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Corruption Risks in Mergers and Acquisitions

By Robert Mayo and Thibaut Kazemi (Jones Day Paris), with input from James Dunlop, Fahad Habib, Linda Hesse and Harriet Terrett (Jones Day Chicago, Dubai, Paris and London). What are the main corruption-related risks faced by companies contemplating an M&A transaction? The risks will vary depending on the buyer, the target and the structure of the transaction. The main risks are: (i) acquiring a company that is tainted by corruption, and therefore assuming criminal and civil liability; (ii) paying too much for the acquired company or business, to the extent that part of the revenue and/or profit is based on corrupt behavior, and is therefore not sustainable; and (iii) risk to reputation of the buyer. In addition, there is the risk associated with the drain on management of resolving any issue along these lines that does show up. It can be expensive, time consuming, and distracting. Certain buyers are more exposed than others. A buyer that is subject to robust anti-corruption laws is at risk if it acquires a corrupt company. Also, even if the target is not directly subject to robust regulation at the time of acquisition, the rules or their enforcement may become more strict going forward. Regarding the target, there are a number of red flags that can be easily identified prior to the transaction based on, in particular, its industry, its geographical footprint, its use of external consultants, intermediaries or agents, and its degree of interaction with government officials. The structure of the acquisition will also affect the risk. Purchasing assets only is different from purchasing a company which carries historical liabilities. However, even with a purchase of assets, the possibility of successor liability that may attach to the assets should be analyzed. Deals structured through a joint venture also carry specific risk factors. In many emerging/developing countries, for instance, you have “forced marriage” laws requiring the foreign investor to associate with a local partner. This is particularly true in regulated industries such as mining, banking, pharmaceuticals or telecommunications. If the foreign government does not impose the choice of the partner, the investor usually has, as a matter

• f fact, only a limited number of serious candidates to consider and many of them have various kinds of

connections to the foreign government (ex-ministers, family or extended family ties to influential political rmayo@jonesday.com tkazemi@jonesday.com Thibaut Kazémi Jim Dunlop Habib Fahad Linda Hesse Harriet Terrett

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figures, etc.). Even if the investor and the joint venture carefully avoid any behavior tainted with corruption, this common type of situation may create an appearance of impropriety that is delicate to handle. Are risks the same under the FCPA, UK Bribery Act, and other countries having transposed the OECD Convention? Currently, companies that are subject to the FCPA are generally at greater risk than others, given the vigorous enforcement policy of the U.S. Department of Justice (DOJ) and the U.S. Securities and Exchange Commission (SEC). This category includes U.S. companies, companies with U.S. operations, and any non-U.S. company that is listed on a U.S. stock exchange. Any persons in the United States are also at risk. Under certain agency, aiding and abetting and conspiracy theories, it can also include non- U.S. subsidiaries of such companies, and non-U.S. joint ventures and their non-U.S. partners. The FCPA also directly prohibits any non-U.S. company from committing an act in furtherance of a bribe scheme within U.S. territory. Acts as minor as sending an email to a U.S. bank requesting a fund transfer can constitute an act “in furtherance” of a bribery scheme. Of equal importance, the U.S. government frequently prosecutes individuals, including officials of non-U.S. companies, who face imprisonment if convicted. As for the UK Serious Fraud Office (SFO), it clearly has ambitions to become a leader among anti- corruption regulators. As a result, companies that previously felt unconcerned by U.S. law may now be concerned by the UKBA. Time will tell as to how the UKBA will actually be enforced. Legally speaking, the UKBA is more strict than the FCPA on facilitation payments, with the latter permitting payment to expedite or facilitate routine (non-discretionary) governmental action in certain narrow circumstances. The UKBA also is very broad in its extraterritorial application, reaching any company carrying on all or part of its business in the UK. The UKBA also criminalizes the receipt of a bribe, thereby extending beyond payments to foreign officials. The requirement under the UKBA to have “adequate procedures” as a defense to liability for bribery by associates (such as agents, consultants or advisors) also impacts on

• transactions. Where problems arise post-acquisition, the SFO will look at what due diligence was done in

advance and what integration and remedial actions were agreed, to assess if these were “adequate” to manage post-acquisition corruption risk (the U.S. DOJ will also take this into account in deciding whether to prosecute or accord leniency, but U.S. law accords no statutory defense for “adequate procedures” like the UKBA). At the same time, the SFO does not have unlimited human and financial resources to investigate and enforce the UKBA, so we will have to wait to see how it is actually enforced. Senior representatives of the SFO have previously stated that where a business identifies corruption issues post- acquisition, self-reports them and has a remedial plan in place, there is a presumption that the company should be given a period of time to sort out the problems without fear of prosecution. We note that David Green, a well known regulatory prosecutor in the UK, will be heading up the SFO starting in April 2012. Are listed companies more concerned by corruption risk than others?

• Yes. First, as mentioned, non-U.S. companies that are listed on a U.S. stock exchange are subject to the

U.S. FCPA, and are therefore subject to the vigorous enforcement policies of the SEC and the DOJ. Interestingly enough, the UK Guidance specifically states that it is not expected that the mere fact that a company’s securities have been admitted to the UK Listing Authority’s Official List and therefore admitted to trading on the London Stock Exchange, in itself, would qualify the company as carrying on a business

• r part of a business in the UK, thereby triggering the application of the UKBA.

