Companies fear litigation rise

There is nothing worse than a recession to show companies in the worst light possible. Not only are their balance sheets showing unhealthy returns, but regulators begin circling to uncover corporate wrongdoing. A recent survey shows that companies expect a rise in the number of potential legal battles they could face in the coming year.

Companies are bracing themselves for a rise in litigation risk with two in five (40 percent) businesses anticipating an increase in the number of legal disputes in the next 12 months, a recent survey has found. According to global law firm Fulbright & Jaworski International’s Litigation Trends Survey 2009, a quarter of firms believe that a key source of action may stem from regulatory non-compliance.

The larger the organisation, the more concerned it is about the possibility of facing more litigation in the year ahead, with more than half (52 percent) of companies with revenues of more than $1bn expecting to see a rise in disputes this year, compared with just six percent who expected to see fewer disputes during the next 12 months.

Businesses identified the economy as the principal reason they expect to see more litigation. Two-thirds of respondents (68 percent) said that the economic crisis had affected their organisation and management of litigation. In terms of the types of litigation seen by companies, a net increase was seen in matters concerning bankruptcy/insolvency (32 percent), contracts (27 percent) and regulatory matters (13 percent), among others, such as patents and labour/employment issues.

“An economic downturn of the type we are experiencing normally leads to an increase in litigation as regulators become more active, company accounts are scrutinised more carefully, laid-off employees head to court and businesses start proceedings to collect money owed,” said Chris Warren-Smith, partner and co-chair of Fulbright’s Global Litigation Practice Group. “Most telling about this year’s results is that very few companies across the board expect any decreases in any area of litigation.”

Perhaps unsurprisingly – given their role in the current financial crisis and how badly affected they are as a result of it – the financial services and insurance sectors topped the list of industries expecting an increase in litigation with 50 percent and 56 percent of respondents, respectively, saying they anticipated facing more disputes. Some have already come a cropper. In November, the UK’s financial regulator, the FSA, fined Swiss bank UBS £8m for systems and controls failures that enabled four employees to carry out unauthorised transactions using customer money on at least 39 accounts. The fine is the third largest ever levied by the regulator.

The unauthorised activity, which took place between January 2006 and December 2007 at UBS’ London-based wealth management business, only came to light when a whistleblower raised concerns internally. UBS employees had taken part in the trading of foreign exchange and precious metals using customer money without authorisation and allocated losses to customers’ accounts. An internal UBS investigation estimated that as many as 50 unauthorised transactions a day were taking place at the operation’s peak.

The FSA investigation found that UBS had failed to manage and control the key risks, and the level of risk, created by its international wealth management business model. The bank also failed to implement effective remedial measures in response to several warning signs from the internal audit function that suggested the business’ systems and controls were inadequate.

UBS agreed to settle at an early stage of the FSA’s investigation meaning it qualified for a 20 percent discount. It has also paid customers compensation in excess of $42m.

The survey highlights an increase of about 10 percent in the amount spent on litigation, excluding costs of settlement and judgement, from a median figure of $833,000 last year to $917,000 in 2009. Of the larger corporates ($1bn or more), just under half (45 percent) spent more than $5m on litigation, an increase of nine percent from 2008.

Regulatory issues remain a critical concern for companies, with about one in four (23 percent) surveyed citing regulatory issues amongst their top three to five types of legal concerns. This is understandable in light of the finding that a third (34 percent) of respondents surveyed have had a regulatory proceeding commenced against them in the past year and that eight percent of all companies surveyed reported a regulatory proceeding commenced against them worth more than $20m. The survey indicates that public companies are more likely to be the subject of regulatory proceedings than private companies.

During the past three years, roughly two in five (37 percent) respondents have spent more time on regulatory investigation requests or regulatory enforcement proceedings, either as a party or non-party, compared with just five percent who are spending less time. In terms of sectors, respondents from the insurance and energy industries both report significant increases in the amount of time spent addressing regulatory requests (53 percent and 47 percent increases, respectively).

