An Examination of the SEC’s Application of Disgorgement in FCPA Resolutions
By Sasha Kalb and Marc Alain Bohn[1]
What do Statoil, Willbros Group, Halliburton/KBR, Siemens and Daimler,[2] who collectively paid $639,500,000 under their respective Foreign Corrupt Practices Act (“FCPA”) civil settlements with the Securities and Exchange Commission (“SEC”), have in common? [3] Not one paid a monetary penalty as part of their respective SEC dispositions. It was not until these corporations settled with the Department of Justice (“DOJ”) for a collective $978,100,000 that any of them incurred a monetary penalty for violating the FCPA. The $639,500,000 these corporations paid as part of their SEC settlements instead represented disgorgement of profits, a now common feature of FCPA resolutions with the SEC.
What is Disgorgement?
Disgorgement is an equitable remedy used to deprive wrong-doers of their ill-gotten gains and deter violations of federal securities law.[4] It is available through the Securities Exchange Act of 1934, which gives the SEC the authority to enter an order “requiring accounting and disgorgement,” including reasonable interest, as part of administrative or cease and desist proceedings.[5] As an equitable remedy, disgorgement is not intended as tool to punish, but as a vehicle for preventing unjust enrichment. The SEC is therefore only permitted to recover the approximate amount earned from the alleged illicit activities. Disgorging anything more would be considered punitive.[6] Of note, because disgorgement is technically a remedy rather than a penalty, companies may be able to claim disgorged sums, along with any pre-judgment interest assessed, as a tax deductible expense.[7]
The SEC first imposed disgorgement in an FCPA context in 2004 in an enforcement action with the Swiss engineering firm ABB Ltd.[8] Since then, it has required disgorgement in 30 of its 42 subsequent corporate FCPA dispositions (roughly 72%). Disgorgement in these dispositions has run the gamut from as little as $259,000 in the 2008 Westinghouse Air Brake Technologies Corporation settlement to $350 million in the 2008 Siemens settlement.[9] The SEC also typically requires the payment of prejudgment interest on disgorged funds, an assessment which can frequently run into the millions.[10]
How is Disgorgement Calculated?
Due in large part to the dearth of litigated FCPA cases, there is no real case law that discusses the SEC’s methodology for calculating disgorgement in the FCPA arena. The SEC, however, has been applying disgorgement in the general securities litigation context for years. The securities litigation cases provide helpful guidance as to the methods by which the SEC calculates amounts to be disgorged and can be applied to the FCPA context.
In calculating disgorgement, the SEC is required to distinguish between legally and illegally obtained profits.[11] The first step in such calculations is to identify the causal link between the unlawful activity and the profit to be disgorged.[12] Once this causal link is established, the SEC may assert its right to disgorge illicit profits that stem from this wrong-doing. Because calculations like these often prove difficult, courts tend to give the SEC considerable discretion in determining what constitutes an ill-gotten gain by requiring only a “reasonable approximation of the profits which are causally connected to the violation.”[13] Once the SEC satisfies this relatively low threshold, the burden shifts to the defendant, who must “demonstrate that the disgorgement figure was not a reasonable approximation” by means such as “pointing to intervening events from the time of the violation.”[14] In short, the defendant must rebut the causal connection.
Rebutting an SEC calculation can prove difficult in practice where a violation leads seamlessly to the formation of a contract or a long-term business deal. For example, if a defendant who secured a series of lucrative contracts after an improper payment to a foreign official is unable to break the causal chain between the improper payment and the ongoing contracts it secured, it may be possible for the SEC to disgorge future, as yet unrealized, profits. The disgorgement of such gains, however, cannot be without limit. Courts have recognized that at some point the continuum between a violation and profits becomes too attenuated to be feasible.[15] These profits would be seen as causally unrelated to the original fraud and attempts to disgorge them would be considered punitive and impermissible under the equitable theory of disgorgement.[16]
In reviewing proposed disgorgements, courts have approved calculations using the “paper profit” realized by defendants rather than the “actual profit” they may eventually earn.[17] This “paper profit” reflects the value of a defendant’s illicit gains at the time of the disgorgement order and does not factor in any losses or devaluation that may affect the actual profit subsequently realized. The distinction between “paper” and “actual” profits is often highlighted in the securities fraud context because stock prices can drop after the initial fraud. Courts will often ignore the subsequent price drop and require defendants to surrender more than they earned by reason of the fraud, noting that to allow disgorgement of only actual profits would create a paradoxical win-win situation for the wrong-doer where it “could keep subsequent profits but not suffer subsequent losses.”[18] This line of thinking almost certainly applies to disgorgement in the FCPA arena.
