DUE DILIGENCE
Investing in the BRICS
December 2011 | David Holley, Boston & Doug Frantz, Washington, DC
Managing bribery and corruption risks through heightened due diligence should be
a paramount focus when expanding into the BRIC markets -- Brazil, Russia, India,
China -- and other emerging economies.
The fertile and fast-growing economies of the BRIC (Brazil, Russia, India, and China) countries are calling to international corporations, investment banks, and investors like the Sirens sang to Jason and his shipmates in Argonautica. The haste to take advantage of these burgeoning markets can lead to rushed decisions, shortcuts in diligence and potentially unmeasured business decisions. Whether a company is entering a new market, contemplating a joint venture with an overseas partner, investing in a foreign business or acquiring an overseas company, an appropriate level of due diligence on the foreign entity, its agents, business partners and intermediaries is required to avoid problems associated with current anti-bribery legislation. However, the results of Kroll’s 2011 Global Fraud Survey (click on link below to download full report) indicate that fewer than one in four respondents believe that their due diligence is sufficient to fully understand whether the acquisition target complies with either the United Kingdom Bribery Act (UKBA) or the United States Foreign Corrupt Practices Act (FCPA). In addition, nearly one out of two respondents consider their companies to be moderately to highly vulnerable to corruption, which is among the leading reasons why companies avoid investing in new regions or countries.
The high level of concern uncovered in the survey may overestimate the true degree of compliance because companies often believe they are doing better in following the law than they are actually are. Even if we accept these self-reported estimates, however, there is cause for alarm over the exposure of many corporations to the criminal sanctions and costs imposed by the FCPA and UKBA, particularly in this era of aggressive enforcement by the Department of Justice (DOJ) and Britain’s Serious Fraud Office (SFO), respectively. The question then becomes what steps should be taken by a corporation determined to follow the spirit and letter of the law. Managing the anti-bribery risks through heightened due diligence should be a paramount focus when expanding into the BRIC markets and other emerging economies.
There is little guidance in either law as to what constitutes sufficient due diligence. The FCPA makes no mention of the term. The DOJ in “Opinion Procedure Release 08-01” has defined a “reasonable” due diligence file as containing the following: an independent investigative report by a reputable international investigative firm; guidance by a foreign business consultant to help navigate the due diligence in the foreign jurisdiction; reports from the US Commercial Service within the Department of Commerce; the results of various databases and watch lists, DNDB, etc.; meeting notes from discussions with the US Embassy in the foreign jurisdiction; a report by outside counsel on the target; a report on the target company by an independent forensic accounting firm; and an opinion by a second outside counsel who reviewed the sufficiency of the entire due diligence process.
While the UKBA and SFO provide some direction on due diligence, they also provide a defense for companies that have adequate procedures in place to prevent the type of conduct that would otherwise give rise to prosecution. The Ministry of Justice provides some guidance on “adequate procedures” indicating that due diligence should be conducted on parties performing services for, or on behalf of, a business and that it should be “proportionate and risk-based.” With relatively little guidance, it is no wonder that there is so much concern around the adequacy of due diligence undertaken in advance of a business transaction.
Assuming that multinational corporations are doing some level of due diligence consistent with the guidance offered by American and British regulators, the question as to why the level of anxiety in respondents over the sufficiency of their due diligence remains high. When undertaking due diligence in contemplation of expansion into the BRIC and other emerging markets, consider the following recommendations:
1. The volume of publicly available information varies from country to country and is generally considerably less than what is available, for example, in the United States. In addition, the information is frequently not as well organized or as readily searchable as in many jurisdictions. This highlights the importance of “feet on the ground” and the ability to undertake discreet source inquiries to fully understand a due diligence subject.
2. The potential for encountering a Politically Exposed Person (PEP) is generally greater in Russia and China than in many other parts of the world. This requires more extensive due diligence on officers, directors, and shareholders than normal to steer clear of violations. An examination of a target’s vendors and agents to ensure arm’s-length transactions with unrelated parties is also recommended.
3. Media searches may not be as thorough, complete, and reliable as in other jurisdictions, as the local media and press are generally less aggressive and less likely to present an in-depth examination of issues. For instance, in countries like China and Russia, both hotbeds of recent and future M&A activity by Western companies, the simple act of checking available media outlets for information about a potential partner is likely to yield incomplete results at best. This is particularly true in China, where the tradition of an open press is weak and corruption is generally regarded as high.
4. There continues to be an absence of strong anti-corruption laws and enforcement in BRIC countries compared to the United States, the United Kingdom, and other countries. This requires a company to engage in more extensive examinations of acquisition targets’ policies, procedures, and employee handbooks relating to corruption, anti-bribery, and gifts and entertainment expenditures.
Understanding the requirements of thorough due diligence is an important step, but problems can also arise when issues turned up in a review are not managed effectively. This point was driven home by the March 2011 settlement involving Ball Corporation, a US manufacturer of metal packaging for food, beverages, and household products. In March 2006, Ball acquired an Argentine entity, Formametal S.A. The Securities and Exchange Commission (SEC) found that during the course of Ball’s pre-acquisition due diligence, information suggested that “Formametal officials may have previously authorized questionable payments” disguised within the company’s books and records. Unfortunately, Formametal executives did not do enough to prevent further improper payments to Argentine customs officials, giving rise to the SEC’s case. The SEC noted that Ball Corporation did not promptly terminate the responsible employees when company accountants learned about the improper payments in February 2007. Still, Ball’s fine was a relatively small $300,000 because of the company’s other remedial efforts, voluntary disclosure of the misconduct, and cooperation in connection with a related investigation.
The BRIC economies are enormously attractive investment opportunities. Estimates are that as much as 60 percent of the world’s GDP will come from them by 2030. Participating in the world’s fastest- growing economies carries growing risks, too. American, British, and multinational corporations need to understand the potential corruption dangers in the BRIC and similar emerging economies and undertake effective due diligence to avoid running afoul of anti-corruption laws. Certainly the DOJ, SEC, and Britain’s Serious Fraud Office have recognized the risks and stepped up their scrutiny of activities in these countries as part of the overall trend in rising enforcement of anti-corruption laws globally.
The Authors: David A. Holley ( This e-mail address is being protected from spambots. You need JavaScript enabled to view it ), a senior managing director and the head of Kroll’s Boston office, is a former member of the Environmental Enforcement Section of the US Department of Justice. Doug Frantz ( This e-mail address is being protected from spambots. You need JavaScript enabled to view it ), a managing director in Kroll’s Washington, DC office, is a former Pulitzer Prize-winning investigative reporter and former deputy staff director and chief investigator of the U.S. Senate Foreign Relations Committee.
This article originally appeared in Kroll's 5th annual Global Fraud Report released in October 2011. Click here to download a copy .