Enforcement News: Canadian Clean Fuel Technology Company and Its Former CEO Charged with Violating the FCPAPrint Article
- Posted on: Oct 7 2019
The Foreign Corrupt Practices Act (“FCPA”) requires issuers to “devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that” all transactions are “executed” and “recorded … to permit [the] preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and … to maintain accountability for [the issuer’s] assets.” 15 U.S.C. §§ 78m(b)(2)(B). As discussed below, compliance with this requirement has been a continued focus of the Securities and Exchange Commission (“SEC” or the “Commission”) for many years. (Here.)
The internal controls provisions of the FCPA apply to all issuers (i.e., entities that register their securities pursuant to Section 12 of the Securities Exchange Act of 1934 (“Exchange Act”) or file reports (periodic or otherwise) pursuant to Section 15(d) of the Exchange Act) whether they are publicly traded or based in the United States.
Under the FCPA, issuers are responsible for their internal controls as well as those of their subsidiaries. However, the FCPA limits the obligations of the parent corporation when the parent owns less than 50% of the subsidiary. Under that circumstance, the parent need only demonstrate a good faith effort to ensure the sufficiency of the subsidiary’s internal controls. 15 U.S.C. § 78m(b)(6).
Compliance with the internal controls provisions of the FCPA requires issuers to give “reasonable assurance” that transactions are executed, and assets are accounted for in accordance with management’s authorization and recorded as necessary to permit the preparation of financial statements in conformity with generally accepted accounting principles. The FCPA defines “reasonable assurances” as “such level of detail and degree of assurance as would satisfy prudent officials in the conduct of their own affairs.” 15 U.S.C. § 78m(b)(7). Courts interpret the “reasonable assurance” standard as follows:
The definition of accounting controls does comprehend reasonable, but not absolute, assurances that the objectives expressed in it will be accomplished by the system. The concept of “reasonable assurances” . . . recognizes that the costs of internal controls should not exceed the benefits expected to be derived.” It does not appear that either the SEC or Congress . . . intended that the statute should require that each affected issuer install a fail-safe accounting control system at all costs. It appears that Congress was fully cognizant of the cost-effective considerations which confront companies. . . and of the subjective elements which may lead reasonable individuals to arrive at different conclusions. Congress has demanded only that judgment be exercised in applying the standard of reasonableness.… It is also true that the internal accounting controls provisions contemplate the financial principle of proportionality—what is material to a small company is not necessarily material to a large company.”
SEC v. World-Wide Coin Invs., Ltd., 567 F. Supp. 724, 751 (N.D. Ga. 1983).
Since compliance with the FCPA’s internal controls provision is a fact-dependent, analysis, courts and the Commission look at several factors to determine whether the issuer has established and maintained an effective internal accounting controls system. Among the factors considered are the “size of the business, diversity of operations, degree of centralization of financial and operating management, amount of contact by top management with [the issuer’s] day-to-day operations.…” Id. See also Foreign Corrupt Practices Act of 1977: Statement of Policy, SEC Release No. 34-17500 (Jan. 29, 1981) (46 F.R. 11544). (Here at Appendix L.) Notably, the materiality of the transaction is not a factor considered by the courts or the Commission.
As noted, enforcement of the FCPA remains “a high priority area for the SEC.” (Here.) In 2010, the SEC’s Enforcement Division created a specialized unit to enhance its enforcement of the FCPA (here). Since that time, the SEC has commenced and/or settled numerous enforcement proceedings involving the anti-bribery and/or internal controls provisions of the FCPA.
Today, this Blog examines In the Matter of Westport Fuel Systems, Inc. et al., Administrative Proceeding File No. 3-19543 (Sept. 27, 2019), which involved alleged violations of the anti-bribery, books and records, and internal controls provisions of the FCPA.
