From The Byrds to The Eagles: Lessons in the Evolution of Compliance in China

I regularly read the Lefsetz Letter, which is the best blog I know about the music business. While Bob Lefsetz, its founder and author, has received criticism from industry peers as someone who furthers himself by tearing others down, I find his personal reflection on songs, songwriters, bands and industry insiders that have affected his unique and independent outlook of the music industry to be some of the finest current writing on the music biz. In yesterday’s post, he talked about the transition of the folk music scene from Greenwich Village to Los Angeles and then charted it from The Byrds to The Eagles. He linked to a BBC documentary which demonstrated this shift. I thought about this change in music venues and musical tastes whilst thinking about some of the ongoing changes in how non-US and UK companies are responding to requirements of doing business under the Foreign Corrupt Practices Act (FCPA) and UK Bribery Act.

One of the areas which continues to raise a large number of questions for US businesses and for compliance officers is about the ritual of gift giving in Chinese business culture. Many US companies believe that it is important to offer gifts to senior people that are more expensive than those offered to their subordinates. However an ever growing number of Chinese companies now discourage gift giving. An article entitled “The Myths of Gift Giving” in the summer edition of the MIT Sloan Management Review explores this question and provides an interesting example from one Chinese company. As Chinese companies engage with partners, globally and locally, their internal and external business practices are evolving. Indeed the article found that many Chinese companies now put greater emphasis on professionalism and building trust and confidence in business capabilities.

The example of the Chinese company China Data Group (CDG) was cited in the article. CDG is a fast-growing company, based in Beijing, with over 4,000 employees, who develops technologies that provide business process outsourcing services for information-intensive industries such as insurance, credit cards and corporate banking. CDG created a goal to become less reliant on guanxi relationships. Guanxi relationships are often viewed as the basic dynamic in personalized networks of influence and are a central idea in Chinese society. However, in the case of CDG it sought to expand the company’s footprint globally by building the company’s brand equity, professionalism and service quality. This expansion targeted businesses in Japan and the US. To facilitate this growth strategy, the company began recruiting executives with substantial international experience.

The article reported that to try to overcome the tensions between the traditional norms of guanxi and new global expectations that the company set for itself, it initially established two separate sales organizations: the day team and the night team. The day team worked at client sites discussing projects, giving presentations and providing technical support. Their objective was to build confidence in the quality and reliability of CDG services. The night team would invite clients to dinner and other social events with the objective of building personal ties and rapport. In other words, the traditional guanxi of connections and relationships.

The company found that internal tensions erupted when CDG secured its largest contract ever from a local Chinese company who had received a cell phone from a senior CDG executive as a gift. Members of the CDG executive team were polarized. Some felt that the vice president in charge of the deal should be promoted. Others argued that such gift giving sullied the company’s reputation and the night team should be disbanded. What was the outcome of this internal discussion? The company moved to change its internal business practices so that expensive gift giving is no longer standard practice, and the night team was disbanded. The article ended with the intonation that the CDG “experience highlights how Chinese companies are moving away from some traditional cultural norms as they align their practices with international business standards.”

Lefsetz ended his piece with the following, “But this is how it worked back then. We followed the music. Business was one step behind…Music just does not have that power today. The California sound put so much money in the system, everybody wanted in. Hell, that company known as Time Warner? Its main asset is its cable system. You know what paid for that? The profits from the record companies!” The change wrought by the power of money may or may not be a good thing for the music business. Bob Lefsetz does not seem to believe so. However, the fact that Chinese companies are moving towards a more Western approach to business practices and compliance tells me that things are moving in the right direction in the compliance world.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2012

China Joins the International Fight against Corruption

China has recently joined most of the western world in passing anti-corruption legislation. As reported by the FCPA Professor, “the legislature of the People’s Republic of China (PRC), the National People’s Congress, passed a slate of 49 amendments to the Criminal Law, one of which is a provision that criminalizes paying bribes to non-PRC government officials and to officials of international public organizations (“the Amendment”).” This Amendment represents the first instance in which PRC law has prohibited PRC nationals and PRC companies from paying bribes to non-PRC government officials and to officials of international public organizations. The Amendment became effective on May 1, 2011.

