Over this series, I am visiting with Eric Feldman, Senior Vice President, Don Stern, Managing Director of Corporate Monitoring & Consulting Services, and Rod Grandon, Managing Director of Government Services, from Affiliated Monitors, Inc., (AMI) who is the sponsor of this series. In it, we explore how to go about assessing ethics and compliance in the mergers and acquisition (M&A) context. In this second episode I visit with Stern on the impact that M&A has on both the acquired entity and the acquirer.
Stern began by noting the inherent risk in the entire M&A process. Yet, the culture perspective is not often considered in the pre-acquisition phase. Stern believes companies are making a big mistake in doing so. Companies spend huge amounts of resources to hire lawyers, investment bankers, accountants for the pre-acquisition phase. They scrub the financials, look at income and look at revenues and expenses. Yet they often spend almost no time in looking at issues like the ethical culture of the company to be acquired. Stern stated, “I’ve never quite understood that everyone understands the risk of any acquisition. That the company picture may not work out quite as rosy as was expected. They may be some synergies that were expected from an expense point of view that don’t quite work out.”
Stern made clear that in the pre-acquisition phase, a company is not required to reinvent the wheel to perform ethics, cultural and compliance due diligence. He stated, “for example, accountants and other people looking over the books and records of the company to be acquired. The question is, are they looking at it through the right lens? Are they looking at it not just in terms of how robust are the revenues and what’s the revenue stream looks like? And is there a way to trim expenses and to look for some synergies of expenses?” Also what do the payments look like? How are they made to? If they are to third-parties in high risk jurisdictions, what is the target’s level of due diligence and training for third-party agents? Stern concluded, “it is not always a question of a brand new set of considerations. It’s sometimes a question of integrating those considerations and educating the acquiring company as to what they should be looking for.”
Stern believes one of the biggest risks is around ethical culture and cultural fit. One of the reasons is the asymmetrical incentives in place. Most usually the senior management of the target company has a very strong financial incentive to push the envelope when it comes to finances and financial projections. Stern believes this requires the acquirer to assess the human capital of an organization. This is more than just the senior executives but talk to employees out in the field, in the sales organization, in finance and accounts payable to get a much broader and well-rounded sense of the culture of the organization.
Post-closing, whether it is a honeymoon period, a period of terror for the former target or perhaps a little of both, if you as the acquirer do not have a full picture of the culture of your new entity, you may be in for not only quite a shock but some potential exposure as well. Stern provided the example where a large multinational US firm purchased a foreign entity that had a great compliance program on paper. They had their own culture, policies, and people but they were not “really paying attention to what the mothership was telling them. And it took really some very serious problems and the Department of Justice investigation for them to get the picture.”
The lack of knowledge on each parties culture can lead to many problems in the post-acquisition phase. Stern emphasized that the key is to not only come in with a plan but to listen and be attentive while implementing the plan. This can lead to a standoff in accomplishing the integration steps required under the Foreign Corrupt Practices Act (FCPA) or similar legislation. However, this is the situation where an independent monitor can assist both parties. Even after closing, an independent integrity monitor can come in and help to smooth out the process. An independent third party comes in with credibility and experience which allows employees at the acquired entity to communicate their concerns in a way that really is very helpful to the acquiring company. Employees can communicate such basic issues as they do not understand the new training they are required to go through, how things do not seem to fit together or the most basic question of why they are now required to do something. Employees can explain why risk areas may exist in other places but not exist in some others. Someone who is truly independent, with no stake in the game, can help make those explanations in a non-threatening way. The key is that independent third-party expert.
However, in practice this is routinely ignored and can lead to some serious FCPA exposure down the road.
Tomorrow, we consider the need for an integration plan to be implemented.