Bribery and corruption: What investors must know about handling unfamiliar issues abroad

Acts of bribery, fraud and corruption are as old as human history. And as tactics by people committing such acts adapt and change, so do initiatives by public authorities to curb abuses.

As Canadian and U.S. private equity (PE) and venture funds have become increasingly active in global deal-making, they need to be more aware of bribery and corruption issues abroad. And investors need to take steps to ensure that they and their investee companies are not in violation of laws concerning the corruption of foreign public officials. (View full Deloitte report here.)

Deal opportunities in emerging economies have become highly popular with Canadian institutional investors and PE funds. And yet it is precisely these regions where a business environment can reflect elevated risks of corruption. For example, BRIC nations — Brazil, Russia, India, and China — all received scores of less than 50 on the 2013 Transparency International’s Corruption Perceptions Index (where a score of 0 is considered highly corrupt and 100 is quite clean.)

In both developed and developing countries, the risks are greatest in sectors that are most susceptible to bribery and corruption. These often include highly regulated industries or industries that see a lot of government contracts, such as infrastructure, healthcare, pharmaceuticals and resources. Other industries that have frequent touch points with foreign government agencies are also not immune.

During the past decade, both domestic and international anti-bribery and corruption statutes have received increased attention. Major developments include an array of enforcement actions by the U.S. Department of Justice and the Securities and Exchange Commission concerning the Foreign Corrupt Practices Act (FCPA), and the introduction of the far-reaching U.K. Bribery Act. We have also seen increased focus on relevant Canadian legislation, the Corruption of Foreign Public Officials Act (CFPOA), through assigned resources and recent amendments.

Corruption 2PE and venture funds have not historically been targeted for legal enforcement, but recent indications by U.S. regulators suggest that this is changing — meaning that regulators in other jurisdictions are likely to follow suit. Unless investors with global exposure address these trends, they may face financial and reputational damages.

In addition to the CFPOA, Canadian PE and venture funds may be subject to the FCPA and U.K. Bribery Act, depending on the extent of their activity in the United States and the United Kingdom, and factors such as the citizenship of relevant individuals. Such legislation carries potentially significant fines — not to mention criminal penalties (including jail time) — that must be taken into account when analyzing risk in foreign markets.

So what factors should PE and venture fund managers keep in mind when assessing bribery and corruption risks? Here are a few examples:

• Risks are elevated when it comes to acquiring a controlling interest in a business operating in foreign jurisdictions, as laws often carry successor liability, meaning that new owners can be responsible for past violations of companies.

• PE and venture funds often rely on the services of third-party agents to identify and facilitate opportunities abroad. For example, they may hire local consultants to establish inroads with foreign governments or state-controlled entities. The definition of a foreign public official under relevant legislation can be broad and may include executives of state-controlled entities. Funds may be liable for the actions of these parties, even if they do not have direct knowledge of any illicit actions.

• Sovereign wealth funds (SWF) are among the world’s largest institutional investors, and they represent a unique risk. With many SWFs now turning to funds to manage their assets, competition for this role is growing. Fund managers in this situation must be cautious about interactions with those responsible for directing investment on behalf of foreign governments, as these individuals may meet legal definitions of foreign public officials.

• There is also the issue of hiring practices. A recent article in the New York Times revealed the existence of a dedicated program at JPMorgan Chase to hire the children of China’s ruling elite in order to secure opportunities with state-controlled entities. The article reported that the program is at the centre of a U.S. federal bribery investigation.

In addition to becoming more aware of the issues meaningful to their global deal-making, PE and venture funds should consider strategies for specifically mitigating bribery and corruption risks. Here are few important items that should appear on to-do lists:

Acquisition due diligence

For investors considering an acquisition of a business operating in a foreign jurisdiction, procedures designed to assess bribery and corruption risks should be built into the due diligence process. These should at a minimum include:

• Performing a top-down risk assessment that includes examining all foreign government touch points within the organization including:

o Considering partnership arrangements with foreign government-related individuals or entities;
o Investigating reliance on third-party agents with government dealings, and checking due diligence files related to the hiring of agents; and
o Analyzing risk in industries that may be more susceptible to bribery and corruption.

• Ascertaining whether a target company has an anti-corruption compliance program and assessing the effectiveness of that program.

• Conducting transaction testing to identify red-flag issues, such as excessive commissions or discounts to third parties; contracts that include vaguely described services; invoice descriptions that do not match services rendered; excessive balances in “miscellaneous” expense accounts; transactions with parties closely associated with foreign officials; and payments to shell companies or offshore bank accounts.

Of course, the outcome of a due diligence process may impact the purchase price of a given deal, or warrant its reconsideration altogether.

Internal programs

To mitigate risks of internal corruption, PE and venture funds also should ensure they have documented anti-corruption compliance programs and that programs are implemented in a timely and effective manner. Programs should include clear guidelines, codes of conduct, training initiatives, whistleblower procedures, scheduled risk assessments and opportunities for periodic review of all of the above.

And to mitigate third-party risk, investors should have in place appropriate mechanisms to examine business relationships for bribery and corruption risks before they occur. Contracts should also include provisions covering key features of relevant anti-corruption legislation, and investors should insist that their potential partners are educated about relevant statutes.

In their own operational policies, PE and venture funds should also have clear guidelines about travel and entertainment expenses. And they should ensure that their own hiring practices are adequately designed and monitored for potential violations of applicable anti-corruption laws.

Remember: Non-compliance with the array of applicable anti-corruption laws and enforcement measures is a real and present risk for PE and venture funds active in international markets. In order to manage this risk effectively, it is critical that those who are most senior within organizations demonstrate the appropriate “tone at the top” by committing to a dedicated anti-corruption compliance program.

A copy of the full Deloitte report summarized in this article is available here.

Andrew Rutherford is a senior manager in Deloitte‘s forensic practice, specializing in investigative and forensic accounting and anti-bribery and corruption matters. He is a chartered professional accountant and a certified fraud examiner.

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