Investigations and White Collar Defense

Eye on the Supreme Court—Corruption and Fraud Edition

Why it matters: This session, the Supreme Court has undertaken the review of numerous cases that raise thorny issues arising in the white collar context. In our last newsletter, we reported on the Court’s March 30, 2016 decision in Luis v. U.S. which held in a criminal healthcare case that the pretrial restraint by the government of legitimate, untainted assets owned by a defendant that are needed to retain defense counsel of choice violates the Sixth Amendment. In this newsletter we report on the Court’s May 2, 2016 decision in Ocasio v. U.S, which dealt with the issue of what prosecutors need to prove to establish a public corruption conspiracy under the Hobbs Act. In addition, we review the April 27, 2016 oral argument before the Court in McDonnell v. U.S., where the Court is reviewing the question of what constitutes an “official act” for purposes of the federal public corruption statutes in the high-profile case involving Virginia’s former governor. Last, we preview the Court’s grant of certiorari on April 25, 2016 in Shaw v. U.S. to resolve a circuit split regarding the intent prosecutors need to prove to establish a “scheme to defraud a financial institution” under the federal bank fraud statute.

Detailed discussion: Read on for a recap of the recent decision, oral argument and grant of certiorari, respectively, in three criminal cases with white collar implications before the Supreme Court.

Ocasio v. U.S.: On May 2, 2016, in a 5-3 decision, the Supreme Court held in a public corruption context that a defendant may be convicted of conspiring to violate the Hobbs Act (18 U.S.C. § 1951) based on proof that he reached an agreement with the owner of the property in question (i.e., the target of the extortion scheme) to obtain that property under color of official right. For purposes of Ocasio, the relevant language of the Hobbs Act provides in Section 1951(a) that “[w]hoever in any way or degree … affects commerce … by … extortion or … conspires so to do … shall be fined under this title or imprisoned not more than twenty years, or both.” Section 1951(b) defines “extortion” in relevant part to include “the obtaining of property from another, with his consent ... under color of official right.”

First, a brief summary of the underlying facts and procedural history that got us to this point. Petitioner Samuel Ocasio (Ocasio), a former Baltimore police officer, was indicted in 2011 along with nine other police officers and two owners of an auto repair shop for participating in a kickback scheme in which Ocasio and the other officers routed damaged vehicles from accident scenes to the auto repair shop in exchange for payments from the shop owners. The shop owners and most of the other police officers pleaded guilty and accepted plea deals, but Ocasio did not and was convicted after jury trial of directly violating the Hobbs Act by obtaining money from the shop owners under color of official right, and of conspiring with others to violate the Hobbs Act in conjunction with the general federal conspiracy statute found at 18 U. S. C. § 371. Relevant to the case before the Court, Ocasio unsuccessfully argued during both the trial (in connection with jury instructions) and on appeal before the Fourth Circuit that he could not be convicted under the federal conspiracy statute of conspiring to violate the Hobbs Act—and thus his conviction should be vacated—because the definition of “extortion” in Section 1951(b) of the Hobbs Act requires that the property at issue be obtained “from another.” Thus, Ocasio argued, the prosecutors had failed to prove that the conspirators agreed to obtain property “from another,” i.e., someone outside the conspiracy, because the shop owners were part of the conspiracy, and so the payments at issue were simply payments between conspiracy members. The Supreme Court granted Ocasio’s petition for writ of certiorari to decide the issue.

Justice Samuel Alito, writing for the majority, succinctly stated up front that “[w]e reject [Ocasio’s] argument because it is contrary to age-old principles of conspiracy law.” Under those “long-standing principles,” the Court held that “a defendant may be convicted of conspiring to violate the Hobbs Act based on proof that he entered into a conspiracy that had as its objective the obtaining of property from another conspirator with his consent and under color of official right.”

The Court went on to briefly review the “basic” principles of conspiracy law in effect. Noting that the federal conspiracy statute under which Ocasio was convicted—Section 371– makes it a crime to “conspire … to commit any crime against the United States,” the Court cited to established case law precedent to hold that the “conspiracy” element of the statute is met if there is “a joint commitment to an ‘endeavor which, if completed, would satisfy all of the elements of [the underlying substantive] criminal offense.’” Further, the Court said that although the conspirators need to pursue the same criminal objective, “‘a conspirator [need] not agree to commit or facilitate each and every part of the substantive offense’” and that a defendant must merely reach an agreement with the ‘specific intent that the underlying crime be committed’ by some member of the conspiracy.” This is true, the Court said, even if the defendant himself is incapable of committing the substantive offense himself.

The Court concluded that “[t]hese basic principles of conspiracy law resolve this case. In order to establish the existence of a conspiracy to violate the Hobbs Act, the Government has no obligation to demonstrate that each conspirator agreed personally to commit—or was even capable of committing—the substantive offense of Hobbs Act extortion. It is sufficient to prove that the conspirators agreed that the underlying crime be committed by a member of the conspiracy who was capable of committing it. In other words, each conspirator must have specifically intended that some conspirator commit each element of the substantive offense.” Applying these principles to the facts of the case, the Court stated that Ocasio and the shop owners “shared the common purpose” of Ocasio and the other police officers conspiring to commit the underlying Hobbs Act extortion offense, with the police officers satisfying the required element of obtaining property “under color of official right” from “another” (i.e., the shop owners) with their consent. Even though the shop owners, as non-public officials, could not themselves commit the underlying Hobbs Act offense, they could and did conspire with Ocasio and the other police officers to do so.

The Court rejected Ocasio’s argument that it was improperly expanding the reach of the Hobbs Act, in effect “creating a national antibribery law and displacing a carefully crafted network of state and federal statutes.” The Court cited to its 1992 decision in Evans v. United States, another Hobbs Act case involving extortion by a public official, where it held that “Hobbs Act extortion ‘under color of official right’ includes the ‘rough equivalent of what we would now describe as ‘taking a bribe.’” The Court concluded that “[h]aving already held that § 1951 prohibits the ‘rough equivalent’ of bribery, we have no principled basis for precluding the prosecution of conspiracies to commit that same offense.” The Court also rejected Ocasio’s claim that its decision was serving to “dissolve the distinction between extortion and conspiracy to commit extortion,” noting that Ocasio was exaggerating the decision’s reach: “Our interpretation thus does not turn virtually every act of extortion into a conspiracy … Nor does our reading transform every bribe of a public official into a conspiracy to commit extortion.”

