FCPA successor liability in M&A transactions

June 2015  |  FEATURE  |  MERGERS & ACQUISITIONS

Financier Worldwide Magazine

Mergers and acquisitions (M&A) activity has boomed over the course of the last 18 months, with 2014 seeing a great number of announced transactions. Global M&A activity hit $3.5 trillion in 2014, an increase of 47 percent from the year before. The first quarter of 2015 followed suit. And with M&A very much back on the corporate agenda, the notion of successor liability is also in the spotlight.

Successor liability can be a serious issue for buyers as it makes acquiring companies liable for any criminal acts carried out by the target prior to deal completion. Should a target company be found to be in breach of the US Foreign Corrupt Practices Act (FCPA), buyers may find the entire value of their acquisition wiped out in cancelled contracts and enforcement action. Successor liability is a particularly important issue for corporates looking to expand into emerging territories where local business practices may differ considerably from developed regions. Territories such as China, a popular location for foreign direct investment, remain rife with potential FCPA risks.

Prudent acquiring companies are proactive in their attempts to carry out strong, broad due diligence procedures. However, for many companies, due diligence should merely represent the first stage in a more comprehensive program aimed exclusively at avoiding successor liability in the long term. For those firms only willing to carry out the most perfunctory of due diligence testing, there may be a nasty surprise in the offing.

In recent years, the number of investigations launched under the auspices of the FCPA, as well as prosecutions by the Department of Justice (DoJ) and the US Securities & Exchange Commission (SEC) has exploded, reaching record levels. Accordingly, firms found to be in violation of the FCPA have been hit with significant fines, which reached a peak in 2008 with the $1.65bn in total fines and penalties imposed against Siemens Corp. by separate German and US prosecutions.

With enforcement actions on the increase, the importance of effective and tailored anti-corruption M&A due diligence is clear. Yet some companies are still neglecting their due diligence obligations. Some commentators have suggested that as many as one-fifth of companies are believed to not even consider anti-bribery and corruption due diligence as a standard part of their pre-acquisition due diligence procedures.

The $16m February 2015 settlement between the SEC and the Goodyear Tire and Rubber Company helped to bring the importance of anti-corruption due diligence into sharper focus. Goodyear’s fine will come in the form of disgorgement and prejudgment interest in order to resolve alleged violations of the books and records and internal controls provisions of FCPA. The violations of the FCPA relate to a number of Goodyear’s international subsidiaries, namely those in Kenya and Angola, which were alleged to have paid over $3.2m in bribes to employees of government-owned entities and private companies to obtain tire sales. Goodyear first acquired a minority interest in its Kenyan subsidiary in 2002, and by 2006 the company owned a majority interest in the unit. Goodyear’s subsequent punishment is indicative of the lax approach some companies still take to FCPA compliance. The Goodyear settlement, though substantial, is still on the lower end of the scale compared with the $135m settlement levied from Avon Products Inc and its Chinese subsidiary in 2014.

Enforcement actions are becoming commonplace and many companies’ approach to FCPA compliance is faltering. Given that buyers also acquire their target’s potential FCPA liabilities, this is a vexing development. Regulators in the US expect companies to conduct due diligence testing even if the target was not previously subject to the FCPA. With these increased pressures, how can firms look to minimise the risk of encountering FCPA enforcement actions in the future?

Pre-planning

According to guidance issued by the DoJ in its second ‘Opinion Procedure Release’ of November 2014, which builds upon its November 2012 Guide, there are a number of main functions which companies must perform in order to ensure that they mitigate or avoid the possibility of becoming caught up in potentially damaging and expensive post-acquisition successor liability enforcement actions. Though these steps are an example of best practice, and the DoJ’s opinion release was tailored specifically for the requestor in question, implementing the advice is likely to put firms on a decent standing with both the DoJ and the SEC going forward. The DoJ’s opinion was requested by a consumer products company that intended to acquire a foreign manufacturer with no direct sales or manufacturing presence in the US. As such, the thrust of the opinion relates to the acquisition of foreign based entities by US firms, and whether the DoJ would pursue an enforcement action against a US firm as a result of the foreign subsidiary’s pre-acquisition activity. Despite its advice, the DoJ has said that it does not intend to pursue enforcement action with respect to any pre-acquisition bribery that may have taken place. Furthermore, the DoJ was heavily reliant on the established corporate law principle that successor liability does not create liability where none existed before. The department notes that if an issuer of securities acquires a foreign corporation that was not previously subject to the FCPA’s jurisdiction, the acquisition alone does not retroactively create FCPA liability for the acquiring issuer. Regardless, the DoJ suggested that acquiring companies should follow its advice and take a number of preventative steps.

