M&A risks rise without pre-closing due diligence: boards and audit committees should insist that merger agreements provide for pre-closing FCPA due diligence and that it be undertaken thoroughly and cooperatively.

• Author: Wendt, Daniel
• Position: INTERNATIONAL M&A

When negotiating mergers and acquisitions, officers and directors must often act quickly and decisively. During these critical moments, it is often necessary to jettison perfect-world deal elements in order to reach an agreement. However, if multinational companies and their boards forego pre-closing due diligence in reviewing the target's compliance with the Foreign Corrupt Practices Act (FCPA), they take on potentially significant risk.

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With the dramatic increase in FCPA enforcement in the last decade by the U.S. Department of Justice (DoJ) and the U.S. Securities and Exchange Commission, the importance of pre-closing FCPA due diligence has become firmly established. The litany of FCPA cases in M&A illustrates the potential benefits of thorough due diligence, as well as the perils of turning a blind eye.

DoJ and the SEC now typically expect any company acquiring a target with international operations to conduct pre-closing FCPA due diligence, and boards and management should do so as well.

Cheryl Scarboro, chief of the SEC's FCPA Enforcement Unit, recently reiterated that "corporate acquisitions do not provide [an acquiring company] immunity from FCPA enforcement [for violations by a target]."

Consequently, failure to conduct pre-closing FCPA due diligence introduces significant risk that could deplete the value of the deal; open the surviving entity to large penalties, fines and disgorgement of any ill-gotten gains; and expose the officers and directors to unwanted shareholder derivative suits.

Fines, Disgorgement and Derivative Suits

When companies decide not to perform pre-closing FCPA due diligence, the consequences can be costly, even catastrophic. Most obviously, the deal's value can be diminished by the discovery, post-closing, of FCPA violations committed by the targeted company.

In 2007, the technology company eLandia Group Inc. acquired LatiNode Inc., a telecommunications company, for $26.8 million. It appeared to have conducted very little if any FCPA due diligence pre-closing. Rather, eLandia performed a review of LatiNode's operations after the closing and discovered questionable payments, initiating an internal investigation that included numerous witness interviews and a review of thousands of documents, according to SEC filings. In 2009, LatiNode pleaded guilty to making improper payments in Honduras and Yemen and agreed to pay a fine of $2 million.

Additionally, eLandia subsequently disclosed that the fair value of LatiNode was less than $7 million, or $20 million less than...