Anti-bribery and anti-corruption due diligence considerations in mergers and acquisitions
February 2013 | SPECIAL REPORT: CORPORATE FRAUD & CORRUPTION
Financier Worldwide Magazine
Although there continues to be uncertainty about the global economic outlook, many companies are taking an opportunistic view towards acquisitions, with less focus on blockbuster deals and more focus on extending existing businesses and filling strategic gaps. US companies continue to pursue emerging markets, especially in China, India, Brazil and Mexico and increasingly throughout Asia and Africa. European companies are increasingly trending towards deals in China, Brazil, India and Eastern Europe. Globally, the highest interest is expected to be in mining and metals, consumer products, industrial products, energy, life sciences and financial services. The majority of these sectors are characterised by high-value investment and significant government interaction and regulation, both of which provide opportunities and incentives for corruption.
The combined inherent risk of the geographic and industry focus described above presents significant bribery and corruption risks that will need to be rigorously addressed under the current international regulatory landscape. Cross-border transactions present unique risks requiring careful consideration, including foreign and domestic government regulations that often leave room for misinterpretation. If not considered and addressed adequately, companies expose themselves to these and other significant risks in all phases of a transaction.
Many times in recent years, failure to perform forensic due diligence has resulted in the failure to identify and address Foreign Corrupt Practices Act (FCPA) violations. Each time, there was a significant impact on the value of the target company, and in at least one case, the entire investment was written off, leading to litigation against the principals of the target company.
The US Department of Justice (DOJ) and the Securities and Exchange Commission (SEC) have demonstrated their shared commitment to fighting bribery and corruption through their continued vigorous enforcement of the FCPA and their recent joint release of A Resource Guide to the U.S. Foreign Corrupt Practices Act (the Guide) on 14 November 2012, which details the approach and priorities of the DOJ and SEC in FCPA enforcement. Specifically related to mergers and acquisitions, the Guide further re-emphasises the view that pre-acquisition FCPA due diligence should be conducted. Further, in May 2012, Transparency International UK published a guidance document discussing the importance of forensic due diligence for transactions.
Along with the joint efforts of the SEC and the DOJ in the US, the Serious Fraud Office (SFO), the UK’s chief enforcer and monitor of the Bribery Act, has increased cooperation and collaboration with other foreign regulators, including in the US, where the SFO has had some “frank and fair discussions with the Securities and Exchange Commission”, according to SFO Director, David Green. The SFO has also commented on its “near daily interaction with the DOJ and the SEC with respect to ongoing global bribery and corruption matters”.
One example of cross-border cooperation is the US DOJ investigation into Innospec Inc. for sanctions and corruption offences. The DOJ referred the case to the SFO in October 2007, and the SFO successfully prosecuted the company in 2010. Similarly, in April 2010, the SFO worked with the DOJ to successfully prosecute the former Director of Marketing at DePuy, after DePuy was acquired and FCPA violations were identified.
Under the provisions of the Bribery Act, there are four offences, which specifically include the failure by a commercial organisation to prevent bribery in the course of business. With respect to this offence, there is a strict liability offence where an organisation must demonstrate it had in place ‘adequate procedures’ designed to stop incidences of corruption. In reference to mergers and acquisitions activity, the Bribery Act can impact associated persons, therefore potentially triggering a liability for failing to prevent bribery.
An offence may be committed if the acquirer knowingly allows or ignores corruption activities of a target. Further, an offence may be committed where the diligence process has revealed potential bribery concerns of the target that remain unresolved post-acquisition. Prosecution against an acquirer is possible where the acquirer was actively involved in the management of the company or as a board member. It is therefore likely that management of an investment portfolio company could be considered ‘associated’ for purposes of the Bribery Act. Similarly, if the acquirer is aware of ongoing bribery and failed to perform forensic due diligence to facilitate completion of a purchase, the conduct may be viewed by the SFO as intent to participate in corruption.
Failure by the acquirer to discover corruption will not necessarily make an individual or company liable for a bribery offence. If bribery is identified post-acquisition, the acquirer may be able to rely on the ‘adequate procedures’ defence, as defined by the Bribery Act, if it can demonstrate that it has conducted comprehensive forensic due diligence.
In the US, as discussed in the Guide, actions have been initiated against successor companies in limited circumstances that generally involve “egregious and sustained violations or where the successor company directly participated in the violations or failed to stop the misconduct from continuing after the acquisition”. As further described in the Guide, this is particularly important to acquirers given that successor liability “prevents companies from avoiding liability by reorganizing”.
The Guide provides examples where forensic due diligence and post-acquisition compliance efforts resulted in the decision not to prosecute successor companies for pre-acquisition violations. When issues surface as a result of an acquisition, the Guide indicates that an evaluation of whether the acquiring company conducted timely and appropriate pre-acquisition forensic due diligence will be a part of the assessment of the acquirer’s commitment to compliance.
In addition, consideration will be given as to whether the acquiring company promptly integrated the acquired company into its compliance program, including implementation of policies, training and audits.
At present, in the UK, there have been no corporate prosecutions under the Bribery Act and only a handful of non Bribery Act corruption prosecutions. However, according to a March 2012 report from the Organization for Economic Co-operation and Development, the SFO has noted a recent increase in its efforts and focus in this area, including 11 active bribery and corruption investigations and an additional 18 cases under consideration.
In November 2012, Abbot Group Limited, a Scottish drilling company, accepted that it had benefited from corrupt payments made in connection with a contract entered into by one of its overseas subsidiaries. The company agreed to pay a £5.6m fine under Proceeds of Crime legislation. The Abbot case is an example of a new owner acquiring an existing bribery concern as part of its acquisition. The contract was entered into in 2007, the private equity acquisition was in 2008, and the tax audit that led to discovery of the bribe was in 2011. Although the Abbot case was reported and settled under Scottish law, it is expected that the outcome will help shape how similar cases are to be prosecuted under the Bribery Act.
Increased enforcement around FCPA and the UK Bribery Act requires companies looking to acquire or sell a business with cross-border activity to be aware of bribery and corruption risks. Companies making global acquisitions need to have a robust forensic due diligence process that includes analysis of a target company’s historical financial and accounting records as well as ownership structure, customer base, supply chain and other third-party relationships, both public and private, with contractors, vendors, agents, etc. Addressing these risks requires global knowledge of fraud and corruption risks, specialised investigative and industry experience, and a thorough understanding of the concerns and needs of each party to a transaction.
Although all transactions involve some uncertainties and inherent risks of operating in the global marketplace, companies need to adequately manage and minimise such exposure so as to not impact the value of the deal to stakeholders and run afoul of regulators. Effective management starts with understanding the regulatory environment and structuring due diligence procedures that are adequate and proportionate to maintain deal value and the company’s reputation.
Gregory E. Wolski is a partner, and Richard I. Thomas is a principal, of Ernst & Young LLP, a US member firm of Ernst & Young Global Ltd. Christopher D. Richardson is a partner of Ernst & Young LLP, the UK member firm. Mr Wolski can be contacted on +1 (312) 879 3383 or by email: firstname.lastname@example.org. Mr Richardson can be contacted on +44 (0) 207 951 0051 or by email: email@example.com. Mr Thomas can be contacted on +1 (212) 773 8932 or by email: firstname.lastname@example.org.
© Financier Worldwide
Gregory E. Wolski and Richard I. Thomas
Ernst & Young LLP