On May 7, 2013, the U.S. Attorney's Office for the Southern District of New York (SDNY) unsealed extraordinary criminal charges against two registered representatives of a U.S. broker-dealer and a high-level Venezuelan government official for engaging in a "Massive International Bribery Scheme." What makes this fraud scheme remarkable is that it involves the activities of a U.S. broker-dealer, its client, a foreign-owned and controlled bank, the Foreign Corrupt Practices Act (FCPA) and several suspicious transactions that potentially should have raised concerns—a perfect storm. This case may be the catalyst that jump-starts a government FCPA sweep of Wall Street that has been predicted since 2011, but not realized.
As some may recall, in January 2011, The Wall Street Journal reported that the U.S. Securities and Exchange Commission (SEC) was conducting an FCPA sweep of certain banks, hedge funds and private equity firms over their relationships with sovereign wealth funds (SWF). The substance of that SEC inquiry related to whether these entities were bribing foreign officials of SWFs for business. Soon after that article, many FCPA experts predicted that following the sweeps of the oil and gas industry and pharmaceutical and medical devices that Wall Street was next. Many detractors of big business believed it was finally due. Since 2011, nothing has materialized from the SWF investigations. For many who represent large financial services companies, this result was not surprising. After all, broker-dealers and financial services companies generally take compliance seriously. However, U.S. authorities may decide to take another look at broker-dealers and others who have foreign officials as clients.
The SDNY prosecution and related SEC civil complaint are not about a Venezuelan SWF, but parallels can be drawn between the SEC concern in 2011 and what was revealed in the criminal complaint on May 7, 2013, and in the related SEC civil complaint. The core issue is whether U.S. persons in the financial markets are paying foreign officials for business. This new prosecution highlights that a broker-dealer's anti-money laundering procedures, as well as oversight of their registered people, should have an FCPA component if the firm is doing international business. This prosecution is likely to act as a wake-up call to broker-dealers, banks, private equity and hedge funds and others who have foreign officials as clients and who engage business with foreign-owned or foreign-controlled companies. We will offer some items for consideration on how to identify and minimize any potential FCPA risks.
The Bribery Scheme
According to the allegations filed by the SDNY, the SEC civil complaint and other records, Tomas Alberto Clarke Bethancourt and Jose Alejandro Hurtado, who were both employees of U.S. broker-dealer Direct Access Partners (Broker-Dealer); and Maria de los Angeles Gonzalez de Hernandez, a senior official in Venezuela's state economic development bank, Banco de Desarrollo Económico y Social de Venezuela (BANDES), were accused of criminally conspiring to pay bribes to Gonzalez in exchange for her directing BANDES's financial trading business to the Broker-Dealer. The nature of the illegal scheme is not new or innovative. The method by which the defendants allegedly attempted to conceal the scheme from authorities was highly sophisticated and complex.
The U.S. Department of Justice (DOJ) described in its release the details of the fraud.
"From April 2009 through June 2010, Clarke, Hurtado, and Gonzalez participated in a bribery scheme in which Gonzalez directed trading business she controlled at BANDES to the Broker-Dealer, and in return, agents and employees of the Broker-Dealer split the revenue the Broker-Dealer generated from this trading business with Gonzalez. During this time period, the Broker-Dealer generated over $60 million in mark-ups and mark-downs from trades with BANDES. Agents and employees of the Broker-Dealer, including Clarke and Hurtado, devised a split with Gonzalez of the commissions paid by BANDES to the Broker-Dealer. Emails, account records, and other documents collected from the Broker-Dealer and other sources reveal that Gonzalez received a substantial share of the revenue generated by the Broker-Dealer for BANDES-related trades. Specifically, Gonzalez received monthly kickbacks from Broker-Dealer that were frequently in six-figure amounts."
The DOJ made a point of identifying what it considered red flags in the operations and trading that should be highlighted.
"Some of the trades the Broker-Dealer executed for BANDES had no discernible business purpose. For instance, in January 2010, the Broker-Dealer executed at least two round-trip trades between itself and BANDES for the same bonds on the same day. In other words, the Broker-Dealer bought certain bonds from BANDES and then immediately sold those same bonds back to the bank. The result of the trades was that BANDES was left with the same bond holdings as before the trades, except that it had paid the Broker-Dealer approximately $10.5 million in mark-ups in the course of the two round-trip transactions."
An apparent implication of the DOJ's allegations is that the Broker-Dealer's supervision and surveillance functions should have detected these transactions. It would not be surprising for a round-trip transaction to raise a red flag for potential money-laundering or possibly for high-frequency or market-timing type of activities, depending on the product involved. Because the DOJ's complaint is the only reference at this point, it is unknown what procedures this particular broker-dealer had in place. Nevertheless, broker-dealers with international business may want to review their policies and procedures to confirm that FCPA issues are properly being considered.
The DOJ allegations further suggest that the defendants shared the proceeds of the alleged fraud with each other and that they used intermediaries to conceal the fraud.
