Earlier today, the U.S. Attorney’s Office for the Eastern District of New York filed a criminal complaint against FalconStor Software, Inc. (“FalconStor”) alleging that the company conspired to pay more than $300,000 in bribes to executives of J.P. Morgan Chase Bank, N.A. (“J.P. Morgan Chase”) to obtain over $12 million in electronic storage licencing contracts. FalconStor was also charged with conspiring to falsify its corporate books and records to cover up the bribery scheme.

Also this morning, FalconStor entered into a deferred prosecution agreement with the U.S. Attorney’s Office in which FalconStor admitted the allegations in the complaint and agreed to forfeit to the United States $2.9 million. The United States Securities and Exchange Commission also filed a civil enforcement action against FalconStor and a proposed final judgment on consent in which FalconStor agreed to pay an additional $2.9 million in civil penalties.

The criminal complaint and deferred prosecution agreement were announced by: Loretta E. Lynch, United States Attorney for the Eastern District of New York, and Janice K. Fedarcyk, Assistant Director-in-Charge, Federal Bureau of Investigation, New York Field Office.

FalconStor is a publicly traded company based in Melville, New York, and provides data storage and protection products and technology. As of December 31, 2011, FalconStor had 468 full-time and part-time employees located in the United States, Asia and Europe.

The Bribes

As alleged in the criminal complaint, between October 2007 and September 2010, FalconStor and its officers and employees arranged for J.P. Morgan Chase executives to receive over $300,000 in restricted FalconStor shares, stock options, gambling vouchers, gift cards, golf memberships and golf-related benefits. One J.P. Morgan Chase executive received 25,000 FalconStor stock options and 40,000 restricted FalconStor shares, both fraudulently granted in the name of the executive’s brother. FalconStor also authorized a $240,000 bonus to be paid to one of its salespeople directing that $100,000 be deposited into a gambling account in Las Vegas, Nevada, for the benefit of the same J.P. Morgan Chase executive. The executive and other employees who received the FalconStor bribes were employed in J.P. Morgan Chase’s Columbus, Ohio, Global Technology Infrastructure division, which is responsible for purchasing J.P. Morgan Chase’s electronic storage products.

The bribes, including the grants of the stock options and restricted shares, were recognized in FalconStor’s books and records, but were falsely recorded as “compensation to an advisor” or as “employment bonuses.”

The Licensing Contracts

In exchange for the more than $300,000 in bribes, between March 2008 and November 2009, FalconStor and J.P. Morgan Chase entered into three contracts for the licensing of FalconStor’s storage software and related maintenance services. The contracts totaled $12.2 million and represented approximately 7% of FalconStor’s revenue during the period 2008-2009.

The Deferred Prosecution Agreement

Pursuant to the deferred prosecution agreement filed in court today, FalconStor has admitted and accepted responsibility for its crimes, has agreed to pay $2.9 million in forfeiture to the federal government, has agreed to continue to cooperate with the government, and has agreed to institute numerous corporate compliance reforms.

The deferred prosecution agreement acknowledges that FalconStor has terminated or accepted the resignation of officers and employees who were responsible and criminally culpable for the crimes. The deferred prosecution agreement requires the company to institute and maintain several institutional changes, including dividing the roles of Chief Executive Officer and Chairman of the Board of Directors and creating the position of Chief of Compliance, whose appointment must be approved by the Board of Directors, and who reports to the Board’s Audit Committee. Additionally, FalconStor has agreed to revise its Code of Conduct and Travel and Entertainment policies to mandate the disclosure and clear delineation on expense reports of all gifts, travel and entertainment; prohibit all gifts to government personnel including travel and entertainment; prohibit all gifts to non-governmental personnel intended to influence or obligate the recipient to do business with FalconStor or otherwise obtain favorable treatment; prohibit all gifts of cash or cash equivalents; prohibit tangible gifts over $100 and intangible gifts over $200; and require the provision of summaries of expense reports to the Controller of the Company.

FaclonStor has agreed to implement additional training initiatives, documentation of equity grants and revisions to its compensation procedures to guard against recidivism. To ensure FalconStor’s compliance with the terms of the agreement, the government will defer any prosecution of FalconStor for a period of 18 months. If, after the 18-month period expires, FalconStor has remained in compliance, the government will dismiss the criminal charges.

“Rather than let their product compete fully and fairly in the marketplace, FalconStor resorted to bribery and graft to win important contracts, in a scheme that reached the highest levels of the company. Such conduct corrodes the integrity of a fair and open marketplace and destroys the public’s confidence in our economic system. This Office is committed to identifying corporate corruption in all of its manifestations on both domestic and foreign soil, and to eradicating the reprehensible practices of bribery and graft. Corporations should also heed this warning – hiding bribes in fraudulent books and records only exacerbates the crime and the punishment,” stated United States Attorney Lynch. Ms. Lynch expressed her grateful appreciation to the SEC and the New York County District Attorney’s Office for their cooperation during the investigation.

FBI Assistant Director-in-Charge Fedarcyk stated, “Corporate corruption – in all of its forms – places the American public at a significant disadvantage and allows for the proliferation of unscrupulous practices in the marketplace. Investigating this type of criminal activity is some of the most important work the FBI does, and today we remind all corporations of our out-and-out commitment to abolish this type of criminal activity.”

The government’s case is being prosecuted by Assistant United States Attorneys Tanya Hill, Patrick Sean Sinclair and James McGovern.

This case was brought in coordination with President Barack Obama’s Financial Fraud Enforcement Task Force. President Obama established the interagency Task Force to wage an aggressive, coordinated and proactive effort to investigate and prosecute financial crimes. The Task Force includes representatives from a broad range of federal agencies, regulatory authorities, inspectors general, and state and local law enforcement who, working together, bring to bear a powerful array of criminal and civil enforcement resources. The Task Force is working to improve efforts across the federal executive branch, and with state and local partners, to investigate and prosecute significant financial crimes, ensure just and effective punishment for those who perpetrate financial crimes, combat discrimination in the lending and financial markets, and recover proceeds for victims of financial crimes.