BY PHILIPPE MONTIGNY AND BLANDINE CORDIER-PALASSE, Mergers & Acquisitions Magazine – 01/2010
Recently, the issue of foreign bribery has been considered a major risk for companies, particularly in the context of M&A processes. Today, a French company that pays an undue commission in the context of a foreign contract, directly or through a subsidiary or a commercial agent, can be prosecuted and convicted by a French court, even though all the elements of the offence are outside French territory. Until June 30, 2000, when the OECD Anti-Bribery Convention was transposed into French law, an act of bribery committed by a French company abroad could not be prosecuted by a French court. More precisely, it was only possible for a judge to recharacterize this act as an abuse of corporate assets, in particular when it had given rise to the payment of a kickback. Today, a French company that pays an undue commission in connection with a foreign contract, directly or through a subsidiary or a commercial agent, can be prosecuted and convicted by a French court even though all the elements constituting the offense are located outside of France.
In addition, the criminal liability of the company’s director may be incurred if it is proven that the act of corruption, decided by an employee or an intermediary of the company, was facilitated due to the absence of an explicitly formulated corruption prevention policy to date, 31 French companies (compared to 19 in 2008) have been prosecuted for an act of corruption committed abroad, more than half of which were reported to Tracfin as a result of a suspicion of money laundering in connection with the use of funds by the corrupt public official.
The French system of incriminating corruption in foreign markets was reinforced by the law of November 13, 2007, which not only broadened the characterization of the offence, notably to include influence peddling, but also gave the prosecution authorities investigative means previously reserved for the fight against terrorism and organized crime – infiltration, telephone tapping, image capture, etc.
The transposition of the OECD Anti-Bribery Convention into domestic law in all signatory countries is now effective and many prosecutions are underway. Several cases of corruption have received significant media attention outside the courtroom, such as those involving British Aerospace in England and Siemens in Germany and the United States.
The emergence of severe multi-jurisdictional sanctions
In addition to the risk incurred on the national territory, there is also the risk of prosecution
Currently, thirteen companies in the OECD area, including three French companies, are subject to multi-jurisdictional investigations which may result in prison sentences for the executive in a foreign court. In the recent case
between Faurecia’s German subsidiary and German car manufacturers, the French CEO, Pierre Levy, was sentenced in 2007 to a one-year suspended prison term by a German court
The U.S. court, under the Foreign Corrupt Practices Act (FCPA)2 , is the most active in prosecuting foreign companies listed in the U.S. or having a subsidiary in the U.S.
Thus, a French company listed on a U.S. stock exchange can be prosecuted by the Securities and Exchange Commission (SEC) for an act of corruption committed in France or in a foreign country.
In the last six years, out of 112 companies sanctioned by the American authorities for an act of public corruption abroad, 35 were not based in the United States.
Most emblematic case concerns the German group Siemens, which was fined 800 million dollars in 2008, after having already paid a fine of 775 million euros in Germany.
The issue of corruption in the context of mergers and acquisitions
In the case of a merger and acquisition process, the issue of corruption arises in a different way depending on whether one is looking at it from the point of view of the acquirer or the seller. The first question that arises is that of the acquirer’s responsibility with respect to the legacy of the newly acquired company’s criminal liabilities. From this point of view, it is necessary to assess which jurisdiction would be competent to incriminate an offence of corruption in the context of the acquisition. In short, we will distinguish two jurisdictional areas, the first being that of the United States and the second being that in force in most European countries, particularly France.
The U.S. jurisdictional space
For the U.S. justice system, the acquirer is responsible for the criminal liabilities of the acquired company unless it has conducted extensive due diligence in this area and, upon discovering acts of corruption, it has initiated or requested the acquiring company to initiate a voluntary disclosure procedure with the competent authorities, the Department of Justice (DoJ) and/or the Securities and Exchange Commission (SEC). This must be done prior to the acquisition or, if the acquisition is hostile, immediately afterwards, by informing the authorities immediately of any suspicions that bribery may have taken place. In the Titan/Lockheed Martin case, the merger agreement signed on September 15, 2003, provided that Lockheed would acquire Titan for $1.83 billion ($22 per share when the stock was trading at about $7). The agreement further stated that “no subsidiary, officer, agent or employee of the company or any of its subsidiaries has engaged in any act that would cause the company or any of its subsidiaries to be in violation of the Foreign Corrupt Practices Act.