First and foremost, companies must conduct thorough risk-based FCPA and anti-corruption due diligence on any potential M&A target. Given the inconsistent and unpredictable nature of M&A transactions, expecting companies to follow a universal, catch-all approach to effective and comprehensive due diligence is unrealistic and impractical. Accordingly, companies should employ bespoke and appropriate levels of M&A due diligence.

One of the most important elements of FCPA due diligence is the need for companies to ensure that they have prepared properly. Buyers need to gain extensive knowledge of their target’s affairs. They must be fully versed in the target’s products, sales and profitability. Prior to undertaking due diligence, buyers should establish and extend communications channels to their target. Should any red flags be detected, strong communication links will be pivotal.

The arrangement of a specialist due diligence team will also go a long way to ensuring that nasty surprises are kept to a minimum. A skilled and dedicated team with a grasp of the legal, financial and business challenges associated with FCPA compliance  will help to facilitate the due diligence process. Employing the expertise of an outside, third party could also prove useful in the long run. An integration manager should also be appointed and involved in the planning stage.

Once the planning phase of the process is complete, the buyer’s FCPA due diligence process should commence. However, it is not enough for acquiring firms to merely scratch the surface; due diligence should be thorough and deep. Companies should be on the lookout for red flags and genuine dealbreakers. In the event that such an FCPA-related dealbreaker is uncovered, acquiring firms must be willing to walk away from a deal. While abandoning a deal is by no means ideal, it is surely more palatable than drawing the ire of the SEC or DoJ.

According to the DoJ, once the acquisition has closed, the acquirer must also look to impose its existing code of conduct, including its anti-corruption policies, on the target firm as quickly as possible. Ideally, the acquiring company will have prepared to adapt to these policies; prudent companies include features such as anti-corruption policies and employee codes of conduct in their integration plan.

Integration planning should also include FCPA and other relevant training for the acquired entity’s directors, employees, third-party agents and partners. Buyers should assess the role of the target company’s board, chief compliance officer and compliance committee. During this assessment period, consideration should be paid to the role and autonomy of the company’s compliance staff. Steps must also be taken to ensure that staff have the tools and resources needed to adequately carry out their function.

In terms of FCPA education, existing staff compliance training should be reviewed, both formally and informally, by the acquiring company. It would be prudent for firms to ensure all measures have been taken to prevent illegal payments being made after a merger has closed. The acquirer needs to decide whether existing staff training methods and materials are fit for purpose, examine how training is being carried out, and determine whether steps are taken to update training based on changes to legislation.

FCPA-specific audits of the acquired entity should be carried out as quickly as possible by the acquiring firm to ensure that there are no surprises lurking beneath the surface. Should any corrupt payments or actions be discovered during the audit period, it is imperative for the acquiring firm to disclose this information to the DoJ immediately. Prior to any voluntary disclosure, however, it is advisable that companies consult with internal or external counsel and consider the potential ramifications of this decision.

Conclusion

As we have seen in recent years, successor liability has become a significant feature of M&A transactions. Failure to carry out sufficient due diligence can have a disastrous effect on the acquiring company’s finances and reputation. The current regulatory climate and the increasing severity of enforcement actions put considerable pressure on firms to ensure that they are cognisant of the risks associated with successor liability, as well as ensuring that they are compliant with the regulatory requirements of the various enforcement agencies. Authorities in the US expect companies to have a considered and comprehensive integration framework in place when undertaking a transaction.

Failure to do the FCPA compliance groundwork at the onset of a transaction can result in a considerable erosion of value down the line. The collapse of Lockheed Martin Corp.’s proposed $2.2bn acquisition of Titan Corp in 2004 is just one example of how FCPA non-compliance can halt a transaction in its tracks. Avoiding a similar fate in 2015 and beyond relies on firms prioritising due diligence.

© Financier Worldwide

BY

Richard Summerfield