WIXLIB

Anti-corruptionconsiderations forprivate equity firms

Anti-corruptionrisksto private equityFinancial riskOperational riskReputational risk Impaired value of the acquiredcompany where value wasbased on revenues generatedfrom bribe-paying Delays in closing due toidentification of a problemat the last minute Difficulty attracting capitalfor future investments dueto negative reputation drivenfrom prior bad acts Significant expensesassociated with conductingan internal investigation,responding to regulatoryinquiries and, payment ofsignificant fines and penaltiesfor those issues identifiedpost-close and relatedlitigation costs Loss of expected revenuedue to segment/specificoperations inherited whereproblem is concentrated Successor liability for PE firmand directors due to violativeactivity performed by theportfolio company — even priorto ownership by the PE firm Difficulty attracting fundingfrom certain SWF investorsif benefits, gifts, travel andentertainment are not beprovided at expected levels Inability to divest or exit frominvestment if problem isinherited and not remedied Loss of key customerand associated expectedsales revenue due torelationship built on sidedeals and/or kickbacks Difficulty engaging upstanding,qualified suppliers,consultants and placementagents due to requiring thirdparties to sign anti-corruptiondue diligence certifications Loss of key supplier/supplierdiscounts due to improperrelationship or relationshipbuilt on bribe paying No knowledge of potentialbooks and records issues dueto denied access or inabilityto audit Liability exposure for directors,fund managers, executives orother associated individualscharged with management orguidance responsibilities overthe portfolio company

Anti-corruption considerationsThe FCPA, enacted in 1977, prohibits US companies, their subsidiaries, officers,directors or employees from bribing foreign officials, either directly or indirectlythrough intermediaries, for the purpose of obtaining or retaining business.The Foreign Corrupt Practices Act (FCPA) has becomean enforcement priority for regulators and a majorcompliance issue for US companies with overseasoperations. The US Securities and Exchange Commission(SEC) and the US Department of Justice (DOJ) havestepped up efforts to investigate and prosecute businesscorruption, significantly raising the reputational andfinancial risks to companies. The FCPA, enacted in 1977,prohibits US companies, their subsidiaries, officers,directors or employees from bribing foreign officials,either directly or indirectly through intermediaries, for thepurpose of obtaining or retaining business. It also requirescompanies registered with the SEC to keep accuraterecords of all business transactions and maintain aneffective system of internal accounting controls.During 2010 and 2011, we saw a continued surge incorporate cases against large corporations by the USauthorities. In 2010, the DOJ and SEC together chargedor otherwise alleged violations of the FCPA against47 companies and levied more than 1.7 billion intotal penalties.1 In 2011, US authorities imposed fines,penalties and disgorgement amounting to more than 509 million in 16 corporate cases, demonstratingthat the US enforcement authorities are continuing topursue FCPA cases aggressively.2 During 2011, 31% ofenforcement actions targeted non-US companies, andrecord number of charges were against non-US individuals(12 of the 18 individual cases) leading many to believethat the US government will continue to use its expansiveview of jurisdiction under the FCPA.3Anti-bribery enforcement is continuing to be a priorityoutside the US as well. The UK Bribery Act of 2010(the Act), which went into effect on July 1, 2011, hasattracted the most attention on the international front.The Act poses a host of new challenges, includingpotentially broad grounds of jurisdiction, reachingcompanies and partnerships established outside the UKbut that “carry on” a business in the UK.4 The expansivestatute covers commercial bribery and does not havean exception for facilitation payments, going beyondthe provisions of the FCPA. In addition, the Act containsan affirmative defense that will allow a company toavoid liability if it demonstrates that it had “adequateprocedures” in place designed to prevent such bribery.5However, as with the FCPA, there is no requirement ofactual knowledge — what is known and what you shouldhave known are equally important.1Shearman & Sterling LLP, FCPA Digest, January 2011, p. 8.2Shearman & Sterling LLP, FCPA Digest, January 2012, pgs 5–7.3Shearman & Sterling LLP, FCPA Digest, January 2012, p. 5.4Shearman & Sterling LLP, FCPA Digest, January 2011, p. 25.5On March 30, 2011, the UK Ministry of Justice issued the implementation guidance asto what constitutes adequate procedures and announced that the Act will be effectiveon July 1, 2011.Anti-corruption considerations for private equity firms 3