What Does This Mean for the FCPA?
While an understanding of the SEC’s use of disgorgement in traditional securities litigation can offer insight into its use of disgorgement in FCPA resolutions, it remains unclear whether the SEC actually uses the same methodology in FCPA matters. A review of FCPA resolutions since ABB Ltd. reveals some interesting patterns while also highlighting how little has been disclosed by the SEC regarding the determination of when and how much to disgorge. The SEC’s Rules of Practice include regulations that call for the SEC to specify each violation that forms the basis of a disgorgement order, the dates on which each violation occurred, the amount to be disgorged for each violation and the total sum to be disgorged.[19] Information along these lines in FCPA settlement documents, however, is often incomplete. Unlike cases litigated in the securities arena, the value of alleged profits or ill-gotten gains is routinely not specified in SEC FCPA pleadings.[20] In cases where the alleged profit is included, it is often unclear how the value of the profit or ill-gotten gain was calculated. Critics have noted that the SEC’s aggressive mode of determining revenue and the profit associated with it has made disgorgement under the FCPA more punitive in nature.
Despite the lack of disclosure here, some noteworthy observations can nevertheless be gleaned from what information is publicly available:
- There is a trend toward the increased use of disgorgement as a tool in FCPA settlements. From 2008 through April 1, 2010, the SEC imposed disgorgement in 80% of FCPA enforcement actions involving corporations compared with just 59% in 2006 and 2007.[21]
- Disgorgement is required more frequently when the charges or findings against a company include an antibribery violation. Since the ABB settlement, 73% of dispositions involving antibribery charges or findings have required disgorgement. In contrast, when excepting the unique category of non-antibribery Oil for Food cases,[22] only 44% of dispositions that alleged accounting-only FCPA violations have imposed disgorgement.[23]
- Dispositions that involve antibribery charges or findings tend to allege much higher amounts of illicit payments and require significantly more in civil fines and disgorgement. Setting aside accounting-only Oil for Food cases (see Footnote 21) as well as the staggeringly large Siemens and Halliburton/KBR dispositions, given their tendency to distort the analysis, antibribery dispositions that imposed disgorgement have alleged significantly more in illicit payments and ill-gotten gains and required significantly more in civil fines, disgorgement and prejudgment interest than accounting-only dispositions imposing disgorgement.
Establishing any reasonable measure of predictability when it comes to disgorgement, however, has proven challenging. This is due in large part to the aforementioned lack of detail accompanying SEC disgorgement orders, specifically how the SEC calculates revenue and profit as well as how it weights variables such as the existence of parallel investigations by the DOJ, differing sets of facts, and varying levels of cooperation.
For example, in a parallel enforcement action by the DOJ and SEC in July 2009, the SEC found that Helmerich & Payne (“H&P”), an Oklahoma-based drilling company, violated the accounting provisions of the FCPA in connection with $185,673 in illicit payments made by its wholly owned subsidiaries that resulted in an estimated $320,604 in avoided costs for H&P. Despite the lack of an anti-bribery finding, the SEC required H&P to disgorge the $320,604 and pay $55,077 in pre-judgment interest, though no civil fine was assessed.[24] In contrast, that same month, the SEC charged Nature’s Sunshine Products (“NSP”), a Utah-based supplement company, in an SEC-only enforcement action for violating both the antibribery and accounting provisions of the FCPA. The charges related to $1 million in illicit payments made by NSP’s wholly-owned Brazilian subsidiary to circumvent Brazil’s import laws. The SEC did not attempt to trace any revenue or estimated profit back to these payments and required no disgorgement of NSP, instead imposing a $600,000 civil fine on the company.[25]
In one of its most recent FCPA dispositions, the SEC settled charges with Innospec, Inc., a specialty chemical company incorporated in Delaware, relating to $6,347,588 in illicit payments in Iraq and Indonesia (as well as the promise to pay $2,870,377 more) that resulted in profits of $60,071,613 for the company. The settlement’s order imposing disgorgement, however, was peculiar. Brought alongside actions by the DOJ and the United Kingdom’s Serious Fraud Office, the SEC action ordered Innospec to disgorge $60,071,613, but then waived $48,871,613 of that amount, requiring the company to only pay $11,200,000.[26] The pleadings in the case state that the SEC waived the majority of the assessed disgorgement due to concerns about Innospec’s financial solvency.
