CORPORATE CRIME REPORTER

PUBLISHED WEEKLY VOLUME 28 NUMBER 9 MONDAY MARCH 3, 2014

CORPORATE CRIME REPORTER

CAMPBELL ON BEING CAUGHT BETWEEN A GREAT WALL AND A HARD PLACE

In January, an administrative law judge (ALJ) for the Securities and Exchange Commission (SEC) sanctioned five Chinese affiliates of major U.S. accounting firms for their failure to produce work papers related to audits of ten China based U.S. issuers who were under investigation by the SEC.

The accounting firms’ defense, essentially was -- China says that if we cooperate with the SEC, we’ll violate the China state secrets law. So, we can’t cooperate.

The Administrative Law Judge who heard the case was not sympathetic to this defense.

"Respondents operated large accounting businesses for years, knowing that, if called upon to cooperate in a Commission investigation into their business, they must necessarily fail to fully cooperate and might thereby violate the law," the judge wrote. “Then, when actually called upon to fully cooperate, respondents complained that they should be relieved from that duty because, among other things, they invested money and effort in building up their accounting businesses. Such behavior does not demonstrate good faith, indeed, quite the opposite – it demonstrates gall. Each Respondent made the affirmative decision, no later than the time it filed its Sarbanes-Oxley 106 designation of agent, to conduct its auditing business ‘at risk.’”

Were these firms betting that it would be easier to go against the SEC than against the Chinese authorities?

“They certainly understood that on the SEC side, there are civil and professional level sanctions for a public company accounting firm,” Bret Campbell, a partner at Cadwalader in Washington, D.C. told Corporate Crime Reporter in an interview last week. “There is the potential of a censure from the ALJ and a practice bar, which means you are not allowed to practice in front of the SEC. That means you couldn’t audit a public company. That is balanced on the other side with real criminal prosecution in China – detention and subsequent

of your organization with a bit less due process than you would expect over here. They were apparently more willing to push the SEC than flout the Chinese regulators.”

Campbell is author of an article titled Caught Between a Great Wall and a Hard Place: Issues for U.S. Public Companies in Responding to

Regulatory Requests for Chinese Data.

“One of the arguments the firms made was --we have invested a tremendous amount of time and money building these practices, we have performed audits for all sorts of companies, we are very important to the smooth functioning of the securities markets because we provide accounting services which cannot be performed by smaller accounting firms,” Campbell said.

“When we registered to perform this kind of work with the Public Company Accounting Oversight Board, we said back then we were going to have this problem and wouldn’t be able to produce these documents. For all of these reasons, you should not sanction us.”

“The ALJ focused on the commercial side of that argument. He said -- you saw profits, you were chasing the money, you decided you wanted to avail yourselves of this client base. You knew full well this could happen. So, if you are having a problem now, you shouldn’t complain about it, because you were chasing the dollars that put you in that place. The ALJ didn’t have a lot sympathy for the argument of the accounting firms.”

What exactly are the state secrets -- what are the Chinese concerned about?

“That’s the crux of the problem for the review team in China and for Chinese regulators,” Campbell said. “You see that in the ALJ’s opinion -- the Chinese regulators would not tell them what were state secrets. It can be a catch all for

misconduct. And there could be political overtones to it. It’s opaque.”

“The Chinese government released what was supposed to be a clarification on state secrets law. And although it provides discretion to officials in determining what is a state secret, it cautions

officials that any official who releases state secrets will be dealt with according to law.”

“What’s nice about the ALJ opinion is that it tells us what the accounting firms were finding and what they thought were state secrets.”

“The two examples that they gave were technology know how and non-public Chinese governance policy -- presumably communications with regulators, advice from regulators on treatment of transactions -- the kind of thing where it would be a discussion with the regulator, rather than something that was publicly issued by the agency.”

“Those are two examples of state secrets. And then the ALJ gives examples of the type of documents where they did not find state secrets. That’s also helpful.”

“Generally they did not find state secrets in bank records, supplier records, customer records, financial books and records, and the auditor’s findings.”

Is the judge saying that these companies, knowing the conflict, should not have operated in China?

“The SEC and the judge wouldn’t take that position,” Campbell said. “What they are saying is -- you were aware of this risk when you chased your profit into China. You understood there was a risk of this happening. And now that you are facing this risk, you need to address it. And I’m not going to tell you how to do it. The SEC Enforcement

Division isn’t going to tell you how to do it. But you need to fix this problem and comply with

regulations here in the United States.” But there might not be a way to fix it?

