Best Practices in Anti-Corruption Diligence on M&A Targets, Joint Venture Partners, and Other Third Parties

1. GOOD. SMART. BUSINESS. PROFIT.
TM

2. Best Practices in Anti-Corruption
Diligence on M&A Targets, Joint
Venture Partners and Other Third
Parties
July 21, 2015

3. Chelsie Chmela
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chelsie.chmela@ethisphere.com
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SPEAKING TODAY
Diane Duvall
VP & Deputy General Counsel, Catalent Pharma
Solutions, NJ
Tabitha K. Meier
Compliance Counsel, Hillenbrand, Inc., IN
Joan Meyer
Partner, Baker & McKenzie, Washington, DC
Marc Paul
Partner, Baker & McKenzie, Washington, DC

5. Baker & McKenzie LLP is a member firm of Baker & McKenzie International, a Swiss Verein with member law firms around the world. In accordance with the common
terminology used in professional service organizations, reference to a "partner" means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an
"office" means an office of any such law firm.
© 2015 Baker & McKenzie LLP
Diane Duvall, VP & Deputy General Counsel, Catalent Pharma Solutions, NJ
Tabitha K. Meier, Compliance Counsel, Hillenbrand, Inc., IN
Joan Meyer, Partner, Baker & McKenzie, Washington, DC
Marc Paul, Partner, Baker & McKenzie, Washington, DC
July 21, 2015
Best Practices in Anti-Corruption
Diligence on M&A Targets, Joint Venture
Partners and Other Third Parties

6. Agenda ◉Introduction
◉Anti-Corruption Due Diligence on Targets
◉Understanding the Risks
◉Due Diligence Procedures
◉What to Do if Potential Corruption Violation Is
Discovered?
◉Anti-Corruption Due Diligence on Joint
Venture Partners and Other Third Parties
6

7. Introduction

8. Tip #1: Understand and explain to management why anti-corruption diligence
on third parties is critical.
Introduction
‒ Enforcement of anti-corruption laws is increasing globally;
enforcement authorities around the world are sharing information
‒ Penalties for anti-corruption violations are on the rise
‒ Serious potential liability for third party actions even if companies
do not participate in bribery scheme
‒ US Department of Justice is increasingly focused on prosecution
of individuals, including managers and compliance “gate-keepers”
‒ Standard legal and financial due diligence conducted on third
parties usually not sufficient to uncover corrupt practices
‒ How to determine when, and what level of, anti-corruption
diligence is necessary?
8

9. Anti-Corruption Due
Diligence on Targets

10. Tip #2: Understand the target’s corruption risks.
Risk Profile of Target
‒ In order to determine whether and how to conduct anti-
corruption due diligence, it is necessary to first conduct
an assessment of the target’s risk profile
‒ A target’s risk profile is a function of several factors:
 Its business model (e.g., direct sales vs third-party
distributors) and industry
 Geographic locations / jurisdictions where target is
headquartered, operates, lists its shares
10

11. Tip #3: Analyze the target’s business model and associated risk factors.
Target’s Business Model
- Business models with greater corruption risks tend to involve:
 Frequent government contact (whether direct or through third
parties)
• Customers: government agencies or state-owned/controlled
companies
• State licenses, permits and authorizations integral to operations
(e.g., sales of state-controlled products such as alcohol)
 Multiple third parties (agents, representatives, consultants,
distributors, intermediaries)
- Industry risk, generally when government is a major market player
or holds heavy influence (A&D, O&G, pharma, mining,
construction)
11

12. Tip #4: Assess the level of corruption in the target’s countries of operation.
Target’s Geographic Locations /
Jurisdictions
‒ FCPA enforcement: West Africa, Middle East, China, Latin
America (Brazil)
 Nigeria (72 cases since 2005), China (62), Iraq (45), Mexico
(31), Indonesia (29)
‒ Corruption is perceived to be a major problem in Brazil, Russia,
India and China (BRIC countries), hence doing business in these
countries increases a target’s risk profile
‒ Transparency International’s Corruption Perceptions Index (CPI)
ranks countries by perceived level of corruption
12

13. 13
Transparency International CPI
‒ Transparency International’s 2014 Corruption
Perceptions Index rankings, illustrated
‒ .
‒ .

