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ACI's Summit on FCPA Risks For Private Equity & Hedge Funds

Sung-Hee Suh

Partner

Schulte Roth & Zabel LLP

Global Risk: How to Manage Corruption Risk for Your Investments in High-Risk Regions

Erica Fung

Legal Counsel and Chief Compliance Officer

KKR Asia Limited (Hong Kong)

Luz María Pineda Lucy

Chief Compliance Officer

Fondo de Fondos (Mexico)

May 21, 2014

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Assessing Jurisdictional Risks

• Country scores and rankings are an important component of risk assessment

• Transparency International's corruption perceptions index measures the perceived levels of public corruption • Country scores:

0-9 10-19 20-29 30-39 40-49 50-59 60-69 70-79 80-89 90-100 Highly Corrupt ----------------------------------------------------> Very Clean

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Assessing Jurisdictional Risks

Score (out of 100) Rank (out of 177 countries)

China 40 80

India 36 94

Mexico 34 106

Russia 28 127

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Risks Based on Industry and Local Market Conditions • Target operates in heavily regulated industries

• Target has significant interactions with foreign officials

• Target does significant amounts of business with foreign governments

• Target requires significant foreign government approvals, permits, licenses

• Target makes extensive use of Third Parties to interact with government

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Target – Specific Risks

• Target has weak internal controls or an ineffective compliance program

• Target lacks transparency in expenses and accounting

• Target has unusually high levels of expenses for marketing, gifts, travel, entertainment, hospitality, etc.

• Target refuses to give FCPA certifications or cooperate with due diligence

• Target refuses to provide information or disclose beneficial owners, principals, partners, etc.

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Typical Types of Corruption

• Asia

• Mexico

• Other High-Risk Regions

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Gifts

• Gift Guidelines Based Upon DOJ Opinions • Should not be given in cash or other bearer instruments • Should be appropriate for the occasion • Must be consistent with the standards of professional courtesy

generally accepted in the relevant foreign country • Should be of nominal value in the relevant foreign country • Should be presented openly and with transparency • Should be for official use rather than personal use, or given as a

token of esteem, courtesy, or in return for hospitality • Must have bona fide business purpose • Must be in good faith, without expectation of quid pro quo or

reciprocation

• Consider the circumstances of the business relationship • Is the foreign government entity about to award a contract?

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Gifts, Travel, Entertainment, Hospitality • All expenses should be accurately recorded

on the company's books and records, subject to audit

• All expenditures should comply with: • The company's policies and procedures • All relevant laws in all applicable jurisdictions • The policies and procedures and guidelines governing the foreign

government entity

• Consider obtaining authorization from the legal/compliance department of the foreign government entity

• Opinion from local expert and/or legal counsel may be necessary or advisable

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Risks Posed by Third Parties

• Ways to mitigate potential liability arising from acts of Third Parties (e.g., agents, consultants, representatives, advisors, introducers/finders, distributors, contractors, JV partners) • Look for "red flags"

• Conduct due diligence on Third Parties

• Document due diligence efforts

• Obtain written anti-bribery/anti-corruption certifications from Third Parties

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Risks Posed by Third Parties

• Red Flags • High-risk jurisdictions

• Above-market commission payments

• Unusual payment arrangements (e.g., cash, through multiple parties, through multiple countries)

• Evidence of relationship with foreign government/foreign official • Third Party was recommended by government customer

• Third Party is related to or closely associated with foreign official

• Refusal to give FCPA certifications or cooperate with due diligence

• Refusal to provide information or disclose beneficial owners, principals, partners, etc.

• Negative background checks or internet/media searches

• Lack of transparency in expenses and accounting records

• Lack of qualifications or resources

• Vague contractual service agreements

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Exceptions & Affirmative Defenses

• Exception: Facilitation payments • Small payments made to expedite performance of routine government action

• Limited to ministerial non-discretionary government functions

• Must be properly recorded on the company's books and records

• Illegal in most countries (e.g., Hong Kong, Mexico, United Kingdom)

• Affirmative Defense: Payments lawful under the written laws of the foreign country • Payments must be authorized by local law (extremely rare)

• Affirmative Defense: Reasonable and bona fide business expenditures • Must be directly related to promotion, demonstration, or explanation of

company's products or services or execution or performance of a contract

• Payments must be authorized by local law and company policy

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Foreign Laws

• Many countries now have laws equivalent to or even more restrictive than the FCPA • Increased cross-border cooperation among government agencies

in different jurisdictions

• Increased enforcement activity by many foreign nations

• Risk of double jeopardy in multiple jurisdictions for the same conduct as more countries enact and enforce their own laws

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Foreign Laws: Mexico

• The Federal Criminal Code and Criminal Codes of the Mexican States prohibit the corruption of government officials

• The Federal Anti-Corruption Law (2012) applies to all persons and companies (whether Mexican or not) that participate – as a shareholder, partner, representative, attorney-in-fact, agent, advisor, subcontractor, or employee -- in federal public contracts in Mexico as bidders, suppliers, contractors or concessionaires

• No exception for facilitation payments

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Tools and Techniques to Assess Target's Compliance Program • Review target's documents (e.g., books and records, relevant

agreements, material contracts, permits and licenses, etc.)

