Nov. 21 (Bloomberg) -- To the risks of doing business in China -- an authoritarian government, sprawling market, worsening pollution -- add another one: running afoul of local and U.S. anti-corruption laws.
Multinational companies are working to navigate bribery risks in China, where possible corruption by JPMorgan Chase & Co., GlaxoSmithKline Plc and Avon Products Inc. have sparked probes by the U.S. or Chinese authorities.
U.S. prosecutors and regulators are examining whether JPMorgan, the biggest U.S. bank, violated the Foreign Corrupt Practices Act by hiring children and other relatives of well-connected politicians in hopes of steering business to the firm in the Asia Pacific region, including China, according to a person familiar with the matter.
Chinese authorities detained four employees of Glaxo, the U.K.’s largest drugmaker, and are probing whether the company steered as much as 3 billion yuan ($490 million), using travel agencies to ease bribes to doctors and others to boost sales.
Avon, the world’s largest door-to-door cosmetics seller, has spent more than $300 million helping the U.S. investigate whether its employees bribed officials in China and other countries. In an Oct. 31 filing, Avon said possible fines could hurt earnings.
China, the world’s second-largest economy, fares poorly in surveys by Transparency International, the Berlin-based anti-corruption organization. Last year, it placed 80th out of 176 countries ranked for the perception of public sector corruption. A survey released Oct. 16 found Chinese companies were the least transparent and most prone to corruption of 100 multinationals examined in 16 nations, including India, Russia and Brazil.
“China is an environment where petty corruption is common and tolerated,” said Daniel C.K. Chow, a law professor at Ohio State University.
As a result, Chinese authorities are “making examples of certain multinational companies, like GSK,” said Chow, a former legal counsel at Procter & Gamble (China) Ltd.
Chinese President Xi Jinping has said widespread government corruption poses a threat to Communist Party rule. Xi took on rival Bo Xilai, the Chongqing politician who is serving a life sentence in prison for bribery and abuse of power. Chinese authorities also enforce anti-bribery laws against companies.
Still, the “most serious” risk to multinational companies, Chow said, comes from U.S. enforcement of the FCPA.
Since the FCPA was passed in 1977, 42 defendants faced actions involving conduct in China, second only to Nigeria with 55, according to Danforth Newcomb, an attorney at Shearman & Sterling LLP. The firm, which represents clients in FCPA matters, tracks cases on its website.
The law, enforced by the U.S. Justice Department and Securities and Exchange Commission, bans payment of money or anything of value to foreign officials to obtain or retain business or gain an improper advantage. The FCPA also affects companies with shares traded in the U.S. by barring off-the-books accounting and internal controls violations that might conceal bribes.
Companies can be prosecuted criminally or civilly, and people can go to jail, like ex-Morgan Stanley & Co. real estate executive Garth R. Peterson. He got nine months in prison for evading the bank’s internal accounting controls. He transferred a multimillion-dollar interest in a Shanghai building to himself and a Chinese public official. The Justice Department declined to charge Morgan Stanley, praising its conduct.
Pfizer Inc., the world’s biggest drugmaker, paid $60.2 million last year to settle claims that it bribed doctors and other health-care professionals in China and seven other countries. International Business Machines Corp. paid $11 million in 2011 to resolve an SEC case involving China and South Korea.
The SEC said IBM-China employees created slush funds at local travel agencies that paid for overseas trips by Chinese government officials. They also created slush funds at business partners to pay cash and buy cameras and laptop computers for officials, according to the SEC.
Hollywood is not immune. The SEC sent letters to studios seeking information about dealings with Chinese officials and possible inappropriate payments, according to people with knowledge of the matter.
The pharmaceutical and medical device sectors are a problem because China’s doctors and other medical professionals are typically employed by the government and some are “relatively underpaid,” said Susan Munro of Steptoe & Johnson LLP, who works in China.
“Some have supplemented their incomes in contravention of the rules, and sometimes caused authorities to look the other way,” Munro said.
By barring improper payments to employees in the government and state-owned enterprises, the FCPA affects how companies deal with many officials in China.