Justice Stephen Breyer wrote a separate concurring opinion that questioned whether the Court’s earlier holding in Evans was correctly decided but agreeing that it was still “good law” on which to base the correctly-reached majority opinion in Ocasio. Writing separate dissents were Justice Clarence Thomas (who argued that Evans should be overturned, echoing his dissent in that 1992 case) and Justice Sonya Sotomayor (joined by Chief Justice John Roberts).

McDonnell v. U.S.: In another public corruption case invoking the Hobbs Act as well as the federal “honest services” statute (18 U.S.C. § 1346), on April 27, 2016, the Supreme Court heard oral argument involving the conviction and sentencing to 24 months in prison of the former Virginia governor Robert F. McDonnell (McDonnell). McDonnell was convicted on various counts of public corruption for “gifts” he and his wife accepted from a Virginia businessman (e.g., lavish vacations, golf outings, expensive watches and clothes, “sweetheart” loans, etc.) allegedly in exchange for McDonnell using the governor’s office and his official position and influence to benefit the businessman’s tobacco-derived dietary supplement business. Following the Fourth Circuit’s opinion, which affirmed the district court’s conviction, the Supreme Court granted certiorari on of “[w]hether ‘official action’ under the controlling fraud statutes is limited to exercising actual governmental power, threatening to exercise such power, or pressuring others to exercise such power, and whether the jury must be so instructed; or, if not so limited, whether the Hobbs Act and honest-services fraud statute are unconstitutional.” On a side note, McDonnell’s wife was also convicted for public corruption and sentenced to 12 months in prison, although her case is presently on hold at the Fourth Circuit pending resolution of her husband’s case.

Most of the oral argument was devoted to the issue of what constitutes an “official action.” McDonnell’s attorney Noel J. Francisco began by pointing out that the government’s position—that “official action” encompasses anything within the range of official duties—is overbroad and “wrong.” Francisco argued that, instead, Supreme Court precedent required that “[i]n order to engage in ‘official action,’ an official must either make a government decision or urge someone else to do so. The line is between access to decision makers on the one hand and trying to influence those decisions on the other.”

Francisco further argued that the jury instructions at the trial were fatally flawed because they failed to instruct the jury that it had to first find that McDonnell used his official position to influence the decisions of others before it could find that he took an “official action.” Here, the argument focused specifically on the factual allegation that McDonnell attempted to influence Virginia state university researchers into agreeing to conduct studies of the businessman’s dietary supplement in order to obtain FDA approval. To this, Justice Anthony Kennedy said that “I take it all parties concede that the act of the university official to undertake or not to undertake a research study would be an ‘official action.’" Francisco agreed, but said “the question is: Did the Governor cross the line into influencing officials to undertake that action and was the jury properly instructed?” There ensued a series of hypotheticals proposed by the Justices as to the parameters of what would constitute “influencing the actions of others” in an “official action” context and the language that a proper jury instruction in this regard would include.

Arguing for the government, Deputy Solicitor General Michael R. Dreeben said that McDonnell was wrongfully trying to “carve out” from the concept of “official action” those actions that, while maybe not influencing others to act, still improperly facilitated access to them via phone calls and meetings. To this, Chief Justice Roberts said that “he’s not the only one,” citing to an amicus brief filed by the former White House counsels to Presidents Reagan, both Bushes, Clinton and Obama that said that, if upheld, the decision would “cripple the ability of elected officials to fulfill their role in our representative democracy” (Chief Justice Roberts joked that “[n]ow, I think its extraordinary that those people agree on anything”). There followed a long back and forth between the Justices and Dreeben with hypotheticals attempting to draw a distinction between improper “quid pro quo” or “pay-to-play” official actions and those that are merely a necessary part of representing constituents in the day-to-day business of government, with the Court’s decisions in Skilling and Citizens United being repeatedly invoked by both sides. Here, Justice Breyer perhaps summarized the issue best with his “two serious concerns” with the Court imposing, in the present case after the fact, an overbroad federal definition of “official action”: “One, political figures will not know what they're supposed to do and what they’re not supposed to do, and that’s a general vagueness problem. And the second is, I’d call it a separation of powers problem. The Department of Justice in the Executive Branch becomes the ultimate arbiter of how public officials are behaving in the United States, State, local, and national. And as you describe it, for better or for worse, it puts at risk behavior that is common, particularly when the quid is a lunch or a baseball ticket, throughout this country.”

Francisco finished up by highlighting the pastiche of federal and state anti-bribery laws on the books and his view that the government was overreaching by invoking the federal statutes such as the Hobbs Act in this case, where McDonnell’s conduct was legal under Virginia state law: “The problem here is that we had a State regime that was much less stringent than the Federal regime, and the government wanted to use the open ended Hobbs Act and honest-services statute to fill that gap in what they perceived is the State law. I would respectfully submit that that is an inappropriate use of Federal power.”

We await the Court’s decision in McDonnell with great anticipation and will report back.

Shaw v. U.S.: On April 25, 2016, the Supreme Court granted certiorari in a bank fraud case to review the question presented of whether, under Section 1344(1) of the Bank Fraud Act of 1984 (18 U.S. Code § 1344) (BFA), the words making it a crime “to defraud a financial institution” require prosecutors to prove “an intent only to deceive a bank, as three circuits have held, or of an intent to deceive and cheat a bank, as nine circuits have held, and as petitioner Shaw argued here.” The case is on appeal from the Ninth Circuit, where the appellate court affirmed a district court’s conviction of Lawrence Shaw (Shaw) under Section 1344(1) of the BFA for using PayPal to convince banks that he was another bank customer, Stanley Hsu, and thus had authority to transfer money out of Hsu’s bank accounts and into a PayPal account in Shaw’s control. In his Petition for Writ of Certiorari (Writ), Shaw argued that while it was undisputed in the proceedings below that his scheme was intended to steal Hsu’s money by deceiving the bank that he was Hsu, it was equally undisputed that Shaw did not intend to steal the bank’s money—which intent prosecutors would have had to prove as a prerequisite to liability under Section 1344(1). The Ninth Circuit had rejected this argument, holding that the government need only prove intent to deceive the financial institution, not defraud it out of money, for purposes of Section 1344(1) (upholding the district court’s denial of Shaw’s requested jury instruction that both need be proven).

