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Just Anti-Corruption recently reported on a lawsuit against a former hedge-fund manager in the United States accused of paying millions in bribes to secure bond swap transactions with a major Latin American pension fund. (See, “Are Hedge Funds Ripe for an Industry Sweep,” subscription required).
Greg Wolski, a partner with Ernst & Young LLP’s Fraud Investigation & Dispute Services practice, comments on the case and overall corruption risks to professional investors in a Q&A with Main Justice Editor-in-Chief Mary Jacoby below.
The Q&A has been edited for clarity.
Jacoby: Do you see hedge funds, private equity and the financial industry in general becoming more of a focus for U.S. and maybe even U.K. anti-bribery enforcement?
Wolski: Yes. Starting a year or so ago, there was increased activity as the Securities and Exchange Commission went to some of the PE firms looking for information around investments they may have gotten from sovereign wealth funds. I think more and more, private equity has become a natural target. On the same hand, they’ve been in a process of implementing a lot of policies and procedures because there has been so much attention on PE.
In doing so, I think certainly the more significant PE firms–especially those that are dealing throughout the world, which most of the significant ones are—are putting in policies and procedures in place as to how they raise their funds. That’s to make sure not only that they don’t run afoul of regulations but that they don’t end up with other reputational risk issues.
Jacoby: What are the reputational risks?
Wolski: If there’s something that becomes public— even if just an allegation—I think that ultimately impacts their ability to raise funds as they move forward in the future. If there are true issues, there is certainly liability exposure for some of the folks that are in the fund, the funds itself, directors, and the people who were actually raising the investment dollars for the PE fund. I think all those would certainly come in to play.
Jacoby: Do you think this particular case we wrote about involving Latin America — as it inevitably becomes more high profile – will serve to educate people about these risks?
Wolski: Yes, because people will able to compare and contrast to say: ‘Well here’s an actual example.’ When people then start to see that scenario may be in their own processes, they will recognize the need to start putting in controls.
Jacoby: What kind of controls would you recommend?
Wolski: Controls around how you seek investments, and controls that document the process. Who are you talking to? How are you spending money associated with those ultimate investors? What kind of entertainment was provided? Were there gifts? Why did someone invest with you versus someone else? These are all things that people have to take into account. Having a process that documents what you paid, what you did, why you were doing it – it all certainly helps to show that you were trying to comply not only with your own policies and procedures, but also with the law. What people often don’t have is that process in place to really educate their folks as to why controls are important or why there could be ramifications if controls are not implemented.
Jacoby: What about inbound investment? One of the questions raised in our article is whether funds need to screen how their investors made their money.
Wolski: I think some of the controls people would put in place there would certainly be to understand who their investor is—even to the extent of some level of background checking on that investor or underlying sources of funds from that investor. If somebody does that at a very basic level and realizes they’re dealing with a sovereign wealth fund—well then, who ultimately is behind that sovereign wealth fund? Similarly, for any other large investor — is money coming just from that person? Is it family money? Is it some conglomerate of money that has been pooled from a variety of sources where you would want to know what some of those sources are? The less information that the investor is making as they provide those investments into the PE funds, the more the PE funds or a hedge funds should be pushing back and requiring that of them.
Jacoby: Can a fund be criminally liable for accepting money it knew or reasonably should have known was the product of corruption?
Wolski: Yes. It all comes back to that what you know or that what you should have known. You want a process in place that somebody from the outside could look at it and say, ‘We followed your process. It was prudent. It was adequate. Maybe it still didn’t uncover in the end that there was an issue, but at least you looked.’ In the cases where someone hasn’t looked — and all you had to do was uncover the first stone that would have pointed you to the answer that somehow these funds were associated with being the product of bribery and corruption — then it’s really easy to fault the private equity firm or the hedge fund.
Jacoby: What kind of controls on the accounting side do you recommend?
Wolski: You start with policies and procedures around the expectations of what can be spent. If you’re talking about controls, you’re really talking about some level of detail and reporting about how monies were spent. Was there advance approval of how they were spent? In what types of categories of expenses do they relate? How do they relate to the business purpose at hand in terms of raising investment for your fund? Who all is involved and why? The harder it is for somebody to document the true business purpose of an expense, the more likely, perhaps, there isn’t a real good business purpose. The controls should be really more around documenting ultimately what was done and why. They shouldn’t be really that time-consuming of a process.
Jacoby: Where do you see all this going?
Wolski: We have continued to see increased enforcement or increased interest in that area. I don’t see it letting up. Certainly from the PE side, the private equity firms are large, they’re investing all over the world, and they’re receiving funds from all over the world. Maybe an easy target is the wrong words to some extent. They’ve become an obvious target just due to their sheer size and where they operate around the globe.