GSK in China-the Book

The year 2013 brought the anti-corruption compliance world a new situation as the Chinese government aggressively investigated, for the first time, a western company for bribery and corruption of Chinese citizens in China, based on Chinese domestic law. The company, GlaxoSmithKline PLC (GSK), was convicted of corruption in September 2014. I wanted to put together, in one volume, the background facts, information from the trials and conviction and add some of the most significant lessons to be learned for any compliance practitioner going forward. For these reasons, I am pleased to announce the publication of my latest book, GSK in China: Anti-Bribery Enforcement Goes Global which is now available through Amazon.com.

I believe that GSK will 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. 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.” GSK became the first western company to pay the piper when this new tune began to play.

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 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.”

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.”

GSK’s actions during the pendency of this entire series of events will long be studied as one NOT to follow when faced with allegations of corruption and bribery. GSK sealed its own fate when they, in the face of credible allegations of bribery and corruption by a well-informed whistleblower, performed an investigation and came up with no evidence to support such allegations. It took the Chinese government less than 30 days to not only develop credible evidence but also secure confessions from GSK employees topped off with a very public corporate apology.

As with any good scandal there is a sex angle with a sex tape surfacing involving the GSK China Country Manager. This sex tape and GSK’s attempts to investigate its provenance led to the conviction of a husband and wife investigators, who are a UK and US citizen, in a trial for violations of Chinese privacy laws.

At the close this phase of GSK’s bribery and corruption saga in China, GSK in China – The Book, provides some thoughtful reflection, which you may be able to put to good use in your compliance program going forward. For the compliance practitioner there have been many specific lessons to be learned from GSK’s missteps. I think the clearest lesson is that the only real hope that a company has in today’s world is an effective, best practices anti-corruption compliance program. Whether it is designed to help a company comply with the US Foreign Corrupt Practices Act (FCPA), UK Bribery Act or other anti-corruption legislation, 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. So while GSK may well suffer going forward, the fight against global bribery and corruption may just have moved a few feet forward.

For a copy of my new book GSK in China: Anti-Bribery Enforcement Goes Global in bound version, click here.

For a copy of my new book GSK in China: Anti-Bribery Enforcement Goes Global in Kindle version, 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, 2015

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

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

Management of Corruption Risks – Business Lessons from GSK

The Department of Justice (DOJ) and Securities and Exchange Commission (SEC) have made it abundantly clear over the past several years that companies should assess their risk and then manage their own risks. In the anti-corruption space, simply putting in a Check-the-Box paper compliance program does not help to prevent, detect or remediate under laws such as the Foreign Corrupt Practices Act (FCPA) or UK Bribery Act. In their joint FCPA Guidance, the DOJ and SEC make clear there are a variety of steps a company can take to manage anti-corruption risks.

One of the tired excuses for cutting back on FCPA enforcement is that it costs US companies business overseas because they cannot engage in bribery and corruption, while the commercial enterprises of countries which do not have robust anti-corruption laws essentially bribe at will. However, there are many business solutions available in the management of risk, which companies can profitably use to help ameliorate bribery and corruption risk.

I was interested to read recently about some of the responses that one of the world’s current poster children for bribery and corruption are considering. In an article in the Financial Times (FT), entitled “Witty comes out fighting for GSK”, Andrew Ward reviewed some of the business responses that GlaxoSmithKline PLC (GSK) has contemplated over the past year since the revelations about allegations of bribery in China. Ward reported that in addition to the uncertainty of the ongoing corruption investigation by Chinese authorities, the UK Serious Fraud Office (SFO) for violations of the UK Bribery Act and the DOJ for violations of the FCPA; the company “issued a profits warning that exposed weakness in the company’s core respiratory medicines business.” These warning turned on “the decline in the company’s best selling drug. Revenues from Advair, an asthma treatment that accounts for a fifth of sales, fell 12 per cent in the second quarter, on top of the 15 per cent drop in the three months before that.” Moreover, the company’s stock is down some 14% in the past year.