In his Writ, Shaw said that his case “presents the recurring question left open” by the Court in its 2014 decision in Laughrin v. U.S. That case dealt with the second prong of the BFA, Section 1344(2), which makes it a crime to “obtain any of the moneys, funds, credits, assets, securities, or other property owned by, or under the custody or control of, a financial institution, by means of false or fraudulent pretenses …” There, the Court held that Section 1344(2) does not require prosecutors to prove the defendant intended to defraud the financial institution out of money, but Shaw argued in his Writ that in so holding the Court either impliedly held that such a showing is required for Section 1344(1) or, at the very least, left the question open, and the circuits appear to be split on the issue. It is likely that the Court thus granted cert in an attempt to harmonize Section 1344’s two prongs. The Court will hear oral argument in the case when it reconvenes in October.

See here to read the transcript of the 4/27/16 oral argument before the Supreme Court in McDonnell v. United States.

See here to read the Petition for Writ of Certiorari in Shaw v. United States.

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Focus on the Foreign Corrupt Practices Act

Why it matters: The Foreign Corrupt Practices Act (FCPA) continues to make news in 2016. Since our last newsletter, DOJ officials have been making the rounds to talk up their recently announced FCPA voluntary disclosure pilot program. In the courts, a Delaware Chancery Court judge dismissed a shareholder derivative lawsuit (brought on “demand futility” grounds) filed on behalf of Wal-Mart against its board of directors alleging the board covered up FCPA violations in Mexico. And a review of recent securities filings sheds a light on the government’s ongoing corporate investigations into alleged FCPA violations in foreign territories around the world.

Detailed discussion: Here, we review some of the recent FCPA-related matters that caught our eye.

FCPA voluntary disclosure pilot program: Since the DOJ announced its new one-year FCPA voluntary disclosure pilot program (FCPA Pilot Program) on April 5, 2016, DOJ officials have been making the rounds to talk up the program and reassure both corporations and the individuals who run them. To briefly recap, the DOJ’s new FCPA Pilot Program is intended to, among other things, motivate corporations in connection with FCPA investigations to (1) “voluntarily self-disclose” both corporate and individual misconduct, (2) “fully cooperate” and (3) "timely and appropriately remediate.” The DOJ also provided written descriptions of those terms and outlined the maximum mitigation credit available to a corporation that adheres to them.

On May 10, 2016, Deputy Attorney General Sally Q. Yates spoke at the New York City Bar Association White Collar Crime Conference where she discussed the new FCPA Pilot Program in conjunction with her eponymous September 9, 2015 memo regarding the DOJ’s overall policy to hold individuals accountable (Individual Accountability Policy—a.k.a. the Yates Memo although Yates said at the conference that that moniker was “disconcerting” to her). After emphasizing yet again that the Individual Accountability Policy was the DOJ’s effort to reinforce and centralize the DOJ’s already existing priorities for holding individuals accountable for corporate misconduct, Yates referred to the FCPA Pilot Program as one example where the Individual Accountability Policy had “led different corners of the Justice Department to announce new component-level policies focused on individuals.” Yates went on to say that the FCPA Pilot Program “helps put into practice not only the Individual Accountability Policy’s threshold requirement for cooperation, but also the revisions to the U.S. Attorney’s Manual I announced in November that separates the concept of self-disclosure from that of cooperation. Those revisions account for the difference between a company raising its hand and voluntarily disclosing misconduct and a company simply agreeing to cooperate once it gets caught. We made this this change to emphasize that while the concepts of voluntary disclosure and cooperation are related, they are distinct factors to be given separate consideration in charging decisions. To recognize the significant value of early, voluntary self-reporting, prompt voluntary disclosure by a company—or the lack thereof—is now an independent factor that will be weighed as we evaluate charging decisions.”

In addition, on May 12, 2016, Assistant U.S. Attorney Leslie R. Caldwell sat down with a reporter from The Recorder for an interview about the FCPA Pilot Program. The reporter began by asking about the FCPA Pilot Program’s goals, to which Caldwell responded “[w]e know that FCPA violations are frankly rampant around the world. We also know that there’s a lot of FCPA activity that we never hear about. And a lot of times [companies have] commissioned an internal investigation, and that internal investigation has been done by an outside law firm. That outside investigation has taken some remedial steps: fired some people, changed some compliance processes. [They've] put that investigation on the shelf and they hoped that’s the end of it. If we ever hear about it through other means, they will then tell us about their investigation and they’ll cooperate with us about what they did two years ago, three years ago. So, part of the goal is to get at the vast amount of information that we know exists about FCPA violations by giving companies a more concrete incentive to self-report.” Caldwell also confirmed that the FCPA Pilot Program dovetails with the DOJ’s Individual Accountability Policy, stating that another of the FCPA Pilot Program’s goals is to “get evidence that might otherwise be very hard for us to get about the individuals who were responsible for the FCPA violation … [The FCPA Pilot Program] implements the Yates memo, the individual culpability memo, to come up with an operational way to get at that information about individuals that we know is out there.”

