Understanding China FCPA Risks. Who Is A Foreign Official?
I am becoming obsessed with the Foreign Corrupt Practices Act (FCPA) because I see it as one of the the "most missed" things for United States companies doing business in or with China.
The other day, I was interviewed by a news service reporter who asked me whether the FCPA is a big issue for my firm's clients. She was calling me to discuss a post I did earlier this year about a client who chose to walk away from a China deal out of fear of violating the FCPA. She asked me if this was common and whether my firm's clients are concerned about the FCPA.
I told her this was actually the first time in years a client had even raised an FCPA issue with me and that clients never even broach the subject with us when going into China. I told her I am the only one who ever brings it up and when I do, clients are generally not terribly interested. I see this as a huge mistake, particularly since the US Department of Justice has made clear it intends to increase its pursuit of FCPA claims and particularly since China is one of the more difficult countries in which to operate.
Most importantly, a little effort towards compliance can go a long way.
It was in that spirit that I asked Mike Koehler of the FCPA Professor Blog to guest write an FCPA post aimed at those who do business in China. Mike is an Assistant Professor of Business Law at Butler University and before that he gained a decade of legal practice experience at an international law firm during which he conducted FCPA investigations around the world, negotiated resolutions to FCPA enforcement actions with government enforcement agencies, and advised clients on FCPA compliance and risk assessment.
Bottom Line: Mike knows whereof he speaks on the FCPA and here is his post.
In many respects, ensuring FCPA compliance in China business operations is no different than ensuring FCPA compliance in other countries. Basic FCPA benchmarks (such as having a clearly articulated corporate policy against FCPA violations; training employees, agents and business partners on the company's FCPA compliance code, standards, and procedures; and having FCPA specific due diligence requirements for retention and oversight of agents and business partners) will serve a company well no matter where it does business, not just in China.
This post, however, is not about what makes FCPA compliance in China similar to other countries, but about "what makes China unique" from an FCPA compliance standpoint. In this post, I share some of my thoughts and experiences from conducting several FCPA internal investigations in China and based on a read of the many recent FCPA enforcement actions involving China business conduct (with little substantive FCPA case law, these enforcement actions are commonly viewed as de facto case law).
The key to understanding China FCPA risk, and thus the key to ensuring FCPA compliance in China business operations, is two-fold.
First, is to realize that despite certain market-based changes China has many state-owned or state-controlled enterprises (so called "SOEs").
Second, is to understand that the Department of Justice and the Securities and Exchange Commission (the two "Enforcement Agencies" with FCPA enforcement authority) view employees of these SOEs (regardless of rank, title, position or how these employees are classified under Chinese law) as being "foreign officials" under the FCPA's anti-bribery provisions on the theory that SOEs are "instrumentalities" of the Chinese government. (See here for the statutory definition of "foreign official").
Many of the recent FCPA enforcement actions concerning business conduct in China involve "foreign officials" under this interpretation. In other words, the "foreign official" recipient of the alleged improper payments in these enforcement actions are not core government officials or employees of government offices, but rather employees of alleged SOEs.
For instance, in the August 2009 Oscar Meza (former Director of Asia-Pacific Sales for Faro Technologies, Inc.) enforcement action, the SEC civil complaint charging FCPA anti-bribery violations refers to "employees of Chinese state-owned companies." (See here).
Likewise, in the July 2009 Control Components, Inc. enforcement action, the DOJ criminal information contains a list of specific Chinese "state-owned customers" along with a conclusory statement that "[t]he officers and employees of these entities, including but not limited to the Vice-Presidents, Engineering Managers, General Managers, Procurement Managers, and Purchasing Officers, were 'foreign officials' within the meaning of the FCPA..." (See here. See also the April 2009 indictment of several company employees based on the same theory here.
I have pointed out elsewhere (see here) that the Enforcement Agencies' interpretation of the "foreign official" - to include employees of SOEs - is an untested and unchallenged legal interpretation.
Not surprisingly, this interpretation comes as a shock to Chinese national employees of U.S. companies (as well as the U.S. business leaders of such companies), and who can blame such shock and confusion. The Enforcement Agencies' interpretation of the "foreign official" to include employees of SOEs is the functional equivalent of someone telling you tomorrow that your neighbor who works for General Motors or the guy you play softball with on Thursday nights who works for AIG are both U.S. "officials" based solely on the fact that these individuals work for companies owned or operated by the U.S. government.
