Imagine a Foreign Corrupt Practices Act (FCPA) investigation that finds the managing director of a major investment bank responsible for real estate deals in China is bribing a Chinese government official to the tune of more than $5 million, and both the US Securities and Exchange Commission (SEC) and Department of Justice (DOJ) do not take any enforcement action against the investment bank. Morgan Stanley was that bank, getting real credit for both its compliance system of internal controls and its cooperation with the government investigators, in the recent DOJ and SEC actions against Garth Peterson, a former Morgan Stanley managing director resident in Shanghai. The rationale contained in these two related actions is instructive, and we believe shows the government is ready to give a corporation credit for “adequate procedures” in evaluating any potential FCPA violation.

First, the background -- On April 25, 2012, Garth Peterson pleaded guilty in the US District Court for the Eastern District of New York to charges he conspired to evade internal accounting controls Morgan Stanley was required to maintain under Section 13(b)2(B) of the Exchange Act. (To read the Justice Department’s media release of Peterson’s guilty plea, please click here. To read the criminal information filed by DOJ, please click here).

Concurrently, Peterson agreed to pay $250,000 to settle the SEC allegations he violated the FCPA by bribing a Chinese government official to steer business to Morgan Stanley. In the SEC settlement Peterson also relinquished his interest in certain Shanghai real estate worth $3.4 million, accepted a lifetime bar from the securities industry, and agreed to an injunction from future FCPA violations. (To read the SEC complaint against Peterson and the related media release, please click here and here.) Peterson will be sentenced on July 17, and faces up to five years in prison and a fine of $250,000 or twice his gain from his offense.

Allegedly, Peterson, a managing director in Morgan Stanley’s real estate investment and fund advisory business in China, “had a personal friendship and secret business relationship” with the head (until late 2006) of Yongye Enterprise (Group) Co., a state-owned entity the SEC said had “influence over the success of Morgan Stanley’s real estate business in Shanghai.” Peterson “secretly arranged to have $1.8 million paid to himself and the Chinese official that he disguised as finder’s fees” and also “secretly arranged for [himself], the Chinese official and [a third person, a Canadian lawyer] to acquire a valuable Shanghai real estate interest from a Morgan Stanley fund.” Peterson kept his payment to the Chinese official and his own kickback a secret from his Morgan Stanley supervisors, and this misappropriation of funds breached the fiduciary duties Peterson owed the fund’s clients. Peterson’s violations occurred between 2004 and 2007.

Assistant Attorney General Lanny Breuer said in the Department of Justice’s April 25, 2012, press release announcing Peterson’s plea, that Peterson admitted he “actively sought to evade Morgan Stanley’s internal controls in an effort to enrich himself and a Chinese government official.” Further, with respect to Morgan Stanley, “after considering all the available facts and circumstances, including that Morgan Stanley constructed and maintained a system of internal controls, which provided reasonable assurances that its employees were not bribing government officials”, the Department of Justice declined to bring any enforcement action against the investment bank related to Peterson’s conduct.

What specifically did Morgan Stanley do to cooperate?

1. It discovered the wrongdoing and voluntarily disclosed it to the government
   
   
2. It conducted a nine month internal investigation of the wrongdoing.
   
   
3. It terminated Peterson in 2008.
   
   
4. It cooperated with the government through its investigation, which apparently lasted into 2012.
   

With respect to its compliance system, Morgan Stanley was commended by the government for the following,

1. Training: It “trained Peterson on anti-corruption policies and the FCPA at least seven times” in both live and web-based sessions. Between 2000 and 2008, it held “at least 54 training programs for various groups of Asia-based employees on anti-corruption policies, including the FCPA.”
   
   
2. Compliance Personnel: It employed “over 500 dedicated compliance officers, and its compliance department had direct lines to Morgan Stanley’s Board of Directors and regularly reported through the Chief Legal Officer to the Chief Executive Officer and senior management committees.”
   
   
3. Regional Compliance Personnel: It employed “regional compliance officers who specialized in particular regions, including China, in order to evaluate region-specific risks.”
   
   
4. Audit: It “randomly audited selected personnel in high-risk areas” and “regularly audited and tested Morgan Stanley’s business units.”
   
   
5. Hotline: It provided a toll-free compliance hotline 24/7, “staffed to field calls in every major language, including Chinese.”
   
   
6. Written Compliance Materials: It distributed written training materials specifically addressing the FCPA, which Peterson kept in his office.
   
   
7. Frequent Compliance Reminders: Peterson personally received more than 35 FCPA compliance reminders during the time he was working for Morgan Stanley in China. These included a distribution of the Morgan Stanley Code of Conduct, reminders concerning policies on gift giving and entertainment and guidance on the engagement of consultants.
   
   
8. Written Certifications: It required Peterson on multiple occasions to certify his compliance with the FCPA. These written certifications were maintained in Peterson’s permanent employment record.
   
   
9. Disclosure of Outside Business Interests: It required Peterson, along with other employees, to annually disclose his outside business interests.
   
   
10. Review and Update Policies: It conducted, “in conjunction with outside counsel,” a formal review annually of each of its anti-corruption policies.
    

Morgan Stanley also had specific policies to conduct due diligence on its foreign business partners.

1. It conducted due diligence on the “Chinese Official” and Yongye (the state-owned enterprise) before initially doing business with them.
   
   
2. It imposed an approval process for payments made in the course of its real estate investments to prevent improper payments.
   
   
3. An in-house compliance officer specifically informed Peterson in 2004 that employees of Yongye, a Chinese state-owned entity, were government officials for purposes of the FCPA.
   
   
4. It maintained a substantial system of controls to detect and prevent improper payments, including required multiple employees to be involved in the approval of payments.
   
   
5. It “continually evaluated and improved its compliance program and internal controls” including “risk-based FCPA auditing intended to detect transactions, payments and partnerships that suggested increased risks.”
   

Here, as the SEC noted in its press release, the government viewed the former executive, Peterson, as “a rogue employee who took advantage of his firm and his investment advisory clients.” Due to its cooperation and its comprehensive anti-corruption policies and procedures, Morgan Stanley was able to avoid any enforcement action whatsoever. Only time will tell whether these actions reflect the government’s adoption of a de facto “adequate procedures” defense to FCPA violations. In the interim, companies would be well advised to review the adequacy of their anti-corruption compliance procedures in light of the elements set forth in these settlements to assure that they meet current best practices.