Second, companies that are public companies anywhere in the world, when they encounter corruption within their organizations, must decide what and when to disclose the information to the market. In France, a company must promptly make public any non-public information that would affect its share price, unless there is a legitimate reason for holding back the information and the company is in a position to keep it confidential. While the U.S. federal securities laws do not provide the same type of an affirmative duty to disclose, companies are subject to strict disclosure obligations and strong incentives to give full and fair disclosure, including as a result of potential 10b-5 liability. In addition, the U.S. Department of Justice and SEC policies place a premium on self-disclosure of illegal conduct. Moreover, the effect of such conduct on a company’s books and records, the need to certify internal controls, and/or the need to reserve for losses associated with unlawful conduct, often convert FCPA violations into matters for disclosure in the company's financial statements. Managing communications is challenging, especially when a company is listed on more than one stock exchange. Also, listed companies may be more sensitive to reputational damage than other companies. We should also mention the Dodd-Frank Act’s whistleblower provisions. In August, the U.S. SEC approved final rules implementing these provisions. The rules provide for awards of between 10% and

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30% for individuals who voluntarily provide the SEC with original information leading to a successful enforcement action (including FCPA enforcement actions) that results in sanctions totaling $1 million or

• more. These incentives have already increased whistleblower reports to the SEC.

What due diligence should companies carry out prior to engaging in M&A operations? The right level of due diligence required will depend on a number of factors, including the level of risk at the target and the type of indemnity that the buyer may receive from the seller for pre-closing liabilities. The greater the risk, and the more limited the indemnity, the more diligence is required. Even with a good indemnity, however, there is no substitute for adequate due diligence, since resolving any claim typically involves significant demands on management’s time and energy, and buyers may also incur reputational damage that will go unaddressed: due diligence is helpful in this respect when it identifies recent or on- going conduct or practices that, if left unaddressed, can lead to future enforcement actions against the new company and/or its owners. Moreover, indemnities do nothing to eliminate criminal liability. Basic due diligence includes requesting documents concerning the company’s compliance program, past problems and internal controls, and analyzing that information against the risk in terms of the sector and geographical footprint. A specific part of the due diligence should also focus on the relationships entertained by the target with its agents, consultants or intermediaries and, in the case of joint ventures,

• n the contemplated partner. Depending on the circumstances, including if the risk is significant, it can be

helpful to involve a forensic accountant who will assist in analyzing the situation within the target. However, once the decision to involve a forensic accountant is made, the scope of the review needs to be

• defined. It can vary from simple background checks, to a detailed, manual analysis of payment ledgers

for all companies within the group. In-person interviews with key persons of the business can be extremely helpful, since they allow for a better understanding of how the business operates, and where the potential weak points are, etc. Sometimes, with more information, a situation that appears to be high- risk turns out to be low-risk. Can corruption-related risks affect the deal value of an acquisition? How else can they affect the transaction documents? The easy answer is “yes”, just like any potential liability. Corruption-related risks are typically dealt with using due diligence before the purchase, and indemnities for post-closing issues. While it may in many cases be difficult for a buyer to negotiate a lower price based on a corruption-related issue, given its unknown and contingent nature, identification of this issue before signature of the purchase agreement

• ffers the buyer strong leverage for contractually shifting the cost of managing and resolving the problems

to the seller. Although indemnity clauses are often heavily negotiated, the basis for them is relatively standard, market- practice clauses. Buyers in particular should consider whether market-standard provisions in indemnity clauses will have undesirable results in connection with a corruption-related liability. The duty to mitigate damages is one example: does this hinder a buyer’s ability to self-report and still retain its indemnity? The specific clause and other related clauses will need to be considered. Even when a seller informally agrees to pay an indemnity, it may formally contest buyer’s claim in order to retain bargaining leverage and reduce the amount it pays. Also, depending on how the indemnity language is drafted, the indemnity may cover only historical liabilities, and not cover losses that flow from a reduction in the value of the ongoing business. If the indemnity does cover a reduction in the value of the business, proving such a loss may prove challenging depending on various factors. In a joint venture transaction, the corruption risk should be assessed beforehand, at the due diligence stage, when selecting a local partner, but the contractual documentation should also provide for measures designed to minimize any future corruption risk. Depending on the sophistication of the partner, someone (counsel or even the more sophisticated JV partner) should assist the partner and the joint venture entity to understand what actions would violate anti-corruption rules and to set up adequate reporting and control procedures with respect to the joint venture entity. Because a violation may nevertheless occur, it is also useful to provide for the consequences of such a violation–e.g., a clause that would allow the shareholder to withdraw immediately from the joint venture in case of a violation. How do rating agencies factor in corruption risks within companies? We can note that Fitch Ratings issued a report in June 2010 discussing how corruption violations can weigh on ratings, and discussing which types of companies may be most affected by a violation (those with limited cash resources to pay fines and meet additional compliance costs, in particular). The title of

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the article for those interested is “U.S. Foreign Corrupt Practices Act – No Minor Matter”. Do asset management firms and other investors actively look for lower corruption risks within companies? Worldwide intolerance of corruption is growing and more investors appear to be, for ethical but also economic reasons, alert to the corruption level of companies in their portfolios. An interesting example is the Norwegian Pension Fund (reportedly the largest pension fund in Europe) that excludes from its investment portfolio any company that is likely to contribute to gross corruption. It remains to be seen whether this idea will become a trend. 13 February 2012

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