Billy the Kid Begins and the GSK China Verdict

According to This Day in History, 139 years ago today, Billy the Kid was arrested for the first time, for theft. Billy the Kid was believed to have been born in New York City and was later taken out west by his mother. He was arrested on September 23, 1875 when he was found in possession of clothing and firearms that had been stolen from a Chinese laundry owner. Two days after he was placed in jail, the teenager escaped up the jailhouse chimney. From that point on Billy the Kid was a fugitive. He later broke out of jail and roamed the American West, eventually earning a reputation as an outlaw and murderer, allegedly committing 21 murders.

I thought about the start of Billy the Kid’s outlaw career and more particularly how it ended as I was thinking through some of the issues surrounding the GlaxoSmithKline PLC (GSK) bribery conviction in China last week. For instance, did GSK obtain a negotiated settlement with the Chinese government when it was announced that the company pled guilty to bribery and corruption and was fined almost $500MM by a Chinese court? Further, what lessons can be drawn from the GSK matter for companies operating in China and the compliance practitioner going forward? Today, I want to explore the lessons that a company might be able to draw from the GSK matter.

I think the first lesson to draw is that the Chinese government will focus more on companies than on individuals. Andrew Ward, Patti Waldmeir and Caroline Binham, writing in a Financial Times (FT) article, entitled “Pain from graft scandal likely to linger”, quoted Mak Yuen Teen, a corporate governance expert at the National University of Singapore for the following, “By handing suspended sentences rather than jail terms to Mark Reilly, GSK’s former head of China, and four of his top lieutenants, the court in Hunan province was holding the company more accountable than the individuals.”

However other commentators said, “GSK got off more lightly than expected for bribing doctors to prescribe its drugs.” The article went on to note, “People close to the situation denied that the outcome amounted to a negotiated settlement. But Bing Shaowen, a Chinese pharmaceuticals analyst, said it was likely that GSK made commitments on research and development investment and drug pricing to avoid more draconian treatment. A further FT article by Andrew Ward, Patti Waldmeir and Caroline Binham, entitled “GSK closes a chapter with £300m fine but story likely to run on”, cited Dan Roules, an anti-corruption expert at the Shanghai firm Squire Sanders, who said that he had expected the penalty to be harsher. Roules was quoted as saying “The fact that GSK co-operated with the authorities would have made a difference.” The article went on to say that Roules “pointed to GSK’s statement on Friday pledging to become “a model for reform in China’s healthcare industry” by “supporting China’s scientific development” and increasing access to its products “through pricing flexibility”.”

What about reputational damage leading to a drop in the value of stock? The market had an interesting take on the GSK conviction, it yawned. Moreover, as noted in the FT Lex Column “The stock market was never bothered. The shares moved little when the investigation, and then the fine, were disclosed.” Why did the market have such a reaction? The Lex Column said that one of the reasons might be that the “China may be too small to matter much for now” to the company.

Another lesson is one that Matt Kelly, editor of Compliance Week, wrote about in the context of the ongoing National Football League (NFL) scandal, in an article entitled “The NFL’s True Problem: Misplaced Priorities Trumping Ethics & Compliance”, when he said that a company must align its “core values with its core priorities.” GSK moved towards doing that throughout the last year, during the investigation into the bribery and corruption scandal in China. Although the Chief Executive Officer (CEO) of GSK, Sir Andrew Witty, has been a champion for ethical reform in both the company and greater pharmaceutical industry, the FT reporters noted that the China corruption scandal, coupled with “smaller-scale corruption allegations in the Middle East and Poland, has raised fresh questions about ethical standards and compliance.” If Witty wants to move GSK forward, he must strive to align the company’s business priorities with his (and the company’s) stated ethical values.

Which brings us to some of the successes that GSK has created in the wake of the bribery and corruption scandal. These successes are instructive for the compliance practitioner because they present concrete steps that the compliance practitioner can do to help facilitate such change. As reported by Katie Thomas, in a New York Times (NYT) article entitled “Glaxo to Stop Paying Doctors To Boost Drugs”, one change that GSK has instituted is that it will no longer pay doctors to promote its products and will stop tying compensation of sales representatives to the number of prescriptions doctors write, which were two common pharmaceutical sales practices that have been criticized as troublesome conflicts of interest. While this practice has gone on for many, many years it had been prohibited in the United States through a pharmaceutical industry-imposed ethics code but is still used in other countries outside the US.

