GSK as a Watershed in the International Fight Against Bribery and Corruption

GlaxoSmithKline PLC (GSK) may well be a watershed in the global fight against bribery and corruption. Behavior and conduct, which was illegal under Chinese law but previously tolerated and even accepted by Chinese government officials, quickly became a quagmire that the company was caught in when charges of corruption were leveled against them last year. Many westerners were skeptical about the claims made against GSK and its head of China operations, Mark Reilly. That is one of the problems in paying bribes to government officials; it is always illegal under domestic law. David Pilling, writing an article in the Financial Times (FT) entitled “Why corruption is a messy business”, said “Multinationals are discovering that there is only one thing worse than operating in a country where corruption is rampant: operating in one where corruption was once rampant – but is no longer tolerated.”

When it began, it was not it clear why China’s Communist Party Chief Xi Jinping began his anti-corruption push. Some speculated that it was an attack on western companies for more political reasons that economic reasons. Others took the opposite tack that the storm, which broke with the bribery and corruption investigation of GSK, was China’s attack on western companies to either hide or help fix problems endemic to the Chinese economic system. My take is that his campaign has a different purpose but incorporates both political and economic reasons. That purpose is that Xi has recognized something that the US government officials and most particularly the Department of Justice (DOJ) have been preaching for some time. That is, the insidiousness of corruption and its negative effects on an economic system.

Xi and China have realized that corruption is a drain on the Chinese economic system. Publications as diverse as the Brookings Institute to the Wall Street Journal (WSJ) have noted that one of the reasons for the anti-corruption campaign is to restore the Chinese public’s faith in the ruling Communist Party. Bob Ward, writing in the WSJ article entitled “The Risks in China’s Push to Root Out Wrong”, said, “China’s anticorruption drive began in late 2012 as a way to cleanse the ruling Communist Party and convince ordinary Chinese that the system isn’t rigged against them. Investigators are targeting some of China’s most powerful officials and disciplining tens of thousands of lower-echelon officials who party investigators contend got used to padding their salaries.” Cheng Li and Ryan McElveen, writing online for Brookings, in an article entitled “Debunking Misconceptions About Xi Jinping’s Anti-Corruption Campaign”, wrote, “If there were ever any doubts that Xi could restore faith in a party that had lost trust among the Chinese public, many of those doubts have been dispelled by the steady drumbeat of dismissals of high-ranking officials since he took office.”

But the economic reasons behind the anti-corruption campaign are equally important. One of the more interesting articulations came from one disgraced former Chinese government official, who was one of the earliest senior officials to be charged with corruption. In a WSJ article by James T. Areddy, entitled “Chinese Ex-Official Admits to Corruption”, he wrote about the trial of Liu Tienan, the “former head of the National Energy Administration and senior director in the National Development Reform Commission” who had been arrested in May 2013. His trial finally came around in September 2014. At his trial he made some rather extraordinary statements. Areddy wrote that “Liu testified that reducing official power is key to curbing corruption: “The major point, which is based on my own experience, is to give the market a great deal of power to make decisions.”” But Liu did not end there, “as he explained his view that China’s state bureaucracies are too powerful and entrepreneurs are too weak. “Approvals should be developed in a system, rather by an individual’s actions. This would help prevent abuse of power for personal self-interest.””

Whether or not Liu thought those statements up on himself, a smart defense lawyer suggested he make them to reduce his sentence, or the Chinese government told him to say it as his role in the well-known show trials of the Chinese justice system; it really does not matter. That is one of the most incredible statements I have ever heard of coming out of anything close to an official Chinese statement or proceeding. Think about it; first Liu is saying that the Adam Smith’s ‘invisible hand’ of the market should be governing market decisions. Next, he speaks against the arbitrary nature in China for entrepreneurs in giving approval about how businesses can expand and grow in China. This arbitrary process should be replaced with objective criteria. It is almost if Lui is channeling his inner FCPA Professor when he speaks against artificial barriers to market entry. Finally, Liu attacks the small-mindedness of bureaucratic mentality in their use of power for self-interest.

