How to Boost Your Merger and Acquisition IQ

Here's a quick quiz to test your merger and acquisition (M&A) IQ.  The success and value of a proposed deal hinges more on:

   A. The “deal-drivers;” or

   B. The “organization protectors.”

It's a trick question. The right answer, and the key to effective M&A corruption due diligence, is:

   C. This distinction should not exist.

The team driving the deal is protecting the organization by enhancing its value. The team conducting corruption due diligence is driving the deal and enhancing organizational value by ensuring that the company makes the right acquisition at the best terms. Too often, these teams are pitted against each other in a tug of war that prevents corruption due diligence from taking place in a sufficiently timely and comprehensive fashion. 

The need to replace the “deal drivers vs. organizational protectors” mindset with a more effective approach has never been greater. M&A activity is on the rise, particularly in regions and countries with high corruption risks. The rapidly developing economies of Brazil, Russia and India rate relatively poorly on Ernst & Young's M&A Maturity Index—an analytical tool that evaluates M&A risk and opportunity globally—and corruption risk is a large reason why.

It's not only a matter of how, but of when to evaluate corruption risks in a proposed deal.  The best solution is to use a structured risk assessment approach in due diligence well before the decision to consummate a deal is finalized. 

If the parties driving the deal and those tasked with managing corruption risk cooperate, they can help prevent the due diligence process from wilting under the pressure of “deal heat,” a term coined by The Financial Times to describe the pressure to get the deal done that obscures the downside of a deal to management. Companies that treat the experts responsible for M&A corruption due diligence as the “Department of Know” instead of the “Department of No” are better positioned to strengthen decision-making no matter how intense the deal heat becomes.

“In my experience, the biggest challenge is to complete adequate due diligence on all third-party business partners, with particular emphasis on commercial agents who earn a commission for new business they bring in.”

—Jay Martin,

Chief Compliance Officer,

Baker Hughes

By participating in the strategic planning meetings that hash out whether it is better to build or buy, what markets a company targets or avoids and other upstream determinations, anti-corruption experts help lower the likelihood of selecting acquisition targets with high corruption risks. By sniffing out top-level corruption threats in the risk assessment phase, the company can identify and resolve corruption issues earlier and at a lower cost than it would incur when scrambling to react to these same issues later in the transaction process. 

There are other benefits as well. Knowledge of corruption risk strengthens the acquiring company's negotiating hand and may result in a more effective deal structure or more favorable purchasing terms. Early detection of corruption risk gives the acquiring company an opportunity to proactively meet with relevant regulators to negotiate resolutions to outstanding issues so that these distractions and potential business interruptions are firmly in the rear-view mirror once the deal is finalized. Planning for post-closing changes can take place as well.

To get these types of returns on their M&A knowledge investments, organizations should deploy corruption due diligence efforts as early as possible. The cost of neglecting this need can be extreme: “Failed M&A can destroy a company's market value, destabilize its financial position and credit ratings, impair its strategic position, weaken the organization and damage the company's reputation,” warns the Ernst & Young paper “Increased Oversight of M&A: An Expanding Role for Audit Committees.”

By treating their deal-drivers as organizational protectors and vice versa, acquiring companies can ace their due diligence and improve their odds of avoiding a failed deal.

Buyer Beware of Corruption Risk: An OCEG Roundtable

Switzer: Not all mergers or acquisitions are between U.S. based companies or those that are located where they are likely to have established anti-corruption programs. What are the biggest challenges in completing effective due diligence for corruption concerns when the company is acquiring an entity that operates completely within a high corruption risk country?

Wolski: Ironically, the confidential nature of a deal often results in overly restrictive access to the proper people for interviews and the target may be sensitive about providing information without full knowledge or appreciation of the purpose, which creates a significant challenge in gaining access to relevant information. But it's critical to gain a full understanding of all key business drivers of the target (key customers, sales channels, etc.) so you can determine how the target operates and identify potential areas of risk quickly. And you have to obtain full disclosure of all key business partners and the true business purpose behind each arrangement.

Martin: In my experience, the biggest challenge is to complete adequate due diligence on all third-party business partners, with particular emphasis on commercial agents who earn a commission for new business they bring in. This challenge arises because of the poor state of records in many lesser developed countries and the propensity of business partners operating in those countries to incorporate in offshore jurisdictions, where it is difficult or impossible to identify complete ownership of an entity and to confirm the lack of involvement in that entity by any foreign official covered by the strictures of the FCPA. Another challenge is to identify all of the key contracts and related amendments covering business with state-owned entities in the limited period of time one has to conduct due diligence in an acquisition context. The fact that documentation exists in huge volumes in many media, and in many locations around the world, creates a major challenge.

Rost: Gathering the extensive range of information needed for effective due diligence can be an arduous and time consuming task when you do not have the in country resources, knowledge, and language skills to perform the proper research and due diligence. Where to get information, how to ask for it, and researching and understanding the complex relationships between legal and government entities requires local expertise, and this is why many organizations rely on trusted information providers to execute on tailored enhanced due diligence activities. Professionally created reports offer detailed background checks on current and proposed individual and organizational business partners, and these professionals also can assist with informed decisions when more information is required.

Switzer: Too often, those who are responsible for due diligence outside of the pure financial realm are viewed as impediments to getting deals done. How do you overcome this view and demonstrate that early understanding of corruption risks presented by the target company can protect the bottom line and provide insight that may make for a better deal?

