The Foreign Corrupt Practices Act: A Picklein M&A Transactions

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1 TheM&A lawyer perform the way the corporation intended. All the corporation needed was a more detailed statement giving stockholders guidance on what was specifically required for notice of director nominations. Conclusion The bottom line with respect to these cases is that the Delaware Court of Chancery wiii enforce advance bylaw provisions if they are clear and specifically describe what, when, and how to give advance notice. However, where the Court is forced to interpret a provision it finds ambiguous, it wiii resolve doubt in favor of the stockholders' electoral rights. The overall focus seems to be on fairness to stockholders, given the importance of stockholders' rights to nominate and elect directors. And that fairness may come in the form of a detailed bylaw giving stockholders guidance on what, when and how to give notice, thus prevailing over a neglectful or tactical stockholder who fails to even try to comply.with advance notice bylaws, specific beats general, and substance beats form. NOTES A.2d228,240 (Del.Ch.2007). 2. /d. at /d. at /d. at /d. 6. /d. at /d. at /d. 9. /d. 1O./d. at /d. 12./d. at Wl (Del.Ch.March13,2008). 14./d. at *3. 15./d. at *1. 16./d. at *3. 17./d. at *5. 18./d. 19./d. 20./d. 21./d. at *5. 22./d. 23./d.Thatsentenceprovidedthat: "Notwithstanding the foregoing, suchnotice must alsocomplywith any applicablefederal securitieslawsestablishing the circumstancesunder which the Corporation is required to include the proposal in its proxy statement or form of proxy."/d. at *2. 24./d. at *5. 25.C.A. No CC,Trans. Op. (Del. Ch. Apr. 4, 2008). 26./d. at /d. 28./d. at /d. at WL (Del.Ch.Apr.14,2008). 31./d. at * /d. at *5. 33./d. at *3. However, the Court found that comparing the previous bylaws to the current bylaws was not of great assistance due to the wide range of changes that had been made to the bylawsover the years./d. at *6n /d. at * /d. at *7. 36./d. at *6. The Foreign Corrupt Practices Act: A Picklein M&A Transactions BY SOREN LINDSTROM AND CURTIS RIDDLE Soren Lindstrom is a partner and Curtis Riddle is an associate in the corporate department of the Dallas office of Baker Botts LLP.Contact: soren.lindstrom@bakerbotts. com or curtis.ridd/e@bakerbotts.com. The Foreign Corrupt Practices Act (FCPA) was enacted in 1977 and then lived in near-hibernation over the next 25 years. That has changed dramatically.since 2002, the FCPA'slife has been marked by a sharp increase in enforcement efforts by the Department of Justice (DO]) and the Securities and Exchange Commission (SEC). The once seldomused law now has its own bar association that, by all accounts, is thriving. Since violations of the FCPA are punishable by steep civil and/or criminal penalties and can result in severe harm to the reputation of a business, the FCPA poses crucial challenges for U.S. companies 6 ]

2 May2008. Volume12. Issue5 in merger and acquisition transactions, in particular when the target is foreign or has substantial foreign operations. The principal FCPA challenges in a M&A context include: How does a buyer conduct its due diligence to get comfortable that the seller has not violated the FCPA? What should a buyer do if FCPA violations are uncovered during due diligence? What should a buyer do to ensure that no violations by the target occur post-closing? Because most business combination transactions are competitive, typically a target would not subject itself to "forensic" type due diligence by a potential buyer. However, while not entirely avoidable, the attendant risks can be lessened by the use of best practices in transactional due diligence as well as the implementation of effectivefcpa policies, procedures and training following a transaction. In the vein of reducing FCPA related risks both pre- and posttransaction, this article will discuss some common FCPA warning signs, offer practical suggestions on due diligence and negotiating the merger/purchase agreement and, finally, offer suggestions for postclosing policies that a buyer should consider implementing in order to avoid problems going forward. BriefFCPABackground The overarching purpose of the FCPA is to prohibit bribery of foreign officials. The FCPAhas three provisions that all work together with the goal of accomplishing this purpose. The "anti-bribery" provision, as its name indicates, outlaws and punishes the act of providing anything of value to a foreign official with the intent to influence the placement or retention of business. The "books-and-records" and "internal controls" provisions are aimed at preventing bribery and corruption by requiring that the company keep accurate books and records and establish a policy of internal controls designed to prevent and detect illegal payments. FCPA violations are punishable by steep civil and/or criminal penalties. For