14. 2014 Corruption Perceptions Index: Rankings
Corruption Perceptions Index – 2014 (Transparency International)
Position Country Grade
1 (least corrupt) Denmark 92
14 United Kingdom 74
17 United States 78
.. .. ..
69 Brazil 43
85 India 38
100 China 36
103 Mexico 35
119 Vietnam 31
136 Russian Federation 27
174 Somalia / North Korea 08
14

15. OECD Foreign Bribery Report
‒ According to the OECD Foreign Bribery Report issued
in December 2014, over two-thirds of cases occurred
in the following industry sectors:
 Extractive, e.g., oil & gas, mining (19%)
 Construction (15%)
 Transportation and storage (15%)
 Information and communications (10%)
 Manufacturing (8%)
‒ Most bribes were paid in order to:
 Obtain public procurement contracts (57%)
 Clear customs (12%)
 Gain preferential treatment (6%)
‒ In 41% of cases management-level employees paid or
authorized the bribes 15

16. OECD Foreign Bribery Report
‒ Bribes were offered most frequently to:
 Employees of state-owned enterprises (27%)
 Customs officials (11%)
 Health officials (7%)
 Defense officials (6%)
 Heads of state and ministers (5%) – but they received 11% of
total bribes
‒ Intermediaries were involved in 3 out of 4 cases:
 Local sales and marketing agents, distributors and brokers
(41%)
 Corporate vehicles (e.g., subsidiaries) (35%)
‒ The average time to resolve a case has increased from
two years in 1999 to more than seven years today
16

17. Tip #5: Ensure risk-based corruption diligence is conducted according to the
plan, and is properly documented.
‒ When a target’s risk profile has been established, a
customized due diligence plan should be developed to
address any particular corruption concerns
‒ Conducting effective due diligence may be challenging in
the case of an uncooperative target, or in certain
jurisdictions with strict laws governing privacy, secrecy,
or information gathering
‒ What level of due diligence is adequate?
Due Diligence Plan and Scope
17

18. Due Diligence
Procedures

19. Tip #6: Use a variety of means to conduct due diligence.
Due Diligence Procedures
‒ Collect as much initial information on the target as
possible through conventional sources:
 Questionnaires (covering the ownership structure to
whether and how the target enforces its policies)
 Interviews with key personnel (GC, CCO, VP Sales, IA)
 Public records
‒ Unanswered questions may require additional
investigative actions (e.g., to uncover hidden
ownership structures or to trace funds)
19

20. Tip #7: Thoroughly investigate all red flags.
Due Diligence Findings – Red Flags
‒ Red flags in anti-corruption due diligence generally
relate to potentially improper payments or potentially
improper activity
‒ Phased due diligence: if encounter a red flag, then
investigate further to ensure no others
‒ Every red flag should be adequately addressed
‒ What are the typical red flags?
20

21. Red Flags - Target
‒ Target has headquarters, assets or operations in a
high-risk country (see CPI ranking above)
‒ Target is in a highly regulated industry
‒ Target owners, officers or directors are current or
former government officials or closely connected
‒ Target refuses to warrant/certify compliance with the
FCPA and other anti-corruption legislation
21

22. Red Flags – Third Parties
‒ If target relies on third parties, such as consultants,
agents and intermediaries, look for:
 Connections to a government official
 Recommendation from the government
 Lack of relevant expertise or professional reputation
 Unclear ownership, control, credit terms
 No physical (or Internet) presence
 Lack of commission, retainer or expense reimbursement
records
 No written agreements or agreements lack economic sense
 Irregular contractual provisions that cannot be satisfactorily
explained
22

23. Red Flags – Payments
‒ Commissions or similar payments appear higher than market
benchmarks
‒ Unconventional payment terms such as cash, to other third
parties, to accounts in tax havens
‒ Inflated or unsupported invoices
‒ Questionable financial statements
‒ Unexplained expenditures
‒ Undocumented payments or transactions
‒ Excessive advance payments
‒ Rents paid for real estate owned by government official
23

24. Other Red Flags
‒ High volume or price discounts / rebates
‒ Excessive credit lines
‒ Irregular and unexplained bonuses
‒ Lavish gifts and entertainment
‒ Political and charitable contributions
‒ Internships or scholarships to relatives of government officials
‒ Slush funds
24

25. ‒ Acquiring companies must analyze, and subsequently integrate, the
target’s anti-corruption compliance program, including policies and
procedures, internal controls, training and auditing
‒ Elements of an effective anti-corruption program:
 Manifest commitment from upper management, “tone at the top”
 Compliance department with access to the Board and sufficient
resources to promote compliance and investigate red flags
 Anti-corruption policy provided to / acknowledged by employees (and
vendors)
 Periodic, customized anti-corruption training for employees (and
vendors)
 Whistleblower reporting channels (anonymous where not unlawful)
 Policies and procedures relating to gifts and hospitalities, political
contributions and donations, travel and entertainment expense
reimbursement
Target’s Anti-Corruption Program
25

26. Tip #8: Review target’s anti-corruption policies, procedures and controls.
 Annual anti-corruption certifications by employees and vendors
 Established procedures for risk-based third-party due diligence
 Anti-corruption representations and audit rights in third-party
agreements
 Non-delegation standard in third-party agreements
 Periodic audits of third-party payments to confirm that adequately
supported and within the scope of contractual provisions and
established benchmarks
‒ The anti-corruption program should be periodically audited and
updated
Target’s Anti-Corruption Program
26

