CFPOA (Bribery) Enforcement Action on the Rise

July 8, 2011

 

Risk Management will be a particular challenge based on the “ground level” exposures and the difficulty identifying and controlling risk that is created by a vast number of activities conducted by a large number of people with significant geographic and supervisory separation.

Therefore, based on single aggregate limits, and considerable number of parties and matters insured under a typical D&O insurance policy, a full understanding of how and where limits are sharing should be a top priority for D&O buyers.

In past blog posts I have been critical of Canadian regulation and enforcement of Bribery. But, I can now suggest there has been an extraordinary increase in Canadian corporate bribery enforcement. I am not suggesting the alarm bells should be raised, as the number of cases has gone from one to two (two to three if you include individuals), and I am sure that 99.something % of Canadians (and nearing that number of politicians) could not tell you what CFPOA stands for. This is not as easily said of FCPA. The Foreign Corrupt Practices Act, here, in the US has seen significant press over the last year. This should be no surprise, the US government provides a website listing enforcement actions in chronological order (there are 14 actions under ‘A’ alone), a dedicated email address for reporting violations, and transparency on settlements/judgments (which have been in the hundreds of millions of dollars.)

I wouldn’t be worried about wiretaps and agents posing as foreign government officials……, if your organization does absolutely no business (purchasing or selling, travel or expenses) outside of Canada. We are not known for aggressively fighting white collar (I prefer the term “financial”) crime. However, if you do any business outside of Canada, perhaps some risk identification and loss control is a good idea.

CFPOA stands for The Corruption of Foreign Public Officials Act. It can be found on a Canadian government site, here, but there is no “enforcement” section, or any obvious “report bribery or corruption” contact information. I don’t even recommend a search of Canadian government information regarding corruption or bribery, as it is a time wasting and frustrating exercise in ineffective links and extraordinarily outdated reports. Prior to this very recent case, I could find reference to only two criminal prosecutions in Canada since the 1999 inception the act and the only one with a dollar figure was for $25,000.

In June, enforcement of bribery in Canada actually made publication. I would like to say that it made headlines, but the only page-one google hits for “bribery enforcement in Canada” were law firm briefs and low profile blogs.

The recent case is Niko Resources Ltd., here, which is based on bribery of a junior energy minister in Bangladesh. As per the Reuters report by Scott Haggett, “the charges stemmed from providing a car worth $191,000 and a $5,000 trip”, but the fine is $8,260,000 plus a victim surcharge of 15% for a total $9.5 million fine. This does not include legal costs and it does not contemplate the reputational damage to Niko, or their 3.2% fall in market cap of their shares (which equates to more than $120 million.) Class action securities claims have been started for less.

A CFPOA settlement in this range is material to even the biggest Canadian corporations and it obvious that the intent is to send a warning signal to all Canadian companies, directors and senior management (and to try to get the Government out of the news for being complete ineffective on bribery and corruption.)

Here is the corporate governance, risk management and insurance spin. For this we will have to look outside of Canada because, in the article here at Canadian Lawyer Magazine by Andi Balla, it has been expressed by the head of the RCMP unit in charge of investigation corruption of foreign officials that “Canadian legislation is very short and hard to interpret.”

Based on the US experience with FCPA, and the very recent UK Bribery Act, the issue of Bribery will receive increased focus as a material Corporate Governance, Risk Management and Compliance responsibility. Risk Management will be a particular challenge based on the “ground level” exposures and the difficulty identifying and controlling risk that is created by a vast number of activities conducted by a large number of people with significant geographic and supervisory separation.

Like most other corporate risks, good loss control will come from establishing, communicating, enforcing and monitoring policies and procedures. But identifying, qualifying and quantifying risk in order develop specific risk based policies and procedures is much easier (not to mention quicker) to say than do.

The U.K. Ministry of Justice, regarding the new U.K. Bribery Act (took effect July 1, 2011), here, has provided some Guidance, here, to their legislation. But enacting policies and procedures is further complicated by the vague language of the official guidance which uses phrases like “extremely unlikely to engage Section 1” (the section prohibiting Active and Passive bribery), and introduces the “reasonable person” test and “common sense approach”. One area that makes it difficult to define or identify risk is the “associated persons” language which is not easily defined and includes any person or entity who “performs services” for the company. Therefore, direct and even indirect contractors could create a risk of liability for the corporation.

Other concerns with the U.K. guidance is that many terms are not defined. One such term is “close connection”, because this close connection to the U.K. could apply to the person committing the offence, or to place of incorporation, or to the location of the consenting senior officers. Another important term “carry on business”, because the parent company or even a subsidiary entity does not have to be incorporated in the U.K. in order to be responsible under the Act.