On February 13, 2004, Lockheed and Titan decided to bring these facts to the attention of the Department of Justice and the Securities and Exchange Commission (SEC). Because of the risk of buyer liability, Lockheed required Titan to reduce the purchase price by $170 million in April 2004, a 9% discount. At the beginning of June 2004, the SEC announced that it was going to take action against Titan for violations of the FCPA, indicating that other violations could be discovered in third countries.
On 26 June 2004, Lockheed announced that it would not pursue the acquisition because of the risk involved. This decision caused the share price to fall by more than 40%, triggering a series of class actions initiated by small shareholders and institutional investors who were hurt by the sharp drop in the share price. In March 2005, Titan was ordered by the SEC to pay $28.5 million.
In June 2005, Titan was finally taken over by L-3 Communication, at a price of $23 per share, which is certainly the same as the nominal price initially offered by Lockheed, but which must be tempered by the fact that between June 2003 and June 2004, the Nasdaq had appreciated by about 30%.
The French jurisdiction
In French law, and in most European laws, the acquirer is generally not liable for the criminal liabilities of the acquired company, what is feared is that a corruption pact made before the acquisition continues without the knowledge of the new managers and that the latter are then liable to prosecution for not having put in place sufficiently effective tools for preventing corruption and controlling business practices. This situation, which characterized the Faurecia case tried in Germany, would undoubtedly have prevailed in France if the case had been prosecuted there. The German company Allibert Sommer AG was acquired by Faurecia in October 2000.
In May 2005, the German tax authorities discovered irregularities in the accounts of Allibert Sommer, which had become Faurecia’s German subsidiary, suggesting that undue commissions had been paid in connection with contracts with German car manufacturers. The investigation uncovered a system of corruption that had been in place since 1998, i.e. before Faurecia’s acquisition of the company, involving amounts of between €600 and €800,000 per year between 1998 and 2005. When the facts were discovered, Faurecia’s CEO, Pierre Levy, who took office in 2000, i.e. after the corruption pact was put in place, was forced to resign in 2006. In addition, the German court sentenced him to a one-year suspended prison sentence and a €300,000 fine.
It is particularly interesting to note that in its conclusions, the court recognized that the CEO had not been at the origin of the bribery pact, that he had not been fraudulently enriched, but that he was guilty of not having taken the necessary measures to put an end to these illegal practices. Finally, if the judgment may seem severe, it is interesting to note that the financial press of the time had qualified the sanction as lenient.
The issue of corruption in the sale process
The search for corrupt practices is increasingly frequent in acquisition procedures, not only because it allows the protection of the buyer’s criminal liability, but also because it can be a way for the buyer to lower the price of the acquisition, as for example Lockheed which obtained from Titan a 9% reduction on the price initially agreed. To protect themselves from this situation, a certain number of companies carry out thorough due diligence prior to the sale of a subsidiary. However, the consequences of discovering corrupt practices can be severe, as illustrated by the recent case of ABB.
In 2003, the Swiss company ABB wished to divest two entities: ABB Vetco Oray UK Ltd. and ABB Vetco Gray Inc. While conducting an internal due diligence, it discovered that corrupt practices had taken place in Nigeria with a view to influencing public officials during the award of contracts. ABB decided to conduct a thorough assessment of its two subsidiaries.
In 2004, ABB brought in 100 outside lawyers to audit more than 4 million pages of contracts and conduct nearly 200 interviews in 21 different countries. ABB then undertook a major overhaul of its business processes and controls. As a result, ABB decided to plead guilty to the U.S. authorities. The Department of Justice fined ABB $10.5 million and demanded $5.9 million in lost profits, for a total penalty of $16.4 million, which was considered very high at the time given the depth of the audit initiated by ABB, the cost of the audit, and the extent of the reforms undertaken.