companies that rely heavily on U.S.Government contracts, a far greater penalty may loom, as violations of the FCPA can potentially result in debarment or loss of the ability to contract with the Federal Government. This potential catastrophic penalty and its chilling effects were best illustrated by the widely publicized failed acquisition of Titan Corp. by Lockheed Martin. Upon discovering Titan's potential FCPA violations, Lockheed Martin backed out of the deal rather than proceeding and risking potential successor liability. Titan/Lockheed Martin is not an isolated case, as the FCPA has played a role in other major M&A transactions, including: Cardinal Health Inc.'s acquisition of Syncor International Corp. and General Electric's acquisitions of InVision Technologies and Vetco Gray. Cardinal did eventually acquire Syncor, but only after Syncor paid a $500,000 civil penalty and pled guilty and Syncor's Taiwan subsidiary paid a $2 million fine. Similarly, GE was able to acquire InVision, but only after a fine and a deferred prosecution agreement. Vetco Gray had already pleaded guilty when GE acquired it, but the ongoing investigation into Vetco by the DOJ resulted in additional guilty pleas at the time of the acquisition and record criminal fines of $26 million. While not producing similar results and not tackled in the same manner, each of these transactions provides ample support for the notion that the FCPA is increasingly present in the transactional world. WarningSigns FCPA problems come in many shapes and sizes, but there are common warning signs that should alert a buyer. While the presence of any number of warning signs, or "red flags", may not present an unacceptable risk, they can help a buyer plan due diligence and negotiation strategies to mitigate its risks. "Red Flag"Jurisdictions and Industries. Where does the seller/ target operate? Transparency International publishes the Corruption Perception Index,1 which should be used as a tool in assessing a foreign jurisdiction's vulnerability to corruption. A company that is operating in a jurisdiction that has no FCPA equivalent or a country that has recently enacted a similar law may be more vulnerable to FCPA-related problems. Additionally, a buyer should take into account that certain industries are historically more susceptible to corruption. Ethics Culture of the Target. The culture that pervades a business can be an important gauge on the likelihood of corruption within the busi-, 7 I I

3 The M&A Lawyer ness. Important warning signs include past violations of any law (even if unrelated to the FCPA) as well as the lack of a code of ethics and business conduct. Past FCPA Problems. If the seller has had past FCPA problems, how were these handled? Inept or incomplete handling of past problems should be an important warning to any buyer. In addition to the obvious ramifications this has on the target's culture, the possibility exists that the problem was not adequately handled because the personnel responsible was considered irreplaceable or the particular corrupt practice was deemed necessary to the continued success of the business. Government Contractors. Does the target derive a substantial amount of business from government contracting? If the target derives a substantial part of its revenue from government contracts and has any of the previously discussed warning signs, a buyer should focus its diligence efforts on ensuring that no corruption is present, which might jeopardize such contracts. Lack of Willingness to Cooperate. If the seller indicates a lack of willingness to cooperate with the buyer's FCPA due diligence procedures or indicates that it will not comply with FCPA compliance efforts going forward, a buyer should seriously reconsider whether to proceed with the transaction. Due Diligence The due diligence efforts undertaken in response to FCPA risks are integral to completing a deal that makes financial sense for both parties while allocating the risks appropriately. In planning its diligence review,a buyer should begin by focusing on any red flags that it identified in its first look at the target. With these risks in mind, the buyer can customize its diligence efforts for maximum efficiency.since a business is often purchased in a competitive situation, a buyer will most often not have the time to conduct an exhaustive due diligence investigation and the seller will normally not subject itself to any kind of forensic investigation. Accordingly, the buyer's focus should be on conducting a commercially reasonable due diligence investigation, taking into account the perceived risks and then preparing to deal with any issues post-closing. Below are some suggestions on how to determine whether the seller, its principals, employees or agents have been engaged in corrupt practices. The degree and intensity of a buyer's due diligence should depend on the facts and