It is beyond the scope of this post to debate this interpretation because the fact of the matter is, until this untested legal theory is challenged, it is the Enforcement Agencies' interpretation and companies doing business or seeking business in China are "playing with fire" if they calibrate corporate FCPA policies and procedures to anything other than the Enforcement Agencies' interpretation.
Calibrating FCPA policies and procedures to this "foreign official" interpretation means that it is imperative for a company operating in China to know its customers and to understand whether its customers (or prospective customers) are owned or controlled by the Chinese government.
How does one do this? Admittedly it is a difficult task, made even more difficult by the fact that the various DOJ/SEC charging documents merely contain conclusory language to the effect that "Company X" is state-owned or state-controlled without discussing the facts or factors supporting the conclusion.
Yet understanding a company's China customer base is an essential task to ensuring FCPA compliance in China. Here are a few practical suggestions to determine if your customers or prospective customers in China are SOEs: (i) if the relationship permits, ask the main contact at the customer whether the government owns an interest in or controls the company; (ii) obtain a copy of the company's annual report or try to determine if government officials serve on the board of directors of the company or in a management role; (iii) visit the company's website or conduct general internet searches to see if there are any connections between the government and the company.
Chinese SOEs can be found in any industry, but are most commonly found in the following industries: oil and gas, other resource extraction, healthcare, transportation, and utilities. Finally, a word of caution. Just because a company may have shares traded on a public stock exchange (whether in China or elsewhere) does not mean that the company is not an SOE. Many Chinese SOEs have publicly traded shares.
Here is why understanding the Enforcement Agencies' interpretation of the "foreign official" element is essential to ensuring FCPA compliance in China.
In my opinion, most companies do not intend to "bribe" a "foreign official" (regardless of the interpretation) and, in fact, find such behavior repugnant. However, most companies actively market its goods and services, "wine and dine" customers or prospective customers, and host golf outings or other entertainment - all in an effort to maintain "good will" with customers and increase sales.
While doing such things with purely private customers in China is viewed as effective marketing, doing the SAME things with SOE customers in China may be inviting FCPA scrutiny. Given the gift-giving, hospitality culture in China, this is no trivial matter.
For this reason, any company doing business or seeking business in China is wise to maintain a roster of its SOE customers and to implement internal controls with the involvement of finance personnel to ensure that increased oversight and review is triggered every time company expenses involve SOEs. Because of time zone and language differences, oversight of such expenses is no easy task, but it is a task companies must commit to undertake.
Training all company personnel in China (not just high-ranking personnel) on the Enforcement Agencies' creative "foreign official" interpretation is also essential as demonstrated by the 2007 enforcement action against Lucent Technologies.
In its complaint, the SEC alleged as follows: "Lucent [FCPA books and records and internal control] violations occurred because Lucent failed, for years, to properly train its officers and employees to understand and appreciate the nature and status of its customers in the context of the FCPA. Many of Lucent's Chinese customers were state-owned or state-controlled companies that constituted instrumentalities of the government of China and whose employees, consequently, were foreign officials under the FCPA." (See here, complaint at para 3).
This paragraph from the Lucent SEC complaint is likely to induce a cold-sweat in most business leaders who may be reminded of their company's own FCPA compliance deficiencies.
The take-away point from an FCPA compliance standpoint is that conducting business or seeking new business in China is different because of the Enforcement Agencies' "foreign official" interpretation. This interpretation certainly increases the due diligence and compliance costs of doing business in China, but companies are wise not to ignore this interpretation and its practical effects so long as the Enforcement Agencies' interpretation remains the "law of the land."
UPDATE: Stan Abrams over at China Hearsay has done an excellent post on this post, entitled, "FCPA and China - Why Paranoia is a Good Thing." Stan says he favors "simple rules like 'Thou shalt not give gifts at all without prior approval.' Doesn't always work, but at least there is no room for interpretation." I agree.
Comments (9)
Read through and enter the discussion by using the form at the endJustin A. - September 22, 2009 3:03 PM
Excellent post and much appreciated. I work for a mid-sized US company with a very profitable, but somewhat unruly, China arm. We are in the process of trying to rein in our China operations and this post is certainly going to give us more to think about. Thanks for bringing in "the professor."
