The Foreign Corrupt Practices Act (FCPA) is being more and more stringently applied, with major potential consequences to private equity investors operating in foreign markets.

The law centers around rooting out bribery and corrupt practices, which can include anything from improper payments to government officials to non-monetary gifts and favors. Once typically applied only to commercial enterprises with operating oversight, regulators have more recently turned their focus to investment firms.

“Investment firms are in a tough spot because the standards are getting tougher,” says David Simon, partner at law firm Foley & Lardner. “Ten years ago you could feel comfortable being an investor and not an operating company, and that’s not really true anymore.”

As the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) focus more on enforcing the FCPA, with several enforcement inquiries in 2014 alone, private equity firms must prepare accordingly.

There are a few key areas that need to be addressed.

First and foremost is the reality that investment firms can be held liable for a portfolio company’s actions prior to the investment, making diligence in this area absolutely critical. In the words of Department of Justice guidance on the issue, due diligence must demonstrate a “genuine commitment to uncovering and preventing FCPA violations.”

“It is critical for investment firms to integrate an analysis of FCPA exposure into [the] preliminary risk assessment process of any potential investment,” says David Kotz, a director at the Berkeley Research Group and former inspector general of the SEC.

Background check

He emphasizes that the diligence process must go back “far enough to ensure that [the investor] is not held liable for the actions of the company as a successor entity.”

There are two other important reasons for appropriate diligence, according to Simon. Not only could previous or existing violations bring the risk of enforcement actions, but the cost of resolving violations or poor practices could completely change the profile of an investment opportunity. 

“If you want to avoid continuing violations, you have to tell [the company] to stop doing it — and this could impact sales, revenue, and your returns on investment,”Simon said.

Thus, there is a strong business case to be made for incorporating FCPA into the overall diligence process. As Simon explains in an article with colleague John Wynn, procedures should cover a range of potential problem areas, including ownership, third party relationships, dealings with foreign officials, and internal controls.

In some cases it might even be advisable to seek an advisory opinion from the DOJ.

Third party agent relationships are another potential risk area. Whether engaged to solicit investment opportunities or investors, an unscrupulous or uninformed agent can bring a great deal of risk to an unsuspecting private equity firm.

“These third-party consultants who have access to decision-makers in foreign countries can cause liability for the investment funds, and are often very difficult to police,” Kotz says.

Considering the broad definition used by the government to assess knowledge of an agent’s activities, “It is critical for an investment fund to clearly understand the third-party agent’s role and how it interacts with the foreign country and its representatives.”

As Simon puts it, firms must “make sure agents understand the rules and are behaving accordingly.”

An article co-written by Kotz with Susan M. Mangiero, managing director of Fiduciary Leadership, LLC, recommends that firms should have “comprehensive, risk-based due diligence on third parties and transactions,” in addition to broader FCPA policies, internal auditing procedures, and reporting and disciplinary mechanisms. 

Finally, there is also the simple matter of doing business in emerging markets. Funds operating in markets like Africa face myriad potential issues with both investors and acquisition targets. As of 2013, fully 90 percent of countries in Sub-Saharan Africa score below 50 on Transparency International’s most recent Corruptions Perceptions Index, a rating that indicates a “serious corruption problem,” according to the organization.

Broad Based Compliance

This means that investors in Africa would do well to tread carefully. With a higher focus on enforcement and a number of risks on the ground, firms cannot be too careful in assessing their potential liabilities and conducting ongoing audits and training to ensure compliance across the board.

Kotz and Mangiero write, “A company with foreign dealings has a choice. It can implement a robust FCPA compliance infrastructure and follow its rules accordingly, or it can count on being lucky.”

For private equity firms working and investing in Africa, the latter option is probably not a wise course. Considering the number of potential risk areas facing investment firms, implementing a robust compliance system and retaining appropriate counsel should be common practice.

However, despite the cost and investment required to comply, the regulations could come with a silver lining.

Speaking on the subject of helping acquisition targets comply with FCPA, Simon points out that “lot of times they’re not as sophisticated, and you need to figure out a way to implement more and better controls and compliance post-acquisition.”

Could this represent an opportunity for governance improvements in African business? As compliance procedures become the norm for investment targets, or even required as part of attracting interest from top financiers, perhaps we could see an increasing number of firms declining to engage in questionable practices.

Whether broader FCPA enforcement succeeds in encouraging better governance simply deters investors from the continent remains to be seen. Considering the high potential returns and a growing investor appetite for Africa, one can only hope that it is the former.