FCPA and Esquenazi: if it walks like a duck...
July 2014 | SPECIAL REPORT: WHITE-COLLAR CRIME
Financier Worldwide Magazine
On 16 May 2014, the Court of Appeals for the Eleventh Circuit became the first federal appellate court to weigh in on the definition ‘instrumentality’ under the Foreign Corrupt Practices Act (FCPA). In that case – U.S. v. Esquenazi – the court held that to determine whether an entity is an instrumentality of a foreign government, the court must take a functional approach and look to “whether that foreign government considers the entity to be performing a government[al] function”. The anti-bribery and books and records provisions of the FCPA apply to payments made to corruptly influence foreign officials. As used in the FCPA, the definition of ‘foreign official’, includes both real persons (e.g., ministers, agency heads), as well as instrumentalities. Therefore, improper payments made to an instrumentality of a foreign government (e.g., a state-owned hospital or a physician employed in a state-owned or run hospital) can trigger FCPA liability in the same way as bribes paid directly to a public minister or other official. The Esqenazi decision is the first decision in which a circuit court has defined ‘instrumentality’ and could have far-reaching implications in district courts across the US, as well as on the way companies do business in foreign jurisdictions.
The FCPA states, “It shall be unlawful for any domestic concern… to make use of the mails or any means… of interstate commerce corruptly in furtherance” of a bribe to a “foreign official” for the purpose of “influencing any act or decision of such foreign official…in order to obtain or retain business”. Although the statute does define ‘foreign official’ as “any officer or employee of a foreign government or any department, agency, or instrumentality thereof”, it is silent as to what constitutes an ‘instrumentality’. Prior to the Esquenazi case, it was unclear whether an ‘instrumentality’ was limited to entities performing core governmental functions, or if it encompassed a broader category of third parties – which is ultimately the position asserted by the Department of Justice (DOJ) in its resource guide to the FCPA.
At issue in Esquenzi was the interpretation of the term ‘instrumentality’ as it applied to Joel Esquenazi and Carlos Rodriquez, co-owners of Terra Telecommunications (Terra), a Florida company that purchased phone time from foreign companies and resold it in the US market. Esquenzi and Rodriquez were convicted at trial for violating the FCPA by bribing Robert Antoine, the Director of International Relations of Telecommunications D’Haiti, S.A.M. (Teleco), in order to reduce bills owed to Teleco for minutes Terra had bought from Teleco. The corrupt payments at issue in the case – over $800,000 – were funnelled through various shell companies before reaching the officials at Teleco.
The district court found that Teleco was an ‘instrumentality’ of the Haitian government, and thus a ‘foreign official’. The district court found that several factors weighed in favour of finding Teleco to be an instrumentality: first, it was owned by the Banque de la Republique d’Haiti, the central bank of Haiti; and second, it had been given significant tax advantages, as well as a telecommunications monopoly by the Haitian government. Finally, Haiti’s president appointed top executives in Teleco pursuant to an executive order, further evidencing the government’s role in Teleco’s operations. Based on the improper payments at issue in the case, Esquenazi received a 15 year sentence and Rodriquez received a seven year sentence. The Eleventh Circuit agreed that Teleco was an instrumentality, largely relying on the factors laid out by the lower court.
On appeal, Esquenazi and Rodriguez argued that only an actual part of the government can be an instrumentality, urging the court to adopt a narrow definition of ‘instrumentality’. The Eleventh Circuit disagreed stating “A government-controlled entity [that] provides a commercial service does not automatically mean it is not an instrumentality.” The court went on to define instrumentality as “[a]n entity controlled by the government of a foreign country that performs a function the controlling government treats as its own”. The court emphasised that this was a factual inquiry.
The court broke down its definition into two inquiries: first, did the government control the entity; and second, did the entity perform a function the government treated as its own? The court, referring to commentary from the Organisation for Economic Cooperation and Development’s Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (OECD Convention) that the US ratified in 1998, provided a non-exhaustive list of factors to aid in deciding the two inquiries.