Preventing the risk of corruption through the quality of human capital
Having an effective system for preventing corruption not only protects the company but also secures its capital in the event of a transfer. For a long time now, companies have been aware of the importance of their intangible assets: know-how, patents, business processes, image and even brand. However, few of them are still aware of the value of their ethical assets.
Since 2000, companies listed on the New York Stock Exchange have begun to take into account the provisions of the Sarbanes Oxley Act on internal control and fraud prevention, which have been added to the extraterritorial provisions of anti-corruption legislation.
The considerable fines imposed for corrupt business practices ($800 million in fines for KBR in the United States this year) demonstrate how costly a failure to comply with ethical practices can be for the company, the law of July 3, 2008 and the order of December 8, 2008 transposing the Eighth Directive have given new responsibilities to directors. They are therefore very much in demand to respond to high expectations in terms of ethics and must ensure the effectiveness of risk management procedures in particular, even if it is up to management to put in place effective procedures. However, the preservation of ethical assets cannot be decreed urbi et orbi. It is not enough to strengthen internal control procedures. It is essential to make employees aware of the value of integrity and to create conviction in order to get everyone on board. Thus, the preservation of ethical assets is built by putting in place an appropriate organization and adapted prevention and control procedures.
To this end, companies generally rely on an ethics document, a repository of culture and values, which will be adapted in the event of a change in scope due to a merger, an acquisition or, on the contrary, a spin-off. Some have been pushed to develop this approach because of external requirements, in particular from stock market regulators (French AMF, American SEC) or extra-financial rating agencies, whose standards have evolved by raising questions about the way in which companies deal with a particular ethical risk (corruption, lobbying for industries dependent on regulatory authorizations, advertising sales practices for consumer companies, sponsorship, respect for private life, etc.) In addition, companies are imposing new conditions on each other: buyers are demanding that suppliers comply with the provisions of their ethical documents, and in particular American buyers are asking to verify the anti-corruption procedures of the companies they deal with.
The development of compliance mechanisms in France is linked to both the strengthening of internal control requirements and the international expansion of groups. Companies that expand internationally, and particularly in certain countries, are aware that they are increasing their risks by exposing themselves to the application of extraterritorial rules (particularly with respect to corruption) and to a globalization of their legal risks, particularly with respect to competition, labor law, human rights, health, safety, sustainable development and the environment. The economic crisis has revealed the rapid spread of failures on a global scale. Companies that were in a quasi-monopolistic situation and are entering the competitive system are worried about new temptations.
The emergence of “compliance” policies
To address these risks, French companies are beginning to adopt compliance policies. In practice, ethics often refers to business ethics, essentially based on integrity and compliance in business practices and individual behavior.
Compliance seeks to protect, maintain and develop the reputation and competitiveness of the company. The purpose of the compliance function is firstly to ensure that the company’s activities are conducted in accordance with civil and criminal laws and regulations, in particular to prevent and detect malpractice, secondly to provide education on the scope of the applicable rules, and thirdly to implement prevention and control procedures.
Thus, in groups with a compliance-oriented approach, we can observe, on the one hand, a highly centralized reference framework in the form of an ethical document that is often universally applicable, with locally adaptable variants to respect cultural differences, and on the other hand, a more extensive network of compliance officers who carry out the functions of awareness-raising and control, while guaranteeing anonymity if necessary.
The personality of the founders or managers, the history and culture of each company influence its approach to ethics and compliance.
For example, some organizations want to convey strong values to maintain integrity in their behavior because of their business model or corporate purpose. This is the case, for example, of mutual companies, cooperatives or public services. Family businesses, on the other hand, are socially committed to the transmission of a strong culture.
Other companies (industrial or service companies that contract with governments) are exposed to legal risks (such as corruption or undermining competition) or are subject to the American legal system (listed on the New York Stock Exchange). As a result, they are developing legal and fraud prevention measures.
Setting up an “Ethics and Compliance” department
The deployment of a compliance policy generally requires the setting up of an “Ethics and Compliance” department.
