FCPA Compliance and Ethics Blog

August 13, 2013

GSK and Missed Red Flags in China

One of the questions that GlaxoSmithKline PLC (GSK) will have to face during the next few years of bribery and corruption investigations is how an allegedly massive bribery and corruption scheme occur in its Chinese operations? The numbers thrown around have been upwards of $USD500MM. It is not as if the Chinese medical market is not well known for its propensity towards corruption, as prosecutions of the Foreign Corrupt Practices Act (FCPA) are littered with the names of US companies which came to corruption grief in China. GSK itself seemed to be aware of the corruption risks in China. In a Reuters article, entitled “How GlaxoSmithKline missed red flags in China”, Ben Hirschler reported that the company had “more compliance officers in China than in any country bar the United States”. Further, the company conducted “up to 20 internal audits in China a year, including an extensive 4-month probe earlier in 2013.” GSK even had PricewaterhouseCoopers LLP (PwC) as its outside auditor in China. Nevertheless, he noted that “GSK bosses were blindsided by police allegations of massive corruption involving travel agencies used to funnel bribes to doctors and officials.”

Types of Bribery Schemes

The types of bribery schemes in China are also well known. In a Financial Times (FT) article, entitled “Bribery built into the fabric of Chinese healthcare system”, reporters Jamil Anderlini and Tom Mitchell wrote about the ‘nuts and bolts’ of how bribery occurs in the health care industry in China. They open their article by noting that the practice of bribing “doctors, hospital administrators and health officials is rampant.” They quoted an un-named senior health official in Beijing for the following, “All foreign and domestic pharmaceuticals operating in China are equally corrupt”. The authors also quoted Shaun Rein, a Shanghai-based consultant and author of “The End of Cheap China” for the following, “This is a systemic problem and foreign pharmaceutical companies are in a conundrum. If they want to grow in China they have to give bribes. It’s not a choice because officials in health ministry, hospital administrators and doctors demand it.”

Their article included a diagram which visually represented two methods used to pay bribes in China, which were designated the Direct incentives and Indirect incentives methods. Whichever method is used, the goal is the same – to boost sales.

In the Direct incentives method, a third party representative of a company would provide cash to the department head of a clinic or hospital. The department head would in turn pay it to the physicians to encourage them to prescribe the company’s medical products. But a third party representative could also contact a physician directly and reward them with “gifts such as storecards, vouchers and travel” expenses. Other direct methods might include the opening of bank accounts or charge accounts at luxury goods store and then the company would hand “the debit card or VIP card directly to the recipient.”

The FT noted that the Indirect incentives method tended to be “used by larger pharmaceutical groups with stricter governance procedures.” Under this bribery scheme there were two recognized manners to get benefits into the hands of prescribing physicians. The first is to have cash incentives paid to a third party representative, such as a travel agency, which would then “pass on some of these rewards to the physician directly.” Another method was for the company itself to make a “lump sum sponsorship paid to hospitals”. The hospitals would then distribute perks “to the doctors as a monthly or annual bonus.” Another indirect method noted was that companies might organize overseas conferences and site visits, which might “include free first class travel and five-star accommodation.”

Anderlini and Mitchell reported that “The 2012 annual reports of half a dozen listed Chinese pharmaceutical companies reveal the companies paid out enormous sums in “sales expenses”, including travel costs and fees for sales meetings, marketing “business development” and “other expenses”. Most of the largest expenses were “travel costs or meeting fees and the expenses of the companies’ sales teams were, in every case, several multiples of the net profits each company earned last year.” They cited the example of Guizhou Yibai Pharmaceutical Co Ltd which earned a net profit last year of Rmb333.3m. However its “sales expenses came to a total of Rmb1.25bn, including meetings expenses of more than Rmb295m and wages of just Rmb88m.” Indeed the “largest expense for the company’s sales team of 2,318 people was Rmb404m spent on travel, for an average of more than Rmb174,000 per sales representative for the year. That is roughly what it would cost every single sales representative to fly 10 times a month between Beijing and Guiyang, where the company is based.”

