MNPI Not Only Risk for Buy-Side

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New York, NY – In the past nine months, many buy-side investors have been focused on trying to identify and mitigate the risk of receiving either material nonpublic information or confidential information from the external research providers they use.  However, a growing number of asset managers have realized that this is not the only information risk that research providers can introduce to their research process.  In fact, some buy-side firms we have spoken with have also been concerned about using research providers that could put them at risk of running afoul of the Foreign Corrupt Practices Act.


Foreign Corrupt Practices Act

Initially passed in 1977 and substantially revised in 1988, the Foreign Corrupt Practices Act (FCPA) prohibits the bribery of foreign government officials by U.S. persons, and prescribes accounting and record-keeping practices for US public corporations. 

The following explanation of the specifics of the FCPA was written by R. Christopher Cook and Stephanie Connor of law firm, Jones Day in a publication called “The Foreign Corrupt Practices Act: An Overview”. 

“A violation of the FCPA consists of five ‘elements.’ That is, a person or organization is guilty of violating the law if the government can prove the existence of:

  1. a payment, offer, authorization, or promise to pay money or anything of value
  2. to a foreign government official (including a party official or manager of a state-owned concern), or to any other person, knowing that the payment or promise will be passed on to a foreign official
  3. with a corrupt motive
  4. for the purpose of (a) influencing any act or decision of that person, (b) inducing such person to do or omit any action in violation of his lawful duty, (c) securing an improper advantage, or (d) inducing such person to use his influence to affect an official act or decision
  5. in order to assist in obtaining or retaining business for or with, or directing any business to, any person.

A covered individual or entity that violates the FCPA can be subject to criminal charges by the DOJ, which might lead to imprisonment or a fine, in addition to penalties by the SEC of up to $500,000 or the amount by which the entity profited from the offense.

The definitions of ‘payment’ and ‘foreign official’ are sufficiently broad to cover virtually any benefit conferred on someone in a position to affect a person’s business dealings with a foreign government. Nonmonetary benefits, including travel and entertainment, fall within the FCPA’s definition.

Likewise, the DOJ has taken the position that employees of state-owned business enterprises are ‘foreign officials’ for purposes of the FCPA.  The statute contains no monetary threshold; even the smallest bribes are prohibited.

Under the terms of the FCPA, a bribe need not actually be paid in order to violate the law. Rather, the FCPA prohibits the offer, authorization, or promise to make a corrupt payment in addition to the actual payment.”

For more information about the Foreign Corrupt Practices Act, click on the following Jones Day publication http://www.jonesday.com/files/Publication/3325b9a8-b3b6-40ff-8bc8-0c10c119c649/Presentation/PublicationAttachment/d375c9ee-6a11-4d25-9c30-0d797661b5ff/FCPA%20Overview.pdf


Application of the FCPA to Research
    

Upon first glance, it doesn’t appear obvious how the FCPA could apply to an asset manager’s use of external research.  However, a few prominent buy-side firms suggest that either directly or indirectly paying (through a research firm) a foreign government official for confidential information which they then trade on could be a viewed to be a violation of the FCPA.

The most obvious scenario where this might take place could be using an expert network to gain access to a foreign government official, party official, or manager of a state owned entity.  If the foreign official is paid (even indirectly through an expert network), the official provides the investor with information that is considered to be confidential, and the investor benefits from this information, the asset manager could be charged with a breach of the FCPA.

However, a foreign government official does not have to be paid in cash to be in violation of the FCPA.   Even a “promise to pay”, or the provision of travel and entertainment could be seen to be sufficient incentive if this leads a foreign government official to breach their lawful duty by providing confidential information to an investor.

This raises the question whether a research provider that sources information themselves from foreign government officials or managers of state owned entities; AND rewards those sources with cash, gifts, meals, trips, or other entertainment might be seen to be in violation of the FCPA themselves.  The research provider obviously benefits from this confidential information by selling it (and their analysis of it) to their customers.

In addition, an asset manager’s use of these research providers could create a potential risk of violating the FCPA for the investor.  An argument could be made that the buy-side client paid the research firm for information which came directly from foreign government officials, and that the research firm, acting as an intermediary, rewarded the officials to provide them with that information.  Some might say that the research firm was merely the intermediary, while the asset manager derived a direct commercial benefit from that confidential information by trading on it.
 

Mitigating FCPA Risks

So, what can buy-side firms do to address this potential risk?  The obvious answer is to conduct appropriate due diligence of the research providers they use to determine:

  1. if any of their providers offer direct access to, and compensation for, foreign government officials, party officials, or managers of government owned entities; or
  2. if any of their providers directly collect information from these sources; and
  3. if these research firms “reward” these sources in any way which could be seen as a bribe to breach their lawful duties such as keeping this information confidential.

Research providers, on the other hand, need to carefully identify the various sources used by their research analysts to determine if any of them might create an FCPA risk.  If a research provider discovers that they collect information from foreign government officials, party officials, or managers of government owned entities, and this is a crucial aspect to their research process, then they need to implement appropriate compliance policies and procedures to ensure that they don’t provide any incentive or reward which could be deemed to be a “payment” to these sources for provision of potentially confidential information.

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