Martin: Our company has successfully conducted many acquisitions over the years which have involved some of the target's activities being in high-risk countries. We have had enough instances where acquisitions were not completed because of significant unresolved compliance issues that the company now readily appreciates the critical role that my compliance team plays in any acquisition to ensure that the company does not take on any hidden material compliance issues which would erode the expected value of the acquisition. We have spent a considerable amount of time educating other members of the company's due diligence team and senior management on the significant risks that are presented by the ineffective treatment of corruption risk and the material impact that unresolved compliance can have on the value obtained by the acquisition.

Wolski: The key is to educate the deal team, preferably even before they identify a potential target, about the range and significance of potential risks which must be identifed and assessed as early as possible. They need to know that the deal may give rise to reputational risks that can create difficulty in attracting capital for future investments. There may be personal civil and criminal exposure for directors and executives with oversight responsibilities. Financial risks could impact the value of the acquired company based on the loss of revenues, customers and suppliers which were generated from or associated with bribery or corruption; not to mention significant expenses associated with conducting internal investigations, responding to regulatory inquiries, and paying fines. There also may be operational risks including delays in closing the contemplated transaction as a result of last-minute identification of potential issues, successor liability arising from pre-acquisition violative activity, difficulty attracting funding for the contemplated transaction, and inability to divest or exit from the investment.

OCEG ROUNDTABLE PANELISTS

Carole Switzer,Moderator

President,

OCEG

Jay Martin,

Vice President, Chief Compliance Officer,

Senior Deputy General Counsel,

Baker Hughes

Gregory Wolski,

Partner, Fraud Investigation &

Dispute Services,

Ernst & Young

Mike Rost,

Vice President,

Thomson Reuters GRC

Source: OCEG.

Rost: The easiest way to overcome the view that more extensive M&A due diligence is an impediment to the deal is to provide the data which highlights the risks associated with corruption, business relationships, and the downside to moving forward without the proper research efforts . The best practice M&A due diligence processes we have seen involves the steps of searching and reviewing similar deals that have been done in the recent past, analyzing legal precedent for M&A corruption risks, review of global M&A deal metrics, governing law, jurisdiction, acquirer characteristics, and related parties, and screening and due diligence reports which outline risky business relationships and associations related to sanctions lists and legal action. All of these activities can be easily done by accessing trusted data sources and information providers who offer M&A specific information capabilities.

Switzer: When issues are identified, typically what can be left to address after the closing and what must be dealt with before the deal is sealed?

Rost: It is a best practice to gather as much information as possible prior to closing. Vendors and customers should be screened, the relationships and networks of those entities should be analyzed and understood, and high-risk areas should receive enhanced due diligence efforts. If these activities are not executed upon prior to closing and the deal still closes, a comprehensive effort be made immediately post closing to screen all vendors, customers, and third-party agents and provide as much information as possible as part of the process.

Martin: In evaluating whether any compliance issues that are identified in the course of the due diligence effort for an acquisition must be resolved prior to the closing and which issues can be resolved post-closing, great judgment and experience must be applied. For example, if an issue is serious enough to require disclosure to one or more government agencies, most acquiring companies will insist that such issues either be satisfactorily resolved or disclosed by the target company prior to closing. This would also be true for issues that present a significant amount of dollar exposure, such as pending litigation or environmental liability issues. With respect to identified issues, that can be pretty accurately priced as to liability, adjustments can be made to the purchase price of the target. As a general matter, compliance issues which do not have to be disclosed and do not present high dollar value exposure, can be dealt with on a priority basis following the closing

Wolski: Prior to closing, you should fully determine and assess the risks of bribery and corruption of the target and really understand the target's existing agent and customer relationships. In connection with closing, include reps and warranties in the deal agreement affirming compliance with FCPA and applicable anti-bribery laws by key target shareholders, executives, and directors. Immediately post closing, be sure to immediately communicate the right tone from the top and fix any shortcomings identified in due diligence. Implement policies, train employees, and ensure a program is established to monitor compliance.

Switzer: What is the biggest mistake made when acquiring entities with weak anti-corruption capabilities?

Martin: In my experience, the single biggest mistake that companies make when acquiring entities with weak anti-corruption capabilities is the failure to recognize how significant the adverse exposures can be. In today's world, many companies have global operations in numerous high-risk countries, and many dealings with state-owned entities and foreign officials. If any of the actions taken by the target company to attain or retain business were violative of anti-corruption laws, the acquiring company may be held fully accountable for those liabilities when they are discovered after closing. These exposures can involve significant reputational damage to the acquiring company, high investigative costs, substantial fines and disgorgement, personal liability to individuals, and potential debarment from government contracts. In a worst case, the collective liabilities resulting from hidden problems can be greater than the value of the acquisition itself.

Rost: When the risk is present with a target company with a weak anti-corruption capability, that risk should not be underestimated. Investing in enhanced due diligence, including screening of third party vendors, prior to deal closing will reduce any post close surprises and provide the acquiring company the information to price the deal correctly.

Wolski: Some acquirers approach transactions assuming that any issue can always be fixed post closing and take more of a check the box approach to

anti-corruption due diligence, which may result in failing to appropriately assess corruption risks based on the information that they have been provided. Just digging a little deeper or talking to the right target employees often results in the identification of information that could have a potentially significant detrimental impact on deal value.