Money Laundering and the M&A Sector

By Richard Parlour, Financial Markets Law International www.fmli.co.uk

Posted: 22nd October 2013 09:22

Money laundering deterrence seems to have taken a bit of a back seat in certain quarters recently.  Many organisations have focused on economic survival, and that has meant cutting what are perceived as “costs”, without much thought being given to the benefits which are being axed by the same stroke of the CFO’s pen.  At the same time, the corporate finance market has been almost dormant for quite some time and M & A activity has been thin on the ground. 
 
During the economic downturn, the criminals have been hard at work, however.  The threat from money laundering has increased and there have been some dramatic fines for those caught up in laundering schemes.  Of course, money laundering relates to a number of underlying crimes, so it is important to look at what the trends here have been too.  Drug trafficking continues unabated, albeit using new routes.  Cyber threats have expanded exponentially to pose the same level of threat as global drug trafficking.  Organised crime groups have become more insidious and international.  Industrial espionage is both growing and left unchecked.  The recent focus on anti-bribery and corruption has misfired and produced little significant change. 
 
It is not just the level of threat which has increased, but also the level of vulnerability.  There is considerable evidence that firms are not spending sufficient resources on effective due diligence to ensure that they really know who they are dealing with, and this is building up a powder keg of risk.  Their systems are not up to the task, or are over-reliant on attempts at automation.  Compliance is mistakenly seen as a cost, rather than as a profit centre.  This not only enables the ungodly to penetrate markets, but it also means that profit opportunities are being left on the table.
 
A sea change in economic terms is on the way, however.  The greatest recession in history is finally drawing to a close and we are now on the brink of a long period of sustained market growth, 18 years of it to be precise.  Corporate finance markets are starting to reawaken worldwide.  With 18 years of incremental growth ahead, now is the best time to invest, provided of course, that you know exactly what you are investing in and where.
 
At the same time, there is also a tectonic shift in global economics, and what were once emerging markets are now becoming the new economic powerhouses worldwide.  Emerging markets now account for a third of global M&A activity.  These are also parts of the world which traditionally are more difficult to access for information and are thought to carry a higher financial crime risk, particularly in terms of corruption, fraud and organised crime.
 
So there are some real challenges ahead for mergers and acquisitions activity.  One of the key ones is the blind spot which certain boards have for money laundering deterrence and financial crime deterrence in general.  They usually come up with a negative cost benefit analysis, when the reverse is more often than not the case.  So in fact, the return on investment (ROI) for proper anti financial crime systems and due diligence is extremely positive, though incorrectly calculated by many.  We have been particularly focused on showing how a firm’s compliance function can be hard wired into a firm’s business model in order to extract profit from what is assumed by many to be a pure cost centre.
 
On the investment side of the ROI equation is a thorough threat and vulnerability analysis and a detailed risk management system.  To this you need to add effective Enhanced Due Diligence to the level of detail where you can describe your top clients, M & A targets, etc., as you would a close friend.  You also need transaction monitoring that looks at the human element rather than just the numbers.  It is after all people who make mergers and acquisitions transactions happen, as opposed to computer programmes.
 
On the returns side of the ROI equation is a greater understanding of the transaction and the key participants, avoidance of getting sucked into transactions which have no hope of success, a better understanding of the correct pricing of transactions, improved structuring of negotiating positions and the MILs of all parties, and significant reduction in legal and regulatory risk. 
 
An understanding of the financial crime position of a transaction and the parties in it is becoming more important.  Recently, a number of transactions in the US have had to be aborted or delayed due to the underlying financial crime position in the target companies, and they won’t be the last.  See the cases of Riggs, M & T Bank Corp and Ebix.  It is not only the financial sector which has this type of concern, as transactions in the general corporate sector have shown with issues of bribery and corruption, organised crime, commercial espionage and cybercrime.  Earlier this week similar difficulties were announced for companies involved in tax evasion.  Mergers and acquisitions are one of the quickest ways to access new markets, build client databases, lower manufacturing costs, increase marketing reach, tap into new talent pools and expand your product and service base.  However, in the rush to secure such commercial opportunity, do not forget that you are not just buying useful assets, but also assuming liabilities, the extent of which may be hard to assess.  If your target is engaged in unlawful activity, then the acquisition you are engaged in could easily bring you within the scope of the money laundering legislation, purely by the fact of acquisition.  The other matter to bear in mind is that you cannot contract out of what may be a criminal law liability.
 
Due diligence as generally understood has a couple of deep flaws.  The first is that it has become rote.  There is a heavy emphasis on legal due diligence as carried out by lawyers, and financial due diligence as carried out by accountants.  The problem is that both types of result can be fixed.  They are documentary driven and just as contracts can be far from what the real position is between two parties, accountancy can be more of an art than a science.  The second flaw is that speed is often given greater weight than getting the deal right.  So what is really needed is reality due diligence, i.e. what is this deal really about and what are the parties really up to?
 
The fundamental difficulty is that few attempt to look below the surface of what we call the “identity iceberg”.  Identity is rather more than the commonly acquired copy of a passport and utility bill.  Which of your friends and colleagues do you know only by these two documents?!  In fact you have to look at all the 36 other elements that make up individual and corporate personality to understand who it is that you are really dealing with, so as to be able to negate your regulatory pain and secure commercial gain. 
 
The above observations and conclusions are based on due diligence, risk management and anti money laundering projects which we have been involved in, covering 140 jurisdictions around the globe, in all sectors of commerce and industry.  Having worked on what has been labelled the leading example of compliance transformation, we are also well versed in going in to clean up a potential target before sale, to reduce risk and increase the sale price, or to do this post transaction, in order to reduce risk and extract the profits left under the table due to the failure of the previous owners to align the compliance function with the business model.  Our application of the five compliance forces brings this to fruition.
 
There is no doubt that money laundering and the underlying predicate crimes have got their hooks into the mergers and acquisitions sector, and that a number of deals will be blown off course or be seriously mispriced (as allegations over the HP/Autonomy deal, for example, showed).  The winners will be those who change their attitude to ROI in this area, who can be bothered to enter into well considered long term relationships with their clients, putting the effort into getting to know them properly, and who are inspired to hard wire their compliance function into their business model to avoid unnecessary risks and secure profit ahead of their competitors.

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