily this blog would not pause to comment on a “justiciability” case, at least one outside the context of directors and officers liability. But we found some of the commentary about the U.S. Supreme Court’s June 23, 2008 decision in Sprint Communications v. APCC Services (here) particularly interesting, and we thought we would pass it along for the benefit of those readers as interested as we are in procedural and jurisdictional matters.

George Washington University Law Professor Jon Siegel has a post on his blog Law Prof on the Loose (here) discussing the decision and the question whether “aggregators” who compiled the claims of payphone operators against long-distance carriers can demonstrate a sufficient injury to have standing to sue. The Supreme Court decided that they do. Siegel’s post does an interesting and humorous job explaining the case, the issues, and the decision, and he also explores the interplay between the majority and dissenting opinions. Read and enjoy.

Attention Deficit: We all suffered through those undergrad classes that seemed like they would never end, but the Chronicle of Higher Education has a June 20, 2008 article entitled “Short and Sweet: Technology Shrinks the Lecture”(here) reporting that after all these years, academia may finally be doing something about it.

Apparently, many Profs who have made their living droning on and on have finally seen themselves on video, as part of the effort to put their lectures on line. Appropriately enough, the experience seems to have been a wake-up call for many professors. As one Prof observed, “You wanted to kill yourself after about 20 minutes.” (I am not sure, but I think that particular Prof may have taught my Econ 101 class.)

So as part of their transition to online teaching, many professors are breaking their sessions into 20-minute segments. I guess the 20 minute time frame was selected to minimize the number of boredom-induced suicides.

At least some of the professors have managed to make the mental leap: “Shorter may work better in the classroom, too.” Tragically, this breakthrough comes too late to benefit the current generation, but at least our children and grandchildren can hope for a better tomorrow.

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The growing importance of global anticorruption enforcement efforts was underscored this past week by the revelation of a cross-border investigation involving the French industrial giant Alstom and by developments in the continuing investigation involving Siemens. Moreover, the Siemens developments highlight the increasing significance of liabilities arising from anticorruption exposures for the D&O insurance industry.

First, in a May 6, 2008 article entitled “French Firm Scrutinized in Global Bribe Probe” (here), the Wall Street Journal reported that French and Swiss authorities are investigating whether officials acting on behalf of Alstom paid hundreds of millions of dollars between 1995 and 2003 to win contracts in Brazil, Venezuela, Singapore and Indonesia.

Then on May 9, 2008, German prosecutors announced that they will pursue a civil enforcement action against former Siemens chairman Heinrich von Pierer and several other (unnamed) former Siemens board members. (Refer here for background regarding the Siemens investigation). von Pierer served as Siemens’ chief executive from 1992 to 2005, and as its Chairman until April 2007. Prosecutors apparently have elected for the time at least not to pursue criminal charges against von Pierer.

According to a May 10, 2008 Wall Street Journal article (here), the company itself has also said that “it may seek financial compensation from former managers but didn’t name individuals.”

According to the Journal article about the Alstom investigation, the Alstom and Siemens investigations “suggest that Europe’s prosecutors have begun taking a tougher line on business practices that their U.S. counterparts have long treated as criminal.” It is not merely coincidental that these investigations are now emerging; they are in fact an outgrowth of relatively recent changes in the laws of both Germany and France.

For many years, under the laws of the two countries, corrupt payments were not only legal, but the amount of the payments were tax deductible. But both countries are signatories to the OECD Convention on Combating Bribery of Foreign Officials in International Business Transactions. To implement the Convention, in 1999 Germany passed the German International Bribery Act. According to the Journal, “France outlawed bribery of foreign officials in July 2000.”

Both companies seem to have had difficulties adapting to the new legal prohibitions, as the conduct under investigation both preceded and followed the enactment of the new laws.

One particularly interesting aspect of the Alstom investigation is the way that the circumstances under review came to light. The investigation apparently arose as a result of an audit commissioned by the Swiss Federal Banking Commission of Tempus Privatbank AG, a small private bank. The audit uncovered documents concerning Alstom-related transactions that detailed the flow of about 20 million euros from Alstom to shell companies in Switzerland and Lichtenstein.

These investigations underscore the growing significance of cross-border anticorruption actions and highlight the fact that anticorruption efforts are no longer just a U.S. priority. Moreover, the potential exposures and liabilities are enormous. Siemens itself has already paid a fine of 201 mm euros.

There are also important implications arising from Siemens’ suggestion that it may pursue claims against its former managers. According to a May 5, 2008 Business Insurance article entitled “German Insurers Brace for Siemens Claim” (here), the company has notified its D&O insurers that it intends to file a claim under its D&O policies relating to the company’s antibribery related exposures. The article reports that the company carries D&O limits of 250 million euros. The article does not detail the specifics of the insurance claim or the matters for which the company claims or intends to claim coverage, so there is no way to assess the likelihood of the company’s eventual recovery under the policies.

It is far from certain that the company’s policies would actually cover the claimed amounts. But to the extent the policy’s limit is exhausted by the claims for coverage, it could, at least according to the Business Insurance article, have a substantial impact on the German market for D&O insurance.

The potential insurance implications from the developments in the Siemens investigation demonstrate the growing significance for the D&O insurance industry of the liabilities arising from anticorruption enforcement activity. As investigations like those involving Alstom and Siemens emerge and develop, and as litigation like that involving Alcoa (about which refer here) continues to arise, these issues necessarily will become a significant priority for companies and for D&O insurers. As I have previously suggested (here), anticorruption violations may well represent the “next corporate scandal.”

The May 9, 2008 Financial Times has an interesting editorial about the Alstom investigation and the expansion of anticorruption efforts, here.

Speakers’ Corner: On May 14, 2008, I will be speaking at the American Conference Institute’s D&O Liability Insurance Conference (refer to the agenda, here). I will be participating on a panel with my good friend Dan Bailey in a session entitled “Emerging Exposures Roundup: Fiduciary Litigation, Global Warming and More.”

Then on May 15, 2008, I will be in Toronto to participate in the Professional Liability Underwriting Society (PLUS) Canadian Chapter’s educational event regarding the subprime crisis. Information about the Toronto event can be found here. The other panelists include Dr. Arturo Cifuentes of R.W. Pressprich & Co., Denis Durand of Jarislowski Fraser, and Robert Murray of Chubb.

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In a powerful affirmation of the rule of law, two justices of the U.K.’s High Court of Justice ruled in an April 10, 2008 opinion (here) that the British Serious Fraud Office (SFO) must reconsider its decision to discontinue its bribery investigation into the award of a weapons contract between Saudi Arabia and BAE Systems plc. My prior post regarding the BAE investigation can be found here.

The SFO announced its decision to discontinue the investigation in December 14, 2006. The investigation had been ongoing for some time and had even withstood a prior attempt in October 2005 to have the investigation stopped. However, in July 2006, apparently when the SFO was about to obtain access to certain Swiss bank accounts, the British government received “an explicit threat made with the intent of halting the investigation.”