“That could be one outcome. In this case, there could be a middle way -- cooperation and sharing agreements with the SEC and in China. Those are slowly becoming unstuck. And it looks as if production materials can occur.”

“Companies face conflicting cross-border regulator demands. And there’s not a perfect fix for it.”

INTERVIEW WITH BRET CAMPBELL, PARTNER, CADWALADER,

WASHINGTON, D.C.

Let’s say you are a U.S. corporation doing business in China. And you get a request for documents from the Securities and Exchange Commission about your Chinese practices. But the Chinese government says you can’t turn those documents over to the SEC because turning them over will violate China’s state secret law. What do you do?

Bret Campbell is a partner at Cadwalader in Washington, D.C.

He’s written an article on the subject titled: Caught Between a Great Wall and a Hard Place: Issues for U.S. Public Companies in Responding to Regulatory Requests for Chinese Data.

We interviewed Campbell on February 24, 2014.

CCR: You graduated from Vermont Law School in 1994. What have you been doing since?

CAMPBELL: I came to Washington in 1994, fresh out of law school. I had some friends down here who were talking about this being a good place for lawyers. I don’t think anybody is going to debate whether that is true or not. You might debate whether that is a good thing. It certainly was a good move for me. I’ve been a defense lawyer here in Washington ever since.

I went to work at Rogers & Wells. And they merged with Clifford Chance back in 2000. I was there until 2004.

For the last ten years, I’ve been with Cadwalader in our white collar group. I’ve been doing defense work, primarily corporate defense, but also representing individuals.

So, my career has been in Washington

representing corporations and individuals, primarily in front of the Justice Department and the Securities and Exchange Commission.

Since 2004, the focus on my practice has been on international problems clients have before the Department of Justice and SEC. That has been a lot of Foreign Corrupt Practices Act (FCPA) work, a lot of anti-fraud work.

For the past ten years, we have been seeing increased globalization of businesses and along with the increased cross-border litigation issues and transactional issues. Many U.S. companies and

issuers are purchasing companies overseas. When you are in that transactional context, you want to know who you are getting in bed with. That’s a big part of our practice as well -- guiding clients through that landscape.

CCR: What part of your practice is corporate versus individual?

CAMPBELL: My practice is probably 85 percent to 90 percent representing the corporation or board of directors or an audit committee. Maybe 10 to 15 percent representing individuals.

CCR: What about criminal versus civil?

CAMPBELL: It’s 90 percent criminal and regulatory. Usually our clients are public companies, so you can’t really separate out a Department criminal action and a parallel SEC regulatory action. They go hand in hand. Straight civil litigation would be ten percent or less.

CCR: But your work is 100 percent defense side, right?

CAMPBELL: Correct.

CCR: Is Cadwalader primarily a white collar firm?

CAMPBELL: Cadwalader is the oldest operating Wall Street firm in the country. The original firm was founded in the mid 1700s. Most people think of us as a New York Wall Street firm with many financial institutional clients in New York.

Our Washington office, which is about 150 lawyers now, looks more like a classic Washington, D.C. law office. We have a large white collar group.

We have nine partners and probably 40 associates working in that group. We have a big antitrust group. And we have an energy group, which is really a commodities and energy group that does both regulatory enforcement work, CFTC work, and transactional work.

CCR: What part of your practice deals with foreign operations work, FCPA work?

CAMPBELL: Probably for the last ten years it has trended anywhere from 80 percent to 100 percent. I’ve had at least a couple of years where 100 percent of what I’m doing involves overseas operations of companies. The focus of the prosecutors and regulators has been on that space.

In the international space, probably 80 percent of it is FCPA. Fifteen percent is other types of fraud -- accounting fraud, securities fraud. Five percent is other -- trade sanctions, OFAC, customs -- that kind of work.

CCR: What part of your time is spent overseas?

CAMPBELL: A good deal. I’m overseas generally every month. At least a week a month I’m outside

the United States. Sometimes it’s more. Sometimes it is half of every month.

CCR: Is that Asia?

CAMPBELL: For the last five years, it has been mostly Asia and Russia. That gives you a lot of China, Korea, Russia and until the Arab Spring two or three years ago, there was quite a bit of travel to North Africa -- Egypt and Morocco.

CCR: You recently wrote an article titled -- Caught Between a Great Wall and a Hard Place: Issues for U.S. Public Companies in Responding to

Regulatory Requests for Chinese Data. Give us the nutshell version.

CAMPBELL: China has a law called The Protection of State Secrets Law. That law criminalizes the export of Chinese state secrets outside of the country. A U.S. issuer has operations in China, you have information there, email, financial data, all that data you are holding there.

