Anti-Corruption Due Diligence In Corporate Transactions

Anti-corruption and anti-bribery issues continue to present significant risks in acquisition and investment transactions, as regulators around the globe continue robust enforcement in this area.  Both the U.S. Department of Justice (DOJ) and the U.S. Securities and Exchange Commission continue to demonstrate their shared commitment to fighting corruption in the context of transactions.  Their vigorous enforcement of the Foreign Corrupt Practices Act (FCPA) and the November 2012 joint release of A Resource Guide to the U.S. Foreign Corrupt Practices Act (the Guide) are two examples.  The Guide underscores the expectation that pre-acquisition FCPA due diligence should be conducted on deals and highlights how appropriate FCPA due diligence and post-acquisition compliance efforts can contribute to the government’s decision not to prosecute a successor company for a pre-acquisition violation. 
 
When issues surface as the result of an acquisition, the Guide indicates that the government will take two actions.  First, it will evaluate whether the acquiring company conducted pre-acquisition FCPA due diligence as part of its assessment of the acquirer’s commitment to compliance.  Second, it will evaluate whether the acquiring company promptly integrated the acquired company into its compliance program, including implementing policies, training and audits. 
 
There are four primary consequences of corruption risk that acquirers face:
 
1. Reputational risks could result in damage to the brand or difficulty obtaining funding for future investments. 
 
2. There may be civil and criminal exposure for the company, employees and board members. 
 
3. Financial risks could impact the value of the acquired company based on the loss of revenues, customers and suppliers, which were generated from or associated with bribery or corruption, as well as significant expenses associated with conducting internal investigations, responding to regulatory inquiries and paying fines. 
 
4. There may be operational risks, which may include delays in closing the contemplated transaction as a result of last-minute identification of potential issues or successor liability arising from pre-acquisition violative activity.
 
Current Regulatory Environment
 
It is interesting to note the transaction focus of recent FCPA settlement agreements with the DOJ.  These agreements lay out their expectations for anti-corruption due diligence, monitoring and reporting in the context of mergers and acquisitions. 
 
Examples of the DOJ’s expectations include:
 

• Conducting FCPA due diligence on potential acquisitions
• Reporting to the DOJ evidence of corrupt payments or weak internal controls in any company which they acquire or with which they merge
• Applying “as quickly as is practicable” their anti-corruption policies and procedures to the new entity once acquired
• Conducting an “FCPA-specific audit” of new, merged or acquired entities.

The agreements reiterate the DOJ’s view on the importance of anti-corruption compliance in the context of transactions.  Further, it is apparent that the DOJ expects that an organization will employ best practices by integrating these components into their acquisition and compliance programs.  These examples continue to be very similar to the minimum standards laid out by the UK Ministry of Justice in the 2010 UK Bribery Act guidance, including proportionate procedures, top-level commitment, risk assessment, due diligence, communication and monitoring. 
 
Are the Procedures Sufficient?
 
As it relates to conducting anti-corruption due diligence on potential acquisitions, the question: “How much is enough?” is a common refrain.  We often suggest a phased approach, starting with high-level procedures that can help determine if additional digging is warranted.  The first phase also typically includes performing background checks on target companies, including key individuals at the target such as owners and executives, and may extend to identified third parties and agents acting on the target company’s behalf.  This phase also includes interviewing key executives (e.g., legal, compliance and finance), reviewing anti-corruption policies and procedures, and performing a high-level risk assessment. 

The purpose of the high-level risk assessment is to gain a high-level understanding of the target’s operations, use of third parties and agents, logistics, customer base and expenses, among other areas.  Potential red flags (i.e., indications of potential corruption) identified influence the decision to move to a second phase.  The second phase may include transaction testing, electronic document review, site visits and additional interviews.  Depending on the findings and whether the transaction is consummated, a third phase may involve the implementation and monitoring of a post-closing anti-corruption compliance program.  This would include assisting in the development or enhancement of existing anti-corruption policies and training.
 
Does the Transaction Present Increased Corruption Risk?
 
The mere location of a company’s operations or business dealings can have an impact on the potential corruption risk.  For example, certain markets, often referred to as “BRIC” – Brazil, Russia, India and China – are large, rapid-growth markets that have a high level of perceived corruption.  More recently, we have seen the list of “EAGLE” - Emerging and Growth Leading Economies - countries expanded beyond BRIC to include Egypt, South Korea, Indonesia, Mexico, Turkey and Taiwan.  The Transparency International Corruption Perceptions Index(1) that is published annually, provides a corruption perception rating for each country around the world and is a good reference to consider during anti-corruption due diligence. 
 
Additionally, the target company’s industry may raise the corruption risk associated with the transaction.  Industries with a high level of government regulation or interaction typically should require a greater amount of scrutiny.  In recent years, US government regulators have often focused on certain industries, including extractive industries (i.e., oil and gas, mining), medical device, pharmaceutical and financial services.  More recently, industries have also included retail and consumer goods as well as media and entertainment.  Potential targets in these industries would typically get additional pre-acquisition scrutiny.
 
An increasingly less common approach taken by acquirers assumes bribery and corruption issues can be fixed post-closing.  This usually involves a check-the-box approach to pre-acquisition anti-corruption due diligence.  The risks of this approach are very high and can result not only in failing to appropriately identify corruption risks but also lead to the nullification of the business reasons to complete the transaction, as well as potential criminal behavior by the acquirer itself.  Not adequately considering bribery and corruption diligence brings to mind the age-old warning: caveat emptor, or let the buyer beware.
 
The views expressed herein are those of the authors and do not necessarily reflect the views of Ernst & Young LLP. 
 
Greg Wolski is a partner at Ernst & Young LLP and the leader of Ernst & Young LLP’s Transaction Forensics team within its Fraud Investigation and Dispute Services practice.  He can be reached at gregory.wolski@ey.com or +1 312 879 3383. 
 
Virginia Adams is a partner at Ernst & Young LLP on the Transaction Forensics team.  She can be reached at virginia.adams@ey.com or +1 212 773 7475.