By Philip T. von Mehren, Partner, Baker & McKenzie
Private equity funds operating in Latin America are increasingly focused on ensuring that the fund and its portfolio companies comply with relevant compliance laws, including the Foreign Corrupt Practices Act, the UK Bribery Act and new anti-bribery legislation in various target jurisdictions, such as Brazil and Mexico. Several factors account for this increased focus by funds. A slew of corruption cases have hit Latin America hard over the last few years raising awareness and making corruption a central issue in many deals. Wal-Mart, Bionet, Orthofix and BizJet are all well known examples, many involving fines of millions of dollars.
The risks for non-compliance for a fund can be catastrophic. In addition to the legal risks that non-compliance presents to corporate entities — fines, prisons terms, loss of a tainted business line, and harm to the brand — many limited partners will simply refuse to reinvest with a fund that gets caught in the web of non-compliance. Thus, the future viability of the general partner itself may be at stake if a serious breach of corruption laws occurs. In addition, representatives of the fund serving on boards of a portfolio company or directly in management may face legal and reputational risks.
In order to minimize these risks, the fund’s deal team must focus on the necessary due diligence stages required to address the risks at the outset of the transaction*. Compliance investigations in the context of a transaction are usually broken into a series of discrete stages and are iterative and evolve as more information is obtained increasing the deal team’s understanding of the target and its risks.
Funds investing in Latin America should adopt a “risk-based” approach to conduct compliance due diligence. Broadly this means that the level of due diligence in each instance is proportionate to the investment and the perceived likelihood of the risk of bribery/non-compliance. This approach is consistent with 2012 guidance published by Transparency International UK, a leading anti-corruption organization whose stated mission is to stop corruption and to promote transparency, accountability and integrity at all levels and across all sectors of society. Transparency International UK’s guide for companies and their professional advisors undertaking due diligence for mergers, acquisitions and other investments included:
a) a statement of “good practice principles”
b) a 6-step template for anti-bribery due diligence; and
c) a checklist of recommended actions.
The general framework suggested in Transparency International UK’s 2012 guidance for anti-bribery due diligence in mergers, acquisitions and investments is reflected in our how-to guide to compliance due diligence.
4-stage plan in a compliance due diligence
Set forth below is a diagram of how a fund should consider approaching compliance due diligence:
Stage 1: The first stage in the compliance due diligence process is to carry out an informal preliminary risk assessment. The focus is to assess the extent to which the target is vulnerable to compliance risk and to identify any immediate potential “red flag” issues which need to be investigated further.
Stage 2: In most instances a simple desk-top review by itself will be insufficient and/or inconclusive because not all information relevant to making an accurate risk assessment will be available through public sources or otherwise be easily discoverable. Some further informal (and potentially formal) investigation will normally be required.
Stage 3: The results of the initial review and any management input (i.e. Stages 1 and 2) should be used to identify any red flags/potential areas of vulnerability and to develop and seek responses to a tailored due diligence questionnaire. This stage can take the form of a more formal Q&A session with the target’s management/compliance officer/key personnel. In each case the questions to be put to management or documents requested in the due diligence questionnaire will incorporate the findings and observations made during the preliminary review phases and be tailored accordingly.
Stage 4: The final stage in the process is to prepare a written due diligence report. For PE funds, this is normally done as a Red Flag/Key Issues report focusing on “deal stoppers” only. Nonetheless, in the area of compliance, funds should consider a full blown report because such a report may help the fund if, despite performing due diligence, an issue arises post-closing.
It is recommended that funds and other financial buyers undertake full blown compliance due diligence in order to protect the fund itself and to minimize the risk that a tainted target becomes a portfolio company. The four stages discussed above are designed to frame the process by which a fund can approach compliance due diligence in a systematic manner. The process of transactional due diligence should be an organic part of the fund’s overall compliance culture. Finally, we also recommend that each time a new company is added to the fund’s portfolio that the company and its management be incorporated into the fund’s ongoing culture of compliance.
To read the full report, click here.
ABOUT THE AUTHOR
Philip T. von Mehren
Partner, Baker & McKenzie LLP
Philip T. von Mehren joined the New York office of Baker & McKenzie LLP as a partner in January 2007. His practice is focused on cross-border acquisitions and dispositions, often for strategic and financial buyers, including private equity and venture capital funds, often in a distressed situation. Mr. von Mehren also represents various strategic and financial purchasers in U.S. LBO transactions. He has substantial experience representing private equity funds with a Latin American focus in offshore and onshore aspects of transactions in Mexico, Brazil, Venezuela, Colombia, Argentina and Chile. Mr. von Mehren was recently appointed as a member of an eight person advisory committee of the Firm’s Global Restructuring Focus Group. He is admitted to practice in the State of New York and in the District of Columbia.
Mr. von Mehren received his J.D., cum laude, from Harvard Law School, his M. Phil from Cambridge University and his B.A. from Reed College.
*This paper is focused primarily on the due diligence phase of a transaction. However, funds will also need to consider how each new portfolio company will be incorporated into the fund’s existing culture of compliance post-closing (for example, by implementing training programs and adopting manuals tailored to the company’s specific type of operations).
© 2014 Baker & McKenzie. All rights reserved. Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an “office” means an office of any such law firm. This may qualify as “Attorney Advertising” requiring notice in some jurisdictions. Prior results do not guarantee a similar outcome.