Challenges of international background investigations

Many transactions today, whether they involve an employment hiring decision or a new business relationship, are cross-border or have an international component. The need for effective risk management both in the U.S. and abroad has vastly expanded in recent years with the passing of legislation and increased enforcement actions. Behind just about every business decision, there is a widening range of stakeholders — from regulators to shareholders to board members — who expect that the due diligence process will minimize unlawful activities.

International background investigations, which are essential for a comprehensive approach to due diligence, present special challenges since each country has its own laws, customs, and procedures. Language barriers, name variations and transliterations, limited information and technology, broad definitions of crimes, and proliferation of fraudulent educational and accreditation institutions, are just some of the factors that add to the complexity of these investigations.

As a general rule, in most European countries, criminal records are not available to the public. In Asia, public accessibility to most court filings is limited. In South America, public records vary greatly from country to country. South Africa provides some disclosure of police records and warrants to the public, along with civil filings. Canada’s public records availability differs by province, and only a few permit criminal records release. India and Australia have the most searchable records, similar to the U.S.

For employment purposes, the Fair Credit Reporting Act (FCRA) imposes certain obligations for international background screening performed by a U.S. Consumer Reporting Agency (CRA), including mandating reasonable procedures to ensure the accuracy of the information it reports. If a public record such as a criminal conviction is found, the CRA must ascertain that the information is correct, up-to-date, and reported in a way that does not violate data or privacy protection rules.

In 2000, an agreement between the U.S. Department of Commerce and the European Commission established privacy and data protection guidelines, the “Safe Harbor Principles,” to enable U.S. companies to satisfy a requirement under European Union law for adequate protection of personal information transferred from the European Economic Area (the 25 member states of the European Union plus Iceland, Liechtenstein and Norway.) In addition to these principles, the Gramm-Leach-Bliley Act (GLBA) requires financial institutions and businesses that receive personal information to establish safeguards for the handling and disclosure of that information. And the Fair and Accurate Credit Transactions Act (FACTA), a federal legislation, also contains provisions to help reduce identity theft and obligates the proper disposal of personal consumer information.

The cost of an international background investigation typically is higher than domestic searches, and varies with each country, the type of information that needs to be obtained and the purpose of the investigation. When performed by a reputable firm with qualified foreign contacts, an international background investigation can reduce negligent hiring liability, and prevent a catastrophic investment or reputational damage.

|Educational Series, Legislation|

Financial advice show hosts have host of problems

Just about any time of the day, the airwaves are filled with self-appointed financial gurus spewing their secrets for managing money and ways to get rich. But the true secrets of more than a dozen of these wealth peddlers may be in their shady backgrounds and off-the-air dealings. Here are a few examples of the bamboozlements, as disclosed by the Securities and Exchange Commission (SEC) and other authorities.

On June 13, 2011, Clifford Robertson was sentenced to 97 months for bank fraud, to be followed by 24 months for aggravated identity theft and ordered to pay $4,627,520 in restitution, according to a statement by the U.S. Department of Justice’s Federal Bureau of Investigation Dallas Field Office. The bureau’s investigation determined that Robertson claimed to be a real estate investment advisor who hosted AM radio real estate investment talk shows and in-person seminars. Robertson admitted that beginning in December 2007, he used the identity of another person to submit a fraudulent personal financial statement to a lending institution in order to obtain money by false pretenses. The loss to investors was estimated at around $3 million.

Another recent financial show host shakedown was announced in a June 3, 2011 press release by the Department of Justice’s U.S. Attorney’s office for the Southern District of Florida which said that “criminal information was filed against Anthony F. Cutaia, charging him with nine counts of mail fraud…” Cutaia, who was the host of “Talk About Mortgages and Real Estate,” a television and radio program, was also the managing member and beneficial owner of CMG Property Investment Group, LLC, which purportedly engaged in commercial real estate investments in Florida, and promised not to collect commissions or fees from the investors until the properties were sold and a profit was made. However, court papers allege that Cutaia invested little of the money and instead used it to make payments to pre-existing investors and to pay his own business and personal expenses. Legal documents further show that Cutaia filed for bankruptcy in 2007, but that case was tossed out. He filed another Chapter 7 petition on May 11, 2011.

