Solving the puzzle of the FCPA in China

Assembling the pieces of a compliance strategy takes planning and diligence

China, with its population of more than a billion potential consumers, its torrid economic development and increasingly important position in the world economy, represents the next great beachhead of growth for many of the largest American companies. But doing business in China is no simple task.

To remain compliant, companies must deal with a number of concerns, from vetting third-party representatives that work on their behalf to understanding cultural differences, or the complexities of the state-run economy, there are a host of factors to keep in mind.

Foreign Corrupt Practices Act

Perhaps the most important piece of legislation to keep in mind when doing business in China is the Foreign Corrupt Practices Act (FCPA). Congress passed the FCPA in 1977, in the wake of a tumultuous time in this country, when Watergate had left a stain of corruption on the face of our own government. After two decades of existence, the FCPA came into the spotlight in 2001, when the government stepped up its enforcement of all aspects of the policy. Though it applies to all foreign nations, the FCPA has had a great effect on companies doing business in China.

Increased enforcement is merely the latest trend, according to Jeremy Perisho, partner at Deloitte Financial Advisory.

“U.S. enforcement has increased, the U.K. and China and Brazil are picking up on the trends,” she explains. “In order to do business in a world where enforcement is fashionable, you must take compliance seriously.”

Today, companies have no choice but to have a compliance program, notes Joseph Spinelli, managing director in the Global Investigations and leader in the Compliance Practice and FCPA Anti-Bribery and Corruption Practice at Navigant.

“The only mitigating factor that you have to abate potential fines and culpability is to have an effective FCPA compliance program,” he says. “But that's not the main reason. It's the right way to do business. To establish the right type of culture, you need to implement a compliance program, you have to behave in a certain way. The Department of Justice has been very clear as to its expectations.”

The big deal about deals in China

What is the big deal about China? Why have there been so many recent actions in the nation, and what do companies need to know about doing business there?

Tamika Tremaglio, principal at Deloitte Financial Advisory, explains that doing business in China has its own unique challenges.

“To some extent, it is very competitive, and companies are playing on a very different field,” Tremaglio says. “In some cases, gifts are expected, and companies that are not as well-versed aren’t used to conducting business in that way. That is a huge hurdle.”

Perisho identifies a number of reasons why China is a tricky place in which to do business. “It's very diverse. Its population is growing exponentially. Americans have a mentality for uniformity, but that is not the case in China. For example, in the U.S. we have the FDA, but China has multiple agencies that perform the same function.”

One of the biggest hurdles in dealing with China is the relationship between the government and the businesses.

“China continues to be a one-party, authoritarian state with a highly regulated economy and state-controlled economic systems. In most instances, business officials are construed by the FCPA statutes as foreign officials,” says Perisho. “No matter who you do business with in China, no matter what industry – steel, finance, oil and gas, telecommunications, air transport, etc. – all are controlled by state-owned enterprises for policy and security reasons, and businesspeople will be construed to be foreign officials because of the state-owned concept.”

Third parties and risk ranking

One way that companies can get into trouble is through the use of third parties. Companies doing business in China are likely to be large, and any large organization must, at times, contract with third parties to manage some aspect of their supply chain or provide a valuable service. But these third parties are responsible for the vast majority of FCPA violations of companies doing business in China.

“80 to 90 percent of cases are related to third party intermediaries – agents, vendors, suppliers, distributors – who will be doing business on behalf of a global organization,” says Spinelli. He cites Department of Justice Opinion 08-02, which mandated that global companies risk rank third parties to know with whom they are doing business.

Tremaglio sees the importance of this risk ranking as well. “All third parties are not created alike, so you need a threat matrix. Rank them as high, medium or low risk. Provide basic background checks for the lower risk firms and for the higher risk, perform more in-depth checks, looking for red flags.” These red flags could include relations to foreign officials, whether they are on strong financial footing, if they have a history of bribes or have been indicted before.

‘Boots on the ground’

Once a company has a basic understanding of the challenges presented by doing business in China, the next logical step is to figure out how to address these challenges. Experts agree that a compliance program requires a combination of different strands in order to be effective.

For example, Spinelli recommends a combination of due diligence and “boots on the ground” when it comes to vetting third parties. “You can do the best job in the world of third party due diligence, updating it, training third parties in relation to your compliance program,” he says, “but you can get a rogue third party out there. You do the prerequisites to show that you have made a good faith effort to get your house in order proactively.” But, he says, that still might not be enough.

Ultimately, companies have to develop the best possible compliance plan under the circumstances, put it in place, and continue to monitor it, adjusting where necessary. No plan will be absolutely watertight, but making a best effort can go a long way.

“It's about putting appropriate controls in place, internal controls,” Tremaglio says. “Do you have a program in place? Are you enforcing it and training people appropriately?” And, Perisho adds, you must keep the program up-to-date. “Monitoring is key. If there are exceptions, see why, and take corrective actions, augmenting training, creating financial disincentives or terminating relationships if it comes to it.”

In order to take advantage of the potentially large market offered by business in China, companies must take their compliance programs seriously in order to reap the benefits of this untapped vein without running the risk of serious legal repercussions.

Managing Editor

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Rich Steeves

Richard P. Steeves is Managing Editor of InsideCounsel magazine, where he covers the intellectual property and compliance arenas. Rich earned a B.A. in English Literature...

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