There have already been demonstrated economic benefits to China’s anti-corruption campaign. In September, Bloomberg reported that China’s fight against bribery and corruption could boost economic growth, generating an additional $70 billion for the budget, in summarizing economists’ forecasts. An article in the online publication Position and Promotions, reported that the bribery “could trigger a 0.1-0.5 percent increase in the world’s second-biggest economy, equivalent to $70 billion dollars.” This crackdown should also be welcomed by western companies, as “it could also benefit foreign companies operating on the Chinese market, who have experienced the negative effects of the omnipresent palm-greasing, according to Joerg Wuttke, president of European Chamber of Commerce in China.” He was further quoted as saying, “It takes the stress away. You’re not afraid that somebody gets an order because he found a better champagne or something like that. It’s not Singapore yet, but it’s a very positive development”.

As we close this phase of GSK’s saga, I think some time for reflection is appropriate. For the compliance practitioner there have been many specific lessons to be learned from GSK’s missteps. However I think the clearest lesson is that the only real hope that a company has into today’s world is an effective, best practices anti-corruption compliance program. Whether it is designed to help a company comply with the Foreign Corrupt Practices Act (FCPA), UK Bribery Act or other anti-corruption legislation, it really does not matter. It is the only, and I mean only, chance your company will have when an issue in some far-flung part of the world splashes your company’s name across the world’s press.

But there may also be cause for celebration to those who have long preached against the evils of corruption, whether it is for economic reasons or for those who view the fight against anti-corruption as a part of the fight against terrorism. For if China is attacking domestic corruption, I believe that will lead other countries to do so as well. We are already seeing stirrings in India under new President Modi. So while GSK may well suffer going forward, the fight against global bribery and corruption may just have moved a few feet forward.

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

Does Motive Matter in Anti-Bribery and Anti-Corruption Enforcement?

Do the intentions behind enforcement of domestic or international anti-corruption laws matter? Or is ‘the law the law’ and it really does not matter what a government’s motives are in enforcing laws that it has on the books. That question comes up for discussion from time-to-time. Some believe that motives and intentions do matter; others believe that enforcement of existing laws are motive and intention enough. This subject has been raised over the past several months in connection with the Chinese government and their anti-corruption enforcement efforts against western companies as exemplified by the GlaxoSmithKline PLC (GSK) enforcement action, announced last summer.

Trying to understand the motives of the Chinese Communist Party and the Chinese government have long been a subject for Americans. China watchers have pontificated and speculated for many years. I am not sure that the true motives are ever clear to us westerners. But simply because we may not always understand them does not mean that we cannot consider them, particularly now that China is so opened up to western businesses which desire to garner a part of the market share in a country with the world’s largest population.

This subject was explored in a recent Financial Times (FT) piece, entitled “China: Red restoration”. The article began with a short discussion about a recent meeting held by the President of China, Xi Jinping, with several prominent leader of western businesses; including Mike Duke, President and Chief Executive Officer (CEO) of Wal-Mart, Indra Nooyi, Chairman and CEO of PepsiCo., Muhat Kent, Chairman and CEO of Coca-Cola, David Rubenstein, co-founder of The Carlyle Group, and Maurice Greenberg, the former Chairman and CEO of American International Group (AIG). As reported by the FT, President Xi told the group, “Your suggestions are a very important source of inspiration for the Chinese government.” The FT believes that this statement and others made by President Xi “were intended to signal that the world’s second largest economy remains open for business.”

Contrast that last statement with what has happened to GSK over the past several months. Company executives have been arrested or detained; passports have been pulled so that company executives could not leave the country; company executives have been paraded in front of state television cameras to confess wrongdoings; a high company official went to China and publicly apologized for the company’s conduct. All of this from a company that was already under a Deferred Prosecution Agreement (DPA) in the United States for fraudulent conduct in marketing certain pharmaceuticals. Moving it from a compliance to a business perspective, the FT noted that GSK “recently revealed that its medicine and vaccine sales had fallen 61 per cent in the third quarter from a year earlier”. Talk about taking it ‘in the wallet’.

However GSK is not the only company to come under Chinese regulatory scrutiny for allegations of bribery and corruption. Since July approximately 15 western companies have heard their corporate names listed as being under investigation. These companies range from other pharmaceuticals, to baby-food and formula companies, as well as others in health care and medical products and supplies. Beyond these anti-corruption investigations, other companies have felt the heat from Chinese regulators. Apple CEO Tim Cook was forced to publicly apologize over poor customer service and “to promise to improve customer services policies.” The German car manufacturer Volkswagen was required to recall over 380,000 vehicles in China after media reports surfaced that they were “unsafe”. Still other companies faced media criticism which led reduced sales. For instance, stories in the media surfaced about Kentucky Fried Chicken (KFC) and food safety issues which led to a 10 per cent slump in sales.

