A recent SEC enforcement action alleging Foreign Corrupt Practices Act violations against Nature’s Sunshine Products and two of its officers may represent a new and disturbing liability threat to corporate officials. The SEC asserted claims directly against the two individuals even though they were not alleged to have either involvement in or knowledge of the alleged misconduct, based solely on their "control person" responsibilities. These allegations, which experts say may represent the first of its kind to be alleged, could represent a troublesome new liability exposure for officers and directors.
The SEC’s Enforcement Action
As reflected in the SEC’s July 31, 2009 litigation release (here), the SEC filed a complaint (copy here) in the Central District of Utah against the company, alleging that in 2000 and 2001, the company had made $1 million in payments to Brazilian customs officials in order to facilitate the company’s importation of certain of its products. The complaint alleged that the company had violated the FCPA’s antibribery, books and records, and internal control provisions.
The complaint also alleges claims against Douglas Faggioli, the company’s CEO who at the time had been the company’s COO and a member of its board of directors, and against Craig D. Huff, who is no longer with the company but who served as the company’s CFO at the time.
With regard to Faggioli, the SEC alleged that his position gave him supervisory responsibility for the senior management of and policies regarding the worldwide distribution of the company’s products. The SEC alleged that Huff had supervisory responsibility for the senior management of and policies regarding the company’s books and records. Both were alleged to have failed to adequately supervise the company’s personnel in 2000 and 2001 to keep the company’s book and records accurately and to devise and maintain a system of books and records sufficient to adequately monitor company activities.
Neither the company nor the individuals admitted wrongdoing, but the company agreed to pay a civil penalty of $60,000 and the individuals each agreed to pay a civil penalty of $25,000
According to an August 11, 2009 memorandum from the Shearman and Sterling law firm (here), the significance of the case is that control person liability allegations have "rarely (if ever) been used by the SEC in FCPA cases."
The memo also notes that the SEC did not allege that Fagiolli or Huff were involved the payments or even aware of the improper accounting for the payments. As the memo states, "the SEC’s decision to charge Faggioli and Huff with control person liability without alleging that either of them participated in or had personal knowledge of the FCPA violations raises the disturbing spectre [sic] of strict liability for executives."
In a separate interview published in the National Law Journal on August 20, 2009 (here), Philip Urofsky of Shearman and Sterling noted that at least in the civil context, control person liability "has been used against a much wider variety of corporate officers and even directors," so there is even a potential for control person allegations for FCPA violations to be raised against directors, "at least where the directors are very active and involved in the operations of the company."
The possibility that directors and officers could be held liable for FCPA violations without any culpable involvement or even knowledge of the misconduct represents a disturbing new potential liability threat to corporate officials. This threat is all the more troublesome because the SEC, under pressure to reestablish its regulatory credentials, has made it clear that FCPA enforcement will be a high priority.
Indeed, in an August 5, 2007 speech (here), Robert Khuzami, the SEC’s new Division of Enforcement head, among other things announced the formation of a new FCPA unit, saying that "more needs to be done" to enforce the FCPA. He described the unit’s goals as "being more proactive in investigations, working more closely with our foreign counterparts, and taking a more global approach to these violations."
There is no private right of action under the FCPA itself. However, civil litigants have long relied control person liability allegations in claims against corporate officials. Whether these civil litigants can use these theories of control person liability for FCPA violations remains to be seen, although that seems unlikely give the absence of private right of action for FCPA violations.
However, as I have frequently noted (most recently here), one of the exposures facing corporate officials related to FCPA enforcement activity is the possibility of follow-on civil litigation – indeed, Nature’s Sunshine Products is itself the subject of a securities class action lawsuit in which investors have alleged that the company and certain of its directors and officers made misrepresentations about the company’s internal controls and financial statements as a result of the overseas FCPA violations. As discussed here, the case previously survived the defendants’ motion to dismiss.
To the extent corporate officials are held liable by the SEC for FCPA violations on control person liability theories, they could also potentially be susceptible to claims by private litigants based on alleged fiduciary duty breaches. In addition, other civil claims, including claims based on alleged violations of disclosure duties under the securities laws, could be bolstered by an SEC enforcement action alleging control person liability claims.
In short, these developments may represent a significant new area of D&O liability exposure, or at least a significant extension of previously existing exposures. The typical D&O liability insurance policy would not likely cover any fines or penalties imposed on corporate officials for their control person liability, but their expenses incurred in defending against the claims likely would be covered under the typical policy, as would their defense expenses and any settlements or judgments against them in any follow-on civil litigation. Because of these possibilities, these developments potentially could represent a significant new loss exposure for the D&O insurers, too – or at least an expansion of a previously existing exposure.
