Executives at Risk: Navigating Individual Exposure in Government Investigations - Volume III

White Collar Alert
04.19.16

Welcome to Volume III of Executives at Risk: Navigating Individual Exposure in Government Investigations. In this edition, we highlight the most significant cases and government investigations that affect corporate executives in the first quarter of 2016.

Policy Issues -- The Yates Memo and Its Aftermath

The Yates Clamor Continues: "Just the Facts": After a report by The Wall Street Journal that the U.S. Department of Justice (DOJ) would require companies to certify that they had fully disclosed all information about individuals involved in wrongdoing, Assistant Attorney General Leslie Caldwell disavowed the rumor. The DOJ's Criminal Division does not expect companies to identify any particular individuals as criminally or civilly liable. Rather, companies are required to just "give [DOJ] the facts." Meanwhile, the DOJ's Antitrust Division and the National Security Division have warned that they will increase their scrutiny of corporate officers and employees. But critics continue to label the Yates Memo a potentially meaningless prosecutorial policy that is nothing more than an "empty threat." Time will tell.

DOJ Wants to Prosecute More Individuals in FCPA Cases: DOJ might be able to prove its skeptics wrong through its new FCPA Pilot Program, which provides financial incentives for companies to self-report allegations concerning bribery of foreign government officials. The new Pilot Program, which is limited to Foreign Corrupt Practices Act (FCPA) cases, provides for a reduction of up to 50% off the bottom end of the Sentencing Guidelines' fine range, among other enticements. According to the Fraud Section's Enforcement Plan, which references the Yates Memo, one purpose of the program is to increase the government's ability to "prosecute individual wrongdoers whose conduct might otherwise have gone undiscovered or been impossible to prove." Under the terms of the Pilot Program, "full cooperation" by a corporation includes "disclosure on a timely basis of all facts relevant to the wrongdoing at issue, including all facts related to involvement in the criminal activity by the corporation's officers, employees, or agents." Indeed, "[m]itigation credit will be available only if a company meets the mandates set out [in the Section's Guidance], including the disclosure of all relevant facts about the individuals involved in the wrongdoing." Importantly, to earn the credit, companies must also disgorge all profits from the transaction, as calculated by DOJ. Thus, like any discount, the bottom-line value of the reduction depends on the fine amount from which the reduction is taken and the amount of any accompanying disgorgement. If the initial fine calculation is unreasonably high or disgorgement is similarly significant, then the reduction -- and therefore the benefit from cooperating with DOJ -- may be partially or completely illusory.

Criminal Actions Against Executives

Criminal Negligence

Former President and CEO Sentenced to a Month in Prison for Criminal Negligence: In an area of increased enforcement, the government brought criminal charges against a corporate CEO for negligently discharging thousands of gallons of a coal-processing chemical into West Virginia's Elk River. Gary Southern, the former president and CEO of Freedom Industries, pled guilty, was sentenced to 30 days in prison and was ordered to pay a $20,000 fine. Prosecutors dropped charges of bankruptcy fraud in exchange for Southern's plea to Clean Water Act and Refuse Act charges. Five other Freedom Industries executives were charged in connection with the chemical spill, including former Freedom Industries owner Dennis Farrell, who was also sentenced to 30 days in prison and ordered to pay a $20,000 fine.

Obstruction

CEO Gets Six Months for Obstruction: In February, Charles J. Moore, the CEO of broker-dealer Crucible Capital, Inc., was sentenced to six months in prison for the destruction, alteration or falsification of records in a federal investigation. As part of his guilty plea, Moore acknowledged that he had ordered an employee to falsify invoices to hide the extent of Crucible's debt from U.S. Securities and Exchange Commission (SEC) investigators. In addition to jail time, Moore was also hit with an industry bar and a cease-and-desist order from the SEC.

Jury Convicts Former Managing Director of Lying to the Feds About Alleged Bribery Scheme: A federal jury convicted Helena Tantillo, the former managing director of BearingPoint Inc., of lying to federal investigators about an alleged bribery scheme linked to Dallas County Commissioner John Wiley Price. Tantillo was accused of initially telling the Federal Bureau of Investigations (FBI) that she could not remember the purpose of a $10,000 monthly consulting fee that was funneled to Price, and then falsely telling agents a different story to cover up the scheme. After a three-day trial, the jury took less than four hours to convict Tantillo. Price's trial is in September.

