The risks for international investments have sharply expanded in recent years. Identifying, managing, and mitigating investment risk, in the current regulatory environment, can be just as essential as managing risk in any other type of international transaction. To help deal with the international regulatory risks inherent in international deals, we are publishing a four-part series on the special regulatory concerns inherent in purchases by foreign companies. This first article, which focuses on international due diligence, would also be of interest to U.S. companies, whether on the buy or the sell side of transactions, as it provides a roadmap regarding the types of due diligence issues that typically are relevant to purchases and sales of companies that operate in, procure from, or sell to international locations.

Conducting comprehensive due diligence and identifying international regulatory risk in deals now is especially important because the presence of export-controlled goods or technical data in a transaction can trigger mandatory Committee on Foreign Investment in the United States (CFIUS or the “Committee”) filings as well as raise the potential for uncovering independent export controls and economic sanctions issues. Through careful due diligence, acquiring companies not only can determine if they need to go through the arduous CFIUS review process but also can identify other forms of international regulatory risk that can impact the risk profile of a deal or even whether a deal should be pursued at all. Because of the timing and costs of CFIUS filings, foreign purchasers should be evaluating CFIUS and other related regulatory issues up front.

Some of the key international trade and regulatory issues that should be evaluated in any acquisition of a company that operates in, procures from, or sells to non-U.S. countries include the following:

• International Regulatory Risks. International regulatory risks such as international antitrust, export controls, OFAC sanctions, AML, and anticorruption arise where targets are multinational companies that operate, export, or sell abroad. For any acquisition with an international risk profile, careful inquiry should be made into these key areas, which are all enforcement priorities for the U.S. government and can be the subject of questions raised by CFIUS during the review process for mandatory and voluntary filings as well.
• Risks from Operations in Countries of Concern.Due diligence should be tailored to the overall risk profile and particular risks of a given transaction. One of the key determinants is the countries where the target operates and sells. Countries that rank high on the Transparency International Perceived Corruption Index also tend to have a general lack of respect for the rule of law and present a heightened risk profile for such things as export controls and OFAC sanctions (diversion risk), anti-money laundering, and other regulatory concerns. Heightened due diligence generally is appropriate when the target has significant ties to such countries as China, India, Russia, much of Latin America, the Middle East, and Africa as well as countries in Europe with a reputation for diminished respect for the rule of law (such as Italy and Greece). Consideration also should be given as to whether the target has adequate procedures for screening for Specially Designated Nationals and other embargoed or restricted persons under Commerce, Treasury, and State Department restrictions, as well as economic sanctions restrictions maintained by other countries.
• Controlled Goods Risks. Companies that manufacture, broker, sell, or export goods that are subject to controls under the ITAR (USML goods or goods that are specially modified to meet military specifications) or the EAR (goods with an ECCN) present special compliance concerns as well as heightened opportunities to commit legal violations of the strict export control regulations. Inquiries always should be made as to the presence of controlled goods or technical data at the target, with a tailored follow-up inquiry should initial results be positive.
• Supply Chain Risks. In recent years, the U.S. government has highlighted the risks from improper sourcing of goods imported from abroad, including for products that are from highly sanctioned countries like Iran or North Korea or from countries or companies that rely on forced labor. U.S. rules against forced labor will be enforced, including for goods that contain parts and components from the Xinjiang region of China, which potentially run afoul of the import restrictions contained in the Uyghur Forced Labor Prevention Act (UFLPA). Thus, due diligence into the supply chain of a target company, including determining whether it has mapped out its supply chain, identified all sources of potential supply chain risk, and taken steps to mitigate such risk, is an important consideration for international deals.
• Import-Related Risks.In addition to concerns relating to the ethical operation of a target’s supply chain and related procurement risks, issues relating to whether any company that frequently imports goods, including parts and components, are being handled correctly. In the current, high-tariff environment, aluminum and steel can be subject to special Section 232 tariffs of 10 or 25 percent, goods from China can be subject to additional special Section 301 tariffs of up to 25 percent (or 100 percent for certain goods subject to a recent executive order), and nearly 700 antidumping and countervailing duty orders can add additional tariffs. Liability for any underpaid tariffs, including penalties that can range up to (or even exceed) the value of the goods would be inherited by a new purchaser, making customs a key area of due diligence attention.

