Strategies for Addressing M&A Fraud Include Post-Merger Probes, Attorney Says

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By Yin Wilczek

June 10 — Fraud may occur in a merger and acquisition deal, resulting in expensive headaches for the buyer, an attorney noted June 10.

Accordingly, buyers who believe they've been defrauded may want to invest in a post-acquisition investigation, said Michael Farhang, a partner in Gibson Dunn & Crutcher LLP's Los Angeles office.

During a Practising Law Institute webinar, Farhang also suggested some strategies for addressing pre-acquisition fraud, such as including representations and warranties in the deal agreement.

Litigation over M&A deals tainted with fraud are “somewhat more frequent than you might expect,” Farhang said.

“It is a situation that is common enough that buyers should be aware of what some of the legal dimensions of these transactions are and what recourse or remedies might be available” to them if they believe fraud has occurred in connection with a transaction, he said.


One high-profile case is Hewlett-Packard Co.'s botched takeover of Autonomy Corp. in 2011. HP's $10.3 billion acquisition of Autonomy led to an $8.8 billion writedown in 2012 over alleged accounting improprieties at the U.K. software maker and spawned a series of lawsuits.

HP June 9 agreed to pay $100 million to settle a lawsuit filed by HP shareholders who claimed they lost money because of the takeover.

Farhang noted that post-acquisition investigations are seen as “an unnecessary distraction” in the hectic period following the deal's closing absent some clear concerns that fraud has occurred or “something has gone significantly wrong.”

As litigation from ill-fated M&A deals show, “it's typically a very significant financial downturn that occurs after closing or a discovery of some significant impairment to an asset of the newly acquired company that the buyer simply didn’t expect or wasn’t aware of and believes could have or should have been disclosed by the seller prior to the transaction that will prompt an investigation of this type,” he said.

When to Investigate?

Farhang said that situations that may trigger such probes include:

• when buyers suspect that the transaction wasn't for fair value;

• when concerns are raised by investors, auditors or regulators; or

• where there is a need to strengthen and maintain adequate internal controls and compliance at the newly acquired entity.


Farhang also noted that fraud typically is found in, among other areas:

• financial statements;

• inflated revenues or projections;

• vendor contracts;

• concealment of customer departures or problems;

• material adverse change events; and

• Foreign Corrupt Practices Act and export controls compliance.



Meanwhile, Farhang said some M&A strategies to deal with pre-acquisition fraud include:

• representations and warranties;

• material adverse change clauses;

• privilege;

• arbitration clauses;

• choice of law and venue clauses; and

• disclaimers in agreements and promotional materials.


With respect to privilege, Farhang noted that in most cases, it is safe to assume that privilege with respect to a firm's ongoing operations—such as customer relationships—generally passes to the buyer. The question is whether the privilege over communications relating to the sale itself will transfer to the buyer absent a particular contractual provision, he said. The answer differs depending on the jurisdiction, he added.


For instance, in Delaware, the privilege over acquisition-related communications passes to the buyer in a stock purchase or sale of the entire company without the need for specific contractual language, Farhang said. In New York, however, the privilege over sale-related communications will not transfer absent specific language, he said. “It's important to check the law” of the relevant jurisdiction in which a dispute over the transaction may arise regarding the passage of privilege, he said.

As to choice of law, Farhang noted that California is very buyer-friendly while Delaware and New York impose more obligations on buyers.

Farhang also had some recommendations for post-merger fraud investigations, including that:

• the board or a special committee should be involved;

• witness interviews should be directed by attorneys to preserve privilege; and

• if dealing with foreign acquisitions, data privacy laws for those jurisdictions should be kept in mind.


Farhang added that e-mail collection is important for such probes. “It's important to know where e-mail” communications for the acquired company are stored and that the data is preserved, he said.

Moreover, Farhang suggested that in egregious cases, buyers might want to refer matters to law enforcement and regulators so they can conduct investigations and address issues.

To contact the reporter on this story: Yin Wilczek in Washington at

To contact the editor responsible for this story: Ryan Tuck at