The FT article noted that there may be several motives for these actions against western companies. One is obviously a strain of nationalism which holds that such markets should belong to Chinese enterprises. Bao Dike, managing editor of the PKU Business Review, summed up this view when he was quoted as saying “they also show how China doesn’t need these foreign enterprises any more”. Kerry Brown, Professor of Chinese Politics at Sydney University, was quoted as saying, “Politically it is also a very easy populist move to beat up on foreign companies; much easier than taking on big Chinese companies and their powerful backers.”

Another motive might be what is termed “killing the chicken to scare the monkey.” Under this motivation, Chinese regulators are investigating western companies in order to send a message to the entire market about pricing and competition. The FT stated, “they intend to clean up things in order to provide quality products at reasonable prices in industries about which the public is concerned.” The Chinese public was certainly concerned about the prices it was paying for pharmaceutical products and one response may have been for the Chinese to investigate, in a very public way, GSK. The same holds true for the makers of baby-formula and milk-powder makers. Li Huafang, an independent economist and newspaper columnist, was quoted as saying “I actually think the new administration wants to strengthen regulations for both foreign and domestic businesses.” Or as Peter Gabriel might say “Shock the Monkey”.

The final motive discussed in the FT article was that of consolidation of power by the new President, Xi Jinping. Wang Lixiong, a prominent political writer, said that “The rough treatment of some foreign businesses stems from Mr. Xi’s need to establish his authority; to impose his will; this is a very common tactic among new rulers. We need to wait until he has consolidated power to see what his real intentions are.”

All of this tells me that western companies need to factor all of the above into their risk assessments when deciding whether to engage in business in China. This is a broader risk assessment than you would normally do for anti-corruption such as under the Foreign Corrupt Practices Act (FCPA). This is a political risk assessment. But the key is that you look at your risks and measure them. The FT ends its article by noting that it appears that President Xi is still welcoming western businesses to China, and said, “As long as they can show that their investments and operations in China support or at least do not get in the way of efforts to garner support for the party and its leadership, they will probably be allowed to stay and even thrive.”

For a western company, from an anti-corruption perspective, this clearly means you need to investigate your Chinese operations now. If you detect problems, you should work expeditiously to remedy them now. The FT article makes clear that whatever the motivations of the Chinese regulators are; if you are in violation of Chinese domestic laws regarding bribery and corruption, your experiences could well be costly and the reputational damage immense.

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

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

Is Your Compliance Program Real?

The GSK attitude towards corruption in all its forms is simple: it is one of zero tolerance, whether committed by GSK employees, officers, complementary workforce or third parties acting for or on behalf of the company.

Source: GlaxoSmithKline – Code of Conduct

At the recent Corruption and Compliance Congress, Asia 2013, Seth Berman, Executive Managing Director, Stroz Friedberg LLC, said that ‘Is Your Compliance Program Real?’ is the question that would be asked of a company’s counsel who came in to discuss a potential violation of the Foreign Corrupt Practices Act (FCPA) with the Department of Justice. This question would seem to be apt, in light of the events now transpiring in China with GlaxoSmithKline (GSK) and the ongoing allegations of bribery and corruption that the company now finds itself in the middle of in China.

For those who may not know the story, GSK finds itself in serious bribery and corruption hot water in China over allegations that it funded a bribery scheme to get doctors to prescribe its drugs. According to a story in the Financial Times (FT), entitled “China steps up GSK bribery probe”, Andrew Jack and Leslie Hook reported that “The Chinese authorities have stepped up their investigation into GlaxoSmithKline accusing it of being the ringleader of a half-a-billion-dollar bribery scandal involving 700 companies.” They reported on a briefing given by “Gao Feng, the lead Chinese investigator on a probe into the UK drugs group, said police were examining Rmb3bn ($488m) in deals from as far back as 2007. Chinese police believe that GSK used travel agencies and consultancies as a conduit to bribe doctors and lawyers in order to boost sales and profits.”

In an article in the Wall Street Journal (WSJ), entitled “China Drops Hammer on Glaxo”, Laurie Burkitt and Chris Matthews reported on a televised interview of Liang Hong, the GSK China Vice President and Operations Manager, where he “described for viewers of China Central Television how staffers would allegedly organize conferences that never happened and divert the money to bribe government officials, hospitals and medical personnel to get them to use Glaxo’s products.” He was quoted as saying, “Dealing with some government departments requires some money that couldn’t be claimed normally under company expenses.” Burkitt and Matthews said that “The broadcast follows detailed allegations by China’s Ministry of Public Security on Monday accusing Glaxo of using travel agencies as vehicles to bribe hospitals, officials and medical personnel to sell more drugs at inflated prices. Officials also alleged the travel agencies offered what the officials called sexual bribes to Glaxo executives to keep company business.”

