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FCPA Disgorgement: Putting SEC To Its Burden Of Proof

By Iris E. Bennett, Sean J. Hartigan, and Lidiya Kirin

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Iris Bennett
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Lidiya Kurin
The ability to require disgorgement of ill-gotten gains in Foreign Corrupt Practices Act cases is a powerful enforcement tool for the U.S. Securities and Exchange Commission. Disgorgement orders are a staple of the SEC’s FCPA enforcement docket, and are often in the millions or tens of millions of dollars. In 2016, for example, out of 24 SEC FCPA corporate settlements, 20 of them imposed disgorgement. Many of those disgorgement orders were for amounts of more than $10 million, and several of them were more than $100 million.

In addition, a new enforcement trend is for the DOJ to require disgorgement in cases resolved under the U.S. Department of Justice FCPA pilot program, pursuant to which the DOJ has declined to prosecute certain companies based on voluntary disclosure and extraordinary cooperation.[1] This is a change from prior DOJ practice, pursuant to which a declination typically meant the case file was closed without any monetary ramifications. All seven declinations under the pilot program have either required disgorgement to DOJ, or noted that disgorgement was not being required because it was being separately required by SEC. Thus, the disgorgement remedy has taken on a new relevance for DOJ FCPA matters as well.

Recently, the U.S. Supreme Court limited the SEC’s power with respect to disgorgement by holding that the disgorgement remedy, contrary to the SEC’s long-standing interpretation, is subject to the five-year statute of limitations generally applicable to enforcement actions under the Securities and Exchange Act.[2] While this decision was clearly important, the practical reality is that only on rare occasions will companies facing an SEC enforcement action have a viable statute-of-limitations argument. First and foremost, it requires, of course, that the conduct be old enough that the statute of limitations would apply. Second, if the statute of limitations has not already run at the time that an SEC investigation commences, and the company being investigated has chosen to cooperate with the SEC’s investigation of the matter, it can be expected that the SEC will ask for an agreement to toll the statute of limitations during the investigation. The pressure to agree to such a measure is significant for a cooperating company.

There is another issue relating to disgorgement, however, that may come up more frequently, and that it is wise for companies facing an SEC FCPA investigation to be cognizant of: the question of whether the SEC can show a causal link between the FCPA violation and the gains alleged to have been derived from the violation. Violation of the FCPA does not require that an improper payment to a foreign official have resulted in any gain: Only the act of payment combined with the corrupt intent to obtain or retain business is required.[3] To impose disgorgement, however, there does need to be some cause-and-effect relationship. In some cases causation will be clear-cut, and a challenge on that ground will not be viable. In other cases the lack of evidence to show that the violation led to any financial gains will be so plain that the SEC, even though it can be expected to take an aggressive view in general, will not pursue disgorgement. However, there will be cases in the middle — we have seen this in our experience as FCPA practitioners — where the SEC may take the view that disgorgement is warranted, yet there may be valid arguments to raise with the agency that causation is not satisfied.

The Causation Element: What Is Required to Prove Ill-Gotten Gains

Because FCPA actions are so rarely litigated — particularly by corporations — the federal case law on disgorgement in SEC actions is concerned with other types of securities law violations. That said, the same general legal standard for causation to support a disgorgement remedy would apply.

Disgorgement may be applied “only [to] property causally related to the wrongdoing.”[4] This is required because disgorgement is an equitable remedy designed to deprive a defendant of ill-gotten gains (and only ill-gotten gains); while it may have its punitive aspects, it is not a punitive sanction as such.[5] At a minimum, “but for” causation must exist between the illegal act and any profits that the government seeks to disgorge.[6]

Thus, for example, in SEC v. Wyly, a federal district court in the Southern District of New York rejected the SEC’s request for disgorgement where the SEC argued that all that was required to impose disgorgement was to show total profits earned during the existence of an unlawful scheme.[7] The court concluded that to hold otherwise would “eliminate the requirement that the government provide a reasonable approximation of the profits that are causally connected to the violation.”[8] There was no dispute that the defendants had committed securities law violations — they were found guilty at trial — or that the defendants sold securities and profited from those sales during the period in which the securities violations were being committed. However, the SEC offered no proof that the gains were “reasonably connected” to the violations.[9]

Where the courts have upheld disgorgement in SEC enforcement actions, causation has been shown. For example, in SEC v. Teo, the defendant violated disclosure requirements regarding his share of ownership in a public company in order to avoid that company’s poison pill provision. The poison pill provision would have allowed other shareholders to dilute the defendant’s shares once his ownership percentage reached a certain level, preventing him from realizing profits made on his shares when there was a tender offer for the company’s stock.[10] As a result, his violation of disclosure requirements was a but-for cause of the profits that he realized.[11]

All this said, there is little doubt that courts may be deferential to the SEC where it asserts disgorgement is warranted. As an example, in First City Financial, which concerned an insider trading scheme, the court concluded that disentangling legitimate from illegitimate gains, as well as various causal factors for the gains, was ultimately not a realistic possibility given the nature of the violation and the complexities of what goes into determining stock prices. The court further concluded that defendant’s alternate theory of causation verged on speculation. In that situation, the court commented, “the line between restitution and penalty is unfortunately blurred, [but] the risk of uncertainty should fall on the wrongdoer whose illegal conduct created that uncertainty.”[12]

Still, it is important to remember that the SEC does have a burden to show causation in order to obtain disgorgement. Thus, turning back to the FCPA context specifically, causation is clearly not required to prove an FCPA antibribery violation per se. However, that is different from what is required to prove that a defendant’s profits were obtained as a result of the corrupt act and thus are subject to disgorgement.

