In recent years, the books and records provision of the Foreign Corrupt Practices Act (FCPA) has taken on new life, as both the Department of Justice and the Securities and Exchange Commission (SEC) have announced their intention to bring more charges, especially against individuals, for violations of this section of the FCPA.1 A review of recent enforcement actions reveals that the Justice Department and the SEC consider the books and records requirements violated whenever corrupt payments are made to a foreign official and recorded in a corporation’s books as anything other than a “bribe,” including, but not limited to, such things as commissions, social payments, or after sales service fees.2 This article proposes that the books and records provision is, in fact, narrower than the Justice Department and the SEC interpretations suggest, and argues that both agencies may be using the provision to punish behavior falling outside the FCPA’s reach.
It has become fairly common practice for FCPA defendants to resolve enforcement actions out of court. Consequently, there has been little judicial interpretation of the books and records provision, and thus, it can be challenging for a defendant to refute the government’s legal assertions. This article attempts to sketch the limitations of the books and records provision in the hopes of providing helpful guidance to both corporate and individual defendants.
Books and Records Provision
The FCPA was enacted in 1977 in order to deter and punish the bribery of foreign officials. In an effort to bolster the effectiveness of the FCPA’s anti-bribery provisions, Congress added the books and records provision, which compels publicly-traded companies to “make and keep books, records, and accounts which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer.”3 The provision applies to “issuers,” defined as companies that have a class of securities registered pursuant to the Securities Exchange Act of 19344 or that are required to file reports with the SEC in accordance with the Exchange Act.5 Additionally, if an issuer holds more than 50 percent of the voting power of a subsidiary, that subsidiary’s compliance is also required.6
The books and records provision demands “reasonable detail” in corporate recordkeeping at a “level of detail and degree of assurances” sufficient to “satisfy prudent officials in the conduct of their own affairs.”7 Unlike many other securities laws, the books and records provision does not include a materiality element.
Establishing a criminal books and records violation by an individual involves proving, beyond a reasonable doubt, that (1) the record at issue was subject to the recordkeeping provisions; (2) the record was inaccurate, and the inaccuracy was something that a “prudent” record keeper would have deemed unsatisfactory; and (3) if the record is deemed false, the individual charged with the violation willfully caused that falsity, knowing that it was, in fact, false. In a criminal case against an issuer, the requirements are the same, except that the government does not need to prove willfulness.8 Civil liability is assessed by a “preponderance of the evidence” standard and, with respect to individuals, requires the government to prove knowledge or recklessness, though not willfulness.9 A civil case against an issuer however, requires the government to prove only the first two of the above factors, rendering the books and records provision a strict liability statute when applied to issuers in a civil action.
Although at first glance the elements of a books and records violation appear simple, a closer look at each of the components reveals that the government’s burden is quite challenging.
Defining Books and Records
There are multiple textual arguments available that curtail an aggressive reading of the books and records provision. One concerns the definition of “books and records” itself. The recordkeeping provisions do not define “book or record,” but definitions for these terms can be found in the larger Exchange Act: “accounts, correspondence, memoranda, tapes, discs, papers, books, and other documents or transcribed information of any type whether expressed in ordinary or machine language.”10
While the Exchange Act’s definition is expansive, the books and records provision of the FCPA must be read more narrowly, as its reach is limited to only those books and records that reflect “transactions and dispositions of the assets of the issuer.”11 Further, the SEC has stated that only those records that relate to the internal control objectives specified in the Exchange Act are within the purview of the recordkeeping provision.12 Thus, practitioners should thoughtfully consider whether the internal reports, emails, due diligence investigations, invoices, and other records pointed to by the government as purportedly containing false information fall within this narrow scope. The origin of the documents should also be considered, as only an issuer’s records are subject to the statute.
Defendants may also contest what it means to “falsify” a book or record.13 Once again, the statute is silent as to the meaning of this term. But, in United States v. Jensen, the Justice Department submitted a brief to the U.S. Court of Appeals for the Ninth Circuit declaring that the recordkeeping provision “makes clear that it prohibits conduct that is inevitably nefarious. [The statute] prohibits ‘falsification[,]‘ not ‘inaccurately recording’ information.’”14 The Justice Department then cited Webster’s Dictionary for its definition of falsify: “to engage in misrepresentation or distortion.”15
While the SEC and the Justice Department aggressively define a “false” record as one that does not adhere to their preferred accounting standards, it is important to remember that it is the government’s burden to prove that a defendant’s accounting practices are unacceptable.16 Because accounting rules differ from region to region, or even within a single corporation, defense attorneys should consult with local accounting firms that can provide expert testimony concerning locally accepted standards.
Indeed, the district court in United States v. Reyes held that a defendant must be allowed to present evidence that a particular accounting rule “provided insufficient guidance for Defendants to have determined with any confidence” what the proper accounting entry might be.17 If the accounting rule itself is unclear, there can be no violation.
Additionally, consultation with a local accounting firm is good practice because the government must also prove that the purported falsity is one that would offend “prudent officials in the conduct of their own affairs.” If the contested entry is one that, under local practices, would have been considered acceptable or to contain only negligible error, the government has failed to carry its burden.
