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

Since late last year, reports have been circulating that the U.S. government is investigating whether drug companies paid bribes overseas to increase sales and to obtain regulatory approvals. Some firms have now announced that they have reached settlements with enforcement authorities. And now the first civil lawsuit relating to these investigations has been filed, as discussed below.

According to press reports and company filings, a number of companies have disclosed last year that they were being investigated for possible FCPA investigations involving a broad range of possible violations including bribing government-employed doctors; paying sales agent commissions that are passed along to doctors, paying hospital committees to approve drug purchases and paying regulators to win drug approvals. Additional press coverage regarding the breadth of this industry probe can be found here.

The first enforcement action and  settlement related to this investigation emerged last month, when governmental regulators announced that Johnson & Johnson had agreed to pay more than $70 million dollars to settle FCPA-related allegations. The SEC’s April 8, 2011 litigation release can be found here, the U.S. Department of Justice’s April 8, 2011 press release can be found here and the U.K. Serious Fraud Office’s press release can be found here.

As reflected in the enforcement authorities’ various press releases, Johnson & Johnson’s subsidiaries, employees and agents were alleged to have paid bribes to public doctors and administrators in Greece, Poland and Romania and kickbacks to Iraq to win business there. Johnson & Johnson’s payments to settle the various probes included $48.6 million to the SEC in disgorgement and prejudgment interest, a $21.4 million criminal penalty to the Justice Department and a £4.8 million ($7.8 million) to the U.K. Serious Frauds Office. A detailed overview of the allegations and the settlements can be found on the FCPA Professor’s Blog (here). According to the FCPA Blog (here), the Johnson & Johnson settlement is the tenth largest FCPA settlement ever.

Moreover, it appears that other settlements arising out of the probe may soon follow. Last week, Eli Lilly. disclosed that it is in “advanced discussions” to settle bribery related allegations. According to news reports, the activities under investigation involve alleged improper payments in Poland and possibly include activities in other countries as well.

The ongoing investigation is affecting ordinary business operations in companies caught up in the probe. For example, SciClone Pharmaceuticals announced earlier this week that its compensation committee would defer decisions on executive compensation until its board receives a report of a foreign bribery probe. The internal investigation is said to be parallel to that of the U.S. enforcement authorities.

And now it appears that the ongoing drug company bribery probe has also produced its first civil lawsuit. On May 2, 2011 investors filed a shareholders’ derivative suit in the District of New Jersey against Johnson & Johnson, as nominal defendant, and eleven board members, relating to the company’s settlement of the bribery charges. The complaint, which can be found here, alleges that the individual defendants breached their duty of loyalty by “failing to cause J&J to implement an internal controls system for detecting and preventing bribes to public doctors and administrators in Greece, Poland, and Romania, and kickbacks to Iraq to win business there.”

The complaint asserts claims for breach of fiduciary duty, mismanagement, abuse of control, corporate waste, unjust enrichment and violations of the federal securities laws.” The complaint seeks to hold the individuals liable to the company for damages, which the complaint alleges, referring to the fines, disgorgement and interest that the company has agreed to pay, exceed $70 million.

The FCPA itself does not provide for a private right of action. But as I have observed in previous posts (refer for example here) , one of the frequent accompaniments of an FCPA enforcement action is a follow on civil action, of the type filed against the Johnson & Johnson officials. And while the fines, disgorgements and penalties paid in connection with the FCPA settlement would not typically be covered un der a D&O policy, the defense costs incurred in connection with the follow on civil action would be covered, and settlements and judgments entered in the civil action would at least potentially be covered, subject to all of the applicable policies terms and conditions.

With the signs suggesting that there may be further enforcement actions and settlements in connection with the ongoing pharmaceutical industry bribery probe, there is an accompanying concern that as the overall investigation moves forward, there may also be a parallel wave of follow on civil litigation. This possibility is not only an added concern for the affected companies themselves and their senior executives, but is also a concern for the D&O insurance carriers.

