FCPA Compliance and Ethics Blog

January 3, 2011

Private Equity and the FCPA

Filed under: FCPA — tfoxlaw @ 9:27 am
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Private Equity and the FCPA 

In a Wall Street Journal (WSJ) article on December 22, 2010 by Joe Palazzolo, he reported that the Securities and Exchange Commission (SEC) is investigating Europe’s largest insurer, Allianz SE, for possible bribery by a German printing press company in which it holds majority stake. Palazzolo opined that this probe could break new ground in US enforcement of the Foreign Corrupt Practices Act (FCPA). The SEC has never charged a private equity firm based on the conduct of a foreign private company in its portfolio. As we enter 2011, one of the things that the FCPA compliance community has learned from the prior year is that the Department of Justice (DOJ) and SEC have announced they will review the conduct of certain industries to determine if they are in compliance with the FCPA. In late 2009, the DOJ made a very public display of announcing it had targeted the pharmaceutical industry and in January, 2010, they arrested 21 individuals in the US armament industry in the largest ever FCPA undercover sting operation, the Gun Sting investigation. 

However, this initial enforcement effort in the private equity arena could be one which grows during this year. In an article in the New York Times Dealb%k, on December 22, 2010, entitled, “Private Equity Looks Abroad, but May Be Blind to the Risks,” reporter Steven Davidoff wrote that some recent comments by Stephen A. Schwartzman, CEO of the Blackstone Group, indicated that the US is “over-regulated and that private equity’s greatest investment opportunities lie across the oceans.” Davidoff indicated that this position may be “overstated” and private equity may encounter a number of problems abroad.” He listed several pitfalls for such investments abroad, however one issue he did not list was the FCPA. 

The SEC investigation of Allianz signals that private equity should proceed with caution because the purchase of an overseas company could lead to potential FCPA liability. The recent FCPA enforcement action against RAE Systems, Inc., drove home once again that a US company is responsible for the actions of joint venture in which it holds a majority interest. There are several other examples where companies, which acquired targets, sustained large FCPA fines for the FCPA violations the acquired companies had engaged in prior to the acquisition. These include the Alliance One matter resolved this past summer with a $4.2 million fine for pre-acquisition conduct and $10 million in profit disgorgement. There was also the $240 million fine levied against Saipem for conduct of an acquired subsidiary of ENI, Snamprogetti, where the conduct at issue occurred over 2 years prior to the acquisition. One of the strongest examples is that of eLandia International Inc., which acquired Latin Node Inc., in 2007. Thereafter, it discovered potential FCPA violations which it self-reported to the DOJ. As reported in the FCPA Blog, in addition to a $2 million fine, eLandia also disclosed that its purchase price for Latin Node “was approximately $20.6 million in excess of the fair value of the net assets” mostly due to the cost of the FCPA investigation, the resulting fines and penalties to which it may be subject, the termination of Latin Node’s senior management and the resultant loss of business. eLandia eventually wrote off the entire investment by placing Latin Node into bankruptcy and shuttering the acquisition. 

As noted by Davidoff, one of the reasons that private equity has been successful in the US “was its ability to reorganize companies by taking majority ownership and eliminating managerial inefficiencies.” Unfortunately the one thing that an FCPA investigation can bring, whether brought on via internal disclosure, whistleblower or DOJ targeting certain industries, is very high costs. Additionally many companies are required to add significant compliance personnel to resolve any FCPA enforcement action. This would not seem to be the pattern for success by the private equity market. Further, if the DOJ or SEC is successful in reaching a private equity owner in the Allianz investigation, where the private equity owner is a European parent, it could well open the doors for investigation in equally high profile private equity entities in the US.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2011

February 2, 2010

SO YOU WANT TO BUY A BUSINESS: THE ROLE OF THE FCPA IN INTERNATIONAL ACQUISITIONS

The recession has lessened and all that cash your Company has been hoarding for the rainy days of the Obama years is burning a whole in your CEO’s pocket. He has his powder dry and is ready to make a big bang by going on a buying spree, targeting overseas entities, to beat the competition in coming out of your industry’s downturn. The Legal Department is told to put together an acquisition squad and to be ready to go at a moment’s notice. The job assigned to you is to make sure that your acquisition does not run afoul of the Foreign Corrupt Practices Act (FCPA) and to prepare a list of FCPA based due diligence that the Law Department should focus on to perform on the Target Company. What should be on your list? In the recent article, “FCPA Due Diligence in Acquisitions,” Securities and Commodities Regulation, Vol. 43, No. 2, January 20, 2010, lawyers from Squire Sanders, thoroughly explored this topic, through a hypothetical case it was based upon a “real life scenario”. Some of their suggestions included the following suggestions.

