FCPA due diligence is no longer an option, but a must in China-related acquisitions

George Qi
[email protected]


In light of the current Foreign Corrupt Practices Act (FCPA) enforcement environment in the US and the increasing awareness and enforcement of anti-bribery laws by the Chinese government, it is critical for US companies to conduct adequate FCPA due diligence when contemplating acquisitions in China.

There are many reasons to conduct FCPA due diligence in acquisitions. First, due diligence helps an acquiring company to accurately value the target. Second, proper due diligence can identify FCPA risks and lay the foundation for adopting an effective anti-corruption programme at the target quickly and successfully after closing. Last, but not least, comprehensive due dili¬gence demonstrates a commitment to uncovering and preventing FCPA violations. FCPA due diligence is a clear regulatory expectation by the US Department of Justice (DOJ) and the US Securities and Exchange Commission (SEC) now.

FCPA due diligence should be tailored to the specific risks of a transaction and start with an FCPA risk assessment of the target's business by understanding the nature of the business and identifying potential risks. Categorising the risk level will dictate the amount of time, energy and resources that need to be spent. This risk assessment may be a continuing exercise throughout FCPA due diligence. For example, FCPA due diligence can go broader and deeper when more risks are discovered than what was revealed by the initial risk assessment.

The following factors should be considered in the risk assessment of the target: the business model as it pertains to interacting and working with government agencies, officials or state-owned enterprises; the corruption level in the target's regions and relevant industries; the use of distributors, consultants, representatives, agents, brokers and other third-party intermediaries; the nature and extent of the anti-corruption compliance programme already in place at the target; prior anti-corruption problems and investigations; and existing internal controls and accounting systems.

A basic level FCPA due diligence should at least include the following steps: a review of the target's existing anti-corruption compliance program; a review of the target's sales and financial data, customer contracts, and third-party and distributor agreements; a review of open-source intelligence to determine the target's as well as its shareholders' and key management members' reputations and prior anti-corruption problems; and interviews with the target's management, including those in charge of the legal, sales, compliance and audit functions.

As the FCPA risk level increases, broader and deeper FCPA due diligence should be conducted by taking one or more of the following steps: a review of the target's marketing expenses, travel and entertainment expenses, donations, etc.; interviews with the target's lower-level employees, as well as third party intermediaries, such as distributors, consultants and agents; hiring forensic accounting firms to verify financial data; an audit of selected (based on the risk level) transactions of the target; and hiring a reputable private investigation firm to conduct background checks on the target, its shareholders and key management members.

FCPA due diligence should look for the following red flags: rumours of improper payments; excessive and large-amount cash payments; payments to offshore bank accounts; undisclosed related-party transactions; frequent use of travel agencies and event companies; unusually large or frequent donations and contributions; retention of unnecessary distributors, consultants or agents; inaccurate books and records; deficient director independence or corporate governance; weak internal financial controls; refusal to certify FCPA compliance; excessive litigation matters; previous regulatory compliance issues (e.g. fraud, anti-money laundering, etc.); business with controversial entities or embargoed countries; affiliations with organized crime, drug cartels or other unsavoury organisations.

To the extent practicable, FCPA due diligence should be concluded before closing. When under time pressure, an acquiring company should decide whether to delay, renegotiate or even cancel the transaction. The acquiring company may also consider using the DOJ's advisory opinion process as provided in FCPA Opinion Procedure Release 08-02, where the DOJ provided a six month post-acquisition grace period, agreeing not to prosecute the company at issue for any post-acquisition FCPA violations occurring within the first six months of closing on a number of conditions such as providing the DOJ with a comprehensive post-acquisition due diligence work-plan, retaining outside counsels and forensic accountants to perform a detailed compliance review of FCPA risk areas, initiating a stringent compliance programme and disclosing any pre-acquisition conducts discovered.

FCPA due diligence should not be the end of an acquiring company's anti-corruption efforts in an acquisition. After FCPA due diligence is completed, the acquiring company will determine whether the risk is so great that it needs to walk away, or that it can be managed post-closing such that it can move forward with the transaction. If the transaction moves forward, the acquiring company should attempt to protect itself through robust contract provisions.

More importantly, the acquiring company should make its best efforts to stop corruption from continuing after closing the acquisition by quickly and practically adopting an effective anti-corruption programme at the target. The acquiring company should determine whether a voluntary disclosure is advisable and, if pursued, be thorough and involve the relevant law enforcement authorities in any remediation plans or internal investigations contemplated.