There are a number of interesting features of the Johnson & Johnson settlement that may be significant in connection with the continuing investigations against the other drug companies. The first is that in connection with the Johnson & Johnson enforcement action, the governmental authorities took the position that the FCPA was relevant with respect to payments made to doctors in the counties specified. The position of the SEC and the other enforcement authorities is that because the health system in the counties involved is a government operation, the doctors involved are “foreign officials” within the meaning o f the FCPA, which , as discussed on the FCPA Professor blog here and here, is noteworthy issue of considerable interest and concern.

The other interesting about the Johnson & Johnson settlement relates to the comments in the DoJ’s press release with respect to Johnson & Johnson’s cooperation. The DoJ noted not only the company’s “timely voluntary disclosure” but also noted the company’s “significant assistance in the industry-wide investigation.” The press release also states that the company received a reduction in its criminal fine” as a result of its cooperation in the ongoing investigation of other companies and individuals.” The clear implication is not just that the probe is ongoing but that other companies and individuals are under investigation. The upshot may well be, as suggested above, that there will be further enforcement actions and possibly further settlements ahead.

The DoJ’s press release also underscored the extent to which the investigation of corrupt activities is a global, cross-border undertaking. In its press release, the DoJ noted not only the investigative collaboration with other U.S enforcement agencies and with the U.K. serious fraud office, but also recognized the helpful assistance of investigative bodies in Greece and Poland. These circumstances highlight both the collaborative international scale of the investigations but also how seriously the matters are being taken by a wide variety of governments and governmental authorities.

Finally in light of the magnitude of the Johnson & Johnson settlement (and the fact that the settlement made the Top 10 List) it is probably worth reflecting that the company reached this settlement while, at least according to the DoJ, receiving a reduction in its penalties not only because of the cooperation noted above, but also because of the company’s “pre-existing compliance and ethics programs, extensive remediation, and improvement of its compliance systems.” That the company should still face fines and penalties of the magnitude to which it agreed notwithstanding the credits the company received for these efforts is a striking development.

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On March 30, 2011, the U.K. Ministry of Justice released its long-awaited Guidance with respect to The Bribery Act of 2010, detailing the Act’s scope and jurisdictional applicability. The Guidance, which can be found here,  has quickly been criticized in some quarters for “watering down” the Act, particularly with respect to the jurisdictional scope of the Act’s commercial bribery provisions. The Serious Fraud Office’s prosecution guidance, also released on March 30, 2011, can be found here.

From the time the Act received Royal Assent, one of its features that has been the focus of particular concern has been Section 7 of the Act. Section 7 creates a new offense which can be committed by commercial organizations that fail to prevent persons associated with them from committing bribery on their behalf. Commentators have been concerned that this provision seemingly would subject any firm --even non-U.K. companies that have operations in the U.K. – to liability under the Act for violative conduct taking place any where in the world.

The newly-issued Guidance proposes a “common sense” approach to the question of applicability of this provision to firms organized outside the United Kingdom. While noting that ultimately the courts will determine whether or not a firm has a sufficient U.K. presence to warrant the Act’s application, the document goes on to say that the Act would not apply to firms that “do not have a demonstrable business presence” in the U.K.

As an example of the kinds of activities that would not be sufficient to constitute the carrying on of business in the U.K., the document states that “the mere fact that a company’s securities have been admitted to the U.K. Listing Authority and therefore admitted to trading on the London Stock Exchange” is not sufficient “to qualify that company as carrying on a business or part of a business in the U.K.

The document further specifies that merely “having a U.K. subsidiary will not, in itself, mean that a parent company is carrying on a business in the U.K.,” as “a subsidiary may act independently of its parent or other group companies.”

The primary thrust of the Guidance document is to identify procedures that companies can put in place to take advantage of the defense available under the Act, which provides that a firm cannot be held liable under the Act if it has adequate procedures in place to prevent persons associate with it from bribing.

 The document describes a principles based rather than a rules based framework, built around six guiding principles. The six principles are: proportionate procedures; top-level commitment; risk assessment; due diligence; communication; and monitoring and review.

The document also provides clarification about hospitality, stating  that “bona fide hospitality and promotional expenditures” are an “an established and important part of doing business” adding that “it is not the intention of the Act to criminalize such behavior.” The document specifically cites as example of such payments that would not typically run afoul of the Act’s provisions as “the provision of airport to hotel transfer services to facilitate an on-site visit or dining and tickets to an event.”  Introductory comments in the document from the Secretary of the State for Justice Kenneth Clarke add that “no one wants to stop firms from getting to know their clients by taking them to events like Wimbledon or the Grand Prix.”

