- Foreign Corrupt Practices Act Compliance: A New Focus for Mergers & Acquisitions
- February 27, 2006 | Authors: Kent J. Schmidt; Parker Schweich
- Law Firm: Dorsey & Whitney LLP - Irvine Office
Trends and fads come and go in law just as in all areas of life. The world of white collar crime and corporate governance is no exception. What Congress touts today as the latest and greatest tool in the campaign to clean up corporate America may be tossed aside tomorrow. For example, the Racketeering Influence Corruption Organization Act ("RICO"), which was "all the rage" in the 1980s, interjected into ordinary business fraud lawsuits, is now viewed by most judges as somewhat passé and draconian except in cases that truly involve a criminal enterprise. A more recently discarded implement is the Federal Sentencing Guidelines, passed by Congress in 1987 to enhance the penalties for white collar crime only to be struck down as unconstitutional by the U.S. Supreme Court last year.
But one area of white collar crime that appears to have staying power is the Foreign Corrupt Practices Act ("FCPA").1 Next year will mark the 30th anniversary of the FCPA, and, if the past year is any indication, the FCPA will be around for many years and will continue to be a major focus for prosecutors and, by extension, companies that intend to avoid its drastic consequences and severe penalties.
The FCPA criminalizes bribery of foreign officials by U.S. corporations and individuals pursuing business in foreign countries. In addition to the express prohibition against improper payments, the FCPA includes accounting regulations designed to prevent cash transactions or "off the books" payments from being made to foreign governments.
Traditionally, FCPA compliance has been a major consideration for companies involved in international commerce, particularly corporations that sell products or services to foreign governmental entities. But one context in which FCPA compliance will most likely be given great attention is in mergers and acquisitions.
The increased focus on FCPA compliance in connection with mergers and acquisitions stems from a highly-publicized case that culminated in an announcement of a conviction and consent decree on March 1, 2005. The case involved The Titan Corporation and reads like a Shakespearean tragedy. Indeed, it was a romance of sorts -- a merger agreement between Titan and Lockheed Martin Corp. -- that led to a tragic ending. After announcing its intent to acquire Titan, Lockheed Martin engaged in extensive due diligence. Lockheed Martin's due diligence was thorough enough to uncover what Titan's compliance program should have uncovered long ago -- violations of the FCPA. Lockheed Martin discovered that Titan had commenced a project to establish wireless phone services in the Republic of Benin in 1998, and shortly thereafter, engaged the services of an agent who claimed to have close ties to the then-President of Benin. Without performing adequate due diligence to determine if its agent was complying with the FCPA, Titan began paying its agent hundreds of thousands of dollars for consulting services. The payments continued for many years. In order to cover up the payments, records were falsified and false invoices were submitted.
The violations, which were reported to the SEC, resulted in Lockheed Martin first dropping its offering price by $200 million and eventually abandoning the deal after Titan missed Lockheed Martin's deadline to resolve the problem. As Lockheed Martin walked out the door, a battalion of regulators entered, including the SEC, the Justice Department and the IRS. According to one source familiar with the case, the resulting investigation and prosecution involved 115 lawyers, 1,600 boxes of e-mails and documents, and 165 interviews in 21 countries. The investigation culminated in a guilty plea, a $13 million criminal fine, and a $15.4 million judgment for disgorgement of profits and prejudgment interest. The combination of the civil and criminal penalties was over $28 million, the largest FCPA civil/criminal penalty to date for a public company. The $28 million fine is particularly staggering given the fact that the improper payments were only $2 million and that, after the investigation commenced, the company reserved only $3 million to pay for the anticipated fines.
The lessons from the Titan tragedy are sobering and should be considered by any company, whether it is the target or acquirer, contemplating a corporate merger or acquisition, especially where the target company engages directly or indirectly in international commerce. The Titan events highlight for potential target companies the importance of establishing and maintaining effective compliance programs. Independent of the prudence required for FCPA purposes, an effective compliance program is mandated by the Sarbanes-Oxley Act of 2002, which requires that public companies implement a system of effective disclosure controls and procedures and a functional code of ethics. In light of what has transpired at Titan, it has become clear that, to be effective, a company's disclosure controls and procedures and code of ethics must be designed to uncover, prevent and deter FCPA violations. Had Titan been as diligent at self-governance prior to the merger announcement as Lockheed Martin was after the merger announcement, the consequences would have been limited and the deal could have been completed. The Titan events also highlight for acquiring companies the importance of involving experienced attorneys and auditors early in the due diligence process, a process that allowed Lockheed Martin to avoid a costly quagmire and potentially significant embarrassment.
The difficulty for the acquiring company that discovers possible FCPA violations is knowing when to terminate a deal and when to proceed. The fact that past FCPA compliance problems exist may point to the need for new management that, along with other corporate changes, will implement a more rigorous compliance program thereby reducing the chance of future violations. The government may be in favor of the acquisition provided that it represents a true regime change furthering the government's goal of enhanced FCPA compliance.
One sign of the government's intent to achieve compliance through allowing responsible acquiring parties to proceed with such a transaction is the Department of Justice's FCPA Opinion 2003-1.2 In that Opinion, the DOJ outlined steps that an acquiring company should take if it becomes apparent that a target company has engaged in activities that violate the FCPA. Generally, the acquiring company must cooperate with the government and foreign law enforcement authorities; ensure appropriate discipline of wrongdoers; disclose any additional pre-acquisition payments that are improper; and implement a compliance program and systems of internal controls to minimize future violations. The level of cooperation that the government expects from the acquiring company, the attendant costs and expenses of an ongoing investigation, and the inherent difficulty of implementing changes to the target company's established patterns and practices, are all factors that the acquiring company must carefully consider. For those acquiring companies unwilling to undertake these burdens, the prudent course of action is to simply to walk away from the target.
1 15 U.S.C. §§ 78m(b), 78m(d)(1), 78m(g)-(h), 78dd-1, 78dd-2, 78dd-3, 78ff.
2 Available at: http://www.usdoj.gov/criminal/fraud/fcpa/o0301.htm.