$60 Billion in US Extraterritorial Enforcement Penalties in 2013-15, Viable Company Responses.

Hong Kong

Paul Backer, J.D., LL.M. Member NYS Bar

Fall 2015 backerpaul@gmail.com

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Company Takeaway• Extraterritorial enforcement will increasingly impact

companies as well as financial institutions.

• Shift from substantive law (court) to administrative law (agency) enforcement key driver of ongoing expansion of size and scope of US enforcement penalties.

• Effective internal policies mitigate impacts.

• External programs can impact regulatory drafting, administrative procedures and application.

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Extraterritorial Enforcement• WSJ: 2013-15, $60 billion in non-US enforcement penalties. Per

World Bank: GNP of half of the world’s nations is less.

• Shift to agency enforcement from court proceedings: rapid growth of size, number and scope of penalties. US enforcers much more rapidly and predictably impose larger penalties.

• Raises issues of sovereignty and respect for local law.

• Dramatically impacts global transacting, yet a lack of agreed terms: extraterritoriality, extraterritorial enforcement, long arm, cross border jurisdiction. Imagine contract or real estate law if no settled terms.

• Discussing extraterritorial enforcement: what is it, why it is relevant, importance of legal ideas, your views, effective policies.

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Enforcement Overview• Defined: enforcement of own laws and regulations

outside own borders. Ability to impose own will, control others’ conduct, promote policy interests and extract penalties.

• Enforced by US against non-US actors for non-US conduct, often without substantive US jurisdiction nexus, increasing reliance on agency not court enforcement.

• FATCA made non-US financial institutions agents of and therefore, regulated by the US Internal Revenue Service. HSBC, Bank of China now effectively agents of US IRS.

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Enforcement Overview (2)• Blockbuster penalties, hundreds of millions, cumulatively

tens of billions of dollars annually against companies, to a much lesser extent physical persons registered and residing, HQ and primary operations, shareholders, clients and transactions outside the US.

• Commentators: US extraterritorial enforcement, one of history’s greatest wealth transfers.

• Targets (non-US financial institutions (banks) and companies, US nationals abroad) seen as wealthy, unpopular, overprivileged and largely defenseless.

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Enforcement Overview (3)• Legal and compliance departments of non-US

companies failed to anticipate shift to agency led enforcement. Erroneously applied old paradigms (litigation) to a new reality (agency enforcement).

• Brought a knife to a gun fight.

• Implementation of effective company policies mitigates impacts, reduce penalties by tens of millions of dollars.

• Implement prevention policies to protect company.

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Legal Ideas Powerful• Legal ideas shape the world.

• Collateralized debt securities (CDS) - bundle, strip and securitize mortgages. Raised RE prices worldwide. Invent and implement CDS impacted everyone.

• Theories and application of US extraterritorial enforcement now being shaped, companies’ external policies can play important role.

• Are legal ideas heroic? Expertise protects HK.

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Global impact of US Extraterritorial Enforcement

July 2014, BNP Paribas pled guilty to criminal charges, to pay almost $9 billion to resolve accusations that it violated US sanctions against Sudan, Cuba and Iran.

“Unprecedented” move - regulators ban BNP for a year from conducting some dollar transactions. An international bank unable to transact in dollars, immediately noncompetitive.

BNP agreed to pay $9 billion rather than litigate. $60 billion in penalties in two years. Decoupling of penalties from actual risks to US policy or systems?

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The Russian Kerfuffle• US Sanctions led to a rapidly declining Russian economy, fall

in trade except raw resources, capital flight, brain drain, failing financial institutions, unemployment, falling real estate prices.

• US systems indispensable. 2014, Russian Embassy in Kazakhstan paid for insurance to a Russian government controlled insurer in Moscow. Payment frozen in JP Morgan Chase NY.

• Your view of Extraterritorial Enforcement? Protects against abuse by overprivileged bad actors or undermines legitimate sovereignty and local law? UnionPay and CIPS as pushback?

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Explosive Growth of Extraterritorial Enforcement

• From Pax Americana to Lex Americana. Achieves sound policy by non-lethal means or undermines local authorities and law?

