Ethics Pitfalls in Mergers, Acquisitions
Integrating two companies’ ethics and compliance programs during the merger and acquisition process is critical and begins well before the union of the companies.
Both the target company and the acquiring company should take care to conduct diligent research into the ethics and compliance programs of all parties involved prior to signing the transaction agreement. Failure to perform such diligence can be fatal to the success of the transaction.
During the pre-acquisition phase, the first rule to keep in mind is that joining two companies’ ethics and compliance programs is about more than paper and numbers. It is also about culture. A company’s ethics and compliance programs are deeply interwoven with company culture. Company culture is not something that shows up in the transaction paperwork or perhaps even in due diligence reports.
Yet, the compatibility of the companies’ cultures is a vital part of merger and acquisition success. Thus, company characteristics that contribute to the make-up of a company’s culture — such as values, work ethic, business practices, leadership style and company mission — are all critical to the merger and acquisition process.
A second rule to keep in mind throughout the process is that ethics and compliance issues, including cultural issues, need to be addressed as they arise. Ignoring ethics and compliance issues or placing them on the backburner can jeopardize the transaction’s success. Consequently, disparities in the parties’ ethics and compliance programs need to be managed and resolved prior to finalizing a transaction to maximize the likelihood of long-term success.
The third rule that target companies and acquiring companies need to keep in mind is that integrating ethics and compliance programs successfully requires patience. Management of the newly formed company should be mindful of the fact that integration of two companies’ cultures can be a slow process. However, the chances of a successful integration of two companies into one larger company, family and team are substantially increased when the right amount of time, effort and resources are allocated to the integration process.
For example, Goodyear in 2015 paid more than $16 million in disgorgement of profits and prejudgment interest as part of a settlement agreement with the Securities and Exchange Commission. The agreement settled Foreign Corrupt Practices Act violations alleged against Goodyear. The violations stemmed from a Goodyear subsidiary in Kenya, Treadsetters Tyres Ltd., paying more than $1.5 million in bribes from 2007 to 2011 to employees of government-owned entities to obtain tire sales. Additionally, as the SEC order reported, Treadsetters paid bribes to police, tax and other local authorities. The bribes were paid in cash and falsely recorded on Treadsetters’ books as expenses for promotional items.
Goodyear began doing business with Treadsetters in 2002. By 2006, Goodyear had acquired a majority interest in the company. Although Treadsetters routinely paid bribes from 2007 to 2011, This practice was likely in place prior to Goodyear’s acquisition of Treadsetters. According to a Securities Exchange Commission order, Goodyear did not detect and prevent the bribes because it “failed to conduct adequate due diligence when it acquired Treadsetters, and failed to implement adequate [Foreign Corrupt Practices Act] compliance training and controls after the acquisition.”
Goodyear’s failure began before it signed the transaction agreement. Goodyear’s first mistake was neglecting to conduct adequate due diligence into Treadsetters’ books and research into the culture of the company. Had Goodyear been diligent in researching Treadsetters’ culture, it likely would have uncovered its pre-2007 history of bribery.
Executing a successful integration of two companies’ cultures takes time and patience after the transaction closes. An essential part of the integration process is ensuring both businesses are operating in a compliant and ethical manner. Goodyear’s failure to implement adequate compliance training and controls after its acquisition of Treadsetters compounded its problem by further delaying the discovery of the bribery.
Ultimately, Goodyear paid more than $16 million to the SEC, divested its ownership interest in Treadsetters in 2013, and terminated its relationship with the company. Had Goodyear extended its diligence efforts to include Treadsetters’ culture, identified and addressed the issues with its pre-acquisition Foreign Corrupt Practices Act violations, and allotted adequate time and resources to the integration of the companies’ cultures, the transaction may have ended differently.
In summary, a key element of a successful merger-and-acquisition transaction is the careful integration of the companies’ ethics and compliance programs. An important rule to remember during the pre-acquisition phase is that considering culture is a vital aspect of successfully merging ethics and compliance programs.
Another critical rule to remember throughout the merger-and-acquisition process is that addressing ethics and compliance issues as they arise is necessary to avoid later pitfalls.
Lastly, it is important to be cognizant of the fact that successfully merging two companies’ ethics and compliance programs takes time and will not happen overnight.
Keeping these three rules in mind will help to maximize the probability of a successful transaction. Ignoring them could lead to a nightmare deal.
Brian S. Haney is a rising third-year law student at the University of Notre Dame Law School. He authored this article under the supervision of Daniel J. Dell’Orto, executive vice president, government relations and general counsel at AM General LLC.