In addition to this ban on paying doctors to speak favorably about its products at conferences, GSK will also change its compensation structure so that it will no longer compensate sales representatives based on the number of prescriptions that physicians write, a standard practice that some have said pushed pharmaceutical sales officials to inappropriately promote drugs to doctors. Now GSK pays its sales representatives based on their technical knowledge, the quality of service they provided to clients to improve patient care, and the company’s business performance.

In addition to the obvious conflict of interest, which apparently is an industry wide conflict because multiple companies have engaged in these tactics, there is also clearly the opportunity for abuse leading to allegations of illegal bribery and corruption. Indeed one of the key bribery schemes alleged to have been used by GSK in China was to pay doctors, hospital administrators and other government officials, bonuses based upon the amount of GSK pharmaceutical products, which they may have prescribed to patients. But with this new program in place, perhaps GSK may have “removed the incentive to do anything inappropriate.”

This new compensation and marketing program by GSK demonstrates that companies can make substantive changes in compensation, which promote not only better compliance but also promote better business relationships. A company spokesman interviewed the NYT piece noted that the changes GSK will make abroad had already been made in the US and because of these changes, “the experience in the United states had been positive and had improved relationships with doctors and medical institutions.”

In addition to these changes in compensation and marketing, Ward/Waldmeir/Binham, reported that GSK announced it would strive to be “a model for reform in China’s healthcare industry” by “supporting China’s scientific development” and increasing access to its products “through pricing flexibility”. They further stated “Rival companies will now be watching nervously to see whether more enforcement action takes place in a sector where inducements for prescribing drugs have long been an important source of income for poorly paid Chinese medics,” which is probably not going to be a return the wild west of bribery and corruption that occurred over the past few years in China. Bing Shaowen was quoted as saying that the GSK matter “is a very historic case for the Chinese pharmaceutical industry. It means that strict compliance will become the routine and the previous drug marketing and sales methods must be abolished.”

Whatever you might think of the GSK result, the company certainly ended its legal journey better in China than Billy the Kid did in New Mexico. But the company still faces real work to rebuild its reputation in China. Moreover, it still faces legal scrutiny for its conduct in the UK under the Bribery Act and the US under the Foreign Corrupt Practices Acct (FCPA). So stay tuned…

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, 2014

GSK Convicted – We are really, really sorry we paid bribes (and got caught)

“GSK plc sincerely apologies to the Chinese patients, doctors and hospitals, and the Chinese Government and the Chinese people.”

 

With those words, the British pharmaceutical giant GlaxoSmithKline (GSK) PLC was convicted in a secret trial in a court in the Hunan province of China for bribery and corruption related to its Chinese business unit. The amount of the fine was approximately $491MM. This fine was the largest levied on a western company for bribery and corruption in China. Moreover, if it had been in the United States for a violation of the Foreign Corrupt Practices Act (FCPA), it would have come in as the third highest fine of all-time, behind those of Siemens and Halliburton. In a Financial Times (FT) article, entitled “GSK hit with record $490m China fine for bribing doctors”, reporters Andrew Ward and Patti Waldmeir noted that the fine is “equal to the Rmb 3bn in bribers that Chinese investigators said had been paid by GSK.”

Many of us had wondered when the GSK investigation in China would end and we all found about the trial when it was announced in the newspapers last week. It certainly showed that the quality of justice in China is quite different than in the west. While it is not entirely clear how long the trial lasted, it appeared that it was in the same range as the one-day trial given to Peter Humphrey and his wife last month, when they were both found guilty for violating China’s privacy laws. In an article in the New York Times (NYT), entitled “Glaxo Fined $500 Million By China”, Keith Bradsher and Chris Buckley reported, “Chinese authorities accused Glaxo of bribing hospitals and doctors, channeling illicit kickbacks through travel agencies and pharmaceutical industry associations — a scheme that brought the company higher drug prices and illegal revenue of more than $150 million. In a rare move, authorities also prosecuted the foreign-born executive who ran Glaxo’s Chinese unit.” Moreover, GSK China’s country manager, Mark Reilly and four other in-country executives were each convicted with potential sentences of up to four years in prison. The NYT noted, “the sentences were suspended, allowing the defendants to avoid incarceration if they stay out of trouble, according to Xinhua. The verdict indicated that Mr. Reilly could be promptly deported. The report said they had pleaded guilty and would not appeal.”