Anti-corruption regulation effectsThe current SEC focus appears to be on improper payments or conferred benefits toobtain or retain business and relationships with sovereign-wealth funds. FCPA penaltiesare significant and include criminal and civil penalties for the company and individuals.Private equity firms should be aware that the SEC appearsto be focused on enforcing the FCPA in the financialservices industry. The SEC and DOJ investigationshave targeted industries in the past (e.g., oil and gas,pharmaceuticals, freight forwarding), and they are likelyto continue to expand. In early 2011, the SEC began tomake initial inquiries regarding FCPA practices at certainbanks, private equity firms and hedge funds, specificallyregarding their interactions with sovereign wealth funds(SWFs). The SEC appears to be focused on and is activelyinvestigating fundraising and investing activities. SWFadvisors, private equity firms and hedge funds havebeen on the anti-corruption radar for several years, andSWF employees are considered “foreign officials” by USregulators and therefore within the FCPA’s scope. Thecurrent SEC focus appears to be on improper paymentsor conferred benefits to obtain or retain business andrelationships with SWFs. FCPA penalties are significantand include criminal and civil penalties for the companyand individuals.Mark Mendelsohn, former Deputy Chief of the DOJFraud Section and partner of law firm Paul, Weiss, Rifkind,Wharton & Garrison LLP, told The Wall Street Journal that,“Financial institutions, private-equity funds, hedge fundshave historically paid less attention to FCPA risks thanindustrial companies have. That’s changing. It’s nota straight-forward issue because these institutions allhave different investment strategies. There are somevery real issues about where responsibility for compliancelies. The private-equity fund often will have some of theirpartners or business leaders sitting on the boards of theinvestment companies. So in a very simple way they aregoing to have exposure.”64 Anti-corruption considerations for private equity firmsAdditionally, UK authorities have made clear that thelevel of control over entities will affect the enforcementof corporate offenses under the UK Bribery Act; forprivate equity firms, this means the level of control intheir portfolio companies.7 In a recent meeting with theclients of the law firm Debevoise & Plimpton LLP, SeriousFraud Office Director Richard Alderman warned that evenif they aren’t aware of the bribes, private equity firms areresponsible for the actions of their investee companies.8Alderman also stated, “it may even be that it is a conditionof investment by fund managers allocating funds to you toinvest that you invest only in companies that are FCPA andBribery Act compliant. This is something you will need tobear in mind. You may also need to look at your exposureif you are directors (whether executive or non-executive)in the companies in which you invest.”9Although the SEC is yet to formally charge a private equityfirm based on the conduct of a foreign private companyin its portfolio, during 2011, the SEC investigated theactions a joint venture of one of Europe’s largest insurersfor possible bribery. Although the SEC reportedly decidedto drop its charges due to lack of access to documentationheld by the insurer’s joint venture partner, the actioncertainly suggests that the SEC is taking corruptionat the investment company level seriously.10Furthermore, private equity continues to seek dealsoverseas and sees emerging markets as a “hot ticket.”11Potential investors should be aware of the corruptionrisks present in many developing nations, particularly inthe “BRIC” countries of Brazil, Russia, India and China.While the developing nations promise strong growthopportunities, high costs to clean up those operations,even within an outsourced distributor or sales office,may present enough cause for walking away. Accordingto a survey of corporate executives, investment bankers,

While the developing nations promise strong growth opportunities, high costs to cleanup those operations, even within an outsourced distributor or sales office, may presentenough cause for walking away.private equity executives and hedge fund managersconducted by Mayer Brown, LLP, “63 percent ofrespondents reported that the FCPA and anti-corruptionissues caused their companies to renegotiate or pull outof planned business relationships, mergers or acquisitionsover the last three years.”12As all of this information suggests, understanding thecorruption risks specific to private equity is extremelyimportant given the current regulatory environment. Forinstance, broad successor liability for the prior actionsof an acquisition, which applies when one corporationacquires another, does not apply in the context of anequity investment. However, two features remain centralto any legal claim of responsibility imposed on privateequity firms — how much you control and how muchyou know.6Dionne Searcey, “Former Enforcer Sees Looming Fights,” The Wall Street JournalOnline, March 17, 2011.7Debevoise & Plimpton LLP, “UK Bribery Act Enters Into Force,” June 30, 2011.8Lindsay Fortado, “Private Equity Firms May Be Covered by Bribery Law, SFO Says,”Bloomberg, June 23, 2011.9Norton Rose Group, “The impact of the UK Bribery Act 2010 on the private equityindustry,” August 2011.10“SEC to limit charges against Allianz,” Thompson Reuters, s/News/2011/11 - October/SEC to limit chargesagainst Allianz/, October 14, 2011.11Jason Kelly, “Private-Equity Managers Aim for Emerging Markets as Deals Shrink”,Bloomberg/Businessweek, May 3, 2011.12Mayer Brown, LLP, “Anti-Corruption Compliance for Private Equity andHedge Funds,” November 8, 2011.Anti-corruption considerations for private equity firms 5