This article was published in a slightly different form in the 2008 issue of the Bloomberg Corporate Law Journal.

Imagine this (hypothetical) course of events: Dan Archer, CEO of ABC Corp., a medium-sized equipment parts manufacturer, received a notice that the US Department of Justice and the Securities and Exchange Commission had launched investigations into whether ABC Corp. had violated the anti-corruption provisions of the Foreign Corrupt Practices Act (FCPA).

Dan’s first thought was that there had to have been a mistake. The company’s auditors had just finished reviewing the company’s books and records and pronounced them pristine. More significantly, the company didn’t have any operations outside the US…so there could be no reason for an employee to bribe foreign officials.

But then Dan learned that a foreign government’s pension fund had recently acquired a major stake in one of ABC Corp.’s clients. Just weeks after the government fund made its investment, ABC Corp.’s Senior Vice President of Sales hosted a lavish dinner in Las Vegas for the client’s executives and their spouses (as part of ABC Corp.’s efforts to woo further business from the client). ABC Corp. landed the deal, a multimillion-dollar sale; thereafter, a competitor, who lost out on the contract, filed a complaint with the US government.

Now the DOJ and the Securities and Exchange Commission were discussing whether to file FCPA charges against ABC Corp. and its senior executives.

These days, global economic and enforcement trends are on a collision course to create a new type of corporate risk. In recent months, foreign governments with massive cash reserves have been branching out into more non-traditional investment opportunities in a host of industries around the world (often through what are called “sovereign wealth funds” or, in the last few months, “SWFs”), including recent headline-grabbing huge investments in major global financial services companies.

As a result, the number of companies that are partially or wholly state-owned is expanding at an increasing rate.

At the same time, government enforcement agencies around the world are stepping up their efforts to prosecute corruption to unprecedented levels. The FCPA’s anti-bribery provisions generally prohibit American companies and individuals from conveying anything of value to a “foreign official” with the “corrupt” intent of gaining or retaining business. Significantly, under the FCPA, an employee of a state-owned company is clearly a “foreign official.” And it is clear that an employee of a company partially owned by a foreign state could qualify. However, there is a near-total lack of guidance from American enforcement officials (or case law) regarding under what circumstances an employee of a partially state-owned entity would be deemed a “foreign official.”

Taken together—and as the fictitious example of Dan Archer and ABC Corp. illustrates—companies like Dan’s will increasingly face the previously unknown risk of violating the FCPA, including for conduct that entirely occurs on American soil. Typical business practices could inadvertently lead to a law enforcement nightmare. Even multinational corporations already accustomed to FCPA requirements will need to re-examine and possibly broaden their compliance efforts.

Suddenly, the decades-old US anti-bribery law is poised to expand its reach in surprising new directions.

Sovereign Funds: Remarkable Growth, Shifting Patterns

Sovereign wealth funds—the investment arms of national governments—invest mammoth amounts of capital in increasingly varied industries and enterprises.

Approximately twenty countries currently maintain sovereign wealth funds valued at US$2-3 trillion— more than the sum of all the world’s hedge funds. China, for example, has US$1.4 trillion in foreign currency reserves, more liquidity than it requires to stabilize its currency. As a result, China recently created a US$200 billion investment pool, called China Investment Corp., dedicated to pursuing asset diversity and higher returns. Already the fund has invested US$3 billion in The Blackstone Group and US$5 billion in Morgan Stanley and now owns approximately ten percent of each. The United Arab Emirates’ Abu Dhabi Investment Authority, Norway’s Government Pension Fund and Saudi Arabia’s wealth fund each have more than a quarter of a trillion dollars to invest, according to International Monetary Fund estimates. The sovereign wealth funds of Kuwait, Singapore, Russia and Hong Kong each total more than US$100 billion in assets.

Some sources estimate that petroleum reserves, trade surpluses and other income sources could propel sovereign wealth holdings to as much as US$12 trillion over the next eight years. With so much cash, the funds are exploring new ways of investing. Traditionally, nations stashed their reserves in relatively low-risk, low-return investments like bank deposits and US Treasury securities and state-owned entities were located predominantly within a narrow range of industries (including defense, aerospace, energy, utilities and transportation). Today, sovereign wealth funds acquire interests in companies across a rapidly expanding range of sectors and invest in private firms, partnerships, real estate ventures, financial institutions and other assets. Foreign government control can extend to grocery store chains, hotels, casinos, private equity firms, banks, securities exchanges and other entities in any developed or developing country.