A Wall Street Journal (WSJ) article, entitled “Meet the Glaxo Executives Convicted in China”, detailed the five GSK executives’ crimes and sentences, the summary is as follows:

• Mark Reilly: GSK’s former China chief. He was sentenced to prison for three years with a four-year suspension. He was also the victim of an illicit recording of he and his girlfriend with the sex tape delivered to GSK management in London.
• Zhang Guowei: GSK China’s former HR Director, who was sentenced to three years in prison with a three-year suspension. Chinese state media said he admitted that the company has used many bribery schemes to ensure the sales of high price drugs to Chinese consumers.
• Liang Hong: Former GSK China’s vice president and operations manager. He was sentenced to two years in prison with a three-year suspension. On Chinese state-controlled television he said he gave bribes to government officials, hospital administrators and doctors via travel agencies to pave the way for drug sales.
• Zhao Hongyan: GSK China’s former legal-affairs director. Ms. Zhao was sentenced to two years in prison with a two-year suspension. On state-controlled television Ms. Zhao said she destroyed evidence relating to bribery to avoid punishment.
• Huang Hong: Huang was a GSK China’s business-development manager. She was sentenced three years in prison with a four-year suspension. The WSJ article reported that she was accused of giving and taking bribes; and informed Chinese officials that GSK China used funds labeled for public relations uses to maintain relationships with “major clients,” who she said were hospital administrators.

The suspension of the sentences was highly significant. The FT article quoted from the trial court that the sentences had resulted directly because “they confessed the facts truthfully and were considered to have given themselves up.” The WSJ article reported that the court also took into account that GSK China country manager Mark Reilly had “voluntarily returned to China, assisted in the investigation and confessed…and had “truthfully recounted the crimes of his employer.”” Also they were in stark contrast to the three-year and two-year sentences handed down to Humphreys and his wife respectively last month. There was no word from GSK, however, on whether it would terminate some or all of the convicted executives.

GSK itself made several interesting statements about the bribery allegations and conclusions of the trial court. The FT article quoted Sir Andrew Witt, GSK Chief Executive for the following, “Reaching a conclusion in the investigation of our Chinese Business is important, but this has been a deeply disappointing matter for GSK. We have and will continue to learn from this. GSK has been in China for close to a hundred years, and we remain fully committed to the country and its people.” The company went further in statements. In addition to the quote above, GSK was quoted in the NYT article as saying, “that it “fully accepts the facts and evidence of the investigation, and the verdict of the Chinese judicial authorities.”” The FT article further said that GSK also said “it had “co-operated fully with the authorities and has taken steps to comprehensively rectify the issues identified at the operations of GSK China.””

These statements of contrition are quite a distance from the place where GSK started last summer when the bribery allegations broke when the company tried to use the ‘rogue employee(s)’ defense, when it said that the bribery and corruption involved only a “few rogue Chinese-born employees” that were “outside our systems of controls” Oops.

The NYT went on to say report that GSK also said, “that the court, the Changsha Intermediate People’s Court, had found the company guilty only of bribing nongovernmental personnel.” This is significant because the bribery of a government official (defined as such in China and not under the FCPA) is a much more serious crime in China. The British Embassy in China also weighed in, at least slightly, with the following statement, “We note the verdict in this case. We have continually called for a just conclusion in the case in accordance with Chinese law. It would be wrong to comment while the case remains open to appeal.”

So the GSK corruption scandal in China ended with no more explosive revelations. Or did it? I will explore where the company may stand and what it all means for the compliance practitioner going forward over the next few blog posts.

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, 2014

The China Market – Changing Times for Foreigners

Ed. Note-today we have a guest post from Michael Short who is the CEO of Pacific Strategies and Assessments (PSA). Mike reports on some of the current issues facing western companies doing business in China. 

Introduction

China has long been a highly complex market. Fraught with a myriad of business risks, foreign companies consider potential access to China’s 1.3 billion consumers as too enticing to ignore. For many multinational firms, the prospect of long term gains outweigh entrenched risks such as corporate fraud, intellectual property theft, regulatory uncertainty, an increasingly nationalistic consumer market, and conforming to anti-bribery legislation.