I was intrigued by the response of GSK’s chief executive, Sir Andrew Witty. Witty did not bemoan the corruption investigations that his company is going through or somehow try to claim that the company simply could not compete because of the scrutiny it is under. On the business front Ward reported, “GSK’s innovation engine is working” as Witty noted that the company had “six new drugs approved across all therapeutic areas last year and a further 40 in advanced development”.

In addition to the specific response regarding the development of new pharmaceutical products, Witty is looking at other sales products and models that will lessen the company’s corruption risk while providing a strong business base. Ward reported that Witty is “strengthening GSK’s two other businesses: vaccines and healthcare.” This move “was reinforced by a $20bn asset swap with Novartis in April under which GSK traded its subscale oncology business for the Swiss group’s vaccines division, while the pair agreed to set up a joint-venture in consumer products.” This means that when this structuring is completed, “half of GSK’s revenues will come from outside [the sale of] pharmaceuticals.”

Witty has also worked to change internal GSK compensation incentives to help manage corruption risks. Late last year, the company announced that it would “sever the link between sales and pay for drug reps and from 2016, stop payments to doctors for promoting its products.” Ward noted that others in the industry have not followed GSK’s lead in changing the way it compensates its sales team but Witty said, “in the long-run, the company will benefit from being the first-mover towards a new marketing model.”

Finally, and perhaps most interestingly, Witty has attempted to become an industry-wide “standard-bearer for [pharmaceutical] industry ethics.” Ward reported that the ongoing scandal has helped Witty “drive home to employees the need for greater transparency.” Ward even quoted Witty for the following, “It gives me the ammunition to say we are in the public eye and our behaviour counts. It’s not just about generating prescriptions, it’s how you do it.”

In another article on the GSK corruption scandal by Ward, entitled “GSK chief floats break-up option”, Ward quoted said that Witty has “zero tolerance for any form of corruption” and that “he was pleased if wrongdoing had been brought to light so that it could be stamped out.” Witty went on to say that “Any company that doesn’t get whistleblower letters isn’t looking hard enough. If you are not getting any don’t dream. It can’t be perfect 100 per cent of the time.”

Another perspective on business solutions to the management of corruption risks came from Tom Mitchell, also writing in the FT in an article entitled “Expats in China should read GSK potboiler carefully”. Mitchell focused on a book by Joe Studwell called The China Dream, which detailed some of the business failures that had befallen western companies in China. Mitchell drew the lesson from Studwell’s book that “When foreign investors’ interests are aligned with those of their domestic partners – as they generally are today in the auto sector – those investors do very well indeed… However, when interests are not aligned – or when outside operators in sectors where they are not required to have joint ventures – foreigners are vulnerable to sudden reversals of fortune instigated by either a bitter partner or by unsympathetic officials.”

How closely does that sound like what happened to GSK? Mitchell noted that GSK “made money from selling goods in China at prices that were – Chinese police allege – were high by the standards of many markets. At the same time, GSK was not sharing revenue streams with a local partner that could help with damage limitation when local authorities appeared on its doorstep.”

The management of risk is essentially a business exercise. That is because risk is what can cause a company to lose money. Some risk is embodied in statutes such as the FCPA or UK Bribery Act. Sometimes risk is a change in the market circumstance. For that I and others have written about the negative side of GSK; the company may well come out the other side of the Chinese corruption scandal stronger because they seem to understand that there is a market based solution to corruption risks. GSK has changed the way it will compensate its sales force and will delete its compensation to doctors. This may take away incentives to cut corners or engage in bribery and corruption. But think about Witty’s steps to diversify the GSK product base. If you are in an industry that is corrupt and you cannot find a way to do business profitably, your company may have other business lines it can move forward to a more prominent role in your business. Lastly, as with most responses to legal issues by lawyers, business executives are only limited by their imaginations in their response to business issues.