“The most significant overall risk in China is the fact that the government still permeates so much of what we would otherwise consider to be the private sector,” said Timothy Dickinson, an FCPA attorney at Paul Hastings LLP.
“State-owned enterprises are everywhere,” he said. “Once you have a state-owned enterprise involved, then you have a government official as defined by the FCPA.”
Companies often hire third-party intermediaries to make introductions, offer language and cultural interpretations and facilitate relationships. Third parties may also act as sales agents, consultants, distributors or joint venture partners, and they pose a high risk of passing bribes, according to Wendy Wysong, a Clifford Chance attorney who practices in Hong Kong.
Suppliers may have relationships built on personal bonds, which may create an expectation of gifts given in gratitude, according to attorney George J. Terwilliger III of Morgan Lewis & Bockius LLP.
“What we may consider a corrupt intent is often more born of a culture where there’s an expectation of valuing a personal relationship through gift giving, sometimes expensive gift giving,” Terwilliger said.
Bribery cases can hinge on payments made by intermediaries to government officials and whether companies knew of them. The corruption may often take the form of travel by third parties that may be masked by phony receipts or fraudulent books, according to Shearman & Sterling’s Newcomb.
“The key issue that triggers liability is whether the company had knowledge that the money would be used for bribes on its behalf in connection with the sale of the company’s goods or services,” Wysong said.
A company’s knowledge, under the law, is defined as not only whether it actually knew, but also whether it should have known and deliberately ignored the risks.
As a result, companies spend millions of dollars on compliance programs to educate Chinese employees on bribery risks. They also closely examine the backgrounds of intermediaries, a process that doesn’t always expose whether they may be corrupt, according to lawyers who advise companies.
“Foreign corruption often starts with a guy who doesn’t know the local market,” Newcomb said. “You send some poor dumb American out to market anything and he doesn’t know anything about the language or culture. If he picks an intermediary who’s a crook, he’s at the intermediary’s mercy.”
Companies also may have contracts with a Chinese governmental authority and be directed to a local subcontractor who is related to the official overseeing the contract, according to attorney Martin Weinstein of Willkie Farr & Gallagher LLP.
“You have to look underneath the cover of consultants and subcontractors to see if they are actually doing the things they say they’re doing,” Weinstein said. “The risk is that companies win a contract and find themselves in business with a subcontractor or consultant selected by the government, where the services and the money paid don’t match up.”
Companies typically demand written certifications from intermediaries stating that they will not engage in bribery.
“In some cases, they do it anyway,” said attorney Joel Cohen of Gibson Dunn & Crutcher LLP. “It suggests that even high levels of due diligence cannot prevent all bad behavior, even if you have a really strong program and do the right things.”
A cottage industry of law firms and consultants competes to advise companies on how to identify FCPA risks, analyze company books, review use of third parties, and train employees to comply with the statute. The education must reach sales and operations employees, said Michael Murphy, co-lead of the China financial advisory practice at AlixPartners LLP, a consulting firm.
“The way to combat the problem is to really spend a lot of time and energy on compliance programs,” Murphy said. “They have to have teeth to them, they have to have follow-up, and they have to have commitments from the boards of companies.”
The U.S. Commerce Department counsels companies operating in China regarding issues affecting their business, including the FCPA, and can help them conduct due diligence on partners and agents, said John Cobau, chief counsel for international commerce.
The department is encouraging the Chinese government to enforce a 2011 amendment to its criminal law that made it a crime to bribe officials in international public organizations and governments outside of China.
In October, officials from the Commerce, Justice and State departments went to China to encourage the country’s officials to implement the amendment, and to join an anti-bribery convention agreed to by 34 members of the Organisation for Economic Cooperation and Development and six other countries, according to Cobau.
“While we were encouraged by China’s willingness to engage in a dialogue about the amendment, we are still looking for them to take strong actions to publicize and enforce the amendment,” Cobau said.
While China remains one of the high-risk countries, it is changing, said Dickinson, who has visited for three decades.
“There really is a different feel among young people in that they don’t want corruption in their society,” he said. “They want the best product for the best price and they don’t want to be shaken down. It’s a very different place than it was 30 years ago.”
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