In terms of overall regulatory activity, the US Department of Justice (DOJ) was the regulator most commonly cited by respondents (41 percent). The most frequently cited UK and EU regulators were the FSA (27 percent), followed by the UK Competition Commission (21 percent), the EU Commission (15 percent) and the Serious Fraud Office (SFO) (12 percent).

Lista Cannon, a report author and managing partner in Fulbright & Jaworski International’s London office, says that “the increased time spent on regulatory matters over the past three years undoubtedly reflects the increased complexity of regulatory issues and the growing confidence of regulators to use their full range of investigation and enforcement powers.”

She adds: “Another prominent feature is the increasing level of cross-border co-operation by regulators, who realise that international problems require a coordinated international solution.”

The law firm’s research also found that one in five (21 percent) of all respondents have been the subject of allegations by a whistleblower in the past three years, as was the case with the UBS complaint. Approximately three-quarters (73 percent) of these whistleblower allegations became the subject of an internal investigation, and 22 percent developed into a regulatory investigation. One in four companies believes that they may be subject to a lawsuit being brought by “whistleblowers” in their industry within the next 12 months.

Influence
But Cannon points out that “these whistleblowers are not necessarily employees in the company that is carrying out the potentially corrupt or wrongful conduct. They can be from competitor companies in the same industry sector, but have decided to blow the whistle on a rival firm, possibly as a way of seeking leniency for their own actions if they have also been involved or approached.”

Cannon says that the case of British Airways and Virgin operating a price-fixing cartel around fuel surcharges is a case in point. In  2007 the OFT made headlines by fining British Airways £121.5m after the airline admitted collusion in fixing the prices of fuel surcharges, while giving a “no-action letter” – essentially a pardon in exchange for information to encourage companies to inform on fellow operators – to Virgin Atlantic, which had colluded in the price-fixing arrangement on six occasions before blowing the whistle. The US Department of Justice fined the company a further $300m, the second largest fine ever dispensed at the time.

“The problem with this kind of deal is two-fold: both companies were involved in the anti-competitive arrangement and admitted that they were, but the one that admitted its part first escaped censure. Secondly, the prosecuting authorities were not obliged to take any action against any of the individuals – from either company – who may have been involved in the arrangement. Therefore, unless the companies involved took voluntary internal action against these individuals themselves, then these people are still working in the companies involved. This just isn’t good enough.”

Bribery and corruption are also major concerns to multinational firms. According to the report, 12 percent of all respondents said that they have engaged outside counsel to assist with a corruption or bribery investigation, while 16 percent of respondents said that they had made a decision not to do business in a country based on the perceived degree of local corruption in that country. “Bribery and corruption has increasingly become a live issue for many large firms. One has only to look at the recent allegations surrounding BAE Systems to see how damaging the negative publicity, as well as any punitive fines, can be,” says Cannon.

Over the past few years US regulators such as the DOJ and the SEC have increasingly turned their attention towards the “more questionable” activities of foreign companies, spurred on by complaints by US corporations that foreign firms are at a competitive advantage because they are rarely prosecuted for corrupt practices overseas by their own domestic regulators.

The legislation – known as the Foreign and Corrupt Practices Act (FCPA) – allows prosecutors to take action against such companies for corrupt practices, even though the corruption may be taking place in another country. Those firms that conduct business in the US are subject to scrutiny, along with those that use the services of firms and individuals based there.

The Act was created in 1977 after a 1970s investigation by the SEC found that over 400 US companies had made questionable or illegal payments in excess of $300m to foreign government officials, politicians, and political parties. During the 30 years since the Act was enacted, its scope has been extended with US prosecutors using it in a tenacious pursuit of corporate wrongdoing – in the US and abroad. US lawyers say that 1995 proved a milestone in terms of prosecution as advanced technology firm Lockheed paid a $25m fine for improper payments relating to contracts in Egypt and, for the first time, a businessman was sentenced to jail for violating the Act.

