What Private Investors Need to Know About the FCPA

July 2007

3163760

Introduction

This presentation will:

• Describe the requirements and prohibitions of the U.S. Foreign Corrupt Practices Act (“FCPA”)

• Outline the risks associated with noncompliance

• Explain how the FCPA can impact private equity and venture capital firms and their partners

Understanding The Legal Risks

The FCPA prohibits:

Improper payments and other practices in connection with overseas business activities

The FCPA requires:

Maintaining accurate books and records, which includes documenting the nature of all payments

Retaining those records for five years

Implementing controls to prevent improper payments

Understanding The Legal Risks

The FCPA has two provisions:

Anti-bribery

Accounting and Internal Controls (“Books and Records”)

The Anti-Bribery ProvisionHow is it applied?

The anti-bribery provision applies to:

•U.S. companies, public and private

•Most foreign subsidiaries of U.S. companies

•U.S. citizens and resident aliens

•Foreign nationals acting for a U.S. company

•Foreign nationals who commit an act in furtherance of a foreign bribe while in the U.S.

The Anti-Bribery ProvisionHow is it applied?

Private equity firms and their partners may be liable for FCPA violations committed by the companies they acquire

•Successor liability for violations that occurred before the acquisition

•Partners who serve as directors may face individual liability

Venture capital firms and their partners may be liable for FCPA violations committed by the companies in which they invest

•Successor liability depends on structure of transaction•Partners who serve as directors may face individual liability

The Anti-Bribery Provision

The FCPA forbids people and entities from:

Corruptly

Making a promise or offer, or authorizing the payment of,

A bribe or anything of value

Directly or indirectly

To a foreign government official

To obtain or retain business or to gain an improper business advantage

Anti-Bribery ProvisionWhat Is A Foreign Official?

Foreign officials include:• Officials of all branches of government

• Government entities

• Public international organizations

• Political parties and party officials

• Candidates for public office

• Employees of government-owned businesses, such as airlines, hospitals, or oil companies

It does not matter whether the foreign official is paid or unpaid or holds an “official” state post

The Anti-Bribery ProvisionHow Does It Affect Me?

The FCPA imposes liability on you or your company if you know or have reason to know that:

• an improper payment or offer for payment was made;

• an improper payment or offer for payment is most likely going tobe made; or

• there are circumstances in place that will lead to an improper payment or offer for payment

Thus, to be liable under the FCPA:• There does not need to be an actual payment, and

• You do not need actual knowledge of the payment or offer

The Anti-Bribery ProvisionHow Does It Affect Me?

Examples of liability-imposing behavior:

Approving an improper payment

Knowingly creating or accepting a false invoice

Covering up an illegal payment or activity

Knowing an improper payment was made or likely made, and not reporting it

Ignoring comments indicating problematic business dealings (e.g., in Nigeria, a suggestion that something was handled “the African way”)

The Anti-Bribery ProvisionPayments by Third Parties

A private equity or venture capital firm and its partners can be held liable for improper payments made or actions taken by third parties who act or acted on behalf of a company the firm invested in or acquired

These improper payments and actions are scrutinized by law enforcement authorities and can occur in many forms, including:

•Gifts and lavish entertainment •Gratuities and kick-backs•Charitable or social contributions•Special processing or intervention fees

The Anti-Bribery ProvisionException for Facilitating Payments

There are exceptions under very specific and extremely limited circumstances for “facilitating” or “expediting” payments

• Made to ensure or speed the proper performance of a foreign official’s duties

• The duties must be essentially clerical and must not require theofficial to use any discretion or judgment

To fall under the exception, the payments must be for small amounts (but there is no magic number)

Many local laws (and FCPA policies) forbid facilitating payments

These payments MUST be recorded properly

The Anti-Bribery ProvisionException for Promotional Expenditures

What is allowed?• Reasonable meals, travel, and entertainment• Small, token gifts and promotional items of nominal value

Expenditures must be bona fide and directly related to a legitimate business purpose, such as:

• The promotion or demonstration of products or services• The execution or performance of a contract with a foreign

government or agency

Payments must be :• Authorized as required by the company’s FCPA Policy• Recorded properly (exception: promotional items of nominal value)