Also exposed this year was John Farahi, a host on a Farsi language radio station in the Los Angeles area. The SEC’s complaint filed in the U.S. District Court for the Central District of California alleges that NewPoint, co-owners John Farahi and Gissou Rastegar Farahi, and its controller Elaheh Amouei targeted investors in the Iranian-American community by touting NewPoint on a daily finance radio program hosted by Farahi. The SEC charges that the Farahis or Amouei would then make appointments with interested listeners to discuss investment opportunities offered by NewPoint, and subsequently misled more than 100 investors into purchasing over $20 million worth of debentures that they claimed were low risk. Many investors also were falsely told that they were investing in FDIC-insured certificates of deposit, or government or corporate bonds issued by companies backed by the funds from the Troubled Asset Relief Program (TARP). According to the SEC, most of the money raised was instead transferred to accounts controlled by the Farahis to, among other things, fund construction of their multi-million dollar personal residence in Beverly Hills.

|Educational Series, Fraud|

SEC issues warning about investing in reverse merger companies

On June 9, 2011, the Securities and Exchange Commission (SEC) issued an Investor Bulletin about investing in companies that enter U.S. markets through the so-called “reverse mergers.” These mergers allow private companies, including those outside the U.S., to access U.S. investors and markets by merging with an existing public shell company. The SEC and U.S. exchanges recently suspended trading in more than a dozen reverse merger companies, citing a lack of current, accurate information about these companies and their finances.

“Given the potential risks, investors should be very careful when considering investing in the stock of reverse merger companies,” said Lori J. Schock, director of the SEC’s Office of Investor Education and Advocacy. “As with any investment, investors should thoroughly research the company – including ensuring there is accurate and up-to-date information – before making a decision to invest.”

The SEC’s warning is especially strong regarding Chinese companies, as more than 150 entities have recently put their shares up for grabs to American investors through the backdoor “without any of the vetting from underwriters and investors that companies undergo when they perform a traditional IPO,” as noted by Commissioner Luis Aguilar.

Shareholders already have sued a string of China-based, U.S.-listed companies for fraud, claiming that they lost money when stocks plummeted after the financial scandals. They charge that the companies operated sham businesses, inflated revenue or gave vastly different information to U.S. and Chinese regulators. And they are starting to sue the auditors who signed off on the financial statements. But it will be tough to win these cases in American courts, as Chinese entities often have refused to comply with U.S. court proceedings.

The best hope for investors may be the SEC, which has launched an inquiry into U.S. audit firms with China-based clients. Investors could benefit if the SEC, which can force companies and auditors to cooperate in investigations, sues more auditors or companies.

|Educational Series|

Asset searches: who can get bank account information and why

A quick Internet search for ways to get someone’s bank or investment account information returns at least a dozen private investigation companies that promise to find these records “anywhere in the US and worldwide” for judgment collections, verification of net worth and for “just about any other purpose.” But a closer look at these Web sites reveals a fine-print disclaimer stating that the information is from public records such as divorce cases and probate filings. And there are a few that do not bother with a disclaimer, providing only an 800 number to call.

Asset searches, which may include bank and investment accounts, are not illegal; however, certain actions to obtain this information, such as pre-texting, are illegal. And although there are methods that can be used to obtain financial information covertly, most if not all, are questionable and often futile. There is no clear way for anyone other than the account holder, a designated representative or a party with a valid court order to get account information without violating the law.

There is a general misconception that a judgment, just by virtue of its issuance, can be used to force a bank or financial institution to disclose account information, but the enforcement of judgments is governed by each state’s laws. In California, for example, a writ of execution is necessary. These writs are rendered on a county-by-county basis and direct a levying officer (usually a sheriff) to serve the writ on the named institution. The institution then may be required to freeze the account and in some cases to hand over the account balance. State laws also allow the creditor, after a judgment is obtained, to examine and request asset information from the debtor. This, however, puts the debtor on notice and may result in draining an account before a writ of execution is served.

The privacy protection laws that govern access to financial information under false pretenses depend on whether the affected customer is a consumer or a business entity. The more significant legislation is directed at protecting consumers, defined generally in the laws and in interpretative decisions as ”individuals consuming goods or services for personal or household use.” The Gramm-Leach-Bliley Act (GLBA) prohibits obtaining customer information from a financial institution under false pretenses and imposes an obligation to protect customer information. Under the GLBA, a customer means “an individual consumer,” which is essentially the same as the definition of a consumer under the Fair Credit Reporting Act (FCRA). In addition to the GLBA and FCRA, there are other potentially applicable federal privacy laws, as well as a long list of state laws. But even if a specific law may cover only consumers, the financial institution’s contract with the business customer would certainly be construed as preventing third-party access.

|Educational Series|

Dodd-Frank rule disqualifies felons and bad actors from securities offerings

On May 25, 2011, the Securities and Exchange Commission (SEC) proposed a rule to deny certain securities offerings from qualifying for exemption from registration if they involve “felons and other bad actors.”