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

No Sex Please, We’re British: More from GSK in China

The above is the title of a British television show/play/movie which is a farcical romp about a newlywed couple who mistakenly receive an initial shipment of pornographic pictures, then movies and women, all sent from Sweden to England. The plot turns on their attempts to dispose of the ‘offending materials’ while under the noses of their parents/in-laws, employers and friends. In his review of the show, Christopher Heath said, “No Sex Please, We’re British shows how we stuffy Brits tie ourselves in knots when it comes to this subject. The funny thing is how the cast, led by Ronnie Corbett, handle their predicament and it has to be said, they cope with aplomb. As you might expect, the plot is all about mix-ups, keeping a stiff upper lip, maintaining a veneer of social respectability, not getting found out about something someone hasn’t done and failing miserably.”

I thought about that ubiquitous work of British visual and audio entertainment when the revelations from late June that the GlaxoSmithKline (GSK) PLC corruption scandal all started with a sex tape. In an article in the MailOnline, entitled “How a secret sex tape plunged British drugs giant Glaxo in a £90million bribery probe”, Rebecca Evans reported “A covert sex tape involving a senior executive and his Chinese lover was the trigger for a major investigation into corruption at British drugs giant GlaxoSmith-Kline, it was revealed yesterday. The video of married Mark Reilly and his girlfriend was filmed by secret camera and emailed anonymously to board members of the pharmaceutical firm. It led to an investigation that has rocked the £76billion company – which stands accused of bribing doctors and other health officials in China with £320million of gifts, including sexual favours from prostitutes, to persuade them to prescribe its drugs.”

This sex tape, along with allegations of bribery and corruption, were sent to GSK Board members, including Chief Executive Officer (CEO), Andrew Witty in March 2013 by someone with the email address “GSK Whistleblower”. Evans reported that two additional emails “making serious fraud allegations” were sent as well, one in January and one in May. In an article in the Wall Street Journal (WSJ), entitled “Sex Video Sheds Light in Glaxo China Case”, Laurie Burkitt reported that “The British drug maker regarded the video—apparently shot without the executive’s knowledge—as a breach of security, the person said.” Evans reported that in addition to this security breach, GSK believed the sex tape to be a “threat or blackmail attempt”. One of GSK’s responses was to hire the firm ChinaWhys Co., to investigate the matter. The firm’s principals, former journalist Peter Humphrey and Yu Yingzeng, a naturalized US citizen, were not able to determine who placed the video camera in Reilly’s Shanghai apartment, who shot the video or who sent it to GSK executives. However Evans reported “But a few months after starting to investigate Miss Shi, Mr Humphrey was arrested along with his wife Yu Yingzeng, a US citizen and daughter of one of China’s most eminent atomic weapons scientists. According to the Sunday Times, Mr Humphrey’s arrest and detention in July was at around the same time that China began a police probe into GSK’s alleged bribery.” And, unfortunately for Humphrey and his wife, they were arrested last August for allegedly breaking of Chinese laws relating to information privacy.

In addition to the investigation into the provenance of the sex tape and its sender, GSK had also engaged in an internal investigation into the substantive allegations of bribery brought forward by the “GSK Whistleblower” in emails to the GSK Board in January and May, 2013. As reported by Evans, “The emails laid out a series of sales and marketing practices described as ‘pervasive corruption’.” Unfortunately for the company, GSK “found ‘no specific evidence’ to substantiate the claims. However, the accusations are virtually identical to the charges laid by police against Mr Reilly and 45 other suspects. Last month, Britain’s Serious Fraud Office announced it is to investigate the company’s ‘commercial practices’.”

‘Honey-pots’ and ‘Sparrow-nests’ are well known terms for anyone who has read cold war tales of espionage between the former Soviet Union and the US. However, the Reilly sex-tape and the GSK bribery scandal would seem to be an entirely different can of worms. In an article in Time, entitled “What the GSK Sex Tape Says About Surveillance in China”, Hannah Beech wrote that in China, “Surveillance – or the threat of surveillance — is a constant in China. As a journalist, I may be more interesting to the powers that be than some other foreigners here. But other expat friends who’ve been followed, hacked or otherwise tracked in China include diplomats, NGO staff and businesspeople. Also, artists and academics.” Such surveillance includes having “email auto-forwarding mysteriously activated or to be tailed by a black Audi while on assignment in the Chinese countryside.”

