SEC and DOJ Issue First FCPA Declination Opinions
Some in the FCPA commentariat have long said that the Justice Department and SEC should publicly issue declination opinions when the agencies decide not to pursue a matter. We already see the factual scenarios that lead those agencies to file charges, in the form of the complaints and indictments themselves. Many have argued that declination opinions would be a very useful window into the factual scenarios that do not rise to that level. They won’t call it this officially, but on April 25th, the SEC and DOJ sort of issued their first FCPA declination opinions. The opinions came in the form of a case where former Morgan Stanley managing director Garth Peterson was charged with FCPA violations and investment adviser fraud, but Morgan Stanley itself conspicuously escaped sanction.
Facts of the Garth Peterson Matter
As a Morgan Stanley managing director and the head of the bank’s Shanghai office, Peterson’s job was to evaluate, negotiate, acquire, manage, and sell real estate investments on behalf of Morgan Stanley’s advisers and funds. As such, he owed a fiduciary duty to Morgan Stanley and to the funds’ clients. By the time he was terminated in 2008, he had worked on at least 28 deals in China. Many of those deals involved Yongye Enterprise (Group) Co. Ltd., a real estate development arm of the Luwan District Government in Shanghai. Peterson’s misrepresentations about some of those deals form the core of the SEC’s complaint.
Investment Adviser Fraud Violations
In one such deal, called Project Cavity, a Morgan Stanley real estate fund known as MSREF IV bought one tower of a two-tower apartment building in Shanghai. As Peterson negotiated Project Cavity, he secretly planned, along with Yongye’s chairman and a Canadian attorney, to buy an interest from MSREF IV after that fund bought the tower. The three used a British Virgin Islands entity called Asiasphere Holdings to purchase and hold their interest in the tower. And because of his relationship with the Yongye chairman, Peterson was able to negotiate both sides of the transaction, in breach of the fiduciary duty he owed to MSREF IV. Peterson repeatedly misled Morgan Stanley about his and Asiasphere’s interests in the tower. He told his superiors that Asiasphere was in fact a Yongye subsidiary, not a separate entity owned by Yongye’s chairman and Peterson himself. “Just to be clear,” he said in an email to several Morgan Stanley employees, “[the Yongye chairman] will not ‘acquire another 4.5% of shares’ from [Morgan Stanley]. It’s Yong Ye. . . .”
FCPA Violations
In another deal, Morgan Stanley negotiated at least five separate Chinese real estate investments involving Yongye and its chairman. To incentivize the chairman to help Morgan Stanley win this business, Peterson invited him to invest personally with the bank and its funds in these five pending investments at a discount. Specifically, he gave the chairman a “3-2-1” deal. Under its terms, Morgan Stanley would sell the Yongye chairman a 3% interest in each deal he brought to Morgan Stanley for the cost of 2%, allowing him to keep the remaining 1% as a “finder’s fee.” Peterson also promised to pay an added return on any completed purchase he called a “promote,” to incentivize the official to help make any acquired investments profitable. Peterson told supervisors about the 3-2-1 arrangement in April 2006. But before the Yongye chair had been paid anything, a Morgan Stanley compliance officer warned him of the bribery implications of paying the official personally for help obtaining business. One of Peterson’s supervisors then told him to abandon the 3-2-1 deal entirely. He didn’t.
Law Enforcement’s View of Morgan Stanley
Morgan Stanley voluntarily reported these violations after they came to its attention, and the government, it seems, could not have been happier. The SEC devoted almost two pages of its complaint to describing Morgan Stanley’s extensive FCPA compliance program and internal controls. In it we learn that Peterson received training on anti-corruption policies seven times between 2002 and 2008. He was reminded 35 times about those policies, and had written materials in his office to back up those reminders. For its part, the Justice Department included an entire paragraph in its press release to Morgan Stanley’s compliance efforts. It notes, among other things, that the bank’s compliance personnel regularly monitored transactions, randomly audited particular employees, transactions, and business units, and tested to identify illicit payments. The quotes from the various law enforcement personnel are also telling for the degree to which they shower praise on Morgan Stanley and blame on Peterson:
Criminal Division Chief Lanny Breuer: “As a managing director for Morgan Stanley, he had an obligation to adhere to the company’s internal controls; instead, he lied and cheated his way to personal profit.”
U.S. Attorney for the E.D.N.Y. Loretta Lynch: “This defendant used a web of deceit to thwart Morgan Stanley’s efforts to maintain adequate controls designed to prevent corruption. Despite years of training, he circumvented those controls for personal enrichment.”
SEC Enforcement Director Rob Khuzami: “This case illustrates the SEC’s commitment to holding individuals accountable for FCPA violations, particularly employees who intentionally circumvent their company’s internal controls.”
SEC FCPA Unit Chief Kara Brockmeyer: “As a rogue employee who took advantage of his firm and its investment advisory clients, Peterson orchestrated a scheme to illegally win business while lining his own pockets and those of an influential Chinese official.”
If these officials are speaking code, it’s pretty easy to crack. They are saying about as plainly as they can that if a company does what it can to prevent FCPA violations from taking place, an employee who ignores those internal controls and lies about his actions will not render the compliance efforts a nullity.
Declination Opinions in the Future?
This does not have to be a one-off event. Occasionally companies walk in the door of the SEC and the Justice Department to report FCPA violations that are not enough to merit prosecution. Believe it or not, it happens. Neither agency has felt comfortable enough to issue opinions describing the facts and why filed charges were not merited. There are legitimate reasons not to. The SEC and DOJ would not want corporations to infer a “floor” below which law enforcement would not deign to prosecute. If companies pay foreign government officials to obtain business, at whatever level, the government would generally like them to fear being punished for doing that. Companies who do escape charges also would want to avoid any public record that could lead to their identification and the private lawsuits that could follow.
It is also no small matter for the enforcement staff to change procedures in a way to allow for public declination opinions. The bureaucratic issues involved in doing that are quite difficult, involve memos and meetings and persuasion on top of whatever one’s day job entails. Still, it can be done. The Justice Department already has an opinion release procedure – not so different from SEC no-action letters – by which companies can seek assurance that their business plans will not trigger an FCPA charge. The program is not hugely prolific; it typically results in two or three opinions each year. But it does add to the mosaic of information available to companies as they plan their global business activities. Declination opinions by both agencies could do the same thing, and could give concrete examples of voluntary self-reports leading to good results – at a time when some question the value of self-reporting at all. Too much money is at stake in the form of penalties, internal investigation expenses, and other costs to ignore this option. The Morgan Stanley matter may indicate the SEC and DOJ could be going in that direction.