Sam Singer, the Foreign Corrupt Practices Act in the Private Equity Era: Extracting a Hidden Element

• Jurisdiction: United States,Federal
• Publication year: 2009
• Citation: Vol. 23 No. 1

THE FOREIGN CORRUPT PRACTICES ACT IN THE PRIVATE EQUITY ERA: EXTRACTING A HIDDEN ELEMENT

INTRODUCTION

A. The Report

In 1976, the U.S. Securities and Exchange Commission (SEC) submitted to Congress the results of an extensive investigation into accounts of questionable payments made by U.S. corporations overseas.¹The report's findings were nothing short of tremendous: more than 400 companies voluntarily admitted to making improper or illegal payments.²Of those companies, a significant number were publicly held, and more than 100 hailed from the ranks of the Fortune 500.³Taken together, the questionable payments exceeded $300 million and spanned a broad range of U.S. industries.⁴

However extraordinary its findings, the SEC's report could not have come as much of a shock. Indeed, the SEC had captured a snapshot of a prevailing culture of corruption long since absorbed by the global economy.⁵In an era of rapid economic development in the third world, an era in which multinational corporations wrestled for market share in undeveloped and often anarchic economies, the bribery of foreign officials was understood to occur as a matter of course.⁶In this environment, corporations intent on expanding internationally while keeping their finances above-board faced a competitive disadvantage.⁷

That Congress previously had been willing to tolerate these practices is testimony to the importance it (or, more precisely, members of the respective banking and finance committees) placed on the uninhibited expansion of U.S businesses overseas.⁸The SEC's contribution was to give the issue a palpable and public texture-a development that made congressional consideration unavoidable. Far from a legislative revelation, Congress's decision to turn its eye to foreign corruption reflected a shifting calculus-a shift that, unsurprisingly, coincided with the final months of the Watergate investigation.⁹In 1977, one year after the SEC released its unsettling report, Congress responded by passing the Foreign Corrupt Practices Act (FCPA).¹⁰

The purpose of the law was straightforward: to prohibit corporate bribery abroad and encourage rigorous and faithful bookkeeping at home.¹¹

B. The Age of Expansion

Before discussing the law in further detail, it is worth exploring some of the distinctions between today's corporate landscape and the one upon which Congress looked when it drafted the bill. If the SEC Report made one thing clear to the 94th Congress, it was that corrupt activity often followed in the wake of expansions of corporate operations overseas.¹²Prior to the passage of the FCPA, federal law did not forbid companies from making corrupt payments to foreign officials.¹³When the SEC successfully prosecuted a company for an illicit payment, it was because the agency could prove that the company failed to disclose a "material" transaction in violation of U.S. securities law.¹⁴Not surprisingly, many U.S.-based multinational corporations made a habit of using foreign subsidiaries as conduits to pass off corrupt payments.¹⁵Conscious of this pattern, Congress built vicarious liability provisions into the FCPA to deter circuitous payments and to encourage parent corporations to proactively monitor the conduct of their subsidiaries.¹⁶

While the parent-subsidiary model of expansion is still prevalent today-in fact, one practitioner's review of recent FCPA enforcement activity reveals that most FCPA actions arise from such relationships¹⁷-and while multinational expansion is still a significant engine of economic growth,¹⁸this Comment focuses on the more contemporary trend of international private equity investment. In particular, it poses three critical questions. First, does the FCPA, as adopted and as historically interpreted and enforced, reflect certain assumptions regarding the relationship between the U.S. investor and the foreign investee? Second, if it does, what is the nature of the presumed relationship, and to what extent should the application of the law vary in a different context? Third, are there principles or policy objectives that might prove instructive in applying these provisions in a modern, more complex investment environment? This Comment takes the position that such assumptions pervade the FCPA and its history of enforcement. Further, it argues that those assumptions must be parsed and carefully considered before applying the FCPA in a new context.