When an individual or a company offers or sells a security such as a stock or bond, generally the offering must be registered with the SEC. However, the SEC’s Regulation D provides three exemptions that can used to avoid such registration. The most widely used exemption is Rule 506, which accounts for more than 90% of the offerings made, as well as the majority of capital raised. If an offering qualifies for the Rule 506 exemption, an issuer can raise unlimited capital from an unlimited number of “accredited investors” and from up to 35 non-accredited investors.

Section 926 of the Dodd-Frank Act requires the SEC to adopt rules that would deny this exemption to any securities offering in which certain “felons and other bad actors” are involved. This new rule is substantially similar to the bad actor disqualification provisions of another limited offering exemptive rule – Rule 262 of Regulation A – which provides for an exemption from registration for certain small offerings.

Under the proposed rule, an offering cannot rely on the Rule 506 exemption if the issuer or any other person covered by the rule (including the issuer’s predecessors and affiliated issuers, directors, officers, general partners and managing members of the issuer, 10% beneficial owners and promoters of the issuer, persons compensated for soliciting investors, and the general partners, directors, officers and managing members of any compensated solicitor) has had a “disqualifying event” identified as follows:

Criminal conviction in connection with the purchase or sale of a security, making of a false filing with the SEC or arising out of the conduct of certain types of financial intermediaries. The criminal conviction would have to have occurred within 10 years of the proposed sale of securities (or five years, in the case of the issuer and its predecessors and affiliated issuers).

Court injunction and restraining order in connection with the purchase or sale of a security, making of a false filing with the SEC or arising out of the conduct of certain types of financial intermediaries. The injunction or restraining order would have to have occurred within five years of the proposed sale of securities.

Final order from state securities, insurance, banking, savings association or credit union regulators, federal banking agencies or the National Credit Union Administration that bar the issuer from: 1) associating with a regulated entity; 2) engaging in the business of securities, insurance or banking; 3) engaging in savings association or credit union activities, or 4) orders that are based on fraudulent, manipulative or deceptive conduct and are issued within 10 years before the proposed sale of securities.

Certain commission disciplinary order relating to brokers, dealers, municipal securities dealers, investment companies and investment advisers and their associated persons, which would be disqualifying for as long as the order is in effect.

Suspension or expulsion from membership in a “self-regulatory organization” or from association with an SRO member, which would be disqualifying for the period of suspension or expulsion.

Commission stop order and order suspending the Regulation A exemption issued within five years before the proposed sale of securities; and

U.S. Postal Service false representation order issued within five years before the proposed sale of securities.

The proposed rule would provide an exception from disqualification when the issuer can show it did not know and, in the exercise of reasonable care, could not have known that a disqualification existed. Any pre-existing convictions, suspensions, injunctions and orders would be disqualifying. For further information, see http://www.sec.gov/rules/proposed/2011/33-9211.pdf

|Dodd-Frank, Educational Series, Legislation|

Spotlight on insider trading

Many people associate the term “insider trading” with illegal conduct. But the term refers to both legal and illegal activities. The SEC’s legal version is that corporate insiders, i.e., officers, directors, employees, or anyone with at least a 10% stake in a company, can buy and sell stock in the company providing they abide by the SEC’s restrictions and transactional requirements.

In 2002, the SEC tightened its rules by adopting the Regulation Fair Disclosure to curb the practice of company executives giving securities analysts an inside track; the rules mandate that anything disclosed to an outsider must be revealed to the general public. The SEC also includes in its definition of insiders those who have “temporary” or “constructive” access to the material information, such as business associates, friends, family members, brokers, attorneys and “other tipees.” The U.S. Supreme Court ruled recently that any individual, with or without ties to the particular company, who is in possession of material information, even if the information was stolen, is an insider.

Illegal insider trading, according to the SEC, refers to the buying or selling of a security in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information. Insider trading violations include “tipping” such information, trading in securities by the person “tipped” and trading by those who misappropriate the information.

