In the first Foreign Corrupt Practices Act (FCPA) enforcement action of the year, the Securities and Exchange Commission (SEC) announced on February 28, 2013, that it had entered into a settlement agreement with Keyuan Petrochemicals Inc. (“Keyuan”) and its former Chief Financial Officer, Aichun Li. The company agreed to pay $1 million, and Li agreed to pay $25,000, for alleged violations of federal securities laws that included FCPA-related accounting violations. This advisory summarizes the FCPA-related aspects of the SEC’s allegations and discusses what guidance companies and executives can draw from the case.
S.E.C. v. Keyuan Petrochemicals Inc.
According to the SEC’s complaint, Keyuan is a China-based petrochemical company that, in 2010, consummated a reverse merger with a Nevada shell corporation. As a result of the reverse merger, Keyuan was able to register with the SEC and have its stock traded in the United States. In 2011, one of Keyuan’s auditors reported concerns about accounting irregularities to the company’s audit committee. Keyuan thereafter began an internal investigation that ultimately disclosed the facts in this case. While the investigation was ongoing, NASDAQ temporarily suspended trading in Keyuan’s stock in 2011 before ultimately delisting the stock in 2012.
The primary allegations in the SEC’s complaint involve the company’s failure to disclose related-party transactions— including sales of products, purchases of raw materials, loan guarantees and short-term cash transfers—in violation of securities laws. The complaint also alleges FCPA-related accounting violations—namely, that Keyuan and an unidentified executive of the company maintained an off-balance-sheet cash account from which more than $1 million was distributed to senior officers of the company, as well as to Chinese government officials. The complaint alleges that the account was used to fund gifts to various foreign officials, including those from local environmental, port, police and fire departments. The gifts ranged from household goods, such as linens, to direct cash payments. As a result of the efforts to conceal this off-balance-sheet account, the SEC alleges books and records and internal controls violations.
Takeaways from the Case
Although the SEC has not publicized the Keyuan settlement as an FCPA matter—principally because the majority of the complaint concerns violations stemming from the alleged failure to disclose related-party transactions—the case still provides a useful guidepost for companies and executives concerned about the anti-corruption implications of doing business in high-risk industries and countries.
First, Keyuan highlights that China remains squarely in the government’s FCPA enforcement crosshairs. As most U.S. companies are already aware, China has long been viewed as a high-risk country for FCPA purposes due to widespread government corruption. Nearly one-third of FCPA enforcement actions in 2012 involved activities in China. Keyuan signals that this trend will likely continue.
Second, this case demonstrates that the government will continue to investigate non-U.S. reverse mergers carefully. In reverse mergers, foreign companies are able to sidestep the longer and more expensive process of an initial public offering in order to secure listing of securities on U.S. exchanges. However, in doing so, the companies become “issuers” and subject themselves to the anti-bribery and accounting provisions of the FCPA. In recent years, the SEC has brought several FCPA enforcement actions in this context. If Keyuan is any guide, the SEC will continue to scrutinize reverse mergers for potential wrongdoing in 2013.
Third, companies must be vigilant in any dealings with foreign officials, even with local government officers. The SEC’s allegations against Keyuan suggest that the majority of the bribes paid by the company were to local or lowerranking government officials, such as police and fire department officers. The case thus underscores the fact that companies can face FCPA risks when dealing with any foreign official, not just high-ranking, national officers.
Fourth, the settlement is evidence that the government intends to follow through on its commitment to pursue FCPA enforcement actions in the target industries identified in the FCPA Resource Guide, released last November by the SEC and the Department of Justice. The Resource Guide specifically named aerospace and defense manufacturing, banking and finance, health care and life sciences, energy (the sector in which Keyuan operated), telecommunications and transportation as industries at particular risk of FCPA violations. Companies and executives in these industries must be especially diligent in their FCPA audit and compliance efforts.
Fifth, Keyuan is an example of how the government combines FCPA-related violations with other claims. Companies should be aware that an investigation that begins as an FCPA matter can quickly expand to include securities law violations, mail fraud, wire fraud, Travel Act violations, money laundering and conspiracy, among other potential criminal and civil liability. Conversely, a government investigation into areas unrelated to the FCPA could eventually unearth issues that ultimately lead to damaging allegations that the company violated the FCPA.
Although this is the first FCPA-related enforcement action publicized this year, it certainly will not be the last. Consequently, companies and executives with overseas operations and business relationships must remain cognizant of FCPA red flags, particularly when doing business in high-risk industries, such as the energy sector, and in high-risk countries, such as China.