When you want to or have to take that data and bring it outside China, to the U.S. or to Europe, let’s say, you are potentially running afoul of a Chinese law which criminalizes exporting that data. So, you have to manage that problem.

It becomes problematic when, say, the SEC says -- I want to see your Chinese data, I want to see your financial statements, information, e-mails from China. And you have to produce it because you are compelled by U.S. law to produce it.

But in China, you have regulators telling you that if you do that, your employees will be subject to criminal prosecution with the different standard of due process in China. And your subsidiaries in China can be subject to fines, license suspensions, the equivalent of the corporate death sentence over there.

That’s why you are stuck between a Great Wall and a hard place. You have the Chinese regulators telling you you cannot do this. You have the SEC telling you you must do this.

CCR: The case you write about dealt with the Chinese affiliates of the major U.S. accounting firms. Did Cadwalader have any involvement in that case?

CAMPBELL: We did not. The SEC was investigating ten issuers -- U.S. companies. They were primarily Chinese companies headquartered in China. These companies were being investigated for various types of fraud -- accounting fraud, financial fraud. Each of those ten companies used the China affiliate of one of the big four accounting firms and BDO. These five firms were all affiliates of U.S.

firms.

The SEC requested the audit work papers from the Chinese affiliates. You had ten different investigations run by ten different enforcement division lawyers. At the end of the day, what the SEC wanted was copies of the Chinese audit firm’s work papers related to these companies that were under investigation.

They wanted to see what the work papers showed, they wanted to see whether the accounting firms were complicit in the alleged fraud, they wanted to understand what was going on.

The Chinese accounting firms said to the SEC -- we would love to cooperate if we could, but the Chinese authorities are telling us that if we produce these materials to you, we are subject to losing our licenses, we would go out of business, and our employees would be subject to criminal prosecution.

CCR: The SEC’s administrative law judge says that if these firms were between a rock and a hard place “it was because they wanted to be there.” What did the judge mean by that?

CAMPBELL: The ALJ’s opinion is over 100 pages long. He sets out all the evidence and arguments marshaled by the accounting firms.

One of the arguments the firms made was -- we have invested a tremendous amount of time and money building these practices, we have performed audits for all sorts of companies, we are very important to the smooth functioning of the securities markets because we provide accounting services which cannot be performed by smaller accounting firms.

When we registered to perform this kind of work with the Public Company Accounting Oversight Board, we said back then we were going to have this problem and wouldn’t be able to produce these documents. For all of these reasons, you should not sanction us.

The ALJ focused on the commercial side of that argument. He said -- you saw profits, you were chasing the money, you decided you wanted to avail yourselves of this client base. You knew full well this could happen. So, if you are having a problem now, you shouldn’t complain about it, because you were chasing the dollars that put you in that place. The ALJ didn’t have a lot sympathy for the argument of the accounting firms.

CCR: How can any company do business in China and answer the SEC?

CAMPBELL: That was the dilemma for the accounting firms. Up until this point, they had not gotten into a spot where they had this type of a request for their work papers. One of the things the ALJ noted was there were a couple of other regional accounting firms involved in some of the

investigations of the ten Chinese issuers. And these smaller firms produced materials to the SEC without making any of these arguments.

But the big firms, like PwC, had thousands of accountants in China. KPMG performed hundreds of audits either as a primary or secondary auditor in China. They have big operations. They decided --we can’t jeopardize our licensing, our regulator posture with the Chinese regulator.

CCR: Were these firms betting that it would be easier to go against the SEC than against the Chinese authorities?

CAMPBELL: They certainly understood that on the SEC side, there are civil and professional level sanctions for a public company accounting firm. There is the potential of a censure from the ALJ and a practice bar, which means you are not allowed to practice in front of the SEC.

That means you couldn’t audit a public company. That is balanced on the other side with real criminal prosecution in China -- detention and subsequent prosecution of your employees and the destruction of your organization with a bit less due process than you would expect over here. They were apparently more willing to push the SEC than flout the Chinese regulators.

CCR: The smaller accounting firms that turned over the information to the SEC, they were not charged by the Chinese, right?

CAMPBELL: As far as I know, that has not happened.

CCR: So, what were the real risks that the Chinese would charge the bigger firms?

CAMPBELL: The possibility is real. The most recent case is the Rio Tinto mining company from a few years ago. Executives in Rio Tinto in China were charged criminally, prosecuted and convicted for violating that state secret law for transmitting information outside the country. So, there is absolutely a real risk of prosecution.