27. Target’s Compliance History
‒ Corrupt practices in the target’s past, even if no longer ongoing,
must be thoroughly reviewed
‒ Information sources may include:
 Press reports; reports or agreements resulting from government
inquiries
 Internal audit or investigation reports
 Regulatory filings, including annual reports and disclosures
‒ Prior corrupt practices may indicate systemic problems at the
target or with the target’s business model
‒ The target’s response to prior corrupt practices will determine
whether the acquiring company should rely on the target’s records
of prior conduct, or investigate it independently
27

28. Tip #9: Properly staff and supervise corruption investigations.
‒ Anti-corruption due diligence reviews should be conducted by
counsel competent in jurisdictions where the target is headquartered
or operates, as well as where the acquirer is located and its
securities are listed
‒ Each of the review steps should be thoroughly documented in case it
becomes necessary to show that the acquirer’s due diligence was
adequate
‒ Acquirer’s general counsel or compliance officer should review and
sign off on the final due diligence report
Review and Approval of Findings
28

29. What to Do if Potential
Corruption Violation Is
Discovered?

30. Consequences of Discovering a
Violation
‒ If due diligence reveals a problem, the acquisition will likely be
delayed
 Additional due diligence
 Remediation plan
 Renegotiation of the deal price and/or structure
‒ Need to decide whether or not the problem is solvable
 Can it be stopped at or before closing, or is it a long-term / endemic
problem?
 Can it be solved via indemnity language in the purchase agreement?
 Can it be “ring-fenced” from the transaction?
30

31. Consequences of Discovering a
Violation
‒ Need to consider potential consequences if violation becomes public
 Loss of credibility with customers
 Books & records may need to be restated due to inaccuracies
 Drop in share price
 Protracted government investigation; risk of derivative lawsuits
 Debarment from government contracts
‒ In some situations, the Board and management may decide not to move
forward with the acquisition:
 Acquirer succeeds to target’s liabilities difficult to quantify
 Target’s value may be substantially less than originally estimated when
founded on corrupt business
 The company’s brand, reputation and bottom line are much more important
than any single transaction
‒ FCPA counsel may consider disclosing violations to government or
obtaining an opinion from the DOJ
31

32. Role of Counsel

33. ‒ Our responsibilities, as counsel, include:
 Assessing target’s risks and developing adequate due
diligence plan
 Ascertaining the acquirer’s risk of exposure to successor
liability in the event target has issues
 Conducting due diligence investigation, including the target’s
anti-corruption policies, procedures and internal controls
 Engaging other investigative resources as needed (e.g.,
forensic accountants), preferably in a manner that protects
legal privilege
 Counseling the acquirer in the event the review finds evidence
of corrupt practices of the target
Role of Counsel
33

34. Anti-Corruption
Diligence on Joint
Venture Partners

35. Tip #10: In case of JVs, ensure proper anti-corruption safeguards are in place.
M&A Diligence vs JV Diligence
‒ In case of M&A, the target will become your company, so you can clean
house after the acquisition (and should do so as soon as practically
possible)
‒ In case of JV – you will have to live with the risk, and may not have
complete control over it so the level of risk is potentially much greater
‒ Need to conduct continuing diligence on the JV and your JV partner if
possible
‒ Need to ensure that proper safeguards are in place for the JV such as
anti-corruption representations, audit rights, mandatory policies for the JV
to follow, and termination rights (including puts and calls where
appropriate)
35

36. 10Tips
for Anti-Corruption Diligence and Beyond
 Understand and explain to management why anti-corruption diligence is critical
 Understand your target’s or third party’s corruption risks
 Analyze the target’s or third party’s business model and associated risk factors
 Assess the level of corruption in the countries of operation
 Ensure risk-based corruption due diligence is conducted and properly documented
 Review target’s or third party’s anti-corruption policies, procedures and controls
 Use a variety of means to conduct due diligence
 Thoroughly investigate all red flags
 Properly staff and supervise corruption investigations
 In case of JVs and other third parties, ensure proper anti-corruption safeguards are
in place
36

37. 37
Baker & McKenzie - Additional Resources
Follow ongoing developments in global compliance
and anti-corruption via:
 http://globalcompliancenews.com/
 Baker & McKenzie’s “Inside the FCPA” Newsletter
http://www.bakermckenzie.com/insidethefcpa/

38. Questions?
Thank You!
38

39. 39
Our Presenters
.
Joan E. Meyer, Partner, Baker & McKenzie, Washington, DC
Tel: +1 202 835-6119
Joan.Meyer@bakermckenzie.com
Marc R. Paul, Partner, Baker & McKenzie, Washington, DC
Tel: +1 202 452 7034
Marc.paul@bakermckenzie.com
Tabitha K. Meier, Compliance Counsel, Hillenbrand, Inc., IN
Diane Duvall, VP & Deputy General Counsel, Catalent
Pharma Solutions, Somerset, NJ

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