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 [link no longer exists] 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 [link no longer exists]. 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.