The accounting firms in China went to the regulatory agencies responsible for their oversight. The central regulator over there is the Chinese Securities Regulatory Commission (CSRC). It’s much like the SEC here in the U.S. CSRC regulates

public companies and public accounting firms in China.

They went to the CSRC. They also went to the Ministry of Finance, which has a regulatory role. They also went to the State Secrets Bureau, the State Archives Bureau. They went to the regulators and said -- what can we do? What should we do?

There was no hiding and hoping that nothing would happen. They very much wanted to get a regulatory decision here and figure out a way to go through this process in a responsible manner so that they could mitigate their risk both in the United States and and in China.

Once you do that, it is out of the bag. Once you go to the regulator, you can’t just produce and hope they don’t come after you.

CCR: What are your proposals on how to deal with this?

CAMPBELL: There can be all kinds of regulatory requests. It can be an SEC request. It could be the Department and the SEC if it’s an anti-corruption case.

It could be the Federal Trade Commission and the Antitrust Division if it’s an antitrust case. It could be a consumer protection case where they are seeking information about your Chinese

manufacturing operations.

So, there’s a regulatory request. Also, as a company internally, being a responsible corporate citizen, you will have an occasion to conduct compliance investigations. You are going to get hotline reports.

You are going to get something coming in from China saying -- you have a problem here, you better go and investigate it. Same thing happens in that case. You have to grab your data from China, process it, export it back to headquarters so that everybody can look at it and see what’s going on.

When that happens, on that day, you need to be able to figure out -- can I remove this data safely or am I risking a prosecution under Chinese law? What exactly is the story here? That is what you are going to have to face.

We conduct investigations involving China all the time. We are over there all the time. We work in this space. How is everyone managing this process? The ALJ opinion describes how the accounting firms dealt with this process. And the way they dealt with this process is the same way that companies should be dealing with this process.

It’s two parts. You are analyzing the data and getting it screened for state secrets prior to

production. The ALJ’s opinion does a really nice job of setting out what the accounting firms told the ALJ they were doing. There is a four step document review process. If you read the opinion, you can garner from that information the evidence they provided and what that process looks like.

That four part process is what companies are doing now in order to feel comfortable about the data they are looking at. It’s about hiring the Chinese law firm that understands what state secrets are under Chinese law. And that’s not every firm.

You need competent counsel to do this. You then convene a review team to go through the materials and produce redacted copies.

Then you create a log of what you have done. The accounting firm at least had a single regulator they could turn to and say -- okay, we have screened the data, now you approve it and you send it to the SEC. You have this regulatory stamp of approval on that transfer.

Companies that do an internal investigation are not always going to have an agency that is

experienced in this area the way the Chinese securities regulators became experienced in this area. With international investigations, you are lacking the last step of the process -- which is -- I screened my data, now you approve it and send it to the American regulators.

Companies are generally reluctant to alert regulators that they are conducting an internal investigation, unless they want to go in and disclose and that’s part of the strategy.

So, that’s what is set out in the ALJ’s opinion. There is a nice screening process.

The second part is having a regulator bless it and then export it back to the US and Europe. That’s the challenge for companies.

CCR: What exactly are the state secrets -- what are the Chinese concerned about?

CAMPBELL: That’s the crux of the problem for the review team in China and for Chinese

regulators. You see that in the ALJ’s opinion -- the Chinese regulators would not tell them what were state secrets. It can be a catch all for misconduct. And there could be political overtones to it. It’s opaque.

The Chinese government released what was supposed to be a clarification on state secrets law. And although it provides discretion to officials in determining what is a state secret, it cautions officials that any official who releases state secrets will be dealt with according to law.

What’s nice about the ALJ opinion is that it tells us what the accounting firms were finding and what they thought were state secrets.

The two examples that they gave were technology know how and non-public Chinese governance policy -- presumably communications with regulators, advice from regulators on treatment of transactions -- the kind of thing where it would be a discussion with the regulator, rather than something that was publicly issued by the agency.

Those are two examples of state secrets. And then the ALJ gives examples of the type of documents where they did not find state secrets. That’s also helpful.

Generally they did not find state secrets in bank records, supplier records, customer records,

financial books and records, and the auditor’s findings.

CCR: The judge was not sympathetic to the companies.

