Business Crimes Hotline

DISTRICT OF COLUMBIA

Malpractice Suit Against Sidley Austin LLP

On June 6, Watts Water Technologies Inc. (Watts), a Massachusetts-based manufacturer of water valves and other water-related products, filed a three-count complaint in the Superior Court for the District of Columbia against Sidley Austin LLP (Sidley), based on the law firm's role in conducting legal due diligence in connection with the potential acquisition of a Chinese company by Watts in 2004. Activities at the Chinese company, Changsha Valve Works, which was ultimately acquired by Watts in 2005, were the basis for Watts' Oct. 13, 2011 settlement of FCPA-related charges with the Securities and Exchange Commission (SEC or Commission), whereby the SEC issued a cease-and-desist order against Watts and the company paid $3.7 million in total sanctions, including disgorgement, pre-judgment interest, and a civil monetary penalty. In addition, a former Watts employee, Leesen Chang, was pursued individually for his role in the matter.

According to the company's complaint, in 2004, Watts considered buying Changsha in order to expand its China operations beyond manufacturing, to include contracting and other water-related services to the expanding Chinese infrastructure market, which necessarily would involve contracting ' via subsidiaries ' with state-owned entities (SOEs) in China. When Changsha was identified as an acquisition target, Sidley, serving as counsel to Watts since 2002, was tasked with vetting the legal risks of the acquisition, including potential FCPA liability, for which Watts paid the firm more than $200,000.

In the course of the due diligence, Changsha produced a document to Sidley detailing Changsha's written kickback policy. In part, the policy provided for kickbacks to specific Chinese government and SOE officials, as a means for securing government contracts. Sidley allegedly did not provide a copy of this policy to Watts, nor make mention of the policy during any of its due diligence reporting to the company.

Eventually, Watts agreed to buy Changsha for $9 million in October 2005. During an FCPA and anti-corruption training program in the spring of 2009, sales managers from the acquired entity informed Watts of potential FCPA violations, based on the written kickback policy. As part of a subsequent internal investigation conducted by law firm Paul Hastings, the written kickback policy was discovered within the original due diligence files of Sidley. Paul Hastings also interviewed Zhengyu Tang, the Sidley partner who led the original due diligence project, who stated that the written kickback policy was a “red flag” indicative of FCPA violations, and that, if discovered during the due diligence, FCPA issues should have been disclosed to the client, Watts. The company stated that, had it known of the written kickback policy at that time, it would not have completed the Changsha acquisition.

As a result of its internal investigation, Watts initiated a voluntary disclosure to the Department of Justice (DOJ) and SEC that culminated in the company's 2011 settlement with the Commission. According to the company, during the course of its investigation, it was forced to sell the Changsha entity at a “substantial loss.” Watts is seeking at least $100,000 in damages, along with legal fees.

Business Crimes Hotline and In the Courts were written by Associate Editors Matthew J. Alexander and Jamie Schafer, respectively. Both are associates at Kirkland & Ellis LLP, Washington, DC.

DISTRICT OF COLUMBIA

Malpractice Suit Against Sidley Austin LLP

On June 6, Watts Water Technologies Inc. (Watts), a Massachusetts-based manufacturer of water valves and other water-related products, filed a three-count complaint in the Superior Court for the District of Columbia against Sidley Austin LLP (Sidley), based on the law firm's role in conducting legal due diligence in connection with the potential acquisition of a Chinese company by Watts in 2004. Activities at the Chinese company, Changsha Valve Works, which was ultimately acquired by Watts in 2005, were the basis for Watts' Oct. 13, 2011 settlement of FCPA-related charges with the Securities and Exchange Commission (SEC or Commission), whereby the SEC issued a cease-and-desist order against Watts and the company paid $3.7 million in total sanctions, including disgorgement, pre-judgment interest, and a civil monetary penalty. In addition, a former Watts employee, Leesen Chang, was pursued individually for his role in the matter.

According to the company's complaint, in 2004, Watts considered buying Changsha in order to expand its China operations beyond manufacturing, to include contracting and other water-related services to the expanding Chinese infrastructure market, which necessarily would involve contracting ' via subsidiaries ' with state-owned entities (SOEs) in China. When Changsha was identified as an acquisition target, Sidley, serving as counsel to Watts since 2002, was tasked with vetting the legal risks of the acquisition, including potential FCPA liability, for which Watts paid the firm more than $200,000.

In the course of the due diligence, Changsha produced a document to Sidley detailing Changsha's written kickback policy. In part, the policy provided for kickbacks to specific Chinese government and SOE officials, as a means for securing government contracts. Sidley allegedly did not provide a copy of this policy to Watts, nor make mention of the policy during any of its due diligence reporting to the company.

Eventually, Watts agreed to buy Changsha for $9 million in October 2005. During an FCPA and anti-corruption training program in the spring of 2009, sales managers from the acquired entity informed Watts of potential FCPA violations, based on the written kickback policy. As part of a subsequent internal investigation conducted by law firm Paul Hastings, the written kickback policy was discovered within the original due diligence files of Sidley. Paul Hastings also interviewed Zhengyu Tang, the Sidley partner who led the original due diligence project, who stated that the written kickback policy was a “red flag” indicative of FCPA violations, and that, if discovered during the due diligence, FCPA issues should have been disclosed to the client, Watts. The company stated that, had it known of the written kickback policy at that time, it would not have completed the Changsha acquisition.

As a result of its internal investigation, Watts initiated a voluntary disclosure to the Department of Justice (DOJ) and SEC that culminated in the company's 2011 settlement with the Commission. According to the company, during the course of its investigation, it was forced to sell the Changsha entity at a “substantial loss.” Watts is seeking at least $100,000 in damages, along with legal fees.

Business Crimes Hotline and In the Courts were written by Associate Editors Matthew J. Alexander and Jamie Schafer, respectively. Both are associates at Kirkland & Ellis LLP, Washington, DC.