Auditing Responses – Missed Red Flags?

But what should GSK have done if such expenses were kept ‘off the books’? Hirschler, in his Reuters article, quoted one un-named source for the following, ““You’d look at invoices and expenses, and it would all look legitimate,” said a senior executive at one top accountancy firm. The problem with fraud – if it is good fraud – is it is well hidden, and when there is collusion high up then it is very difficult to detect.” However, Jeremy Gordon, director of China Business Services was quoted as saying “There is a disconnect between the global decision makers and the guys running things on the ground. It’s about initially identifying red flags and then searching for specifics.”

There are legitimate reasons to hold Continuing Medical Conferences (CME), such as to make physicians aware of the latest products and advances in medicine. However, this legitimate purpose can easily be corrupted. Hirschler quoted Paul Gillis, author of the China Accounting Blog, for the following “Travel agencies are used like ATMs in China to distribute out illegal payments. Any company that does not have their internal audit department all over travel agency spending is negligent.” Based on this, GSK should have looked more closely on marketing expenses and more particularly, the monies spent on travel agencies. Hirschler wrote, “They [un-named auditing experts] say that one red flag was the number of checks being written to travel agencies for sending doctors to medical conferences, although this may have been blurred by the fact that CME accounts for a huge part of drug industry marketing.”

One other issue might be materiality. If GSK’s internal auditors had not been trained that there is no materiality standard under the FCPA, they may have simply skipped past a large number of payments made that were under a company’s governance procedure for elevated review of expenses. Further, if more than one auditor was involved with more than one travel agency, they may not have been able to connect the dots regarding the totality of payments made to one travel agency.

What about the external auditors, PwC? Francine McKenna, who writes and speaks extensively on all things related to Big 4 auditing, wrote last year, in blog entitled “What The SEC And PCAOB Fail To Acknowledge About Chinese Fraud”, that Pam Chepiga, of Allen & Overy LLP, in 2012, “told the audience that FCPA investigations in China are difficult because, “you can’t take the documents out of the country.”” After her panel, Chepiga, told McKenna “that not only does China restrict the dissemination of documents outside of China, but internal investigations by multinationals must be done by Chinese lawyers with support from the Chinese accounting firms. Given the experience that the SEC is having with Deloitte, it seems, “previous cooperation agreements are not in force”. The SEC would have a hard time going over and investigating a fraud or FCPA violation by the Chinese arm of a US based company”. So things may not have been any easier for PwC. However, the recent agreement between the Securities and Exchange Commission (SEC) and the Chinese Securities Regulatory Commission will allow the SEC some access to audit the work papers of Chinese companies listed in the US may influence this issue.

Ongoing Monitoring

Another response that GSK could have implemented was to engage in greater ongoing monitoring. In the Texas Law, Out of Order column, entitled “5Tips for Avoiding Email Compliance Traps”, Alexandra Wrage, President of TRACE International, reported that “Internal Glaxo documents and emails reviewed by The Wall Street Journal show Glaxo’s China sales staff was apparently instructed by local managers to use their personal email addresses to discuss marketing strategies related to Botox. In the personal emails, sales staff discuss rewarding doctors for prescribing Botox with cash payments, credits that could be used to meet medical education requirements and other rewards.”

Wrage uses the GSK matter as a jumping off point “For companies wanting to get a handle on the compliance risks they face through email (mis)uses and other forms of technology”. She gives five tips to avoid email compliance traps: (1) Encourage communication between compliance and IT departments. (2) Map out your universe of data. (3) Know your obligations, then develop an established set of policies and procedures around them. (4) Train employees to speak up about the new uses in technology. (5) Stress-test your program.

Remember with the technology available to companies today it is possible that companies have the ability to determine if employees are accessing personal email accounts business computers. Also to Wrage’s list, I would add one other point and that is call Eddie Cogan at Catelas Software. Relationship monitoring is what they do and they can help you out immediately.

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, 2013

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