Law360, New York (February 09, 2009) -- The recent trend of increasing U.S. Securities and Exchange Commission and Department of Justice investigations and enforcement proceedings arising out of Foreign Corrupt Practices Act (“FCPA”) violations has been well documented and analyzed.
Concomitant with that increase is an increase in collateral civil litigation relating to FCPA enforcement matters, including securities class actions — the focus of this article.
(Other possible collateral civil actions include shareholder derivative actions, commercial litigation, employment and whistleblower litigation, ERISA actions, RICO actions and Alien Tort Claims Act litigation, to name a few.)
FCPA violations or allegations, as revealed by reported investigations, settlements, plea bargains or other reports, can trigger private securities class actions because such violations or allegations often involve companies’ false material statements about compliance with antibribery laws or failure to disclose material facts, such as corrupt payments to foreign officials, and such reports may have an effect upon a company’s stock price.
Several courts have found such misstatements or omissions to be actionable under Section 10 of the Securities and Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 and have allowed the cases to proceed where plaintiffs were able to demonstrate at the pleading stage a strong inference of scienter on the part of the officers who made such misstatements or omissions.
As set forth below, these precedents may inform companies’ decisions in dealing with both FCPA enforcement matters and potential collateral civil litigation.
The Ninth Circuit Court of Appeals’ recent decision in Glazer Capital Mgmt. LP v. Magistri, 549 F.3d 736, (9th Cir. 2008) is but the latest example of such collateral FCPA securities litigation, and, among other things, shows the importance of the issue of collective scienter in such cases.
In Glazer, Ninth Circuit affirmed the dismissal of a private securities class action brought against InVision Technologies Inc. and its CEO and CFO because the plaintiffs failed to allege facts to support a strong inference that the company officers who made false statements acted with the requisite scienter.
In Glazer, the plaintiff alleged that a representation contained in InVision’s publicly filed Merger Agreement with GE that — InVision was “in compliance in all material respects with all laws” — was false.
Plaintiffs alleged that at the time the representation was made, InVision was involved in making illegal payments to foreign sales agents in China, the Phillippines and Thailand, knowing the “high probability” that those funds would be used to make improper payments to local government officials to obtain or retain business.
InVision announced that an internal investigation had revealed possible FCPA violations in July 2004, several months after InVision filed the merger agreement.
At the time, InVision also announced that it had voluntarily reported the potential misconduct to the SEC and the DOJ and that the merger with GE could be delayed or terminated.
Following the announcement, the price of InVision’s stock dropped by more than six dollars per share, and a few days later shareholders filed a class action.
In December 2004, InVision announced that it had entered into a non-prosecution agreement with the DOJ and had agreed to pay a fine of $800,000 and that the SEC staff had agreed to recommend an offer of settlement that InVision had submitted.
The merger was consummated that same day as the resolution of the government enforcement action was announced.
Although the Ninth Circuit concluded that the plaintiff “has satisfied the pleading requirements of the PSLRA with respect to the issue of falsity” as to at least some of the statements, the court held that the plaintiff was not able to plead sufficiently that Sergio Magistri, InVision’s CEO who signed the merger agreement, had the requisite scienter.
The court did not decide whether in some circumstances scienter may be pled under a collective theory, the conclusion reached by the Second Circuit in Teamsters Local 445 Freight Division Pension Fund v. Dynex Capital Inc., 531 F.3d 190 (2d Cir. 2008) and by the Seventh Circuit in Makor Issues & Rights Ltd. v. Tellabs Inc., 513 F.3d 702 (7th Cir. 2008), because of the unique context and limited general compliance nature of the alleged misstatements in Glazer (as distinguished from the hypothetical in Makor, if General Motors said it sold one million SUV’s in 2006 when the actual number was zero).
The court held that the plaintiff did not plead any facts to demonstrate that Magistri was personally aware of the illegal payments or that he was actively involved in the details of InVision’s Asian sales.
The court rejected the plaintiff’s arguments that Magistri’s scienter could be inferred from:
(1) the nature of InVision’s business,
(2) the fact that Magistri signed a SOX certification,
(3) the discovery of the FCPA violations by GE during the due diligence process,
(4) the personal financial incentives for Magistri to consummate the merger, or
(5) the conclusions contained in the DOJ and the SEC settlement documents — in particular, the court relied on the fact that the company’s admissions in the settlement documents “were largely legal conclusions, rather than particularized facts giving rise to a strong inference of scienter,” and that the documents did not show Mr. Magistri’s actual knowledge of the violations.