circumstances, including whether there are any red flags, and, therefore, may consist of one or more of the following suggestions: Due Diligence Questionnaire. A buyer should start its FCPA due diligence by distributing a carefully crafted due diligence questionnaire to the seller.this questionnaire should request information and related documents from the seller regarding its ownership structure, directors and management, ties to governmental officials, and the use of commercial agents, consultants and subcontractors. u.s. Government Inquiries. Inquiries to officials from U.S.Embassies, the Department of Commerce and Department of State can provide valuable information about the reputation of a company and its management as well as the climate for corruption in a country. Electronic Research. The electronic research should include a review of the target's website, appropriate news and legal databases on Lexis! Nexis or Westlaw, searches for resources from the countries in which the target operates as well as general searches on internet search engines such as Google or Yahoo. These searches will help alert a buyer to FCPA-related news stories or litigation involving the target or a related person. Document Review. The buyer should also review documents relating to the ownership of the target, its principals and commercial agents as well as banking documents. From these documents the buyer may be able to ascertain whether any government official is a direct or indirect owner or beneficiary of the target, and whether the seller utilizes any unusual payment or banking practices. Interviews. The buyer could also choose to interview persons related to the target. The interviews should principally pertain to the reputa- 8

4 May2008. Volume12. Issue5 tion and qualifications of the interviewee and the ultimate beneficial owners of the target. Use of Investigative Firms. If the buyer is not satisfied with the results of the previous methods, feels there is more information that the target is not disclosing or just wants to be more thorough, it should also consider employing an investigative firm such as Control Risks or FTI Consulting. The results of each of the methods of investigation should be memorialized so that the buyer can demonstrate that it employed commercially reasonable due diligence in case an FCPA violation is later discovered. If the buyer, during the due diligence process, uncovers past problems with unethical behavior or corrupt practices, it becomes imperative to dig deeper and obtain more information about such things as: Whether the unethical behavior/payments have been or will need to be continued in order to retain important contracts, benefits or relationships? If a substantial portion of the target's business has been obtained and retained through unethical behavior, the value of the target may be substantially reduced to the buyer, as the buyer will be unable to continue the behavior once in control of the target. Whether any corrupt individual or entity remains connected to the target? It is important to learn whether the target removed anyone participating in unethical behavior at the time of the discovery. If the target is a government contractor, whether there is any risk of debarment? For many Federal contractors, debarment would be a death sentence. Whether the past unethical behavior may result in accounting or disclosure issues for the target and/or expensive or time consuming litigation? Accounting restatements and litigation are very costly, but a buyer must also consider the distraction to management such predicaments will cause. Whether the past corrupt behavior should be reported to authorities? This is a particularly delicate situation that will require open communication between the buyer and target. Public disclosure may result in near term consequenc- es, but may prove beneficial to both the buyer and the target in the long term. In particular, if a buyer is already under government investigation, the buyer's only real option may be to disclose and discuss the target's past behavior with the authorities (i.e., DO] and SEC). Negotiationof PurchaseAgreement Gathering the appropriate information during the due diligence investigation will help to ensure that the buyer knows what it is buying and pays a fair price. The representation below, made by the seller for the benefit of the buyer, ensures a level of comfort, even if small, on the part of the buyer, as no diligence review will ever turn up all potential FCPA related risks. The specific representation should vary from deal to deal based on the facts and circumstances involved, but below is an example of a representation that offers broad protection for the buyer: "Neither the Company, nor any of its subsidiaries, nor any of their respective directors, officers. employees or agents has taken any action, directly or indirectly, that would result in a violation by