International Cartel Investigations

DOJ Yet to Secure Public Indictment or Guilty Plea in International Cartel Investigations in 2016: Notably, during the first quarter of 2016 there were no public indictments or guilty pleas involving executives in DOJ's international cartel investigations. The lack of public indictments and guilty pleas thus far in 2016 may, in part, signal the end of DOJ's six-year-old investigation into the auto parts industry. It may also suggest that DOJ is having difficulty extraditing and prosecuting foreign executives abroad.

The December 2015 indictments of three German executives are the most recent that DOJ has managed to secure in an international cartel investigation. But all three executives reside outside of the United States and beyond the prosecutorial reach of the United States government. It is not clear whether these individuals will ever come to the U.S. to face charges, or whether these indictments will remain a hollow victory for DOJ. For further analysis of DOJ's difficulties in prosecuting foreign executives abroad, see our article.

Former Rabobank Executive and Trader Sentenced Well Below Prosecutors' Recommendations in International LIBOR Manipulation Scheme: Thus far in 2016, DOJ's only action against executives in international cartel investigations was the sentencing of a former executive and a former senior trader of Rabobank for their involvement in rigging the LIBOR benchmark interest rate. Anthony Allen, Rabobank's former head of liquidity and finance, was sentenced to 24 months in prison, and trader Anthony Conti received a year and a day. The sentences fell well below prosecutors' recommendation for Allen (87 months) and for Conti (57 to 71 months). Both defendants were convicted in November 2015, in the first U.S. trial against individuals accused of rigging LIBOR.

UK's LIBOR Manipulation Investigation Dealt Final Blow as Jury Acquits Sixth Defendant: In January, a UK jury acquitted six defendants accused of rigging LIBOR. The jury found that the six brokers did not conspire to manipulate LIBOR, as alleged by the UK's Serious Fraud Office (SFO). The SFO has only achieved one conviction in its LIBOR cartel investigation, against former UBS and Citigroup trader Tom Hayes. Hayes was convicted by a UK jury in August 2015 and sentenced to 14 years in prison. In December 2015, a London appeals court reduced the sentence to 11 years but upheld the conviction.

Domestic Cartel Investigations

Two Executives Indicted in a Domestic Water Treatment Cartel Investigation: In February, a grand jury returned indictments against two water treatment chemical company executives. Vincent J. Opalewski, the former president of a New Jersey company, and Brian C. Steppig, former director of sales and marketing for an Indiana company, were charged in New Jersey federal district court with conspiring to rig bids, fix prices and allocate customers in the companies' sales of water treatment chemicals to municipalities and private entities. These are the second and third indictments returned in DOJ's domestic water treatment cartel investigation. As reported in Volume II of Executives at Risk, Frank A. Reichl pled guilty in October 2015 to participating in a 13-year conspiracy to fix prices, rig bids and allocate the market for chemicals supplied to municipalities and pulp and paper companies.

Former CEO Indicted in Oil and Natural Gas Lease Domestic Cartel Investigation: In March, a federal grand jury indicted former oil and gas company CEO Aubrey K. McClendon on charges of conspiring to rig bids for the purchase of oil and natural gas leases in Oklahoma. McClendon allegedly orchestrated a conspiracy between two large oil and gas companies to agree on a method for dividing up the bids to guarantee that a particular company would win certain ones. It is the first indictment in DOJ's ongoing investigation into cartel conduct in the oil and natural gas industry.

Head of Pipe Supply Company Sentenced for Involvement in Domestic Power Generation Cartel: More than three years after pleading guilty, a New Jersey industrial pipe supply company owner was sentenced to 32 months and a day in prison for his role in rigging bids, bribery, fraud and other offenses in the power generation industry. Andrew Martingano pled guilty in 2012 to wire fraud and conspiracy to defraud. He admitted that he paid bribes to a manager of Con Ed, a New York utility company, in return for confidential competitor information that enabled Martingano's company to win industrial pipe supply contracts with Con Ed. Martingano also admitted that he requested fraudulent price increases from Con Ed. Five individuals have been indicted in DOJ's investigation into cartel conduct in the power generation industry.