As the Chinese market matures, change in consumer preferences, regulatory oversight, and media scrutiny will present renewed challenges for foreign corporations. Most notably:

1)    China’s growth is moderating. Real GDP growth slowed to 7.7% in 2013 from its breakneck double-digit growth that peaked at a whopping 14.2% in 2007.

2)    Costs are rising. It was inevitable that China would reach a tipping point whereby labor costs would rise with the expanding middle class and improving standards of living.

3)    Intensifying Competition from Chinese firms, which are offering comparable products to their foreign competitors, but often at cheaper prices.

4)   Increasing hostility to foreign brands. The social media savvy Chinese consumer and local media, often at the behest of the government, are becoming increasingly hostile and critical of foreign companies.

Enter the Dragon 

It used to be that Chinese consumers associated foreign brands with quality and prefered them over the Chinese brand equivalents (or imitations), but now many Chinese brands have become trusted household names in their own right and are sold at a cheaper price – giving their foreign competitors a run for their money. Chinese consumers often prefer to buy Li-Ning instead of Nike and Xiaomi and ZTE smartphones instead of Apple’s iPhone.

The growing relevance of Chinese brands has changed the competitive landscape. Furthermore, this strenthened position of Chinese products in their market, combined with an often hostile attitude to foreign companies, is now giving rise to a “we don’t need you anymore” message to foreign companies.

China First 

Recently, foreign enterprises have found that they are facing increasing antagonism in the Chinese market. It is becoming increasingly common for state-run media organizations, such as CCTV or Xinhua, to conduct publicized “investigations” of foreign companies, usually portraying their targets as trying to cheat or take advantage of the Chinese consumer.

The attacks are often unfounded. Starbucks, which has done a remarkable job building a brand in China, came under intense media fire in 2013 for pricing its beverage products higher in China than in other markets. While the coffee-shop chain had a reasonable defense of its pricing policy, including the high shipping costs and tariffs China imposes on coffee bean imports, netizens and the media reproached Starbucks for charging a premium. Starbucks also came under attack for using a chemical in their baked goods, despite the fact that the additive is legal and widely used across China.

These media rants at times seem awkwardly targeted or retaliatory. On International Consumers Day in 2013, Apple found itself the target of a Chinese state-run media exposé on its product warranty policies. According to reports, its one-year warranty on consumer electronics components was in violation of Chinese law that requires a minimum two-year warranty.   Additionally, it was stated that Apple’s policies seemed more generous in markets outside of China. Apple had operated in this unenforced legal grey area for years, so why had it suddenly come under attack? Some attributed it to Apple’s market-share growing too fast at the expense of Chinese brands, while others saw it as retaliation for US President Barack Obama’s accusations of China’s involvement in corporate espionage.

Foreign companies often relent under pressure in an attempt to calm the consumer backlash. Apple apologized to the Chinese consumer and changed its warranty policies to be consistent with Chinese law and its other global policies.

The China Market – Changing Times for Foreigners

In December 2013, car makers Jaguar Land-Rover, Subaru and Audi were accused by state broadcaster CCTV of charging ‘unfair prices’ for spare parts. These companies denied the accusations, but are now faced with defending themselves in the ‘court of public opinion’.

Chinese media also relishes in any case involving foreign firms having similar problems as its own domestic firms. New Zealand dairy giant, Fonterra, had to recall its milk powder exports to China for food safety issues. This had resonance in the market due to the widely publicized milk-powder scandal involving large Chinese companies who were caught adding illegal additives to milk supplies with official connivance; resulting in a number of infant fatalities, market panic and the state-ordered executions of several industry executives.

A recent survey released by the US-China Business Council found that fewer US businesses were viewing China as a top priority. This is mainly due to rising costs, heightened competition with local brands and difficulties obtaining business approvals from local regulators. Most respondents believed that Chinese state owned enterprises received favorable treatment when compared to foreign firms.

The Party is still not over – but gatecrashers beware!

While these factors are indeed game-changers, and do point to a significant change of attitude within the Chinese market to foreign firms, they are not by any means signs that the party is coming to end.  China is the world’s second largest economy and therefore is a market that cannot be ignored. While growth is slowing, even the most conservative estimates for China’s growth in 2014 are in the range of 7%.