The Act will now come in to force on July 1, 2011. The provisions in the Guidance document have been welcomed by some commentators, who note that the proportionate approach reflect in the document should be “good for business.” At the same time other commentators have criticized the guidance as having introduced “loopholes.”  Others have criticized the government for “watering down” the Act’s provisions.  

My own view is that while the Guidance has provided some clarification, it has not provided absolute clarity either, and the lack of clarity remains a concern. The examples given about what kind of activity would not be sufficient to support liability under the Act are helpful as far as they go, particularly that merely having a U.K. listing or a U.K. sub is not enough to support liability against a listed firm or the sub’s parent. Those activities are not sufficient, but what level of activity is sufficient?

The clarification that the government will be pragmatic and that the government will be guided by principles of proportionality is reassuring. However, the government’s Guidance document does not by any means put to rest all concerns. The upcoming applicability of the Bribery Act should remain an issue of focus and concern for companies with a business presence in the U.K I worry about the first non-U.K. company whose activities will become the test case under the Act.

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My weekend reading over the Memorial Day holiday included a hefty selection from the stack of law firm memos that accumulated in my inbox in recent weeks. Many of the most recent memos related to the Senate’s passage of its version of the financial reform legislation, but the memos also reflected a variety of other developments, including recent significant case developments and the passage of the UK bribery bill. I have set out below some of the more noteworthy recent law firm memos that have crossed my desk.

The Senate Financial Reform Bill

The Senate’s passage of the Restoring American Financial Stability Act of 2010 has triggered a flood of law firm memos. Though many of the memos have attempted to provide an overall description of the sweeping legislation, some have concentrated on focused on a narrow part of the bill. Several law firms have released memos focused just on the bill’s proposed corporate governance.

A May 24, 2010 memo from Sullivan & Cromwell provides an overview of the bill’s corporate governance reforms, including the bill’s provisions relating to majority voting for directors, "say on pay," executive compensation clawbacks, compensation committee independence and disclosures, and limitations on broker non-votes. The Sullivan & Cromwell memo points out that a number of the provisions in the bill – whistleblower protections, amendments relating to whistleblowers, private placement provisions and broker voting—would apply to non-U.S. issuers.

A May 28, 2010 memo from the Bingham McCutchen law firm also discusses the bill’s corporate governance reforms. Of particular interest, the Bingham memo contains an extensive discussion of the proposed "say on pay" reforms, with particular emphasis on concerns about "the amount of power the change would place in the hanks of proxy advisory firms," which provide compensation guidelines in connection with the proxy advice.

The Morgan Lewis firm also issued a May 27, 2010 memo about the Senate bill, here. The Morgan Lewis firm memo has an interested in discussion about the provision in the Senate bill that would require the securities exchanges to include the adoption of a compensation clawback policy as a listing requirement (by which incentive based compensation would be clawed-back from company officials in the event of a financial restatement of the financial statement of prior periods to which the compensation relations). The memo details the way that this provision the existing clawback requirements promulgated by SOX.

A May 27, 2010 memorandum from the Sidley Austin firm also provides an overview of the corporate governance reforms in the bill, and notes that that the bill contains additional compensation limitations for bank holding companies, and a separate provision requiring public companies to file a special SEC report of they using certain specified mineral products that may have originated in the Democratic Republic of Congo.

The Senate bill contains provisions designed to encourage corporate employees to blow the whistle on securities fraud. A May 21, 2010 Morgan Lewis memo (here) points out that these new provisions "give whistleblowers significant enhanced incentives to make a report" as part of the SEC’s new whistleblower program, and also provides extensive additional retaliation protections. The provisions would allow whistleblowers to receive rewards of between 10% and 30% of the monetary recovery. The provisions would also allow the whistleblower claiming retaliation to bypass existing administrative procedure requirements and proceed directly in federal court. The provisions also proposed a much longer statute of limitations and would create a double-back-pay remedy for retaliation claims, which created an incentive to bring retaliation claims.

