International Law Advisory - SEC Adopts Several Expansive Applications of the Federal Securities Laws in the Recent FCPA Enforcement Action Against Nature’s Sunshine and Two Senior Executives

On the heels of the criminal conviction in the July 2009 FCPA action United States v. Bourke, ^[1] U.S. enforcement authorities continue to adopt expansive theories in FCPA cases.  At the end of July, the U.S. Securities and Exchange Commission (“SEC”) filed an action against Nature’s Sunshine Products, Inc. (“Nature’s Sunshine”) and two of its executives that is noteworthy for its broad application of the federal securities laws to foreign payments.

Nature’s Sunshine

On July 31, 2009, the SEC brought an FCPA enforcement action against Nature’s Sunshine Products, Inc. (“Nature’s Sunshine”), a Utah-based, publicly-traded producer of nutritional and personal care products, as well as two executives.  To resolve the action, the defendants consented to the entry of a civil injunction, judgment, and penalties.

The SEC action stated that the wholly-owned Brazilian subsidiary of Nature’s Sunshine, Natures Sunshine Produtos Naturais Ltda. (“NSP Brazil”), made improper cash payments to customs officials in Brazil in 2000 and 2001 to import unregistered products into Brazil; purchased fictitious documentation to make the cash payments appear to be for legitimate expenses; and improperly failed to disclose the payments in its securities disclosures.  At least some of the payments were made indirectly, through customs brokers, who received over $1 million in cash that NSP Brazil typically booked as “importation advances.” NSP Brazil reportedly made the payments after Brazilian authorities had reclassified certain nutritional products as medicines, subjecting the products to a registration requirement that Nature’s Sunshine was not able to meet.  As a result of its inability to lawfully import unregistered products into Brazil, the revenues of NSP Brazil had fallen almost tenfold.  Before introduction of these restrictions, Brazil had become one of the largest markets for Nature’s Sunshine.

The SEC noted that Nature’s Sunshine disclosed in its 2001 Annual Report (10-K) that NSP Brazil had experienced a significant decline in sales “due to import regulations imposed by the Brazilian government.” ^[2]  The SEC then criticized NSP for omitting from that disclosure “any material information related to the Cash Payments” to customs brokers. ^[3]

The SEC charged Nature’s Sunshine with violation of the following statutes, as well as related rules:  (1) the anti-bribery provisions of the FCPA; (2) the FCPA accounting (internal controls and books and records) requirements; (3) the antifraud provisions of Section 10(b) of the Exchange Act of 1934; and (4) the reporting provisions of Section 13(a) of the Exchange Act.  

The SEC also took enforcement action against Nature’s Sunshine’s Chief Executive Officer Douglas Faggioli (who was Chief Operating Officer at the time of the alleged conduct), and its former Chief Financial Officer Craig D. Huff.  The SEC alleged that Messrs. Faggioli and Huff “had supervisory responsibilities for the senior management and policies” of the company including the “export and sale” of its products. ^[4]  In this regard, they “failed to adequately supervise” ^[5] their subordinates who were responsible for ensuring the accurate recording of the “state of registration of products sold in Brazil” ^[6] and for ensuring a system of controls to provide assurances that “registration of NSP products sold in Brazil was adequately monitored.” ^[7]  On that basis, the SEC charged Messrs. Faggioli and Huff with violation of the FCPA’s accounting provisions, invoking authority under Section 20(a) to bring charges against “control persons”. 

To resolve the matters, Nature’s Sunshine agreed to a US$600,000 monetary penalty, while Messrs. Faggioli and Huff agreed to pay civil penalties of US$25,000 each.  Nature’s Sunshine and Messrs. Faggioli and Huff agreed to an injunction against future violations of the provisions they were charged with violating.

The Nature’s Sunshine case illustrates the SEC efforts to ramp up FCPA enforcement against individuals, and particularly high-level executives, through the expansive application of various securities law provisions:

• Assertion of “control person” liability against senior executives in FCPA cases.  Two high-level officers of the parent company were charged as “control persons”.  The securities laws provide for such charges, even where officials are not directly responsible for or involved in the conduct, but such charges have rarely been attempted in FCPA cases.  Below we discuss several noteworthy aspects of the “control person” charges in this case.
  • Executives can face “control person” charges based upon accounting violations by the company.  Under Section 20(a) of the Exchange Act of 1934, any person who “directly or indirectly controls” another person who is liable for violation of the securities laws (including the FCPA) can face liability as a “control person.” ^[8]  Interestingly, in this case, the SEC charged Messrs. Faggioli and Huff, without charging individuals under their control with a primary violation.  Rather, the SEC held the two senior executives responsible for “fail[ure] to adequately supervise” the company’s compliance with the accounting provisions of the FCPA. ^[9]  No affirmative acts by the two are alleged.  Although this is not the first time the SEC has sought to impose “control person” liability in an FCPA case, ^[10]  it is the first time the SEC has brought such charges based upon an underlying violation by the company, based upon an underlying violation that did not require knowing conduct (i.e., the company’s violation of the FCPA accounting provisions), and without any allegation that the “control person” knew of the underlying violation.  The SEC alleged only that certain NSP Brazil personnel informed two former Nature’s Sunshine controllers of the scheme in late 2000, and that one of the controllers claimed to have told another senior manager. As a result, for the first time, in the Nature’s Sunshine case, the SEC has signaled that it may seek to hold senior executives responsible as “control persons” for a company’s violation of the accounting provisions, even where the executives are unaware of the underlying conduct.  In this way, Section 20(a) liability risks in FCPA cases can be considerably broader than the risk of a violation of Section 10(b), which, as discussed below, requires a showing of scienter.
  •  Defense or exception for “good faith” conduct under Section 20(a) underscores the importance of management commitment to compliance.  Section 20(a) liability does not apply when it can be shown that the “controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation . . .”  15 U.S.C. § 78t(a).  The statute does not define the standard of “good faith”, and the applicability of the “good faith” exception or defense in the Nature’s Sunshine case is unclear.  Nonetheless, it is likely that documented efforts to adopt, and in specific situations to ensure compliance with, FCPA internal controls and books and records requirements can be used by management to establish good faith.  In this way, efforts to establish an effective compliance program can help to mitigate the risk of Section 20(a) liability.
  •  Risk of even broader “control person” allegations in FCPA shareholder derivative suits.  The “control person” theory also can be used by private plaintiffs in spinoff shareholder derivative actions.  For example, in the Nature’s Sunshine case, private plaintiffs brought a shareholder derivative action alleging that the CEO (Faggioli) was aware of violations of the securities laws apparently related to the improper payment scheme and disclosure issues.  The plaintiffs also went beyond the SEC theory, and alleged that the audit committee chair was a “control person”.  The court declined to dismiss the “control person” charges against these individuals, holding that it had been adequately alleged that defendants possessed “the power, directly or indirectly, to direct or cause the direction of management and policies of the primary violator”. ^[11]
•  Expansive application of Section 10(b) and Section 13(a) liability against the company.  In addition, the SEC’s charges in the Nature’s Sunshine case included other provisions of the federal securities laws not heretofore seen frequently in FCPA cases – including a Section 10(b) charge and a Section 13(a) charge based upon inadequate public disclosures.
•  Inadequate Disclosures.  The SEC pursued Nature’s Sunshine over its inadequate disclosure of information regarding the Brazilian import situation.  The company publicly disclosed in its SEC filings that the Brazilian import regulations had a significant impact on its revenues and that it expected that impact to continue, but the company did not disclose the subsidiary’s indirect cash payments to officials designed to blunt the impact of those regulations.  Under Section 10(b), a company and its personnel can be held liable for securities fraud if they act with scienter to omit from a securities disclosure information that is necessary to prevent the disclosure from being materially misleading.  Thus, in bringing the charge, the SEC appears to be taking the view that, when a company discloses a problem with a foreign governmental authority in a country that is a significant (material) market, an investor would assume that, unless the company discloses otherwise, no improper payments are being made to deal with the problem.  The SEC also implicitly alleges that the parent company was on sufficient notice, through its controllers who had gathered information about the payments from NSP Brazil, to have acted with scienter in not disclosing the nature of those payments in their financial statements.  This stance expands the type of FCPA cases that can raise Section 10(b) risks beyond the realm of mergers and acquisitions. ^[12]  If the position taken in this case reflects a broader enforcement policy, then public companies may begin to make increased disclosure of improper payments in material markets. 
•  Section 13(a) Charges.  The Nature’s Sunshine case also shows that the SEC is now more commonly bringing charges in FCPA cases that are based upon allegations of misleading financial statements and/or periodic securities filings.   In most FCPA cases outside the merger and acquisition context, the SEC has relied exclusively on the books and records requirements in the FCPA, 15 U.S.C. 78m(b)(2)(A), and has not alleged violation of Section 13(a) – a provision requiring issuers to file accurate reports that do not omit material information that would otherwise make information in the filing not misleading, which is more often reserved for accounting fraud cases.  In bringing this charge in the Nature’s Sunshine case, however, the SEC concluded that the booking of the payments in Brazil rendered the financial statements and/or periodic disclosures materially misleading.  While the allegation of a Section 13(a) violation in an FCPA case is not new, ^[13] it also is not brought in all cases – even in cases involving similar types of payments. ^[14]  Thus, the risk the Section 13(a) liability may arise from improperly booked payments may depend on whether the payments or business affected by the payments is material.  If so, the SEC may seek to allege violation of Section 13(a).  In this case, the complaint identifies Brazil as Nature’s Sunshine’s largest foreign market.  Alternatively, the SEC may be making a broader statement that any information relating to improper payments is material regardless of the importance of the business.  Moreover, unlike Section 10(b), there is no requirement that the SEC prove scienter (i.e., that the company intended to mislead investors) to establish a Section 13(a) violation.
• The Bribery Charge.  Even the FCPA count, as reflected in the complaint, seems aggressive. It appears to hold the parent vicariously liable for the actions of the subsidiary.  Whether this is in fact the case, or whether the complaint in this settled case is simply summarily drafted, is not possible to determine on the face of the complaint.