"Certain payments to Gonzalez directly from Hurtado and an entity controlled by Clarke totaled at least $3.6 million. When added together with other payments referenced in the Complaint, Gonzalez received a total of at least $5 million. To further conceal the scheme, the kickbacks to Gonzalez were often paid using intermediary corporations and offshore accounts that she held in Switzerland, among other places. For instance, Clarke used an account he controlled in Switzerland to transfer funds to an account Gonzalez controlled in Switzerland. Gonzalez then transferred some of this money to an account she held in the United States. Additionally, Hurtado and his spouse received substantial compensation from the Broker-Dealer, portions of which Hurtado transferred to an account held by Gonzalez in Miami and to an account held by an associate of Gonzalez in Switzerland. Hurtado also sought and received reimbursement from Gonzalez for the payment of U.S. income taxes related to the money that he used to make kickback payments to Gonzalez."
Again, broker-dealers often review the bank accounts of their registered people to confirm that client funds are not being stolen and that commissions are not being improperly split with non-registered people. But are broker-dealers adequately considering FCPA issues when monitoring the financial transactions of their registered people? This review is often limited to an annual audit, which occurs yearly or perhaps only every couple of years. If the broker-dealer is conducting international business, it may be worthwhile to posit: Should these reviews happen more frequently?
Were there any red flags in the case? According to the SEC complaint, there may have been red flags for the U.S. broker-dealer to consider. "In 2007 and 2008, [the Broker-Dealer] reported revenues of approximately $15 million and $27 million, respectively, almost exclusively from unsolicited equity transaction commissions." (SEC Complaint para. 21.) In 2009, the Broker-Dealer's business changed dramatically, as its "revenues soared in 2009 to $75 million (five times what it had been only two years before) and were $31 million in the first half of 2010, with the increase almost exclusively due to the fraudulent scheme." Id. Broker-dealers are required to have a process in place to ensure that their policies and procedures are reasonably designed to achieve compliance with applicable Financial Industry Regulatory Authority (FINRA) rules, Municipal Securities Rulemaking board (MSRB) rules and federal securities laws and regulations. As the broker-dealer's business model changes, the process should ensure that the policies and procedures evolve with the business. Each year, the chief executive officer is required to certify that the firm is in compliance with these requirements. If a broker-dealer is conducting international business or is considering expanding into international business, then perhaps these processes need to include some consideration and testing for FCPA compliance.
Without casting blame on the broker-dealer in this case, it remains to be seen what programs it had in place and whether there is any exposure for a failure-to-supervise charge by the regulators, or more.
For Broker-Dealers and Financial Companies
The purpose of this Alert is not to focus on the guilt or innocence of those charged in the government cases or to negatively cast an industry for the alleged acts of a few. This case demonstrates that Wall Street is not immune to the concerns and risks of other industries and global companies, large and small. It is important to note that the broker-dealer in this case had revenues in the range of $15 million to $30 million.
Below are possible strategies to consider on how to identify and potentially minimize FCPA risks.
Conduct a Risk Assessment. Market participants that have no contact with foreign companies as part of your operations are likely to be in good shape. If the answer to this question is not readily apparent, then it may be worthwhile to learn quickly. If a company conducts regular business with foreign companies, then it should understand whether the entities with which it does business are "foreign officials." The purpose of the risk assessment is to determine FCPA risks given a company’s business model, interaction with foreign officials and jurisdictions in which it does business. Working with qualified FCPA experts may help to identify areas of concern. Additionally, broker-dealers and others need to know their historical trading with foreign clients and should understand the relationships and note any major increases in business.
Develop and Implement an Anti-Corruption Compliance Plan. A well designed program that is tailored to the specific risks of the company may go a long way toward avoiding problems or addressing them as they arise. It may be worthwhile to train employees actively and to secure periodic certifications of their obligations and knowledge of the FCPA. This will likely link with and complement the company's anti-money laundering compliance program; however, other aspects of the company's compliance and supervisory programs may require some enhancements for FCPA compliance purposes.
Due Diligence. Companies should know whether they are doing business with foreign officials and ensure that they know who the foreign officials are and how they are doing business. It may be prudent to know and conduct due diligence on all third parties, finders or intermediaries.
Monitor FCPA Compliance Plan and Periodic Reassessment. A company with a plan in place should ensure that it creates systems to allow for active monitoring. Each company has to decide the level of the monitoring and audit regime.
In many cases, developing an FCPA compliance program will not be challenging to add to an existing compliance system. It requires experience and judgment to tailor to the company's needs.
For Foreign Banks
Foreign banks and those who manage the foreign companies may want to look into the mirror and ask if they are doing enough to monitor the risks posed by this case. Here are some items to consider:
How are U.S. broker-dealers (private equity and hedge funds) reviewed and selected by the institution?
Find out who is being compensated, including finders and third parties with whom the company does business, and secure the answers in writing.
Understand the historic trading with the U.S. entities.
Create compliance programs to ensure integrity of the selection process and the business.
In each case, the needs may be different and the internal and external relationships may be complex. It may be prudent for a company to tailor the review to its specific needs.
In the event that there was previous uncertainty, U.S. financial markets are now on notice that the FCPA is an obligation and that the U.S. government has reason to ask more questions. It appears worthwhile for companies to be prepared and have their house in order to potentially avoid problems later. There is no excuse now for medium- to small-broker dealers, companies and funds to avoid looking into these matters, as it may end up being a worthwhile endeavor in the end.
For Further Information
If you have any questions about this Alert, please contact Mauro M. Wolfe, John Goselin, any member of the White-Collar Criminal Defense, Corporate Investigations and Regulatory Compliance Practice Group or the attorney in the firm with whom you are regularly in contact.