"Respondents operated large accounting businesses for years, knowing that, if called upon to cooperate in a Commission investigation into their business, they must necessarily fail to fully cooperate and might thereby violate the law," the judge wrote. “Then, when actually called upon to fully cooperate, respondents complained that they should be relieved from that duty because, among other things, they invested money and effort in building up their accounting businesses. Such behavior does not demonstrate good faith, indeed, quite the opposite - it demonstrates gall. Each Respondent made the affirmative decision, no later than the time it filed its Sarbanes-Oxley 106 designation of agent, to conduct its auditing business ‘at risk.’”

CAMPBELL: I don’t think that the lack of sympathy is unique to this particular judge or even unique to the SEC. That’s the way they will view these situations.

CCR: Is the judge saying that these companies, knowing the conflict, should not have operated in China?

CAMPBELL: The SEC and the judge wouldn’t take that position. What they are saying is -- you were aware of this risk when you chased your profit into China. You understood there was a risk of this happening. And now that you are facing this risk, you need to address it. And I’m not going to tell you how to do it. The SEC Enforcement Division isn’t going to tell you how to do it. But you need to fix this problem and comply with regulations here in

the United States.

CCR: But there might not be a way to fix it?

CAMPBELL: That could be one outcome. In this case, there could be a middle way -- cooperation and sharing agreements with the SEC and in China.

Those are slowly becoming unstuck. And it looks as if production materials can occur. Companies face conflicting cross-border regulator demands. And there’s not a perfect fix for it.

CCR: Was there a way the companies could have dodged the SEC enforcement action here?

CAMPBELL: Essentially, no. The client companies had high profile public accusations leveled against them. The big four accounting firms either withdrew, were fired, or noisily withdrew as auditors or investigators for these public companies. When that happens, there is no stopping the

investigation of the client. At that point, it is pretty standard for the SEC to seek those work papers.

They look at that as a legitimate area of inquiry in those kinds of cases. So, once those clients were firing their accounting firms, it was almost

inevitable for the SEC to go to the accounting firms and say -- we want to see the work papers.

This is not a new issue. We’ve seen it with the privacy issues in Europe. But in this case it’s China. And so it’s on the forefront for the commercial guys thinking about how to get into the market and the regulators thinking about how to police that market. And China has these state secret laws that are backed by criminal prosecution.

CCR: The accounting firms are going to appeal the ALJ’s decision.

CAMPBELL: Yes. They can appeal it to the SEC and then they can appeal the SEC’s decision to the U.S. Court of Appeals here in Washington. This case can continue on. And the ALJ has stayed his penalties pending that appellate process.

There was a separate proceeding against Deloitte for its Chinese affiliate to turn over data related to a Chinese company. In that case, Deloitte adopted the procedure set out in the ALJ opinion. They got the Chinese SEC equivalent to take the reviewed documents, look at them and pass them on to the SEC.

After that happened, the SEC withdrew it’s subpoena enforcement action. So, Deloitte, in one slice of this case, has been essentially dismissed.

They are still in it in another slice because of some other things that are going on. But for one part of it, they did figure out a practical solution that ended the case for them.

My guess is that the other accounting firms are doing the same thing, trying to do the reviews, have the documents produced at the CSRC and have those produced to the SEC so that this can work itself out with a practical solution, rather than litigation.

Based on the ALJ’s opinion, it appears that while they are going to appeal the case, they will move ahead and try to conduct the reviews and nudge the SEC’s equivalent in China to finish its review of the documents and produce them on.

If that happens, and the SEC Enforcement Division feels it has received all of the information it wants, then most likely it will be a policy decision as to what they want to do. Would they withdraw that case? Or pursue it for some broader policy objective?

CCR: Let talk FCPA bit. Is there a lull in enforcement?

CAMPBELL: There is no lull. There are several very high profile investigations ongoing. JPMorgan and other multinational banks are being investigated for the hiring of sons and daughters of high ranking Chinese officials. That’s almost an industry wide investigation by the Justice Department and the SEC.

Then there is a pharmaceutical and life sciences industry wide investigation. That was launched as an industry sweep in 2009. Those cases have been working their way through the process. Baxter just announced yesterday that it had reached the conclusion of that process and had received a declination. Other companies are still working through their cases.

Wal-Mart is moving forward. You see more releases from Wal-Mart on the state of that

investigation. Avon is trending toward a resolution. That’s another big one. One that has kept a lot of people busy is the GlaxoSmithKline investigation in China by the Chinese. That was started in China by dawn raids and arrests by the Chinese prosecutors. The UK’s Serious Fraud Office is apparently also investigating that case and on the US side, the SEC and the Department of Justice are looking into it.

[Contact: Bret Campbell, Cadwalader, 700 6th Street NW, Washington, DC 20001. Phone