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A Focus on Compliance Monitoring Solutions for Portfolio and Newly Acquired Companies

By Mihnea Rotariu

Private equity (PE) firms face a complex landscape of risks when acquiring new companies, with regulatory compliance ranking among the most critical. A key focus within this compliance sphere is anti-corruption, with particular attention given to adherence to the Foreign Corrupt Practices Act (FCPA). The timing of closing a private equity acquisition incorporates several variables, including the completion of due diligence, negotiation of the Sale and Purchase Agreement (SPA), and acquiring necessary regulatory approvals.

Interestingly, the period between signing the SPA and closing the transaction offers a strategic opportunity for PE firms to enhance the compliance program of the target company. This proactive approach, specifically related to FCPA compliance, can provide significant risk mitigation benefits. In this post, we will delve into the risks associated with FCPA compliance that PE firms face during acquisitions, detail practical steps to mitigate these risks, and highlight the advantages of implementing anti-corruption compliance monitoring solutions in both existing portfolio companies and newly-acquired businesses during this crucial transitional phase.

Understanding FCPA Risks

The FCPA is a US law prohibiting companies from bribing foreign officials to obtain or retain business. It also requires companies to maintain accurate books and records and to have a system of internal accounting controls. Private equity firms must ensure that their portfolio companies comply with the FCPA and other anti-corruption laws, as non-compliance can lead to significant fines, reputational damage, and even imprisonment for individuals involved in corruption.

Examples of cases involving PE firms include:
  • Och-Ziff Capital Management Group (now Sculptor Capital Management): In 2016, Och-Ziff, a prominent hedge fund and alternative asset management firm, agreed to pay over $400 million in penalties to resolve FCPA charges. The firm was accused of participating in a widespread bribery scheme involving African officials to secure mining rights and other business advantages.
  • Teva Pharmaceutical Industries Ltd.: In 2016, Teva, an Israeli pharmaceutical company with private equity investors, agreed to pay $519 million to resolve FCPA violations. The company was accused of bribing government officials in Russia, Ukraine, and Mexico to boost sales of its products.

One critical aspect of FCPA compliance that private equity firms must consider is successor liability, which refers to the potential legal responsibility a parent company may assume for the actions of a newly acquired company. In the context of anti-corruption and FCPA compliance, a PE firm may be held accountable for past and/or ongoing corrupt practices of its portfolio companies. Therefore, it is crucial for PE firms to address these risks proactively, both during the due diligence phase and after the acquisition.

Addressing Successor Liability in the Due Diligence Process

To mitigate the risks associated with successor liability, PE firms should consider the following steps during the due diligence process:

  • Conduct a thorough assessment of the target company's FCPA compliance history, including any previous investigations or enforcement actions.
  • Review the target company's relationships with third parties, particularly those in high-risk jurisdictions or industries, to identify potential corruption risks.
  • Evaluate the target company's internal controls and record-keeping practices to ensure they meet FCPA requirements and effectively prevent corrupt activities.
  • Examine the company's historical transactions for any red flags.

Managing Successor Liability Post-Acquisition

Once a private equity firm acquires a new company, it must proactively address potential successor liability risks. Managing these risks may include undertaking the following activities:

  • Conduct a comprehensive compliance audit to identify any ongoing corruption issues or areas of concern.
  • Implement a tailored compliance integration plan that addresses the specific risks and challenges of the acquired company.
  • Ensure that the portfolio company's compliance program is aligned with the parent company's policies and procedures and industry best practices.
  • Monitor the portfolio company's ongoing compliance with anti-corruption laws and promptly address any issues that arise.
  • Update and enhance the company's anti-corruption policies and procedures to ensure alignment with industry best practices.
  • Implement effective training programs for employees to ensure they understand the importance of compliance and the consequences of non-compliance.

Benefits of Implementing Anti-Corruption Compliance Monitoring Solutions Pre-Close

Time is of the essence when it comes to PE deals, so there are some added benefits to implementing a compliance monitoring tool on a newly-acquired portfolio company between the time of signing a Sale and Purchase Agreement (SPA) and closing the transaction:

  • Cost Savings: By identifying potential compliance issues early, the company can avoid significant penalties and negotiate financial terms. This process can also reduce the need for extensive post-acquisition remediation.
  • Integration Planning: Implementing a compliance tool early in the purchase process can help plan for post-acquisition integration. It will help identify any gaps in the target company's compliance program that need to be addressed and align the two companies' compliance practices.
  • Record-Keeping: Implementing compliance software will assist with record-keeping and documentation, which are crucial for FCPA compliance. The software can help create an audit trail, which could be used to demonstrate compliance in the event of a regulatory investigation.
  • Compliance Culture: By implementing a compliance tool, the PE firm sends a strong message to the acquired company's employees about the importance of compliance, fostering a culture of transparency and integrity.
  • Real-time Monitoring: A compliance monitoring tool can continuously track the company's operations and transactions, identify any suspicious activity, and alert the compliance team in real-time, thereby reducing the risk of potential FCPA violations.

