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FCPA for dealmakers: A tutorial

by contributors Frank Aquila, Krishna Veeraraghavan and Jeffrey Lee, Sullivan & Cromwell | Published August 23, 2012 at 1:54 PM

With the recent sharp uptick in enforcement actions brought by the U.S. Department of Justice and the Securities and Exchange Commission, Foreign Corrupt Practices Act due diligence has never been more essential to potential buyers. Since the Dodd-Frank Act of 2010 has further incentivized whistleblowers to report FCPA violations, we are likely to see a further increase in FCPA enforcement activity. The ongoing saga involving alleged illicit payments by Wal-Mart Stores Inc.'s Mexican subsidiary clearly illustrates that no corporation is immune to the reach of FCPA investigations. The serious consequences that may arise from violating the anti-bribery and record-keeping/internal controls provisions of the FCPA, or assuming successor liability for an acquired company's violations, should give any potential buyer pause before acquiring a business with non-U.S. operations.

A perfect assessment of FCPA compliance, however, is easier said than done given the practical limitations that accompany any M&A or joint venture deal -- particularly with respect to access to necessary records and sufficient time to complete an investigation. Any would-be buyer's diligence plan, however, should begin with an initial review of publicly available information for potential "red flags," which can include operations in markets with a reputation for corruption, irregularities in the use of third-party contractors and involvement of government officials in the enterprise.

After taking into consideration the results of the initial review, the actual diligence plan may include investigations into the target's use of intermediaries, employment of government officials, litigation and regulatory investigations, gifts/hospitality spending and political/charitable contributions. The diligence plan should be continuously revisited as a fuller picture of the target is developed (and if additional red flags appear). The target's senior management may also be asked to complete questionnaires or participate in interviews focused on corruption issues. The buyer should, as a baseline, aim to develop an understanding of the target's existing (if any) FCPA compliance policies and training programs, standards for maintaining books and records, internal reporting and controls and any past or ongoing internal or external investigations or inquiries. Third-party service providers can also be engaged to conduct background checks on the directors and officers of the target and their personal and professional relationships, particularly with respect to government officials and agencies. Where a potential buyer identifies red flags in financial statements or accounting records and opts to continue with the transaction, the assistance of forensic accountants may be needed to further assess FCPA and other risks.

While indicia of corrupt activities in a potential target are not necessarily fatal to a deal, they will almost certainly create a dilemma for a potential buyer. The buyer needs to be able to answer three threshold questions before moving forward: Can the target continue to operate successfully without the corrupt activities or are the corruptive activities an integral part of the target company's success? Can the suspect activity be quarantined from the rest of the target? Can the risk or liability be satisfactorily allocated between the parties? Even in situations where the corrupt activities can be isolated so that the acquisition remains commercially viable, the buyer must still weigh the potential time, effort and cost required to remedy and halt the offending conduct.

If a buyer believes that these concerns can be properly addressed, several options may be considered as the transaction terms are agreed. First, the buyer may explore the possibility of structuring the transaction so that it does not assume FCPA liabilities (a buyer would normally assume all liabilities in a merger or stock purchase of an entire company). Asset purchases may allow a buyer to carve out desired assets and employees while leaving liability for past FCPA violations in the target, subject to certain limitations (an acquisition of all or substantially all of a target's assets, for example, would generally be considered a de facto merger). Second, representations and warranties in the transaction agreement should be drafted broadly (while closely tracking statutory language) with explicit reference to the FCPA and specific coverage of particular areas of concern. Third, buyers may also consider asking for post-closing indemnification in the event of a breach of FCPA-related representations or even standalone indemnification for losses incurred as a result of FCPA issues. Finally, closing conditions should be tailored so that buyers can exit the arrangement in the event of any inaccuracy of the representations and warranties; they may also be structured to require the complete remediation of the FCPA issue prior to closing (and the implementation of necessary controls and procedures). While these are potential options, like any other aspect of the transaction the ultimate resolution will be subject to negotiation.

If a buyer discovers an FCPA violation at the target company in the course of the transaction, reporting the violation is an option, although efforts to do so can be hampered by confidentiality agreements or a target's uncooperativeness. Where buyers have been able to close acquisitions without assuming successor liability, in some cases they have required the target's settlement with the SEC and the DOJ as a preclosing condition and diligently cooperated with the agencies (and any attendant penalties and continuing obligations). Under certain circumstances, a buyer may also be able to conduct post-closing diligence on the acquired entity by seeking relief from the SEC and the DOJ, as Halliburton Co. received in 2008. Post-closing integration of FCPA policy, procedures and accounting controls with the former target's existing programs should be conducted as soon as possible, including FCPA training for newly acquired officers and employees and monitoring of FCPA compliance in the acquired operations.

Ultimately, while it is essential for buyers to assess the potential FCPA risks of a transaction up front, an assessment is not alone sufficient. In these situations all buyers would be well-served by taking a thoughtful approach to transaction structuring, contract drafting and post-closing monitoring and integration. FCPA liability and risks may not be capable of being eliminated but they are manageable.

Frank Aquila is co-head of Sullivan & Cromwell LLP's general practice group. Krishna Veeraraghavan is a partner in the firm's mergers and acquisitions group, and Jeffrey Lee is an associate in the M&A group.

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