The Chinese government is implementing market reforms to boost consumption and increase reliance on market forces over state-control.  If implemented correctly, market opportunity will increase while market policies should be more balanced.  China’s stated policy is now to relax market entry requirements for foreign firms in the areas of finance, medical care and education; although this is seemingly currently at odds with events on the ground.

Foreign companies like Starbucks, Apple, and Audi will always be able to operate in China – but they are now aware that the market is changing and they know they will have to become more attuned to ‘local’ attitudes and perceptions to fit in.

The government is also keen to promote Chinese companies in the domestic market. Once proven successful in China, they are encouraged to proceed to the global stage.  This will enable the market to evolve from an investment led model to one that is consumer-led.

China’s current Five-Year Plan (12^th Five Year Plan, 2011-2015) provides some insight into the areas of the economy that the Government seeks to champion.  The current plan is largely focused on gearing China’s economy away from low-cost, high volume manufacturing to high-technology research and development projects. China plans to invest heavily in promoting innovation, in areas such as IT, biotechnology, high-end equipment, new energy, environmental technologies and clean vehicles.

These are areas of opportunity for foreign brands but there are obvious risks to foreign companies operating in such cutting edge sectors in China.  Thus, finding the right balance between the advantages of selling advanced technology and expertise in China and protecting one’s intellectual property, brand and reputation is imperative.

 

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Michael Short is based in Hong Kong and is the CEO of Pacific Strategies and Assessments (PSA).   PSA is the premier Asian business risk consultancy with offices across China and Asia-Pacific.  PSA are privately owned and therefore truly independent and free of conflicts of interest. Clients hire PSA with confidence.  PSA provides comprehensive and integrated solutions to manage the business risks our clients face in Asia. Specifically we provide Market Entry and Intelligence, Enhanced Due Diligence, Security and Crisis Management and Corruption and Fraud Prevention Services – enabling our clients to make informed decisions about their business.   We are recognized across the region as the leading provider of timely, accurate and business-focused risk solutions.   Our clients include global financial institutions, oil, gas and extractive companies, manufacturers, power and energy providers, retail and professional service firms.  PSA helps clients minimize the risks and maximize the benefits of doing business in markets that are complicated by political and economic uncertainty, endemic corruption, terrorism and lax rule of law. For further information please contact us at info@psagroup.com .

Of Princelings and Princess-lings – Does Their Employment Have Corrupt Intent?

There was an excellent article this weekend in the Financial Times (FT), entitled “Finance: Plugged Into the Party”, where reporters Henry Sender and Tom Mitchell explored the hiring of sons and daughters of Chinese government officials, in what now might be called the ‘Era of the Prince-lings’. However, it appears that this era is closing when they noted, “amid a US regulatory probe and a new political climate in China, the era is coming to an end.” The article detailed how the practice of hiring the sons and daughters of high government officials began in the early 1990s. The practice seems have begun with the hiring of the first princess-ling – Margaret Ren, the daughter-in-law of a former Chinese Premier.

Given this long standing practice I wondered how it might be viewed under the Foreign Corrupt Practices Act (FCPA). In last year’s FCPA Guidance, it related that to violate the FCPA, an offer, promise, or authorization of a payment, or a payment, to a government official must be made “corruptly.” As Congress noted when adopting the FCPA, the word “corruptly” means an intent or desire to wrongfully influence the recipient:

In order for a corporation to be criminally liable under the FCPA, it must be found to have acted corruptly. The word “corruptly” is used in order to make clear that the offer, payment, promise, or gift, must be intended to induce the recipient to misuse his official position; for example, wrongfully to direct business to the payor or his client, to obtain preferential legislation or regulations, or to induce a foreign official to fail to perform an official function.

The Guidance goes on to relate that the FCPA focuses on intent, so that it does not require that a corrupt act succeed in its purpose. Further, a foreign official need not solicit, accept or indeed receive a bribe for the FCPA to be violated. The Guidance points to the Innospec enforcement action in which “a specialty chemical company promised Iraqi government officials approximately $850,000 in bribes for an upcoming contract. Although the company did not, in the end, make the payment (the scheme was thwarted by the U.S. government’s investigation), the company still violated the FCPA and was held accountable.” Further, this is why “Regardless of size, for a gift or other payment to violate the statute, the payor must have corrupt intent—that is, the intent to improperly influence the government official. The corrupt intent requirement protects companies that engage in the ordinary and legitimate promotion of their businesses while targeting conduct that seeks to improperly induce officials into misusing their positions.”