Finally, a May 25, 2010 memo from the Faegre & Benson firm reports that the Senate’s financial reform bill "may give plaintiffs little to celebrate," noting that Congress "largely has chosen not to empower private parties" to enforce the rules. Indeed, the House bill’s provisions that would create the new consumer protection agency specifies that "nothing" in the provision establishing the new consumer protection "shall be construed to create a private right of action."

The Faegre & Benson memo does note that both the House and the Senate versions of the bill have "carved out a role for private litigants" to "help safeguard the integrity of the rating process" by allowing investors to sue credit rating agencies for securities fraud. The two versions disagree on the standard of liability to be required. Though the two versions must now be reconciled, some allowance private civil litigation against the rating agencies seems likely.

Securities Law Case Developments

A number of law firms have written memoranda discussing the Second Circuit’s April 27, 2010 opinion in the Pacific Investment Management Co. v. Meyer Brown case. Though the case outcome, in which the Second Circuit affirmed the dismissal of the securities fraud lawsuit against Refco’s lawyer, may have been unsurprising given the Supreme Court’s decision in Stoneridge, the law firm memos make the point that we may not have heard the last of the case.

As detailed in Arnold & Porter’s May 2010 memo about the case (here), the Second Circuit rejected the "creator theory" that both the plaintiffs and the SEC (in an amicus brief) had urged the court to adopt and instead held that "a secondary actor can only be held liabile for false statements in a private damages action for securities fraud only if the statements are attributed to the defendant at the time the statements are disseminated."

The Arnold & Porter memo points out that the decision, adopting the attribution test and rejecting the creator theory, has "two crucial limitations"; that is that it relates only to private civil actions under Rule 10b-5 and "does not speak" to government enforcement actions; and the Second Circuit refrained from addressing the question whether attribution is required for claims against corporate insiders.

The memo also notes that "perhaps most significant" is the fact that the decision was accompanies by Judge Barrington Parker’s concurring opinion, essentially calling for en banc review and even inviting the Supreme Court to weigh in on the matter. In other words, the memo notes, the Second Circuit’s recent opinion may not be the "final word on the subject."

Chadbourne & Parke also has a May 6, 2010 memo on the case, here. The Paul Hastings firm’s May 2010 memo on the case can be found here.

Finally, a May 26, 2010 memo from the Pillsbury Winthrop law firm discusses the Second Circuit’s May 18, 2010 decision in Slayton v. American Express , in which the Second Circuit held that even though forward-looking statements in the defendant’s SEC filing was not accompanied by meaningful cautionary disclosure, the plaintiffs failed to show that the statements were made with actual knowledge that they were misleading.

The Pillsbury firm memo identifies two "key takeaways" from the case: first, that "meaningful cautionary language must be specifically tailored to the statement at issue," as "boilerplate disclosure can be turned against a registrant because of its inherent lack of specificity." The Second Circuit’s holdings confirm the importance of "regularly reviewing the cautionary statements and risk factor disclosures contained in their public filings to ensure that the disclosure continue to be current and meaningful."

Second, the Second Circuit considered it to be a close call whether the plaintiffs had carried the burden of proving actual knowledge of falsity, "executive officers should remain vigilant and thoughtful when evaluating whether they have a reasonable basis for a particular forward-looking statement."

The U.K.’s Bribery Act 2010

The Morgan Lewis firm has a May 2010 memo entitled "The New UK Regime on Bribery" (here) describing the "far reaching implications" of the U.K.’s Bribery Act 2010. Among other things, the memo notes that the new law expands the scope of behavior that is targeted; no longer limited just to bribes paid to foreign officials, the new law applies to all bribes including purely commercial bribes, and applies to both the person paying and the person accepting the bribe.

Even more significant, the Act’s new Section 7 creates a new strict liability offense for organizations if a person associated with the organization bribes another person with the intent of benefiting the organization. However, organizations have a defense if they can show that they have in place "adequate procedures" to prevent bribery. In essence, the new Act is mandating compliance programs, to create controls against improper payments.

The Act has what the memo describes as a "wide territorial scope," applying of an act or omission forming part of the violation occurs in the U.K, or if in is carried out by a person with a "close connection" to the U.K.