In the proceedings before the court, the government refused to characterize the threat, but the opinion quotes news reports that what happened was that Prince Bandar bin Sultan bin Abdul Aziz of al-Saud “went to Number 10” and told the Prime Minister’s Chief of Staff to “get it stopped” or the military weapons contract ‘was going to be stopped and intelligence and diplomatic relations would be pulled.” (Prince Bandar, the Saudi ambassador to the United States from 1983 to 2005, is now and in 2006 was the Secretary-General of the Saudi National Security Council.)

Following the July 2006 threat, an internal governmental review process unfolded, including high level consultations with the British ambassador to Saudi Arabia and others, culminating in a previously confidential December 8, 2006 memorandum by then-Prime Minister Tony Blair to his Attorney General Peter Goldsmith that “developments” had “given rise to the real and immediate risk of the collapse of UK/Saudi security, intelligence and diplomatic cooperation.” This, the Prime Minister said, would “have seriously negative consequences for the UK public interest in terms of both national security and our highest priority foreign policy objectives in the Middle East.” The government was particularly concerned with the Saudis continued counter-terrorism support, without which, it was feared, British lives could be in danger.

According to news reports (here), in August 2006 (that is, one month after Prince Bandar’s visit to “Number 10”), BAE won a $8.7 billion order from the Saudi government for 72 Eurofighter Typhoon warplanes, purportedly the latest component of the Al Yamamah arms deal, which dates back to 1985 and is the largest British export contract ever.  

The legal challenge to the decision to terminate the investigation was presented by two public interest groups, Corner House Research and the Campaign Against Arms Trade. They challenged the SFO’s decision to accede to the threat as “contrary to the constitutional principle of the rule of law,” as well as on other grounds. By contrast, the government argued, as the court summarized, that “the law is powerless to resist the specific, and as it turns out, successful attempt by a foreign government to pervert the course of justice in the United Kingdom.” (The court said of this argument that “so bleak a picture of the impotence of the law invites at least dismay, if not outrage.”)

The April 10 opinion was written by Lord Justice Alan Moses. After a detailed review of the background to the SFO’s decision to terminate the investigation, the Court considered the claimants’ challenge, which Lord Justice Moses said did not question the government’s assessment of the national security risk. The threat that was the basis of the decision to terminate the investigation “was not simply directed at the company’s commercial, diplomatic and security interests, it was aimed at its legal system.”

The threat was made “with the specific intention of interfering with the course of the investigation.” The court noted that “had such a threat been made by one who was the subject of the criminal law of this country, he would risk being charged with an attempt to pervert the course of justice.” Surrender to such threats “merely encourages those with power, in a position of strategic and political importance, to repeat such threats.” The court concluded that “in yielding to the threat, the [SFO director] ceased to exercise the power to make the independent judgment conferred on him by Parliament.” As a result, the court concluded that the submission to the threat was “unlawful.”

The court’s opinion reviews a host of other considerations, including in particular the U.K’s obligations as a signatory Organization for Economic Cooperation and Development’s Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (which specifies that investigations “shall not be influenced by considerations of national economic interest, the potential effect upon relations with another State or the identity of the natural or legal persons involved.”). But the court’s essential conclusion is that the decision to terminate the investigation was contrary to the principles of the rule of law. “It is difficult,” the court said,” to identify any integrity on the role of the courts to uphold the rule of law if the courts are to abdicate in response to a threat from a foreign power.”

The full opinion is lengthy but it is well worth the read. The details surrounding the government’s consideration of how to respond to the threat are fascinating, and the court’s analysis of the legal considerations involved is thought-provoking, particularly its consideration of how imminent a threat of loss of life must be before a court might consider yielding. The inherent tension in the court’s decision arises from the fact that this case tests the limits of what any government might be willing to risk in resisting corruption; the lesson the court rejected is that if the corrupt forces are rich and powerful enough, they have nothing to fear from the force of law.

It remains to be seen, however, whether the investigation will go forward in the end; the court did not rule that the investigation must proceed, only that the December 2006 decision to terminate the investigation was unlawful. According to an April 11, 2008 article in The Guardian (here), “the high court will reconvene in a fortnight to decide what remedy to award the two groups of anti-corruption campaigners who brought the judicial review of the Serious Fraud Office decision to end the inquiry.”

As I have noted in a number of prior posts, most recently here, many governments around the world (including the U.S. government) are increasingly committed to enforcing anti-corruption laws. BAE is also being investigated in the U.S. and in Switzerland, and is only one of several current high-profile corruption investigations. The April 10 opinion underscores the seriousness of the issues involved, as well as the stakes. Courts will continue to grapple with the challenges these cases present, but it is important for companies to understand that the risks involved with corrupt practices include the threat of civil litigation, as I discussed here. BEA is in fact already the target of a shareholders’ derivative lawsuit in the United States. The growing threat of this type of litigation suggests why corrupt activity may represent the “next corporate scandal.”

Press coverage of the April 10 decision can be found here and here. The FCPA Blog’s post on the decision can be found here.

Subprime Litigation Webcast: On Friday April 11, 2008, at 11:00 a.m., I will be a panelist on a webcast sponsored by Risk Metrics on the topic “Subprime Litigation and Liability.” The panel will be moderated by Adam Savett, author of the Securities Litigation Watch blog, and will include defense attorney Darryl Rains, of the Morrison and Foerester firm, and plaintiffs’ attorney Mark Lebovitch, of the firm Bernstein, Litowits, Berger & Grossman. Registration for the webcast (which is free) can be accessed here. Further information, including links to background papers by Risk Metrics, can be accessed on the Securities Litigation Watch, here.  

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In prior posts (most recently here), I have commented on the growing threat of follow-on shareholder litigation ensuing in the wake of Foreign Corrupt Practices Act (FCPA) enforcement actions. A lawsuit recently filed in the United States District Court for the Western District of Pennsylvania represents an entirely different kind of threat arising from allegations of foreign corrupt activities, in the form of a civil action brought directly against the alleged wrongdoer(s) by the alleged victims of the corrupt activity, without any preceding FCPA enforcement action.

On February 27, 2008, Aluminum Bahrain B.S.C. ("Alba") filed a lawsuit against Alcoa, an Alcoa affiliate, and two individuals, one of whom was an officer of an Alcoa affiliate. Alba (owned by an entity in which the Bahrain government has a 70% ownership interest), alleges that the defendants engaged in a 15-year conspiracy involving overcharging, fraud, and bribery of Bahraini officials. A copy of the complaint can be found here. Alba is in the aluminum smelting business, and it has depended since 1990 on Alcoa affiliates for its supply of alumina, a key ingredient in the production of aluminum.

The complaint alleges that beginning in 1993, over $2 billion in payments were funneled through companies (located in Singapore, Guernsey, Switzerland and elsewhere) owned or controlled by a Canadian businessman of Jordanian descent named Victor Dahdaleh, who is named as a defendant in the complaint. A portion of these payments were secretly directed to one or more (unnamed) Bahraini government officials as part of an alleged conspiracy to cause Alba to cede a substantial portion of its equity to Alcoa, to pay inflated prices for alumina, and to corrupt the integrity of senior Bahraini government officials.