According to the SEC, Westport Fuels Systems, Inc. (“Westport”), a Canadian clean fuel technology company headquartered in Vancouver, Canada, and its former chief executive officer (“CEO”), Nancy Gougarty (“Gougarty”), of Leesville, South Carolina, violated the anti-bribery, books and records, and internal controls provisions of the FCPA by paying bribes to a foreign government official in China. Westport registers its common stock with the SEC pursuant to Section 12(b) of the Exchange Act and trades its securities on the NASDAQ and the Toronto Stock Exchange.
[Ed. Note: the factual discussion below is taken from the SEC’s Order Instituting Cease-and-Desist Proceedings Pursuant to Section 21c of The Securities Exchange Act Of 1934, Making Findings, and Imposing a Cease-and-Desist Order (the “Order”).]
The proceeding arose from a joint venture (“JV” or “Joint Venture”) between Westport and a Chinese state-owned entity (“SOE-1”). In March of 2013, at the direction of a Chinese Government Official, SOE-1 proposed taking the JV public in China through an initial public offering (“IPO”). The JV’s manager, appointed by SOE-1, falsely represented to Westport that Chinese law required SOE-1 to have a majority interest in the Joint Venture to qualify for an IPO. Accordingly, the manager of the JV advised Westport that a preliminary step in the IPO process would involve restructuring the Joint Venture so that a portion of the shares held by Westport and a privately held Hong Kong conglomerate would have to be transferred to SOE-1 and a Chinese private equity fund (in which the Government Official held a financial interest). Although the shares were transferred to the private equity fund, the contemplated IPO never took place.
Once the proposed restructuring was complete, SOE-1 would own 51% of JV’s shares, Westport would own 23.33% through its Hong Kong subsidiary, the Hong Kong conglomerate would own 16.67%, and the Chinese private equity fund would own 9%. On February 11, 2014, the JV board of directors approved the proposed share transfer. Gougarty, who at the time was Westport’s Chief Operating Officer, led the Westport team in the negotiations with SOE-1.
In April 2014, Gougarty recruited and hired a Chinese national to head Westport’s Asia Pacific regional office (the “Asia Pacific GM”). The Asia Pacific GM played a central role in the negotiations with SOE-1 and the Chinese private equity fund.
Early in the negotiations, the Asia Pacific GM reported that the Government Official had a significant but undisclosed financial interest in the Chinese private equity fund that was to receive the JV shares from Westport and the Hong Kong conglomerate. He also reported that it was the Government Official’s personal financial interest, not Chinese law, which was motivating the transfer of shares to the private equity fund.
According to the SEC, the Government Official’s personal interest became a central part of Westport’s negotiation strategy. Gougarty recommended alternatives that included seeking a supply agreement in exchange for a transfer of shares to the private equity fund. No later than March 2015, Westport explicitly conditioned the share transfer on obtaining a long-term sales agreement. Having acknowledged Westport’s position of “no component sales contract, no share transfer,” Gougarty instructed Westport employees working for her on the transaction in March 2016 that the component supply agreement was a necessary element to complete the deal.
The negotiations progressed slowly as the Government Official and Westport disagreed on the share transfer price, a figure derived from the valuation of the Joint Venture. In March 2015, after meeting with executives at the private equity fund, the Asia Pacific GM reported that the Government Official was seeking a low valuation in order to “make quick and big money” outside the scrutiny of Chinese regulators. At the same time, Westport was seeking to maximize its value in order to alleviate its deteriorating financial condition and cash needs. However, as oil prices declined in 2014 and 2015, increasing the market for gasoline-powered car engines and reducing the market for Westport’s alternative fuel products, Westport became more willing to accept a lower valuation in order to close the deal and obtain the much-needed, albeit smaller, infusion of cash.
On June 29, 2015, Westport’s Board of Directors (the “Board”) authorized Westport’s management to complete the negotiations and execute the share transfer. Gougarty did not disclose to the Board what the Asia Pacific GM had told her about the Government Official’s personal financial interest in the private equity fund or that the Government Official had requested a discount in the share transfer price. In fact, alleged the SEC, approximately nine months before obtaining the Board’s approval, Gougarty withheld this information from the Board, deleting a sentence in a September 2014 draft letter to the Board prepared by the Asia Pacific GM that described the proposed transfer. If Gougarty had not redacted the sentence, the SEC maintained, it would have reported to the Board that the Government Official had a financial interest in the Chinese private equity fund.
