Why it matters: What connects (1) an almost billion-dollar multi-federal agency resolution involving Iran sanctions violations where the district court judge in the case took the unprecedented action of rewriting the plea agreement to appoint his own independent monitor; (2) a major law firm insider trading conviction where the tip was allegedly passed by a slightly intoxicated partner over dinner; (3) a multibillion-dollar accounting fraud in the Mexican housing industry that was uncovered by the novel use of high-resolution satellite imagery; and (4) gatekeeper failures in connection with a multimillion-dollar fraudulent municipal bond offering? All figured significantly in recent enforcement and court matters that caught our eye.
Detailed discussion: Read on for a roundup of some of the recent enforcement matters that caught our eye:
Sanctions violations: On March 22, 2016, the DOJ announced that China-based telecommunications company ZTE Corp. pleaded guilty to conspiring to violate the International Emergency Economic Powers Act by "illegally shipping U.S.-origin items to Iran, obstructing justice and making a material false statement." The DOJ said that the plea agreement with ZTE ended a five-year joint investigation into ZTE's export practices that was being conducted by the DOJ's National Security Division, the U.S. Attorney's Office for the Northern District of Texas, the FBI, the U.S. Department of Commerce's Bureau of Industry and Security (BIS), the Department of Homeland Security, and U.S. Immigration and Customs Enforcement's Homeland Security Investigations.
To briefly summarize the facts (detailed in the press release), between 2010 and 2016, ZTE conducted business with Iran and either directly or indirectly (through improper third-party arrangements) shipped approximately $32 million of U.S.-origin items to Iran without obtaining the proper export licenses from the U.S. government. The facts show that when Reuters published an article regarding ZTE's sale of equipment to Iran in March 2012, ZTE temporarily ceased its dealings with Iran; however, ZTE resumed doing business with Iran by late 2013 and had recommenced illegal shipping to Iran by mid-2014.
According to the plea documents, ZTE took several affirmative steps to conceal relevant information from and mislead the U.S. government despite its knowledge of an ongoing jury investigation into its Iran exports. These affirmative steps included (1) requiring employees who were involved in the Iran sales to sign nondisclosure agreements in which the employees agreed to keep confidential all information related to ZTE's U.S. exports to Iran; (2) knowingly communicating false statements directly (or indirectly via outside counsel that had unknowingly been lied to) to the DOJ and federal enforcement agents as to whether ZTE was continuing to do business with and shipping items to Iran; and (3) knowingly hiding data related to ZTE's resumed illegal sales to Iran from a forensic accounting firm hired by defense counsel to conduct an internal investigation into ZTE's Iran sales.
As part of the plea agreement, ZTE agreed to pay a criminal fine of $286,992,532 and a criminal forfeiture of $143,496,266, and submit to a three-year period of corporate probation, "during which time an independent corporate compliance monitor will review and report on ZTE's export compliance program." Interestingly, according to a March 31, 2017, Inside Counsel article written by Sue Reisinger, the Northern District of Texas judge overseeing the case, Judge Ed Kinkeade, took the "unprecedented step" of ignoring the usual protocol involved in appointing independent monitors and rewrote the plea agreement to appoint his own independent monitor, a Dallas-based civil and personal injury lawyer with special master experience but no experience in cases such as this. In addition, Reisinger reported that Judge Kinkeade rewrote the plea agreement in several places—such as in the dispute resolution and ongoing reporting requirements provisions—to substitute his court's authority for the DOJ's.
The DOJ said that, simultaneously with its agreement to plead guilty on March 7, 2017, ZTE reached settlement agreements with the BIS and the Treasury Department's Office of Foreign Assets Control, with total payments to the U.S. government aggregating almost $900 million. The DOJ also said that BIS had "suspended" an additional amount of $300 million, "which ZTE will pay if it violates its settlement agreement with the BIS."
Big law insider trading: On March 15, 2017, Reuters reported that a partner in a major U.S. law firm was convicted of insider trading by a federal jury in Brooklyn, NY. The jury found that the partner tipped an investment adviser friend, who then tipped a stockbroker friend, about Pfizer Inc.'s $3.6 billion plan to buy King Pharmaceuticals Inc. in 2010, which resulted in approximately $400,000 in illegal profits.