A front-page February 28, 2008 Wall Street Journal article describing the complaint (here) states that the lawsuit emerged from Bahrain’s own effort "to root out misbehavior." The Journal also reports that last year Bahrain retained Kroll Associates, which "had uncovered cases of corruption in its state-owned enterprises, and numerous individuals had been arrested."

The FCPA prohibits corrupt payments to foreign officials, but, as pointed out in a post on The FCPA Blog (here) commenting on the Alba case, "there is no private right of action under the FCPA." So enforcement of the FCPA is exclusively the province of the Department of Justice and the SEC. But as the Department of Justice notes in its Lay Person’s Guide to the FCPA, "conduct that violates the antibribery provisions of the FCPA may also give rise to a private cause of action for treble damages under the Racketeer Influenced and Corrupt Organizations Act (RICO) or to actions under other federal or state laws." Alba’s complaint, in fact, seeks to recover damages from the defendants based on their alleged violations of RICO, conspiracy to violate RICO, and for fraud.

The Alba complaint underscores the civil liability exposure that may potentially arise from foreign corrupt practices. While I have previously emphasized the potential threat of lawsuit filed by shareholders against company management as a follow-on to government FCPA enforcement actions, the Alba lawsuit illustrates the threat of direct civil litigation based on foreign corrupt activity without any prior enforcement activity.

This kind of litigation may represent a significant corporate threat for companies engaged in business in countries whose cultures encourage or even seemingly compel this type of corrupt activity. This threat may also extend beyond the corporation and its corporate affiliates to individuals, as well. Only one of the individual defendants named in the Alba lawsuit appears to be an officer of an Alcoa affiliate, but the complaint does also specifically allege that Alcoa’s Chairman and CEO traveled to Bahrain in connection with Alcoa’s efforts to obtain an equity ownership position in Alba. The complaint alleges that this effort was corrupted by the bribery-induced intervention of a Bahraini government official.

Individual directors and offices who find themselves the target of corruption-based civil litigation may face challenges in securing insurance protection in connection with these allegations. Certainly, a determination of liability for the kinds of corrupt conduct alleged in the Alba complaint could run afoul of the typical D & O liability policy’s conduct exclusions. In addition, some D & O policies still retain a commissions and payments exclusions specifically calculated to preclude liability for improper payments. However, individual director or officer defendants could have a strong basis on which to argue that their defense expenses incurred in connection with this kind of litigation should be covered. They could even have a basis on which to try to argue that settlement amounts, in the absence of an actual finding of liability, ought to be covered.

With respect to the corporate entity defendants in these kinds of lawsuits, the picture is slightly different. The typical public company D & O policy provides entity coverage only for claims based on alleged violations of the securities laws. None of the allegations in the Alba complaint arise under the securities laws, so there would not appear to be coverage under the typical public company D & O policy, even for defense expense. Even were entity coverage to extend beyond securities claims (as is the case for many private company D & O policies), the conduct exclusions and any applicable commissions and payments exclusion would preclude coverage for damages imposed on the basis of an adjudication of liability

But in any event, given the increasing globalization of trade and the increasing significance being given to anticorruption efforts in many jurisdictions, the possibility exists for further civil litigation based on alleged corrupt activity, even in the absence of prior enforcement actions. This litigation threat represents another way in which corrupt activity exposure may possibly represent, as I recently wrote, the "next corporate scandal."

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In prior posts (most recently here), I have discussed the growing threat that Foreign Corrupt Practices Act (FCPA) enforcement may present for companies doing business overseas. This trend became even more pronounced in 2007, and at least one legal commentator has suggested (here) that the increasing FCPA enforcement trends raise the possibility that FCPA violations "may be this year's corporate crime of the century."

The one thing that is clear is that FCPA enforcement activity is escalating. As discussed in the January 28, 2008 Fenwick & West memorandum entitled "The Foreign Corrupt Practices Act: The Next Corporate Scandal?" (here), 2007 was "a watershed year for FCPA enforcement." Among other things, the memo notes that that "the number of enforcement actions brought by the DoJ and the SEC doubled compared with the number brought in 2006."

The memo also notes that "public companies disclosed over 50 pending government investigations." In addition, the DoJ and the SEC imposed the largest combined civil and criminal fines in history in 2007, the total fines of $44 million imposed against Baker Hughes and its subsidiaries (as discussed in my prior post, here).

There are a number of important trends driving this increased FCPA enforcement. Obviously the globalization of business activity provides an important context, but globalization alone does not explain the increased enforcement. The enforcement activity is being driven by a number of trends and patterns.

First, the DoJ and the SEC have developed a practice of targeting specific industries, through an industry-wide investigation. For example, a January 25, 2008 Sidley Austin memo entitled "FCPA Enforcement Trends During 2007" (here) notes that the authorities have targeted "sales and marketing practices of companies in the medical device industry in Europe." A January 24, 2008 Jenner & Block memorandum entitled "Recent Enforcement Activity Under the Foreign Corrupt Practices Act" (here) also cites the recent enforcement actions involving the "companies participating in the U.N. Iraq Oil for Food program." The Fenwick & West memo cited above also notes that the FCPA is now "being actively enforced against technology companies."

Second, the authorities have targeted companies doing business in countries where bribery is part of the local business culture. The Jenner & Block memo notes that the authorities have "continued to press enforcement as to companies doing business in Nigeria." Business activities in China have also drawn scrutiny, which is certainly a challenge given that many companies are finding it indispensible to have a China strategy.

Third, the U.S. authorities have shown an increased willingness to cooperate with foreign governments in joint investigations, even, the Jenner & Block memo notes, where the target companies "are already the subject of law enforcement investigation or sanction in their home country." The most prominent example of this latter phenomenon is the current investigation involving Siemens (which I discussed in prior posts, here and here). Another example is the investigation of BAE Systems (which has been surrounded by some significant controversy, as discussed here).

Fourth, increased M & A activity has led to the discovery and disclosure to the authorities of a number of FCPA violations. The Sidley & Austin memo referenced above cites the entry of Delta & Pine into a $300,000 FCPA settlement following its merger with Monsanto (refer here) and York International's FCPA settlement following its merger with Johnson Controls, whereby York agreed (here) to a $10 million criminal penalty, a $2 million civil penalty, and the disgorgement of $10 million profit.

The Sidley & Austin memo notes that "acquisition due diligence is an essential program, and the failure to adequately assess potential liabilities can result in serious consequences." The Fenwick & West memo notes that "FCPA issues can be a major sticking point in negotiations with the acquiring party, often causing delay of the deal or a change in the price terms."

Fifth, as a result of changing priorities and increased resources, the authorities are no longer dependant on self-reporting alone as the means by which FCPA violations are identified. In recent year, the combination of the increased self-scrutiny SOX requires and corporations' desire to obtain cooperation credits have led companies to self-report, providing the authorities with the bases for many of the FCPA enforcement investigations. But, as the Jenner & Block memo notes, "the Government is increasingly interested in developing cases affirmatively, without relying on disclosures." Both the DoJ and the SEC have increased their staffing in this area, and the agencies have said repeatedly said publicly that they will be more "proactive."