Directors of affected companies will to have look at the “relative ‘value’ of the spend” in every foreign business dealing and determine its ‘proximity’ to a pending business deal in order to identify activities that generate risk. They will then have to prioritize which activities could become the subject of scrutiny under the Act and direct resources accordingly.

The insurance response has yet to be determined. Some ideas are presented by Anjali Das, a partner in the Chicago office of the Wilson Elser law firm, are published in The D&O Diary Blog, here.

Insurance underwriters will eventually be requesting copies of Anti-Bribery policies and procedures, but that has not started (in Canada) and we hope to provide warning of any such change.

Directors, if not already, will soon be asking their General Counsel, CFO, Corporate Secretary, or whoever else is their go-to-person on personal liability and directors’ and officers’ liability insurance (D&O), about the potential response of their D&O policy to a CFPOA investigation. Since there are many dozens of different D&O policy wording and hundreds of endorsements in current use in Canada, there is no one-size-fits-all answer to this question. Your current in force policy wording needs to be reviewed. I suggest asking for an electronic searchable version from your insurance broker and searching for the term “fine”. If you are attempting to find the answer in paper form I recommend starting from the last endorsement and working backward. It is common for large publicly-traded companies to have more than 20 endorsements on their D&O policy, changing a good portion of the base policy wording. You will likely see a “fines and penalties” exclusion (unfortunately not in the exclusion section,) hidden in the definition of Loss. However, there may be a ‘carve-back’ (and exception to the exclusion) for defence costs.

Before you do anything regarding affirmative insurance coverage for an CFPOA action, an examination of priorities is warranted. Meaning, what do all of the Insureds, or at least Classes of Insureds, want the policy to do? I have not seen a CFPOA exclusion used in Canada, and Canadian underwriters are not likely to take a knee-jerk reaction to the Niko CFPOA enforcement action. I have also not seen any specific CFPOA endorsements in the Canadian marketplace, but I am sure they are in the works. But, the “broadening” of coverage to include Loss based on CFPOA actions may not be in the best interest of all Insureds. There is usually only one limit of liability available and it is shared by every director, officer, employee and the corporate entity (including every subsidiary) for every individual allegation, investigation and lawsuit. Also, it is common that in the middle of a potentially large group of claims (or circumstances which could lead to a claim) policy limits are not renewed (refreshed) at the expiry of the policy and therefore the one limit of liability may be the only limit available for all of these parties and matters for many years.

Therefore, based on single aggregate limits, and considerable number of parties and matters insured under a typical D&O insurance policy, a full understanding of how and where limits are sharing should be a top priority for D&O buyers.

I try not to subject my readers to 2,000 words in a post, but this does not give the corporate governance, risk management and insurance spin the detail it deserves. Therefore, if you would like more details in these areas, or if you would like help understanding your D&O policy and its potential triggers (positive and negative) regarding CFPOA enforcement, notice obligations or risk of limit exhaustion, please don’t hesitate to call me directly.

Greg Shields is a D&O, Professional Liability and Crime insurance specialist and a Partner at the University and Dundas (Toronto) branch of Mitchell Sandham Insurance Services. He can be reached at gshields@mitchellsandham.com,  416 862-5626, or Skype at risk.first. And more details of risk and loss control can be found on the Mitchell Sandham blog at http://mitchellsandham.wordpress.com/

CAUTION: This article does not constitute a legal opinion or insurance advice and must not be construed as such. It is important to always consult a registered and truly independent insurance broker and a lawyer who is a member of the Bar or Law Society of the relevant jurisdiction with regard to this material before making any insurance or legal decisions. All material is copyrighted by Mitchell Sandham Inc. and may not be reproduced in any form for commercial purposes without the express written consent of Mitchell Sandham Inc. Anyone seeking to link this document from any external website must receive the consent of Mitchell Sandham Inc. by sending an e-mail to gshields@mitchellsandham.com.


What is the Direction of Canadian Corporate Fraud?

June 23, 2011

 

Interesting article on Corporate Fraud and Executive Compensation available, here, at Marketwatch.

I will let you read it, but the Greg’s notes on it, 1) “97% of companies on the S&P 500 Index pay incentive compensation to executives even when the company is underperforming its peers”, and 2) “FBI Director Robert Mueller recently told Congress that the FBI had 667 ongoing probes into corporate fraud and 1,700 open cases of securities fraud.”

In case the authors are correct in their observation that crime is not down we are just numb to it, why don’t we do a quick “lest we forget” and recount: Bernard Madoff, Jeffrey Skilling, Kenneth Lay, Dennis Kozlowski, John Rigas, Joe Nacchio, James McDermott Jr., Sam Waksal, Sam Israel, Bernie Ebbers (see the Time article, here, called Top 10 Crooked CEOs).