When asked by the reporter whether, to date, there have been “any takers” i.e., corporate participants in the FCPA Pilot Program, Caldwell said that “[w]e certainly have companies that have already self-reported who are eligible for the program. Some companies that self-reported are getting the benefits—including in one case a declination of prosecution—because of the way they handled the violations.” Caldwell stressed that the DOJ is not interested in prosecuting “discreet, small violations such as a one-time bribe to a customs official in name-that-country to get a shipment into that country earlier than they otherwise would have” and that instead the FCPA Pilot Program is intended to root out “self-reports where there is a significant violation of the FCPA.” When asked which corporations she believed would participate in the FCPA Pilot Program, Caldwell reflected that “I think that a company with a really big program might be more worried about the possibility of discovery through other means and that might also motivate self-reporting. I could see where a smaller company or a big company with a smaller problem might be willing to take their chances. But you know that they should realize that there are a lot of people out there who are aware of the FCPA and we’re working with governments in other countries who are sharing information with us. I think the risk of getting caught goes up every day.”

In re Wal-Mart Stores, Inc. Delaware Derivative Litigation: On May 13, 2016, Delaware Chancery Court Judge Andre Bouchard dismissed the shareholder derivative litigation brought in that state against the board of directors (Board) of Wal-Mart Stores Inc. (Wal-Mart) in connection with the Board’s alleged inadequate investigation and cover-up of FCPA violations by a subsidiary in Mexico. Judge Bouchard’s 58-page opinion went into great detail about the underlying facts of the case, but to quickly recap, in April 2012 The New York Times published an article describing the cover-up by the Board of an alleged bribery scheme at Wal-Mart subsidiary Wal-Mart de Mexico. The article prompted 15 lawsuits to be filed shortly thereafter by Wal-Mart stockholders in Arkansas federal court (where Wal-Mart is headquartered) and Delaware chancery court (where Wal-Mart is incorporated) asserting derivative claims on behalf of Wal-Mart. Key to Judge Bouchard’s ruling, the shareholders in both states had filed the actions as derivative suits on behalf of the corporation, alleging “demand futility” due to the claimed inability of the Board to adequately exercise independent and disinterested business judgment in evaluating the shareholders’ claims.

The Delaware and Arkansas courts consolidated the complaints that had been filed in their respective jurisdictions (the Delaware derivative litigation and the Arkansas derivative litigation, respectively). The shareholders in the Delaware derivative litigation successfully pushed for access to Wal-Mart’s books and records pursuant to Section 220 of the Delaware General Corporation Law in a contentious fight that went all the way up to the Delaware Supreme Court, and filed an amended derivative complaint in May 2015 based on information learned in the corporate books and records about the alleged Mexican bribery cover-up by the Board. Meanwhile, the shareholders in the Arkansas derivative litigation proceeded without first seeking to obtain the Wal-Mart books and records on their own or waiting for the outcome of the Delaware shareholders’ Section 220 fight. In March 2015, the federal court in Arkansas dismissed the Arkansas derivative litigation for “failure to adequately allege demand futility” because, based on the evidence (or lack thereof) presented, there was no basis to infer that the majority of the Board had actual or constructive knowledge of the Mexican bribery scheme or cover-up, and thus no basis to infer that the Board could not exercise independent and disinterested business judgment in evaluating the claims. The Board then filed the motion to dismiss the Delaware derivative litigation that was the subject of Judge Bouchard’s ruling, alleging that issue preclusion (i.e., the legal principle that stops a party who litigated an issue in one jurisdiction from later re-litigating the same issue in another jurisdiction) prevented the re-litigation of demand futility in the Delaware derivative litigation.

Judge Bouchard agreed, and granted the Board’s motion to dismiss, finding that the Delaware shareholders were in privity with the Arkansas shareholders and thus the issue of demand futility in the Delaware derivative litigation was indeed precluded. Judge Bouchard began his analysis by stating that the basic test for issue preclusion under Arkansas law—the applicable law in this matter—was “easily satisfied.” However, given that Arkansas courts had not to date addressed issue preclusion in the context of shareholder derivative suits, which context would require a determination as to whether “two different stockholder plaintiffs asserting derivative claims on behalf of the same corporation in separate cases are in privity,” Judge Bouchard stated that “this case presents the challenge of having a Delaware trial court predict how a court in Arkansas likely would resolve an open question of Arkansas law.” Judge Bouchard concluded, “consistent with the clear weight of authority from other jurisdictions,” that an Arkansas court would find the two groups of shareholders to be in privity in this situation. The Judge also found that the Arkansas plaintiff shareholders were “adequate representatives” of the corporation even though they launched the derivative litigation without first pursuing Wal-Mart’s corporate books and records. Thus, given the findings both of privity and of adequate representation, Judge Bouchard held that “the plaintiffs in this case are barred from re-litigating demand futility and their complaint must be dismissed.”

Securities filings: Disclosures in securities filings with the SEC can be a font of information into the status of the government’s global FCPA enforcement efforts, and the filings for the first quarter of 2016 were no exception. Here are a couple of recent disclosures that caught our eye.

  • Hedge fund Och-Ziff Capital Management Group (Och-Ziff) disclosed in a securities filing on May 3, 2016 that it had reserved $200 million for potential criminal and civil settlements with the DOJ and SEC involving the government’s investigation, initiated in 2011, into FCPA violations in Libya. Och-Ziff stated that the $200 million reserve was the “minimum” amount of the potential settlement and that the final amount could well exceed $200 million. The firm also said that it had incurred $15.9 million in professional fees during the preceding quarter. On April 12, 2016, Reuters (citing the Wall Street Journal) reported that federal authorities were attempting to get Och-Ziff to plead guilty to the FCPA violations with a possible DPA and that the government was seeking over $400 million in penalties.
  • Houston-based oilfields services company Key Energy Services LLC (Key Energy) disclosed in a securities filing on April 28, 2016 that it had received a letter from the DOJ informing it that the DOJ was declining to bring an enforcement action against Key Energy in connection with its FCPA investigation into Mexican bribery allegations. Key Energy further disclosed that it had reached a “settlement agreement in principle” with the SEC over the same Mexican bribery allegations for which it had accrued $5 million. Key Energy first disclosed the government’s FCPA investigation into the Mexican bribery allegations in 2014 in connection with its self-disclosure of possible bribery of government officials by employees of its Mexican operations.