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In prior posts (most recently here), I have noted the threat of Foreign Corrupt Practices Act (FCPA) investigations as a growing area of corporate risk. Several recent reports substantiate this concern and help explain why this area of risk continues to grow, and also highlight some of the barriers to antibribery enforcement.

A June 26, 2007 memorandum prepared by the Shearman & Sterling law firm entitled "Recent Trends and Patterns in FCPA Enforcement"(here) reports that "there has been a dramatic increase in new investigations" and that "both the DOJ and the SEC have become increasingly aggressive." According to the memorandum, there are now 55 open FCPA investigations (at least that have been publicly reported by the companies under investigation).

Part of the reason for the increased investigative activity is the increase in governmental resources devoted to foreign bribery investigations. According to a July 16, 2007 Law.com article entitled "Why Are More Companies Self-Reporting Overseas Bribes?" (here), the SEC has "added about 700 staffers to help enforce all compliance laws," and the DOJ and the FBI have both added substantial staff focused exclusively on FCPA investigations.

The more important factor for the growth of FCPA cases may potential corporate defendants desire for leniency under federal sentencing guidelines. A corporation's cooperation can produce substantial benefits; the Law.com article linked above describes in detail the substantial efforts to cooperate that Baker Hughes recently undertook in connection with its ongoing FCPA investigation (about which see my prior post, here), as a result of which Baker Hughes apparently avoided paying "an additional $27 million in fines."

These kinds of incentives have motivated companies to come forward and self-report (as I have previously noted, here). According to the Shearman & Sterling memo, during the period 2005 to 2007, some 23 of 26 new FCPA cases were self-reported. The memo notes that these numbers "underscore the trend toward companies taking on the onus of reporting or accountability and may indicate that companies now perceive the act of self-reporting to be favorable to the ultimate outcome of the investigation." An interesting additional statistic the memo notes is that many of the voluntary disclosures came after violations were unearthed in the due diligence process for a merger or acquisition. (The memo cites the recent ABB, InVision and Titan Corporation investigations as examples.) As the M & A pace continues, there may be more of these M & A related self-disclosures.

The international scope of the crackdown on corrupt practices is documented on the 2007 Progress Report (here) of Transparency International (here) on enforcement of the Convention on Combating Bribery of Foreign Public Officials (here) of the Organization for Economic Co-Operation and Development (OECD) (here). The OECD Convention, first established in 1997, is a compact of now 37 countries (including the United States) to adopt and enforce antibribery laws. The Report shows that while there has been some progress in the battle against bribery and corruption, "there has been little or no enforcement in twenty countries, demonstrating significant lack of political commitment by over half the signatories."

The Report specifically cites the UK's termination of its investigation of bribery allegations against BAE Systems on the Al Yamamah arms project in Saudi Arabia (see my prior post here) as a "serious threat to the convention," and states that the UK's "national security concern" explanation for terminating the investigation "opens a dangerous loophole that other parties could assert when investigations may offend powerful officials in important countries." Because of these concerns, the Report notes that the Convention may be "at a crossroads."

Despite these concerns, the Report does also note that during the prior year foreign bribery investigations were brought in twenty countries out of then thirty-four active signatory countries, as opposed to only seventeen out of thirty-one countries the preceding year. In addition, during the prior year there were bribery prosecutions bourght in sixteen of the thirty-four then-active signatories.

These numbers, as well as the growing number of Convention signatories, suggest that notwithstanding troublesome setbacks and lapses in political will, enforcement of antibribery laws remains an important factor in the global business marketplace. As I have noted previously (here), this exposure represents a substantial area of D & O risk, particularly with respect to the threat of follow on civil litigation based on antibribery investigations. These recent reports suggest that this could become even more significant in the months ahead.

Special thanks to a loyal reader for the link the Law.com article. Hat tip to the SOX First blog (here) for the link to the Transparency International report.

A Backdating Case Dismissal: In an order dated July 16, 2007 (here), in the consolidated options backdating related Ditech Networks derivative litigation, Judge Jeremy Fogel of the Northern District of California granted (with leave to amend) the individual defendants' motion to dismiss based on the insufficiency of the plaintiffs' pleading. The Opinion states:

As currently pled, the Complaint alleges fraudulent conduct by labeling various grants as backdated and describing them as having been made at low points within certain defined periods....While counsel for Plaintiffs represented at oral argument that the statistical likelihood of the options having been granted properly is very low, that theory is not alleged in the Complaint or in a document that the Court may consider on this motion. Even assuming that the factual allegations of the Complaint are true, many explanations other than options backdating exist for the coincidence of the grants and a low share price. The following factual detail likely would strengthen the Complaint: the degree to which the options were granted at the discretion of the compensation committee or the board, versus at fixed, preestablished times; the actual grant dates of the options and the appropriate price of the options; the date that the options were exercised; whether required performance goals were met before the options were granted; the presence or absence of other major corporate events, such as an acquisition, at the time of the grants; and the results of any request by Plaintiff for information.

Because of the inadequacy of the plaintiff's allegations, Judge Fogel noted that it would be "premature" to address federal statute of limitations and Delaware state law demand futility issues. (It should be noted that the Ditech opinion is designated as "not for publication" and "may not be cited.")

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for the link to the Ditech Networks opinion.

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With its announcement (here) that it is the target of a Department of Justice antibribery investigation, BAE Systems added its name to the growing list of foreign-domiciled companies targeted by U.S. officials for alleged violations of U.S. anticorruption laws. The recent high-profile investigation of Siemens (about which refer here), as well as investigations involving Total, the French oil company, and Magyar Telecom of Hungary, not to mention a long list of domestic companies, are all part of an increasingly tough stance by U.S. regulators and prosecutors toward allegedly corrupt business activities.

The BAE disclosure says that the U.S. investigation relates "to the company's compliance with anticorruption laws including the company's business concerning the Kingdom of Saudi Arabia." News reports (here) state that the investigation involves a 20-year old transaction involving the Al-Yamamah Saudi arms deal, and encompasses two areas of activities. The first is the alleged use of a supposed slush fund that BAE used to transfer tens of millions of dollars of hospitality benefits to Saudi officials. The second is the allegation that Prince Bandar bin Sultan, the former Saudi ambassador to Washington, received a total of up to 1 billion British pounds in the form of deposits to a Saudi embassy bank account at Riggs Bank in Washington, D.C. In addition to the Department of Justice investigation, the Financial Times reports (here) that BAE is also the target of an SEC investigation focused on potential violations of the books and records provisions of the Foreign Corrupt Practices Act (FCPA).

The British government previously brought a halt to an investigation by the Serious Frauds Office because of national security concerns. (Saudi Arabia apparently threatened to end intelligence collaboration with Great Britain if the investigation continued.) Beyond these concerns, there are additional complications to the circumstances under investigation. The first is that the Saudi government's relation the Saud royal family is highly interwoven, creating a complicated issue over the question, for example, of who rightfully was the beneficiary of the deposits to the Riggs Bank account. And while Prince Bandar undoubtedly was, as the Saudi Ambassador to Washington, and as Saudi Arabia's current national security chief, a government official, it could prove very difficult to show that even very large amounts of cash actually bought influence, since he is a an extremely wealthy person (his 56,000 sq. ft. Aspen mansion is on sale for $135 million).

