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A Look At The Raytheon – United Technologies Merger Through An FCPA Lens

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A few days ago Raytheon Company and United Technologies Corporation announced entry “into an agreement to combine in an all-stock merger of equals.” The merger was unanimously approved by the Boards of Directors of both companies and is expected to close in the first half of 2020.

The aerospace and defense industries have significant points of contact with “foreign officials” in the global marketplace and thus a relatively high degree of FCPA risk. Indeed, United Technologies resolved an approximate $14 million FCPA enforcement action in 2018 regarding conduct in Russia, Azerbaijan, China, Kuwait, South Korea, Pakistan, Thailand, and Indonesia.

This post examines the Foreign Corrupt Practices Act and related provisions of the merger agreement as well as a prior example of how FCPA issues scuttled a defense industry merger.

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The FCPA’s Long Tentacles

There are numerous reasons to comply with the Foreign Corrupt Practices Act.

One reason is that mere existence of an FCPA inquiry can significantly throw a wrench into a company’s ability to sell itself. Another reason is that mere existence of an FCPA inquiry can cause an analyst to downgrade a company’s stock.

Both are discussed in this post starting with a real-world case study.

The case study involves Allied Defense Group, Inc. (here).

It turns out that Smith & Wesson (see here) is not the only publicly traded company affected by the Africa Sting case (see here for prior posts).

Also affected is ADG – a “multinational defense business focused on the manufacture and sale of ammunition and ammunition related products for use by the U.S. and foreign governments.” According to its website, ADG has “has two operating units in the Weapons & Ammunition industry: Mecar, S.A. and Mecar USA.”

On January 19, 2010, ADG agreed to be acquired by Chemring Group PLC (see here). See here for the release.

January 19, 2010 turned out to be an eventful day at ADG because on that same day, the company received a subpoena from the DOJ requesting that it produce documents relating to its dealings with foreign governments. ADG learned that the subpoena was related to an employee of Mecar USA being indicted in the Africa Sting case. The employee (reportedly Mark Frederick Morales) was terminated the next day and ADG stated that Mecar USA transacted business, either directly or indirectly, with six individuals indicted in the Africa Sting case.

In a June 2010 press release (see here), ADG stated as follows:

“The DOJ recently advised ADG that it is conducting an industry-wide review, and therefore the DOJ’s investigation of ADG will be ongoing. As a result, Chemring indicated that it was unwilling to consummate the merger pursuant to the terms of the merger agreement.”

Cherming Group noted (see here) that because of the DOJ’s expanded review “it could not complete the acquisition of ADG pursuant to the Merger Agreement.”

Instead, Cherming “entered into a new conditional agreement with ADG to acquire ADG’s two principal operating businesses – Mecar S.A., based in Nivelles, Belgium and Mecar US, based in Marshall, Texas (collectively “Mecar”). Pursuant to this new agreement, Chemring agreed to acquire the entire issued share capital of Mecar S.A. and the business and assets of Mecar US for a total cash consideration of $59 million.

Fast forward to last week.

ADG filed its definitive proxy statement regarding the merger.

In pertinent part it stated as follows:

“ADG’s audit committee, with the assistance of independent outside counsel, is conducting an internal review of the matters raised by the DOJ’s subpoena and the related indictment of Mecar USA’s former employee. ADG has been cooperating with the DOJ and is working to comply with the DOJ’s subpoena. ADG has also been providing regular updates to Chemring on the progress of the internal review and has been responding to Chemring’s requests for additional information.”

“As a result of the DOJ subpoena, the special meeting of stockholders to adopt the Merger Agreement with Chemring, originally scheduled for April 8, 2010, was postponed twice and then adjourned several times, most recently to June 30, 2010. As discussed below, our board of directors determined that these postponements and adjournments were desirable, for among other reasons, to continue ADG’s internal review, to respond to requests from Chemring for additional information and, with respect to the later adjournments, to provide additional time for ADG and Chemring to discuss restructuring Chemring’s acquisition of ADG.”

Restructuring did indeed occur.

As stated in the proxy materials:

“After Chemring indicated it would not complete the originally contemplated merger pursuant to the Merger Agreement, we entered into the Sale Agreement to restructure the acquisition as a purchase of our assets in order to address Chemring’s concerns about the uncertainties arising out of the DOJ subpoena. This revised transaction structure allows us to complete the sale of our operating assets to Chemring while retaining liabilities and expenses associated with the DOJ subpoena.”