At the recent Dow Jones Global Compliance Symposium, Scott Lane, President and Chief Executive Officer (CEO) of the Red Flag group, talked about this new Chinese anti-corruption legislation, contrasted it with the US Foreign Corrupt Practices Act (FCPA) and UK Bribery Act and then raised some key interpretive questions that are yet unanswered. He prepared for me the text of the Amendment and a written summary of his remarks which forms the basis of this article.

Text

Initially Lane noted that the key to the new law is “what’s not said” and the laws implementing regulations. The text of the Amendment (for a western trained lawyer) is amazingly brief. It reads:

Whoever, for the purpose of seeking illegitimate commercial benefits, gives money or property to any foreign public official or official of an international public organization, shall be punished in accordance with the provisions of the preceding paragraph (i.e., the pre-existing Article 164)

The pre-existing Article 164 criminalized the commercial bribery of giving money or property to any employee of a company, an enterprise or other institutions for the purpose of seeking illegitimate benefits. The Amendment also provides:

•       Penalties: When the amount paid is relatively large, an offense is to be punished by imprisonment or detention for up to three years. When the amount paid is very large, an offense is to be punished by imprisonment from three to 10 years plus a fine.

•       Corporate and Individual Liability: Personnel in an entity (including, but not limited to, companies) who are in charge of the offense or bear other direct responsibility are subject to such penalties, and the entity itself is subject to a fine.

•       Size of Payments that Constitute a Criminal Offense: Although Article 164 does not specify the thresholds for criminality, under relevant interpretations by the Supreme People’s Court (SPC), the criminality threshold for giving a bribe is RMB10,000 (approximately $1,550 USD). As such, payments of less than RMB10,000 would not constitute a criminal offense.

•       Voluntary Disclosure: Article 164 provides for leniency if the perpetrator voluntarily reports the violation before an investigation has been initiated.

Jurisdiction of the Amendment

Under the Criminal Law, the Article 164 (with the Amendment) shall apply to:

•       All Chinese citizens, wherever located on a world-wide basis;

•       All individuals of any nationalities within China; and

•       All companies, enterprises, and institutions organized under or regulated by Chinese law, which generally includes, in addition to domestic companies, Sino-foreign joint ventures, wholly foreign-owned enterprises, and representative offices.

This means that in regards to a foreign investment in China, a foreign individual, a wholly-foreign owned enterprise, a joint venture between a domestic company and a foreign company, and a representative office of a foreign company, could all possibly be prosecuted for the overseas bribery.

Interpretation of Key Terms

The Amendment does not define key terms such as “illegitimate commercial benefits”, “money or property”, or “foreign public officials”. The pre-existing opinions issued by the SPC and the Supreme People’s Procuratorate (SPP) in connection with commercial bribery (“the Opinions”) may be used as references.

Regarding the term “illegitimate commercial benefits”, a related provision in the Opinions is the term of “illegitimate benefits”. The “illegitimate benefits” is defined as a bribe which seeks any advantage in breach of laws, regulations, rules or policies; or requires the other party to provide assistance or facilitation that is in breach of laws, regulations, rules, policies, or industry codes of practice.

Currently, it is unclear whether there are any differences between the “illegitimate commercial benefits” and “illegitimate benefits”. The narrowed description in the Amendment may mean that certain activities that are prohibited in a domestic context may be permissible in a foreign context.

Regarding the terms “money or property”, according to the Opinions, it includes not only money and property in kind, but also property whose value may be calculated in monetary terms, such as provision of home decoration, membership cards having monetary value, token cards, and travel expenses.

Lastly, another regulation issued by the State Administration for Industry and Commerce (SAIC) regarding commercial bribery also includes “properties disguised as a promotional fee, publicity fee, sponsorship fee, research fee, labor fee, consulting fee, commission etc., or by way of reimbursement of various fees” into the term.

Regarding the term “foreign public officials”, a related provision in the Opinions is the explanation on “domestic public officials”. In the context of domestic bribery, public officials may refer to any officials working in the government, state-owned enterprises, medical institutions, and education institutions.

