DUE DILIGENCE, COOPERATION AND THE FCPA

DUE DILIGENCE, COOPERATION AND THE FCPA

FCPA enforcement officials repeatedly emphasized the necessity for adequate compliance procedures and the value of voluntarily reporting and cooperation when a violation is discovered. The FCPA settlement of RAE Systems Inc. with the Department of Justice and the SEC illustrates the necessity for pre-merger due diligence and taking the necessary follow-up steps to ensure that there are proper internal controls are in place. DOJ Press Release Dec. 10, 2010, available at http://www.justice.gov/opa/pr/2010/December/10-crm-1428.html; See also SEC v. RAE Systems, Inc., Civil Action No. 1:10-cv-02093 (D.D.C. Filed Dec. 10, 2010); Litig. Rel. 21770 (Dec. 10, 2010). It is also a good example of the value of self-reporting and cooperation. See RAE Systems Deferred Prosecution Agreement, December 10, 2010, available at http://www.justice.gov/criminal/fraud/fcpa/cases/docs/12-10-10rae-systems.pdf.

RAE Systems is a San Jose, California based manufacturer of rapidly deployable, multi-sensor chemical and radiation detection monitors and networks. The company had significant operations in the People's Republic of China. Its shares are listed on the NYSE Alternext US Exchange. Those operations were conducted under a holding company called RAE Asia based in Hong Kong. Sales in China were made primarily through two second-tier subsidiaries organized as joint ventures with local entities. One venture is RAE-KLH. The other is RAE Fushun.

The violations occurred between 2004 through 2008. RAE, through its two second tier subsidiaries, made improper payments directly and indirectly to government officials in China to obtain or retain business from Chinese government entities. For example, in January 2006, RAE-KLH entered into a consultancy agreement with a Chinese third-party agent. The agreement was supposed to be for technical services related to a government-affiliated oil project contract related to the Dagang Oil Field. The agent was paid about $86,195. The money actually went to one or more employees of a state owned enterprise. As a result RAE-KLH won a contract from the Dagang Oil Field.

In 2007 more bribes were paid through RAE-KLM and RAE-Fushun. RAE-KLH sales personnel used cash advances to bribe government officials. In one instance, a notebook computer was purchased for the Deputy Director of a state-owned chemical plant. In another, RAE-KLH entered into a contract with the same third-party agent used in the Dagang Oil Field deal. Portions of the money paid to the agent were used to secure business from a large state-owned enterprise or government departments.

RAE Fushun used cash advances and reimbursements for improper purposes. Those included giving gifts and paying for entertainment. In addition, there were direct and indirect payments to officers and employees of customers.

Payments of this type were typically improperly booked as "business fees" or "travel and entertainment" expenses. While the company received notice of improper conduct, and on occasion took some appropriate steps, overall it failed to halt the wrongful conduct. In sum, the payments resulted in contracts with abut $3 million in revenues and profits of about $1,147,800.

RAE Systems acquired a controlling interest in RAE-KLH in 2004. Due diligence was conducted. A significant number of RAE-KLH's customers were government departments and bureaus and large state-owned agencies and instrumentalities. During the due diligence, the RAE board received reports suggesting there were difficulties and a lack of internal control. RAE knew that the company did not have internal controls like a western company and acknowledged it could not force fit such controls. The company also recognized that RAE-KLH had been successful using its then current business practices and that altering those could impact future opportunities. At one point, a high company executive noted that RAE could either increase the costs or follow the local practices with an understanding of the risk. While some FCPA training was undertaken, RAE Systems acknowledged in the deferred prosecution agreement that it "did not impose sufficient internal controls or make sufficient changes to high-risk practices, such as sales personnel obtaining cash advances." When RAE Fushun was acquired the company did not do any due diligence.

RAE Systems voluntarily disclosed its violations and fully cooperated with DOJ. The company conducted a full internal investigation and took appropriate remedial steps. As a result it resolved the matter with the Department of Justice by entering into a deferred prosecution agreement. Under the terms of that agreement the company will pay a criminal penalty of $1.7 million.

The company also settled with the SEC on terms consistent with other Commission settlements. In the settlement, the company consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B). RAE Systems also agreed to pay $1,147,800 in disgorgement plus prejudgment interest and was ordered to comply with certain undertakings in its FCPA compliance program. The SEC's papers do not mention the cooperation of the company.

These settlements clearly illustrate the need for adequate pre-merger due diligence and the necessity of taking corrective steps when necessary. The settlement with DOJ also illustrates the value of cooperation. Overall, the papers make it clear that had the company implemented the appropriate internal systems at the time it acquired subsidiaries in a high risk area, it may have halted the improper practices and avoided much of the difficulties ultimately encountered.

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