Kickbacks and Fraud

Healthcare CEO and CFO Get New Trials After Fifth Circuit Concludes Exculpatory Evidence Was Improperly Excluded: The convictions of ArthroCare Corporation's former CEO Michael Baker and CFO Michael Gluk were reversed by the Fifth Circuit in January because the trial court erroneously barred the defendants from introducing evidence that two other executives were responsible for the accounting fraud at issue and hid the fraud from the defendants. Both outside counsel and the SEC determined that others hid the fraud from Baker and Gluk, yet a Texas federal judge refused to permit introduction of that evidence. The trial court sentenced Baker to 20 years in prison and Gluk to 10 years.

Seven Years After Indictment, Former CEO of Canadian Hazardous Waste Treatment Company Convicted of Kickbacks and Major Fraud Scheme: In March, a jury convicted Canadian citizen John Bennett, former CEO of Bennett Environmental Inc., of conspiring to pay kickbacks and commit major fraud against the United States in a scheme to obtain subcontracts for the treatment and disposal of contaminated soil at a New Jersey superfund site. The conviction came seven years after the government charged Bennett and two years after Canada extradited him to the United States to face trial. Bennett is expected to be sentenced in June 2016. He is the tenth individual, and his company is the third company, to be convicted in connection with the scheme.

Three Trucking Company Executives Receive Multi-Year Prison Terms for $11 Million Fraud Scheme: Three former executives of USA Dry Van Logistics, a cross-border trucking company, were sentenced to prison for their role in a scheme to defraud commercial lender GE Capital Corporation out of $11 million. Former CEO Sergio Lagos, former COO Aurelio "Jim" Aleman and former Controller Oscar Barbosa admitted that they inflated their company's accounts receivable so that GE Capital Corporation would authorize a $38 million revolving line of credit. The defendants' misrepresentations allegedly allowed the company to appear that it was operating more profitably than it actually was. Lagos was sentenced to more than eight years in prison, while Aleman and Barbosa received terms of almost four years, and two years, respectively.

Two Former Oil Supply Company Executives Plead Guilty to Taking Kickbacks from Third-Party Sales Agent: Franklin Marsan and Eduardo Betancourt, former executives of a Houston-based oil supply company, pled guilty in February to fraud charges in connection with a scheme to obtain kickbacks from third-party sales agents hired to promote their products outside the U.S. They admitted that they skimmed at least $150,000 off of commissions received by the third-party sales agents over a three-year period. The two defendants are slated to be sentenced in July 2016.

Government Contracts Fraud

No Prison Time for IT Executive Who Pled Guilty to Small Business Set-Aside Fraud: In March, a federal judge sentenced Jonathan Mickle, the former COO of Maryland-based Quantell, Inc., to three years of probation for his involvement in schemes to defraud the United States out of more than $10 million in federal government contracts intended for small businesses, and to divert more than $1.6 million in employee benefit money for his personal benefit. In June 2015, Mickle pled guilty to conspiracy to commit wire fraud and to tax fraud in connection with the schemes. In July 2015, two of Mickle's co-conspirators, the controlling officers and majority shareholders of the company, pled guilty to defrauding the government of more than $30 million in federal contracts, and to involvement in the employee benefit fraud scheme. Shaun Tucker was sentenced to eight years in prison and his wife, Joan Tucker, received a year-and-a-day sentence. Both were ordered to pay more than $32 million in restitution, forfeiture and back taxes for their role in the schemes.

Convictions in Scheme to Win Disadvantaged Business Contracts Lead to No Prison Time for Construction Execs: The owners of two Pennsylvania construction companies avoided prison time for their roles in a 15-year scheme to defraud the United States Department of Transportation out of $18.7 million in federal contracts intended for disadvantaged businesses. Judy Noll, the president of Karen Construction Inc., was sentenced to three years of probation and ordered to pay more than $336,000 in restitution for her role in the scheme. Weber Steel's owners, Dennis and Dale Weber, were each sentenced to six months of house arrest and five years of probation, and ordered to pay $1 million in restitution. The government did not seek prison terms. We reported the three defendants' guilty pleas in Volume II of Executives at Risk.