While the Ninth Circuit in Glazer affirmed the dismissal, the same court reversed the dismissal of another FCPA-related securities class action and allowed claims to proceed against the company and several officers in Milton Arbitrage Partners LLC v. Syncor Int'l Corp. (In re Syncor Int'l Corp. Sec. Litig.), No. 05-55748, 2007 U.S. App. LEXIS 14257 (9th Cir. 2007) (unpublished).
In Syncor, the defendants made numerous statements attributing Syncor’s overseas earnings to a variety of legitimate business practices, while omitting any mention of illegal payments, which, plaintiffs alleged, were a significant reason for such growth.
To state their case, plaintiffs relied on confidential witnesses who claimed the defendants were present at a meeting in which the payments were credited with driving the company’s overseas growth and that the defendants referred to the payments as “bribes” and “buying off doctors.”
Similarly, in In re Immucor Inc. Sec. Litig., 1:05-cv-2276-WSD, 2006 U.S. Dist. LEXIS 72335 (N.D. Ga. Oct. 4, 2006), the plaintiffs alleged that Immucor and its CEO and president made false statements that:
(1) understated the scope and gravity of potential FCPA violations by Immucor’s Italian subsidiary and
(2) misrepresented that Immucor had in place controls adequate to prevent the wrongful conduct alleged.
Unlike in Glazer, the court held that plaintiffs in Immucor satisfied PSLRA’s pleading requirement because, among other things, they showed that the officers who made the misleading statements were directly involved in the conduct and knew or strongly suspected that Immucor had engaged in multiple acts of bribery.
Although Immucor revealed that its president was a subject of criminal investigation in Italy, the court held that Immucor did not completely and accurately describe the situation.
The court was satisfied that claims under Sections 10 and 20 of the Exchange Act were adequately pleaded and denied defendants’ motion to dismiss.
As a final example, in In re Nature’s Sunshine Products Securities Litigation, 486 F. Supp. 2d 1301 (D. Utah 2007) (“NSP”), the district court denied defendants’ motion to dismiss a securities fraud action brought under Sections 10 and 20 of the Exchange Act.
The plaintiff alleged in NSP that NSP’s officers filed false SOX certifications and provided false reassurances that NSP’s financial statements were accurate.
The plaintiffs claimed the statements were false in light of NSP’s auditors’ statement to the SEC that an investigation by a special committee of the board of directors of NSP found electronic evidence that the president of NSP knew of a fraud in the international operations of NSP, yet represented otherwise to the auditors, and that the president himself approved a payment in violation of the FCPA.
Defendants argued that the plaintiffs failed to demonstrate a connection between the fraud which the president knew of, and the alleged illegal FCPA payment referred to by the auditors, other than that they both related to NSP’s international operations.
The court rejected the defendants’ argument, finding that the plaintiffs set forth factual allegations which support that NSP took steps to cover-up a misdeed, failed to take remedial actions requested by the auditors and that suspicious insider trades took place. The court held that, taken as a whole, these allegations supported a strong inference of scienter.
As more companies are facing FCPA scrutiny from the SEC and DOJ, the number of collateral securities cases is also increasing.
The likelihood of such cases being filed should be considered by companies and their counsel involved in FCPA investigations or dealings with the SEC or DOJ, especially in conjunction with voluntary disclosure and settlement decisions, remediation, interactions with auditors and disclosures to investors.
In conducting investigations, companies should analyze whether, assuming a potential violation is uncovered, it would be material, what effects if any it may have if publicly disclosed, and who in the company knew about the conduct and whether that person made any statements that investors might subsequently assert were false, as was the question in Glazer, for example.
If disclosure is made, careful attention must be paid to whether or not the disclosure is complete and accurately and sufficiently identifies the problem and the risks, as was at issue in Immucor.
While each securities action relating to FCPA allegations will be analyzed and decided on its own facts, these considerations may inform companies’ courses of action, with respect to regulatory agencies, investigation and disclosure decisions, collateral civil litigation and otherwise.
Reprinted with permission from Portfolio Media, Inc.