Foreign Corrupt Practices Act Alert
June 2008
Authors:
Matthew J. Fader
412.355.6358
matthew.fader@klgates.com
Brian F. Saulnier
412.355.6504
brian.saulnier@klgates.com
Paul C. McCaffrey
412.355.8626
paul.mccaffrey@klgates.com
K&L Gates comprises approximately
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information, visit www.klgates.com.
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Faro Technologies, Inc. and AGA Medical
Corporation, in Separate Actions, Settle
Foreign Corrupt Practices Act Charges Arising
Out of Alleged Payment of Bribes to Chinese
Government Officials
On June 3 and 5, 2008, the United States Department of Justice (“DOJ”) announced
settlements of two separate Foreign Corrupt Practices Act (“FCPA”) charges, both of
which arose out of allegedly corrupt payments to government officials or employees of
state-owned enterprises in the People’s Republic of China (“China”).
In the first case, DOJ filed on June 3 in the United States District Court for the District
of Minnesota a three-year deferred prosecution agreement (“DPA”) and related criminal
information against AGA Medical Corporation (“AGA”), a privately-held manufacturer
of medical devices. Pursuant to the DPA, AGA will pay a $2 million criminal penalty
and adopt certain compliance measures, including the appointment of a corporate monitor
acceptable to DOJ, in exchange for DOJ deferring prosecution of AGA for allegedly paying
bribes to physicians at state-owned hospitals and officials at China’s State Intellectual
Property Office (“China Patent Office”) between 1997 and 2005.1
In the second case, DOJ entered into a two-year non-prosecution agreement (“NPA”) on
June 5 with Faro Technologies, Inc. (“Faro”), a developer and marketer of computerized
measurement devices and software, to settle charges that Faro’s Chinese subsidiary paid
more than $440,000 in bribes to persons defined under the FCPA as Chinese government
officials between 2004 and 2006.2 Pursuant to the NPA, Faro will pay a $1.1 million
criminal penalty and abide by certain compliance measures, including appointment of a
corporate monitor acceptable to DOJ. In addition, Faro consented to the Securities and
Exchange Commission (“SEC”) filing a cease-and-desist order (the “SEC Order”) against
it in connection with Faro’s alleged violations of the books and records and internal control
provisions of the FCPA.3 Pursuant to the June 5 SEC Order, Faro will pay an additional
$1.85 million in disgorgement and prejudgment interest.4
The AGA and Faro settlements highlight two critical realities in today’s FCPA enforcement
environment. First, there are potential pitfalls in doing business in China where many
business enterprises are owned or operated, at least in part, by the government and whose
employees or agents thus potentially come within the scope of the FCPA. Local third-party
agents hired to help U.S. companies navigate complicated government approval processes
may not be familiar with – or may be indifferent towards – the requirements of the FCPA
which prohibits the business practice, common in China, of gift-giving.5 Second, DOJ and
the SEC will not ignore alleged FCPA violations simply because the purported bribe-payer
is a relatively small company; indeed, no company should assume that its relatively small
size will immunize it from costly and damaging government investigation or prosecution.
This is perhaps especially true for companies doing business in China where the surge in
U.S. companies establishing operations there has led to increased focus on the area by
DOJ and the SEC which in turn has led to numerous and costly FCPA settlements over
the past two years.6
Foreign Corrupt Practices Act Alert
AGA’s Alleged Violations of the FCPA
Faro’s Alleged Violations of the FCPA
AGA, incorporated and headquartered in Minnesota,
is a privately-held company that specializes in the
manufacture of medical devices used to treat heart
defects.7 As such, AGA is considered a “domestic
concern” for purposes of the FCPA.8 According to
the DPA, AGA sells its products in over 90 countries;
AGA’s sales in China between 1997 and 2005 totaled
$13.5 million.9 In December 1998, AGA retained
a Chinese company to act as the sole distributor of
its products in China. When an employee of that
company left in 1999 to form his own company, AGA
moved its business to the new company started by
this individual (the “Chinese Distributor”).10 AGA’s
primary customers were hospitals owned and operated
by the government of China and the hospital-employed
physicians who worked there. The hospitals were
considered to be “instrumentalities” of the Chinese
government and their physician-employees “foreign
officials,” as those terms are used in the FCPA.11
Faro, a public company headquartered in Florida,17
began direct sales of its products in China through
a subsidiary based in Shanghai (“Faro China”) in
2003.18 Based on the recommendation of a regional
sales manager (the “Regional Manager”), Faro decided
to retain a Chinese citizen as its new country manager
for China from which position he would oversee all
sales of Faro products to Chinese customers (the
“Country Manager”).19 During negotiation of the
Country Manager’s initial employment contract, he
asked other Faro officers and employees by e-mail if he
could “do business the Chinese way.”20 In relaying this
request to Faro’s management, the Regional Manager
explained that this meant providing things of value,
including monetary payments, to the employees of
Faro’s customers in order to retain business.21 After
receiving advice from counsel that such payments
would violate China law, management orally informed
the Regional Manager and the Country Manager not to
make any such payments, but nevertheless proceeded
to hire the Country Manager.22
The DPA documents a series of e-mail communications
