Monday, October 16, 2006

More About the FCPA and D & O Risk

In prior posts (here and here), The D & O Diary has written about the increasing level of Foreign Corrupt Practices Act enforcement activity and the growing D & O risk that it represents. An October 4, 2006 opinion in the United States District Court in Atlanta by Judge William Duffey Jr. in the consolidated Immucor securities litigation (view complaints here) illustrates how the increased level of FCPA enforcement activity can lead to heightened D & O risk.

Plaintiffs sued Immucor and two of its officers (a third individual defendant died after the Complaint was filed and was dismissed from the action). The Complaint alleges that between August 16, 2004 and August 29, 2005, the defendants made numerous statements about corruption problems at Immucor’s Italian subsidiary. The plaintiffs did not allege that the defendants failed to disclose the existence of problems; rather, the plaintiffs allege that in SEC filings, press releases and conference calls with stock analysis, the defendants misled potential investors into an over optimistic assessment of Immucor’s corrupt foreign business practices and the strength of Immucor’s internal control mechanisms. An unusual aspect of this case is the allegation that one of the individual defendants was head of the Italian subsidiary at the time the alleged bribes took place, prior to his becoming Immucor’s CEO, and therefore this individual (and by extension Immucor) had actual knowledge of the falsity of the misrepresentations at the time they were made.

The defendants moved to dismiss the Complaint on the grounds that the plaintiffs had not alledged any false or misleading statements, and on the grounds of scienter and failure to adequately plead loss causation.

Judge Duffey denied the motion to dismiss as to several of the allegedly misleading statements. Even though the company disclosed the existence of an Italian criminal investigation and an internal investigation of allegedly improper payments, the Judge found that

these disclosures created the impression that the investigation was limited to a single incident of poor bookkeeping by Immucor …but Plaintiffs allege that multiple legally dubious payments made by De Chirico [the former head of the Italian subsidiary and CEO at the time the alleged misstatements were made] or under his direction were being investigated. The omission creates a distorted picture of Immucor’s alleged liabilities. That is, while parts of the disclosure may have been accurate, Defendants’ duty was to describe fully the nature and scope of the conduct under investigation – conduct of which De Chirico was fully aware because he participated in it. The omitted information would have been viewed by a reasonable investor as affecting the total mix of information available, and a reasonable investor’s investment decision would have been swayed had the alleged omitted information been included in the press release.

Judge Duffey also found that the allegations of actual knowledge represented sufficient allegations of scienter to survive a motion to dismiss, and that the plaintiffs had adequately pled loss causation.

As The D & O Diary noted in its prior posts, the D & O risk arising from FCPA actions is not so much due to the enforcement proceedings themselves, since any fines or penalties likely would not be covered under the typical D & O policy; rather, the risk arises from the follow-on civil actions. The Immucor case, while it has some unusual features, illustrates how these follow on civil actions can arise. Plaintiffs’ allegations in the Immucor case that the defendants did not fully disclose the extent of the company’s FCPA exposure is not in and of itself unusual in securities litigation, as securities cases often allege that defendants soft-pedaled or minimized adverse information. However, the increasing level of FCPA enforcement activities provides increasing opportunities for these kinds of issues to arise. That is one reason why The D & O Diary has identified the increase in FCPA activity as one of four D & O trends to watch (here).

One particular feature of Immucor’s circumstances explains why FCPA activity is increasing. That is, Immucor itself identified the existence of potentially improper payments and self-reported the payments to the SEC. This type of self-reporting is one of the causes behind the increase in FCPA activity. Due to the requirements of Sarbanes Oxley, companies are undertaking a more thorough operational review, including review of their overseas operations, and are finding a greater number of concerns. As a result of guidelines requiring self-reporting in order to avoid corporate criminality, more corporations are turning themselves in. (There is more than a little irony in the fact that having self-reported to the SEC, Immucor is now accused of withholding information.) FCPA enforcement activity because more companies are turning themselves in for violations they have found themselves.

An October 12, 2006 memorandum from the Wilkie, Farr & Gallagher law firm discussing the Immucor case and the ruling on the dismissal motion can be found here.

Bad News Disclosure: The Immucor case is also a good illustration of the pitfalls that attend bad news disclosure. (The allegations in the Immucor complaint of course remain unproven; for purposes of the motion to dismiss, and for purposes of this discussion, the allegations are taken as true.) As I have written elsewhere about the pitfalls of bad news disclosure (here), "partial, incomplete or overly optimistic disclosure can exacerbate the damage from bad news disclosure and risk the creation of securities litigation exposure." As bad as the consequences of bad news are, they can always be made worse by attempts to bury the news. As the Immucor case demonstrates, the risk from trying to put positive "spin" on bad news is that it may later be alleged that the "calming statement" itself is misleading – in other words, the securities litigation arises from the "damage control," not the underlying event.

Today’s Stat: According to The Economist magazine (here, subscription required), "The State of California alone has more venture capital than any country outside the United States."

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