A May 24, 2010 memo from the Weil Gotshal firm says that the new Act "provides the UK with one of the toughest regimes for regulating corruption in the world.

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In many prior posts (refer here), I have suggested that FCPA-related losses could represent a growing D&O exposure. In a recent demonstration of just how significant these kinds of exposures can be, Siemens disclosed  earlier this week that it has reached a 100 million euro settlement with its D&O insurers in connection with the claims arising from the company’s bribery scandal. The filing, which incorporates the insurance settlement documentation, raises a number of interesting issues.

In its December 8, 2009 filing of Form 6-K (here), Siemens reports that on December 2, 2009, the company reached a settlement agreement with its D&O liability insurers, while simultaneously announcing that it had also reached settlements with a number of its former directors and officers against whom it has asserted damages claims arising out of the bribery scandal. The settlements include the agreement of the company's former CEO Heinrich von Pierer to pay 5 million euros, and of his successor, Klaus Kleinfeld, to pay 2 million euros. Other former board members agreed to pay amounts ranging from 1 million euros to 3 million euros.

The filing explains that Siemens had a total of 250 million euros of D&O insurance coverage, arranged in five layers of 50 million euros each. Each layer had a lead insurer as well as participating coinsurers. The settlement agreement, which can be found in Annex 10 to the filing, identifies the lead insurers and the participating coinsurers for each layer.

The insurance settlement requires a payment to Siemens of up to 100 million euros, consisting of two parts: a payment of 90 million euros (against which prior defense payments of 5.5 million euros are to be credited) and as well as the payment of an additional fund of 10 million euros. The 10 million euro fund is to be maintained for the defense of future claims as well as for the satisfaction of "justified claims." that are asserted against former Board Members based on the bribery allegations or that have no connection with bribery allegation but for which coverage would have otherwise have been available under the D&O insurance program.

All of the layers in the Siemens D&O insurance program participated in the settlement, with each successive layer contributing a proportionately smaller percentage of the layer's 50 million euro limit.. (The percentage participations applicable to each layer are specified in the settlement agreement.) The 10 million euro fund is to be managed by the lead insurer on the primary layer on behalf of all the insurers.

The settlement agreement recites that the insurance settlement was the result of "intensive discussion" and that the Insurers had previously indicated that coverage might be denied on the grounds of, among other things, "pre-contractual knowledge and/or fraudulent/intentional violations of duties, and/or certain rights by unilateral declaration [that] can be exercised, which would lead to retroactive rescission of the D&O insurance." The parties reached the settlement in order to avoid the need to litigate these issues as well as to avoid the need for Siemens to pursue an action against … former Board Members who settled with Siemens in order to establish their liability as a precondition for the obligation to provide coverage."

Siemens’ SEC filing also reflects the settlement agreements reached separately with various former company officials. The filing recites that in connection with the individual settlements the individuals have agreed "not to draw on the D&O insurance coverage" in connection with their agreed payments to the company.

The agreement is subject to shareholder approval, which will be determined at the company’s January 26, 2010 shareholder meeting. (The shareholders will also vote on the individual settlements as well). The agreement clarifies that upon the effectiveness of the settlement, the insurance policies will be "retroactively terminated."

If it is "determined by a non-appealable court decision that individual Former Board Members intentionally or knowingly … violated their duties," then the Insurers shall be entitled to ask for reimbursement of defense costs paid to the respective former Board Member. The lead primary insurer is designated to administer this portion of the agreement.

There are a host of interesting things about this settlement.

The first is the marginal note accompanying the settlement stating that Michael Diekmann, a member of Siemens’ Supervisory Board, is the chairman of the Management Board of the parent holding company of the lead insurer on Siemens’ primary D&O insurance policy. The filing states that "Mr. Diekmann did not participate in the consultations and decisions pertaining to the Coverage Settlement." Call me cynical, but even if he didn’t participate in the consultations, this connection didn’t exactly impede the settlement either, if you take my meaning. To me this fact seems like it might help explain how there was any settlement at all, rather than the mother of all European D&O coverage lawsuits.