See here to read the DOJ’s 5/10/16 press release entitled “Deputy Attorney General Sally Q. Yates Delivers Remarks at the New York City Bar Association White Collar Crime Conference.”

See here to read the 5/13/16 Delaware Chancery Court opinion in In re Wal-Mart Stores, Inc. Derivative Litigation.

See here to read the 4/12/16 Reuters article by Bhanu Pratap entitled “U.S. authorities aim for guilty plea from Och-Ziff over bribery allegations—WSJ.”

See here to read the 4/28/16 press release issued by Key Energy Services LLC entitled “Key Energy Services Provides Foreign Corrupt Practices Act Investigation Update.”

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Spotlight on the False Claims Act

Why it matters: The government is involved in many disparate types of activity, and if “government dollars” are involved, we are seeing more and more how possible it is to run afoul of the False Claims Act (FCA). This month, we review the Supreme Court’s grant of certiorari in an FCA case involving allegations of insurance fraud on the government, where the Court agreed to review the question of what standard governs the dismissal of a qui tam case when a violation of the FCA’s 60-day “seal” provision is alleged. In addition, we review the Second Circuit’s reversal of a Southern District of New York court’s $1.27 billion judgment in an FCA-related government-sponsored mortgage lending context, in which the Court tackled the question of when an alleged breach of contract can also constitute fraud. We also review recently-announced FCA resolutions and filings by the DOJ in three very different business sectors where fraud on the government was alleged: mortgage lending, healthcare supply referrals, and customs duties. Read on for a recap.

Detailed discussion: What do Hurricane Katrina, mortgage lending, continence care products, and bedroom furniture have in common? All figured prominently in recent FCA-related cases and government resolutions.

We begin by looking at two recent FCA matters in the courts:

  • On May 31, 2016, the Supreme Court granted certiorari in State Farm Fire and Casualty Company v. U.S ex rel. Cori Rigsby; Kerri Rigsby, a case involving a qui tam suit filed by two independent claims adjustors against State Farm Fire and Casualty Company (State Farm) alleging that, following Hurricane Katrina, State Farm misadjusted federal flood claims in Mississippi by attributing wind damage (covered under State Farm’s homeowners insurance) to flood damage (covered by flood policies under the federal government’s National Flood Insurance Program). The issue that the Court agreed to address involves the actions of the relators in the period following the filing of their qui tam suit. The FCA requires that qui tams be filed under seal for a period of 60 days before service on the defendant to give the government the opportunity to investigate and decide whether to intervene. Instead of honoring the 60-day “seal,” State Farm alleged that the relators went on a “media binge” to “demonize” State Farm by disclosing the existence of their qui tam to news outlets on at least three occasions within the seal period, thereby justifying dismissal of the case. The circuits are split on the issue of when dismissal would be warranted in such a circumstance, and the Court thus granted certiorari to consider the question of “[w]hat standard governs the decision whether to dismiss a relator’s claim for violation of the FCA’s seal requirement, 31 U.S.C. § 3730(b)(2)?” The Court declined to review State Farm’s second question presented involving the standard under which a corporation can be found to have “knowingly” presented a false claim in violation of the FCA, leaving that particular issue for another day. The Court will hear oral argument when it reconvenes in October.
  • On May 23, 2016, the Second Circuit in U.S. ex rel Edward O’Donnell v. Countrywide Home Loans, Inc. et al. overturned a $1.2 billion penalty that had been imposed by Southern District of New York Judge Jedd S. Rakoff against Countrywide Home Loans, Inc. and related entities (Countrywide) and its successor-in-interest Bank of America, NA and other BA entities (BA) in connection with the sale of mortgages to government-sponsored entities (GSEs). To briefly summarize the facts, commencing in 2007 in an internal restructuring after the collapse of the subprime market, the Full Spectrum Lending Division (FSL) of Countrywide began selling what the government alleged were poor-quality prime mortgages. In 2012, Countrywide employee Edward O’Donnell filed a qui tam suit under the FCA with respect to the FSL lending, in which the government intervened and added claims under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The FCA claims and certain of the Countrywide and BA entities were subsequently dismissed, and only the FIRREA claims were presented at trial against the remaining defendants. At the trial, the government alleged that, when made, the mortgage loans were not in compliance with the lending requirements even though Countrywide represented and warranted in investment purchase contracts that they were “Acceptable Investments” and of “investment quality” (as those terms were defined). Key to the Second Circuit’s analysis, the government failed to present evidence at trial to show that Countrywide had fraudulent intent during the negotiation and execution of the investment contracts. Instead, the government presented evidence to show that Countrywide executives knew that the mortgages were of poor investment quality when subsequently made in breach of the representations and warranties contained in the contracts and thus Countrywide intended to defraud the GSEs. The defendants countered at trial that, at most, they were guilty of intentional breach of contract, but the evidence was insufficient as a matter of law to support a finding of fraud. The federal jury returned a verdict in favor of the government, and Judge Rakoff imposed a fine against Countrywide and BA of $1.27 billion.

    The Second Circuit reversed and ordered that judgment be entered in favor of Countrywide and BA. The Second Circuit began its analysis by posing the question “[w]hen can a breach of contract also support a claim for fraud?” The Court looked at the common law of fraud, as incorporated in criminal statutes such as FIRREA, and found that “where allegedly fraudulent misrepresentations are promises made in a contract, a party claiming fraud must prove fraudulent intent at the time of contract execution; evidence of a subsequent, willful breach cannot sustain the claim.” Thus, the Court concluded that “the trial evidence fails to demonstrate the contemporaneous fraudulent intent necessary to prove a scheme to defraud through contractual promises.”

Next, we review some recent DOJ FCA resolutions and filings that caught our eye in the disparate areas of FHA mortgage lending, healthcare supply referrals and customs duties:

FHA mortgage lending: The DOJ recently announced that it had resolved an action with one financial institution and filed a complaint against another in connection with the participation by those institutions in the Federal Housing Administration’s (FHA) Direct Endorsement Lender (DEL) program, through which private financial institutions directly originate, underwrite and certify mortgages for FHA insurance.