It seems likely that the SEC will continue in the near future to use a wider range of securities law tools than historically has been used in FCPA cases.  The SEC also is likely to continue its efforts to target individuals for enforcement action.  Indeed, on August 28, 2009, the SEC brought another enforcement action against a former employee of FARO Technologies, Inc., SEC v. Meza, Case No. 09cv1648 (D.D.C.).  The SEC also announced the formation of a new FCPA Unit, which it expects will lead to streamlining and focus in its FCPA investigations, and to increased enforcement activity. ^[15]

We will continue to keep you apprised of developments related to FCPA enforcement. If you have any questions or for further information, please feel free to contact Lucinda Low at 202.429.8051; Ed Krauland at 202.429.8083; Pat Norton at 202.429.8034; Erik Kitchen at 202.429.8132; Philip Khinda at 202.429.8189; Matt Herrington at 202.429.8164; Brian Heberlig at 202.429.8134; Andrew Irwin at 202.429.8177; Julia Court Ryan at 202.429.6418; David Lorello at 44(0)20.7367.8007; Alexandra Baj at 202.429.6478; Tom Best at 202.429.8079; Owen Bonheimer at 202.429.6266; Michael Pass at 202.429.8101; Brittany Prelogar at 202.429.5518; Sarah Lamoree at 202.429.6488; William Gordon at 202.429.8013; Vincenza Rabenn at 202.429.1305.

[1] See Steptoe & Johnson LLP Advisory, Private Investor Convicted for Involvement in Scheme to Bribe Officials in the Republic of Azerbaijan (July. 22, 2009), available at http://www.steptoe.com/publications-6252.html.

[2] Complaint, ¶ 41.

[3] Id., ¶ 42.

[4] Id., ¶ 43.

[5] Id., ¶¶ 45, 48.

[6] Id., ¶ 46.

[7] Id., ¶ 44.

[8] The statute does not define “control”.  Regulations interpreting a different federal securities statute offer one potential definition.  17 C.F.R. § 230.405 (defining “control” as “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.”).

[9] Complaint, ¶¶ 45, 48.

[10] See SEC v. Murphy, Kay, and Theriot (S.D. Tex. 2002) (civil action stayed pending criminal trial), Complaint of July 29, 2002, ¶ 46 (alleging that the President of American Rice, Inc., was derivatively liable as a “control person” for a knowing violation of the internal control requirements of the FCPA by the Vice President of Caribbean Operations of the company), available at http://www.sec.gov/litigation/complaints/comp17651.htm.

[11] In re Nature’s Sunshine Products Sec’y Litig., Case No. 06cv267 (D. Ut.) (Memorandum Decision and Order Denying Motion to Dismiss at 23, citing Adams v. Kinder-Morgan, 340 F.3d 1083, 1108 (10th Cir. 2003); see also 17 C.F.R. § 230.405.  Other recent FCPA cases have spurred class actions in which plaintiffs seek to hold executives civilly liable as “control persons”.  See, e.g., In re InVision Technologies, Inc. Sec’y Litig., Case No. 04cv3181 (N.D. Ca.); In re FARO Technologies, Inc. Sec’y Lit., Case No. 05cv1810 (M.D. Fl.).

[12] SEC Section 21(a) Report, Rel. No. 51283 (Mar. 1, 2005) (“Titan Report”) (warning that the SEC may bring Section 10(b) charges against companies based upon misleading proxy representations concerning FCPA compliance).

[13] See, e.g., In the Matter of Bristow Group, Inc., Admin. Proc. File No. 3-12833 (Sept. 26, 2007), http://www.sec.gov/litigation/admin/2007/34-56533.pdf, (alleging violation of Section 13(a) and other provisions).

[14] See, e.g., In the Matter of Helmerich & Payne, Inc., Admin. Proc. File No. 3-13565 (July 30, 2009), http://www.sec.gov/litigation/admin/2009/34-60400.pdf.  By contrast to the Nature’s Sunshine case, the SEC did not charge Helmerich & Payne, Inc. with violation of Section 13(a) of the Exchange Act, even though this case also involved allegations of payments to customs officials in Latin America that were not properly recorded in the company’s books.

[15] Remarks Before the New York City Bar:  My First 100 Days as Director of Enforcement, by Robert Khuzami, Director of U.S. Securities and Exchange Commission Division of Enforcement, (Aug. 5, 2009), available at http://www.sec.gov/news/speech/2009/spch080509rk.htm.