It is also possible that, as a member of the UN Convention Against Corruption (UNCAC), China may use the definition of “foreign public officials” under the UNCAC which refers to any person holding a legislative, executive, administrative or judicial office of a country, and any person exercising a public function for a country, including for a public agency or public enterprise.

Comparing to the FCPA and UK Bribery Act

The FCPA Professor noted that “The Amendment is a rather high-level law, whereas the text of the FCPA includes considerably more detail, even if the interpretation of those details is being actively debated and litigated. The absence of clear definitions, exceptions, and affirmative defenses also would appear to require PRC prosecutors to exercise somewhat more discretion in interpreting and enforcing the law.” Lane had the following comparisons:

Scope:

•       It is generally understood from statutory provisions that the Amendment is against only the actual payment and not merely offers or promises or authorization thereof to pay.

•       The interpretation on “money or property” in the Amendment may be not as broad as “anything of value” under the FCPA.

Exceptions:

•       Unlike the FCPA, the Amendment does not contain an exception for “facilitating payments”. Given that Chinese companies have a large presence in developing countries, in South Africa and elsewhere, where facilitating payments are often seen as necessary for conducting business, it is possible that China will have a higher tolerance on such payments.

•       Unlike the FCPA, the Amendment does not specify any exceptions regarding “reasonable and bona fide expenditures” either. However, given the culture of hospitality prevalent in China, it is possible that modest payments for hospitality and gifts won’t be interpreted as to seek “illegitimate commercial benefits”.

Defense:

•       Unlike the UK Bribery Act, the Amendment does not provide any affirmative defenses such as “adequate procedures”.

As noted by the FCPA Professor, it is not clear if “China is really going to enforce this law against its own companies operating outside of China.” He believes that “China’s enforcement of its domestic bribery laws historically has been somewhat uneven and focused mainly on the demand side.” However, he considers that the Chinese “government has shown an increasing willingness to target bribe-payers as well, as corruption remains a primary concern of the general population and thus a concern for the government and ruling Communist Party, which is at its core focused on social stability.” He concluded his post by stating that “It remains to be seen whether the Amendment will actually be enforced in a way that deters bribe-paying by PRC companies and citizens.”

Lane concluded that the Chinese legislation demonstrates a key reason why anti-corruption and anti-bribery legislation like the FCPA and Bribery Act are helping business development on a world-wide basis. The Chinese understand that if they are going to join the international business community they will have to play by certain rules, such as these now well-known international business standards. Interestingly, Lane noted that the one thing that the current Chinese government fears the most is political unrest. By fighting corruption, this effort could help lead to greater stability in the country.

Whatever the reasons for the passage of this Chinese anti-corruption legislation, I believe that it is welcome addition to the list of nations adopting such measures. It shows once again the effect of the FCPA in encouraging other companies to aid in the fight against bribery and corruption in the international business arena.

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The author wishes to thank Scott Lane for providing the text of his remarks. The Red Flag Group provides a wide range of consulting and compliance services to multinational companies, with a key focus on delivering practical, business-oriented advice and solutions to manage risk and improve corporate compliance programs. Mr. Lane can be reached via email at scott.lane@redflaggroup.com.

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This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2012

Watts Water: Don’t Get Caught on the (FCPA) Slow Boat to China

Last week, the Securities and Exchange Commission (SEC) instituted a Cease and Desist Order again Watts Water Technologies, Inc. (WWT) and one of its employees, Leesen Chang (Chang). The Order was to obtain certain civil penalties and fines for conduct of WWT and Chang concerning violations of the books and records and internal control provisions of the Foreign Corrupt Practices Act (FCPA) for its China operations. As noted by the FCPA Professor, “The Watts enforcement action is yet another example of an FCPA enforcement action focused on Chinese Design Institutes.” WWT paid a fine of $200,000, agreed to disgorge profits of $2,755,815 and paid prejudgment interest of $820,791. Chang paid a fine of $25,000.

The violations revolved around the WWT China subsidiary, Watts Valve (Changsha) Co., Ltd. (CWV) which did business in China and purchased another Chinese company Changsha Valve in April 2006. This Chinese company was consolidated in CWV. In 2010, WWT sold CWV to a Hong Kong entity. Chang was the Vice President (VP) for sales of CWT from 2006-2009.