Due to the extra-territorial nature of the legislation – as well as its highly punitive measures – business advisers now warn that many UK companies and individuals could be in the firing line, and that many of them fail to appreciate the risk. According to a report published last year from KPMG Forensic, the fraud investigations arm of professional services firm KPMG, almost half (46 percent) of respondents that conduct business in the US either wrongly believe they are not subject to the FCPA or do not know whether they are subject to it. In addition, 56 percent of respondents who said they are subject to the FCPA did not have, or did not know whether they had, an FCPA compliance programme.

Experts agree that sanctions under the FCPA are potentially the toughest in the world. Under criminal prosecution, corporations and other business entities are subject to a fine of up to $2m while officers, directors, stockholders, employees, and agents are subject to a fine of up to $100,000 and imprisonment for up to five years.

Moreover, under the Alternative Fines Act, these fines may be up to twice the benefit that the defendant sought to obtain by making the corrupt payment. So, for example, if a company paid an official $10,000 to secure a $30m contract, then the SEC and DOJ can attempt to fine the company $60m. Furthermore, fines imposed on individuals may not be paid by their employer or principal.

The Act also affords a threat of civil action. The Attorney General – the government’s principal legal adviser – or the SEC may bring a civil action for a fine of up to $10,000 against any firm as well as any officer, director, employee, agent of a firm, or stockholder acting on behalf of the firm who violates the anti-bribery provisions.
And one has only to look at a recent joint SEC/Department of Justice investigation to see how punitive the act can be. On February 11, 2009 construction firm KBR (formerly Kellogg Brown & Root) and oil services firm Halliburton agreed to pay $177m in disgorgement to settle the SEC’s charges. At the same time, KBR agreed to pay a $402m fine to settle parallel criminal charges brought today by the US Department of Justice. The sanctions represent the largest combined settlement ever paid by US companies since the FCPA’s inception.

Kellogg Brown & Root LLC’s predecessor entities (Kellogg, Brown & Root, Inc. and The MW Kellogg Company) were members of a four-company joint venture that won construction contracts worth more than $6bn. In September 1998, Halliburton acquired Dresser Industries, Inc, the parent company of The MW Kellogg Company. The SEC alleges that beginning as early as 1994, members of the joint venture paid bribes to officials within the Nigerian government in order to obtain these contracts. The former CEO of the predecessor entities, Albert “Jack” Stanley, and others involved in the joint venture met with high-ranking Nigerian government officials and their representatives on at least four occasions to arrange the bribe payments. To conceal the illicit payments, the joint venture entered into sham contracts with two agents, one based in the UK and one based in Japan, to funnel money to Nigerian officials. In September 2008, Stanley pleaded guilty to bribery and related charges and entered into a settlement with the SEC.

“FCPA violations have been and will continue to be dealt with severely by the SEC and other law enforcement agencies,” said SEC chairman Mary L Schapiro. “Any company that seeks to put greed ahead of the law by making illegal payments to win business should beware that we are working vigorously across borders to detect and punish such illicit conduct.”

Antonia Chion, associate director of the SEC’s Division of Enforcement, added: “The SEC will not tolerate violations of the FCPA, regardless of the lengths to which public companies will go to structure their corrupt transactions to avoid detection. Multi-national companies should take heed that attempting to conceal bribes by funnelling them through intermediaries or offshore entities will not be successful.”

However, such cases can be few and far between. In the UK, for example, the prosecution record of enforcement agencies such as the SFO and the FSA are not exactly crowned in glory. In fact, lawyers point out that there have been relatively few successful convictions, compared to high profile (and highly expensive) acquittals. As a result, the government has decided to tip the balance in its favour. Under the latest government changes that came into effect as of October 31, 2009, companies and directors cleared of criminal charges are now barred from recovering their defence costs to curb taxpayer-funded legal spending. Lawyers warn that the changes could leave businesses and individuals acquitted of fraud, corporate manslaughter and other serious offences with bills ranging up to several million pounds.