  • M&T Bank Corp: On May 13, 2016, the DOJ announced that New York-based M&T Bank Corp. (M&T) agreed to pay $64 million to resolve allegations that it violated the FCA while participating in the FHA’s DEL program by “knowingly” originating and underwriting mortgage loans that did not meet applicable FHA origination, underwriting and quality control requirements. As part of the settlement, M&T admitted to violations of the DEL rules during the period from 2006 to 2011, including (1) filing false certifications for FHA insurance mortgage loans that did not meet the U.S. Department of Housing and Urban Development’s (HUD) underwriting requirements and did not adhere to FHA’s quality control requirements; (2) failing to conduct reviews of all “Early Payment Default” loans (i.e., loans that become 60 days past due within the first six months of repayment) and adequate samples of closed FHA loans as required by HUD; and (3) failing to adhere to HUD’s self-reporting requirements regarding defective loans. The DOJ’s press release stated that “[a]s a result of M&T’s conduct and omissions, HUD insured hundreds of loans approved by M&T that were not eligible for FHA mortgage insurance under the Direct Endorsement Lender program and that HUD would not otherwise have insured. HUD subsequently incurred substantial losses when it paid insurance claims on those loans.” The DOJ said that the settlement resolved allegations in a whistleblower lawsuit filed under the qui tam provisions of the FCA by a former employee of M&T, whose award had not yet been determined.
  • Guild Mortgage Company: On May 19, 2016, the DOJ announced that it had filed a complaint in D.C. district court against San Diego–based Guild Mortgage Company (Guild) under the FCA for improperly originating and underwriting mortgages insured by the FHA while participating in the DEL program. In the complaint (through which it was intervening in an FCA qui tam lawsuit), the DOJ alleged among other things that, from 2006 to 2012, Guild (a) “knowingly submitted … claims for hundreds of improperly underwritten FHA-insured loans, (b) “grew its FHA lending business by ignoring FHA rules and falsely certifying compliance with underwriting requirements in order to reap the profits from FHA-insured mortgages,” and (c) allowed its underwriters to “waive compliance with FHA requirements when underwriting a loan” and “used unqualified junior-underwriters who did not have a [DEL] certification to waive mandatory conditions on higher risk loans where HUD required underwriting only by highly trained [DEL] underwriters.” To support its claims, the DOJ alleged that Guild management “focused on growth and profits and ignored quality,” citing to facts regarding the discovery through branch audits of high percentage rates of defective loans being issued by untrained underwriters (“significant defects included fraud, misrepresentation and other serious findings while moderate defects included not following guidelines”) and the failure of Guild’s internal quality control group to flag and report the defective loans to management or attempt to remediate them. The DOJ alleged that “as a result of Guild’s knowingly deficient mortgage underwriting practices, HUD has already paid tens of millions of dollars of insurance claims on loans improperly underwritten by Guild, and that there are many additional loans improperly underwritten by Guild that are currently in default and could result in further insurance claims on HUD.”

Healthcare supply referrals: On April 29, 2016, the DOJ announced that Byram Healthcare Centers Inc., a medical products supplier (Byram), and Hollister, Inc., a manufacturer of disposable health care products (Hollister) agreed to pay approximately $9.4 million and $11.44 million, respectively, to resolve allegations that the companies “engaged in a kickback scheme designed to increase sales and profits.” The DOJ said that the settlement with Hollister resolved allegations (which were neither admitted or denied by Hollister) that, from 2007 to 2014, it paid kickbacks to Byram in return for “marketing promotions, conversion campaigns, and other referrals of patients to Hollister’s ostomy and continence care products.” The DOJ said that the settlement with Byram resolved allegations (that were neither admitted or denied by Byram) that, in 2012 and 2013, Byram received numerous kickbacks from Hollister and three other manufacturers of ostomy and continence care products (including Coloplast Corp. (Coloplast)) in return for Byram’s agreement to “conduct promotional campaigns and to refer patients to the manufacturers’ products.” The Byram settlement also resolved state and federal FCA allegations that Byram submitted inflated claims to the California Medi-Cal program in violation of the state’s regulation which limits the amount a provider can bill for certain products. In connection with the FCA settlement, Byram agreed to pay $127,117 to the state of California and to enter into a corporate integrity agreement with the U.S. Department of Health and Human Services, Office of Inspector General. The DOJ said that the settlements resolved allegations in a whistleblower lawsuit filed by two former employees and one current employee of Coloplast under the qui tam provisions of the FCA, and that the whistleblowers’ award had not yet been determined. Finally, the DOJ said that claims against Coloplast and another defendant were resolved in December 2015 for approximately $3.6 million, bringing the total recovery in the case to approximately $24.6 million.

Evasion of customs duties: On April 27, 2016, the DOJ announced that Los Angeles-based Z Gallerie LLC (Z Gallerie), a seller of upscale furniture and accessories, agreed to pay $15 million to resolve allegations that it engaged in a scheme to evade customs duties on imports of wooden bedroom furniture from the People’s Republic of China (PRC) in violation of the FCA. The DOJ explained in its press release that the Department of Commerce assesses various duties to protect U.S. manufacturers from unfair competition abroad by “leveling the playing field for domestic products.” This case involved “antidumping” duties that protect domestic manufacturers from foreign companies “dumping” products on U.S. markets at prices below cost. Relevant to this case, imports of wooden bedroom furniture manufactured in the PRC have been subject to antidumping duties since 2004. According to the DOJ’s allegations (which were neither admitted or denied by Z Gallerie), Z Gallerie evaded antidumping duties on wooden bedroom furniture imported from the PRC between 2007 and 2014 by misclassifying the imported furniture as pieces intended for non-bedroom use on documents presented to customs officials. Qui tam whistleblower to receive $2.4 million.

See here to read State Farm’s Petition for Writ of Certiorari in State Farm Fire and Casualty Company v. U.S ex rel. Cori Rigsby; Kerri Rigsby.

