Managing FCPA risks in PE

Dawn Zhang and Calvin Ding

[email protected] and [email protected]

As enforcement of the US Foreign Corrupt Practices Acts (FCPA) has increased in recent years, the importance of compliance has taken centre stage. Multinational companies operating in countries that are perceived to have high degrees of public corruption, like China, have proactively implemented FCPA programmes to limit their exposure to FCPA-related risk. This is especially true for those companies operating in industries that have recently been subject to enforcement actions like the pharmaceutical, telecommunications and retail sectors. As investors in these industries, private equity must be attentive to FCPA compliance both from a fund perspective and from the investment side.

The FCPA broadly prohibits bribery of non-US government officials by US issuers, domestic concerns and certain other persons. It requires US issuers to maintain accurate books, records and reasonable accounting controls. Employees of state-owned companies may be deemed as foreign officials for purposes of the FCPA. The FCPA not only applies to the company, but also to any stockholder, officer, director, employee or agent acting on its behalf. Simply put, the FCPA anti-bribery provisions prohibit directly or indirectly providing or offering a monetary payment or anything of value to a foreign governmental official to benefit the business of a defendant.

Recently, the number and size of FCPA investigations and prosecutions have soared, such that FCPA actions now amount to one of the top areas of prosecution by the US government. While these cases carry the threat of substantial terms of imprisonment and frequently result in significant fines, the government investigations that precede prosecutions often plague a company for years, scar its good name with the taint of corruption and, perhaps most significantly, very commonly generate internal and external costs that eventually dwarf the size of the fine itself.

FCPA risks from a fund perspective

Although the broad successor liability for prior bad acts of portfolio companies not subject to the FCPA does not typically apply in the context of private equity investments, broadly speaking, US companies face exposure for the actions of their foreign subsidiaries as shown in both the US Department of Justice's guidance on the FCPA and historic settlements. A US company's liability may arise from various legal theories, including: (i) agency principles if the US company had knowledge of or was wilfully blind to the misconduct of its foreign subsidiary; (ii) a US company directing, authorising or controlling the corrupt acts of its foreign subsidiary; (iii) respondeat superior, which allows for piercing of the corporate veil; and (iv) under the FCPA's 1998 alternative theory of nationality jurisdiction. Accordingly, private equity investors should assess corruption risk not only in their overall risk analysis when making an investment decision, but also after an investment has been made.

Another major FCPA risk area for private equity is in the solicitation of investments from the Chinese government or Chinese companies, many of whom are state-owned enterprises whose employees may be deemed foreign officials for purposes of the FCPA, or in attempting to find potential limited partner in China via government recommendations. Frequently, third-party intermediaries (TPIs) representing the private equity firm are engaged in such contexts to provide preliminary introductions or to expedite the relationship. While such TPIs may certainly add value by providing legitimate services, private equity funds should be mindful that such TPIs may also be offering improper payments or other prohibited items of value in developing the relationship. To address such risks, the background of TPIs should be checked before an engagement and their roles should be clearly defined in the engagement agreement. Relevant FCPA clauses should also be inserted into the agreement to regulate their behaviour. Necessary training, auditing, periodic diligence and other measures should be implemented to regulate and monitor the actions of TPIs on an ongoing basis.

Recommendations

The private equity firm itself should have a robust compliance programme in place to train its fund managers, manage its agents or TPIs, and control and monitor any payments relating to foreign officials. Pre-investment due diligence should be conducted on the portfolio company to determine the level of FCPA risk. During due diligence, efforts should be made to determine the top touch points the portfolio company has with the government, via itself or a third-party. Depending on the specific industry of the target company, the risk profile may be different. For example, pharmaceutical companies, clinical research organisations, or medical device companies may interact with hospitals and doctors frequently, whereas telecommunication equipment companies or internet companies may deal with the major telecommunication companies more often. In China, most hospitals and telecommunication companies are state-owned. After due diligence, an assessment should be conducted to see whether compliance with the FCPA will have any adverse financial impact for the company. After the investment has been made, any red flags identified in FCPA due diligence should be addressed, an FCPA compliance programme should be implemented and FCPA training should be given to relevant employees. In addition, proper due diligence on the company's business partner and TPIs should be conducted. This must be a continual process.