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June 28, 2017

The Enforcement Background

On September 12, 2016, the U.S. Securities and Exchange Commission (SEC) issued a declination to Harris Corporation resulting from the SEC's investigation of the global communications company for alleged violations of the Foreign Corrupt Practices Act. On the same day, the SEC announced that the former head of Harris' China subsidiary, Jun Ping Zhang had agreed to pay a $46,000 civil penalty for engaging in an alleged bribery scheme that he had concealed from Harris. According to the SEC, the alleged bribes in the amount of $200,000 and $1 million in improper gifts were given to Chinese government officials who awarded $9.6 million in contracts to the Harris’ China subsidiary. The SEC's decision to decline to prosecute Harris was similar with the November 2015 declination issued to Harris by the U.S. Department of Justice.  The SEC stated that Harris achieved this resolution as a result of its due diligence in advance of acquiring the China subsidiary, its integration of the subsidiary after the closing, and its voluntary disclosure, remediation and cooperation.

Adequate pre-acquisition due diligence, self-reporting, and future compliance may mitigate a buyer's risk of acquiring an unexpected liability or otherwise overpaying for the target. In a time when anti-corruption enforcement is a top priority for governments across the globe, establishing a due diligence plan and proceeding accordingly is critical when mergers and acquisitions reach across borders.

The year 2016 was a very active year for mergers and acquisitions and even though there continues to be uncertainty about the global economic outlook, many companies are taking an opportunistic view towards acquisitions, and deal activity is expected to remain strong in 2017 and 2018. U.S. companies continue to pursue emerging markets, especially in China, India, Brazil and Mexico, and increasingly, throughout Asia and Africa. European companies are also increasingly looking towards deals in China, Brazil, India and Eastern Europe. The markets identified as the most active for mergers and acquisition are technology, oil and gas, pharmaceutical/biotechnology, mining and metals and financial services. Most, if not all, of these industries are rife with government interaction and regulation, both of which provide significant opportunities and incentives for corruption. 

Anti-bribery and anti-corruption due diligence is now a standard component of a merger or acquisition, as both the DOJ and SEC have undertaken several enforcement actions based on due diligence failures, pre- and post-closing.

Recently, the SEC announced that a U.S.-based multinational confectionery company and its acquired subsidiary agreed to settle Foreign Corrupt Practices Act (FCPA) charges relating to allegations of bribery in India. The company will pay $13 million to settle the charges arising from payments the subsidiary made to a consultant in India to obtain licenses and approvals for a factory. The SEC alleged due diligence failures by both the company and the subsidiary. Allegedly, the subsidiary failed to conduct adequate diligence on the consultant, whereas the company failed to conduct adequate diligence on the subsidiary, both before and after its acquisition.

The Importance of Anti-Bribery Due Diligence in Mergers and Acquisitions

Anti-bribery due diligence needs to be integrated from the start of the process to run alongside legal, financial and other pre-deal due diligence.

Anti-bribery due diligence can help purchasers to manage their investment risk in transactions more effectively; however, it is often not undertaken, neglected, or not properly allocated with sufficient time and resources. A 2011 survey found that: “Despite the many recent examples of the perils of ignoring the fraud and corruption dimension of these assessments, a fifth of companies still do not consider it as part of M&A due diligence, and a quarter never consider it in a post-acquisition review.[1] In a more recent survey it was reported that just over half of all companies that exited investments in Africa, Brazil, China, Eastern Europe or India cited fraud, bribery and corruption risks as a contributory factor.[2]

To demonstrate compliance, anti-bribery and corruption checks must be factored into the overall due diligence exercise, particularly in high-risk jurisdictions. Pre-acquisition anti-bribery due diligence should alert prospective purchasers to red flags, such as large or unexplained payments, lavish gifts or entertainment and inflated expenses claims, notably those relating to government officials.

The failure to conduct pre-acquisition anti-corruption due diligence can lead to severe legal and financial consequences, as well as reputational damage, for both buyers and sellers.

For buyers, anti-corruption diligence can be especially critical because, under principles of successor liability, a buyer may be held liable for pre-closing bribery and corruption violations by the target. And if illegal conduct by the acquired company continues post-closing, the buyer can be held directly liable, even if it had no knowledge of or participation in the violation. Some of the largest FCPA fines resulted from successor liability, including a 2009 case where a multi-national oilfield services company was fined more than $400 million over bribes paid to Nigerian government officials to win construction contracts.

For sellers, putting aside any individual liability concerns (which would survive a transfer of ownership or control), about potential pre-closing violations can strongly influence a deal’s value, if not threaten the entire transaction. Sellers should also "clean house" to find and resolve potential violations of anti-corruption laws before a buyer learns of them and walks away, as a global aerospace corporation did after discovering that one of its targets had previously made $3.5 million in improper payments. Although the buyer gave the target eight months to obtain assurances from the DOJ or reach a plea agreement, the target failed to satisfy the conditions, prompting the buyer to terminate the acquisition.

Conducting Your Pre-Deal Anti-Corruption Due Diligence

Alvarez & Marsal Disputes and Investigations’ anti-corruption due diligence practice typically covers the business ethics and practices of a company or companies and their principals, their economic and political standing in the local business community, their relationships with the government and the various agencies of government. The practice also identifies any signs of financial or tax difficulties, past or current criminal or civil legal problems and any evidence of bribery or other forms of corruption.

The purpose of pre-deal anti-corruption due diligence within M&A transactions is to assess corruption risk associated with the target company and its officers, directors, principals or shareholders and includes the following: 

  • Identification of corrupt behavior (have bribery, kickbacks, illicit payments taken place historically);
  • Determination of the commitment of the board and top management of the target to countering bribery;
  • Review of the target entity’s anti-corruption compliance program and internal enforcement controls. (While most companies have anti-corruption policies, the difficult task for the buyer is determining whether the target has merely a "paper program" or a truly effective program);  
  • Background investigations consisting of reviews of public records, local language news media reports, other open source intelligence, and specific reputation and confidential source information on the target company and principals;
  • An assessment of the employees’ and third parties’ (subcontractors, suppliers, agents) understanding of the target’s anti-corruption compliance program (obtained through A&M’s Anti-Bribery and Anti-Corruption Survey and management interviews);
  • An understanding of anti-bribery laws/regulations in both the host and target company’s respective country; (It is important to establish the complete picture of laws applicable to the business and industry of operation and to thoroughly investigate whether the business meets these compliance requirements)
  • Transaction testing and reviews to include; existing contracts (directly or indirectly with government agencies), sale reports, supply chain, commission payments.

The execution of the anti-bribery due diligence at the onset of the M&A process, allows the purchaser or investor to identify and mitigate (pre-closing) specific risks associated with the target entity. 

The Department of Justice and SEC “encourage companies to conduct pre-acquisition due diligence.” [3]As described in A&M’s resource guide, conducting pre-acquisition FCPA diligence can provide a range of benefits to both buyers and sellers that lays the foundation for a buyer to rapidly and successfully integrate the target company into its operations post-closing, including reducing the risk that the target company, once acquired. As part of our process, we will continue to engage in any conduct that violates the FCPA.

Companies that adopt a robust pre-deal anti-corruption due diligence program based on the above principles should be ideally positioned to take full advantage of the opportunities for cross-border transactions while avoiding unwanted regulatory scrutiny.

[1] Driving ethical growth – new markets, new challenges, 11th Global Fraud Survey, Ernst & Young, 2011

[2] E&Y, 14th Global Fraud Survey 2016