According to Reuters, the SEC filed a civil complaint against the investment adviser and stockbroker tippees—but not the law partner tipper—in 2013 (subsequently put on hold pending resolution of the criminal case for conspiracy brought against the stockbroker), in which the SEC alleged that the law firm partner "became intoxicated on several glasses of wine while dining at home with his wife and [investment advisor friend] in August 2010 and blurted out, 'It would be nice to be King for a day.'" Reuters continued that the investment advisor "took the hint" and purchased tens of thousands of King shares on the next trading day, including hundreds for himself and his stockbroker friend. Testimony to this effect before the jury was presumably a significant factor leading to the partner's conviction.
Accounting fraud: On March 3, 2017, the SEC announced that the Mexico-based homebuilding company Desarrolladora Homex S.A.B. de C.V. agreed to settle charges that it reported fake sales of more than 100,000 homes to boost revenues in its financial statements during a three-year period from 2009–11. Specifically, the SEC alleged that Homex "inflated the number of homes sold during the three-year period by approximately 317 percent and overstated its revenue by 355 percent (approximately $3.3 billion)."
Notably, the SEC used high-resolution satellite imagery to prove that Homex had not even broken ground on many of the homes for which it reported revenues during the three-year period. For example, the SEC alleged in its complaint that Homex "reported revenues from a project site in the Mexican state of Guanajuato where every planned home was purportedly built and sold by Dec. 31, 2011" but, to the contrary, "satellite images of the project site on March 12, 2012, show[ed] that it was still largely undeveloped and the vast majority of supposedly sold homes remained unbuilt." Said Melissa Hodgman, associate director of the SEC's Enforcement Division, "We used high-resolution satellite imagery and other innovative investigative techniques to unearth that tens of thousands of purportedly built-and-sold homes were, in fact, nothing but bare soil."
Homex declared bankruptcy in 2014 and is under new management, and the SEC said that "Homex has since undertaken significant remedial efforts and cooperated with the SEC's investigation." Stephanie Avakian, acting director of the SEC's Enforcement Division, said that "[t]he settlement takes into account that the fraud occurred entirely under the watch of prior ownership and management, the company's new leaders provided critical information regarding the full scope of the fraudulent conduct, and the company continues to significantly cooperate with our ongoing investigation."
The SEC said that, without admitting or denying the allegations in the SEC's complaint filed in the Southern District of California, "Homex consented to the entry of a final judgment permanently enjoining the company from violating the antifraud, reporting, and books and records provisions of the federal securities laws, and the company agreed to be prohibited from offering securities in the U.S. markets for at least five years."
Gatekeeper failures: On April 5, 2017, the SEC announced that Arizona-based brokerage firm Lawson Financial Corp.; its CEO, Robert Lawson; and its former underwriter's counsel, John T. Lynch Jr., agreed to settle charges for due diligence gatekeeping failures "related to municipal bond offerings they were underwriting that turned out to be fraudulent." Director of the SEC's New York Regional Office Andrew M. Calamari said in the press release that "[u]nderwriters are critical gatekeepers relied upon by investors to ensure that accurate information is being provided in municipal bond offering documents."
According to the SEC's findings (which were neither admitted nor denied by the defendants), LFC specifically "failed in its role as a gatekeeper to conduct reasonable due diligence when underwriting bond offerings to purchase and renovate nursing homes and senior living facilities." In this regard, the SEC found that LFC failed to ensure that the offering manager, Christopher F. Brogdon (who was himself charged in the same matter by the SEC in 2015 and has been ordered by a court to repay $85 million to investors), and his related borrowers were in compliance with their continuing disclosure undertakings as required by the securities rules and regulations relating to the purchase and sale of municipal securities. LFC's founder and CEO Lawson and then-underwriter's counsel Lynch were also charged with failing to conduct reasonable due diligence (Lynch was further charged with failing to disclose that he was not authorized to practice law, contrary to what was represented to investors in the bond offering documents).
In the settlement, LFC and Lawson agreed to pay a combined amount in disgorgement of nearly $200,000, as well as penalties of nearly $200,000 for LFC and $80,000 for Lawson, who was barred from the securities industry for three years. The SEC said that LFC ended up paying a penalty that was approximately double what it would have paid had it been eligible for more lenient remedies under the SEC's Municipalities Continuing Disclosure Cooperation Initiative. Lynch agreed to pay $45,000 and was permanently barred from practicing before the SEC or representing or advising clients in SEC matters.