See here to read the DOJ’s 5/13/16 press release entitled “M&T Bank Agrees to Pay $64 Million to Resolve Alleged False Claims Act Liability Arising from FHA-Insured Mortgage Lending.”

See here to read the DOJ’s 5/19/16 press release entitled “United States Files Lawsuit Alleging That Guild Mortgage Improperly Originated and Underwrote FHA-Insured Mortgage Loans.”

See here to read the DOJ’s 4/29/16 press release entitled “Byram Healthcare and Hollister, Inc. to Pay $20 Million to Resolve Kickback Allegations.”

See here to read the DOJ’s 4/27/16 press release entitled “California-Based Z Gallerie LLC Agrees to Pay $15 Million to Settle False Claims Act Suit Alleging Evaded Customs Duties.”

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NY Court Reviews Expansion of Common Interest Rule

Why it matters: The New York State Court of Appeals recently heard oral argument in the case of Ambac Assurance Corporation v. Countrywide Home Loans, Inc. and Bank of America Corp., and its decision could have important ramifications under New York law regarding when the common interest rule can be used to preserve the attorney-client privilege. The common interest rule has traditionally been narrowly construed by New York courts to allow for the sharing of attorney-client privileged documents with third parties—without waiving that privilege—only in situations where litigation is pending or reasonably anticipated. In December 2014, a lower state appellate court in Ambac ruled that the common interest rule should not be so limited and could apply to protect attorney-client privileged documents that are shared with any third party who has a “common interest” with the sharer, such as in this case where the documents were shared in merger negotiations. On appeal, the New York State Court of Appeals will decide if the lower court’s expansion of the common interest rule in this manner was appropriate. As of press time, the Court’s decision was still pending. We will be watching with great interest to see how it decides.

Detailed discussion: On May 2, 2016, the New York Law Journal reported on the oral argument before the New York State Court of Appeals in Ambac Assurance Corporation v. Countrywide Home Loans, Inc. and Bank of America Corp., a case which, as the reporter described it, “began as a fraudulent inducement claim on insuring mortgage-backed securities [that] has mushroomed into what litigants and observers say could be a defining moment for attorney-client privilege in New York and the ‘common interest’ rule.”

To briefly recap the facts as set forth in the December 2014 ruling of the Appellate Division, First Department (First Department) court that was the subject of the appeal before the New York State Court of Appeals, the discovery dispute at issue in the case arose from a lawsuit filed by Ambac Assurance Corporation (Ambac), a financial-guaranty insurer, against Countrywide Home Loans, Inc. (Countrywide) in connection with the guaranty by Ambac of payments on residential mortgage backed securities (RMBS) issued by Countrywide. In its complaint, Ambac alleged among other things that, between 2004 and 2006, Countrywide fraudulently induced it to enter into agreements to guaranty the RMBS transactions. Ambac also asserted secondary claims against Bank of America Corp. (BAC) as successor-in-interest to Countrywide due to the merger between Countrywide and a BAC subsidiary in 2008. Relevant to this discussion, all information exchanged between Countrywide and the BAC subsidiary was subject to confidentiality provisions and a common interest agreement entered into shortly before the merger agreement was signed. The merger agreement required the parties to work together to effectuate several pre-closing matters, as to which BAC claimed the parties “shared legal advice from counsel together in order to ensure their accurate compliance with the law and to advance their common interests in resolving the many legal issues necessary for successful completion of the merger.”

As part of its lawsuit, Ambac sought discovery of the “several hundred” joint documents (challenged documents) reflecting communications between BAC and Countrywide and their legal counsel during the pre-merger period between January and July, 2008, arguing that the documents were significant to its successor-liability claims against BAC and also to see whether BAC was put on notice of the fraud at Countrywide before the merger closed. BAC argued that the challenged documents were subject to the attorney-client privilege and refused to produce them. In 2013, a discovery referee granted Ambac’s motion to compel BAC to turn over the challenged documents, finding that the attorney-client privilege had been waived with respect to them and the common interest rule that would have preserved the privilege did not apply because the challenged documents were not prepared in anticipation of litigation. A motion court upheld the discovery referee’s ruling, and BAC appealed to the First Department.

The First Department panel reversed the motion court and discovery referee in December 2014, holding that the traditionally narrow view of when the common interest rule applies was no longer viable and that the common interest rule will still protect attorney-client privileged communications that have been shared with third parties so long as the third parties have a “common interest” with the sharer, regardless of whether the common interest arises from pending or reasonably anticipated litigation. Ambac appealed to the New York State Court of Appeals, which heard oral argument in late April 2016.

According to the New York Law Journal reporter who observed the oral argument, Ambac’s attorney, Stephen Younger, began by arguing that the First Department’s ruling represented an unacceptable and unnecessary “dramatic expansion” of the common interest rule and that “[f]or two decades, lawyers have operated under the assumption that the privilege is waived by an exchange of information among merging entities and their attorneys prior to closing.” In addition, Younger pursued an “if it ain’t broke, don’t fix it” line of reasoning, arguing that “[t]here is nothing wrong with how this doctrine is working in New York … [and] there is nothing in the record to say that this rule hasn’t been working.” Arguing that privileges “are supposed to be narrowly construed,” Younger urged the Court to consider the potential negative public interest ramifications of upholding the First Department’s overbroad ruling, such as imposing further limitations on a litigant’s access to relevant discovery.

BAC’s attorney, Jonathan Rosenberg, argued that the First Department ruling altered the common interest rule only to “the reasonable extent of making it clear the privilege can be invoked by parties who ‘share a common legal interest—not a business interest, but a legal interest.’" To this argument, Judge Eugene Fahey countered that it was difficult to tell the difference between the two: “Here's what I struggle with, how to distinguish a common business interest with a common legal interest and how this court could ever do that … In the environment that we live … a ‘common business interest’ and a ‘common legal interest’ are the same thing.” Judge Fahey continued that he thought limiting the common interest rule to cases of pending or anticipated litigation was a manageable and “measurable” rule, much easier to identify than what Rosenberg was proposing, which “seems to almost subsume every communication of any particular business transaction.”

