Month: October 2010

Real Estate, China and the FCPA

China is hotbed for violations of the Foreign Corrupt Practices Act. The real estate industry is not immune from the dangers. In February of 2009 Morgan Stanley’s real estate group reported an employee based in China in an overseas real estate subsidiary that appeared to have violated the Foreign Corrupt Practices Act.

My company has significant business relationships with CB Richard Ellis so it saddens me that they are the latest to report a problem under the FCPA.

As a result of an internal investigation that began in the first quarter of 2010, the Company determined that some of its employees in certain of its offices in China made payments in violation of Company policy to local governmental officials, including payments for non-business entertainment and in the form of gifts. The payments the Company discovered are minor in amount and the Company believes relate to only a few discrete transactions involving immaterial revenues. Nonetheless, the Company believes that the payments may have been in violation of the U.S. Foreign Corrupt Practices Act or other applicable laws. Consequently, the Company voluntarily disclosed these events to the U.S. Department of Justice (the “DOJ”) and the Securities and Exchange Commission (the “SEC”) on February 27, 2010 and has continued to cooperate with both the DOJ and the SEC in connection with this investigation. The Company engaged outside counsel to investigate these events and has implemented thorough remedial measures.

In addition, in the third quarter of 2010, the Company began another internal investigation, with the assistance of outside counsel, involving the use of a third party agent in connection with a purchase in 2008 of an investment property in China for one of the funds the Company manages through its Global Investment Management business. This investigation is ongoing and at this point the Company is unable to predict the duration, scope or results thereof. In light of the Company’s cooperation with the DOJ and the SEC as described above, the Company voluntarily notified both agencies of this separate internal investigation and will report back to them when the Company has more information.

The real estate industry should be just as concerned about bribery of foreign officials as any other industry. Perhaps even more so. Real estate is inherently local and you undoubtedly need to deal with government officials to get building permits, occupancy permits, zoning approvals and a myriad of other interactions.

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Revoking a Subscription Agreement

Private equity funds investors sign a subscription agreement, promising to deliver cash when the fund makes a capital call. In a recent Delaware case, investors sought to revoke their subscription agreements and recover their capital contribution. They were investors in a Lehman Brothers sponsored investment fund.

In 2007 the three plaintiffs became limited partners in Lehman Brothers Merchant Banking Partners IV L.P. After Lehman declared bankruptcy, the the Fund’s management team bought out Lehman, took over the Fund’s general partner and investment advisor, and changed the Fund’s name to Trilantic Capital Partners IV, L.P.

Among the other investors in the fund was Lehman Brothers itself. The company had made a $250 million capital commitment. The fund itself was not part of the Lehman bankruptcy estate, but the general partner’s interest, the investment advisor and the $250 capital commitment were involved.

The plaintiffs told the fund they would not make any capital calls after they heard of the Lehman bankruptcy. That was probably a sensible position to take initially.

But the fund emerged from the Lehman bankruptcy proceedings. The existing fund management team would stay in place. A third party capital source funded their purchase of Lehman’s general partner interest and investment adviser. The investor also agreed to assume the unfunded and uncommitted portion of the Lehman’s capital commitment. The management team offered all the limited partners a chance to reduce their capital commitments. Ultimately, the fund reduced in size from $3.3 billion to $2.6 billion.

These three plaintiffs sought a rescission based on three counts: supervening frustration, mutual mistake and violations of the Texas Securities Act.

Supervening frustration

“The doctrine of supervening frustration can be invoked ‘[w]here, after a contract is made, a party’s principal purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made.’ … The doctrine does not apply if the supervening events were “reasonably foreseeable, and could (and should) have been anticipated by the parties” at the time of contracting.”

The limited partnership agreement contemplated that Lehman might transfer its general partnership interest and the fund would continue to operate. The LP Agreement also contemplated the potential bankruptcy of Lehman.

This claim did not even come close to working.

Mutual mistake

“Under this doctrine, a party can rescind an agreement if (i) both parties were mistaken as to a basic assumption underlying the agreement; (ii) the mistake materially affects the agreed-upon exchange of performances; and (iii) the party adversely affected did not assume the risk of the mistake.”

The plaintiffs claimed they were mistaken about Lehman’s financial condition and the continued presence of Lehman was one of their basic assumptions. The LP agreement contemplated the removal of Lehman. The private placement memorandum made not representations about Lehman’s financial health. The subscription agreement stated that the investors were not relying on any other representations.

This claim did not even come close to working.

Texas Securities Act

“This statute prohibits the soliciting of an investment ‘by means of an untrue statement of a material fact or an omission to state a material fact necessary in order to make the statements made, in the light of the circumstances in which they are made, not misleading.’”

The plaintiffs claimed that Lehman failed to disclose its financial instability. Given this instability, its unlikely Lehman could continue its sponsorship of the fund.