I. Who is the Owner of the Target Company?

An initial inquiry should be made into the ownership structure of the target company. If any portion of the entity is owned or held by a government or governmental entity then such an entity is covered under the FCPA as a “foreign governmental instrumentality”. There are several factors to consider in making such a determination. Some of these factors include: percentage ownership of the target company; control exercised over the target company; and how are the employees of the target company described by their country’s government.

II. Are Agents involved in the Transaction?

Many times a “consultant” will be used in facilitating the purchase of a target company in a country outside the United States. If there is a clear and articulated business case for the Agent to be involved in the transaction, there should be due diligence on the Agent. It should include some a review of the Agent’s credentials, ownership structure and financial records going back 3 to 5 years. Lastly, it is also critical to know the reputation of the Agent in the country’s business community. If the Agent passes all these reviews, you establish a business relationship with a strong written contract.

III. Does the Target Company want you to pay for Travel?

What if the Target Company desires your business to pay for a representative to come to the US to visit your facilities? Such a trip falls under the FCPA and its proscription of “offering or promising anything of value”. However, if there are legitimate business expenses which can be paid by the US purchasing company under the FCPA. The key is to evaluate each travel and entertainment request. Generally, coach class travel and hotel expenses such as room charges, business center and telephone charges related to business can be reimbursed. Personal room expenses such as minibar, Pay-for-Movies and spa fees at the hotel should not be reimbursed. Receipts should be provided for any charges and if possible, the third party service provider should be paid directly rather than reimbursement of the Target Company’s representative. Entertainment and business dinners can be reimbursed if there is a legitimate business purpose but personal, including the family expenses of the Target Company’s Representative, cannot be reimbursed under the FCPA. Lastly, do not give a “per-diem” in cash.

IV. Did the Target Company make any “Red Flag” Payments?

In your company’s financial due diligence of the Target Company, did any evidence of “Red Flag” payments turn up which warrant further investigation? If such “Red Flags” arise, the US purchasing company must not turn a blind eye. If there is reason to believe that payments of the Target Company may violation the FCPA, further investigation is mandated. The recent conviction of Frederick Bourke for engaging in “conscious indifference” in that he knew, or should have known, that bribery and corruption was involved in the proposed acquisition, demonstrates the power of the FCPA in the acquisition arena. Red Flag areas would include the discovery of payments for gifts, entertainment, use of agents, facilitation payments or other payments which could not be adequately accounted for are discovered.

V. Are the Books and Records Reasonable?

In addition to its anti-bribery provisions, the FCPA also requires that a company keep such books and records which reasonably reflect the transactions of the entity and that there are proper internal controls. A key in this area is if the Target Company has any payments which are labeled as “miscellaneous” or there are payments which cannot be reasonably described. Gifts, entertainment and business expenses need to be recorded and documented. Internal controls are required to show that the Target Company has its statements in accordance with some form of accepted accounting principles.

VI. What Happens Afterwards?

Your Company has completed all the above steps but your due diligence has turned up items which cannot be resolved before your Company’s President wants to fire that dry powder. What can you do? In Opinion Procedure Release 08-02, the Department of Justice gave its opinion on the steps required by a US company contemplating a such a transaction. This opinion held that if Halliburton, in purchasing a Target Company, satisfactorily completed a rigorous, DOJ-mandated 180-day FCPA and anticorruption due diligence work plan after the closing, then the DOJ did not “presently intend” to take enforcement action against Halliburton for any disclosed unlawful pre-acquisition conduct by the Target Company within 180 days of the closing. Halliburton was not the successful bidder for the Target Company but the DOJ’s flexibility and Halliburton’s open dialogue with the DOJ indicates there will be increased involvement between companies and regulators during FCPA acquisition due diligence.

VII. The End or Is it?

The potential liabilities for failing to engage in pre-acquisition FCPA due diligence can be severe. Just how severe can be demonstrated by the eLandia acquisition of Latin Node. The FCPABlog reported that “eLandia also disclosed that its purchase price for Latin Node “was approximately $20.6 million”. After the acquisition, eLandia discovered that Latin Node had engaged in bribery and corruption. eLandia investigated, albeit after the purchase, and self-reported the violations to the DOJ. eLandia was assessed a $2 million fine, shut down Latin Node as an operating business and wrote off the entire purchase. For those of you keeping score at home, that is several years of pre-acquisition due diligence, plus legal fees for the FCPA investigation added to the fine, purchase price, business shut down and full financial write-off.

So what’s the moral of this story? You can keep your powder dry but you must engage in full FCPA due diligence in any overseas transaction before moving forward.

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This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication.

© Thomas R. Fox, 2010

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