Prison Term Reduced for Small Business Fraudster: In February, a federal judge reduced by 20 percent the sentence of a construction company executive convicted for his role in a scheme to defraud the United States government of $136 million in federal construction contracts intended for minority-owned companies. The sentence reduction -- from 51 to 41 months -- came after the Third Circuit vacated the sentence of Ernest G. Fink and his co-conspirator in United States v. Nagle. As we reported in Volume II of Executives at Risk, the Third Circuit found that the loss calculation for sentencing purposes in a small business government contracts fraud case should credit the value the government received. Thus, the Court held that loss should be calculated based on net loss by "taking the face value of the contracts and subtracting the fair market value of the services rendered under those contracts." On remand, the district court judge accepted the government's position that it had suffered more than $1 million in losses and adjusted Fink's sentence accordingly. Fink argued that he should be freed because the government had not suffered monetary harm, and that the 14 months he had already served, along with credit for good time served, nearly doubled the highest possible sentence under the Sentencing Guidelines.

Tax

Biofuel Credit Schemes Result in Prison Sentences: In March, an Indiana man was sentenced to 72 months in prison and ordered to pay more than $56 million in restitution for his role in a biofuel tax scam involving millions in federal fuel tax credits that were claimed for biodiesel that never existed or did not qualify for the credit. The government asserted that E-Biofuels purchased biodiesel that had already been used to claim the tax credits and resold the fuel to others as pure biodiesel eligible for the credits. Chris Ducey, logistics manager for E-Biofuels LLC, pled guilty to wire fraud, obstruction of justice and false statements. Ducey's two brothers were also involved in the scheme and pled guilty last year. Another co-conspirator, Joseph Furando, has appealed his 20-year sentence to the Seventh Circuit. Furando owns Caravan Trading Co. and CIMA Green, companies that supplied biodiesel to E-Biofuels.

Separately, also in March, Philip Joseph Rivkin was sentenced to 10 years and a month in prison after pleading guilty to mail fraud and false statements for claiming to produce millions of gallons of biodiesel that his Houston companies never produced. Under the scheme, Rivkin sold fraudulent renewable identification numbers (RINs) to companies desiring to use the RINs to claim tax credits.

Tennessee CEO Pleads Guilty for Failing to Pay Employment Taxes: In March, Larry Thornton, president and CEO of Memphis-based First Touch Payment Solutions LLC and Software Earnings Inc., pled guilty to failing to pay employment taxes to the IRS. According to court documents, Thornton's companies withheld more than $6.8 million in employment taxes from employee paychecks but failed to pay those withholdings to the Internal Revenue Service (IRS) or timely file Forms 941. Thornton faces a statutory maximum sentence of five years in prison, three years of supervised release, a fine and restitution. DOJ's Tax Division recently stated that it has made employment tax enforcement a priority.

FIFA Corruption Scandal

Former President of Honduran Soccer Federation Pleads Guilty: In March, Rafael Callejas, former president of the Honduran soccer federation (FENAFUTH), pled guilty to racketeering conspiracy and wire fraud conspiracy in connection with his receipt of bribes in exchange for the awarding of contracts for the media and marketing rights to Fédération Internationale de Football Association (FIFA) World Cup qualifier matches. Callejas served as the president of the Republic of Honduras from 1990 to 1994. According to court filings, Callejas accepted hundreds of thousands of dollars in exchange for awarding contracts to Media World, a Florida sports marketing company, for the media and marketing rights to the Honduran national soccer team's home qualifier matches for the 2014, 2018 and 2022 editions of the World Cup. Callejas agreed to forfeit $650,000 and faces a maximum sentence of 20 years for each count. Several other high-ranking FIFA officials -- including Rafael Esquivel, former head of the Venezuelan soccer federation; Eduardo Li, former president of the Costa Rican soccer federation; and Costas Takkas, former secretary general of the Cayman Islands soccer association -- have been extradited to the U.S.

Brazil's Petrobras Investigation

"Operation Car Wash" Continues to Nab Top Executives: Brazil's investigation into alleged corruption involving the country's national oil company Petrobras, known as "Operation Car Wash," continues to implicate top executives. In March, a Brazilian judge sentenced nine individuals to multi-year prison terms for their involvement in an alleged $35 million scheme to bribe Petrobras agents. Notably, Marcelo Odebrecht, the former CEO of Odebrecht SA, Brazil's largest construction company, was sentenced to more than 19 years in prison. Odebrecht SA allegedly colluded with other construction companies to submit fraudulent bids and pay bribes on contracts with Petrobras. Four other Odebrecht executives received sentences ranging from more than nine years to more than 19 years. In addition, the judge sentenced two former Petrobras directors and a former Petrobras manager to more than 20 years, but suspended their sentences in light of their cooperation. A ninth individual also received a suspended sentence. We reported on major events in the Petrobras investigation that occurred in the last quarter of 2015 in Miller & Chevalier's FCPA Winter Review 2016.