C. The Emergence of Private Equity

While private sector finance has existed for decades, international private equity (or at least our contemporary understanding of the term) took hold in the mid-1990s, by which point a global consensus had emerged that private companies, as opposed to states and large banks, would play an increasingly important role in financing investment and development in emerging markets.¹⁹For purposes of this Comment, private equity refers to financing for privately held companies from third-party investors seeking above-market rates of return.²⁰Private equity is a valuable source of financing for small and mid-sized companies, many of which have risk profiles that make it difficult to raise capital through conventional channels.²¹Private equity was popularized as a gap-filling vehicle, a source of capital for those companies large enough to seek external finance but not yet mature enough to obtain it from major lenders or public equity investors.²²Somewhere along the way, the private equity model matured from a chic cottage industry to a $100 billion-plus investment sector.²³It is from this vantage point that this Comment considers the historical context of the FCPA.

D. Critical Distinctions

When contrasted with the expansion-intensive trends of the 1970s, the rise of the private equity model brings some important distinctions to light. First, consider motivation. As already alluded to, multinational corporations sending capital overseas were historically motivated by their thirst for expansion.²⁴As many do today, these corporations entered developing markets in search of economies of scale and lower operating costs.²⁵Their motivation was strategic, their approach hands-on. In these instances, foreign subsidiaries typically operated as extensions of their U.S. parent corporations, often clearly identifiable with the U.S. company and, in some instances, bearing its name.²⁶

Contrast the typical private equity investor. Whether institutional or individual, private equity investors are purely profit-driven.²⁷Once an attractive rate of return draws their eye, regulations permitting, their money is all but certain to follow.²⁸Put differently, private equity investors are not concerned with strategic expansion and exposure, but only with financial fundamentals. This leads to a second distinction. As bottom-line-driven investors, private equity players are typically ready and willing to take their hands off the wheel.²⁹Whereas overseas expansion often requires extensive involvement on behalf of the parent company in order to ensure an efficient integration of the foreign operation, private equity firms are less likely to play a hands-on role in the day-to-day management of a venture.³⁰This is especially true in the international private equity context, where fund managers, lacking specific industry expertise and knowledge of foreign business customs, often rely on local partners to pilot operations.³¹Further, when an investor does retain significant contractual rights, it is usually reactive control-typically in the form of limited veto rights over major corporate decisions-instead of proactive control over day-to-day operations.³²It is important to emphasize that these companies are merely investment targets (as opposed to strategic extensions of a parent corporation) and thus will often retain their original foreign identity.

An additional distinction relates to timing. In contrast to the long-term investment of capital and resources likely to be involved in a typical corporate expansion, private equity deals often progress on expedited timelines. Unlike operating companies that enjoy a perpetual existence, private equity funds, by their terms, are limited-life vehicles-most are required to be liquidated by a specific date.³³As a result, these funds look to exit an investment when their financial returns are optimized, and the arrangement with the target company will often facilitate some form of liquidity event to allow for the return of the investment.³⁴The short-term nature of this investment horizon makes it less likely that it will enjoy substantial influence over the operations of the foreign company. These distinctions must be kept in mind as this Comment considers the appropriate scope of the application of the FCPA to the private equity model.

Part I of this Comment provides an overview of the FCPA, with a particular focus on the various channels of liability built into the law's anti- bribery provisions. Part II examines the ascendance of the private equity sector, beginning with a brief history of its development and presenting two representative investment scenarios, which will help to guide the analysis in Part V. Part III of this Comment explores the legislative history surrounding the FCPA's passage in 1977, as well as its subsequent amendments, with the aim of extracting a set of guiding principles that will prove instructive in applying the law in the private equity setting. Part IV examines recent FCPA enforcement activity in search of any pertinent applications of the law's principles and policies. With these conclusions in mind, Part V uses a basic factual illustration to reexamine the two principal private equity scenarios in order to determine whether and to what extent FCPA liability might attach. Finally, the Conclusion suggests an approach to applying the policy and purposes of the FCPA to the foreign private equity model as it exists in the current investment climate.

I. AN OVERVIEW OF THE FOREIGN CORRUPT PRACTICES ACT

The FCPA...