An anti-corruption due diligence process typically involves thoroughly reviewing the target company's operations, financial records, business practices, and compliance systems to identify potential corruption risks. This process generally focuses on providing a snapshot of the company's risk profile at a specific point in time, usually prior to the acquisition. On the other hand, a compliance monitoring tool with a lookback capability provides continuous and retrospective oversight of a company's operations. This tool allows for a more dynamic and comprehensive view of potential corruption risks, as it looks back and then continuously monitors and analyzes data going forward. Some examples of what a compliance monitoring tool might catch that a standard anti-corruption due diligence process could miss include:

  • Delayed Transactions: The tool might catch delayed transactions that were not apparent during the initial due diligence phase but became apparent over time. For example, it could uncover payments made to third parties that were delayed until after the due diligence process was completed to avoid detection.
  • Full Data Coverage: While traditional due diligence typically involves a review of a sample of data or documents, compliance monitoring tools can analyze all of the data generated by the target company's operations. Operations data provides a more comprehensive analysis of the company's activities and behavior, providing a more accurate picture of potential corruption risks. By analyzing all available data, the tool can identify risk areas that may have been missed by traditional due diligence, such as anomalies or patterns that emerge from data sets that were previously unexamined.
  • Inconsistent Practices: A longer-term view allows for a more comprehensive analysis of a company's compliance practices and controls. A historical data set can help identify inconsistencies or weaknesses that might not be apparent from a single point-in-time review.
  • Effect of New Relationships or Contracts: The tool can assess the impact of new business relationships or contracts on the company's risk profile. For example, entering into a contract with a new reseller in a high-risk country could significantly increase the company's exposure to corruption risk.

Benefits of Implementing Anti-Corruption Compliance Monitoring Solutions on Existing Portfolio Companies

By adopting an anti-corruption compliance monitoring solution, PE firms and their portfolio companies can unlock numerous benefits, such as:

  • Enhanced Detection and Prevention of Corruption
    • A robust compliance monitoring solution can help detect potential corruption risks and prevent violations by enabling organizations to:
      • Monitor transactions for red flags, such as unusual payment patterns or dealings with high-risk third parties.
      • Implement real-time alerts to identify potential issues, allowing for swift action to mitigate risks.
      • Integrate advanced analytics and machine learning capabilities to identify patterns indicative of corruption, even in large volumes of data.
  • Improved Operational Efficiency
    • Implementing a compliance monitoring solution can lead to increased efficiency by helping companies to:
      • Automate routine compliance tasks, freeing up resources for other essential business activities.
      • Streamline the review and approval process for high-risk transactions, reducing bottlenecks and delays.
      • Provide a centralized platform for managing compliance data, simplifying reporting and analysis.
  • Reduced Legal and Financial Risks
    • A properly implemented compliance monitoring solution can help to reduce the potential for legal and financial consequences by enabling companies to:
      • Decrease the likelihood of costly fines and penalties due to violations of anti-corruption laws.
      • Reduce the risk of lengthy and expensive legal proceedings and investigations.
      • Mitigate the potential for reputational damage that can harm relationships with customers, investors, and regulators.

In conclusion, compliance with anti-corruption regulations, such as the Foreign Corrupt Practices Act, is an important consideration for private equity firms when acquiring new companies. Failing to adhere to these regulations can result in significant legal, financial, and reputational risks. However, PE firms can proactively mitigate these risks by undertaking practical steps, such as conducting thorough due diligence, implementing robust compliance policies and procedures, and providing ongoing monitoring and training. Additionally, leveraging anti-corruption compliance monitoring solutions can provide added benefits in identifying and addressing potential issues in newly acquired companies. By prioritizing FCPA compliance, PE firms can safeguard their investments, protect their reputation, and ensure sustainable and responsible business practices in their portfolio companies.

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