It’s a brave (but scary) new world out there. Private equity funds operating in the international arena should have by now switched to red alert with respect to the severity of the combined impact of the US Foreign Corrupt Practices Act of 1977 (FCPA) and the UK 2010 Bribery Act (the Bribery Act), due to come into force April 2011. As US and European authorities have intensified enforcement efforts, record fines and criminal convictions are becoming commonplace. For instance, Siemens has agreed to pay US$1.6 billion to US and German authorities in fines, penalties and disgorgement of profits. The ultimate question for private equity funds is how far does liability extend – the fund vehicle, the general partners, limited partners or the portfolio companies? The cumulative effect of both pieces of legislation poses a significant risk in part to all the aforementioned parties for the actions of agents, portfolio companies, third-party successor liability and the failure to institute adequate controls and mechanisms to prevent bribery. The ramifications for violators of the legislation include stepped up criminal and financial sanctions in addition to decreased portfolio company valuations, debarment from government contracts, director disqualification, Financial Services Authority restrictions, reputational risk, diminished exit opportunities and stringent non-prosecution agreements.
The anti-bribery provisions of the FCPA prohibit an offer or payment of anything of value to a foreign official for the purpose of securing an improper advantage or obtaining or retaining business. The United States Department of Justice (DoJ) and the Securities and Exchange Commission (SEC) have been vigorous in their enforcement of the FCPA. And it appears this enforcement is likely to become even more thorough with the enactment of § 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). This provision encourages whistleblowers to report suspected violations directly to the SEC. Whistleblowers providing information leading to a conviction or settlement will receive a bounty of at least 10 percent and up to 30 percent of the fines collected worldwide by the SEC in connection with that violation.
Funds looking at deals that are inherently more risky, but with a higher potential for returns, as in emerging markets, should be aware that a floodgate of opportunistic whistleblowers may appear from the shadows looking to capitalize on the Dodd-Frank Act. This may prevent companies from initiating their own internal investigations and self-reporting to the relevant authorities. Therefore, it is recommended that funds institute their own internal whistleblower procedures and policies in order to have control on self-investigation and decide whether to self-report.
The Bribery Act casts a wider net than the FCPA, covering improper payments to representatives of both public bodies and private companies, extending to senior officers of a company, if they are proven to have “consented or connived” in the commission of an offense, provided that they have a “close connection” to the UK. Furthermore, the statute imposes a strict liability corporate offense for commercial organizations that fail to prevent bribery, which applies to acts by all persons “associated” with the company who secure an improper business advantage for the organization.
It is the Bribery Act’s corporate offense that raises the greatest reason for concern for all the players of private equity. The broad terminology of the law potentially covers all acts by persons “associated” with a company, including agents, joint venture partners, employees or those performing services on behalf of the fund. The category of associated persons to whom a fund may be linked to is so wide that the fund vehicle, its limited partners or the general partner may face liability if the agent has provided services and acted in a corrupt manner, even though there has not been direct knowledge of the bribery taking place. To be more specific, associated persons may include those persons who raise capital, advisers on the transaction or persons appointed to the board of a portfolio company. And the penalties are nothing to shrug off: individual liability is up to 10 years of imprisonment, while commercial organizations face an unlimited fine.
If found to be liable, a fund’s only defense is to prove that it had in place “adequate procedures” designed to prevent persons associated with the company from undertaking such conduct. While definitive guidelines defining “adequate procedures” will not be published until next year, the UK Ministry of Justice has provided some non-exhaustive considerations: risk assessment, top level commitment, due diligence, clear, practical and accessible policies and procedures, effective implementation, and monitoring and review. Thus, the Bribery Act effectively establishes strict liability for failure to implement adequate compliance mechanisms in order to prevent the commission of a bribe for a commercial organization. Therefore, private equity funds should promptly begin a review of their policies and procedures. This will allow time to revise and fully implement their policies and procedures before the Bribery Act comes into force in the Spring.
As a general matter, to protect against liability arising from the corrupt activities of a target, investors must conduct targeted preclosing due diligence. The due diligence investigation should examine key individuals associated with the target, as well as examine the target itself. Also, the investigation should be tailored to take into account the particular compliance risks presented by the target and its business. Obviously, key
assets which have a governmental nexus, such as licenses or concessions, should receive particular attention. In all events, relationships with outside advisers and consultants should be carefully examined for signs that these relationships may have been a conduit for improper payments. And, of course, those conducting the due diligence should take care to make themselves familiar with any recent corruption problems in the public eye and any known patterns of corruption involving relevant government or political figures.
Once the acquisition has taken place, it is critical to establish for the target a rigorous compliance program which is vigorously implemented. The compliance program must be supported by senior management of the target and must be effective to establish a compliance culture within the target. Relationships with advisers and consultants should be reviewed and clear procedures for the retention and payment of such service providers should be clearly defined. Also, the program must include strong financial controls which are effective in identifying questionable payments.
It is critical to note that there is no one-size-fits-all compliance program and that programs that were in place to safeguard against the wrath of the FCPA will need to be revisited once final guidance is released for what is meant for “adequate procedures” under the Bribery Act in order to span both statutes. If a violation does occur for funds with both UK and US interests, dual prosecution may occur under each law. This has significant impact for private equity funds that are based in either country and that have multi-jurisdictional portfolio companies.