Tackling corruption and regulatory risk in M&A transactions

Publication | July 2015


Global companies face pressure to maximise investor returns and may elect to pursue growth through mergers and acquisitions, potentially expanding overseas into both developed and emerging markets. Alongside the usual financial, commercial and legal due diligence requirements, M&A activity, particularly in emerging markets, brings with it an increased level of regulatory and corruption risk. Legislation around the world has long made the act of bribery illegal but the perception of risk is changing as the enforcement of that legislation has increased to an all-time high. Buyers are exposed to the risk of inheriting liability for historic or ongoing unlawful behaviour and can face large fines, reputational damage and the erosion of deal value.

Below we examine how M&A practice is changing to adapt to the increased regulatory risk, and offer thoughts on the safeguards that can be implemented in M&A transactions.

What comfort can buyers gain that the target does not engage in improper business practices?

Bribery schemes are often complex and structured so as to evade detection. There are many examples of companies which have paid bribes, often through middlemen or intermediaries, to government officials to obtain licences, to obtain a business advantage, to move equipment through customs or even in some instances to impede the access of a competitor to a particular jurisdiction or market. If the target’s reliance on such practices is not uncovered before completion, a buyer’s valuation of a target could be significantly over-inflated. Whilst the current scandal unfolding at world football’s governing body, FIFA, did not arise in the context of an acquisition or sale process, it does serve to highlight two key issues that are relevant to M&A practitioners.

Firstly, the hidden actions of a select few can have a severe negative impact on the reputation and value of an organisation. Secondly, regulators are willing to examine conduct that stretches back beyond the normal three to five years that would be picked up during typical buy-side pre-acquisition due diligence questions (the initial round of FIFA indictments unveiled by the US Department of Justice (US DOJ) charged defendants with conduct which took place as long ago as 1996). Accordingly, buyers need to appropriately scope their due diligence methodology to deal with these challenges to ensure the methodology reflects the risk presented by the target, the transaction and the jurisdictions in question. No due diligence exercise can provide a buyer with absolute certainty, but following a proportionate strategy can put a buyer in the strongest position to protect deal value.

When considering a low risk acquisition, enquiries can be focused on assessing whether bribery is a known or likely risk factor. This may involve a high-level review of the target’s anti-corruption programme as well as a series of follow-up questions to help identify any structural compliance weaknesses or prior instances of misconduct.

If, on an initial assessment, the transaction is rated as higher risk, buyers ought to scale up the due diligence workstream and conduct a deeper analysis. The scope of enquiries may focus on how the target’s compliance infrastructure and culture works in practice, its third party due diligence procedures, how robust its financial controls are, its human rights history etc. In the context of an acquisition where the target relies heavily on government licences or permits (such as telecoms, extractive industries, healthcare etc.), there will be two key areas of diligence: (1) a review of the material licences of the target’s business, including the circumstances of the award and maintenance of such licences; and (2) an examination of the nature of ongoing interaction with government officials as well as regulatory bodies. The two issues are often closely intertwined. Ultimately this means compliance due diligence will need to be wider than purely focusing on the target, and extended to cover the parent or selling entity. To the extent the parent has conducted any lobbying on behalf of the target, it will be appropriate to investigate activities at the parent company level.

The risk represented by government interaction is not merely theoretical. There are a number of high-profile examples where governments in emerging markets have proactively taken corrective action that has affected particular industries. In 2013 the Guinean government sought help from the G8 to fight corruption in the mining industry and, following a two year inquiry, subsequently revoked certain key licences. The Ghanaian government recently required certain oil and gas companies to certify compliance with the US Foreign Corrupt Practices Act 1977 (US FCPA) and the UK Bribery Act 2010 (UK BA) prior to entering into new petroleum agreements. In 2012 the Indian Supreme Court delivered a judgement which quashed 122 mobile 2G licences awarded four years earlier after concluding the award of frequency allocation licences was manipulated by the former telecoms minister to his own advantage. The released spectrum was subsequently reallocated by competitive auction.

Investing alongside a local partner

A significant proportion of investment activity in developing markets is undertaken by way of joint venture. The decision to participate in conjunction with a joint venture partner may be based upon the need to adhere to foreign ownership restrictions or perhaps because commercially it makes sense to invest alongside a local partner with existing infrastructure and/or industry connections. However, most international legislation recognises that acts undertaken by a partner, if intended to benefit the joint venture as a whole, are seen as the actions of the joint venture and penalised accordingly. A joint venture partner is therefore not a typical third party. Due to the long-term nature of a joint venture and the close nature of the relationship between the parties to a joint venture, the risks are different when compared to acquiring outright control of a company. In the context of a joint venture, the scope of due diligence should have a similar focus to the diligence on a standard M&A transaction, but should be extended to identify the historical business practices and approach to ethics of the local partner. In appropriate cases, the scope of due diligence should penetrate up the holding chain of a company to understand who is in ultimate control of the joint venture partner.

Particularly in emerging markets M&A, companies should be aware of the cultural differences that they may encounter and how their requests for information will be received. Not every local partner (or seller) will respond kindly to probing requests about their historic business practices. As a result, buyers may have to accept certain risks (for example, where the seller will not provide access to sensitive information pre-sale) but should seek advice before doing so. Regulators will not accept as an excuse the explanation from a buyer that it did not undertake due diligence in sufficient detail because of the cultural sensitivities of the local partner.

