An Ounce of Prevention in M&A Due Diligence


 “An ounce of prevention is worth a pound of cure” – Benjamin Franklin 

During a merger or acquisition, usually there is at least some leadership recognition that:

  1. the cultural fit of the two (or more) companies is important
  2. that the ethical climate of the organizations needs to emphasized; and
  3. that compliance standards must not be allowed to slip.

This recognition can be easily identified in public statements by the executives involved, and the plethora of opinion survey studies of managers.

For example, a recently released survey of global executives conducted by international consultancy Deloitte, found that they agreed that culture is one of the dominant barriers to effective integration during an M&A. The study concludes that “culture must be a focus in efforts to integrate companies, because when left to itself, culture will often undermine value-creation.”

Furthermore, regulators sometimes pay especially close attention during a merger.  In a recent Compliance Week article, Kara Novaco Brockmeyer, chief of the Foreign Corrupt Practices Act (FCPA) unit for the Securities and Exchange Commission’s Division of Enforcement, recently wrote that “investigators will focus on companies that turned a blind eye to pre-existing risks, especially if they take ‘years, not months’ to either identify or admit to a problem with a subsidiary.”

And yet, despite such widespread understanding of the importance of culture, ethics and compliance, and warnings from regulators, the reality is that too often executives ignore ethics and compliance risks and focus mainly on the financial implications of a merger. And while the impulse to focus on the money is understandable, forgetting the broader ethics and compliance landscape can lead to legal, reputational, and (yes!) even financial problems down the road (as our own Randy Stephens recently shared with the Wall Street Journal).

So the question we’re left with is why do issues as important as culture, ethics and compliance get ignored during such a critical point in any organization’s history? In our experience, it is mostly because saying you understand the importance of the topics is not the same thing as having an effective plan for managing them. But the stakes are high, and companies that take a systematic and pragmatic approach to issues of culture, ethics and compliance alongside other concerns, will certainly save themselves a lot of trouble.

To minimize culture, ethical and compliance risks during a merger or acquisition, you need to have a plan. When developing such a plan, ask yourself these three questions:

  • What are the culture, ethics and compliance risks of the other organization? Your plan needs to go beyond simply identifying their risks. It also needs to establish, early on during merger discussions, how the combined organization is going to manage these risks. Will one partner’s compliance program essentially be the model for the new organization? This is also a good opportunity to improve both companies’ ethics programs since working together on practical details will help compliance personnel from both companies develop a rapport with each other.
  • What communications about ethics and compliance will you be sending to the combined companies’ employees?  Employees are usually nervous during a merger, often analyzing every communication sent by management to see how it might personally affect them. You should also expect that at least some of these nervous employees will be updating their resumes. Such an environment is one in which the risks of ethical misconduct are heightened, especially as it applies to conflicts of interest (“Hey there!  I’m looking for a job.  Are you hiring? Well of course I can make sure you get a new contract to supply us while I’m still here!”), and confidential information (e.g., if an employee leaves the company for a competitor). But it isn’t all bad – the increased employee attention is also the perfect opportunity to emphasize ethics and compliance standards, and communicate management’s commitment to responsible business conduct.
  • Are there cultural norms or compliance responsibilities which will need to be addressed? A merger can mean an enormous change for employees regarding their responsibilities. Employees, for example, of a company based in Argentina merging with a company based in the U.S. may suddenly be asked to adhere to compliance requirements they are not even aware exist. Foreign Corrupt Practices Act compliance may suddenly extend to the Argentine employees literally overnight, for example. Will they be ready when that day arrives?

Once you have a plan in place, don’t ignore it. Ethics and compliance professionals need to be at their best when the stakes are highest. Be ready!

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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