alerts & publications
FCPA Investigation into RINO International CorporationJanuary 1, 0001
RINO International Corporation (“RINO”) recently disclosed in a public filing with the Securities and Exchange Commission (the “SEC”) that it is currently the subject of a formal investigation by the SEC regarding the company’s financial reporting and compliance with the Foreign Corrupt Practices Act (the “FCPA”). Although RINO is technically a Nevada corporation, all of its operating subsidiaries and affiliates are based in China. RINO was listed on NASDAQ on July 13, 2009, following a reverse merger between an existing U.S. company (Jade Mountain Corporation) and Innomind Group Limited. RINO provides environmental protection equipment for Chinese steel mills -- a sector dominated by state-owned firms. Many companies have run afoul of the FCPA through the conduct of their employees and subsidiaries in China. RINO’s disclosure marks the first published instance in which a wholly China-based company has been the target of an FCPA investigation.
Overview of the FCPA
The FCPA comprises two sets of rules: the “antibribery” provisions and the “accounting provisions.” Violations of the anti-bribery provisions of the FCPA involve (i) an act by a covered person or entity within the statute’s jurisdictional reach, (ii) in furtherance of an offer, payment, promise to pay, or authorization to pay anything of value, (iii) to a foreign official, (iv) corruptly, and (v) in order to obtain or retain business.1 Different jurisdictional requirements apply to different categories of defendants, based on the extent of their connections with the United States.
The “accounting” provisions apply only to “issuers” of securities registered on U.S. stock exchanges. Issuers are required to “make and keep books, records, and accounts, which, in reasonable details accurately and fairly reflect the transactions and dispositions of the assets of the issuer”2 and to “devise and maintain” an adequate system of internal accounting controls.3 Under current practice, issuers are also responsible for ensuring that their controlled subsidiaries and affiliates comply with the accounting provisions.
Both the U.S. Department of Justice and the Securities and Exchange Commission have jurisdiction to enforce the FCPA, although only the Justice Department can bring criminal charges. Both agencies frequently work together on FCPA matters.
(For more details on the FCPA, see the 2009 edition of the O’Melveny & Myers Foreign Corrupt Practices Act Handbook at http://www.omm.com/fcpahandbook/.)
Background of RINO and Its Disclosure of the FCPA Investigation
RINO disclosed the pending FCPA probe in a December 2, 2010 filing as follows:
“The company has been notified by the Staff of the Securities and Exchange Commission (the “SEC”) that it is conducting a formal investigation relating to the Company’s financial reporting and compliance with the Foreign Corrupt Practices Act for the period January 1, 2008 through the present. The Company is cooperating with the SEC’s investigation. It is not possible to predict the outcome of the investigation, including whether or when any proceedings might be initiated, when these matters may be resolved or what if any penalties or other remedies may be imposed.”
RINO did not disclose further details about the inquiry. On the same day, RINO announced that its shares were delisted from the NASDAQ exchange. In November 2010, a China-focused research firm, Muddy Waters, issued a report alleging that RINO had drastically overstated its revenues in U.S. filings and that its management was siphoning money from the company for personal use. This research may have triggered the SEC’s inquiry and the delisting of RINO’s shares. So far, it is unclear whether the SEC’s FCPA inquiry focuses on corporate governance issues under the “books and records” and “internal controls” provisions of the FCPA, or whether questions have also arisen under the “anti-bribery” provisions of the FCPA.
Applicable Jurisdiction of the FCPA
RINO’s disclosure demonstrates the breadth and complexity of the FCPA’s jurisdictional provisions.
First, issuers such as RINO are required not only to comply with the accounting provisions of the FCPA in their own internal operations, but also to cause their controlled subsidiaries (such as RINO’s Chinese operating companies) to comply. The SEC has frequently invoked the accounting provisions to hold issuers liable for the actions of their foreign subsidiaries regarding improper payments and promotional activities by alleging that the payments were not accurately and sufficiently recorded (in violation of the “books and records” provision) or that the issuer and its subsidiaries lacked reasonable controls to prevent, detect, or correct corrupt conduct (in violation of the “internal controls” provisions). These theories of liability allow the SEC to reach “commercial bribery” not involving personnel of governmental entities or state-owned enterprises, as well as bribery of foreign government officials where the jurisdictional requirements of the antibribery provisions are not clearly satisfied.
