Global M&A deal activity is at its highest level since 2007. Takeovers of European companies totalled US$336 billion in the second quarter, up 19 per cent from last year. Of the five biggest deals globally so far this year, two have come from Europe: Royal Dutch Shell PLC’s US$70 billion agreement to acquire BG Group PLC and Monsanto Co’s US$45 billion bid to buy Syngenta AG. For many European strategic and financial buyers, the most attractive growth opportunities reside outside the eurozone. 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 anti-corruption and anti-money laundering laws.
The legal climate against corruption is changing rapidly, with many European countries enacting anti-bribery legislation, and which will amplify the due diligence requirement for any cross-border M&A transactions. Last year saw the first conviction obtained by the UK’s Serious Fraud Office under the UK Bribery Act, though its extraterritorial reach has not yet been tested by a UK court and this did not involve a merger transaction. The Act, which took effect in July 2011, was viewed as complementary legislation to the US Foreign Corrupt Practices Act (FCPA), first passed in 1977. In terms of jurisdictional reach and worldwide impact, the FCPA remains the most influential piece of anti-corruption legislation brought to bear on cross-border M&A transactions involving US companies or their subsidiaries. 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 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. With the global wave of anti-corruption laws on the books, even in countries where corruption is widely seen as a problem, such as China, Brazil and India, these risk assessments must take on a global scope, or at least pass muster with the laws of the countries hosting the companies involved in any such transaction.
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 the FCPA or other anti-corruption laws, 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 pre-acquisition due diligence
Comprehensive risk assessment and identification are pivotal components of the FCPA and global complementary, or even more stringent, anti-corruption legal compliance and due diligence in both the pre and post-acquisition 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 licences, or assistance with tax issues. Other steps in a risk assessment include interviewing employees to obtain information about the business. It is 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, UK Bribery Act or EU member states’ anti-corruption statute-related 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 post-closing 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?
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, particularly in countries that have recently strengthened their anti-bribery laws, from the United Kingdom to China, Brazil and India. Securing licences or permits in these three countries, as well as certain taxation issues in high-risk regions can significantly affect a transaction. If during due diligence the acquirer uncovers potential violations of anti-corruption laws, the 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 and UK and EU anti-corruption regulatory 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 post-closing integration. For example, it may be important to learn how licences were obtained and maintained, how key contracts were procured, and how local tax requirements, which are usually complex, will be met.
Once a transaction closes, the acquiring company may need to implement a compliance programme or modify the existing programme so as to address corruption issues. If so, the programme should establish measures and obligations of the target company’s management to mitigate the risk of corrupt activity and related transactions. The programme should establish proactive measures that can enable the acquirer to identify and manage related risks. And the programme should include policies and procedures, employee training, and reporting mechanisms for reporting alleged misconduct, such as by way of a whistleblower hotline or other hotlines. It is 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.
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, which is now an area of legislative attention in both western Europe and in key emerging markets. 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. The SEC’s settlement with Goodyear illustrates the power and importance of both conducting thorough anti-corruption due diligence prior to an acquisition and making sure that FCPA and similar UK and local anti-corruption training and compliance programmes are put in place promptly after completion of the acquisition.
* The information in this chapter is accurate as of May 2016.
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