To conduct due diligence and prepare for a potential CFIUS filing, a foreign purchaser should have a basic understanding of the operations of the target company. Relevant questions to begin diligence and assess risk of a U.S. target include the following:

Basic Background Information. Relevant information starts with the following basic information requests:

• A list of countries where the target conducts business.
• A list of countries where the target has sold directly or indirectly to foreign governments.
• A list of companies that the target does business with, which are owned by a foreign government.
• Estimates of what percentage of the target’s business depends on dealings with foreign governments and state-owned entities.
• Copies of all contracts for purchases by, or sales to, state-owned entities and details regarding how these contracts were negotiated.
• A list of any joint ventures or other arrangements with state-owned entities.
• A list of any business relationships with government officials.

Compliance and Training. A target company that gives short shrift to compliance programs, internal controls, codes of conduct, vendor handbooks, and related training represents.an increased risk of purchasing ongoing liability for international regulatory violations. Information regarding the target’s training and compliance measures provides a window into the culture of the target. Discovering this type of information is accomplished by requesting the following information:

• A description and contents of the target’s antibribery, export control, and economic sanctions compliance programs and all their elements including trainings.
• A copy of any materials provided to employees as part of their training.
• A list of all red flags uncovered through the operation of the target’s compliance programs.

Agents, Distributors, and Third Parties.Third parties cause many international regulatory problems, especially for the FCPA, export controls, and economic sanctions. To minimize this risk, the acquirer should seek information regarding:

• Lists of all distributors and what measures they take to prevent the diversion or shipment of goods to prohibited countries, regions, governments, or persons.
• Lists of all legal provisions in third-party contracts, including measures designed to ensure compliance with key U.S. international regulations.
• Whether the target has hired any foreign officials as agents or in any other role and whether any of these relationships are ongoing.
• The due diligence procedures relating to the hiring of agents, the results of any due diligence performed, and a description of how any red flags discovered during the hiring of agents were addressed.
• Any contracts with agents or other third parties, including certifications of FCPA compliance.
• Any past or present relationships between foreign officials and any agents hired by, or acting on behalf of, the target.
• The services provided by any agents, the total compensation paid in relation to those services, and the basis for establishing the compensation.
• Any payments made to foreign officials for any reason, including visits to conferences, trips, and entertainment.
• The procedures used to reimburse agents for entertainment of foreign officials.
• Any hiring by the target of government officials as agents, consultants, or in any other business capacity.
• Any documents relating to the suspension of payments to agents or other third-party representatives, including information pertaining to the red flags that led to the suspension.

Dealing With Potential International Regulatory Violations. Where it appears that the target has potentially violated U.S. international regulations, there are a number of tough questions for the acquiring company to ask itself before proceeding. These include:

• Is the conduct over? Are there likely other legal violations that have not yet been discovered or disclosed?
• Will continuing violations be required to maintain the acquired company’s business? Will ending the conduct at issue significantly impact the target’s business?
• If it appears that the acquirer will need to terminate personnel who were involved in the violations, how important are these personnel to the operation of the target’s business? If they are demoted or dismissed, what is the impact on the business of the target?
• Where it appears that third-party agents, consultants, representatives, distributors, joint venture partners, and other business partners are involved, what will be the impact of reforming or ending relationships with those parties?
• How will accounting and disclosure issues be dealt with after the closing?
• Does the price for the target need to be adjusted in light of not only the known illegal activities but also those whose discovery might not occur until after closing? Is the possibility of future discoveries taken care of in the sale agreement, including the potential expense of investigations, voided contracts, lost business, or other potential problems?
• Is there the potential for shareholder class action or derivative suits?