Mens rea arguments provide additional opportunities for defense. While a civil violation imposes strict liability upon an issuer, the government must prove a heightened burden in criminal cases and when bringing a civil case against an individual.
In a criminal case against an individual, the government must prove both willfulness and knowledge, meaning the individual voluntarily made false entries that he or she knew were false in the issuer’s books and records. The defendant need not be aware of the specific statute he or she may be violating. It is sufficient that he knew his conduct was generally unlawful.18 Coupled with the government’s burden of demonstrating that the accounting principles employed were imprudent, the willfulness requirement may offer significant leeway to defendants who performed the ministerial or bookkeeping tasks that purportedly disguised the unlawful conduct of others. As the government has admitted, willfulness “requires additional proof of the ‘evil-meaning mind’ on which criminal liability is usually based.”19
In all criminal cases, including those against an issuer, as well as in civil cases against an individual, the government must prove knowledge.20 The defendant must be cognizant that a falsification is taking place; awareness is not satisfied by the defendant merely learning of the falsification after the fact, or by the falsification falling under the defendant’s general area of responsibility.21 Instead, proving knowledge requires the government to demonstrate that the defendant “was aware of the falsification and did not falsify through ignorance, mistake, or accident.”22 Indeed, when drafting the books and records provision, the U.S. Senate was adamant that the statute was “not intended to make unlawful conduct which is merely negligent.”23
The Ninth Circuit has further clarified the government’s burden with respect to intent in a criminal case, stating,
[The defendant's] presumed knowledge of GAAP as a qualified CFO does not make him criminally responsible for his every conceivable mistake. If simply understanding accounting rules or optimizing a company’s performance were enough to establish scienter, then any action by a company’s chief financial officer that a juror could conclude in hindsight was false or misleading could subject him to fraud liability without regard to intent to deceive. That cannot be.24
Notwithstanding the above, willful blindness or knowing disregard will establish the requisite knowledge.25 Furthermore, while the books and records provision does not contain a materiality requirement, the materiality—or lack thereof—of the contested accounting may be considered when evaluating a defendant’s intent.26
Finally, a good-faith belief that a record is accurate is a defense to a recordkeeping violation. According to the court’s instructions to the jury in United States v. Reyes, “[g]ood-faith on the part of [the defendant] is inconsistent with a finding that [the defendant] knowingly or willfully committed…the alleged offenses.”27 Instead, “if the evidence in the case leaves you with a reasonable doubt about whether [the defendant]…possessed a good-faith belief that the alleged false or misleading statements were in fact accurate, you must find [the defendant] not guilty on that count.”
Good faith is thus a rather strong defense for certain defendants, especially since it remains a defense “even if a defendant’s belief in the proof [sic] of his statements was one that a reasonable person would not have embraced.”28 Additionally, evidence of good faith can include reliance on counsel’s advice. The good-faith instruction given to the jury in United States v. Thompson addressed this scenario:
[T]he defendants would not be willfully doing wrong if, before taking any action with regard to the alleged offenses, the defendants consulted in good faith with…counsel whom the defendants considered competent, made a full and accurate report to those attorneys of all material facts of which the defendants had the means of knowledge, and then acted strictly in accordance with the advice given by those attorneys.29
The above analysis aims to refute the assertion that a books and records violation inevitably follows bribery of a foreign official. The government’s burden is simply not that easy. Instead, defense attorneys should carefully parse the government’s analysis, looking critically at the type of documents offered as indicative of a false entry, the underlying accounting principles involved in making the entry, and the specific questions of willfulness and knowledge as they relate to each individual defendant. Additionally, evidence of good faith, or reliance on professional advice, should be sought out and communicated to the government. The Justice Department and the SEC cannot make law by prosecutorial fiat, and defendants should not shy away from challenging overbroad assertions of illegality.
Michael S. Schachter is a partner in the litigation department of Willkie Farr & Gallagher and co-head of the firm’s white collar criminal defense practice group. Casey E. Donnelly, an associate at the firm, assisted in the preparation of this article.
1. See Lanny A. Breuer, Assistant Attorney General, Criminal Division, Dept. of Justice, Prepared Address to The 22nd National Forum on the Foreign Corrupt Practices Act (Nov. 17, 2009) (available at http://www.justice.gov/criminal/pr/speeches/2011/crm-speech-111108.html).
2. See, e.g., United States v. Volvo Construction Equipment, No. 1:08-cr-00069 (D.D.C. 2008); United States v. Head, No. 06-cr-01380 (S.D. Cal. 2006); United States v. Novo Nordisk, No. 09-12C (RJL) (D.D.C. 2009); SEC v. Bobby Benton, No. 04:09-cv-03963 (S.D. Tex. 2009).
3. 15 U.S.C. 78(m)(b)(2)(A). The FCPA’s financial reporting and internal controls provisions were incorporated into §§13(b)(2)(A) and (B) of the Exchange Act. Securities and Exchange Act of 1934, ch. 404, 48 Stat. 881 (2006).
4. 15 U.S.C. 78l.
5. 15 U.S.C. 78o(d).