2007 was a breakout year for the funds’ investments. For example, in one week in December 2007, Abu Dhabi Investment Authority purchased a US$7.5 billion stake in Citigroup Inc., becoming one of the company’s largest shareholders and the Government of Singapore Investment Corp. invested nearly US$10 billion in investment bank UBS. Yet although they made the international news, these transactions form only a small piece of a global trend.

In 2007, sovereign funds closed at least forty-three transactions worth US$33  billion, a thirty-three percent increase from the US$25 billion they spent on thirty-eight deals in 2006. Middle Eastern funds spent more than US$80 billion. And of all these investments, the US has been the largest recipient.

If these trends continue, nearly any type of enterprise could be owned outright or significantly influenced by a foreign government. Unlike in the traditional state-owned enterprise context, the industries affected by the new wave of sovereign wealth investment have no common denominators or identifiable characteristics to tip off a potential business partner to FCPA risks.

In some cases, companies receiving the investments claim that they also expect to benefit in other ways. When China and Singapore purchased stakes in Barclays for approximately US$18 billion in 2007, Barclays’ chief executive stated that he anticipated potential new business opportunities in China, including through debt issuances and other structured products and by managing more assets for Chinese clients.

So far, public discussion of sovereign wealth funds’ increased appetite for equity-type investments (and their increased influence over markets) has focused on whether and how to regulate the funds, force them to be more transparent and/or restrict them through protectionist measures.

For example, in the US, political opposition ended a bid by a Chinese entity for Unocal Corp. Security concerns affected Dubai Ports World’s proposal to acquire a stake in a company operating several seaports. Congress passed the Foreign Investment and National Security Act of 2007 in part to formalize government review and increase legislative input in proposed transactions involving foreign investments in more areas of the US economy. The European Union and several countries outside the EU may be considering similar changes.

But there has been little commentary on the FCPA ramifications of this trend.

The High Cost of Violating the FCPA

Adopted in 1977, the FCPA prohibits paying or offering anything of value to foreign officials for the purpose of obtaining or retaining business. It also mandates that companies maintain books and records to make sure that they, their subsidiaries and affiliates do not make these types of payments.

The anti-bribery provisions apply to several categories of people and organizations. These include US citizens, nationals and residents as well as corporations, partnerships and other business entities that have a principal place of business in the US or are organized under US law. The provisions also apply to any foreign company or person who causes, directly or through agents, any act in furtherance of a bribe to take place on US territory.

The DOJ and SEC both investigate potential FCPA violations and take enforcement actions against violators. For companies that make illegal payments—even inadvertently—the penalties can be stiff. In April 2007, Baker Hughes Incorporated, a Texas-based provider of oil field products and services, paid a record-setting US$44 million to settle civil and criminal FCPA charges. A few months later, Chevron Corporation agreed to pay US$30 million in fines.

Officials from both the DOJ and SEC have stated repeatedly that prosecuting FCPA violations remains a high priority for their staff. In November 2007, the New York Times reported that DOJ officials have sixty cases under investigation or prosecution in the US, with a “new, five-member F.B.I. team dedicated to examining possible violations” of the FCPA.1

In 2007, US regulators publicly disclosed at least two industry-wide FCPA investigations. After uncovering evidence that at least one participant in each market (oil and gas services, orthopedic implant manufacturing) had made improper payments, the SEC and DOJ began to scrutinize nearly every other participant in those markets. Anti-corruption enforcement is on the rise outside the US, too. In one recent high-profile example, Siemens AG, a German company, admitted to having more than €1.3 billion in suspicious payments on its books.