The Anti-Bribery ProvisionIllegal Payments

Illegal payments:(not proper facilitating or promotional payments)

Excessive payments for “facilitation” or “expediting”

Payment to persuade a government official to do something discretionary

Lavish gifts, entertainment, or travel

Improper campaign contributions

Lump sum per diem in advance of travel

Payments to family members of government officials for education, shopping, or travel

Under-pricing of services or overpayment to government officials

The “Books and Records” Provision

Applies to all U.S. and foreign companies with registered securities and companies that file reports with the SEC

Requirements:

•Maintain accurate books, records, and accounts

– Must have reasonable detail

– Must accurately and fairly reflect nature of transactions• E.g., document all facilitating payments and nature of all

payments to government officials

– Must show disposition of assets

•Retain records of those payments for five years

The “Books and Records” Provision

Requirements (cont.):

• Implement a system of internal controls that:– Prevents improper payments

– Ensures that transactions are executed with management's authorization

– Ensures that assets are recorded to permit preparation of financial statements

•Conduct periodic audits at reasonable intervals– The audits should ensure financial accountability

– If there are discrepancies in the books, additional research must be done to determine the cause

Due DiligenceWhat Is It, And What Diligence is Due?

Due Diligence is an evaluation of the potential advantages and risks of a given transaction (e.g., third party contract, merger, acquisition)

To comply with the FCPA, a company must evaluate the individuals and entities with which it associates to determine if their conduct could negatively impact the Company

Occurs in third party relationship and M&A contexts

Private equity and venture capital firms should conduct FCPA due diligence before acquiring or investing in a company and should ensure the company continues to conduct due diligence on third parties after the acquisition or investment

Due DiligenceWhat Is It, And What Diligence is Due?

For third parties:

• Choose third parties carefully; inquire into background, reputation

• Ensure that all third party relationships are subject to a written agreement, including an FCPA certification, before any work begins

• Screen and monitor all business opportunities with third parties who may interact with foreign government officials

For mergers and acquisitions:

• Understand the target company’s international business and industry

• Conduct pre-acquisition due diligence to determine potential FCPA issues

• Ensure due diligence is covered in clauses and agreements

Due DiligenceRed Flags

A “red flag” is a clue that there is a potential FCPA violation

When a “red flag” is discovered during due diligence or otherwise, you should:• Subject it to greater scrutiny than normal• Try to resolve it immediately• Implement safeguards

Examples:

• The transaction is in, or involves, a country known for corrupt payments

• Lavish entertaining of government officials or their relatives

• Insistence by the foreign customer that a particular agent be used

• Objections to FCPA, anti-bribery, or other compliance requirements

• Unusual contract terms or payment arrangements

• Excessive commissions or fees

Compliance

When making compliance decisions:• Use common sense• Document your decisions

A “culture of compliance” develops by:• Committing to compliance “at the top”• Developing thorough and value-driven policies• Providing regular training and updates• Giving practical guidance geared to real business situations• Conducting regular audits and other monitoring

The PenaltiesFor the Company

Anti-Bribery: •Up to $2 million fine (per violation) and/or restitution

Books & Records:•Criminal: up to $25 million fine (per violation) and/or restitution•Civil: $10,000 fine per violation (for public companies)

In addition, a company can be:•Suspended or debarred from contracting with U.S. Government•Have its import and/or export licenses revoked or denied

Anti-Bribery:•Up to $250,000 fine (per violation), 5 years in prison, and/or

restitution

Books & Records:•Criminal: up to $5 million fine (per violation), 20 years in

prison, and/or restitution•Civil: $10,000 fine per violation

In addition, foreign nationals may face extradition to the U.S. and/or seizure of personal assets

The PenaltiesFor Individuals

FCPA EnforcementIt Really Happens

U.S. v. Kay & Murphy, 2004• A criminal case brought against Kay and Murphy, executives for

American Rice, Inc., for allegedly authorizing payments to customs officials in Haiti to induce the officials to accept false documents underestimating the quantity of rice their company shipped, thusreducing the customs duties and sales taxes owed by the company.

