FCPA: Functional Control

The U.S. Securities and Exchange Commission’s (“SEC”) resolution with Elbit Imaging Ltd. (“Elbit”) is reflective of the degree to which the FCPA’s accounting and recording-keeping provisions will be used to address questionable conduct on the part of an indirect subsidiary over which a parent has only “functional control.”1  Elbit is a holding company based in Israel and listed on the NASDAQ.2   As an issuer, Elbit’s subsidiaries were subject to the FCPA’s accounting and record-keeping provisions.

Plaza is a Netherlands-based company.  It is an indirect subsidiary of Plaza.  During the period in question, Plaza’s financial statements were consolidated into Elbit’s financial statements for purposes of SEC reporting.  Elbit’s CEO owned or controlled approximately 50 percent of Elbit’s equity and served as Plaza’s Executive Director.3  He also served on the board of directors of both companies.  Even after 2014, when Elbit underwent a reorganization and its ownership of Plaza was reduced to 45 percent, it continued to exert functional control over Plaza.4

Over a period of several years, Plaza entered into agreements with two third-party offshore entities for consulting services to assist it in securing an invitation from the Romanian government to participate in a project and later to secure government approvals in Romania.5  No due diligence was performed on the consultants before entering into the agreements.  Nor was there evidence that the consultants performed any services.  Yet, over several years, the consultants were paid approximately $14 million.

Elbit and Plaza later retained a third-party offshore entity (“Entity C”) to assist in the sale of a portfolio of assets.6  No due diligence took place on Entity C and Elbit’s CEO did not obtain a second signature as required by Elbit’s policy.  Unknown to Elbit or Plaza, Entity C conveyed most of its interests to another third-party off-shore entity (“Entity D”).  The indirect beneficial owner of Entity D was later found to be Elbit’s CEO.

The SEC’s Order found Elbit’s and Plaza’s internal controls to be deficient for a number of reasons:  (1) despite having no evidence that any of the consultants performed any services, millions of dollars in payments were made;7 (2) Plaza’s legal department’s supervision of the third-party contracts was inadequate; and (3) no policies and procedures to detect corruption risks existed and little, if any, anti-corruption compliance training took place.8  The SEC’s Order also found there to be record-keeping violations as corrupt payment and embezzled funds were mischaracterized as legitimate business expenditures.9

No different than the SEC’s resolution with BellSouth,10  having less than 50 percent control does not necessarily eliminate an issuer’s obligation to comply with the accounting and record-keeping provisions. When an issuer holds an interest of 50 percent or less in a subsidiary, the issuer remains obliged to “proceed in good faith to use its influence to the extent reasonable under the circumstances to cause [the subsidiary] to devise and maintain a system of internal accounting controls” consistent with the requirements of the accounting and record-keeping provisions.11