SEC and the Disgorgement Remedy in FCPA Settlements

Since FCPA investigations against corporate entities are almost universally resolved through settlement rather than federal court litigation, many details about the facts and the SEC’s legal reasoning in any given matter are not part of the public record. Thus, while we have gained certain insight into the approach that may be taken by the SEC based on our own experience, when it comes to analyzing the public record of any given case, any analysis of how strong or weak the case may have been in terms of causation is significantly constrained by this limitation. That said, there are certainly cases where causation is quite clear, and others where it is not.

For example, in a case that arguably represents one end of the spectrum in terms of strong proof of causation, the settlement documents reflect detailed allegations by the SEC relevant to causation, including, among other things: that the company — JP Morgan Chase — maintained a running log of business deals attributable to entities whose officials had requested and obtained personal benefits, in the form of jobs and internships for relatives, as well as the title and role of the officials in question; that there was email evidence that explicitly referred to the “quid pro quo” rationale for hiring certain officials’ family members and “an almost linear relationship” between making such hires and obtaining new business; and that the timing of hires versus the obtaining of new or expanded business with particular agencies was consistent with the theory that the hires were at least part of the reason that business was obtained.[13]

By way of comparison, in a nonprosecution agreement with Nortek Inc., the SEC alleged that the company provided improper payments and gifts to officials from a variety of different Chinese government agencies with an improper motive, i.e., “in order to receive preferential treatment, relaxed regulatory oversight, and/or reduced customs duties, taxes, and fees.” The settlement also describes how the payments occurred over a several-year period. The agency then imposed a disgorgement order of $291,403 without specifying how that amount was reached, or what evidence there was that the payments and gifts were a but-for cause of the monetary benefit represented by the disgorgement order — for example, in reduced customs duties, taxes and fees.[14]

Tips for Practitioners: Challenging Causation for Disgorgement Orders in FCPA Cases

In challenging causation for disgorgement, it is important to recognize that, if a federal court were confronted with such a challenge, such a court would very likely take into account the fact that causation can be difficult to prove in FCPA cases, just as it can be in investment fraud cases, albeit for different reasons. For example, a court might note that it will be a rare case indeed where direct evidence available of a foreign official’s state of mind revealing whether he or she was in fact influenced by a payment and awarded business or other monetary benefits as a result.

That said, it is always worth analyzing the record carefully to determine the strength of the evidence of that element. In doing so, questions that may be worth asking, depending on the facts of the case, are:
  • How significant were the payments or improper benefits to the officials? Was the value provided to them very low in comparison to the alleged ill-gotten benefit obtained as a result of those payments? Is it realistic to conclude that one was a “but for” cause of the other?
  • What is the timing of the payments or improper benefits, as compared with the timing of the ill-gotten contract award or other gains? If the benefits were provided after the gains, is there evidence to show discussion with the officials that they would be rewarded in some fashion? Conversely, if the benefits were provided prior to the ill-gotten gain, how much time passed, and what evidence is there to show that one was causally linked to the other?
  • Is there evidence showing more than that business was obtained during a period of time that payments or benefits were being provided, i.e., that the payments or benefits actually played a role in obtaining that business?
  • Did the officials who received payments or other benefits have decision making power with respect to the business obtained or retained by the company? What is the evidence that they did? Is there evidence that it was actually other officials who held that power?
  • If an official waived a requirement or bent a rule in favor of the company, did the company nonetheless ultimately comply with whatever the applicable requirements were?
Conclusion

While not all cases will be amenable to such arguments, in FCPA matters involving the SEC, it is important to remember that SEC should not seek disgorgement unless it can prove a causal connection between the illicit conduct and the ill-gotten gains. Where appropriate, arguments testing SEC’s theory for disgorgement should be raised to the agency, to seek to ensure that this burden is satisfied even if the case is being resolved by settlement.


 
Iris E. Bennett and Sean J. Hartigan are members and Lidiya Kurin is a summer associate at Smith Pachter McWhorter PLC in Tysons Corner, Virginia.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.


[1] See Department of Justice, The Fraud Section’s Foreign Corrupt Practices Act Enforcement Plan and Guidance (April 5, 2014), available at https://www.justice.gov/archives/opa/blog-entry/file/838386/download; see, e.g., CDM Smith Declination Letter from Department of Justice (June 21, 2017), available at https://www.justice.gov/criminal-fraud/page/file/976976/download.

[2] See Kokesh v. SEC, 137 S. Ct. 1635 (2017).

[3] 15 U.S.C. § 78dd-1, et seq.

[4] SEC v. First City Financial Corp., Ltd., 890 F.2d 1215, 1231 (D.C. Cir. 1989).

[5] Id.

[6] See id.; SEC v. Teo, 746 F.3d 90, 107 (3d Cir. 2014).

[7] SEC v. Wyly, 56 F. Supp. 3d 260, 265 (S.D.N.Y. 2014).

[8] Id. at 269.

[9] Wyly, 56 F. Supp. 3d at 270.

[10] Teo, 746 F.3d at 93-94.

[11] Id. at 93-94, 107. See also, e.g., SEC v. Razmilovic, 738 F.3d 14, 31 (2d Cir. 2013) as amended (Nov. 26, 2013) (upholding SEC estimate of profits subject to disgorgement where SEC showed there were “transactions in securities whose market price has been affected by the frauds”); SEC v. Bilzerian, 29 F.3d 689, 696-97 (D.C. Cir. 1994) (upholding disgorgement where the SEC showed that the defendant’s “misrepresentations inflated the price he received from the sale of the securities”).

[12] First City Financial, 890 F.2d at 1232.

[13] In the Matter of JP Morgan Chase & Co., SEC Cease and Desist Order (Release No. 79335 / November 17, 2016).

[14] Nortek, Inc., SEC Non-Prosecution Agreement (May 3, 2016).