[Note – in an asset sale an acquirer ordinarily does not acquire the selling entity’s liabilities, in a stock sale or merger the acquirer ordinarily does]

“Our board of directors’ original decision to enter into the Merger Agreement, and its subsequent decision to restructure the acquisition as the proposed Asset Sale, were the result of a decision-making process that evaluated ADG’s strategic alternatives, including its prospects of continuing as a stand-alone company, and that followed a market test process with the assistance of our financial advisor.”

The proxy materials then state:

“Our board of directors recommends that you vote FOR the authorization of the Asset Sale.”

The special meeting of shareholders is currently scheduled for August 31, 2010.

The ADG – Chemring saga is an interesting case study of the FCPA’s long tentacles.

It is particularly relevant given the recent General Electric settlement of a SEC FCPA enforcement action for $23.4 million. As noted in this prior post, GE’s exposure was primarily based on the conduct of two entities GE acquired after the conduct at issue occurred. Yet, as the SEC alleged, GE acquired the liabilities of these entities, along with assets, in the acquisition and that GE is the successor to the liability of these entities.

ADG – Chemring is not the only deal in which the FCPA is an issue.

For another real-world example look no further than The PBSJ Corporation – WS Atkins merger.

Remember PBSJ?

In January, the company disclosed the existence of an internal investigation to “determine whether any laws, including the Foreign Corrupt Practices Act (“FCPA”), may have been violated in connection with certain projects undertaken by PBS&J International, Inc., one of our subsidiaries with revenue of $4.3 million in fiscal year 2008 and $3.9 million in fiscal year 2009, in certain foreign countries.” (See here).

In its May 10-Q filing (see here) PBSJ stated that the “udit Committee completed the internal investigation in May 2010. The results of that investigation suggest that FCPA violations may have occurred.”

According to this recent filing, the company has spent $7 million on the FCPA investigation … that’s nearly twice the FY 2009 revenue of the relevant subsidiary!

Yesterday, PBSJ announced (see here) “that it has entered into a definitive merger agreement by which WS Atkins plc, [headquartered in the United Kingdom] the world’s 11th largest design firm, will acquire PBSJ in an all-cash transaction for $17.137 per share of PBSJ.”

The merger agreement (see here) states that PBSJ “has fully disclosed to [WS Atkins] all information that would be material to a purchaser’s assessment of the FCPA Investigation or that has been prepared or gathered in connection with the FCPA Investigation that could reasonably be expected to have a Company Material Adverse Effect.” The agreement further states that the parties “agree that neither the existence of the FCPA Investigation nor any particular development in the FCPA Investigation shall, in and of itself, constitute a Company Material Adverse Effect, but any significant effect, event, development or change relating to the FCPA Investigation may be considered in determining whether there has been a Company Material Adverse Effect.”

One more example of the FCPA’s long tentacles?

Analysts may downgrade a company because of FCPA issues.

That is exactly what Cowen & Co. recently did with Raytheon Company.

Among the reasons for the downgrade to neutral from outperform was the FCPA.

In a report authored by Cai von Rumohr, Gautam Khanna, and Mark Hokanson the authors state:

“Since second-quarter 2009, Raytheon has conducted ‘a self-initiated review’ of FCPA issues with ‘possible areas of concern’ regarding ‘a jurisdiction where we do business.’ It’s unclear when the review might end or if it’s related to early retirement of D. Smith, president of IDS when Raytheon signed the $3.3 billion UAE Patriot order. FCPA issues are a risk given: (1) increased Department of Justice priority; (2) rising size of FCPA fines (top four year-to-date average equals $300 million-plus); (3) noncompliance is fined even with voluntary disclosure and strict ethics programs; and (4) whistleblower provision in Financial Reform Law.”

The company’s most recent 10-Q filing (see here) states as follows:

“We are currently conducting a self-initiated internal review of certain of our international operations, focusing on compliance with the Foreign Corrupt Practices Act. In the course of the review, we have identified several possible areas of concern relating to payments made in connection with certain international operations related to a jurisdiction where we do business. We have voluntarily contacted the SEC and the Department of Justice to advise both agencies that an internal review is underway. Because the internal review is ongoing, we cannot predict the ultimate consequences of the review. Based on the information available to date, we do not believe that the results of this review will have a material adverse effect on our financial position, results of operations or liquidity.”

Raytheon “is a technology and innovation leader specializing in defense, homeland security and other government markets throughout the world.” The company is one of the largest defense contractors to the U.S. government and the majority of its revenue comes from U.S. government contracts.

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