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I have frequently noted in prior posts that a frequent development after a company announces the existence of an FCPA investigation is the filing of a follow on civil action (refer, for example, here). But while plaintiffs’ lawyers often are eager to file these lawsuits, in many instances they prove to be unsuccessful (as discussed here). A recent ruling in the FCPA follow-on securities class action lawsuit involving Avon Products illustrates the hurdles companies face in trying to pursue these kinds of claim. At the same time, however, recent dismissal motion denial in the FCPA follow-on securities class action lawsuit involving Wal-Mart Stores illustrates what may be sufficient for these kinds of cases to survive the initial pleading hurdles.
Avon, a beauty products company that earns much of its revenue from direct sales operations, derived significant sales revenue from direct sales operations in China. The Chinese direct sales operations were made possible by licenses granted by the Chinese government. On October 20, 2008, Avon disclosed in a SEC filing on Form 8-K that in June 2008 the company’s CEO had received a whistleblower letter suggesting that certain travel and entertainment expenses associated with the company’s operations in China may have violated the FCPA. The company also announced that it had launched an internal investigation.
Between October 2008 and October 2011, the company reported generally increasing sales through its Chinese operations. In October 2011, the company announced that the SEC had launched a formal investigation of the company. Later in 2011, the company announced that its CEO would step down from that role but would remain as Executive Chairwomen for two years. In early 2013, the company announced that its Chief Financial Strategy Officer had been terminated in connection with the ongoing bribery investigation.
In July 2011, plaintiff shareholders filed the first of several securities class action lawsuits against the company and certain of its directors and officers. The plaintiffs alleged that the company had failed to disclose prior to the October 2008 8-K filing that it allegedly had obtained its licenses for direct sales operations in China through bribery of Chinese officials and that in subsequent communications reporting the company’s growing revenues in China the company failed to disclose that the revenue was possible as a result of the allegedly improperly obtained licenses. The defendants moved to dismiss.
In a detailed September 29, 2014 opinion (here), Southern District of New York Judge Paul G. Gardephe granted the defendants’ motion to dismiss the plaintiffs’ consolidated complaint. He did grant the plaintiffs leave to file an amended complaint.
With respect to Avon’s disclosures prior to the October 2008 8-K filing, he found that the plaintiffs had failed to show that any of the misleading statements had been made with the knowledge or awareness of the existence of the allegedly improper payments. In particular, he found that the allegations that the company’s executives “must have known” or “had to have known” about the improper payments because of their senior positions and direct involvement in the negotiation of the Chinese licenses were insufficient to satisfy the state of mind pleading requirements. He found with respect to the statements after the October 2008 8-K filing that the plaintiffs had failed to show that the statements were materially false or misleading.
On December 8, 2011, Wal-Mart disclosed in an SEC filing that as a result of information disclosed in an internal review, the company had begun an internal investigation whether certain matters were in compliance with the FCPA, and that the company had engaged outside counsel in the investigation and had voluntarily disclosed the matter to the SEC and the DoJ. In the subsequent securities class action lawsuit, the shareholder plaintiffs alleged that the company had learned of suspected corruption in its Mexican operations as early as 2005 and had conducted an internal investigation in 2006. The plaintiffs alleged that the December 2011 filing was misleading because it left investors with the impression that Defendants had first learned of the suspected corruption at that time. In June 2012, when Wal-Mart disclosed the events in 2005 and 2006, its share price declined significantly.
The defendants moved to dismiss the plaintiffs’ consolidated complaint. In a September 26, 2014 order (here), Western District of Arkansas Susan O. Hickey entered an order adopting the report and recommendation of the Magistrate Judge in the case denying the defendants’ motion to dismiss. Judge Hickey expressly agreed with the Magistrate Judge’s conclusion that the plaintiff had sufficiently alleged that the omission from the 2011 statement of 2005-2006 events rendered the 2011 statement materially misleading. She further affirmed the Magistrate Judge’s finding that omission of the information concerning the 2005-2006 events could have left a reasonable investor with the impression that the defendants first learned of suspected corruption at the time of the December 2011 statement – “an impression that would be untrue.”
The defendants had argued that Magistrate Judge’s conclusion that the plaintiffs had satisfied the requirement to plead scienter were incorrect. Judge Hickey concluded that the plaintiff had sufficiently alleged that defendants knew or had access to information suggesting that the December 2011 statement was not entirely accurate. She noted that the plaintiff had alleged that in October 2005, a Wal-Mart attorney had had given the Vice Chairman of the company’s international operations a detailed report of the suspected corruption allegations and that the Vice Chairman had rejected calls in 2006 for an independent investigation and instead assigned the investigation to the very office implicated in the corruption scheme. The complaint alleges that the company only disclosed the 2005-2006 events after an article appeared in the New York Times discussing the circumstances. Judge Hickey said that “the inference that the Defendants intentionally omitted certain information is just as strong, of not stronger, than any competing plausible inference.”
The different outcomes of the two dismissal motions are obviously attributable to critical differences between the allegations in the two cases. Largely as a result of disclosures in theNew York Times articles (and elsewhere) the plaintiff in the Wal-Mart case had a basis on which to allege that senior officials at Wal-Mart allegedly were aware of the alleged improper payments in Mexico prior to the SEC filing in December 2011, whereas the plaintiffs in the Avon case were able to allege only that the senior officials at the company must have known or should have known of the improper payments prior to the company’s October 2008 SEC filing.
The outcome of the dismissal motion in the Avon case shows that It will not be enough for securities class action plaintiffs to succeed for them to allege that the company was involved in significant bribery activities, and that even the existence of significant bribery allegations may not be enough to support a securities class action lawsuit, even where the revelation of the existence of bribery allegations results in a significant share price decline. To be sure, the plaintiffs in the Avon case have been given leave to amend their complaint, and their amended complaint may succeed in overcoming the initial pleading hurdles. But the ruling the case discussed above underscored how difficult it can be for plaintiffs to overcome the pleading hurdles.
The Wal-Mart case shows how significant and serious an FCPA follow-on lawsuit can be where the plaintiffs are able to present factual allegations sufficient to overcome the initial pleading hurdles. Of course, whether the plaintiff in the case ultimately will succeed remains to be seen. However, because surviving the initial pleading hurdles often is the name of the game for securities class action plaintiffs, the shareholder plaintiff in that case already has made it to a critical litigation milestone.
These cases are interesting in and of themselves. They are also interesting in the context of a changing global environment where a number of countries are becoming increasingly active in enforcing their own anti-bribery laws. Among other countries, Canada, China, Brazil, Italy and the UK have recently become more active in this area. For many years, anti-bribery enforcement had been an activity almost exclusively limited to U.S. authorities. As an increasing number of countries become active in this area, overall levels of anti-bribery activity will increase — a prospective development that could have a number of important implications.
Among these implications it the possibility that increase anti-bribery enforcement activity could lead to more of the kind of follow-on civil litigation these two cases exemplify – both here in the U.S. and perhaps even outside the U.S. as well. As the Avon case shows, it may be challenging for the plaintiffs in these follow-in civil lawsuits to succeed, but as the Wal-Mart case shows, with sufficient factual ammunition, the plaintiffs in these kinds of cases can raise sufficient allegations at least to survive initial pleading hurdles.
Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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