The SEC considers the prosecution of insider trading violations a top priority. The exhaustive publicity of illegal insider trading cases sends a strong message that no one is outside its radar. A spokesperson for the Division of Enforcement said that the SEC is aggressively rooting out and identifying hard-to-detect insider trading by connecting patterns of trading to sources of material nonpublic information, whether those sources are law firms, banks or others with a duty to keep the information confidential. Prosecutors add that illegal trading is now easier to prove as direct evidence of fraudulent intent can be obtained through wiretaps, e-mails, text messages, social media contacts, etc. And that evidence also is useful to convince co-conspirators to turn on each other and provide even more substantial proof of fraud. Going after the violators is critical because their actions hurt individual investors and undermine public confidence that allows firms to raise money in the capital markets.

Individuals who are convicted of criminal insider trading face prison terms (the Sarbanes-Oxley Act extended the maximum length of sentences) and fines in addition to civil penalties, which can be triple the realized profit or the loss avoided. Violators also may be charged with mail and wire frauds and possibly with tax evasion and obstruction of justice. Further consequences include being barred from serving as executives or directors of public companies and being named as defendants in multi-million dollar lawsuits. Corporations are subject to penalties for failure to establish compliance programs and for failure to ensure reasonable efforts to prevent violations under the theory of “controlling person” liability. Even if an insider trading investigation does not result in formal charges, the company’s reputation may suffer from the stigma and adverse publicity.

|Educational Series|

U.K. Bribery Act now slated to take effect July 1, 2011

After receiving widespread criticism for the lack of guidance and compliance clarification, the U.K. Bribery Act of 2010 (Bribery Act) originally scheduled for implementation in April 2011, is now set to take effect July 1, 2011. The act’s jurisdiction extends to commercial organizations incorporated or formed in the U.K. or “which carr

[y] on a business or a part of a business in the U.K. irrespective of the place of incorporation or formation.” Determination of such existence will be made by the U.K. courts and will require “a demonstrable business presence.” The official guide states that an organization will not be deemed to be carrying on a business in the U.K. merely by virtue of having its securities listed on the London Stock Exchange or by having a U.K. subsidiary.

Unlike the anti-bribery provisions of the U.S. Foreign Corrupt Practices Act (FCPA), which focus primarily on corruption involving non-U.S. government officials, the Bribery Act widens its scope to prohibit domestic and international bribery across both private and public sectors. And while the FCPA allows exceptions for facilitation payments (generally small payments to lower-level officials for “routine government actions,”) the Bribery Act does not. These payments were illegal under the previous legislation and the common law, but the difference under the Bribery Act is that non-U.K. organizations are broadly subjected to these restrictions for the first time.

The Bribery Act specifically criminalizes the offering, promising or giving a bribe (active bribery) and the requesting, agreeing to receive or accepting a bribe (passive bribery) to obtain or retain business or secure a financial or other advantage. It also contains a provision whereby an organization that fails to prevent bribery by anyone associated with the organization can be charged under the Bribery Act unless it can establish the defense of having implemented preventive “adequate procedures.” The official guide recommends the following six principles as foundation for developing “adequate procedures” to prevent bribery:

Proportionality – Actions should be proportionate to the risk, nature, size and complexity of the organization.
Top-level Commitment – Board of directors, owners, officers or equivalent top level- management should establish and promote a culture where bribery is never acceptable and be committed to preventing bribery, both within the organization and with anyone associated with the organization externally.
Risk Assessment – Various risk exposures, both internal and external, such as country of operation, business sector, types of transaction, new markets, and business partnerships should be evaluated and documented on an ongoing basis.
Due Diligence – Proportionate, risk-based approach to due diligence procedures assessing existing and proposed relationships should be taken to ensure trustworthy associations and mitigate identified bribery risks.
Communication – Appropriate channels of communication, awareness and training, both internal and external, on anti-bribery policies and procedures should be implemented and evaluated on a regular basis.
Monitoring and Review – Anti-bribery policies and procedures should be monitored on an ongoing basis and amended as quickly as possible when activities and risks change.