Add to this the fact that the line between private and state-controlled companies continues to blur. In a December 2007 speech,2 SEC Chairman Christopher Cox emphasized the global trend towards the semi-privatization of government enterprises in areas such as banking, oil and gas, infrastructure, transportation and real estate. Government-owned companies conduct public offerings in which private investors purchase significant minority shareholdings, thus creating publicly traded but state-owned companies in which the foreign government still controls all of the decision-making. Of the world’s twenty largest publicly traded companies, he pointed out, eight are state-owned sovereign businesses, including PetroChina, which boasts the world’s largest market capitalization. Regulatory filings show that PetroChina offered twelve percent of its shares to the public, but the Chinese government owns the rest of the company.

Another Complicating Factor: So Who’s a “Foreign Official?”

One of the difficulties companies already face in connection with their FCPA compliance programs is getting their employees to grasp the fact that the FCPA does not merely apply to payments made to government officials per se (e.g., foreign ministers, legislators, bureaucratic clerks, etc.). The FCPA’s anti-bribery provisions define a foreign official as an officer or employee of “a foreign government or any department, agency, or instrumentality thereof, or of a public international organization, or any person acting in an official capacity for or on behalf of any such government or department, agency, or instrumentality, or for or on behalf of any such public international organization.” Because of this broad definition, a robust compliance program will often include specific examples of non-intuitive “foreign officials” (e.g., doctors employed by public hospitals, employees of state-owned entities, etc.).

Unfortunately for companies looking for a clear rule, US enforcement officials have declined to specify what percentage of sovereign ownership—or other set of characteristics—determines whether a company and its employees count as foreign officials for FCPA purposes. The statute contains no minimum percentage interest that specifies whether a partially state-owned entity qualifies as a foreign government or department. Nor is there guidance from the DOJ or SEC.

At an FCPA conference in 2006, DOJ officials stated that whether a company’s employees are foreign officials depends on whether the foreign government has “effective control” over the company that makes it a government actor for FCPA purposes. In other words, their benchmark for determining when to bring commercial bribery charges remains relatively vague: Did a foreign government effectively control the company or individual receiving something of value?

Recent congressional hearings illustrate the opacity of this standard. The Wall Street Journal reported that, in a recent Congressional hearing on sovereign funds, one senator questioned the influence of a Saudi prince on decisions made at Citigroup, including the firing of the bank’s CEO. “‘Does he have a controlling interest in the company? Most people would ordinarily say at four percent, no’…‘But it’s hard to say he didn’t exert some significant influence.’”3

Best Practices to Protect Yourself

First, the most significant—and likely, easiest, thing—a company could do to adapt its FCPA compliance program to this new era where any client could be a “foreign official” is institute its FCPA compliance program here in the US. Companies often think that their US facilities and personnel do not need to concern themselves with the FCPA. Such thinking is clearly wrong (as illustrated by the recent Lucent FCPA settlement, in which Lucent paid a significant fine for allegedly paying for foreign government officials’ tourist excursions in the US).4 The rise in sovereign wealth fund activity simply exacerbates the risk of possible FCPA “bribery” activity in the US, by, in effect, bringing the foreign officials to the US (and effectively, in disguise).

Second, without more guidance from enforcement officials regarding whether there are any ownership thresholds or other safe harbors that would render an employee of a state-owned entity a non-foreign official, the best way to avoid an unwitting FCPA issue is to do some basic research on potential business partners, acquisition targets, customers and clients (i.e., know whether your customer is or is not government-owned). If the sovereign wealth funds’ recent broader investment activity continues, a sovereign wealth fund could have an interest in your client or business partner (regardless of what industry you are in).

Third, systematize the process of “knowing your customer” as part of your FCPA compliance program. The FCPA’s books and records provisions require that companies have a system of internal accounting controls that are sufficient to ensure (1) that the books and records “accurately and fairly” record the transactions of the company and (2) that the company otherwise is in compliance with the FCPA and other laws. Thus, it is possible the US government could extend liability for a books and records violation to a company whose systems could not detect a payment to a sovereign wealth fund-owned company’s employees (even if such a payment never occurred). For that reason, getting in front of the sovereign wealth fund curve and the new government ownership environment (and being able to tell a government agency that you were aware of the potential issues and trying to steer clear of them) may well augur in your favor in the event you end up in Dan Archer’s position.