Now, just in case you are like many Canadians who have allowed themself to be lulled into a false sense of security, based on a lack of fraud enforcement in Canada and extraordinarly little media coverage attention to corporate fraud and a Canadian moral superiority complex, here is the Canadian content.

Please keep in mind that thanks to the absence of criminal enforcement in Canada, some of these cases should be classified as securities concerns and not allegations of fraud against any individuals. Based on the low level of media coverage, you may never have heard about these incidents – Barry Landen (here, Penna estate fraud, not huge, but very sad), Peter Sbaraglia and Robert Mander (here, accused by OSC of $40 million fraud), Milowe Brost and Gary Sorenson (here, Brost was jailed this year for forgery, but accused with Sorenson of a Ponzi scheme which could reach $400 million), Wolfgang Stolzenberg (here, accused of a $1 billion fraud in the Castors Holdings case), Ronald Weinberg, Hasanain Panju, and Lino Pasquale Matteo and John Xanthoudakis (here, facing 36 charges including fraud and publishing a false prospectus in the Cinar case, with Xanthoudakis also being part of Norshield (here, $215 million alleged fraud) and Matteo also part of Mount Real (here), Earl Jones (here, surrendered and pleaded guilty (so I don’t know how quick I would be to count that as a win for our justice system) to two fraud charges related to a $50 million Ponzi scheme that ran from 1982 to 2009),  Ian Thow (here, originally accused of a $32 million Ponzi fraud but pleaded guilty on amounts totaling $8 million and sentenced to 9 years). There are many more, but I have run out of time, and hopefully opened a few eyes.

I have decided to avoid pure Canadian class actions securities claims due to the risk of suggesting fraud in any of these cases, and/or the risk of reprisal for any such inference. But I can assure you that we have had more than our share of securities related games played in Canada resulting in massive losses suffered by Canadian investors.

Now the risk management spin. There are many ways for investors, fund managers, investment advisors, directors and officers to protect yourself.

  1. If things are going absolutely great and you have no complaints or concerns about your current position: pull your head out of the sand and start your own investigation immediately. Take two, three, four hours, pull out a recent prospectus, annual report or one of those intentionally complicated sell sheets, and read the fine print, notes and management assumptions. If it does not make any sense, read it again. If it still doesn’t make any sense, start asking questions and preface each question with “pretend you are answering this question like I am your mother or your five year old” (keep in mind that some of the people above did actually defraud their mother);
  2. If a few things are bugging you but you can’t put your finger on it, see point 1 above.
  3. If you have not invested or accepted the board position, see the points above;
  4. Request evidence of Fidelity/Crime insurance. You can’t rely on this in place of the points above, but at least you will get some comfort that the company and the individuals have been vetted by a large financial institution who shares a financial exposure to the company. Then take the evidence of insurance, Google the name of the insurer, call the company from the info online, not the one on the evidence of insurance, and confirm the company and policy actually exist. This four minutes will be more due diligence than most stakeholders perform, and it will improve your comfort level with your risk;
  5. Repeat point 4 for Directors’ and Officers’ liability insurance (D&O) and Professional Liability insurance (E&O). Many, but not all, fraudsters avoid any additional audit, review or questions, (unfortunately they don’t seem to be subject to much of that from regulators, auditors, lawyers, suppliers or investors), so they reject any suggestion of insurance coverage as a waste of money;
  6. Find the references to a contract, sales agreement, independent third party review, or other “feel good statement” attributed to any third party in any company document, pick two (or if you are really diligent, three) and take four minutes to Google the name, call the company or person from the online information, and confirm the details of the pronouncement;
  7. Read the Ian Thow link above and the victim statements detailed in the sentencing decision, and be thankful they allowed their tragic and embarrassing stories to be publicized so that we can learn without having to suffer more loss that we already have (yes, every mutual fund holder, pensioner, bank client and insurance buyer pays a significant amount for fraud losses every year.) It could be the most valuable 20 minutes of your life.

With prosecutions being rare and convictions (without a guilty plea) being almost non-existent, one can only surmise the actual number for frauds that are currently being perpetrated in Canada.

So what is the direction of Canadian corporate (aka, white collar, or financial) fraud? It doesn’t matter, there is plenty of it right now to warrant concern and the 4 hours and 44 minutes of time suggested above.

Greg Shields is a D&O, Professional Liability and Crime insurance specialist and a Partner at the University and Dundas (Toronto) branch of Mitchell Sandham Insurance Services. He can be reached at gshields@mitchellsandham.com,  416 862-5626, or Skype at risk.first. And more details of risk and loss control can be found on the Mitchell Sandham blog at http://mitchellsandham.wordpress.com/

CAUTION: This article does not constitute a legal opinion or insurance advice and must not be construed as such. It is important to always consult a registered and truly independent insurance broker and a lawyer who is a member of the Bar or Law Society of the relevant jurisdiction with regard to this material before making any insurance or legal decisions. All material is copyrighted by Mitchell Sandham Inc. and may not be reproduced in any form for commercial purposes without the express written consent of Mitchell Sandham Inc. Anyone seeking to link this document from any external website must receive the consent of Mitchell Sandham Inc. by sending an e-mail to gshields@mitchellsandham.com.