The penalties for violating the Bribery Act are severe, with individuals facing up to 10 years in prison and organizations facing unlimited fines. Violations also may result in damaging collateral consequences such as director disqualification, ineligibility for public contracts, and asset confiscation.

|Educational Series, International, Legislation|

Investment advisers miss deadline for filing new “plain English” ADV Part 2

For most investment advisers, the deadline for preparing and submitting the new Form ADV Part 2 was March 31, 2011, and many missed it, according to industry sources. All investment advisers registered with the SEC are mandated to file the new Form ADV Part 2 or disclosure brochure within 90 days of their fiscal year end. For the majority, the fiscal year ends on December 31, which means that the new form should have been filed by March 31, 2011. Most state securities regulators have ratified similar requirements.

Securities lawyers indicate that investment advisers who missed the filing deadline are likely in violation of several investment advisory rules, and may be subjected to possible actions by the regulators, ranging from warnings and fines to revocation of registration. At a minimum, a failure to submit the new form may flag the adviser as lacking strong compliance controls and requiring heightened scrutiny.

The new form rulings, adopted by the SEC in October 2010, required 18 sections on fees, soft-dollar pay arrangements, investment strategies and disciplinary histories, along with a supplement detailing each adviser’s background. An SEC spokesperson said that the changes “will allow clients access to information about advisers of a wholly different character and quality than was available under the previous regime. It will enable investors to better evaluate their current advisers, or comparison-shop for an adviser that best serves a particular need. Most significantly, this disclosure may result in advisers modifying their business practices and compensation policies which may pose conflicts, in ways that better serve the interests of the clients.” For more information, see http://www.sec.gov/answers/formadv.htm.

|Educational Series, Legislation|

FTC and CFTC will share information on energy investigations

The Federal Trade Commission (FTC) and the Commodity Futures Trading Commission (CFTC) announced yesterday that they entered into a Memorandum of Understanding (MOU) to share non-public information on investigations being conducted by the agencies, including investigations into the oil and gasoline markets. The agreement will help the FTC enforce its petroleum market manipulation rule, which prohibits fraudulent manipulation of U.S. petroleum markets. The information sharing also will assist the CFTC in exercising its authority in the oil markets.

Both the FTC and CFTC can take legal actions in connection with fraud-based manipulation of the petroleum markets, but the CFTC has exclusive jurisdiction to regulate exchanges, clearing organizations and intermediaries in the U.S. futures industry. This MOU will further facilitate information sharing on regulatory issues of common interest.

The MOU also directs the FTC and CFTC to ensure that the confidentiality of the non-public information is maintained, and provides that the agreement does not modify the agencies’ current abilities, responsibilities, or obligations to comply with existing laws or regulations, including the FTC’s confidentiality mandates under the pre-merger laws.

|Criminal Activity, Educational Series|

China’s bribery law amendment resembles a version of the FCPA

In February 2011, the People’s Republic of China (PRC) legislature, among 49 amendments, passed Amendment No. 8 to Article 164, which criminalizes the payment of bribes to non-PRC government officials and to international public organizations. Legal experts say that that the passing of this amendment is the PRC’s effort to comply with the United Nations Convention Against Corruption to which the PRC is a signatory. Although no interpretive guidance has been issued, the amendment resembles an early version of the Foreign Corrupt Practices Act (FCPA).

Before the amendment was passed, the PRC prohibited bribery of PRC officials and provided for civil and criminal liability for making commercial bribes to private parties for the purpose of obtaining illegitimate benefits, but had no specific law that criminalized the payment of bribes to non-PRC officials. Effective May 1, 2011, the amendment adds the following clause to Article 164 of the PRC Criminal Law:

“Whoever, for the purpose of seeking illegitimate commercial benefit, gives property to any foreign public official or official of an international public organization, shall be punished in accordance with the provisions of (Article 164.)”

Article 164 states that “if the payer is an individual, depending on the value of the bribes, he/she is subject to imprisonment for up to 10 years. If the payer is an entity, criminal penalties will be imposed against the violating entity and the supervisor chiefly responsible; other directly responsible personnel also may face imprisonment of up to 10 years. Penalties may be reduced or waived if the violating individual or entity discloses the crime before being charged.”

According to legal experts, the PRC Criminal Law applies to all PRC citizens (wherever located); all natural persons in the PRC regardless of nationality; and all companies, enterprises, and institutions organized under PRC law. Thus, in addition to PRC domestic companies, any joint venture or other business entity formed under PRC law, including ones involving non-PRC companies, may be criminally liable under the amendment. Non-PRC companies with representative offices in the PRC may also be subject to the provisions of the amendment.

|Educational Series, Legislation|

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