• Kay, the Vice President of Operations, was sentenced to 37 months in prison and Murphy, the President and CEO, was sentenced to 63 months.

• The court held that in enacting the FCPA, Congress intended to cast “a wide net over foreign bribery” and that a bribe does not have to relate directly to obtaining a particular piece of business to violate the FCPA.

FCPA EnforcementIt Really Happens

Baker Hughes Incorporated, 2007• Among other things, Baker Hughes allegedly paid $4.1 million in bribes to a

third party consulting firm, knowing that such funds were to be transferred to an official of the state-owned oil company in connection with a $220 million oil field services contract.

• Baker Hughes characterized the payments in its books and records as “commissions,” “fees,” and “legal services.”

• The DOJ and SEC criminally charged Baker Hughes with violating the anti-bribery and internal controls provisions of the FCPA and a 2001 cease-and-desist order.

• Baker Hughes paid a record settlement of almost $44 million in combined fines and penalties.

FCPA EnforcementFCPA in the News

Leo Winston Smith, 2007• Smith, a former executive of Pacific Consolidated Industries

(“PCI”), was arrested for allegedly violating the FCPA by offering more than $300,000 in bribes and providing lavish hospitality to a UK Ministry of Defence official to secure equipment contracts valued at $11 million

• The case was referred to the DOJ by a private equity investment group, Cherington Capital, that acquired PCI after the alleged wrongdoing and discovered nine suspicious payments during a post-acquisition audit

• This is the first FCPA case to involve a private investment firm

Hypothetical Situations

Need some practical guidance?

Let’s take a look at the following hypothetical situations...

Hypothetical SituationsThird-Party Conduct

During a board meeting, a U.S. company’s executive reports that the company’s consultant in India has successfully facilitated several large contracts with the Indian Ministry of Communications.

When a director inquires about the consultant’s success, she learns that the consultant has a “close relationship” with an influential Communications Minister and was paid a 25% success fee upon the award of each contract.

Red Flags:• The “close relationship” with the Procurement Minister could be problematic if

the consultant is a relative or has an otherwise improper relationship• Did due diligence uncover this relationship?• “Success fees” are red flags because they do not require detailed invoices or an

explanation of the services performed for payment• The director has a duty to inquire further about the details of this transaction

Hypothetical SituationsGifts and Entertainment

A U.S. technology company wanted to host several Chinese officials for a tour of the company’s U.S. operations and a demonstration of the company’s products.

While the Chinese officials paid for their own airfare to the U.S., the company paid for the officials’ local transportation, hotel charges, meals, and entertainment, and provided them with a $100 /day per diem. They also paid for a weekend excursion to a luxurious local resort.

A few of the officials brought their spouses on the trip. One of the officials ran up a very large hotel bill, including lavish food and entertainment charges.

Red Flags:• Payment of entertainment expenses and a weekend excursion for the officials is not

likely to be considered related to a legitimate business purpose

• The spouses should not be allowed on the trip

• Large hotel bill – the company should not reimburse the official; to prevent the problem up front, the officials should be asked to pay for all incidentals

Hypothetical SituationsMergers and Acquisitions

Company A, a U.S. public company, plans to acquire Company B, another U.S. company with several foreign subsidiaries.

During pre-acquisition due diligence, Company A’s auditors discover that Company B made three $30,000 payments to an agent working with its Indonesian subsidiary to a bank account in London. The auditors also discover that Company B entered into a contract with the Cameroon government that required Company B to pay $2 million to improve Cameroon’s schools and to make the payment to a bank account held by the business advisor of Cameroon’s President.

Red Flags:• Indonesia and Cameroon are high-risk countries• Large, round-number payments and payments to overseas accounts are red flags• While the $2 million to improve Cameroon’s schools is included in a legitimate

contract, making the payment to an individual suggests an improper purpose • An investigation of these issues, and more extensive due diligence, should be

conducted before this deal goes through

This presentation is intended only as a general discussion and should not be regarded as legal advice.

For more information, please contact your Fund Services Group attorney or Lisa A. Prager of WSGR's white collar crime and internal

investigations practice.