The Violations

There were two forms of bribery set forth in the Cease and Desist Order. First CWV made payments directly to employees of a Chinese Design Institute. According to the FCPA Professor, Chinese Design Institutes are “typically state-owned enterprises that provided design engineering and technical integration services that can influence contract awards by end-user state-owned customers.” These direct payments were made to influence design institutes to recommend CWV be awarded the sale of products for Chinese state enterprises. The second form of bribery was that CWV paid “sales-related expenses such as travel, meals, entertainment” of the Chinese Design Institute. Lastly, CWV employees made direct payments to Chinese Design Institute for sales made by CWV.

These payments for such sales-related expenses were made by CWV employees out of their sales commissions and hidden on the CWV books and records as employee expenses. The commissions paid directly to the Chinese Design Institute for sales made by CWV employees were also hidden on the books and records of CWV as its employees commissions. Chang knew about these payments and attempted to block the US Company, WWT, from discovering them or correcting the false entries into CWV books and records.

Discovery and Remedial Measures

The discovery of the above issues began with the WWT General Counsel (GC) becoming aware of an enforcement action against another company for unlawful payments to a Chinese Design Institute. This led to FCPA training for certain CWV management who disclosed some of the above information. WWT instituted an internal investigation and self-disclosed to the SEC.

The Cease and Desist Order listed several remedial measures taken by  WWT, one of which included changing the incentive based compensation. There was also the creation of an enhanced compliance program including policies and procedures, specifically including a Travel and Entertainment Expense Reimbursement Policy for the company’s Chinese subsidiaries. Additionally there were enhanced due diligence procedures for foreign business partners. WWT conducted a thorough world-wide FCPA anti-corruption audit. Lastly, it was noted that WWT hired a Director of Legal Compliance to head up the company’s compliance efforts going forward.

Lessons Learned

• The primary lesson learned in this enforcement actions is that it does not matter how much of a company’s revenue a subsidiary may represent, a FCPA violation is a FCPA violation. Here it was specifically noted in the Cease and Desist Order that the Chinese subsidiary’s revenues were “approximately 1% of Watts gross revenues.” A very expensive lesson indeed.
• The second lesson is that if a VP of Sales, in any region, resists translating company expense accounts into English, do not run but sprint to those areas, with all possible haste, to secure the records because that VP is most probably hiding something that can you get in big, big trouble.
• Next is that a company must use several varied resources to continually assess and re-assess its risk profile. The actions which led to the WWT investigation began because the GC saw that another company was involved in an enforcement action involving a Chinese Design Institute. This is not something traditionally listed as an area to be assessed. However, if a competitor is involved in an enforcement action or a company that is using a sales model very similar to that used by your company, you should re-assess the risk to your company accordingly.
• The final lesson I would suggest is the absolute necessity of in-person training for high risk employees or those company employees in high risk countries. It was through the in-person FCPA training that the WWT learned about the violative conduct. If this training had been video or web-based such disclosure may never have happened.

The Watts Water enforcement action provides concrete information for the compliance practitioner to review and re-assess your compliance program and risk profile to determine if your company has any risks which you are not currently seeing.

For a copy of the SEC Cease and Desist Order, click here.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2011

SciClone FCPA Lawsuit Settlement: New Enhanced Best Practices?

In a story in the D&O Diary, entitled “More Woes for Companies with Chinese Connections”, Kevin LaCroix discussed the settlement reached by the entity SciClone Pharmaceuticals, and its individual defendant directors and officers, in litigation involving three consolidated derivative lawsuits that were filed following the company’s announcement that it was the target of Securities and Exchange Commission (SEC) and Department of Justice (DOJ) investigations for possible violations of the Foreign Corrupt Practices Act (FCPA). As reported by the FCPA Professor and others, within the first two weeks after the company’s announcement of the investigation there was a literal whirlwind of announcements by law firms of investigations of SciClone and the lawsuits which were consolidated into the settled action.

