Private Equity Alert

February 2008 Ignorance of the FCPA is No Excuse

Weil News By Chip Roh ([email protected]), Joe Tortorici ([email protected]) n Weil Gotshal won Private Equity and Joseph Johnson ([email protected]) Team of the Year at the 2008 Legal Business Awards for the firm’s Private equity sponsors and hedge funds are increasingly investing in emerging involvement in advising Terra Firma markets, including through dedicated investment funds. The risk of corrupt on the $6.4 billion take private bid of EMI Group plc payments is higher in those markets than in most developed markets and U.S. investors are subject to the U.S. Foreign Corrupt Practices Act (FCPA) in connection n Chambers recommended seven of with those investments. Recently, the U.S. government has become more aggressive our European private equity partners in its 2008 Chambers in enforcing the FCPA. In addition, as evidenced by the ongoing Siemens inquiry, Europe directory: Gerhard Schmidt European governments have also become more aggressive in pursuing FCPA-style in Frankfurt, Marco Compagnoni corruption investigations. Private equity sponsors and hedge funds investing and Mark Soundy in London, David outside the U.S., especially those that invest in emerging markets, should be Aknin, Frederic Cazals and Emmanuelle Henry in Paris and proactive in ensuring that they and their representatives take appropriate actions David Dederick in Central & in connection with those investments to avoid or reduce the risk of civil or even Eastern Europe criminal liability under the FCPA. n Weil Gotshal advised Thomas H Lee Partners in connection with The FCPA the acquisition of approximately The FCPA prohibits bribery of foreign government officials, candidates for office 63% of the equity securities of MoneyGram International, Inc. by and officials of political parties. It is framed and interpreted very broadly to prohibit affiliates of Thomas H Lee Partners not just actual direct bribes, but virtually any way a company might directly or and Goldman Sachs & Co. through agents or joint ventures improperly influence foreign government officials, n Weil Gotshal advised Capital Z candidates for office and political parties. The FCPA applies not only to U.S. Investment Partners in connection nationals and to companies organized under US laws (wherever the individuals or with a management buyout of its companies are located), but also to foreigners or foreign companies with a hedge fund sponsorship business connection to the United States. Both the substantive law and its coverage are n Weil Gotshal advised Union Square given a very broad interpretation, well beyond what is customary for most non- Partners in connection with its Americans. Paying for entertainment or arranging a cushy job for a current or investment in MountainView former government official or his or her relative could all be considered a bribe. Capital Holdings, LLC, a specialty financial services company Private equity sponsors and hedge funds can have a problem under the FCPA even n Weil Gotshal advised American if the bribery occurred prior to their acquisition and not on their watch. A U.S. Capital Strategies in connection private equity or hedge fund that buys a foreign company that has been violating with its sale of Exstream Software, the FCPA not only inherits the liability of that company for its past actions, but may LLC to Hewlett-Packard Co. find that the fund itself is liable for ignoring the ongoing nature of the bribes, even n Weil Gotshal advised American if there is no evidence that the fund or its officers directly knew of the bribery. The Capital Strategies in connection potential liability for public companies is still greater, since the mere fact of filing with its sales of Ranpak Inc. to Odyssey Investment Partners reports with the SEC is enough to make a company liable under the FCPA, and the issuers face additional responsibilities in terms of books and records controls. n Weil Gotshal advised Genstar Capital, LLC in connection with its acquisition The FCPA can also adversely affect exit opportunities for U.S. private equity of TravelClick Holdings, Inc. sponsors and hedge funds regardless of whether the Department of Justice (DOJ)