For the compliance practitioner the lessons of GSK in China continue to resonate, unfortunately for the negative consequences to GSK and its employees. All of the above articles note that the allegations of bribery and corruption presented to GSK by the “GSK Whistleblower” were also made to Chinese officials, who then began to investigate the company. Andrew Ward, reporting in a Financial Times (FT) entitled “Sex tape adds to murk of GSK China scandal”, said “A separate internal investigation was already under way into the bribery allegations that had first been made by a whistleblower in January.” Unfortunately for GSK, its internal investigation failed to turn up any evidence of bribery and corruption. More unfortunately for the company, “Mr. Reilly, a Briton and long-time GSK executive, was among 46 company employees identified by Chinese police in May as suspects when they handed evidence of “massive and systematic bribery” to prosecutors after a 10-month investigation.”

It does seem incredible at this point that any serious internal investigation could fail to turn up any of the evidence that the Chinese government has been able to develop against GSK. This points to the absolute importance of your internal investigations. Although the GSK investigation was focused in China, the same is true in the US, particularly for a US listed company subject to Dodd-Frank. Further, we must invoke that well-known British author George Orwell for reminding you that in some countries Big Brother really is watching you. And finally, you may not be paranoid as people really may be watching you and filming your most intimate acts.

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

Coolness in Being the Bad Guy? Eli Wallach and GSK

Eli Wallach died Tuesday. For my money, he was about the coolest bad guy out there. Not tough like Lee Marvin, just cool. My favorite Wallach roles were as Calvera in The Magnificent Seven and as Tuco in The Good, The Bad and The Ugly. An early proponent of method acting, Wallach performed on the stage and in films for over 60 years. Although originally from Brooklyn, Wallach was also a fellow Texas Longhorn, having attended the University of Texas. He served in France as a Second Lieutenant in France during World War II.

I thought about Wallach’s über coolness when considering the most decided uncool position of the UK pharmaceutical giant GlaxoSmithKline PLC (GSK) recently. Last month the Chinese government issued a most very stern warning to GSK when it accused the former head of GSK’s China business of direct involvement in bribery and corruption. But more than this direct accusation, the move was a clear warning shot across the bow of not only western pharmaceutical companies doing business in China but also all western companies. In an article in the Wall Street Journal (WSJ), entitled “Beijing Warns Sernly on Glaxo”, Laurie Birkett quoted Helen Chen, a director and partner at consultancy L.E.K., as saying “Focusing much of the blame on a foreigner sends a strong message to all. Companies will see that if authorities are willing to accuse even a foreigner, who is in senior management, the issue is being taken seriously, it’s a clear message that bribery is unacceptable in the market.” Burkitt went on to say, “Experts say China’s medical system is deeply underfunded, giving doctors, hospitals and administrators an incentive to overcharge and overprescribe. Glaxo, in the past, organized trips for doctors around China and to places such as Budapest and Greece as part of a broader effort involving perks and cash to get doctors to boost drug prescriptions, according to documents previously reviewed by The Wall Street Journal.”

Such reports of endemic corruption are not new. An article, entitled “GSK China probe flags up wider worries”, in the Wednesday edition of the Financial Times (FT) reporters Andrew Jack and Patti Waldmeir discussed not only the endemic nature of corruption in China but how, in many ways, the Chinese health care system is based on such corruption. The piece quoted George Baeder, an independent drug industry advisor, for the following, “Financial flows – both legal and illegal – tied to drug and device sales are funding perhaps 60-80 per cent of total hospital costs. Without this funding, the current system would collapse.” Further, “central and provincial Chinese governments cannot afford to pay doctors a living wage, and may patients cannot afford to pay the true cost of care.” And finally, “Up to now, Beijing has turned a blind eye as pharma companies find ways to subsidise doctor salaries and underwrite their medical education.” How about that for structural corruption?

Intertwined with this structural issue is the problem of the quantity and quality of the drug supply. Many Chinese doctors do not feel that there is an acceptable alternative to foreign pharmaceutical products. This drives up the cost of prescribed medicines, as this quantity is therefore limited. But even where indigenous Chinese generic drugs are available as alternatives, many patients do not trust these medicines. This restricts the quality of drugs available.

