The 2012 enforcement action against FalconStor Software, Inc. stands as a stark reminder that corporate ambition, when unchecked by ethics, can lead to severe legal and financial disaster. This case wasn't about a simple sales oversight; it was an egregious, calculated scheme of commercial bribery coupled with a deep-seated effort to deceive the public and regulators.
A decade later, let's revisit this scandal involving the Long Island-based company, the core laws it violated, and the lasting consequences of trying to purchase contracts instead of earning them.
The Crime: Buying Loyalty with Stock and Gambling Money
Between 2007 and 2010, FalconStor, eager to secure licensing contracts worth over $12 million with J.P. Morgan Chase, engaged in a systematic bribery operation. This involved giving J.P. Morgan Chase executives over $300,000 in value, including:
Restricted Stock and Options: Fraudulently granted to relatives of the executives.
Cash Equivalents: Large deposits into Las Vegas gambling accounts.
Perks: Golf club memberships, gift cards, and other benefits.
The key to the crime's severity was the attempt to conceal it. FalconStor’s books and records—the primary source of information for its investors—were falsified, recording the bribes as legitimate "compensation to an advisor" or "employment bonuses." This concealment transformed the commercial bribery into a major securities violation.
The Laws Violated: Bribery and Securities Fraud
FalconStor's actions triggered both criminal prosecution by the U.S. Attorney’s Office and a civil enforcement action by the Securities and Exchange Commission (SEC), demonstrating the government's dual-pronged approach to corporate corruption.
1. Commercial Bribery and Conspiracy
The core crime was conspiracy to commit commercial bribery. While the high-profile Foreign Corrupt Practices Act (FCPA) deals with bribing foreign officials, domestic commercial bribery is typically prosecuted under federal laws like the Travel Act, Mail Fraud, and Wire Fraud statutes, which prohibit using interstate commerce (wires, mail, travel) in furtherance of an unlawful activity, such as bribery. The criminal complaint charged FalconStor with conspiring to pay the bribes to obtain a commercial advantage.
2. Securities Law Violations
The act of lying on the company's financial statements brought in the SEC, which charged FalconStor with violating key provisions of the Securities Exchange Act of 1934:
Books-and-Records Provision ($13(b)(2)(A)): This provision requires publicly traded companies to make and keep accurate books, records, and accounts that, in reasonable detail, accurately and fairly reflect the company’s transactions. By mischaracterizing bribes as legitimate compensation, FalconStor knowingly violated this.
Internal Controls Provision ($13(b)(2)(B)): This requires companies to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are executed and recorded properly. FalconStor's lack of controls allowed the fraudulent payments to occur and be concealed.
Antifraud Provisions: By issuing false or misleading public statements (like earnings releases) that did not disclose the corruption and artificially inflated the company’s revenue and financial health, the company also ran afoul of rules designed to prevent fraud on investors.
The Consequences: Penalties and Institutional Change
FalconStor ultimately entered into a Deferred Prosecution Agreement (DPA) with the DOJ and a final judgment on consent with the SEC, resolving both cases without the company suffering a corporate criminal conviction. The price for this was substantial, totaling $5.8 Million in financial penalties and forfeiture:
Criminal Forfeiture: Under the DPA, the company paid $2.9 Million in criminal forfeiture to the U.S. government.
Civil Penalty: The civil action brought by the SEC resulted in an additional $2.9 Million in civil monetary penalties.
Beyond the Fine: The Mandate for Reform
The true long-term consequence came in the form of required institutional restructuring designed to ensure non-recidivism. As part of the DPA, FalconStor had to:
Terminate Culpable Employees: Immediately fire or accept the resignation of all officers and employees responsible for the crimes.
Separate Leadership Roles: Divide the roles of Chief Executive Officer and Chairman of the Board of Directors.
Enhance Oversight: Create a Chief of Compliance position reporting to the Board's Audit Committee.
Implement Strict Gift Policies: Institute mandatory and strict limits on gifts, travel, and entertainment for all personnel, forbidding any gifts intended to influence or obligate a recipient.
This case serves as a powerful illustration that regulators prioritize not only punishment through fines but also fundamental governance reform to protect investors and uphold the integrity of the marketplace. For corporations, the cost of corruption isn't just the settlement; it's the total overhaul of leadership and culture required to regain the public's trust.
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