One final note is that there seems to be a disturbing new trend where the SEC is seeking to use its authority to impose liability on or to effect recoveries upon corporate officials even where the individuals themselves are not alleged to have engaged in culpable misconduct. As I noted here, the SEC recently took steps to try to clawback executive compensation form the CEO of CSK Auto even though he was not alleged to have any knowledge or involvement in the events that required the company to restate its previously issued financial statements. In the Nature’s Sunshine Products case, the SEC sought to impose control person liability on the two individual defendants despite their lack of culpable participation in or awareness of the FCPA violations.
I recognize that the SEC is under pressure to show that it is tough and that it is a trustworthy regulatory guardian, but I find this new willingness to try to impose liability on individuals who are not themselves alleged to have engaged in culpable misconduct troubling. I recognize the theoretical appeal of a "captain of the ship" type approach to corporate misconduct, but I still think individuals without culpable participation in or even awareness of misconduct ought not to be subject to the burden, humiliation and expense of governmental enforcement activity. The pursuit of persons lacking culpability seems to me like the essence of overzealous regulatory action.
That said, I note that the law firm memo linked about does recite certain background features of the Nature’s Sunshine Product case that may go a long way toward explaining why the SEC sought to impose control person liability in this particular case. It is entirely possible that the claims asserted are simply a reflection of the facts involved, and nothing more.
Special thanks to the several readers who sent me links regarding the Nature’s Sunshine Products case.
Has Global Financial Turmoil Increased FCPA Risks?: The FCPA prohibits corruptly offering or providing anything of value to "foreign officials." As a result of the global financial crisis, government ownership in a wide variety of enterprises has proliferated. According to an August 10, 2009 New York Law Journal article by Stephanie Melzer and Christopher Tierney of the Cadwalader law firm entitled "Has Economic Uncertainty Expanded the Reach of the Foreign Corrupt Practices Act?" (here), the number of "foreign officials" may have dramatically increased, in ways that could have transformed long-established business practices into conduct violative of the FCPA.
The authors show that the published guidance and case law resources do not really establish conclusively what level of governmental involvement or ownership in an enterprise is required in order for an entity’s representative to be a "foreign official." Various settlements do show that U.S. authorities have been willing to extend the FCPA to "conduct involving payments to employees of entities that are less than majority-owned or controlled by foreign governments."
Accordingly, the authors conclude that given the massive amounts that governments have injected in a wide variety of enterprises, "a legitimate question arises whether employees of previously private enterprises will be viewed as ‘foreign officials’ under the FCPA." In short, "the current financial crisis may have turned some previously private employees into ‘foreign officials.’" – creating the unsettling possibility that previously acceptable and appropriate business entertainment or other ordinary business activities could now be alleged to constitute conduct violative of the FCPA.
Does FCPA Enforcement Encourage Corruption?: It may sound counterintuitive, but a recent paper (here) by attorney and scholar Andy Spaulding suggests that among the "unintended consequences" of aggressive FCPA enforcement may be that it could cause corruption to proliferate unimpeded in emerging markets.
As reflected in an August 5, 2009 Wall Street Journal article discussing Spaulding’s paper (here), Spaulding contends that FCPA enforcement might be deterring corporations from investing in developing countries where corruption is rampant. But if U.S. corporations stop investing in emerging markets, entities from other nations that are not as committed to fighting corruption will step in. As Spaulding puts it, "’black knights’ will move in to fill the void," as a result of which "the world economy could slowly begin to bifurcate into two economies: one in which bribery is tolerated and one in which it is not."
Spaulding concludes that "the FCPA is thus revealed to be a large-scale study in the law of unintended consequences."
Portrait of a Corrupt Society: An August 22, 2003 Wall Street Journal article entitled "Pride and Power" (here), about the current political and economic conditions in Russia, reported the following about the culture of corruption in that country:
One of the major obstacles to conducting business in Russia is the all-pervasive corruption. Because the government plays such an immense role in the country’s economy, controlling some of its most important sectors, little can be done without bribing officials. A recent survey by Russia’s Ministry of the Interior revealed, without any apparent embarrassment, that the average amount of a bribe this year has nearly tripled compared to the previous year, amounting to more than 27,000 rubles or nearly $1,000.
And Finally: For those readers who like me are fascinated with these emerging FCPA-related issues, The FCPA Blog is an absolutely essential daily read. The blog’s author, Richard Cassin, regularly updates the key developments in anticorruption activities around the globe. For example, Cassin’s take on Spaulding’s provocative paper about the FCPA’s unintended consequences can be found here.