How strong do you think the GSK commitment to anti-corruption is? They certainly seem to say the correct things when confronted with such public allegations. In the FT article, it was reported that GSK said in a company released statement that “These allegations are shameful and we regret this has occurred. We are deeply concerned and disappointed by these serious allegations of fraudulent behaviour and ethical misconduct by certain individuals at the company and third-party agencies.”

But what about their actions? In another article in the FT, by Hook and Jack entitled “GSK is test case in China’s rules laboratory”, they listed a timeline in this matter. They noted that GSK had investigated claims of bribery and corruption and publicly announced that the company had found no such evidence of “bribery or corruption in relation to our sales and marketing…in China”. Further, the company claimed it was unaware of any allegations of bribery of doctors to prescribe its drugs until there was a public announcement by China’s Public Security Ministry on July 11.

We started with Seth Berman’s question and adapting it to GSK, just how real is the company’s compliance program? While I am sure they GSK management, much like Captain Renault in Casablanca is SHOCKED, SHOCKED, to discover that anyone in the company is engaged in corruption, the question remains just how real is the company’s compliance program. One of my FCPA mantras is the following: Document, Document and, Document. The reason being is that if you do not document what you have done, it never existed. So if you have performed the steps necessary to qualify third parties as sales or supply chain partners, it really only counts if you have documented each step in the process.

If your company has Chinese operations, what should you do about now? In another WSJ article by Chris Matthews, entitled “Western Companies Sweat as Glaxo Probe Unfolds”, he warns that “The rapidly unfolding bribery probe by Chinese authorities into the U.K. drug maker has alarmed Western companies with business there that are accustomed to highly-publicized corruption crackdowns on Chinese officials, but who see the Glaxo matter as new territory, China watchers said. The push against Glaxo could signal that a new anticorruption push in China could now also include foreign companies.” I would suggest that a review of your sales operations is in order, as in immediately. Matthews quoted Joe Warin, a partner at Gibson Dunn & Crutcher LLP, who said, “In particular, companies should examine relationships with travel agencies and event-planning companies, which have long been an “Achilles heel” in China”. The first thing that you should check on is to see the spend that you have with any Chinese travel agencies. You should then match up all receipts and other documentation with all costs to see if there is anything out of line.

However, you should also look at your own employee base. Regarding a company’s own employees, Matthew quoted Jerome Cohen, co-director of New York University School of Law’s U.S.-Asia Law Institute, for the following, “This is a fairly obvious warning that companies need to conscientiously scrutinize the activities of their employees there”. Remember the Eli Lilly FCPA enforcement action brought by the Securities and Exchange Commission (SEC) late last year? The bribery scheme which got Lilly into trouble in China involved its own employees, who inflated their expense accounts and used the extra money to pay bribes to secure sales.

It is clear that companies should follow Matthews’ advice that “multinationals need to scour their operations in China to limit their vulnerability to future investigations.” Now is the time to begin your own investigations because you certainly do not want to be like GSK and find out about allegations that your employees engaged in a multi-year, multi-million dollar bribery and corruption scheme through a public pronouncement from the Chinese Public Security Ministry.

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

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

TOP 3 FCPA CASES OF 2010 PART II-(DING DONG) AVON CALLING

This is the second installment of our three part series on the Top 3 Foreign Corrupt Practices Act (FCPA) matters of 2010 to date and their significance for the FCPA compliance professional. In Part I we focused on the Gun Sting matter. Now we turn our attention to the Avon bribery scandal in China. 

As early as October 2008, Avon reported, in a Statement of Voluntary Disclosure, that it was investigating an internally reported allegation by an undisclosed whistleblower that corrupt payments had been made in its China operations. These allegations claimed that certain travel, entertainment and other expenses may have been improperly incurred. Although the details of the Avon case have not been disclosed, direct selling was not allowed in China under a law passed in 1998. The National Law Review reported that Avon was able to secure permission in late 2005 to begin direct selling on a limited basis. Later the Chinese government issued direct-selling regulations and granted Avon a broader license in February 2006 to make such sales.

