In what is thought to be the first FCPA-related enforcement action ever taken against a China-based company, the SEC entered into a joint settlement yesterday with Keyuan Petrochemicals Inc. and its former CFO, Aichun Li, over alleged violations of the books and records and internal controls provisions of the FCPA, and anti-fraud and reporting provisions of other federal securities laws.
The Keyuan settlement represents the first FCPA enforcement action of 2013, though it has escaped notice as such because the SEC’s press release and settlement documents don’t explicitly reference the statute by name. One possible reason for this omission is that the thrust of the allegations in the joint settlement (including all of those against Ms. Li) relate to a form of insider trading, not the Company’s accounting violations related to improper payments to Chinese officials.
The non-FCPA related allegations involve Keyuan’s “systematic” failure to disclose numerous “related party” transactions involving the company’s three controlling shareholders, entities controlled by or affiliated with them, and entities controlled by Keyuan’s management or their family members. However, the complaint (available here) also states that from 2008 until 2011, Keyuan maintained an off-books account into which it channeled approximately $1 million that was used, in part, to fund gifts to Chinese government officials, including officials from the local environmental, port, police, and fire departments. The gifts, which were typically given around the Chinese New Year, ranged from household goods (such as beddings and linens) to “red envelope” gifts, in which cash was directly gifted to the officials.
Keyuan initiated an internal investigation into these issues in March 2011, after the company’s former auditor elevated certain irregularities to the company’s Audit Committee. Keyuan was delisted from the NASDAQ exchange in October 2011, after it amended its prior SEC filings to disclose the existence of potential violations of both Chinese and U.S. securities laws, including the FCPA. The company currently trades shares on the OTCQB marketplace.
As part of their joint settlement, Keyuan and Ms. Li agreed to an injunction against future violations of the relevant U.S. securities laws and consented to civil penalties of $1 million and $25,000, respectively. Ms. Li also agreed to a two year suspension of her right to appear or practice as an accountant before the SEC. The proposed settlement is still subject to court approval.
Keyuan, which is headquartered in Ningbo, China, was formed in April 2010 when its predecessor, Ningbo Keyuan Plastics Ltd., consummated a reverse merger with a Nevada shell corporation that traded on U.S. exchanges.
Reverse mergers have become a popular “backdoor” method for firms from emerging markets to secure a listing on U.S. exchanges without having to go through the rigor of a formal IPO. In doing so, these firms take on substantial compliance obligations and open themselves up to increased liability as “issuers,” in some instances without a full appreciation of the risks involved. As a result, these types of foreign-based issuers have drawn increased attention from the SEC in recent years, particularly those based in China.
For instance, in April 2011, the SEC temporarily suspended trading in the China-based environmental protection equipment manufacturer RINO International Corp., which had recently disclosed that it was the subject of an SEC investigation for, among other things, potentially violating the FCPA.
Marc Alain Bohn is a contributing editor of the FCPA Blog.