• Discuss bribery and corruption issues with representatives of target

• Conduct personal interviews of specialized employees (and perhaps Third Parties)

• Consider hiring a local expert

• A local expert or private investigation firm with access to information or knowledge about the target and its principals can be invaluable

• Local experts can advise on regulatory requirements, such as what government approvals, permits, licenses are needed, how they are obtained, and when renewal is required

• Apply due diligence to select the local expert

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Tools and Techniques to Assess Target's Compliance Program • Commitment from senior management ("tone from the top") • Clearly articulated policies and procedures against bribery and

corruption • Code of Conduct with strong internal controls • Management oversight and accountability for compliance • Adequate resources dedicated to compliance • A risk-based approach, tailored to the company's needs • Training for all directors, officers, relevant employees, and where

appropriate, Third Parties • Third Party due diligence and monitoring of payments/relationships • Disciplinary measures to punish noncompliance and incentives to

promote compliance • Confidential reporting and internal investigations • Continuous improvement via periodic testing and review See FCPA Guidance, chapter 5

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The Due Diligence File

• Should be retained for at least five years

• May include the following: • Results of background checks and internet/media searches

• Results from reputational assessments

• Due diligence questionnaires with responses

• Memoranda from interviews

• Reports prepared by local experts and/or legal counsel

• Other relevant documents

• Final report

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Documentary Protections

• Representations/Warranties that no unlawful payments have been made by or on behalf of the target

• Representations/Warranties that any compensation provided pursuant to the agreement is not for the use or benefit of foreign officials

• No involvement of foreign officials in the transaction • Covenant that FCPA-prohibited conduct will not be permitted and

that efforts will be made to prevent such conduct • Agreement by target to provide periodic certifications of

compliance with such covenant • Agreement by target and/or among key shareholders to take

certain remedial steps (e.g., adopt or improve FCPA policies post-closing)

• Audit rights with respect to books and records of the target • Indemnification rights in the event of a violation by the target • Termination rights in the event of a violation by the target

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Post-Investment Compliance

• Factors affecting FCPA liability • "DOJ and SEC evaluate whether the acquiring company promptly

incorporated the acquired company into all of its internal controls, including its compliance program." See FCPA Guidance, page 62 (emphasis added)

• For FCPA violations that occur post-closing, the extent of investment and degree of control will be important – but not necessarily determinative – factors that regulators will consider in assessing potential liability

• If an investment company's ownership interest in a portfolio company is de minimis, the prospect that a regulator would seek to hold the investment company liable for FCPA violations by the portfolio company is remote

• However, there is no bright line test for when FCPA liability will attach, and exposure to liability will turn on an analysis of all the relevant facts and circumstances, including whether the investment company knew, or should have known, of the unlawful payments

• Also consider reputational risk issues

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Recent FCPA Cases

• Azerbaijan Privatization Case • In the 1990s, Azerbaijan sought to privatize its state-owned oil

company, SOCAR

• An investment consortium, organized by a Czech businessman named Viktor Kozeny and including several U.S. investors, sought to purchase SOCAR

• Kozeny orchestrated a scheme to bribe the Azeri president and other senior government officials with hundreds of millions of dollars in shares of stock, cash and other gifts

• Several U.S. investors were investigated and/or prosecuted as part of DOJ's FCPA investigation

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Recent FCPA Cases

• Azerbaijan Privatization Case: United States v. Bourke • Bourke and others arranged and paid for medical care,

travel and lodging in the United States for the Azeri president's son (a SOCAR official) and family

• Bourke did not pay bribes directly and lost $8MM on deal

• Case turned on "conscious avoidance"

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Recent FCPA Cases

• United States v. Peterson (Morgan Stanley declination) • Peterson was managing director of Morgan Stanley's Chinese real

estate investment and fund advisory business, which co-invested with a Chinese state-owned entity in a Shanghai real estate deal

• In exchange for steering business to Morgan Stanley funds and helping obtain requisite government approvals, the Chairman of a Chinese state-owned entity received illicit payments

• Bribes took the form of "finder's fees" and secret real estate interests

• Peterson benefited personally from illicit payments

• Criminal prosecution based on theory that Peterson evaded Morgan Stanley's "robust" internal controls

• Peterson sentenced to nine months in prison, plus monetary fines, and permanently barred from the industry

• Morgan Stanley not charged

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Recent FCPA Cases

• Direct Access Partners ("DAP") • DOJ and SEC have charged several executives and

employees of DAP, a broker-dealer registered with the SEC

• Case grew out of a routine SEC examination

• DAP brokered bond trades for two state-owned economic development banks in Venezuela

• DAP directed kickback payments to a Venezuelan bank official in exchange for steering bond trading business to DAP ("pay to play")

• Bribe monies generated through intra-day "round trip" transactions and mark-ups/mark-downs on the bond trades

• Scheme included sham "foreign finder fees"

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Recent FCPA Cases

• Hiring Relatives of Foreign Officials ("Princelings") • JP Morgan Chase is reportedly under investigation for hiring children of

prominent Chinese officials and business leaders (JPMC "sons and daughters" program)

• Goldman Sachs announced in its March 2014 10-Q that the firm is being investigated for FCPA issues with respect to its hiring practices

• The government "princelings" probe has reportedly expanded to the technology sector

• There is nothing inherently illegal about hiring family members of foreign officials and numerous DOJ FCPA Opinion Procedure Releases have permitted such relationships

• However, several FCPA enforcement actions have been based, at least in part, on the hiring of family members of foreign officials • United States v. Daimler Chrysler China, Ltd. (company made "a purported

commission payment to the wife of a Chinese government official at Sinopec")

• United States v. Siemens Bangladesh Limited (company allegedly paid $5K to the daughter of a Bangladesh Telegraph Telephone Board official ostensibly to work as an "engineer" on the project despite the fact none was needed and there was no budget for the position)

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Conclusions

• When managing corruption risk for investments in high-risk regions • Conduct enhanced due diligence tailored to jurisdiction, industry,

target company's business and local market conditions

• Be vigilant about complying with relevant laws in applicable jurisdictions and relevant company policies and procedures

• Consider hiring a local expert to better understand (and navigate) the corruption risks unique to each region and industry

• Open up channels of communication

• Document your decisions

• Consult the Chief Compliance Officer and/or legal department with any questions or concerns