By early December 2015, Westport and the Government Official, negotiating through SOE-1 and the private equity fund, struck a deal. They agreed on a valuation of $70 million for the JV, and Westport agreed to transfer shares to SOE-1 and the private equity fund in exchange for a long-term framework supply agreement and a cash dividend of 30% of undistributed profits – 20% more than what was provided for under the joint venture agreement and more than Westport had received in the past. Westport also agreed, as Gougarty explained earlier in November 2015, that the public announcement of the deal would be limited to “talk[ing] about the transfer of share[s] to [SOE-1] and [an] unidentified Chinese company.”
On August 20, 2016, Gougarty, by then Westport’s CEO, executed the share transfer agreements with the Chinese private equity fund and with SOE-1. That same day, the JV and Westport entered into a framework supply agreement pursuant to which the JV eventually would purchase approximately $500,000 of engine components from Westport. By separate resolution, executed on the same day, the JV authorized the distribution of a 30% dividend to all of the shareholders.
On September 29, 2016, as reflected in bank records maintained as source documents in Westport’s files, the private equity fund wired a payment of approximately $3 million to Westport’s bank in Vancouver, Canada, from its bank in China through a correspondent bank in the United States. However, even though Westport’s accounting controls required the comparison of source documents with journal entries, Westport’s books and records accounting for the transaction falsely reflected the identity of the counterparty in the transaction as SOE-2, an entity related to SOE-1, rather than the true counterparty, the private equity fund.
In October 2016, Westport received approximately $3.5 million, representing the increased dividend approved by the JV board of directors on August 20, 2016, the same day that Westport executed the share transfer agreements to the private equity fund and SOE-1. The $3.5 million dividend was credited to Westport’s bank account in Vancouver, Canada, having been sent from a bank in China through a correspondent bank in the United States.
On November 9, 2016, Westport filed its Form 6-K with the SEC which, according to the Commission, falsely described the identity of the counterparty in the share transfer as SOE-2 instead of the Chinese private equity fund. Even though Westport’s internal accounting controls purported to establish a process to reconcile public filings with source documents to provide reasonable assurance with respect to the accuracy and consistency of its filings, it failed to follow this process, alleged the SEC.
On March 31, 2017, Westport filed its annual report on Form 40-F for the year ended December 31, 2016. According to the SEC, the Management Discussion & Analysis and financial statements attached to the Form 40-F falsely reported the identity of the counterparty in the share transfer as SOE-2 instead of the Chinese private equity fund. In connection with the filing of the Form 40-F, Gougarty executed a certification attesting that Westport had disclosed all significant deficiencies and material weaknesses in the design and operation of its internal controls to the outside auditors. However, said the SEC, the certification was knowingly false because Gougarty failed to disclose the deficiencies and weaknesses in the internal controls that she had exploited in carrying out the transaction in circumvention of Westport’s anti-bribery policies and its key accounting controls.
Westport and Gougarty agreed to settle the SEC’s charges for $4.1 million without admitting or denying the SEC’s findings. In that regard, Westport agreed to pay $2,546,000 in disgorgement and prejudgment interest and a civil penalty of $1,500,000, and Gougarty agreed to pay a civil penalty of $120,000. In determining to accept Westport’s offer, the SEC considered remedial actions undertaken by Westport concerning its anti-corruption and financial reporting compliance programs, and its cooperation with the SEC’s investigation.
“A company’s commitment to compliance is only as strong as the effort put in by senior management,” said Charles Cain, Chief of the SEC Enforcement Division’s FCPA Unit. “Here, the chief executive exploited weaknesses in the company’s controls to engage in bribery, undermining shareholder interests.”