such persons of the Foreign Corrupt Practices Act of 1977, as amended (such act, including the rules and regulations thereunder. the "FCPA"),including, without limitation, offered, paid, promised to payor authorized the payment of any money. or offer, gift, promise to give. or authorized the giving of anything of value to any "foreign official" (as suchterm is defined inthe FCPA)or any foreign political party or official thereof or any candidate for foreign political office, in contravention of the FCPA,and the Company and. to the knowledge of the Company, its affiliates have conducted their businesses in compliance with the FCPAand have instituted and maintain policies and procedures designed to ensure, and which are reasonably expected to continue to ensure. continued compliance therewith." A FCPA representation of the target drafted and tailored to the specific transaction should be included in each merger or purchase agreement. In

5 The M&A Lawyer addition, the buyer should seek to negotiate specific indemnification provisions with respect to any past FCPA violations. However, no representation or indemnification will serve to fully correct a flaweddiligence process--each buyer should focus on diligence as the most effective method of limiting liability to the FCPA and assuring itself of what is being purchased. FCPAComplianceAftertheDeal The investigation and mitigation of FCPA risks by the buyer prior to closing are an indispensable part of an overall strategy meant to combat potential liabilities, but the efforts must not end on the day of closing as the true test still lay ahead. If the target has no past problems and has an effective FCPA compliance program in place, then the next step may involvenothing more than administrative matters such as changing the internal person to whom possible violations are reported. However, if the seller has a history of problems and/or does not have a functioning FCPA compliance program, then the next step will involvea greater challenge. Every purchase of a company that does not havean effective FCPA compliance program should involve the immediate implementation of such a program. The DO], at least implicitly,provided guidance as to what constitutes an effectivefcpa compliance program in its]uly 12,2004 Opinion Procedure Release.2 In that release, an investment group requested that the DO] not pursue an enforcement action based on FCPA violations by the target it was acquiring. The requestors made several representations regarding an FCPA compliance program that would be implemented going forward, and, ultimately, the DO] declined to pursue enforcement against the requestor. The FCPAcompliance program had many parts, but among the most important and universally applicable were that the compliance program: contain a clearly articulated policy against corruption; be implemented and overseen by senior executives; be accompanied by regular training and annual certifications of compliance; contain a hotline for reporting possible violations; be implemented in future business relationships through such things, among others, as representations in contracts and education of business partners; contain appropriate discipline, monitoring, accounting and reporting procedures; and contain appropriate provisions regarding audits by outside counsel and auditors to ensure its effectiveness. These are some of the elements of an effective FCPA compliance program, but they are not comprehensive, and they may not be sufficient in every situation. In order to be effective, a FCPA compliance program must be backed by a corporate culture of integrity. From the CEO down, each company that wishes to avoid exposure to the FCPA must back up the policy with action that leavesno doubt in the mind of each employee as to where the company places its values. Conclusion The implications of the FCPA, especially for government contractors, are enormous, and the acquisition of another company may open a veritable Pandora's Box of potential FCPA-related risks. These risks are particularly acute in cross-border transactions where "red flags" are present. Every buyer must walk the fine line between performing adequate due diligence while not scaring away the target. This can be an especially tough task if the target is foreign, where cultural differences must also be taken into account. Some of the attendant burdens, uncertainties and risks faced by u.s. buyers could be alleviated through greater transparency in the interpretation and enforcement of the FCPAby the DO] and SEC and the adoption of "safe harbor" type guidelines. In the absence of such measures, U.S.companies will continue to be competitively disadvantaged in the global mergers and acquisitions markets. NOTES 1. See /surveysjndiceslcpi. 2. See DOJ Foreign Corrupt PracticesAct Review, Opinion Procedure ReleaseNo (July 12, 2004),availableat fraudlfcpalopinionl2004/0402.html. 10