suggesting that AGA authorized its Chinese Distributor
to pay bribes to Chinese government officials, including
various discounts, commissions and “rewards” paid to
physicians who purchased AGA products. Evidence
of kickbacks of up to 25% of the sale prices of AGA
products were reflected in e-mails, correspondence and
memoranda implicating AGA officers.12 According
to the DPA and as reflected in e-mail correspondence
recited in the DPA, AGA also paid bribes to officials
at the China Patent Office in order to secure approval
for patents for which AGA applied from March 2000
to late 2002.13
Count One of the criminal information charged that
AGA, its officers and certain employees and the
Chinese Distributor conspired to violate the FCPA
by paying bribes to Chinese government officials in
order to influence the officials’ decisions and to secure
an improper advantage over AGA’s competitors.14
The specific alleged purpose of the conspiracy was
to cause government-owned hospitals to purchase
AGA products and to cause the China Patent Office to
approve AGA’s patent applications.15 Count Two of
the criminal information charged that the same conduct
constituted a direct violation of the FCPA.16
Like the evidence of bribery against AGA, DOJ relied
upon e-mails between the Regional Manager and the
Country Manager which suggested that the Regional
Manager authorized or instructed the Country Manager
to make corrupt payments, called “referral fees,” to
employees of state-owned businesses in order to
benefit Faro’s business in China. In this case, the
Managers’ e-mails expressly referred to the referral
fees as bribes, lamented having to pay them, and
cautioned each other to be careful in light of news that
the Chinese government intended to “start enforcing”
anti-bribery laws.23 In early 2005, apparently growing
concerned about the increasing size of the referral fees
and associated visibility, the Regional and Country
Managers decided to “avoid exposure” by funneling the
referral fees through a corporate agent that allegedly
had no legitimate business purpose and provided no
legitimate services.24 The agent paid kickbacks as
directed by Faro China and then invoiced Faro China
for the amount of the kickbacks, alleged to have totaled
approximately $444,492.25
The NPA and the SEC Order also allege that
Faro, as an issuer, violated the books and records
provisions of the FCPA by inaccurately recording
approximately $238,000 in payments to Chinese
government employees as “referral fees” instead of
June 2008 | 2
Foreign Corrupt Practices Act Alert
bribes.26 Thus, the NPA and SEC Order allege that
this inaccurate recording is evidence of Faro’s failure
to devise and maintain a system of books, records
and accounts which, in reasonable detail, accurately
and fairly reflected its transactions. The NPA and
SEC Order also allege that Faro failed to maintain a
system of internal accounting controls sufficient to
provide reasonable assurances that transactions were
executed in accordance with the authorization of Faro’s
management,27 as evidenced by the following facts:
• Faro did not address the FCPA or foreign bribery in
its code of business conduct;28
• Faro did not offer FCPA training of any kind to its
employees, including those in countries like China
with a higher risk of corruption;29
The Take-Away
The AGA and FARO settlements serve as reminders
of the importance of a rigorous and effective FCPA
compliance program, particularly when conducting
business in China. Companies who are considering
expanding their operations to China, or who may
be operating there already, would be well advised
to critically re-evaluate their internal controls and
compliance practices. At a minimum, the AGA and
Faro settlements show the need for companies to:
• perform due diligence into all foreign business
partners, agents, representatives, and transactions;
• follow up on any “red flags” that come to light;
• Faro had no in-house counsel or personnel tasked
with monitoring FCPA compliance or compliance
with other anti-corruption laws;30
• k now when to walk away from a prospective
transaction when there is evidence that the proposed
partner is not willing or able to adhere to the
company’s FCPA policy guidelines;
• Faro did not specifically require its personnel in
charge of international sales to comply with the
FCPA and refrain from paying bribes, nor did
it require them to certify their past and future
compliance with the FCPA;31
• implement effective anti-corruption policies and
training for employees, agents and representatives
involved in overseas sales; and
• provide management with an active role in enforcing
these robust anti-corruption policies.
• Faro entered into a services contract with an agent
without performing any due diligence and without
requiring the agent to agree to comply with the FCPA
and other applicable anti-corruption laws; and
These settlements also warn U.S. companies doing
business abroad that it is not only Fortune 500
companies that are on the enforcement radar when it
comes to FCPA violations. Faro and AGA are both
much smaller than other companies that have recently
entered into FCPA settlements with DOJ or the SEC.
Faro has a market capitalization of approximately
$446 million.36 AGA is currently a private company
and as such does not have a market capitalization,
but had revenues of approximately $147 million in
2007.37 Both are significantly smaller than some of
the previous companies involved in FCPA settlements.
By contrast, Willbros Group, Inc., which entered into a
DPA in May 2008, has a market capitalization of $1.77
billion; Flowserve Corporation, which entered into a
DPA in February 2008, has a market capitalization of
$7.6 billion; and Alcatel-Lucent,38 which entered into
an NPA in December 2007, has a market capitalization
of $13.85 billion.