To determine whether a foreign government controlled an entity, relevant factors include: (i) the formal designation of the entity by the state; (ii) whether the government held a majority interest in the company; (iii) the government’s ability to hire and fire principal agents of the company; (iv) whether the entity’s profits were sent to the government; and (v) the level of support the government would provide if the entity failed to break even. To determine the second element, whether the entity performs a function the government treats as its own, relevant factors to consider are: (i) whether the entity enjoys a monopoly; (ii) whether the government subsidises costs; (iii) whether the services are provided to the public at large; and (iv) whether the public and the government believe the entity is performing a government function.
Interestingly, the definition of instrumentality provided by the court is closely aligned with the definition provided by the DOJ and the Securities Exchange Commission (SEC) in its guide to the FCPA. The guide emphasises that the definition of ‘instrumentality’ is broad and includes state owned or state controlled entities. Many of the factors listed by the Eleventh Circuit are identical to the relevant factors listed by the DOJ and SEC. Although the Eleventh Circuit embraced the government’s general position on the definition of ‘instrumentality’, it did not embrace the idea that all government owned entities providing a service constituted an instrumentality. For example, many Chinese companies operate essentially independently from the government, even though they are owned by the government. By not embracing the broadest possible approach, the court has attempted to place at least some limits on how far the FCPA can reach. Despite this, the government’s prosecution tactics probably will not change – it has already been functionally using the definition of ‘instrumentality’ that was adopted in the Eleventh Circuit in prosecuting FCPA cases.
It is important to remember that the Eleventh Circuit stated, “We believe Teleco would qualify as a Haitian instrumentality under almost any definition we could craft”. This is in large part attributable to the cumulative nature of the factors noted above on the court’s decision, as well as to the longstanding involvement by the government in Teleco’s operations. For the Eleventh Circuit, the application was straightforward and the facts weighed heavily in favour of the government’s case. The outcome may be different in more factually complicated cases where the government does not own the majority of an entity, or the company’s ties to the government are weaker than in the Esquenazi case. It is also unclear if certain factors may weigh more heavily than others, given that the court spent little time applying the factors laid out to the facts of the case.
Another issue that may arise in future cases is a business’s ability to determine whether an entity is a government instrumentality. The Eleventh Circuit weighed in stating, “[w]e think it will be relatively easy to decide what functions a government treats as its own…businesses…have readily at hand the tools to conduct that inquiry.” This inquiry may not ultimately be as straightforward as the Eleventh Circuit suggests. In some circumstances, it may be very difficult to determine if an entity is an instrumentality of a government because the information required to consider the various factors may not be readily available. For example, a business may not have the resources, or a third party may be unwilling to provide the information needed to determine if all or part of the entity’s profits go to the government. A foreign government may also not want this information made available. This is not an excuse however, and a company should proceed with caution, and only after consulting with counsel, if this information is unobtainable.
As a result of the Esquenazi decision, compliance officers and company counsel must ensure that proper due diligence is performed on all third parties, that employees are properly trained on compliance procedures and policies, and that compliance programs are in place and routinely updated. Going forward, such policies must incorporate the lessons learned from Esquenazi. The adoption of such a broad view of ‘instrumentality’ by the Eleventh Circuit has the potential to result in more difficult and time consuming due diligence processes. Businesses that are not formally recognised as a traditional arm of a government may now nonetheless still be considered an instrumentality for purposes of FCPA liability.
John Carney is a partner, Kaitlyn A. Ferguson is an associate and Lauren Berglin is a summer associate at Baker Hostetler. Mr Carney can be contacted on +1 (212) 589 4255 or by email: firstname.lastname@example.org. Ms Ferguson can be contacted on +1 (212) 589 4204 or by email: email@example.com.
© Financier Worldwide
John Carney, Kaitlyn Ferguson and Lauren Berglin