But while there are these complicating factors, it is apparently not a constraint on any enforcement action against BAE that it is foreign domiciled and the alleged corrupt activity aimed at influence outside the U.S. Even if the involvement of the Riggs bank account were not a sufficient nexus, the U.S. authorities have already demonstrated their willingness and ability to pursue foreign domiciled companies for corrupt activities abroad. Indeed, last year, the Department of Justice forced Statoil, the Norwegian state oil company, to pay a $21 million fine for bribery activities involving Iranian government officials, even though the company had already paid a $3 million fine in connection with a Norwegian investigation. (The company did get a credit for the prior payment).

The current high profile investigations against Siemens and now BAE are significant in their own right, but the larger significance is that these two prominent cases may be that they are only a part of more than 55 public companies the Financial Times reports (here) that U.S. officials are currently investigating for overseas corruption. These investigations can of course result in fines and penalties that may be significant in and of themselves. But as I have pointed out in prior posts (most recently here), these investigations can also lead to follow on civil lawsuits alleging improper disclosures or accounting inadequacies as a result of the underlying activities or the investigations themselves.

With over 55 publicly traded companies under investigation, the possibility of follow on civil litigation could represent an increasingly significant D & O risk. These risks extend to foreign domiciled companies whose shares trade on U.S. exchanges, as well as domestic companies with significant overseas operations or activities. In an increasingly global economy, this risk could become an important part of the D & O liability exposure, particularly given the U.S regulators' and prosecutors' increased focus on anticorruption issues.

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Add Bed Bath & Beyond to the growing list of companies whose options backdating related shareholders' derivative lawsuits have been dismissed because of the plaintiffs' failure to adequately plead demand futility. According to a May 22, 2007 article in the New York Law Journal (here), a New York Supreme Court Justice dismissed the Bed Bath & Beyond lawsuit because the plaintiffs failed to show that demanding action from the company's board would be futile.

The New York court focused on the fact that, because the majority of the company's board had not received backdated option grants, the plaintiffs needed to allege with particularity why these directors also had an interest in the backdating transactions. "The mere presence of directors on committees is not particular as to their individual participation or alleged collusion with interested directors in the backdating of stock options," the Judge said.

The Bed Bath & Beyond case joins the CNET (here) and Computer Sciences Corp. (here) lawsuits as instances where the courts have found that plaintiffs' demand futility allegations were insufficient. However, in two notable Delaware cases (here), the court denied dismissal motions and held that the demand futility requirements had been met. (A good overview of the demand futility requirement in derivative actions generally can be found here.)

Another interesting aspect of the Bed Bath & Beyond decision relates to the Court's remarks about the company's remedial measures. The company has adopted reforms to its options grant policy and revised the dates of certain grants. It also adjusted its balance sheet to reduce its shareholders' equity by $66 million and took a $7.2 million charge to quarterly income. According to the article, the Court said that "the voluntary actions could have rendered the derivative suit moot." The possibility that remedial measures might moot backdating related derivative lawsuits could potentially have a significant impact on the many pending cases, since many of the companies involved in the lawsuits have also taken similar remedial measures. It will be interesting to see whether other courts conclude that remedial measures would moot pending derivative lawsuits.

Dismissal Denied in FCPA Follow-On Lawsuit: I have frequently noted (most recently here) the growing risk of civil actions following on Foreign Corrupt Practices Act investigations or enforcement proceedings. Another example of an FCPA follow-on action is the securities class action litigation involving Nature's Sunshine Products. A May 21, 2007 order in the case (here) denied the defendants' motion to dismiss, in a case that arises out of allegedly improper foreign payments.

In opposing the motion, the plaintiffs relied heavily on a letter the company's former auditor, KPMG, had sent to the SEC. In the letter, KPMG asserted that the company's CEO was aware of "fraud in international operations of the company," yet represented otherwise to the auditors in audit representation letters; that the CEO had approved a payment that violated the FCPA; that the CEO had sought to cover up the fraud; and that the fraud had a material impact on the company's prior financial statements. The plaintiffs also relied on the Company's March 20, 2006 8-K (here)in which the Company stated that it had contacted the U.S. Department of Justice about potential violations of law. The plaintiffs also alleged that the CEO gave false reassurances to investors that the company's financial statements were accurate when he was aware of the fraud, and was aware that KPMG had raised issues concerning the fraud. According to the plaintiffs, following the reassuring statements, the CEO and others sold large portions of their holding in the Company's stock.

In ruling on the motion to dismiss, the court concluded that the plaintiffs had sufficiently identified false and misleading statements and had adequately pled materiality and scienter. The court did, however, shorten the class period.

The Nation's Sunshine Products case not only represents another instance of the FCPA follow-on action, but it also presents another example of the reason why these kinds of cases could become more prevalent. That is, the investigation was the result of the company's own self-reporting. This phenomenon of self-reporting is resulting in more FCPA investigations and enforcement actions. And increasingly, civil actions follow.

A May 21, 2007 Salt Lake Tribune article describing the Nature's Sunshine Products decision can be found here.

Speaking of Follow-On Lawsuits: It sure didn't take long after the resignations of Jonathan Weil and Lynn Turner from proxy advisory firm Glass Lewis for the lawsuits to come in. It has barely been 24 hours since the news broke (refer here) that the two prominent executives had quit the firm after questions were raised over whether its parent, Xinhua Finance Media, had withheld unfavorable information about its chief financial officer from investors. In his resignation letter, Weil said he was "uncomfortable and deeply disturbed by the conduct, background and activities of our new parent company Xinhua Finance Ltd., its senior management, and its directors." Weil said further that"to protect my reputation, I no longer can be associated with Glass Lewis or Xinhua Finance." (Xinhua acquired the 80% of Glass Lewis it did not already own earlier this year.) A May 22, 2007 Wall Street Journal article discussing the resignations, as well as Glass Lewis' relationship to Xinhua, can be found here (subscription required).

The resignations seem to relate to the recent resignation of Xinhua's Chief Financial Officer, over the company's failure to report in its March2007 IPO documentation that the CFO was under a cease and desist order from NASD for violating securities laws at another organization for which the individual was also CFO.

A press release distributed late in the day on May 22, 2007 (here) states that the plainiffs firm of Bernstein Liebhard and Lifshitz had commenced a securities class action lawsuit against Xinhua in Manhattan federal court. The claim reportedly alleges that Xinhua failed to disclose in its March 2007 prosectus and subsequently the true circumstances involving the CFO, including the existence of the cease and desist order.

This all strikes me as very unseemly for a proxy advisory firm, a point the Journal also makes in the article linked above. Special thanks to a loyal reader for the class action press release link.

The venerable Lies, Damn Lies blog had an interesting post late last year (here) about the alacrity with which securities class action complaints sometimes follow on bad news.