6. 15 U.S.C. 78m(b)(6). When an issuer does not have an interest in an affiliate greater than 50 percent, it must “proceed in good faith to use its influence to the extent reasonable under the circumstances” to cause the affiliate to adhere to the recordkeeping requirements.
7. 15 U.S.C. 78m(b)(7); H.R. Conf. Rep. No. 578, 100th Cong., 2d Sess. 916-925, 916 (1988).
8. 15 U.S.C. 78ff(a).
9. See Statement of Policy Regarding the Foreign Corrupt Practices Act of 1977, Interpretive Release No. 34-17500, 46 Fed. Reg. 11544, 11545-47 (Jan. 29, 1981) (A “knowing or reckless” state of mind is required for a violation). Although the SEC’s policy statement indicates that only knowing or reckless misconduct violates the books and records provision, courts have held that a Rule 13b2-1 violation requires “unreasonableness,” which can be satisfied through a showing of recklessness. SEC v. Espuelas, 579 F.Supp.2d 461, 486-87 (S.D.N.Y. 2008). Recklessness is “conduct which is highly unreasonable and which represents an extreme departure from the standards of ordinary care to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it.” Id. at 470.
10. 15 U.S.C. 78c(a)(37).
11. Recent jury instructions from United States v. Reyes offer a simpler definition: “A book, record, or account is a document that was created or maintained to accurately and fairly reflect, in reasonable detail, the transactions and dispositions of the assets of a company.” Duties of Jury to Find Facts and Follow Law, No. CR 06-0556-1 CRB (March 23, 2010).
12. See Statement of Policy Regarding the Foreign Corrupt Practices Act of 1977, 46 Fed. Reg. at 11545-46 (“[W]e believe that records which are not relevant to accomplishing the objectives specified in the statute for the system of internal controls are not within the purview of the recordkeeping provision…[i]n essence, these objectives are that assets be safeguarded from unauthorized use, that corporate transactions conform to managerial authorizations and that records be accurate”).
13. 15 U.S.C. 78(m)(b)(4)-(b)(5).
14. United States v. Jensen, Brief for the United States as Appellee, No. 08-10047 (Oct. 27, 2008).
16. United States v. Bradstreet, 135 F.3d 46, 51 (1st Cir. 1998) (“[W]here a defendant advances an understanding of the principles by which truth and falsity are judged that differs from that of the government; and where the defendant’s actions might have been truthful under such an understanding, the government cannot carry its burden without first demonstrating the unreasonableness of the contrary understanding”).
17. United States v. Reyes, Memorandum and Order, re: Motions to Dismiss, No. CR 3:06-0556-1 CRB (May 30, 2007).
18. United States v. Tarallo, 380 F.3d 1174, 1189 (9th Cir. 2004).
19. See United States v. Jensen, Brief for the United States as Appellee, No. 08-10140 (9th Cir. Oct. 27, 2008).
20. 15 U.S.C. 78(m)(b)(4)-(b)(5) (individuals who “knowingly falsify” books and records may be held liable”); Statement of Policy Regarding the Foreign Corrupt Practices Act of 1977, 46 Fed. Reg. at 11545-47 (A “knowing or reckless” state of mind is required for a violation).
21. While personal knowledge has traditionally been a requirement of an individual violation, the SEC recently evaded this element by utilizing a “control person” theory of liability to bring charges against individual defendants who lacked personal knowledge of the violation. Former COO Douglas Faggioli and former CFO Craig Huff of Nature’s Sunshine Products were charged with books and records violations on the basis of their supervisory authority over those who were directly responsible for the improper accounting entries. The SEC did not allege that either defendant had participated in, or had any knowledge of, the violation. See SEC v. Nature’s Sunshine Products, Douglas Faggioli, and Craig D. Huff, No. 2:09-CV-0672 (D. Utah 2009).
22. United States v. Reyes, 577 F.3d 1069, 1080 (9th Cir. 2009).
23. S. Rep. No. 95-114 at 9 (1977), reprinted in 1977 U.S.C.C.A.N. 4098, 4107.
24. United States v. Goyal, 629 F.3d 912, 919 (9th Cir. 2010).
25. United States v. Jacobs, 475 F.2d 270, 287 (2d Cir. 1973).
26. See United States v. Lake, 472 F.3d 1247, 1262 (10th Cir. 2007) (“Thus, there was no evidence that the defendants’ failure to disclose information in the D&O forms ever caused a material omission in SEC reports. To be sure, this fact is not dispositive of defendants’ intent…. Nevertheless, in assessing the state of mind of each defendant, the jury would likely be influenced by knowing that the omission on the D&O forms apparently did not cause any errors in the reports to the SEC”).
27. United States v. Reyes, Duties of Jury to Find Facts and Follow Law, No. CR 06-0556-1 CRB (March 23, 2010).
28. United States v. Bradstreet, 135 F.3d 46, 51 (1st Cir. 1998).
29. United States v. Thompson, Jury Charge (N.D. Ala. May 17, 2005) (defendants were indicted for violating the books and records provision because they allegedly recorded a sham contract as legitimate in the books of issuer, HealthSouth Corporation. Following a jury trial, both defendants were acquitted).