• Westphalian Peace Conference of 1648. Sovereignty principle.

• Companies support ANY single standard. Governments seek to defend own authority and own standards, disunity. Companies economically motivated and pass costs, governments pursue policy, largely insensitive to costs.

• Regulatory blocs emerging, US/UK share penalty proceeds. Current US/EC conflict on swaps, future conflict with China? Emergence of China led bloc? AIIB, CIPS and UnionPay.

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Your view of Extraterritorial Enforcement?

• Transforms international transacting and financial markets. Tens of billions in penalties and new legal risks. Distorts markets, products, client base or punishes powerful political and economic bad actors?

• Enforcement moving from substantive law to administrative law. Erosion of territorial jurisdiction.

• Enforcement annually yields billions. Financially and politically cheap means to impose state will. No delays or casualties.

• Enforcement will grow in scope and impact. Non-US companies must implement programs to mitigate impact.

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Proper Function of Law?• Integrate for efficiency and to implement global best

practices. US law has longest successful track record of cost effectively governing large markets, low cost large transactions. Extraterritoriality is broadly positive.

• Protect local values, history, views. Extraterritoriality is broadly negative, undermines sovereignty.

• Seek justice of every situation. Extraterritorial enforcement but differently administered?

• Corporate finance and transacting strongly integrative.

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Substantive Aspects• Broad scope of covered activities.

• Subject companies.

• Enforcers.

• Benefits disputed.

• Jurisdiction, erosion of territorial principle.

• Enforcement standards.

• Drivers of increased enforcement and its likely evolution.

• Responding to extraterritoriality.

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Broad Scope of Covered Activities

• Civil litigation under the Alien Torts Act, anti-money laundering (“AML”), anti-bribery (“FCPA”), anti-tax evasion (“FATCA”), anti-terrorist financing, anti-trust, criminal prosecution (“RICO”, drug trafficking, sexual exploitation of children), privacy and data protection, derivatives swaps under Dodd-Frank Act, know your client (“KYC”), sanctions and the Volcker Rule under Dodd-Frank Act and more.

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Subject companies

• Primary impact on non-US financial institutions and their executives: banks, broker/dealers, custodians, transfer agents, insurance companies, investment funds.

• Other targeted companies include trading companies and active non-financial foreign entities.

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Enforcers• Courts no longer dominant players in setting and enforcing

blockbuster penalties.

• Federal enforcing agencies include Commodity Futures Trading Commission, US Department of Justice, US Department of the Treasury including OFAC and FinCen, Federal Deposit Insurance Corporation and the Federal Reserve. Likely other agencies.

• State enforcing agencies include New York State Department of Financial Services (“NYDFS”) as the primary player and others such as the California Department of Business Oversight.

• Emerging international alliances driven by revenue sharing, such as US and UK regulators.

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Benefits Disputed• May 20, 2015, US government: six banks agree to pay

$5.6 billion for FX manipulation and “breathtaking” anti-trust violations.

• The Economist on the same matter: “no individuals charged with any crimes and some confusion as to what exactly the banks were admitting to and [to] what effect”.

• WSJ estimates that largest banks paid $60 billion in penalties to settle allegations over past two years. Administrative v. substantive law.

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Benefits Disputed (2)• May 20, 2015 Benjamin Lawsky, NY State’s first

Superintendent of Financial Services announced Barclays to pay $2.4 billion and to fire employees for a scheme to manipulate FX. Was NYS injured?

• Fine split: NYDFS $485 million, Commodities Futures Trading Commission $400 million, US Department of Justice $710 million, US Federal Reserve $342 million, UK Financial Services Conduct Authority (FCA) $441 million. Incentives.

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JurisdictionHistorically,  becoming  subject  to  a  state’s  territorial  jurisdiction  required  a  voluntary  act  in  that  state:    entry  into,  incorporation,  acquiring  a  license  to  engage  in  a  regulated  business,  transacting,  targeting/impacting  residents,  otherwise  acting  to  create  a  jurisdictional  nexus  leading  to  being  regulated,  governed  and  punished  by  state  enforcement  authorities.  