Did Culture Enable Backdating?: Bloomberg.com has a long, interesting May 22, 2007 article entitled "Billionaires from Jakarta, Shanghai Undermined by Options" (here) examining the options backdating scandal at Marvell Technology Group. The article explores the company's history from its earliest days, and examines how Sehat Sutardja built up the company after coming to the U.S., working with his brother, Pantas, and his wife Weili Dai. The article also goes in depth into the company's backdating woes.

While the article focuses primarily on Marvell itself, it also explores the Silicon Valley culture out of which the options backdating scandal grew. The article contains the following comment, which I found quite arresting:

``Silicon Valley has a bad case of exceptionalism that we're so special and important to American society that some of the rules do not apply or ought to be loosely interpreted,'' says Kirk Hanson, executive director of the Markkula Center for Applied Ethics at Santa Clara University. ``That's a slippery slope that leads to various forms of misbehavior, and backdating is the best current example.''

Hanson is later quoted in the same article as saying ``Backdating is a product of the bubble,'' Hanson says. ``There was so much money awash in the streets of Silicon Valley that less thoughtful executives were trying to sweep as much into their pockets as possible.''

While these statements are noteworthy and attention grabbing, it is also fair to note that options backdating may perhaps have been more common in Silicon Valley, it was by no means confined to Silicon Valley.

The article is long but it merits a complete reading. Special thanks to a loyal reader for the link the Bloomberg article.

Speakers' Corner: I will be speaking at the Reinsurance Association of America (RAA) Current Issues Forum at the Four Seasons Hotel in Philadelphia, Pa. on Thursday May 24, 2007, on the topic "D & O: Where it Stands Today?" The program brochure can be found here. If you are attending the conference, I hope you will greet me and introduce yourself.

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In prior posts (most recently here), I have written about how the increased level of Foreign Corrupt Practices Act (FCPA) enforcement activity (about which refer here) can lead to heightened D & O risk. The risks arise not so much from the enforcement activity itself, but from the threat of follow-on civil actions. A recently announced securities class action lawsuit settlement demonstrates this FCPA follow-on civil suit claim risk.

On May 21, 2007, Immucor announced (here) its entry into an agreement to settle the class action lawsuits that had been filed against the company and certain of its directors and officers. According to the company's press release, the company's insurance carrier agreed to pay $2.5 million to settle the claims.

The plaintiffs' claims against the Immucor defendants grew out of an FCPA investigation involving "payments made by the Company's Italian subsidiary to individuals associated with government medical facilities." (The Company's news release regarding the SEC's FCPA enforcement action can be found here.) The plaintiffs in the civil action alleged not that the defendants failed to disclose the existence of the problems; rather, the plaintiffs alleged that in its periodic reports to the SEC, press releases and in conference calls with stock analysts, the defendants misled potential investors into an overly optimistic assessment of the extent of Immucor's corrupt business practices and the strength of Immucor's internal controls. (A copy of the plaintiffs' Consolidated Amended Complaint can be found here.)

An unusual aspect of this case is the allegation that one of the individual defendants (Gioachinno De Chirico) was the head of the company's Italian subsidiary at the time the alleged bribes took place, prior to his becoming Immucor's CEO (a position he still holds). In denying the defendants' motion to dismiss, the Court said (refer here) that "while parts of the disclosure may have been accurate, Defendants' duty was to describe fully the nature and scope of the conduct under investigation - conduct of which De Chirico was fully aware because he participated in it." The Court denied the motion to dismiss because the omitted information was material and its omission was misleading.

The Immucor settlement joins the previously announced settlement involving the Willbros Group. As discussed in a prior post (here), Willbros agreed to pay $10.5 million to settle the class action lawsuit that alleged that the company was forced to restate several years of financials and to establish a reserve to accrue for possible fines and penalties for FCPA violations. The Willbros action (and its settlement) are described further here.

These settlements illustrate the growing risk that FCPA enforcement activity represents. The threat is not so much from the enforcement activity itself, since the resulting fines and penalties would not be covered under the typical D & O policy. The threat comes from the follow-on civil action, which seem to follow enforcement proceedings with increasing frequency. Indeed as I noted in recent in a recent post (here), both the current Siemens bribery investigation and the recent Baker Hughes enforcement action have triggered follow on shareholders' derivative lawsuits.

These types of lawsuits are likely to increase in the future, as FCPA actions themselves increase. More companies are self-identifying FCPA violations because of operational reviews required by Sarbanes Oxley, and the companies are self-reporting in an effort to avert prosecution under the Justice Department's guidelines for corporate criminality.

The First Public Law Firm: According to the May 21, 2007 Sydney Morning Herald (here), the Melbourne law firm of Slater & Gordon has become "the first law firm in the world to list on a stock exchange." The firm, which projects 2007 revenue of A$58.7 million, raised a total of A$35 million in its IPO. (According to XE.com, one Australian dollar is currently worth 0.821383 US dollars.) The firm's shares are now traded on the Australian Securities Exchange, under the symbol SGH. The shares closed their first day at A$1.40, up from their initial offering price of A$1.00. For more about the firm's ASX listing, refer here.

On its website (here), the firm describes itself as "specializing in personal injury, commercial, family and asbestos-related law." The firm's offering prospectus can be found here.

While I certainly wish the firm and its shareholders every success, there is a part of me that would be curious to witness the plaintiffs' lawyers-suing-plaintiffs' lawyers spectacle that could unfold if the firm disappoints investors and winds up in a securities class action lawsuit.

Hat tip to The Blog of the Legal Times (here) for the link to the news article. The Best in Class blog (here) also has a post on the law firm IPO.

Now, Here's Something: According to a May 21, 2007 press release from the Bank of International Settlements (here), the over-the-counter derivatives market grew last year from $298 trillion in 2005 to a notional outstanding value totaling $415 trillion worldwide as of December 2006. Yes, that's trillion.

A CFO.com article (here) commenting on this truly astounding statistic quotes European Central Bank President Jean-Claude Trichet as saying that credit derivatives may create risks to the financial markets if events prompt investors to bail out at the same time. Investors "may react in a way that can suddenly lead to dangerous herding behavior," he reportedly said at the annual meeting of the International Swaps and Derivatives Association. "Such situations are also a matter of concern from a systemic liquidity viewpoint."

With all due respect to Monsieur Trichet, I prefer to refer to the words of the Sage of Omaha himself, Warren Buffett, who wrote in his 2005 Letter to Berkshire Shareholders with respect to financial derivatives (here):

A business in which huge amounts of compensation flow from assumed numbers is obviously fraught with danger. When two traders execute a transaction that has several, sometimes esoteric, variables and a far-off settlement date, their respective firms must subsequently value these contracts whenever they calculate their earnings. A given contract may be valued at one price by Firm A and at another by Firm B. You can bet that the valuation differences - and I'm personally familiar with several that were huge - tend to be tilted in a direction favoring higher earnings at each firm. It's a strange world in which two parties can carry out a paper transaction that each can promptly report as profitable.

Or as he said, perhaps more vividly, in his 2004 Berkshire shareholders' letter (here):

Investors should understand that in all types of financial institutions, rapid growth sometimes masks major underlying problems (and occasionally fraud). The real test of the earning power of a derivatives operation is what it achieves after operating for an extended period in a no-growth mode. You only learn who has been swimming naked when the tide goes out.

