When contemplating an international acquisition, particularly one in China, the prudent thing for an acquiring company to do is conduct due diligence, including specifically as to any Foreign Corrupt Practices Act issues. As to FCPA due diligence, the prudent thing to do is to hire skilled and experienced FCPA counsel. Given the fees counsel charges for such services, it is reasonable for the company to expect that counsel will conduct complete and thorough due diligence and bring any and all adverse information to the company’s attention so that it can assess the risk of completing the transaction.
That in a nutshell is the substance of Watts Water Technologies recent complaint (here) filed in Superior Court for the District of Columbia against Sidley Austin LLP. See here for the original reporting by Reuters.
In summary fashion, the complaint alleges as follows.
“When Watts was considering the acquisition of a Chinese company, Watts hired Sidley as its attorneys to perform legal due diligence with respect to the potential acquisition so that Watts could evaluate the legal risks associated with the acquisition and decide whether to proceed. Sidley’s legal representation required its attorneys to thoroughly investigate the target company and identify all potential legal risks and liabilities that Watts might be exposed to or acquire if it purchased the target company. Sidley was aware that these potential liabilities and legal risks could include possible violations of the FCPA. In the course of its legal due diligence, Sidley uncovered a document demonstrating that the target company had a written ‘kickback’ policy, by which the company paid Chinese government officials or officials of state-owned entities (such as Chinese ‘design institutes’) in order to secure government contracts for the company. This policy violates the FCPA, and the Sidely partner responsible for the due diligence has subsequently admitted that this document was a ‘red flag.’ Undoubtedly, Sidley should have disclosed the kickback policy and the document to Watts. Nonetheless, despite obviously discovering this written policy in its legal due diligence, Sidley never disclosed its existence to Watts in any of Sidley’s legal due diligence reports or in any other communication. As a result of Sidley’s failure, Watts was unaware of the kickback policy. Watts paid millions of dollars to purchase the target company, and Watts operated it for several years. The undisclosed FCPA violations ultimately required an expensive internal investigation and audit by outside attorneys. After Watts self-reported the violations to the SEC and DOJ, both agencies initiated investigations. Watts paid millions of dollars in disgorged profits, fines and other penalties to the SEC, millions of dollars in attorneys’ fees and related costs, and Watts was also forced to sell the company for a substantial loss. Sidley is liable to Watts for these injuries and damages.”
Based on the above allegations, Watts alleges professional negligence, breach of contract, and negligent misrepresentation.
Certain of the allegations in the complaint would seem to be corroborated by an October 2011 SEC FCPA enforcement action against Watts – see here for the prior post. In that action, Watts agreed to an administrative cease and desist order requiring it to pay approximately $3.8 million ($2.8 million in disgorgement, $820,000 in prejudgment interest and a $200,000 civil monetary penalty).
The allegations in the Watts complaint against Sidley also cast the SEC action in a different light. Surely, FCPA counsel for Watts shared the substance of the allegations in its complaint with the SEC and DOJ and query whether this is what caused the DOJ to decline prosecution and for the SEC to resolve the matter via an administrative cease and desist order finding violations only of the FCPA’s books and records and internal control provisions.