But, beyond corruptly, for an individual to be criminally liable under the FCPA, that person must act ‘willfully’. The Guidance notes that the FCPA does not define ‘willfully’ but the Guidance points to its construction by federal court decisions. Indeed in US v. Kay, the US Supreme Court upheld jury instructions stated that willfully is “knowledge that [a defendant] was doing a ‘bad’ act under the general rules of law” thereby connoting a willful act is one which is committed both voluntarily and purposefully, and with a bad purpose in mind. The Guidance went on to cite the US Supreme Court in Bryan v. United States, for the proposition that “[a]s a general matter, when used in the criminal context, a ‘willful’ act is one undertaken with a ‘bad purpose.’ In other words, in order to establish a ‘willful’ violation of a statute, ‘the Government must prove that the defendant acted with knowledge that his conduct was unlawful.’”

So what if we look at JP Morgan Chase under the above. The FT article reports that the Securities and Exchange Commission (SEC) is looking into whether the Bank hired the sons of two government officials to “get lucrative mandates from the Chinese Ministry of Railways and Everbright Bank.” Further, this investigation has “turned up internal documents linking hires to mandates JPMorgan was trying to win, raising questions about whether the recruits were signed up on merit or purely for their pedigree”.

The article goes on to note that that any possible enforcement actions for such Princeling hiring’s could well be complicated by the fact that “many of the princelings can boast impressive qualifications, such as an Ivy League education.” They can also be “highly experienced, highly qualified people in their own right.” Even if these people were well-connect in mainland China and this is one of the reasons they were hired does this rise to the level of “The word “corruptly” is used in order to make clear that the offer, payment, promise, or gift, must be intended to induce the recipient to misuse his official position”. Further, what if there is some type of mixed motive but no outward indicia of corruption; is that sufficient to bring a FCPA violation?

I do not pretend to have any insight into how the JPMorgan Chase investigation will turn out. Last week, it JPMorgan Chase indicated that the dreaded ‘Where Else’ question of FCPA investigations had been asked when it revealed that the original investigation in hiring practices had expanded into other countries. However, I believe that simply the hiring of the sons and daughters of government officials does not violate the FCPA. There still must be corrupt intent. To overcome any such suspicion, I think the key is to ‘Document, Document, and Document’ your hiring practices to demonstrate that any family members of government officials are qualified for any position that you might offer them and they went through the same hiring process as all other candidates.

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

Scalping Tickets and the Use of Fake Invoices in China

I long ago learned that there is no such thing as a ‘sold out event’; as the scalping of and for tickets to sports events is a long and time honored tradition. However with the advent of such websites as StubHub.com, it certainly has never been easier to purchase tickets to any concern or sporting event. Please note that I did not say cheaper, just easier. In many ways the scalpers have adjusted by setting up computer programs to gobble up all the tickets to an event within minutes of them going on sale so that your only choice is now the equivalent of online scalping. But if you are willing to pay, there is a well-developed market that will sell tickets to you.

This long honored tradition of scalping has come to impact companies under the jurisdiction of the Foreign Corrupt Practices Act (FCPA) in China. In an article in the Sunday New York Times (NYT), entitled “Coin of Realm in China Graft: Phony Receipts”, reporter David Barboza writes about the buying and selling on the black market of business and tax receipts. One way this Chinese scalping business does differ from the American business of scalping is that many of the receipts sold in China are fakes. Hopefully if you buy tickets to a concert of sporting event here in the US, the tickets are genuine.

However, Barboza writes that “To begin to comprehend China’s vast underground economy, one need only visit this city’s major transportation depots and watch as peddlers openly hawk fake receipts. A scalper mumbles, “Fapiao, fapiao,” or receipts, at the Shanghai Railway Station. The trade in receipts is more or less open. “Receipts! Receipts!” calls out a woman in her 30s to passers-by as her two children play near the city’s south train station. “We sell all types of receipts.” While many buyers use them to defraud employers and evade taxes, they have recently come under FCPA and UK Bribery Act scrutiny due to the ongoing investigation of GlaxoSmithKline PLC (GSK) which apparently is “still trying to figure out how four senior executives at its China operation were able to submit fake receipts to embezzle millions of dollars over the last six years. Police officials say that some of the cash was used to create a slush fund to bribe doctors, hospitals and government officials.”