To translate Monsieur Trichet's comments quoted above into more vivid terms, it is not going to be pretty when the tide goes out.

For those readers interested in such things, $415 trillion is approaching half a quadrillion dollars. That would be ten to the fifteenth power. (I freely admit that I had to ask my 13 year-old son what comes after a trillion.) That's getting up there. A few more zeros and you will be all the way to a googol.

For some reason, I can't think about these statistics without the song "Wipe Out" by the Safaris running through my head.

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As I have previously noted (most recently here), Foreign Corrupt Practices Act (FCPA) investigations and enforcement actions represent an increasing corporate threat, and, in the form of follow-on civil actions, an area of growing D & O risk. Two recent developments underscore the growing magnitude of these concerns.

The first of these two developments is the agreement of Baker Hughes and one of its subsidiaries to settle criminal and civil FCPA charges. News stories about the Baker Hughes agreement can be found here and here. The $44 million in fines and penalties under the agreement represent the largest amounts of combined fines and penalties ever imposed in a FCPA case. Baker Hughes' subsidiary pled guilty to criminal charges and agreed to pay a $10 million criminal fine in connection with payments of $4.1 million in bribes paid to a consultant in order to secure and oil services contract with Kazakhoil, the state oil company of Kazakhstan, in the Karachaganak oil field. The contract generated more than $219 million in gross revenues from 2001 to 2006. A copy of the April 26, 2007 Department of Justice press release regarding the criminal matter can be found here.

Baker Hughes itself simultaneously agreed to pay $23 million in disgorgement and prejudgment interest and to pay a civil penalty of $11 million for violating a 2001 SEC cease-and-desist order in connection with a prior FCPA matter. The fines and penalties were assessed against the parent company in company in connection with the Kazakhstan bribe, as well as other charges that the company violated the books and records and internal control provisions of the FCPA in Nigeria, Angola, Indonesia, Russia and Uzbekistan. The SEC's April 26, 2007 press release regarding the Baker Hughes matter may be found here, and the SEC's complaint is here. An April 27, 2007 CFO.com article describing the Baker Hughes FCPA settlement may be found here.

The second of the two recent developments relates to the proliferation of publicity and action surrounding the burgeoning Siemens corruption investigation. Not only are the company's top two executives leaving (refer here), but the company has warned that it expects a "significant increase" in the number of possible bribes identified in an internal investigation. This prospective increase is on top of the previously disclosed $544 million in suspected bribes. A prior D & O Diary post about the Siemens bribery investigation can be found here. In its April 26, 2007 filing on SEC Form 6-K (here), Siemens also reported that the SEC had "advised" the company that the SEC had "converted its informal inquiry into these matters into a formal investigation." The Company previously disclosed that the U.S. Department of Justice is conducting an inquiry of possible criminal violations.

The company also noted in its 6-K filing that it will be obliged to make a number of tax asset and liabilities adjustments in future reporting periods, which could be "material." The company also said that it "cannot exclude the possibility that criminal or civil sanctions may be brought," as a result of which its "operating activities may also be negatively affected." The company said that to date "no charges or provisions for any such penalties have been accrued as management does not yet have enough information to reasonably estimate such amounts." The company did say that in its most recent fiscal quarter, it had spend 63 million euros (roughly $83 million) in connection with the investigation.

According to news reports (here), Standard and Poor's has put Siemens on a watch for a possible downgrade.

Several things about these two cases reinforce my view that FCPA investigations will become an even greater concern in the months ahead. First, the sheer scope and magnitude of the concerns, both at Siemens and at Baker Hughes, suggest a larger problem that inevitably will attract increased prosecutorial interest and involve more companies. The enormous unlikelihood that these two companies alone were the only ones involved in this type and scale of activity will encourage investigators and regulators to search for similar activities elsewhere.

Second, a significant factor in the Baker Hughes subsidiary's plea agreement, which included a deferred prosecution agreement and a three-year probationary period, was the Company's self-reporting of the violation. The Department of Justice's press release states that the agreement "reflects, in large part, the actions of Baker Hughes in voluntarily disclosing this matter." The unmistakable message is that companies have a substantial incentive to self-report FCPA violations, as I have previously noted (here). The increased internal review compelled by the Sarbanes Oxley Act, together with the incentive to self-report, increases the likelihood of further FCPA investigations and enforcement actions. As a recent memo from the Gibson, Dunn & Crutcher law firm notes (here), more than three quarters of the FCPA enforcement actions in the last two years arose as a result of voluntary disclosures.

Third, Siemens' 6-K discloses that in February 2007 it was sued as a nominal defendant in a New York state court shareholders derivative complaint "seeking various forms of relief relating to the allegations of corruption and related violations." The complaint also names "certain current and former members of the Company's Managing and Supervisory Boards." As I have previously noted (here), the D & O risk arising from FCPA enforcement actions comes from this type of follow-on civil action; the FCPA fines and penalties themselves would not be covered under the typical D & O policy, but the threat of follow-on civil action creates substantial D & O risk. UPDATE: On May 4, 2007, a shareholders derivative suit was filed against Baker Hughes (as nominal defendant) and certain of its present and former directors and officers, alleging breach of fiduciary duties in connection with the FCPA violations described above.

Finally, the unprecedented level of international cooperation involved in the Siemens investigation further increases the likelihood that the various national authorities will provide information across borders that could support antibribery enforcement actions here and overseas.

As the SEC Actions blog noted (here) in its commentary on the Baker Hughes FCPA enforcement case, "it is clear that the number of FCPA cases being brought by the SEC and the DOJ are on the rise. This suggests prudent companies that do business abroad and their directors and officers carefully review their compliance systems in this area to avoid difficulties rather than later at the insistence of the SEC or the DOJ." In any event, FCPA compliance undoubtedly will become an area of heightened scrutiny for D & O underwriters.

Internal Affairs Doctrine: The shareholders derivative complaint filed against Siemens could face substantial hurdles in the form of the "internal affairs doctrine." Under New York legal principles that only one state should have the authority to regulate a corporation's internal affairs, New York courts will refuse to allow actions to proceed against corporations from other jurisdictions if the shareholders have sufficient avenues to address management malfeasance under the laws of the corporation's domicile.

A March 12, 2007 New York ruling where the court applied these principles to dismiss a shareholders derivative complaint that had been filed against directors and officers of ABN Amro Holdings NV may be found here. An interesting discussion and analysis of the ABN Amro case may be found on the With Vigour and Zeal blog, here.

An interesting article about the possible applicability of the internal affairs doctrine to the BP Alaska shareholders' derivative action, written by Francis Kean of the Barlow Lyde & Gilbert law firm, may be found here. Special thanks to Francis for providing a copy of this article.

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The D & O Diary has long contended (most recently here) that civil claims following on enforcement actions under the Foreign Corrupt Practices Act (FCPA) represent a growing area of D & O claim risk. The entry last week (refer here) of a $26 million criminal fine - the largest criminal penalty ever under the FCPA - underscores the growing importance of FCPA enforcement cases. A February 7, 2007 memorandum from the Gibson, Dunn & Crutcher law firm entitled "2006 Year-End FCPA Update" (here) provides a useful overview of 2006 FCPA enforcement activity, and underscores the growing importance of civil claims based on FCPA proceedings.

