Dealbook reported this week that emerging market opportunities are beginning to bear fruit, noting that China boasts three of the largest markets for I.P.O.’s and the fastest growing markets for deals are Ukraine, Thailand, and Chile. Private equity firms like the Carlyle Group and Blackstone have committed significant capital to acquiring stakes in companies abroad and have set up offices in many emerging economic nations to capitalize on the shift of opportunity from the developed world to these untapped frontiers. Wall Street is responding to the sluggish growth at home by turning its eyes abroad, but these opportunities can bring headaches.
Putting aside the administrative costs and barriers to entry of working with foreign governments and in new, sometimes recalcitrant, markets, one major legal problem that arises when an American firm buys stakes in a foreign company is the need to comply with the Foreign Corrupt Practices Act (FCPA). Under this act, a U.S.-based company may not use bribes to “obtain or retain” business.
Private equity funds all offer substantially the same things: capital infusions and management expertise. While name recognition and a good track record may go a long way, the terms of the deals between companies and private equity firms are almost always on substantially similar terms, and the firms exert control over the companies in substantially similar ways—20% cut of the net profits as carried interest upon exit, preferred stock and management control by seeking board placements and various other mechanisms to mitigate downside exposure and maximize upside gains. Why should a company in a foreign jurisdiction respond to a bid from one private equity firm over another? In many cultures, gifts are an expected part of business transactions, and it is a natural impulse to try to grease the wheels of a negotiation. Indeed, a common practice on Wall Street in domestic deals is to do just that. A dinner here, a Broadway show there. Why not? Because the S.E.C. and D.O.J. say you can’t.
There are ways that skilled lawyers could exploit the margins of meaning in the language of the FCPA, contracting the scope of the word “bribe” so as not to capture the activity of their client. But this opportunity would only be meaningful in the context of defending an enforcement action, and private equity firms, like any rational actor, want to avoid litigation. It is risky business to depend on a creative argument from a verbal technician where the act may be questionable. The issue is not whether the act is an actual bribe, but whether the agencies will pursue an enforcement action. The agencies have lawyers too, and those lawyers spend their days scouring filings for suspicious activities and get paid to show how an act fits within the scope of the language. Moreover, beyond litigation costs, who wants to be on the S.E.C’s or D.O.J.’s bad side?
Consequently, when engaging in a deal abroad, especially in nations known for corruption, firms are having to spend more and more on FCPA compliance. While this is good news for law firms (FCPA compliance is a huge cash cow), the robust enforcement of the act is leading to astronomical costs that could arguably be stifling foreign investment. Certainly, American ideals require that firms act with integrity abroad, but with compliance costs going through the roof, at some point firms are likely to accept the cost of being on the bad side of U.S. Government and take the risk of losing a suit. In a world of rational economic actors, the loudest input in a firm’s decision is cost.
In the meantime, however, while costs of either option are comparable, firms will likely choose to comply. There is talk in Washington to make compliance less onerous, but with the election season in full swing, who knows when that will happen.