Second, issuers such as RINO are subject to the anti-bribery provisions of the FCPA. The antibribery provisions of the FCPA include several alternative jurisdictional provisions based on the nature of the connection between the United States and the defendant or the corrupt conduct.
- The antibribery rules apply to the worldwide conduct of (a) all U.S. citizens, permanent residents or other U.S. nationals (regardless of employer or location) and (b) all entities incorporated or organized under U.S. law, regardless of whether the corrupt conduct has any connection with the United States. For these defendants, nationality alone supports jurisdiction.
- The antibribery rules apply to the worldwide conduct of all other “issuers” of U.S. securities and all other entities with a principal place of business in the U.S., plus any officer, director, employee or agent of such issuers or entities, or shareholder acting on their behalf, provided that they make use of U.S. mail, telecommunications, or other instrumentality of interstate commerce in furtherance of the corrupt conduct. This requirement for a nexus with the U.S. is a low threshold, and can be satisfied with email and phone communications, use of U.S. bank accounts, and other minimal contacts. In several recent cases, U.S. authorities have pursued enforcement actions against individual foreign employees and agents of foreign issuers on the basis of minimal contacts with the U.S.
- The antibribery rules also apply to all other entities and individuals plus any officer, director, employee, agent, or shareholder acting on their behalf, to the extent that they make use of an instrumentality of interstate commerce while in the territory of the United States.
Unlike the accounting provisions, the anti-bribery provisions do not explicitly apply to the non-U.S. subsidiaries of issuers. In practice, however, U.S. enforcement authorities have aggressively enforced the anti-bribery provisions of the FCPA against conduct by non-U.S. subsidiaries (1) by characterizing the non-U.S. subsidiary as an “agent” of the parent issuer or (2) by finding that the non-U.S. subsidiary took some action “within the territory of the U.S.”, thus supporting jurisdiction.4 Nevertheless, U.S. enforcement authorities must still establish some nexus between the conduct of the non-U.S. subsidiary and the U.S.
A Chinese company that lists in the United States through an offshore listing vehicle (such as Cayman Islands or British Virgin Islands company) becomes a “foreign issuer” subject to the antibribery provisions with respect to corrupt conduct entailing some use of an instrumentality of interstate commerce in the U.S.
However, some Chinese companies listed in the U.S. may be more vulnerable to the jurisdictional reach of the antibribery provisions. In recent years, many Chinese companies, including RINO, have pursued of strategy of executing a reverse merger between their China operations and an existing U.S. shell company, which then becomes the listing vehicle. Consequently the “issuer” is then a U.S. company subject to worldwide jurisdiction under the antibribery provisions regardless of the extent of contacts with the United States. For example, the actions wholly within China of China-based directors, officers, and employees of the U.S. “shell” issuer may be attributed directly to the issuer itself, potentially making it easier to satisfy the jurisdictional requirements of the FCPA antibribery provisions.
As Chinese companies are increasingly listing shares on U.S. stock exchanges, they need to be prepared to handle the legal consequences that accompany such a listing, including the exposure to potential liabilities under the FCPA. Although no issuer incorporated in China have been prosecuted in the U.S. for FCPA violations so far, the SEC’s investigation of RINO signals the U.S. government’s willingness to enforce the FCPA against Chinese entities for conduct in China.
1. See 15 U.S.C. §§ 78dd-1, 78dd-2, 78dd-3
2. See 15 U.S.C. § 78m(b)(2)(A)
3. See 15 U.S.C. § 78m(b)(2)(B)
4. See 15 U.S.C. § 78dd-3
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