 Private Equity Alert February 2008 commences an investigation of connection with these recent pleas, Cherington, following completion of bribery by a portfolio company or its Vetco Gray UK Ltd. agreed to the its purchase of Pacific Consolidated agents. If a portfolio company or its appointment of an independent Industries, apparently discovered agents has engaged in illegal or monitor, to undertake further investi- records of suspicious payments made questionable behavior under the gations, and agreed to monitoring and to the Ministry of Defense during its FCPA, that may make it difficult to compliance obligations that would post-acquisition audit. Pacific Consoli- take the company public in the U.S. bind any future purchaser. dated Industries voluntarily referred or to sell the company to a U.S. public this matter to the DOJ and fully company or other buyer that performs Investors should not bury their cooperated in its subsequent investi- rigorous FCPA diligence. The private head in the sand and ignore gation. It is not known whether equity sponsor or hedge fund may Cherington Capital will incur any fines also have potential liability to the any potential problems or or penalties in connection with this buyer under FCPA-specific or hope they go away. FCPA violation. compliance with laws representations There are dangers in trying to draw and warranties in the sale agreement. Also in 2007, Omega Advisors agreed too many lessons from the very to pay $500,000 as a civil penalty as Recent FCPA-Related Actions limited record available, but these part of its non-prosecution agreement examples demonstrate that private Some recent FCPA enforcement where it acknowledged that a fund equity sponsors and hedge funds can actions illustrate the risks under the officer had been aware, prior to the have potential exposure under the FCPA for private equity sponsors and investment, that there was bribery FCPA even if they had no direct part hedge funds. In early 2007, the DOJ involved in a transaction in which in the alleged illegal conduct. announced that three Vetco Interna- Omega invested, and that the officer tional Ltd. subsidiaries pled guilty to had entered into these investments on Dos and Don’ts for Investors violating the anti-bribery provisions behalf of Omega with the understanding The cases referenced above illustrate of the FCPA and had agreed to pay that he was taking advantage of these only a few of the many ways FCPA $26 million in fines and penalties. arrangements. The DOJ indicated that issues may arise before or after a Vetco Gray UK Ltd., one of these three it exercised leniency toward Omega private equity sponsor or hedge fund subsidiaries, had previously pled because of Omega’s past and guilty in 2004 to related violations. continuing cooperation with the completes an acquisition. Investors Around that time, a group of private investigation, its implementation of active in emerging markets need to equity investors sought to acquire that remedial measures, including an FCPA make sure they are taking steps to company. In anticipation of the acqui- compliance program, and the absence ensure compliance with the FCPA, sition, those investors conducted an of prior similar conduct by Omega. especially as an acquisition of a extensive compliance review and The former Omega officer pled guilty company does not necessarily requested an opinion release from the to charges of conspiracy to violate and eliminate exposure to past violations. DOJ. In response to this request, the violation of the FCPA in 2004. Private equity sponsors and hedge DOJ issued an opinion indicating it funds should consider the following In a third example in 2007, Leo did not intend to undertake actions to avoid or reduce any potential Winston Smith, a former executive against the acquirers or acquired liability under the FCPA: vice president and director of sales and company for violations that may have marketing for Pacific Consolidated n Do have an effective FCPA occurred prior to the acquisition. Industries, was indicted for allegedly compliance program for your fund, However, the opinion was premised conspiring to provide bribe payments including periodic training of on the institution of an extensive to an official in the U.K. Ministry of employees to be sensitive to FCPA compliance program and indicated Defense for the purpose of obtaining and related issues that it did not encompass prospective contracts. Pacific Consolidated conduct. When the payment of n Do a thorough due diligence review Industries was a privately-owned various illegal bribes continued after of a potential acquisition target for Californian company, which was the acquisition and until April 2005, potential FCPA violations, particu- acquired by Cherington Capital, a the DOJ brought new enforcement larly where red flags are uncovered. private equity group, in 2003, after the actions, ultimately resulting in the Examples of red flags include a events that ultimately resulted in the 2007 guilty pleas and fines. In 2007 indictment of Mr. Smith. history of corruption in the

Weil, Gotshal & Manges llp  Private Equity Alert February 2008

particular countries where the target true” due to superior access to or With the increasing investments by company does business, weak or accommodations by government private equity sponsors and hedge poorly enforced FCPA compliance officials. Bribery may be one reason funds in emerging markets, those policies by the target company, why that investment opportunity investors need to proactively ensure weak or non-transparent accounting seems like such a sure bet and U.S. that they and their representatives policies, procedures and records in authorities may not be sympathetic take appropriate actions in connection the target company, a failure by the to pleas by U.S. investors of lack of with those investments to avoid or target company to require actual knowledge of the bribery. If a reduce the risk of civil or even compliance by its agents and red flag is discovered, investors criminal liability under the FCPA. consultants and business that is should carefully diligence the target Investors should not bury their head dependent on government company to identify any potential in the sand and ignore any potential customers or governmental problems. problems or hope they go away. No regulatory approvals. one wants to become the poster child n Don’t ignore potential problems n Do consider voluntarily reporting for DOJ enforcement of FCPA viola- discovered in due diligence and any potential problems uncovered tions by a private equity sponsor or make the investment without to the DOJ in connection with an hedge fund. resolving the problems. Trying to investment if you decide to proceed * * * with the investment or if you ignore or bury problems can be a For more information regarding FCPA discover the potential problems time-bomb—whistleblower after you made the investment. employees, former employees, compliance, please contact Chip Roh competitors, foreign governments (+1-202-682-7000, chip.roh@weil. n Do periodic FCPA compliance audits and auditors all can reveal bribes, com) in our Washington, DC office, of portfolio companies after you and more than one FCPA violation Joe Tortorici (+420-2-2140-7300, joe. make your investment. has come to light as result of the [email protected]) in our Prague n Don’t ignore red flags, which may be diligence of buyers when an investor office or Peter Feist (+852-3476-9100, as obvious as an investment oppor- tries to re-sell its portfolio company [email protected]) in our Hong tunity that seems “too good to be or in connection with an IPO. Kong office.