Crime / Fidelity / Bond / 3D / Employee Theft / Financial Institution Bond / Fraud Insurance

July 9, 2010

Denial of Crime Coverage for Misrepresentation

Like most types of insurance coverage there can be many names within the same family of insurance policies. I will use them indiscriminately in this post, because it helps with Search Engine Optimization.

There are also a number of terms directly associated with the Bond, including but not limited to, ‘material non-disclosure’,  omission, concealment, misrepresentation, ‘incorrect statement of material fact’, and ‘false information’, and these terms are used with respect to the application for insurance that forms part of the 3D policy (Dishonesty, Disappearance, Destruction), and for the grounds for rescission of the Fidelity policy.

Denial of coverage by way of Cancellation ab initio (from the beginning) based on alleged misrepresentation in the application for Fraud insurance is far too common in Canada. There are many precedent setting cases and many more unknown situations not determined in court. The result can be catastrophic for the insured corporation, and for the individual directors and officers who had no knowledge of or involvement in the alleged misrepresentation.

Most Crime insurance applications require the signature of the Chairman and the CEO, or next highest person if the Chm and CEO are the same person. The concern here is that alleged misrep by the highest executives of the firm will at minimum fall within American jurisprudence which follows the “sole representative” doctrine, and therefore the knowledge of such will be imputed to the principal.

However, if the board of a corporation adopted the policy to select an independent committee to review the insurance application and have a fully independent director sign the application (in addition to the executive , because the underwriter might not accept an application signed only by a non-employee of the firm), it could improve the chances that a misrep by any of the signers would fall within the exception to the principal / agent rule because the fraud would have been perpetrated on the principal not on the Insurer (see. Bowstead on The Law of Agency, 15th ed. (Toronto: Carswell, 1985), p. 414, states that the presumption that knowledge will be passed on to the principal may be nullified by proof that the agent was defrauding the principal in that transaction.) They can assert that misrep by the executive in the application was the intent to further their fraud against the principal, especially in a regulated industry where the purchase of a bond is mandatory, not optional, and therefore more difficult for the insurer to suggest the misrep in the application for the FIB by the allegedly fraudulent executive was an obvious attempt to induce the insurer to provide a policy and perpetrate a fraud against the insurer.

There is also inconsistency between insurers with respect to the questions in their applications. Some applications do not specifically ask “are you aware of any claims or potential claims”,  but they will rely on the representations regarding ‘past losses’ (whether or not there was reimbursement), or previous cancellation of a Bond or denial of coverage. Therefore, the policy improvements or limitations may be found in the application.

Risk of rescission, cancellation, non-renewal or claim denial is present within any policy renewal, even if staying with the same insurer, because the application is completed each year. This risk increases if the buyer does not cover all their bases when changing insurance carriers, or when increasing the limits of liability. Some insurers will ask for an ‘increased limits warranty statement’ asking if the buyer knows of any situation which could lead to a claim under the proposed policy. Others will rely on the representations made in the renewal or new business application.

Current regulatory changes in Canada will significantly increase this risk because the Canadian Securities Administrators’ National Instrument 31-103 has come into effect, requiring many financial institutions (investment dealers, investment advisors and investment funds) to register or re-register, demanding new bond coverage in addition to working capital and other requirements. The result is companies buying new policies, where they never had before, or buying substantial increases in their limit (in some cases the $200,000 limit needs to be $10 million.)

The big concern is that poor explanation or negotiation of the new policies or new limits will not be known until a loss is discovered and a claim is made. Only at this point will you realize that your $5,000 premium savings cost you $5 million in insurance coverage.

For risk management techniques, loss control tools, and coverage enhancements, please feel free to call me directly.

Greg Shields, Partner, Mitchell Sandham Insurance Brokers, 416 862-5626, gshields@mitchellsandham.com

CAUTION: The information contained in the Mitchell Sandham website or blog does not constitute a legal opinion or insurance advice and must not be construed as such. It is important to always consult a truly ‘independent’ registered insurance broker and a lawyer who is a member of the Bar or Law Society of the relevant jurisdiction with regard to this material before making any insurance or legal decision. All material is copyrighted by Mitchell Sandham Inc. and may not be reproduced in any form for commercial purposes without the express written consent of Mitchell Sandham Inc. Anyone seeking to link this site from any external website must seek the consent of Mitchell Sandham Inc. by sending an e-mail to gshields@mitchellsandham.com.


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