In many cases it is not the paper that the receipts are printed on that is fake, only the information contained therein which is fraudulent. For instance, the unused receipts from a hotel may be pilfered and “then resold to dealers and enter the black market. In Shanghai, companies actually advertise by fax that they buy unused receipts. One such advertisement sent by fax read “Due to our diverse accounting service for other companies, we now need invoices from various industries (13% or 17% VAT),” one ad sent out last week by the Shanghai Fangyuan Accounting Agency reads, referring to the value-added tax receipts. “If your company has leftovers of 13% or 17% VAT invoices, we can offer good rates to buy them.”

Further, “Signs posted throughout this city advertise all kinds of fake receipts: travel receipts, lease receipts, waste material receipts and value-added tax receipts. Promotions for counterfeit “fapiao” (the Chinese word for an official invoice) are sent by fax and through mobile phone text messages. On China’s popular e-commerce Web site, Taobao.com, sellers even promise special discounts and same-day delivery of forged receipts.”

As bad as this system of selling fraudulent invoices is, it pales beside the damage created by the sale of invoices by government officials themselves. Barboza notes that “state employees, whether they work for government agencies or state-owned enterprises, seem as eager as anyone else to bolster their compensation by filing fake invoices.” He quoted Wang Yuhua, an assistant professor of political science at the University of Pennsylvania and the author of a study on bribery and corruption in China, for the following “Their salaries are relatively low, so they supplement a lot of it with reimbursements. This is hard to monitor.”

Barboza reported that “In the Glaxo case, Chinese investigators say the drugmaker’s top Chinese executives worked closely in recent years with a Shanghai travel agency to falsify documents. For instance, airline ticket receipts were filed for trips that never took place and when executives listed 100 guests at a conference, perhaps only 80 showed up, making it possible to file false inflated receipts and thus embezzle from Glaxo’s London headquarters.” Six other international pharmaceutical companies have also acknowledged that they have used this travel agency in the past three years.

Barboza detailed that such corruption schemes were not unknown to FCPA enforcement. He cited to Securities and Exchange Commission (SEC) complaints against IBM where its “employees in China created “slush funds” with its travel agencies and business partners, partly to “provide cash payments and imported gifts, such as cameras and laptop computers to Chinese government officials.” In another SEC Complaint, it found that “between 2005 and 2010, Wyeth, a division of the drug company Pfizer, had “submitted false or inflated invoices for organizing large-scale consumer education events.””

Even yesterday, the FCPA Blog reported, in a post entitled “Baxter confirms China payment offenses”, that the company in question paid for an event which never occurred. It paid a travel agency identified as the Beijing Youth Travel Service Co. approximately $15,100 for a conference at the Crowne Plaza Shenyang Parkview. The article quoted the Wall Street Journal (WSJ) which had written, “But an employee in the banquet and meeting department of the Crowne Plaza Shenyang Parkview said no event was organized for that date involving Baxter or medicines. She also said the hotel had no record of a meeting on that date organized by the Beijing Youth Travel Agency.”

Barboza refers to some un-named analysts who “say the cost of monitoring is high and would involve the tedious work of verifying millions of receipts by calling hotels, airlines and office supply stores and scrutinizing countless transactions for signs of fraud.” My response to these analysts is to say that if your compliance risks are known for a certain profile, then you should devote the necessary resources to making sure you are in compliance in that area. Eric Carlson pointed out in his three post series in the FCPA Blog, entitled “Corruption Risk—China Travel Edition”, that there have been a plethora of FCPA enforcement actions related to travel in China. With regard to the abuse through travel agencies, Carlson wrote about four different corruption scenarios, including (1) event abuse planning; (2) mixture of legitimate and illegitimate travel; (3) other collusion with travel agencies; and (4) parallel itineraries. So those risks are well known and have been documented.

So while scalping tickets may be a time honored tradition here in the US; the buying and selling of real or fake invoices can lead to some serious trouble in China. While there has not yet been any employees of non-Chinese companies who went to jail for the fraudulent use of a real or fake invoice, that may be just around the corner. And I can assure you, wherever you may not wish to be, there cannot be many places you do not want to be more than a Chinese prison.

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

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