The Analogic Settlement: What’s behind the issue of cooperation credit?

As reported by the FCPA Blog Tuesday, the SEC and DOJ entered into parallel resolutions with Analogic Corporation and Analogic’s wholly-owned Danish subsidiary BK Medical ApS in connection with violations of the books and records and accounting controls provisions of the FCPA.

The SEC’s cease-and-desist order against Analogic also extended to BK Medical’s former CFO, Lars Frost, for his alleged role in the misconduct.

BK Medical’s non-prosecution agreement (NPA) is the DOJ’s first corporate enforcement action under the recently announced pilot program, which provides prosecutorial guidance focused on promoting voluntary self-disclosures, cooperation, and remediation. This disposition comes on the heels of declinations the DOJ announced it had extended to Akamai Technologies, Inc. and Nortek, Inc. earlier this month in recognition of those companies’ voluntary self-disclosures, cooperation, and remediation.

Here, however, the DOJ noted that although BK Medical had self-disclosed and engaged in “extensive” remediation, its cooperation was not without issue:

the Company did not receive full cooperation credit because… the Company’s cooperation subsequent to its self-disclosure did not include disclosure of all relevant facts that it learned during the course of its internal investigation; specifically, the Company did not disclose information that was known to the Company and Analogic about the identities of a number of the state-owned entity end-users of the Company’s products, and about certain statements given by employees in the course of the internal investigation

Under the parameters of the DOJ’s pilot program, the DOJ can offer a company an up to 50% reduction below the Sentencing Guidelines for the fine amount. Here, BK Medical received a discount of 30% from the DOJ.

The pilot program guidelines and BK Medical’s NPA do not disclose how much credit was provide for the company’s self-disclosure and remediation versus its cooperation, but receiving only partial credit for cooperation may have potentially cost Analogic an additional 20% penalty reduction.

In an interesting intersection of the Yates Memo and the trend toward increased international cooperation we’ve seen in recent years, BK Medical’s NPA included a specific commitment by the company to “cooperate with foreign authorities that are prosecuting individuals involved in this matter.”

By contrast, the NPA between the DOJ and PTC Inc. from February 16, 2016 — the only other NPA to date this year — included only general commitments to cooperate with domestic and foreign authorities.

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Based on our review of the pleadings, additional noteworthy aspects about the facts in the Analogic/BK Medical case include:

• High-Level Accounting Failures: BK Medical’s former CFO, Lars Frost, a Danish citizen and resident, personally authorized approximately 150 conduit payments (including 10 while he was CFO) to unknown third parties, despite knowing that the payments violated BK Medical’s internal accounting controls.  Among other things, Frost submitted numerous false quarterly sub-certifications to Analogic and knew and failed to disclose the fake contracts requested by the distributor, despite his responsibility of completing quarterly checklists designed to identify unusual transactions for Analogic’s controller. Other unnamed employees were also involved in parts of the scheme, including in wire transfer authorizations and the manufacture of fake invoices. Of note, the DOJ characterized the books and records violations here as criminal, a charge it brings less frequently than the SEC because of the mens rea required for a criminal count.

• “Unknown” Third Parties: In total, BK Medical served as a conduit for at least 180 payments (totaling $16.1 million) to “unknown” third parties at the direction of its Russian distributor and 80 payments (totaling $3.8 million) to “unknown” third parties at the direction of distributors in Ghana, Israel, Kazakhstan, Ukraine and Vietnam. Significantly, BK Medical did not know or have a business relationship with the third parties to whom it was making payments, though evidence suggests that some of the money went to employees at state-run hospitals.

• Novel Distributor Overpayment Scheme to Generate Funds: The distributor scheme described in the pleadings is uncommon. BK Medical, acting at the direction of its Russian distributor, inflated the distributor’s invoices. Upon receiving the inflated distributor payment, however, BK Medical only reported receiving payment for the products at their standard prices on the company’s books and records, crediting the excess funds paid by the distributor to an accounts receivable account for the benefit of the distributor. BK would then redistribute these excess funds outside of its standard accounting system to unknown third parties designated by the distributor, including shell corporations in places such as Belize, the British Virgin Islands, Cyprus, and Seychelles, and to individuals in Russia. BK Medical complied with the directives from the distributor despite not knowing the purpose of the payments or the nature of the payees.  In two cases, BK Medical made payments to unknown third parties prior to receiving funds from the distributor.

• Conduct Flagged Twice over Ten Year Period without Being Stopped: In 2004 and 2008, a BK Medical executive and an Analogic executive, respectively, identified potential risks surrounding BK Medical’s use of distributors. In the first instance, BK Medical’s Vice President of Sales specifically discussed the purpose of the payments with the Russian distributor and memorialized the exchange in an e-mail to himself that suggested the payments were subsidizing the salaries of officials in the Russian market. No remedial action was taken, however, and the conduct continued unimpeded. In the second instance, a Senior Vice President at Analogic executive identified the risk posed by BK Medical’s business model and recommended the company implement an FCPA training program and create an official process for validating that distribution partners did not (and were not likely to) engage in prohibited behavior. Analogic acted on part of the recommendation, providing a business ethics and FCPA compliance training to BK Medical, but took no further steps verify compliance by its distributors. It was not until 2011 that Analogic flagged the distributor scheme, discontinued the distributor payments, conducted an internal investigation, and self-disclosed the misconduct to U.S. enforcement authorities.

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Ann Klibaner Sultan is a Senior Associate with Miller & Chevalier’s International department. Her practice focuses on international corporate compliance and white collar defense related primarily to the FCPA.

Marc Alain Bohn is a Contributing Editor of the FCPA Blog and an editor of Miller & Chevalier’s FCPA Spring Review 2016. He’ll be a speaker at the FCPA Blog NYC Conference 2016.