The memo notes that "2006 marked one of the busiest years of FCPA enforcement and further evidenced the recent proliferation of FCPA enforcement activity." The memo identifies a number of important FCPA trends, including:

Voluntary Disclosure: "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 the SEC following internal investigations by the companies."

Increased Penalties: "Enforcement activity in 2006 continued the trend of increasing the severity of penalties."

Increasingly Broad Jurisdiction: "U.S. enforcement authorities have shown a willingness to reach far and wide outside traditional jurisdictional boundaries....The Statoil matter marked the first time that the DOJ has taken criminal enforcement action against a foreign issuer for violating the FCPA."

Ongoing Civil Liability: Even though there is no private right of action under the FCPA, plaintiffs lawyers may be able to pursue securities fraud lawsuits based on FCPA-related misrepresentations. In the Immucor decision (discussed previously on The D & O Diary, here), "for the first time a federal court held that plaintiffs had met the heightened pleading standard requirement for fraud under the PSLRA in an FCPA case."

According to the memo, "more than 24 other major corporations are under investigation for FCPA violations." The memo suggests that in this environment, securities claims based on FCPA violations "may start to gain traction" and therefore "the legal road towards resolving an FCPA violation in the U.S. now stretches far beyond achieving peace with the SEC."

The Gibson Dunn memo confirms a couple of themes that The D & O Diary has been sounding for some time. First, FCPA enforcement activity is increasing, both in frequency and severity, and, second, the threat of follow-on civil litigation from FCPA enforcement activity is also growing. As FCPA enforcement actions grow in number and magnitude, this exposure could pose an increasingly greater D & O risk.

Special thanks to a loyal D & O Diary reader for the link to the recent record-setting FCPA criminal fine.

Record Number of Restatements in 2006: According to a February 12, 2007 Wall Street Journal article entitled "Restatements Still Bedevil Firms" (here, subscription required) publicly traded companies filed a record 1,876 restatements of financial results in 2006, an increase of 17% over the number of restatements in 2005. However, the number of 2006 restatements by large companies (defined as those with over $700 million in shares available to the public) filed 196 restatements in 2006, a drop of about 20% from 2005. By contrast, companies with a public float of less than $75 million filed 1,108 restatements in 2006, more than two-thirds of all 2006 restatements, representing a 42% jump in restatements for companies of that size compared to the prior year.

The most frequent cause of restatement was related to the "measurement and recognition of debt and stock or equity instruments," and the second most frequent cause related to compensation issues (including, in particular, options backdating).

The drop in restatements for larger companies, which have had to adapt to the reporting requirements of Section 404 of the Sarbanes Oxley Act, suggests that those companies' internal controls are working better. The smallest companies, which do not yet have to follow Section 404, are clearly continuing to struggle.

Buy-Backs and EPS: When I commented (here) on the controversy surrounding Robert Nardelli's compensation as the departing head of Home Depot, one of the concerns I specifically noted was the way stock buy-backs had been used to improve Home Depot's reported earnings per share (EPS), at the same time that the executives' compensation was adjusted to reward executives based on EPS. Fortune Magazine has a more detailed elaboration of this concern in a February 9, 2007 article entitled "Nardelli's Fake Bogey: Earnings Per Share" (here).

The D & O Diary's prior post about the pitfalls of stock buybacks and the way they interact with executive compensation can be found here.

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The growing bribery scandal at Siemens has made the front pages of the world's financial papers in recent days. For example, on January 31, 2007, the Wall Street Journal (here, subscription required) ran an article entitled "At Siemens, Witnesses Cite Pattern of Bribery." In its February 1, 2007 SEC filing on Form 6-K (here), Siemens, whose ADRs have traded on the NYSE since 2001, reported that the U.S. Department of Justice is "conducting an investigation of possible criminal violations of U.S. law" and also announced that it "understands that the U.S. Securities and Exchange Commission's enforcement division is conducting and informal inquiry into matters at this time."

Siemens apparently is already under investigation in German, Lichtenstein, Italy, Switzerland and Greece. The investigation gained momentum in November 2006, when, according to the Journal, more than 200 German police raided about 30 offices and homes of current and former Siemens employees." The German police searched office of Siemens management board members, including that of Siemens' CEO, Klaus Kleinfeld. In December, the company announced that it had uncovered $544 milllion in "suspicious transactions." covering over seven years. The investigation involves the possibility that Siemens officials diverted funds through sham consulting contract to slush funds used to bribe potential customers. Investigators are looking into possible bribes in a number of countries, including Saudi Arabia, Russia, Slovakia, Argentina, Nigeria, Egypt, Cameroon, and Kazakhstan. A number of high-ranking Siemens officials have been arrested, including a member of the management board. The Company's former CFO reportedly is a suspect.

It obviously remains to be seen whether the DoJ investigation or the informal SEC investigation will lead to further proceedings. But according to the February 3, 2007 Wall Street Journal article discussing the U.S.-based investigations (here, subscription required), these U.S investigations "heighten the legal risk for Siemens, which could face lawsuits and be banned from bidding on infrastructure contracts in the U.S. and other countries if there is evidence of wrongdoing."

The company also faces significant (but uncertain) financial risk as well. In its 6-K announcing the U.S. investigations, while acknowledging that the company "cannot exclude the possibility that criminal or civil sanctions may be brought against the Company itself or against certain of its employees," the company also reported that so far "no charges or provisions for any ...penalties or damages have been accrued as management does not yet have enough information to reasonably estimate such amounts." As a company with 2006 sales of over $113 billion, Siemens would have to sustain a very significant fine, penalty or damages for it to have a material impact on its financial condition, although certain enforcement outcomes could definitely impact the company's future prospects. The absence of any accrual at this time does raise at least the possibility of a negative financial effect from an adverse investigative development.

The involvement of the SEC in the Siemens investigation underscores a point that The D & O Diary has made in several prior posts relating to investigations involving the Foreign Corrupt Practices Act (most recent posts here and here). That is, these investigations can give rise to follow on securities claims. This is the reason that I have often cited the FCPA as a threatening potential new source of D & O exposure. The threat is not so much from the corrupt practices investigation itself, but from the follow on claims that could arise in which it is claimed that the corrupt practices caused a misrepresentation of the company's financial condition - which presumably is the question the SEC is examining in connection with the Siemens probe.

The Siemens investigation is also important in connection with the current calls inside the U.S. for regulatory reform to improve the competitive position of U.S. securities markets in the global financial marketplace. The Siemens investigation originated outside the U.S. and only came to this country after the provision by foreign authorities of investigative information to U.S. authorities. It is evident that regulators throughout the world increasingly understand the importance of vigilance and scrutiny. The magnitude and scope of the Siemens investigation suggest cross-border commitment to regulatory rigor and the extent of the alleged misconduct is likely to spur further efforts for oversight and reform As international regulatory standards respond to these circumstances, differences between the standards in the U.S. and those elsewhere are likely to continue to dimi