Now,  de  minimis  nexus  such  as  use  of  email,  payment  or  communication  systems  may  be  jurisdictionally  suf?icient  over  non-­‐US  companies  and  persons,  even  without  a  US  presence.

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Jurisdiction (2)• The US dollar is the global payments currency, US

payments systems handle most of the world’s transactions, currency trading and transfers. US financial markets are a leading global funding source. US telecom and internet infrastructure dominant.

• Use of systems or actions posing a threat to their stability or to US foreign policy or security interests serve as basis for extraterritorial jurisdiction.

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Jurisdiction (3)• Emerging arguments for “worldwide” application of

US criminal law. Bitcoin law review article.

• Courts consistently opposed extraterritoriality absent statutory language or legislative history.

• No policy or national interest in a worldwide substantive law jurisdiction. Scarce resources, forces US to subsidize foreign controversies. Agency enforcement, no cost disincentives.

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Jurisdiction (4)• US Supreme Court, “United States law governs

domestically, but does not rule the world.”

• 1985, the NY Southern District Court, “We start with the proposition that the laws of any jurisdiction apply only to activities within its borders unless there is some indication to the contrary.”

• 2013, Second Circuit Court, “absent specific authority from Congress, the federal government cannot prosecute foreign activity.”

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Enforcement Standards• Enforcement standards vary broadly, from strict

liability of sanctions enforcement by the US Department of the Treasury Office of Foreign Asset Control and the US Department of Justice to substantive due process rights in civil and criminal (tort, anti-trust) litigation before the courts.

• Financial regulation enforcement, middle between strict liability and substantive due process. Effective company policies impact enforcement.

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Enforcement Standards (2)

• Administrative law and agencies materially differ from courts and substantive law.

• Agency enforcement is destabilizing, limited due process, limited instructional value. Court enforcement: stabilizing, written record.

• Agency proceedings, documentation not published. Different staff and skill sets.

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Drivers of Increased Enforcement

• Bloodlessly achieves state policy objectives. Pax Americana v. Lex Americana. No loss of soldiers. No political costs.

• Blockbuster penalties show justice done. Popular outcomes against the unpopular, unprepared, politically defenseless.

• Increasing technological data storage and processing capacity.

• Tens of billions annually go to federal and state budgets. Agencies unconcerned with compliance costs.

• Estimated $600-800 million annual FATCA revenue v. imposed annual compliance costs estimated at $8 billion+. 1000%.

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What is to Come?• Expanded scope and impact of extraterritoriality.

• Material expansion of whistleblower status and programs. Aug. 2015, broader SEC view.

• Accelerated shift from court to agency enforcement. Agencies faster, more predictable, generate revenue. De minimis jurisdiction and standing.

• More settlements rather than litigation.

• Regional pushback: adopt own extraterritorial regulations and statutes, implement regional settlement and payment systems.

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Responding to Extraterritoriality

• Government - greater national agency cooperation through IOSCO and other groups. Increased mutual regulatory substitution recognition.

• Academic - HKU and other law, compliance and policy programs, establish knowledge centers, coordinate with other academic institutions.

• Company - lobby, influence drafting, definitions, education, internal company programs.

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Extraterritorial Enforcement Drivers

• Convergence:

• Laws and regulations

• Education, training, experience sharing

• Transacting language

• Transacting currency

• Payment and Settlement infrastructure

• Communication/Internet infrastructure

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Extraterritorial Enforcement Drivers (2)

• Increased capacity, decreased cost of data:

• Gathering

• Storage

• Processing

• Mining and analysis

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Conclusion• Lex Americana, move from convergence to coercion.

• Former NYDFS leader, “Surprised how easy it was.”

• Agency staff quality, policies, procedures, penalty setting, and incentives differ materially from the courts.

• Substantive legal arguments, appeals to international law not effective in administrative law environment.

• Normative or cost arguments fail against multi billion dollar revenue streams to federal and state budgets.

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