The tone of Judge Fahey’s questioning suggests that he would vote to overturn the First Department’s decision and return to a narrow construction of the common interest rule, which was the position being urged in amicus briefs filed by both the New York State Academy of Trial Lawyers and the New York State Trial Lawyers. The Court’s decision is expected by early June 2016. We will keep an eye out and report back.

See here to read the 5/2/16 New York Law Journal article by Joel Stashenko entitled “Court Weighs Merits of Attorney-Client Privilege Expansion.”

See here to read the 12/8/14 Appellate Division, First Department opinion in Ambac Assurance Corporation, et al., Plaintiffs-Respondents v. Countrywide Home Loans, Inc., et al., Defendants, Bank of America Corp., Defendant-Appellant.

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Keeping an Eye Out—Updates and Briefly Noted

1. Updates to prior stories:

  • SEC’s Whistleblower Program (follow-up to the story in our May 6, 2016 newsletter under “Still Whistling While You Work—Whistleblower Programs Update”)—with the addition of these three recently-announced awards, the SEC said that it has awarded over $68 million to 31 whistleblowers since the program’s inception in 2011:
    • May 20, 2016—SEC announced whistleblower award of $450,000 to be split between two individuals: The SEC said that the award was made to the two individuals “for a tip that led the agency to open a corporate accounting investigation and for their assistance once the investigation was underway.”
    • May 17, 2016—SEC announced whistleblower award of over $5 million: Billed as the third highest award granted to date under its whistleblower program, the SEC announced that it was awarding “between $5 million and $6 million” to an unidentified “former company insider whose detailed tip led the agency to uncover securities violations that would have been nearly impossible for it to detect but for the whistleblower’s information.”
    • May 13, 2016—SEC announced $3.5 million whistleblower award: The award was made to the unnamed whistleblower for providing information that “significantly contributed to the success” of the SEC’s ongoing investigation in the case. The SEC had previously denied any award to the whistleblower on the grounds that the information provided related to an existing investigation, but reversed its denial after the whistleblower appealed.
  • May 6, 2016—Liberty Reserve founder sentenced to 20 years in prison for money-laundering: Arthur Budovsky was sentenced in the S.D.N.Y. to 20 years imprisonment for running a massive money laundering enterprise through his company Liberty Reserve S.A., a virtual currency once used by cybercriminals around the world to launder the proceeds of their illegal activity. Follow-up to the story about this case in our February 2016 newsletter under “FCPA and Anti-Money Laundering Enforcement Review—‘Follow the Money.’"

2. Briefly Noted

New rulemaking:

  • May 5, 2016—In response to the Panama Papers, the White House announced a series of “Steps to Strengthen Financial Transparency, and Combat Money Laundering, Corruption, and Tax Evasion: The steps set forth in the Fact Sheet released by the Obama Administration are “actions to combat money laundering, terrorist financing and tax evasion,” and include (1) final Department of Treasury/FinCEN regulations issued under the Bank Secrecy Act (BSA) regarding “Customer Due Diligence Requirements for Financial Institutions” that will increase transparency by requiring U.S. financial institutions to “know” and keep records on the true beneficial owners behind the anonymous entities that use their services (posted in Federal Register on May 11, 2016; effective date July 11, 2016; final applicability date May 11, 2018); (2) proposed Treasury/IRS tax rules that would close a loophole that allows foreigners to hide assets or financial activity behind anonymous entities established in the U.S.; and (3) proposed legislation aimed at strengthening the tools in the government’s arsenal to fight corruption and money laundering. The Obama Administration also specifically called upon Congress “to act on long-overdue proposals that help crack down on tax evasion” and “to provide additional tools to combat illicit financial activity and tax evasion.”
  • April 4, 2016—FinCEN proposed an amendment to the definition of “Broker-Dealer in Securities” in the BSA to include “funding portals”: FinCen published the Notice of Proposed Rulemaking in the Federal Register, requesting that comments be submitted by June 3, 2016. FinCen said that it proposed the amendment in order to ensure that funding portals “that are involved in the offering or selling of crowdfunding securities” are required to implement the same policies and procedures designed to achieve compliance with the BSA requirements that are currently applicable to brokers or dealers in securities, including the filing of suspicious activity reports.

April 19, 2016—SEC announced the following two financial fraud cases against “companies and then-executives accused of various accounting failures that left investors without accurate depictions of company finances”:

  • Technology manufacturer Logitech International agreed to pay a $7.5 million penalty for fraudulently inflating its FY 11 financial results to meet earnings guidance and committing other accounting-related violations during a five-year period. Logitech’s then-controller and then-director of accounting agreed to pay penalties of $50,000 and $25,000, respectively, for violations related to Logitech’s warranty accrual accounting and failure to amortize intangibles from an earlier acquisition. The SEC also filed a complaint in federal court against Logitech’s then-CFO and then-acting controller alleging that they deliberately minimized the write-down of millions of dollars of excess component parts for a product for which Logitech had excess inventory in FY11; and
  • Three former executives at battery manufacturer Ener1 agreed to pay penalties for the company’s materially overstated revenues and assets for year-end 2010 and overstated assets in the first quarter of 2011. The financial misstatements stemmed from management’s failure to impair investments and receivables related to an electric car manufacturer that was one of its largest customers. The former CEO and Chairman, former CFO, and former CAO agreed to pay penalties of $100,000, $50,000, and $30,000, respectively.

3. Talks about town:

  • On May 16, 2016, FinCEN Deputy Director Jamal El-Hindi spoke at the Institute of International Bankers Annual Anti-Money Laundering Seminar in New York.
  • On May 12, 2016, SEC Enforcement Director Andrew Ceresney gave the keynote speech at the Securities Enforcement Forum West Conference in San Francisco, California. Assistant Attorney General Leslie R. Caldwell also spoke at the event.
  • On April 18, 2016, Assistant Attorney General Caldwell spoke at the Health Care Compliance Association’s 20th Annual Compliance Institute in Las Vegas.

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