• F aro made payments to the agent without any
oversight to determine that those payments were
not being used for bribes.32
Independent Corporate Monitors
In addition to the civil and criminal penalties imposed
upon them, both Faro and AGA, as a condition of
their respective NPA and DPA, agreed to engage an
“Independent Corporate Monitor” to oversee and assist
in implementing a more rigorous FCPA compliance
program at the companies.33 Consistent with the recent
trend in FCPA settlements, Faro and AGA have the
right to select the compliance monitor, who must have
demonstrated FCPA expertise and experience; however,
DOJ retains the right to reject any proposed compliance
monitor until one acceptable to both parties is located.34
Faro has publicly estimated that the corporate monitor
and enhanced compliance requirements imposed by
its NPA will cost the company between $1 million and
$2 million.35
K&L Gates continues to monitor developments relating
to the FCPA and other laws and regulations affecting
U.S. companies doing business abroad and stands
ready to assist clients on these matters.
June 2008 | 3
Foreign Corrupt Practices Act Alert
Endnotes
1 F
or more information, see DOJ’s Release # 08-491, available at
http://www.usdoj.gov/opa/pr/2008/June/08-crm-491.html.
2 F
or more information, see DOJ’s Release # 08-505, available at
http://www.usdoj.gov/opa/pr/2008/June/08-crm-505.html.
3 I d.; see also Securities Exchange Act of 1934 Release No. 57933/
June 5, 2008, Accounting and Auditing Enforcement Release No.
2836/June 5, 2008, Administrative Proceeding File No. 3-13059
(the “SEC Order”).
4 See SEC Order § V.
5 F
or a more detailed discussion of the potential FCPA-related
dangers of doing business in China, see the K&L Gates FCPA Alert
by Edward J. Fishman and Jeffrey B. Maletta, “FCPA Enforcement
Activity and Severity of Penalties Relating to Business Activities
in China Likely to Increase Dramatically as Global Trade with
China Surges to Record Levels,” available at http://www.klgates.
com/newsstand/Detail.aspx?publication=3580.
18 See Non-Prosecution Agreement, Appendix A, Statement of Facts
¶ 3 (hereinafter “NPA Statement of Facts ¶ __”).
19 NPA Statement of Facts ¶ 4.
20 Id. at ¶ 6.
21 Id.
22 Id. at ¶¶ 7, 8.
23 Id. at ¶¶ 9-12.
24 Id. at ¶ 13.
25 Id. at ¶¶ 14-16.
26 Id. at ¶¶ 19, 20; SEC Order at § III.D.
27 NPA Statement of Facts ¶ 21; SEC Order at § III.D.
28 NPA Statement of Facts ¶ 22.
29 Id.
6 I n addition to Faro and AGA, companies that have recently settled
charges of FCPA violations in China include Schnitzer Steel
Industries, Inc., Lucent Technologies, Inc. and Paradigm B.V.
30 Id.
7 DOJ Release # 08-491.
32 Id. at ¶ 24.
8 See 15 U.S.C. § 78dd-2(h)(1)(B).
33 DPA ¶ 10; NPA Appendix C, ¶ 1.
9 D
eferred Prosecution Agreement, Attachment A, Statement of
Facts ¶¶ 2, 31 (hereinafter “DPA Statement of Facts ¶ __”).
34 DPA ¶¶ 10, 11; NPA Appendix C, ¶¶ 1,2.
10 DPA Statement of Facts ¶ 8.
11 See id. at ¶ 10; 15 U.S.C. § 78dd-2(h)(2)(A).
12 DPA Statement of Facts ¶¶ 12-18; 24-29.
13 Id. at ¶¶ 18-24.
14 See Criminal Information, United States of America v. AGA
Medical Corp., June 3, 2008, at ¶ 14 (hereinafter “Criminal
Information ¶ __”).
15 Criminal Information ¶ 15.
16 Id. at ¶ 19.
17 Faro, whose shares trade on the NASDAQ, was (and is) an
“issuer,” as that term is used in the FCPA. See 15 U.S.C. §
78m(b)(2).
31 Id. at ¶ 23.
35 See Press Release, Faro Technologies, Inc., FARO, DOJ & SEC
Formally Resolve FCPA Matter (June 5, 2008), available at http://
www.faro.com/contentv2.aspx?ct=di&content=misc&item=5.
36 The market capitalization numbers for Willbros Group, Inc.,
Flowserve Corporation, Alcatel-Lucent, and Faro were obtained
from Yahoo Finance, at http://www.finance.yahoo.com, and are
current as of the close of trading on June 23, 2008.
37 See Christopher Snowbeck, AGA Medical Files IPO To Raise $200
Million, ST. PAUL PIONEER PRESS, June 23, 2008, available
at http://www.twincities.com/news/ci_9677626?source=rss.
38 Alcatel-Lucent was formed in December 2006 through the merger
of Alcatel, a French corporation, and Lucent Technologies, Inc.,
an American corporation. Lucent was alleged to have paid bribes
in violation of the FCPA prior to its merger with Alcatel.
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