PBGC Ruling Extends Control Group Liability to Private Equity Fund

By Andrew Gaines ([email protected])

A recent decision by the Appeals group is generally a parent subsidiary was a “trade or business” and was, Board of the Pension Benefit group of trades or businesses in which therefore, a member of the same Guaranty Corporation (PBGC) may the parent owns a controlling interest controlled group as its 80% owned have important implications for in the subsidiary. A controlling portfolio company. The decision by private equity funds. In its decision, interest is defined in the case of a the PBGC is not surprising since it is the PBGC held that a private equity corporation as stock ownership by the the quasi governmental entity respon- fund and its other portfolio parent of at least 80% of the total sible for insuring participants and companies were jointly and severally voting power of all classes of stock beneficiaries in situations when a liable for the funding deficiency in a entitled to vote or at least 80% of the pension plan is terminated with defined benefit pension plan total value. Prior to this decision, insufficient assets to cover accrued sponsored by one of the portfolio many practitioners argued that a liabilities. However, it is still not clear companies. As such, the private private equity fund should not be whether the federal courts will concur equity fund was required to use its included in the same control group as with the PBGC’s interpretation of the their portfolio companies because a assets to fund the pension obligations control group rules fund does not carry on a “trade or of a bankrupt portfolio company. business” within the meaning of While it is less common today for Control group liability is not new or ERISA. In its decision, the PBGC private equity sponsors to own its controversial. Under ERISA, a control found that the private equity fund interest in portfolio companies

Weil, Gotshal & Manges llp  Private Equity Alert February 2008 through one fund (e.g., most private equity sponsors own interests through a series Boston of partnerships including alternative investment vehicles and thus dilute the James Westra +1-617-772-8377 ownership of any one portfolio company entity to less than 80%), the PBGC decision highlights the significant ramifications for private equity funds of control Budapest David Dederick group liability. The decision is also a reminder that the control group rules extend +1-361-302-9100 beyond joint and several liability for underfunded pension plans. For example, Dallas credit agreements often prohibit pension plan underfunding for any members of a Glenn West controlled group of corporations, which will require portfolio company borrowers +1-214-746-7780 to make representations and monitor the ERISA liabilities of other control group Frankfurt members of the private equity sponsor. Gerhard Schmidt +49-69-21659-700

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Private Equity Alert is published by the Private Equity Group of Weil, Gotshal & Manges LLP, Shanghai 767 Fifth Avenue, New York, NY 10153, +1-212-310-8000. The Private Equity Group’s practice Steven Xiang includes the formation of private equity funds and the execution of domestic and cross-border +86-21-6288-1855 acquisition and investment transactions. Our fund formation practice includes the representation Silicon Valley of private equity fund sponsors in organizing a wide variety of private equity funds, including Craig Adas buyout, venture capital, distressed debt and real estate opportunity funds, and the representation +1-650-802-3020 of large institutional investors making investments in those funds. Our transaction execution practice includes the representation of private equity fund sponsors and their portfolio companies Warsaw in a broad range of transactions, including leveraged buyouts, merger and acquisition transactions, Pawel Rymarz strategic investments, recapitalizations, minority equity investments, venture capital investments +48-22-520-4000 and restructurings. Washington, DC Editor: Douglas Warner ([email protected]), +1-212-310-8751 Robert Odle Deputy Editor: Michael Weisser ([email protected]), +1-212-310-8249 +1-202-682-7180

©2008. All rights reserved. Quotation with attribution is permitted. This publication provides general information Wilmington and should not be used or taken as legal advice for specific situations which depend on the evaluation of precise E. Norman Veasey factual circumstances. The views expressed in these articles reflect those of the authors and not necessarily the +1-302-656-6600 views of Weil, Gotshal & Manges LLP. If you would like to add a colleague to our mailing list or if you need to change or remove your name from our mailing list, please e-mail [email protected], or call +1-646-728-4056. www.weil.com

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