Mine Safety

Blankenship Sentenced to a Year in Prison for Conspiring to Violate Mine Safety Laws: Don Blankenship, the former CEO of Massey Energy, was sentenced to a year in prison following his conviction on a misdemeanor charge of conspiring to violate mine safety standards. The court sentenced Blankenship to the maximum possible penalty for his role in the conspiracy, which preceded a 2010 explosion that killed 29 miners. Blankenship has asked the Fourth Circuit to let him remain out of prison pending his appeal to that court, arguing that he would serve the entire sentence before the appeal is decided.

Extradition and Extraterritoriality

After Five-Year Battle, New Zealand Agrees to Extradite Megaupload Founder to the U.S.: In December, a New Zealand court approved the extradition of Kim Dotcom, the founder of internet file-sharing service, Megaupload Ltd., to the United States to face criminal copyright, racketeering and money laundering charges. The U.S. government alleges that Dotcom and other Megaupload executives encouraged Megaupload's users to download and exchange copyrighted material, costing movie and record companies more than $500 million and reaping more than $175 million in profits for the company. In a decision spanning more than 200 pages, the New Zealand court found overwhelming evidence to support the U.S. government's prima facie case. The court also approved the extradition of three other executives allegedly involved in the scheme. The extradition battle has already dragged on for nearly four years, commencing when DOJ shut down Megaupload's website in January 2012. Dotcom has appealed the ruling, a process that is likely to last until at least October 2016.

Privilege Issues

Commodity Traders "Tilting at Windmills," Cannot Withhold from Grand Jury Communications They Had With Their Lawyer: The Fourth Circuit recently upheld the application of the crime-fraud exception and denied claims of privilege asserted by two bank commodity traders. The case involved a 2010 regulatory investigation of a bank and two of its traders. The traders met with a lawyer who later made a written submission to a regulatory body on their behalf. Federal prosecutors later convened a grand jury to consider the traders' activities and subpoenaed documents from the traders' attorney. The district court denied a motion to quash, holding that the traders' communications with their attorney "were made ‘precisely to further the [t]raders' criminal scheme' of misusing information about impending trades for personal gain." On appeal, the Fourth Circuit applied a "deferential" standard that required "a clear showing of abuse of discretion" to overturn the district court's decision. The court affirmed, and upheld the district court's finding that the traders "intended to avoid detection and continue their scheme in communicating with [the attorney]," including by having the attorney "misrepresent their activities to the regulator." The traders claimed that nothing in the record supported application of the crime-fraud exception, but the court noted that they were "by definition[] excluded from the grand jury proceedings and thus not privy to what evidence or theories the complete record contains," and the court chided them for "tilting at windmills."

Just a few weeks earlier, the Ninth Circuit came to a different conclusion in a recent case involving a U.S. Food and Drug Administration (FDA) investigation into allegedly misleading advertising of surgical devices. The court applied a more privilege-protective "reasonable basis" standard and reversed a district court's order applying the crime-fraud exception. The Ninth Circuit directed the district court to conduct an in camera review of the documents at issue in order to ensure that the documents had a sufficient nexus to "the intended, or present, continuing illegality."

Financial Regulations

New Regulations Up the Ante for Chief Compliance Officers: In December, the New York Department of Financial Services (NYDFS) published proposed regulations that would require a covered financial institution's Chief Compliance Officer (CCO) or equivalent to file an annual certification of compliance with the NYDFS. If finalized, the certification requirement would add a risk of criminal liability for CCOs far beyond what currently exists. It would require CCOs to certify that their institution's anti-money laundering and combating the financing of terrorism (AML/CFT) transaction monitoring and watch-list filtering programs comply with the highest accepted regulatory expectations. Criminal penalties could be assessed not only for false certifications but also for incorrect certifications.

