Assessing anti-corruption risks in transaction due diligence efforts

July 2013 | PROFESSIONAL INSIGHT | FRAUD & CORRUPTION

Financier Worldwide Magazine

Companies engaged in cross-border business transactions have become sensitised to the need to implement and enforce effective policies against corrupt business practices. Faced with increasingly aggressive governmental enforcement efforts, many companies have strengthened anti-corruption policies and training initiatives to prevent commercial bribery and other corrupt practices. But, when companies contemplate the potential acquisition of assets, potential mergers, and similar transactions, they may commit the crucial mistake of overlooking anti-corruption considerations during due diligence.

Perhaps the most fundamental risk of not incorporating anti-corruption considerations into due diligence efforts is potentially mispricing the transaction. Governments have assessed significant penalties for violations of anti-corruption laws. Just like pending lawsuits need to be evaluated for pricing considerations in business transactions, so does the risk of anti-corruption violations. Not only may a company inherit liability for past violations, but a climate conducive to corrupt business practices may create additional violations after the transaction has closed. Still worse, if unchecked, a lax compliance environment in an acquired company or business line can also undo the compliance successes of the acquiring company, undermining a culture of compliance, frustrating efforts to inculcate anti-corruption policies across the organisation, and creating an environment more conducive to corrupt business practices that can have severe financial consequences.

Due diligence efforts on the front end of a transaction can also pay dividends with regulators. Companies that regularly incorporate an evaluation of corruption risk into their transaction due diligence may be viewed more favourably by governmental enforcement staff than companies that do not evaluate such risks. Even when a particular problem or risk is missed in due diligence, the company is in a much better position in negotiating with governmental regulators when it can argue that the problem was missed in a well thought out due diligence effort, rather than having to admit that it never considered the issue in conducting due diligence.

Deciding that the risk of corrupt business practices should be evaluated is only a part of the battle. A company must then conduct an effective review of the risk in its due diligence efforts. This effort should begin with publicly available information regarding the target company or line of business, but should also include other areas, such as the following:

Is the company involved in ongoing investigations or governmental enforcement proceedings? While this can be a major red flag, the existence of such matters is not always a reason to forego a transaction. However, the magnitude and risk of the issues must be evaluated and financial responsibility assigned in the transaction documents. Personnel conducting due diligence should obtain a list of any such proceedings, review key documents related to those proceedings, and conduct any additional inquiry deemed necessary given the context of the transaction to evaluate whether any future liability might be incurred in the future and a reasonable estimate of any such liability. Past enforcement actions should also be reviewed to determine if appropriate enhanced policies and controls were put in place to prevent recurring problems.

Are the geographic areas in which the company conducts its business, areas that are prone to corrupt business practices? While corrupt practices can occur in any country, operations in some countries create a heightened risk of corruption. Accordingly, personnel conducting due diligence will want to prioritise their work with this in mind. A list of countries in which the company operates should be obtained and compared to Transparency International’s Corruption Perceptions Index, which rates countries by perceived corruption risk. If the transaction involves countries that are perceived to be highly corrupt, due diligence efforts should be particularly robust with respect to such operations.

Does the company have an effective anti-corruption compliance program? Corrupt practices tend to occur and thrive more often in companies that fail to implement an effective compliance program. Therefore, due diligence should identify whether the company has an anti-corruption policy. If none exists, it is a clear red flag that needs to be evaluated. If a policy does exist, then due diligence should evaluate whether it has been effectively implemented. This will include assessing whether the policy covers the appropriate subject matter; to what extent personnel have been trained regarding the policy; and whether any audits, reviews, or other self-analysis has been conducted to assess compliance with the policies.

Does the company utilise third parties to conduct business operations? Any third parties used by the company to conduct its business operations, such as agents, should be evaluated. Corrupt practices often involve the use of in-country agents or representatives who can determine what bribes or other corrupt practices may be effective in obtaining additional business or business advantages. Because these third parties often work on commission, the incentives for them to engage in such practices are often high. Accordingly, due diligence should include obtaining a list of any agents or other third parties used by the company. Any agreements with or due diligence files regarding these third parties should also be obtained. If no agreement exists, that is a cause for concern and payments to these agents may need to be closely evaluated. If an agreement does exist, then it should be reviewed to see whether it reveals any areas for further inquiry. For example, due diligence should assess whether the agreement obligates the third party to comply with the target company’s anti-corruption policies, whether it includes any right to audit the third party or obtain information from the third party, and whether the rate of payment is consistent with industry norms. Unusually high commission rates can be used to reimburse an agent for bribery and other corrupt practices in an indirect way. Therefore, any third party relationships involving an unusually high rate of payment should be carefully reviewed.

Does the company regularly interact with government officials or government-owned companies as part of its business operations? Anti-corruption laws typically focus, at least in part, on bribery of government officials and employees. Accordingly, due diligence should investigate to what extent the company interacts with government officials or employees, including employees of state-owned corporations. Any payments or gifts to any such individuals should be carefully reviewed to see if they raise any concerns under applicable law.

Do the company’s financial records reveal any additional risks? Companies utilising bribery or other corrupt business practices usually do not accurately reflect such payments in the company’s books and records so that such activities can be concealed. Thus, the due diligence effort should also be sensitive to insufficient support for payments, non-specific descriptions of payments, an abnormal number of cash payments, abnormally high cash payments and other financial information that could be consistent with an effort to conceal corrupt activity.

These are just some of the steps that can be taken to effectively conduct due diligence to assess the risk of corrupt business activity. Of course, any specific due diligence plan should be tailored to the specific transaction and parties involved, but competent counsel should be able to assist in developing an effective due diligence plan. Incorporating an assessment of business corruption risk into due diligence could save a company millions of dollars and prevent unwanted governmental enforcement actions that are both costly and distracting.

Brent Benoit is a partner at Locke Lord LLP. He can be contacted on +1 (713) 226 1570 or by email: bbenoit@lockelord.com.

Brent Benoit

Locke Lord LLP