IN a downturn, the likelihood of fraud increases and financial integrity concerns are more frequently uncovered.
In a merger or acquisition, due diligence that includes the use of forensic accountants to assess bribery and corruption risk can help the acquiring company better understand the risks associated with a target, including its relationships with customers, suppliers, government agencies and officials, and other business partners.
Fraud within an organisation takes many forms involving the falsification of revenues or assets, where the collaboration of a counter party is common. These are potential risks that should be considered in the financial due diligence process.
Another risk to consider is the possible violation of relevant bribery and corruptions laws, such as the Foreign Corrupt Practices Act (FCPA). This should be an integral part of target due diligence in light of the current enforcement environment and potential for criminal and civil penalties to be imposed on individuals and corporations alike.
Key areas to probe include the existence, or lack, of anti-bribery and corruption policies and procedures, awareness of applicable bribery and corruption laws and regulations, attitudes and behaviours toward applying anti-bribery and corruption, standards within the local operating culture, and the target’s business model as it pertains to interacting and working with government agencies, officials, or state-owned enterprises.
The FCPA is a US act but applies to any organisation with operations in or transacting business through the United States. It is being strictly enforced and liability for acts in contravention of the law now include not only corporations and executives in charge of operations, but also investors.
Organisations that incur penalties and fines for non-compliance with the FCPA may also find that they suffer from a loss of investor confidence, loss of revenue based on illegal conduct that US-owned companies cannot condone and in some instances, indictments or convictions that put the acquirer at risk of being barred from doing business with federal governments.
Why the FCPA matters
Anti-bribery provisions apply to all US citizens and residents and all officers, directors, employees and agents of entities (whether public or private) either having their principal place of business in the United States or organised under the laws of a US jurisdiction.
The US Department of Justice (DoJ) and Securities and Exchange Commission (SEC) may assert jurisdiction over non-US entities and individuals and bring FCPA claims if they take or cause any action to be taken in the United States in furtherance of a corrupt payment to a foreign official.
There has been renewed emphasis on individual culpability and prosecutions. There is no materiality threshold when considering whether a corporation has violated FCPA provisions.
Factoring FCPA issues into due diligence
In the context of merger and acquisition (M&A), acquirers need to assess the existence and awareness of systems and controls over the following areas:
·expense claims, payments and petty cash disbursements
·use of agents and outside consultants
·entertainment and gifts provided to third parties
·contracting with government bodies
·fraud response mechanisms
·identification and monitoring of relationship development and maintenance with state-owned enterprises and their employees
·accurate recording of transactions within the target’s books and records
·record keeping protocols in respect of transactions recorded in the books and records
Based on the information learned through due diligence, a company may decide that the corruption and/or liability risk is tolerable. However, it may decide that the risk is so high that the value of the relationship is significantly reduced.
Assessing FCPA-related risks is an important step, but one that should not be conducted in isolation from more conventional financial and tax due diligence procedures.
Much like these other steps, the findings can play an important part in determining successor liability, revenue estimates and value attributed to goodwill.
Fully assessing FCPA risks can require the involvement of legal counsel and forensic accounting resources, alongside conventional transactional advisory support.
Planning is important because it may make sense to adopt a phased approach to FCPA due diligence that includes, among other key steps, risk assessment interviews and identification and validation of red flags.
Initial findings may create a case for further due diligence focusing on particular areas, for example, relating to specific geographies, third-party relationships, and commission, incentive and compensation structures.
Routine financial due diligence should be complementary, as a review of the target company’s financial records should help in determining whether such books, records and accounts accurately and fairly reflect all transactions and expenditures that have occurred and can provide the basis or foundation for further investigations and analysis.
Forensic due diligence such as this should be seriously considered when acquiring not only a distressed asset but also an entity that appears to be performing strongly.
Bribery and corruption has traditionally been considered as an inherent risk or feature of business in many parts of Asia-Pacific.
But increasing interest in corporate governance and transparency within the region, and the more pervasive reach of legislation such as the FCPA, means that companies can no longer take this issue lightly.
·The writer is executive director of forensic practice, KPMG Malaysia