As things stands now, corporations involved in settlement talks with the SEC over potential FCPA violations have to rely on best-guess estimates in assessing how much the SEC may seek to disgorge. The SEC may ask a company to calculate its profits from alleged violations and outline any assumptions it made in producing these figures; however, this is no guarantee that the SEC will use such calculations. The SEC may challenge a company on assumptions it has made or seek to make its own approximation of profits. The SEC carries considerable leverage into these negotiations. Any approximation of profit that is produced will ultimately depend on the discretion exercised by the SEC in determining what charges to bring or findings to make in the first place. These charges and findings will form the basis on which all calculations of ill-gotten gains will end up resting.
In light of the leverage wielded by enforcement agencies in these settlement talks, many companies and law firms involved in the settlement process have found negotiations about profit calculations and disgorgement amounts to be arbitrary. The line between penalty and restitution can often blur as potential amounts to be disgorged are negotiated alongside potential civil fines. In order to avoid the expense and uncertainty of litigation, a company may end up consenting to a disgorgement figure that it does not feel is an accurate reflection of profits yielded by the alleged violations.
Conclusion
Over the last six years, disgorgement has served to significantly increase the financial loss that companies are exposed to in FCPA enforcement matters. In addition to the considerable civil penalties often imposed by the SEC as part of FCPA settlements, the SEC has made clear that it will not hesitate to seek recovery of large sums through disgorgement provided they are reasonably related to the alleged misconduct. Yet the methodology used by the SEC to support the amounts it seeks to disgorge has not been much discussed. In the absence of adequate guidance as to how these sums are calculated, disgorgement poses an even greater risk in the current aggressive FCPA enforcement climate.
About the Authors
Sasha Kalb and Marc Alain Bohn are associates in Miller & Chevalier Chartered’s FCPA & International Anti-Corruption practice group.
Sasha Kalb focuses on the Foreign Corrupt Practices Act (FCPA), customs law, and export controls. Ms. Kalb has worked on numerous internal compliance reviews in Europe, Asia, and Central Asia. She has also worked with companies to tailor and enhance corporate compliance programs.
Marc Alain Bohn focuses on the Foreign Corrupt Practices Act (FCPA), export controls and economic sanctions, and other international trade and policy issues. He advises U.S. and international companies on compliance and enforcement matters, including export licensing, voluntary disclosures, and internal investigations. He also works with companies to develop tailored forward-looking compliance programs with effective systems of internal control.
References:
[1] Sasha Kalb and Marc Alain Bohn are associates in Miller & Chevalier Chartered’s FCPA & International Anti-Corruption practice group.[2] See In re Statoil ASA, SEC Admin. Pro. File No. 3-12453 (Oct. 13, 2006); SEC v. Willbros Group, Inc. et al., No. 4:08-cv-01494 (S.D. Tex. 2008); SEC v. Halliburton Co. and KBR, Inc., No. 4:09-cv-00399 (S.D. Tex. 2009);
andSEC v. Siemens Aktiengesellschaft, No. 08-CV-02167 (D.D.C. 2008), and SEC v. Daimler AG, No. 1:10-cv-00473 (D.D.C. 2010).[3] The FCPA criminalizes the bribery of non-U.S. foreign officials. See 15 U.S.C. §§ 78dd-1(a), 78dd-1(g), 78dd-2(a), 78dd(2)(i) and 78dd-3. In addition, the FCPA also requires issuers (corporations that have issued securities that have been registered in the United States or who are required to file periodic reports with the SEC) to keep accurate books and records and to establish and maintain a system of internal controls adequate to ensure accountability for assets. 15 U.S.C. § 78m.
[4] See SEC v. First City Financial Corp., 890 F.2d 1215, 1230 (Dist. D.C. 1989); see also SEC v. Patel, 61 F.3d 137, 139 (1st Cir. 1995); and SEC v. Druffner, 517 F. Supp. 2d 502, 511 (Dist. Mass, 2007).
[5] See Securities Exchange Act of 1934, §§ 78u-2(e) and 78u-3(e).