The second interesting thing is the way the D&O insurance policies are responding. The insurers are making a claims payment directly to the company, for claims that have been asserted by the company against its former officers. Unless the company’s European-issued insurance policies lack the kind of Insured vs. Insured exclusion that is standard in D&O policies issued in the U.S., there is something very peculiar about this payment. Even if the company itself is not an insured under the policy, it would seem like there would be an exclusion to protect against the possibility of collusive claims. Of course, there might have been such as exclusion in Siemens program and it was simply compromised as part of the settlement. (Readers who can help rationalize this apparent Insured vs. Insured problem are cordially invited to clarify, using this blog’s comment function.)

UPDATE: A knowledgeable European reader who prefers anonymity sent me a note with the following observation:"Regarding the payment towards the company we usually don´t carry IvI-exclusions over here in Germany. Most of the claims are made by the companies against individual directors and officers, word is that it´s around 80% or more of the times. We are basically still in the fledging stages of D&O litigation over here, D&O coverage was allowed in 1986, distribution really didn´t took off until the end of the 90s. The mentality over here regarding the pursue of claims against your directors and officers is totally different than in the US. Until the middle of the 90s, courts hadn´t even ruled on supervisory boards being forced to pursue claims against directors and officers."

The other thing about the insurers’ 90 million euro payment (less defense expenses previously paid) is the question of what exactly it represents. Simultaneously with the insurance settlement, Siemens settled its claims against most of the former company officials. So those claims have been resolved by individual payments for which the individuals are prohibited from seeking insurance. There are remaining claims against other individuals, but that is what the 10 million euro fund is for. So what exactly is the 90 million euro (less prior defense expense) payment for? Of course, the company has incurred literally billions of costs, expenses, fines and penalties in connection with the bribery scandal, but I don’t think the insurers are paying for the company's own scandal related expenses. 

The settlement agreement recites that, among other things, the insurance settlement relieved the company of the need to file and pursue actual lawsuits against former board members. I guess the internal logic of the settlement agreement is that the company could have pursued the lawsuits, and if they did, each would have to be litigated and separately settled, and the insurer would have to pay (assuming the claims were covered). The insurance settlement in effect says that we are just going to cut out all the intervening steps and compromise everything for a single payment.

The third feature is the way the settlement incorporates a settlement fund for future losses. It is on the one hand an escrow fund, but on the other hand it is more like insurance, or perhaps the residue of insurance with certain insurance-like attributes (e.g., it only applies to "justified" claims) The insurers are in effect providing a limited amount of insurance, but in a bargained down amount, with many fewer conditions.

Fourth, to the extent the insurance policies provided any type of insurance coverage for securities claims, the compromise and termination apparently precludes the availability of insurance in connection with the securities class action lawsuit filed in the Eastern District of New York last week, in which the plaintiffs alleged violations of U.S. securities laws solely against Siemens. (The $10 million fund would not be available in connection with this claim, because the claim was filed solely against the company, but the fund was set up only for claims asserted against former board members.)

Finally, I wonder what this settlement and the company’s settlements with the individual former company officials do to the derivative lawsuit that was filed in New York earlier in connection with the bribery scandal (refer here, see page 18). It is entirely possible that that case fell by the wayside earlier on, or that it was preempted by the claims the company itself asserted against the individuals. But it is an interesting question what impact these developments would have on the New York derivative lawsuit if it were still an active case. (Readers who may have any insight into the status of the derivative lawsuit are encouraged to provide updated information via the comment feature of this blog.)

Whatever else may be said about the settlement, it clearly represents a massive hit to the European D&O insurers. Hits on this scale may have become almost commonplace in the U.S., but this type of loss is still represents an extraordinary D&O insurance development in Europe. I wonder if this settlement is a game changer for the European D&O insurance community. UPDATE: Readers have advised me that massive D&O settlements on this scale are unfortunately becoming all too common in Europe as well; one example cited is the recent 57.5 million euro settlment involving EM.TV.

Finally, it is worth noting that the massive amount of the insurance settlement underscores the extent of the exposure that bribery-related claims represent. Though the Siemens case is extraordinary on many levels, the kind of insurance losses on claims related to bribery-related allegations are becoming increasingly common. As the Siemens insurance settlement demonstrates, the exposures are clearly not limited just to the United States.

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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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