Sure, emerging markets offer numerous growth opportunities for multinational companies, but they also bring an increasing amount of compliance and integrity risk.
A survey of 500 executives at companies in North America conducted by Deloitte and Forbes Insights found that 85 percent said their level of concern over the potential for compliance and integrity risks related to growth overseas has increased lately.
Due to the heightened risk climate, more than 80 percent of respondents said they “always” conduct compliance and integrity due diligence before entering into a foreign merger, acquisition, or business relationship, and more than 60 percent reported walking away from a target based on what they found. At the same time, 89 percent rated their compliance skills as excellent or good in the area of integrity and reputation.
Wendy Schmidt, a principal from Deloitte and an author of the report, says those results are surprising and that companies may be “overly optimistic” in some ways. “Companies certainly believe they are adept at conducting compliance and integrity due diligence. But I question how well they are actually doing it based on how many issues and problems there seems to be in this area,” She adds.
A heightened regulatory and legislative enforcement environment has driven some companies to bulk up their overseas compliance efforts. “Our due diligence has become even more robust over the past two years as a result of the focus by the Justice Department on FCPA, as well as increased focus on corruption globally,” Marvin Risco, vice president of international operations at global forest product company Weyerhaeuser, said in the survey. “We essentially took a process we had one step further by formalizing and centralizing it within our legal department, applying it throughout the entire company.”
Ed Rial, leader of Deloitte's FCPA consulting practice, says he is noticing the same trend among other companies. “Increased governmental crackdowns on corporate corruption and foreign bribery issues are dramatically changing the playing field for potential transactions,” Rial says. “As such, companies are either reevaluating the costs and benefits of these deals, or are scuttling those that present unacceptably high risks.”
FCPA Risks
By far, the number-one stumbling block for deals in emerging markets was concerns over FCPA compliance. Almost two-thirds (63 percent) cited FCPA and anti-corruption as issues that have led to an aborted deal or a renegotiation over the past three years.
Survey respondents cited lack of transparency or unusual payment structures in contracts as the biggest FCPA red flag. Ranking second was the use of agents, consultants, distributors, or third parties to obtain or facilitate business. “While it is relatively easy to manage our own employees, it's much harder to control those outside the company,” said Risco of Weyerhaeuser. “We work at this by, among other things, using very specific language in our contracts.”
FCPA due diligence on a possible target is just the first step. “It's very important for companies to continually monitor FCPA risks,” Schmidt says. Providing adequate training and providing it in the local language is important, she says.
“Companies certainly believe they are adept at conducting compliance and integrity due diligence. But I question how well they are actually doing it based on how many issues and problems there seems to be in this area”
—Wendy Schmidt,
Principal,
Deloitte
Schmidt also warns companies to provide clear instructions on what to do if employees at an overseas unit suspect a possible FCPA violation. “We find that significant decisions are often made locally without consulting the corporate office,” she says.
Other reasons companies cited for breaking off a deal or renegotiating the price were material misrepresentations or omissions, and the reputation and risk profile of the target company. “This is the most important issue from our perspective,” said Richard Bradeen, senior vice president at Canadian aerospace and rail transportation company Bombardier. “If we don't like the risk profile of a target, we won't even begin discussions.”
Bombardier assesses reputation by checking with its other business partners in the country and by looking for litigation by the target in previous deals, Bradeen said.
Of the countries that present the most concerns to companies, 81 percent of respondents identified China. A region that combines Mexico, Central America, and South America ranked second at 76 percent, and South Asia—Vietnam, Indonesia, and Philippines—ranked third at 74 percent.
Additional Risks
Companies are focusing the most due diligence energy on legal and regulatory environments of the target country. More than half (56 percent) said their program was “very detailed,” in that area while 29 percent described it as somewhat detailed.
DUE DILIGENCE TRENDS
Below are two charts from Deloitte in which respondents were asked about their due diligence processes when entering into a foreign merger, acquisition, or business relationship.
Source: Deloitte.
Other issues that companies said merited extra effort were criminal or administrative violations imposed by a government agency; the background and reputation of the top principles and executives; and the extent of an entity's international operations, sales, and business relationships in high-risk countries.
Schmidt says it is particularly important to pay attention to the aspects of the business that involve government—such as taxes, customs, or sales to government officials—“because those are at the most risk for corruption,” she says.
To determine whether to terminate a relationship with a third party, other red flags to watch out for include slush funds, large cash payments, and excessive payments to third-party intermediaries, Schmidt says.
To assess all the risks and red flags, most respondents said they prefer the help of outside parties—such as outside counsel, investigative firms, and financial advisers—to assist in the due diligence process. Nearly a third (32 percent) said they always use outside professionals, while more than that (37 percent) said they sometimes do.
Others go on a case-by-case basis. “For anything but the biggest deal we rely very heavily on our internal legal staff,” one compliance chief said in the survey. “Outside counsel will get involved in contact negotiations on those large transactions, but even then the work may be passed on to our in-house lawyers. It will be handled by whoever we think is most appropriate at the time.”
Other respondents said they depend on the local advice of the targeted territory to assess that country's business climate or to investigative the history of a potential target. Corruption risks are going to vary by country, Schmidt says, “but I think it's very important to know the local environment that you're operating in.”
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