D&O Issues

D&O Coverage Denied Due to CEO's Receipt of Letter from State AG's Office Five Years Prior to Federal DOJ Indictment: The Second Circuit's recent decision in Weaver v. Axis Surplus Ins. Co. upheld an insurance company's denial of coverage for an executive facing a criminal investigation. In late 2007, Multivend LLC and its CEO, Edward Weaver, received a cease-and-desist letter from the Maryland State Attorney General's Office directing that the company, a candy vending machine operator, cease all business in the state and turn over certain documents. In 2008, Multivend and Weaver purchased a directors and officers liability insurance (D&O) policy. Four years later, Weaver received a target letter from DOJ informing him that a Florida grand jury was investigating him and the company for false statements made to prospective customers regarding the profits customers could expect from doing business with Multivend. When Weaver sought coverage for the DOJ investigation, his insurer, Axis, denied his claim on the grounds that the DOJ investigation was part of "one claim" arising from interrelated wrongful acts identified in Maryland's 2007 (pre-policy) letter. Weaver and Multivend took the dispute to federal court, and Axis was awarded summary judgment. The Second Circuit recently affirmed, concluding that even though the 2007 letter did not state that Multivend was in violation of any law and merely requested that the company voluntarily agree to cease its sales, the letter was nonetheless sufficient to constitute a "demand" and put Multivend on notice of potential legal consequences before it purchased the insurance policy. That gave the insurer the right to deny coverage on the basis of a pre-policy exclusion in the contract, leaving Weaver financially exposed.

Delaware Chancery Court Decision Leaves Director-Removal Provisions at Risk: In December 2015, the Delaware Chancery Court ruled in In re Vaalco Energy, Inc. that under Section 141(k) of Delaware's General Corporation Law stockholders have a right to remove directors without cause under certain circumstances. The ruling affects 175 companies incorporated in Delaware and leaves them open to shareholder suits unless the boards of those companies amend their provisions. The court said there was no "normative policy rationale . . . driving" the law, but that the court favored "formality . . . in statutory interpretation" over the equities -- and perhaps, the corporation's freedom to determine the scope of its own governance provisions.

Corporate Directors Continue To Enjoy Reasonable Protection: Recent developments provide corporate directors some peace of mind regarding their exposure to federal enforcement proceedings and shareholder derivative lawsuits.

The SEC says it "isn't second guessing good-faith decisions" by boards of directors, but is instead "bringing cases where directors have either taken affirmative steps to participate in fraud or enabled fraudulent conduct by unreasonably turning a blind eye to obvious red flags." This is according to comments by Lara Shalov Mehraban, associate director in the SEC's New York Regional Office, who said that even though enforcement actions against directors are "rare" and typically involve "a significant departure from normal corporate governance and appropriate conduct," directors nonetheless must take "concrete steps to learn all of the relevant facts" when receiving "information suggesting the company filings are materially inaccurate," including "ensur[ing] that the company cease filing annual and quarterly reports until they are satisfied with the accuracy of the filings." She cautioned that, in the emerging age of cyber attacks, companies and their directors must "take reasonable steps to protect their customers['] information from cyber attacks or where their cyber-related disclosures [in the company's securities filings] are materially false or misleading."

Two recent cases demonstrate the outcome when corporate directors properly discharge their duties. In a case decided by the Delaware Supreme Court relating to the discovery of an ignition switch defect in certain GM vehicles, the court affirmed the preliminary dismissal of claims against GM directors. The lower court held that the shareholders who brought suit failed to demonstrate that there had been an "utter failure" to implement a system of safety controls or a "conscious effort to ignore red flags" regarding the safety issue. In another case, decided by the Seventh Circuit, directors of a restaurant holding company faced shareholder claims over the directors' approval of three allegedly improper transactions. The Seventh Circuit upheld the preliminary dismissal of the claims on two grounds. First, the shareholders had failed to show that a pre-suit demand on the company's board would have been futile. And second, the shareholders did not allege sufficient facts to show either that the directors failed to exercise independent business judgment in approving the transactions at issue or that the transactions did a disservice to the interests of the shareholders.


Editors: Dawn E. Murphy-Johnson, Lauren E. Briggerman, Kirby D. Behre, Jonathan D. Kossak, Charles F. B. McAleer, Jr., Andrew C. Strelka, Kathryn Cameron Atkinson and Marc Alain Bohn

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