The FCPA does not provide for a private right of action, the announcement of a FCPA investigation can often bring civil lawsuits against the company, as nominal defendant, and certain of the company’s directors and officers. In the SciClone lawsuits, it was alleged that “the Individual Defendants, by reason of their failure to implement and maintain internal controls and systems at the Company to assure compliance with the FCPA, breached their fiduciary duties and may be held liable for damages.” As reported by LaCroix the parties have agreed, subject to court approval, to resolve the consolidated actions based on the company’s agreement to adopt certain specified corporate governance reforms and their agreement to pay $2.5 million in plaintiffs’ attorneys’ fees. The payment of the plaintiffs’ attorneys’ fees is to be made by “SciClone’s insurers under its director and officer insurance policy.”

SciClone has a large amount of its business in China and on its website announces, “SciClone’s goal is to grow sales of our significant marketed portfolio in China”. As noted by LaCroix, “The existence of the FCPA investigation underscores the challenges facing companies attempting to do business in China.” This “China-centric” business focus may have led to some of the issues involved in the FCPA investigation.

The Settlement has several features that are well worth noting by the compliance practitioner.

Clawbacks

In addition to agreeing to seek to retrieve any incentive-based compensation from company officers in the event of  an earnings restatement, SciClone is required to “take legal action to recoup” all incentive-based compensation “paid to the director, officer, employee, or independent contractor” that was earned if an “Established Violation” is found. An Established Violation is defined to be “a guilty plea or other admission of guilt under penalty of perjury, or a criminal or civil judgment or sanction.” This requirement on a company is something not generally or previously seen. The requirement against third party “independent contractors” is also a new wrinkle. Is this language broad enough to include agents, resellers, distributors or any other monikered foreign business partner?

Compliance Coordinator

The Settlement goes into substantial detail about the creation of a new position within SciClone named “Compliance Coordinator”. While never calling this position the Chief Compliance Officer, the Compliance Coordinator has many roles usually associated with that position. In addition to the duties of the Compliance Coordinator, which will be enumerated below, the position requires fluency in both English and Mandarin. Other requirements of the Compliance Coordinator include:

• A senior profession with FCPA compliance experience, who would be a part of the executive management team.
• Knowledge of and experience with the types of compliance issues faced by SciClone.
• The Compliance Coordinator shall report directly to the Audit Committee of the Board of Directors on all compliance efforts going forward through no less than quarterly and annual reports.
• Provide an annual assessment of the Company’s compliance program and perform unannounced site visits to China to ensure compliance with the program.
• Liaise with a designated compliance “point person” at all locations other than the home office of the Compliance Coordinator.
• The Compliance Coordinator shall have the right to be present at any regularly-noticed meeting of the Board of Directors.

Compliance Program and Code of Conduct

The Settlement adopts the 13 point best practices compliance program as set for in all Deferred Prosecution Agreements (DPAs) since at least the Panalpina DPA of November, 2010. The Settlement also goes into some detail about the Code of Conduct specifically adding a component for “Health Care Professionals” as that is the type of business in which SciClone is involved.

Internal Controls, Use of Agents and Employee Training

In three separate sections of the Settlement, there are further requirements regarding “Internal Controls and the Compliance Function”; “Use of Foreign Agents and Distributors” and “Employee Compliance Training”. In the Internal Controls section the company’s Internal Auditor “shall report directly to the Audit Committee at least quarterly” and “shall provide a balanced assessment of significant legal compliance risks and effectiveness of the system of internal controls in managing these risks.” Regarding the use of foreign business partners, compensation should be “commercially reasonable” and the company should contractually limit compensation to “specific, identified tasks and should avoid large percentage-based commissions and success fees.” In the training section it is specifically noted that the training should be both in English and Mandarin.

The SciClone Settlement has several unique and interesting factors. The first is that is has great specificity for a civil settlement. One can only speculate but it would certainly appear that these compliance roles, policies and procedures were not in place and that the lack of them has led to at least one or more potential violations. Certainly not referenced anywhere in any of these proceedings is the role of the DOJ or SEC and how these compliance roles, policies and procedures may have been influenced by DOJ or SEC input, or how these might factor into any settlement  with the DOJ or SEC. This civil Settlement Agreement adds greater specificity to the 13 points of a minimum best practices compliance program that was set forth in the Panalpina settlement.

For a copy of the parties’ stipulation of settlement click here.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2011