Duncan - September 22, 2009 5:46 PM
The point about the interpretation of the term foreign official is interesting. I wonder to what extent it would apply also to party officials in China, given the dual nature of the party/state personnel apparatus. Personally I can see an argument for viewing senior appointments in SOEs as government officials (when both government and SOE officers are appointed by the Organization department and move seamlessly between these two job types the correlation is clearly strong), but for lower level managers I guess there's more room for debate.
Patrick M. Norton - September 23, 2009 11:27 AM
The blog above is a useful summary of some of the difficult FCPA issues in China that are often over-looked. I would add only a few additional comments.
One reason that it is difficult to challenge the broad US Gov't interpretation of "foreign official" is that Chinese law uses very similar terminology. Chinese criminal laws distinguish clearly between commercial bribes and bribes paid to government officials -- "state personnel" or "state functionary" is the usual translation of the Chinese term. And Chinese criminal law defines "state functionary" very broadly to include employees of SOEs.
This was vividly illustrated a few years back when charges were made in the US that a US company had violated the FCPA by bribing the then President of China Construction Bank (Zhang Enguo). There were immediate cries on a number of fronts (including the accused company's US lawyers) that the president of such a prominent bank could not possibly be a "foreign official" -- a mere bureaucrat. Wrong. The central gov't fired him within a week and later convicted him of violating the criminal statute applicable to bribery of a public official, not commercial bribery.
Other cases may be more problematic, e.g., the doctors and administrators at state-owned hospitals, who are treated as "officials" under both Chinese law and the FCPA. (See the 2005 DPC case.) Whether that is conceptually wrong or not is beside the point. Anyone doing business in China had better get used to these rules because Chinese and US criminal laws follow them quite consistently.
In my experience, it's also not difficult nine times out of ten to know that you are dealing with an SOE. The FCPA aside, a lot of different laws apply to SOEs, and a foreign company is well advised to know with whom they are dealing in this regard.
Note, too, that bribes to public officials in violation of the FCPA may no longer be the sole concern for US companies doing business in China. The Department of Justice has taken an aggressive interpretation of the federal "Travel Act" to charge US companies with violations of US law for commercial bribes abroad, specifically in China. The recent (July 2009) CCI decision included charges for commercial bribes in China, as did Schnitzer Steel a few years ago. I personally think that this reading of the Travel Act is entirely unjustified, but all FCPA/Travel Act cases against companies are settled, not adjudicated. No company wants to litigate issues like this for an additional two to three years, with all the attendant costs and risks. For all intents and purposes, therefore, there is no judicial review of federal prosecutions in this area, and companies must presume that they will have to live with the DOJ interpretation of the law, reasonable or not.
One area in particular that may be affected by the possibility of charges for commercial bribery may be M&A. Any foreign acquiror in China these days should be conducting active due diligence in the anti-corruption area to avoid successor liability and to identify post-acquisition risks. Adding commercial bribery to official bribery will make the due diligence task all the more expensive and burdensome.
Amy - September 23, 2009 12:05 PM
What about employees in a joint venture where a US investor and an SOE each owns 50% of the equity? Will the JV employees be considered government officials? What about the employees assigned by the US company to the JV?
Twofish - September 23, 2009 12:06 PM
I think that rather than trying to figure out whether or not a firm is "state-owned" for the purposes of the FCPA, the safest course of action is to assume that anyone that one does business with in China is covered under the FCPA. There is simply no practical way I can see of separating out "purely private" enterprisess since every enterprise in China could have some state involvement.
One issue here is that there is no clear distinction under Chinese law or for that matter under US law as to what enterprises are "state-owned enterprises" and which ones are not. Also it's far from clear what "state ownership" as far as FCPA goes.
Twofish - September 23, 2009 4:57 PM
Also this has to be seen as part of a broad effort by the Chinese government to get serious about corruption. One problem with Chinese efforts to impose economic regulation is that these efforts are not taken seriously because the theory is that once they go against entrenched interests, that the regulators will back off.
So one trick that the Chinese government has used is to have outside regulators enforce Chinese laws and regulation. They've done this with the SEC, and once you have someone that is outside the Chinese government enforcing Chinese laws, then those laws have a lot more credibility.