But the false statements were in Lehman’s public filings, not the fund documents. They failed to show that the subscription agreement, the limited partnership agreement or the PPM contained any representation about Lehman’s financial health. They merely pointed to general statements in the PPM about how the fund would benefit in the future from its affiliation with Lehman.

The plaintiffs also failed to allege that the fund knew its representations about Lehman were “false when made.” It failed the scienter requirement under the Texas Securities Act.

It’s tough for a fund to get in a fight with its investors. Here, it was the investors who filed suit. it was probably sensible to resist making capital calls when Lehman filed bankruptcy. Once the fund survived and was spun out with the existing management team, the investors should have re-thought their position.

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Embarrassment from the American Bar Association

As the head of compliance, I frequently call on a team of lawyers for advice on how to interpret the law and move that interpretation into implementation. As a consumer of legal services, I have an interest in innovation and improvements in the delivery of those services. As an former practicing lawyer, I understand the challenges.

The American Bar Association ran a  Legal Rebels contest on the theme of “What innovation will be most valuable to you in your future practice as a solo practitioner?”

I don’t deal with solo practitioners very often for legal advice, even though they represent a big portion of legal practice. Having left a big law for compliance, I’m now more like a solo practitioner (without having to look for clients.)

I was interested to hear what innovations the ABA found interesting. The crop of runners-up was a mixed bag. With some interesting thoughts and some mere statements that technology alone will be innovative.

I was hoping the winner would offer something new and interesting about improving the delivery of legal services, legal skills or the delivery of client service.

The winner thinks a fancy answer machine will be the most valuable innovation: Solo Dreams of Full-Functioning Digital Messaging Assistant.

Kevin O’Keefe and Scott Greenfield already expressed their dismay. I think this one of the worst things to come out of American Bar Association. I don’t see how this would help the lawyer. I don’t see how this helps you be a better lawyer or deliver better client service.

For the most part, lawyers are dealing with their clients at a critical time in their lives: divorce, imprisonment, merger, bankruptcy, internal investigation, etc. A personalized greeting from a robot on the phone is not going to make me think any better of the lawyer.

For me, simple questions can be answered by email. More complicated issues and more problematic issues require a real person. Do you feel better about a service provider because you can handle transactions through voicemail?

Parts of the lawyers day can be handled by technology, but personal interaction between the lawyer and the client cannot.

Maybe the ABA should just stick with selling skateboards.

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Compliance Bits and Pieces for October 1

Here are some recent compliance-related stories that I found interesting:

The face of the financial crisis by Larry Ribstein in the Creative Destroyer

We need somebody we can send off to jail. Jail apparently provides the moral clarity necessary to wrap up a financial crisis. Bernie Madoff’s just an old-fashioned fraud from another era. The Justice Department has sent almost 3,000 people to jail for financial fraud between October, 2009 and June 2010, but no faces.

House Passes Impotent Debarment Bill by Mike Koehler in FCPA Professor

On September 15th, the House, by a unanimous 409-0 vote, passed H.R. 5366 (“Overseas Contractor Reform Act”) (see here). The Act generally provides that a corporation “found to be in violation of the [FCPA’s anti-bribery provisions] shall be proposed for debarment from any contract or grant awarded by the Federal Government within 30 days after a final judgment of such a violation.” The Act’s key trigger term for debarment – “found to be in violation” of the FCPA’s anti-bribery provisions – is a trigger that is not reached in nearly every FCPA enforcement action because of the façade of FCPA enforcement. Thus, the Act represents impotent legislation.

Small Change – Why the revolution will not be tweeted by Malcolm Gladwell in the New Yorker

Innovators tend to be solipsists. They often want to cram every stray fact and experience into their new model. As the historian Robert Darnton has written, “The marvels of communication technology in the present have produced a false consciousness about the past—even a sense that communication has no history, or had nothing of importance to consider before the days of television and the Internet.” But there is something else at work here, in the outsized enthusiasm for social media. Fifty years after one of the most extraordinary episodes of social upheaval in American history, we seem to have forgotten what activism is.

After Dodd-Frank, SEC Getting At Least One FCPA Tip A Day in WSJ.com’s Corruption Currents

The Securities and Exchange Commission has been receiving at least one tip a day about potential foreign bribery violations since a whistleblower bounty program became law in July, according to a person familiar with the matter.

A Tale of Two Strategies for SOX Compliance by Matt Kelly in Compliance Week‘s the Big Picture

Only that elite group can manage the responsibility of working with public investors—people so far removed from the corporation itself, that they have no choice but to trust in the accuracy of financial statements. SOX is one measure this country uses to determine which corporations belong in that group, and which don’t. Alloy Steel and Facebook both said today that they don’t, and they deserve praise for it. This is how the system is supposed to work.

Image of Bits & Pieces is By Thunderchild7.