A cautionary M&A tale from the telecoms sector

An illustration of how these issues can impact buyers during M&A is highlighted by an example from the telecoms industry involving eLandia International Inc (eLandia), which acquired Latin Node Inc (Latin Node) in 2007 for US$26.8 million. Soon after the acquisition was concluded, eLandia uncovered significant corrupt practices at Latin Node that were not identified during due diligence. From 2004 to 2007, the US DOJ found that Latin Node made a series of payments to officials at the Honduran state-owned telecoms company in return for which Latin Node was awarded certain interconnection rights at a reduced rate. Payments were made via a third party agent, its Honduran subsidiary and direct from its own US bank account. During the same period, payments were also found to be made to Yemeni officials, again to secure favourable interconnection rates in Yemen. Latin Node pleaded guilty to violations of the US FCPA as part of a plea agreement entered into with the US DOJ and agreed to pay a fine of US$2 million.

However, as many companies who have been penalised for corruption offences will attest, the fine represents only the tip of the iceberg. In 2008 eLandia disclosed information in their public financial statements which analysed the value of the Latin Node acquisition. According to their internal assessment, due to the resulting fine but also to the cost of the investigation, action taken to terminate employees (including senior management) and the resultant loss of business, the purchase price of US$26.8 million was adjudged to be approximately US$20.6 million in excess of the net assets which were acquired.

What steps can a buyer take to preserve value?

Prior to completion, buyers can use the knowledge gathered during the due diligence phase to prepare integration plans with the aim of promptly incorporating the target into the acquirer’s internal control environment. Buyers should focus initial efforts on any revisions necessary to high-risk business activities, such as the procedures for interacting with government officials or selling products/services into high-risk countries via sales agents. Other practical steps available to buyers include training the target’s staff, requesting that the target adopt comprehensive new compliance policies, reinforcing the target’s on-boarding of third parties, introducing new financial controls and authorisation limits, and assigning a senior level executive to be responsible for establishing the compliance models in the target.

Irrespective of whether a thorough pre-acquisition due diligence process has been conducted, buyers should consider whether a post-acquisition non-financial audit would be appropriate. If problems are identified, such post-acquisition diligence may shield a buyer from acquiring successor liability in the short-term and should allow buyers a “grace period” to fix any problems. The US DOJ recently issued an update of what it considers to be an acceptable postcompletion integration process (Opinion Procedure Release 14-02). The overall message from US regulators is in line with the approach suggested in the UK Ministry of Justice guidance which was released following the introduction of the UK BA (as well as regulators in a number of other countries): in summary, an acquirer needs to take prompt and proportionate steps which are specifically tailored to address the corruption risks of the target business.

Should sellers be concerned?

To reduce the risk of a failed sales process and to maximise the value to be achieved, it may be prudent to assess the compliance health and performance history of any subsidiary that is intended for disposal. Whether via a low-key health check or as part of a full vendor due diligence report, sellers are reacting to the risk of bribery issues being uncovered during the sale process. A growing number of companies are electing to carry out some form of assessment, particularly if they are looking to large international buyers who are subject to one or more extra-territorial anti-corruption or anti-money laundering regimes.

Sellers should make note that any detected concerns will need to be addressed which may range from reinforcing existing policies and controls to more drastic measures such as terminating relationships with problematic third parties and/or disclosing improper conduct to the relevant authorities etc. The requirement of remedial work may impact upon the transaction costs and sale timetable.

This issue is particularly relevant to private equity funds or financial backers who may not have a detailed day-to-day knowledge of their portfolio companies. Uncovering a latent compliance issue that requires immediate attention pre-sale could negatively impact the exit strategy. If a private equity fund wishes to exit during a particular time window, it may find itself constrained from doing so whilst it procures the necessary steps are taken to clean up any improper business practices at the portfolio company level.

Reaction in the boardroom

Unsurprisingly, as the message of increased bribery and corruption risk spreads, boards of directors are adopting a more inquisitive stance when being asked to approve a new acquisition. Non-executive directors are taking time to scrutinise both the scope and effectiveness of corruption due diligence. Deal teams should be prepared to answer these questions and as best practice, ensure that the investment papers submitted to the board sufficiently outline the identified compliance risks of the target’s business, as well as proposals for how those risks can be mitigated.

A spotlight on human rights

Whilst the legal framework around the responsibility of businesses in relation to human rights has not yet developed to the same level as that of bribery and corruption, this area nevertheless can present major risks depending on the nature of the transaction. Significant reputational damage, class action law suits and business delays (e.g. where a factory is forced to halt work due to a strike by its workforce) may arise from a violation of human rights. There is an increasing international focus on the responsibility of businesses to protect human rights, most notably since the UN Human Rights Council unanimously endorsed the UN Guiding Principles on Business and Human Rights. Certain sectors in particular – such as construction, extractive industries, pharmaceuticals, textiles and telecoms – are more familiar with the human rights challenges. To illustrate, issues can arise when dealing with community consent matters (where indigenous peoples may hold a claim to rights over land that is the subject of an extractive licence or a right to be consulted prior to exploration), working conditions at a construction site or textiles factory, the impact of pollution on a local community or data privacy issues (particularly where police or other enforcement agencies make requests for personal data). In certain high-risk sectors, there is a trend towards buyers focusing on a target’s historic treatment of human rights issues and sellers should prepare themselves to answer questions on this subject during pre-sale due diligence.


The search for growth and market share may lead a company into a jurisdiction with a less than perfect track record of combatting instances of corruption. This brings an increased risk that the value of a target business may be eroded after acquisition upon the discovery of unlawful behaviour. Whilst this should not be a complete deterrent to an acquisition strategy, the best defence to corruption risk is to approach an acquisition with open eyes. Companies and their deal teams should be armed with appropriate strategies and engage with the right advisers in order to manage and mitigate this increased risk.



Robin Brooks

Robin Brooks

London Nordic region
Oliver Stacey

Oliver Stacey