By definition, the “Ethics and Compliance” department must be independent of the operational sphere in order to be able, for example, to refuse the choice of a commercial agent whose integrity is questionable to the point of putting the company at risk. But this independence must be coupled with a perfect understanding of the company’s business, its mode of acquisition or retention, without which it would have little credibility.
The legitimacy of an “Ethics and Compliance” department rests on two pillars, the first of which is its position in the company’s organization chart. It must be sufficiently close to the CEO and show that it has his absolute support. Its director must have access to the company’s governing bodies: executive committee, management committee or board of directors, depending on the case. It is of course essential that it has direct access to the audit committee, which must be regularly informed of its actions.
The second pillar guaranteeing the legitimacy of this management consists in the legitimacy of the director. The director must be a man or woman whose integrity is beyond doubt and who enjoys a reputation for independence and rigor. A form of charisma is also necessary because, in addition to implementing and monitoring anti-corruption procedures, it is a matter of bringing ethics to life in the company, whether in the operational departments or in the support functions: human resources, legal department, audit and internal control.
The interpersonal skills of the compliance director and his or her team are fundamental in conveying the conviction and gaining the support of all employees. Indeed, employees must take ownership of compliance with the rules and procedures in place and must be able to identify with the values defended and widely disseminated within the company.
This eminently cross-functional function must cooperate and interact with all operational and support functions: – the finance, audit, risk and internal control departments are involved in the fight against fraud; – the human resources department is involved in setting up appropriate training to reinforce employees’ vigilance in preventing corruption; – the legal department is involved in implementing compliance with anti-corruption obligations, particularly in contracts.
The ethics and compliance officer must therefore position himself in relation to these different departments. The fact that he or she reports to the highest level gives him or her the legitimacy to issue an “independent” opinion on questions submitted in confidence by employees or management.
Thus, the cooperation and involvement of the various operational departments and support activities varies according to three essential elements: – the nature of the risks to which the company is exposed; – the history of precedence and legitimacy of the various functions; – the legitimacy of the ethics and compliance department as a function of the personality and charisma of the director as well as the legitimacy provided by the highest level of the pyramid within the company.
The success of a corruption prevention policy depends on the mobilization of all employees
It is therefore important that the ethics and compliance department can rely on a network of compliance officers located in the different entities of the group and in the different countries. Depending on the size or risk of a subsidiary or country, these compliance officers may be either dedicated to this function or share it with their primary responsibility: legal, human resources, audit, finance.
Finally, some companies adopt a formula where regional compliance officers work full time while those in the countries work part time.
There is no standard qualification for a compliance officer: these correspondents generally have a triple mission of awareness, advice and reporting. Compliance programs include training on increasingly targeted risks such as corruption, antitrust, purchasing practices and human rights.
Their role is assigned on the basis of their personal profile and the nature of the prevailing risks in the business or country. Thus, depending on the case, they may be people with a legal, accounting or auditing background, but there are often excellent compliance officers who are former sales people, operational managers, administrative or human resources managers or even sometimes communication officers.
A team of compliance officers must bring together complementary skills and combine several talents: imagination to design the most appropriate procedures for the company’s businesses, rigorous analysis to identify potential risks, and the psychology to know how to convince operational staff in the field to strictly apply precautionary principles that can slow down their activity.
Regardless of the financial and human resources deployed, the support of each employee is required for these measures to be fully effective. The value of human capital is once again fundamental in order to ensure the effectiveness of and compliance with the measures put in place.
The company’s top management must set an example. Relayed by the management, it has a fundamental influence to ensure the legitimacy of the whole approach and to develop the compliance reflex in the whole organization and in the international activity of the group.
The durability of the company and its international development can be ensured in better conditions of legal, financial and operational security. This will contribute to strengthening the overall security of the company and its human capital and to a constant improvement in the value of the company.
In this way, the compliance policy contributes directly to the creation of value within the company. More precisely, it attests that the company’s turnover is based on business practices that comply with legal requirements and the expectations of citizens.
This is why it is particularly scrutinized during the acquisition process, as it determines the credibility of the figures that will be used as a basis for negotiations.