The FCPA exempts transactions that are legal under the foreign governments written laws, and if China didn't want the USDOJ to enforce these the FCPA against US companies doing business in China, there are things that it could do to make this more problematic. My sense is that that the Chinese central authorities support the loose definitions of "foreign officials."
It is rather easy to know that you are dealing with an SOE. IMHO, it's pretty hard to tell if you are *not* dealing with an SOE since even companies that look and seem private often have a lot of state involvement that isn't obvious. I really don't see any safe thing to do other than to assume that *any* commercial transaction that you undertake in China could be subject to FCPA issues.
The other thing is that
a) most businesses would prefer not to be a test case. Even if a US court were to rule that the Justice Department's interpretation of "foreign official" was overly broad, "we did the bribe someone but that person was not a foreign official" is not they type of defense that will look good on the news,
b) in the situations that I have seen the FCPA being used, they were really things that didn't pass the "smell test." We aren't talking about expensive dinners, but rather cash bribes and kickbacks. Although the USDOJ could try to put everything under the microscope, if it did try to start a prosecution against a company for something that doesn't look "obviously wrong" then they run the risk that the company *will* get a court to overturn the DOJ's interpretation of the law.
So I think the basic standard is if you are staring in front of a bunch of reporters asking about what you did, can you argue that you did nothing wrong?
Benjamin S - September 24, 2009 2:49 AM
Seems like a good business model somewhere in this headache. For example, templated "FCPA Compliance kits" available for download which companies can purchase to educate staff and demonstrate compliance, perhaps coupled with brief (read: inexpensive) training and audit sessions.
Professor Mike Koehler - October 5, 2009 10:00 AM
Some comments on the "comments."
(1) I completely agree with Patrick's comment that "[f]or all intents and purposes [...] there is no judicial review of federal prosecutions in this area, and companies must presume that they will have to live with the DOJ interpretation of the law, reasonable or not."
The question though is whether this is desirable for any number of policy reasons.
I don't believe it is and I struggle to come up with another example of a law being aggressivly enforcd based on tenuous (and in some cases untested and unchallenged) legal theories resulting in multi-million corporate fines and penalties, but yet enforcement is NOT subject to judicial scrutiny, let alone the adversarial system.
The compliance costs alone of the FCPA meaning what DOJ/SEC says it means is stagerring. Many corporations deploy teams of lawyers and forensic accounting experts around the world (at a cost of several million dollars) investigating conduct or allegations of conduct that may NOT even violate the FCPA.
Surely the government (particulary the DOJ) "carries a big stick" and there are several practical reasons why FCPA enforcement actions are not litigated.
However, this could change if HR 2152 were to be enacted (for more see http://fcpaprofessor.blogspot.com/2009/09/if-hr-2152-were-to-be-enacted.html
(2) I also agree with the comment that "the safest course of action is to assume that anyone one does business with in China is covered under the FCPA."
Again, however, is it advisable from a policy standpoint to impose an obligation on a company (and the resulting compliance costs) based on a legal theory that may not even be valid? Further, because of the third-party payment provisions, to also impose that legal obligation (and resulting compliance costs) on all agents, distributors, etc?
(3) As to the joint venture question, there have been several FCPA enforcement settlements regarding employees of Nigerian entities (based on the theory that such employees are "foreign officials") even though the entities are in a joint venture that is MAJORITY-OWNED by PRIVATE MULTINATIONAL COMPANIES. So yes, DOJ/SEC can deem such JV employees as "foreign officials."
(4) The FCPA does not exempt transactions that are legal under the foreign government's written law. Rather, this is an affirmative defense, meaning the defendant must meet the burden of establishing the elements.
(5) There are many, many "templated FCPA compliance kits" out there. However, my view is that while such "off-the-shelf" kits are better than no FCPA compliance policies and procedures, nothing is better than compliance policies and procedures specifically targeted to a company's unique FCPA risk profile after conducting a comprehensive FCPA risk assessment.
Alison Morgan - March 19, 2011 8:54 AM
American Conference Institute and C5 Group bring the acclaimed 4th China Summit on Anti-Corruption to help you understand China FCPA risks. It will be held June 8 - 9, 2011 at the Le Royal Méridien Hotel, Shanghai
Find more information at www.americanconference.com/AntiCorruptionChina.
Hope to see you there.