[6] See First City Financial Corp., 890 F.2d 1215, 1230
[7] See “Deducting Disgorgements,” FCPA Blog, January 6, 2010, available at http://www.fcpablog.com/blog/2010/1/6/deducting-disgorgements.html (accessed February 18, 2010). [8] See SEC v. ABB Ltd., No. 1:04-cv-01141 (D.D.C. 2004). [9] See SEC v. Westinghouse Air Brake Techs. Corp., No. 08-cv-706 (E.D. Pa. 2008) and Siemens Aktiengesellschaft, supra n.1. In 2006, the SEC technically required Tyco International, Ltd. to disgorge $1 as part of its settlement of numerous charges, including securities fraud and FCPA violations. We have not counted this as a disgorgement disposition in our statistics for this article since nothing was essentially disgorged and many of the allegations revolved around non-FCPA charges, making it unclear whether the token disgorgement was rooted in an FCPA charge. See SEC v. Tyco Int’l. Ltd., No. 06-cv-2942 (S.D.N.Y. 2006). [10] No prejudgment interest was required as part of the Siemens disgorgement, but this is the exception rather than the rule. See, e.g., SEC v. AGCO Corporation, No. 1:09-CV-01865 (D.D.C.) ($2,000,000 in pre-judgment interest assessed); SEC v. Fiat S.p.A. and CNH Global N.V., No. 08 CV 0221 (D.D.C.) ($1,899,510 in pre-judgment interest assessed); and Willbros Group, supra n.2 ($1,400,000 in pre-judgment interest assessed). [11] See First City Financial Corp., 890 F.2d 1215 at 1231. [12] See Id. [13] See Id. In insider trading cases, the “proper amount of disgorgement is generally the difference between the value of the shares when the insider sold them while in possession of the material, nonpublic information, and their market value ‘a reasonable time after public dissemination of the inside information.’” See SEC v. Happ, 392 F.3d 12, at 44 (1st Cir. 2004). [14] See First City Financial Corp., 890 F.2d 1215 at 1231. [15] See SEC v. Macdonald, 699 F.2d 47, 54 (1st Cir. 1983). (“When a fraudulent buyer has reached the point of his full gain from the fraud, viz., the market price a reasonable time after the undisclosed information has become public, any consequence of a subsequent decision, be it to sell or to retain the stock, is res inter alios, not causally related to the fraud.”) [16] See Id. [17] See SEC v. Shapiro, 494 F.2d 1301, 1309 (2nd Cir. 1974). [18] See Id. [19] See 17 CFR §201.600 [20] See, e.g., Statoil supra n.1 (generic reference to an Iranian oil contract that the company secured); SEC v. Chevron Corp., No. 07-cv-10299 (S.D.N.Y. 2007), (generic reference to contracts for the sale of oil the company secured); SEC v. Flowserve Corp., No. 08 CV 00294 (D.D.C.) (generic reference to seals, valves and service contracts the company secured); SEC v. ITT Corp., No. 1:09-cv-00272 (D.D.C. 2009) (alleged $4 million in realized revenue, but did not stipulate profit); Fiat S.p.A. supra n. 9 (alleged $59 million in realized revenue, but did not stipulate profit; and SEC v. Avery Dennison Corp., No. CV09-5493 (C.D.Cal. 2009), (alleged $1.25 million in realized revenue, but did not stipulate profit). [21] Note that Tyco, with its $1 token disgorgement, is not counted as a disgorgement disposition here. See n. 9. [22] The Oil for Food cases generally involve no antibribery charges because payments were routed to the Iraqi government rather than individual foreign officials. Nevertheless, these cases, which typically involve significant kickbacks and willful conduct by senior executives, tend to bear more similarity to antibribery dispositions than to dispositions alleging only accounting violations. See, e.g., SEC v. El Paso Corp., No. 07-cv-00899 (S.D.N.Y. 2007); Chevron Corp., Supra n.20; Fiat S.p.A. supra n.10., and AGCO Corporation, supra n.10. Incidentally, every disposition involving the U.N. Oil for Food scandal thus far has required disgorgement. [23] Accounting-only FCPA violations include violations of the reporting, books and records and/or internal controls provisions of the FCPA. See n. 3. [24] See In re Helmerich & Payne, Inc., Admin.Pro. File No. 3-13565 (July 2009). [25] See SEC v. Nature’s Sunshine Products, Inc. et al., No. 2:09-0672 (D. Utah 2009).[26] See SEC v. Innospec, Inc., No. 1:10-cv-00448 (RMC) (D.D.C.).
