Cross-Border M&A - Bribery and Corruption Issues in International Transactions

 

 

 

Bribery and Corruption Issues in International Transactions

 

 

Global mergers-and-acquisitions (M&A) deal activity is at its highest level since 2007, and for many strategic and financial buyers, the most attractive growth opportunities reside outside the United States. But even though the merger or acquisition of an international target can bring expansion, it can also pose risks—particularly in light of today’s increased levels of enforcement of anticorruption and anti-money-laundering laws. 

In February 2015, the US Securities and Exchange Commission (SEC) announced a settlement with Goodyear Tire & Rubber Company in connection with alleged violations of the Foreign Corrupt Practices Act (FCPA). The charges had stemmed from two of the company’s African subsidiaries, which had allegedly paid bribes to government officials in exchange for sales. The alleged improper-payment practices had been in place prior to Goodyear’s acquisition of the subsidiaries, and the SEC alleged that the company had failed to detect the practices because the company had not conducted adequate due diligence when acquiring the subsidiaries. The settlement demonstrates the importance of companies’ performing FCPA-risk-based assessments and due diligence during the M&A process.

Companies face a number of risks in connection with acquisitions. Perhaps the most significant one involves successor liability. Companies may be held liable for the target’s civil and criminal violations of such regulations as the FCPA even if the alleged misconducts occurred prior to the acquisition. There are other risks, too, such as potential violations of tax regulations or licensing controls.

Risk assessments and preacquisition due diligence

Comprehensive risk assessment and identification are pivotal components of FCPA compliance and due diligence in both the pre- and postacquisition phases. By conducting an initial risk assessment of the target company, a buyer can identify high-risk areas or possible corruption issues. Such an assessment can also help the acquiring company and its management prepare for steps it could take to improve compliance once the transaction has been completed. Information resulting from the risk assessment can also inform the due diligence process. For example, it might help identify major areas to focus on such as sales and marketing expenses, travel and entertainment expenses, and the use of consultants.

As part of the assessment, acquirers should seek to learn about the target’s business activities and transactions—for example, whether the target relies heavily on sales through joint ventures or relationships with state-owned entities. Companies should pay close attention to the target’s use of third parties in cases of potential government interaction, in such areas as importation services, obtaining of licenses, or assistance with tax issues. Other steps in a risk assessment include interviewing employees to obtain information about the business.

It’s also important that the acquirer assess the target’s internal controls and accounting systems to pinpoint areas that sometimes raise red flags, such as employees who interact with government officials. The acquirer might also want to consider auditing the target company’s transactions or reviewing its sales data for high-risk regions or from third-party channels.

By conducting adequate due diligence before the completion of a transaction, a company can mitigate its risk prior to the acquisition or merger. For example, FCPA concerns involving a target could affect the timing and successful completion of a transaction. In addition, an acquirer may be able to address potential regulatory enforcement action that could arise as a result of a problem. By performing good due diligence, an acquirer can both identify potential risk areas and deal with the value of the transaction and any postclosing issues.

Due diligence should account for both financial factors and operational risk factors. By asking certain questions at the outset, an acquiring company can be in a better position to determine the target’s risk level. Such questions may include the following..

  • Are the right processes and procedures in place to guard against potential bribes and to ensure books and records are sufficiently detailed?
  • Are safeguards in place to make sure that third-party compliance is adequate in such areas as background checks, contractual terms, and monitoring rights?
  • Are there potential issues with key customers and contracts?

Due diligence may not eliminate an acquiring company’s liability. An effective due diligence review may include requests for documents and information related to the target’s anticorruption policies, government contracts, and use of third parties. The acquirer should also evaluate the effectiveness of controls in main business areas that interact with government officials through transactional testing around key activities and government touch points. Once such information has been collected and reviewed, the acquiring company can determine whether further examination of the target’s business practices, risks, and controls is required.

In conjunction with all of the foregoing, it is important to be familiar with the guidelines and structure of country-specific laws that govern bribery and corruption. Similarly, the securing of licenses or permits and certain taxation issues in high-risk regions such as China, Africa, and Brazil can significantly affect a transaction.

If during due diligence the acquirer uncovers potential violations of anticorruption laws, next steps may involve conducting an internal investigation, requesting self-disclosure, ordering a renegotiation, or establishing future compliance-monitoring procedures. An investigation may be critical to determine the prevalence and magnitude of any issues prior to closing. As part of that process, it is vital to examine the target’s books and records and conduct interviews with frontline staff and key employees. The results of such an investigation may dictate whether the completion of the transaction might get delayed, whether the transaction’s terms need revision, or whether elevated risk levels might lead to termination of the deal. 

Limitations on due diligence

Due diligence may not eliminate an acquiring company’s liability. An effective due diligence review may include requests for documents and information related to the target’s anticorruption policies, government contracts, and use of third parties. The acquirer should also evaluate the effectiveness of controls in main business areas that interact with government officials through transactional testing around key activities and government touch points. Once such information has been collected and reviewed, the acquiring company can determine whether further examination of the target’s business practices, risks, and controls is required.

In conjunction with all of the foregoing, it is important to be familiar with the guidelines and structure of country-specific laws that govern bribery and corruption. Similarly, the securing of licenses or permits and certain taxation issues in high-risk regions such as China, Africa, and Brazil can significantly affect a transaction.

If during due diligence the acquirer uncovers potential violations of anticorruption laws, next steps may involve conducting an internal investigation, requesting self-disclosure, ordering a renegotiation, or establishing future compliance-monitoring procedures. An investigation may be critical to determine the prevalence and magnitude of any issues prior to closing. As part of that process, it is vital to examine the target’s books and records and conduct interviews with frontline staff and key employees. The results of such an investigation may dictate whether the completion of the transaction might get delayed, whether the transaction’s terms need revision, or whether elevated risk levels might lead to termination of the deal.

To be sure, FCPA risk can affect deal price or structure. A potential issue might delay the completion of a transaction—or terminate it entirely. If a transaction presses ahead, FCPA risk may need to be handled during postclosing integration. For example, it may be important to learn how licenses were obtained and maintained, how key contracts were procured, and how local tax requirements, which are usually complex, will be met.

Postclosing considerations

Once a transaction closes, the acquiring company may need to implement a compliance program or modify the existing program so as to address corruption issues. If so, the program should establish compliance program measures and obligations of the target company’s management to mitigate the risk of corrupt activity and related transactions. The program should establish proactive measures that can enable the acquirer to identify and manage related risks. And the program should include policies and procedures, employee training, and reporting mechanisms for reporting alleged misconduct, such as by way of a whistle-blower hotline or other hotlines. It’s also important that the company establish requirements related to the oversight of third parties such as business partners and agents. Such oversight can better prepare an acquiring company for future risk—and it may also increase company value.

Conclusion

Acquisitions in high-growth regions worldwide can represent significant growth opportunities and access to new markets, but they may also precipitate regulatory and business risk. Such risks may damage an acquiring company’s profitability or reputation or result in lengthy and costly investigations that disrupt management from conducting business. Entities that account for transaction risk by performing due diligence and risk assessments may become positioned to execute transactions and preserve the values of the targets. Regardless, it is important that buyers consider potential exit strategies as well, because the risk of inheriting a problem—and the costs associated with its remediation—may render a deal too risky to pursue.

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