On February 7, 2007, the Department of Justice (DOJ) announced that it had reached a settlement agreement with El Paso Corporation with respect to alleged misconduct in the United Nations Oil-for-Food Program. According to the Agreement, the Coastal Corporation, which merged with El Paso in early 2001, and El Paso obtained Iraqi oil under the Program from third parties that paid secret, illegal surcharges to the former Government of Iraq, in violation of US wire fraud statutes, as well as sanctions administered by the Department of Treasury’s Office of Foreign Assets Control that prohibited transactions with the former Government of Iraq. Pursuant to the Agreement, El Paso will forfeit approximately $5.5 million to the United States. In a separate agreement, El Paso will also pay approximately $2.2 million to the Securities and Exchange Commission (SEC).

The complaint filed by the SEC contains two Foreign Corrupt Practices Act (FCPA) books and records related charges: failure to keep books, records, and accounts accurately and fairly reflecting transactions and dispositions of assets; and failure to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that: (1) payments were made in accordance with management's general or specific authorization; and (2) payments were recorded as necessary to maintain accountability for its assets.

The complaint also outlined evidence of knowledge that illegal surcharges were being paid, which presumably led to the criminal inquiry, including the following:

• Iraq’s State Oil Marketing Organization (SOMO) demanded a surcharge from a Coastal employee prior to Coastal’s merger with El Paso. Ultimately, an El Paso consultant and former Coastal official made the requested payments; after the merger, the consultant insisted that El Paso reimburse him for the payments. However, El Paso refused
• When El Paso learned from SOMO that all contracts under the Oil-for-Food Program would have surcharges, it refused to enter into contracts with SOMO directly; however, El Paso purchased from third parties when it knew (or was reckless in not knowing) that these third parties had to pay illegal surcharges
• Telephone conversations of El Paso trader’s where blatant demands for surcharges by SOMO officials were discussed
• Articles in the press discussing illegal Iraqi surcharge demands
• Records indicating that surcharges had been paid, despite a clause in El Paso’s third party oil purchase contracts stating no surcharges had been paid
• After becoming aware of the illegal surcharges, El Paso:
  • Failed to maintain a system of internal controls sufficient to ensure company's transactions executed in accordance with management's authorization
  • Failed to adequately record its Iraqi crude oil contracts, including inadequate documentation, inadequate due diligence, no proof that invoices had been paid for at least 13 shipments, no process for documenting commercially reasonable prices paid for oil cargos, no evidence documents reviewed by anyone to ensure propriety and adequacy, and inadequate explanations of why documents were missing from files 
  • Failed to record surcharges paid as surcharges

The US Attorney’s Office handling the criminal investigation indicated that its decision to enter into a settlement agreement with El Paso was guided by the factors set forth in the DOJ’s recently amended memorandum, “Principles of Federal Prosecution of Business Organizations.” Among other factors, the US Attorney’s Office took into consideration El Paso’s:

• Cooperation since approximately September 2004 with the various US Government investigations into the corruption of the Oil-for-Food Program, which included, among other things, providing both documents and audio tapes of its oil traders’ telephone conversations (from both domestic and international locations), facilitating meetings between federal investigators and numerous current and former employees from both its domestic and international corporate entities, and providing the complete results of its comprehensive internal review of its own involvement in the Oil-for-Food Program
• Commitment to continue to provide cooperation
• Implementation of enhanced compliance procedures, supervised by the company’s Legal and Ethics departments, that are designed to prevent future violations of law by its employees
• Confirmation that culpable employees were no longer working for the company
• Voluntary abandonment of its trade in Iraqi oil under the Oil-for-Food Program in mid-2002 based, in part, on concerns about the effectiveness of compliance efforts in preventing the payment of illegal surcharges by others to the former Government of Iraq
• Settlement of the SEC’s civil enforcement action
• Agreement to forfeit approximately $5.5 million, which represents the amount of illegal surcharges paid to Saddam Hussein’s Government by third parties from whom El Paso purchased Iraqi oil

The US Attorney’s Office also considered the significant consequences that a criminal indictment would have upon the legitimate operations and innocent employees and shareholders of El Paso.

Interestingly, the information currently available about the settlement agreement does not indicate that an independent compliance monitor was a part of the terms. Many recent similar settlement agreements have included such a provision. The lack of a compliance monitor may be due to the fact that El Paso appears to be continuing to provide information to the SEC and DOJ about its knowledge of illegal payments made in connection with the Oil-for-Food Program.

This case also illustrates yet again the issues of successor liability in the context of mergers and acquisitions, since the greatest liability seems to stem from Coastal’s activities. Additionally, the case highlights the problems of ignoring red flags in transactions. Despite El Paso’s refusal to pay surcharges directly and its inclusion of compliance language in its contracts that required others to certify that surcharges would not be paid, evidence suggests that at least certain personnel of the company were aware that it would not be possible to participate in the Oil-for-Food program without such payments being made.

The Justice Department and the SEC are continuing their aggressive enforcement posture, as evidenced by El Paso and other recently announced cases. Our FCPA practice group is monitoring developments and will provide periodic updates.

For further information please feel free to contact the authors or any member of the International practice team.

Regan Alberda
202.715.8547
alberda.regan@arentfox.com

Jennifer Fischer
202.828.3469
fischer.jennifer@arentfox.com