But with this recent round of accusations against GSK it appears that the Chinese government has opened a new front. In an article in The Telegraph, entitled “GSK bribery scan could cause ‘irreparable damage’, says China”, Denise Roland reported that “Beijing has apparently issued a warning to all foreign firms, cautioning that the corruption charges against GlaxoSmithKline executives could cause “irreparable damage” to the drug maker’s Chinese operations.” She quoted from the state news agency Xinhua for the following, “GSK’s practices eroded its corporate integrity and could cause irreparable damage to the company in China and elsewhere. The case is a warning to other multinationals in China that ethics matter.”

In addition to these charges against a senior GSK executive, which could lead liability up to the GSK boardroom, Jonathan Russell, also writing in The Telegraph, in an article entitled “GlaxoSmithKline is facing more than double jeopardy”, said that “GlaxoSmithKline’s problems are multiplying fast. In China authorities have identified 46 individuals connected to the company they claim were involved in “massive and systemic bribery”. In the UK the Serious Fraud Office (SFO) marked out its pitch this week, revealing it has opened an official investigation into allegations of bribery; and an internal GSK probe is looking at potential wrongdoing in Jordan and Lebanon.” More ominously, he also noted that “Given the slew of allegations so far it seems a fair assumption that other international law enforcement agencies, notably the US Department of Justice, will be taking a long, close look at the allegations.”

While Russell points to the general UK prohibition against prosecutions, which might invoke double jeopardy, he says “As ever with the law there are exceptions to the principle. However they are limited in scope and rare in number. It may also be the case that the principle of double jeopardy may not be invoked in this case if the alleged offences the SFO is investigating are separate to those under investigation in China. They could relate to matters that took place in Jordan or Lebanon.” Russell also pointed out that “international prosecutors carving up parts of prosecutions so they can all have their pound of flesh. A very painful prospect for GSK.” It will also be interesting to see if GSK is charged under the UK Bribery Act, under the prior law or both. If charges are brought under the Bribery Act, which became effective on July 1, 2011, do you think GSK would try and raise a compliance defense based on the Six Principals of Adequate Procedures? I guess having a compliance defense is pretty useless if your company engages in bribery and corruption.

While Russell talks about the aggressiveness of US prosecutors under the Foreign Corrupt Practices Act (FCPA), he does not discuss what may be GSK’s greatest exposure in the US. GSK was under the equivalent of a Deferred Prosecution Agreement (DPA) called a Corporate Integrity Agreement (CIA) for its prior sins related to off-label marketing. This CIA not only applied to the specific pharmaceutical regulations that GSK violated but all of the GSK compliance obligations, including the FCPA. In addition to requiring a full and complete compliance program, the CIA specified that the company would have a Compliance Committee, inclusive of the Compliance Officer (CO) and other members of senior management necessary to meet the requirements of this CIA, whose job was to oversee full implementation of the CIA and all compliance functions at the company. These additional functions required Deputy Compliance Officers for each commercial business unit, Integrity Champions within each business unit and management accountability and certifications from each business unit. Training of GSK employees was specified. Further, there was detail down to specifically state that all compliance obligations applied to “contractors, subcontractors, agents and other persons (including, but not limited to, third party vendors)”.

For the compliance practitioner, one clear message from the GSK matter is to monitor, audit and continuously review your Chinese operations. I will have more to say about the China corruption crackdown in an upcoming blog post but just like Eli Wallach as Calvera in The Magnificent Seven told the gunmen hired to protect the Mexican village, you have been warned.

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 in China: A Game Changer in Compliance

I have published my first eBook-GSK in China: A Game Changer in Compliance. In this eBook, I review the information on the GlaxoSmithKline bribery and corruption allegations in China to-date, what you can do about it as a compliance practitioner and what it may all mean for international companies doing business in China.

I am sure that you will find it useful going forward to your compliance challenges. It is available through Kindle for only $4.99. You can download a copy here and start reading about it now.

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