In its 2009 Annual Report, Avon noted that the internal investigation and compliance reviews, which started in China, had now expanded to its operations in at least 12 other countries and was focusing on reviewing “certain expenses and books and records processes, including, but not limited to, travel, entertainment, gifts, and payments to third-party agents and others, in connection with our business dealings, directly or indirectly, with foreign governments and their employees”. The FCPA Professor, citing the Wall Street Journal, reported that Avon suspended four employees, including the

President, Chief Financial Officer and top government affairs executive of Avon’s China unit as well as a senior executive in New York who was Avon’s head of Internal Audit.

 One of the significant pieces of information to come out of the Avon matter is the reported costs as reported in the 2009 Annual Report the following costs have been incurred and are anticipated to be incurred in 2010:

Investigate Cost, Revenue or Earnings Loss
Investigative Cost (2009)	$35 Million
Investigative Cost (anticipated-2010)	$95 Million
Drop in Q1 Earnings	$74.8 Million
Loss in Revenue from China Operations	$10 Million
Total	$214.8 Million

Marketwatch also reported that after these additional investigations were made public Avon’s stock prices fell by 8%. Lastly, in addition to the above direct and anticipated costs and drop in stock value, the ratings agency Fitch has speculated about the possibility of a drop in Avon’s credit ratings. In a June 1 Press Release, Fitch noted that not only could the above listed investigative costs come out of Avon’s ordinary cash flow, thereby putting a strain on the company, but that Fitch would expect companies such as Avon to make every effort to comply during an agreed upon deferred prosecution period with the Department Of Justice (DOJ) given the severity of an indictment. 

An indictment for FCPA violation(s) would be viewed as ‘Event Risk’, a term used by Fitch to describe the risk of a typically unforeseen event to the analyst which, until the event is explicit and defined, is excluded from existing ratings. An indictment would be an externally triggered event that would generate a rating review based on materiality and impact. 

But what does all of this mean for the Chief Compliance Officer sitting in his office in the US? It should mean quite a bit. There are several lessons from which you can learn and immediately implement in your FCPA compliance program if you have not previously done so. 

But what does all of this mean for the Chief Compliance Officer sitting in his office in the US? It should mean quite a bit. There are several lessons from which you can learn and immediately implement in your FCPA compliance program if you have not previously done so. 

1.     Who is a “foreign governmental official”? China poses a major challenge for US companies trying to comply with the law. The DOJ has consistently interpreted the FCPA as extending to any employee working for a state-owned business. Further, in a communist country, the DOJ has taken this interpretation a step further by opining that all employees are state employees and therefore a foreign governmental official. This means that from top to bottom, all persons in China are covered by the proscriptions of the FCPA. This interpretation has never been tested in a US court but it puts the broad swaths of the Chinese economy directly under the FCPA. Couple this with the pressure felt by foreign companies to sponsor trips by Chinese regulators, who do not seem to be shy in asking for perquisites, and you have a situation which is ripe for a FCPA violation. 

2.     Travel, Gifts and Entertainment under the FCPA. The FCPA includes an affirmative defense for payments to officials related directly to “the promotion, demonstration, or explanation of products or services” that are “reasonable and bona fide” 15 U.S.C. §§ 78dd-1(c)(2)(A) and 78dd-2(c)(2)(A). That defense is loaded with uncertainty and very difficult for companies to safely use. It may well be that Avon provided trips to the US for the Chinese Regulators with regulatory oversight for Avon’s China operations, or gifts and entertainment which did not fall under the FCPA exemption. If so, the FCPA compliance professional should review the company policy on such matters.  

3.     Internal Enforcement of Company FCPA Compliance Policy. One of the employees suspended was the (former) head of Internal Audit. In addition to a strong FCPA compliance policy, a company should continually monitor its compliance program, through a strong internal audit program, to use  as a first line of defense to not only prevent FCPA violations before they occur but also detect FCPA compliance violations.  

A key ‘best practices’ FCPA compliance program component is to utilize internal audit to monitor for FCPA compliance issues on a regular basis to not only assess compliance but to also identify anything which warrants further investigation. Taken a step further, a continuous controls monitoring program can assist a company to identify unusual expenses, budgeted items, or any other event which is outside an established norm and Red Flag such expense, item or event for further investigation.

All of the facts of the Avon matter should be carefully studied by the Chief Compliance Officer of any company doing business in China. The case stands for the proposition that a company should not only have a robust FCPA compliance policy in place but that it must continually monitor the policy to ensure compliance.

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, 2010