Under the previous system, defendants found not guilty of criminal charges were compensated for “reasonable” legal defence costs. But the Ministry of Justice complained that public legal spending was vulnerable to high cost, one-off cases where privately funded defendants, often in circumstances where a company has been accused of a criminal offence, were acquitted. For example, engineering firm Balfour Beatty and Network Rail, the organisation that is responsible for the UK’s rain infrastructure, for example, recovered GBP21m in legal costs from the government’s central funds pool after being cleared of manslaughter charges in connection with the 2000 Hatfield rail crash, despite being fined a combined £11m for related health and safety failings.

Jonathan Grimes, a member of the London Solicitors Litigation Association (LSLA), an organisation that represents the interests of a wide range of civil litigators in London, and a solicitor at Kingsley Napley, says that the changes are likely to mean that companies will bear greater costs. “These changes mean that it is likely that there will be an effect on the cover that insurers are willing to offer and the cost of that cover since insurers will no longer be able to recover if their insured is acquitted or the case discontinued,” he says.

“A similar situation may arise for company directors, many of whom have the benefit of Directors’ & Officers’ (D&O) policies that cover their legal costs in respect of criminal action brought against them relating to their employment,” adds Grimes. “The range of potential criminal offences facing directors is already large with penalties becoming more severe. The Health and Safety (Offences) Act 2008, for example, will increase from a fine to a custodial penalty the maximum sentence available for certain health and safety breaches. These developments in the law – in combination with the potential for insurance cover to become unavailable or prohibitively expensive – may result in directors choosing more carefully the areas of corporate responsibility in which they are prepared to be involved,” he says.

Recent case studies
Fulbright & Jaworski International’s Litigation Trends Survey 2009 found that the US Department of Justice, the UK’s Financial Services Authority, the UK Competition Commission, the European Commission and the UK’s Serious Fraud Office are at the forefront of the world’s enforcement agencies that are actively looking to prosecute firms for wrongdoing. Below are some recent examples where they have taken firms to task:

BP
In October the US government imposed a record fine of $87.4m on oil giant BP for failing to fix hazards at its Texas City oil refinery in the wake of a disastrous explosion that killed 15 people four years earlier. The fine is four times higher than any previous penalty levied by the US workplace safety regulator, the Occupational Safety and Health Administration (OSHA), and it raises the possibility that a criminal prosecution of BP over the tragedy could be reopened.

An official investigation into the causes of the Texas City explosion concluded in 2007 that senior BP executives, under the company’s former chief executive, Lord Browne, had failed to act on red flags over safety at Texas City.
After the disaster, BP paid a $21.3m fine to OSHA and undertook a long list of improvements under the supervision of an independent safety auditor. But the authority has now announced that it had since issued 270 notifications to BP for failure to correct hazards and that it had found 439 new “willful violations”.

BP has immediately pledged to appeal against the fine, which it described as “disappointing”, and said that it “strongly disagrees” with OSHA’s findings.

Plastics firms cartel
A group of plastics companies was fined $173m by the European Commission for price-fixing and organising a market-sharing cartel. The case centres on information exchanged over heat stabilisers that are used in packaging, credit cards and bottles amongst other items.

Of the twenty-four businesses that belong to 10 different corporate groups that were punished, the larger firms include Akzo, Ciba and Elf Aquitaine. Competition Commissioner Neelie Kroes said companies must learn that “breaking the law does not pay”. She added that repeat offenders face stiffer penalties and that “elaborate precautions to cover their tracks did not prevent the Commission from revealing the full extent of their determined efforts to rip-off their customers”.

Mabey & Johnson
In September specialist bridge-building firm Mabey & Johnson was ordered to pay a total of £6.6m in fines, repayments and prosecution costs for corruption and breaching UN sanctions.

The fine follows the company’s guilty plea at Westminster Magistrates Court in July on charges of paying bribes in Jamaica, Ghana and Iraq. The successful prosecution was the first of its kind against a UK company operating overseas. Since the spring of 2008, five company directors have stepped down. A new management team has been appointed and extensive training has taken place throughout the organisation. An SFO approved independent monitor has also been appointed to report on the company’s ethical compliance to both the Mabey & Johnson board and the SFO.

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