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A Dim (Sum) Defense: China And The FCPA

Richard Meyer | July 24, 2007

The next time you take a client in China out to dinner, you may want to bring your attorney along. You might need his help ordering.

The Foreign Corrupt Practices Act is a cornerstone of antibribery legislation in the United States and increasingly around the world, as prosecutors here try to extend the scope of the law. China, however, is proving to be especially difficult territory for FCPA compliance.

The FCPA forbids a U.S. company—or a U.S. citizen, or a non-citizen working for a company that trades on U.S. stock exchanges—from bribing foreign officials to gain business. But many large Chinese companies are owned by the government, and many high executives are Communist Party members. That means the person you negotiate with to close a commercial deal might be considered a foreign official under U.S. law.

Dinner is one simple yet telling example. Chinese executives often expect to be wined and dined before they will even consider conducting business. That is acceptable up to a point, but American executives need to make sure that a night out to build a business relationship doesn’t start to look more like an attempt to influence the executive with food, drink, and entertainment.



Hough

“You have to draw the line on what is over-the-top lavish,” says James Hough, a partner at the law firm Morrison Foerster.

As recently as a decade ago, thinly disguised bribes were routine. American executives had a sense that the FCPA was rarely enforced, and a “when in Rome” attitude prevailed. Chinese executives would be invited to conferences in the United States, given some spending money, and not expected to show up. “Red Packets” with cash were distributed to clients at Chinese New Year, ostensibly because the packets are a Chinese custom American should respect.

That environment has changed in recent years, as the Justice Department stepped up FCPA enforcement. Regulators and prosecutors have warned that corruption is a particular problem in China—which is old news to most corporate executives, but recent FCPA enforcement actions touching Chinese operations do have people paying more attention.

After many years without any reported FCPA investigations involving China, a number of U.S. companies have been punished under the law for alleged bribery there, and others admit they are under investigation, according to Patrick Norton, a partner at the Steptoe & Johnson law firm. Schnitzer Steel, a scrap metal company, paid more than $15 million in fines and other penalties in 2005 because of kickbacks it made to Chinese and Korean Steel mills. GE InVision, a maker of bomb detection equipment, paid more than $1 million in fines in 2004 for FCPA violations in China, the Philippines, and Thailand. (The violations were discovered before General Electric acquired the company and in fact were found from due diligence conducted in the course of GE’s acquisition of InVision.)

To be fair, one extravagant meal isn’t likely to attract the feds. The government, attorneys say, is reasonable in its application of the FCPA; it understands that in some cultures doing business without a modicum of generosity at meals is impossible. But a history of expensive entertainment combined with other extravagant incentives could lead to an investigation.

“Lavish entertainment is only part of what they look at,” Hough says. It’s a problem “if you are lavishingly entertaining someone and you’re also giving a kickback to that person.”

Some American executives have found themselves in uncomfortable situations in China. They hold what they consider an impressive banquet for their local business partner, only to find that their guests have started ordering shark’s fin soup and other costly delicacies. Some Chinese officials will consider it an insult if they are not treated properly and have even been known to correct what they view as a meal that does not reflect their importance.

A Healthy Diet Of FCPA Compliance

Lawyers familiar with the law suggest that an FCPA compliance program must be established, relevant due diligence undertaken, and appropriate documentation maintained. In the case of a client dinner, for example, limits should be set for cost per person. If those limits happen to be broken—if, for example, the guest takes control of the ordering—a system should record that breach of the expense ceiling.

What the Justice Department wants from companies, corporate lawyers say, are good-faith efforts to stay on the right side of the law and to expose and correct problems as they arise. For payments to Chinese business partners, a system needs to be created where a third party—either a compliance officer or a lawyer—reviews and authorizes any spending that could potentially violate the FCPA. In cases where an American company buys another business (either American- or foreign-owned) it should undertake a systematic review of that business’s operations.

“When you do due diligence, keep good records,” says Stuart Deming, a lawyer in private practice who specializes in FCPA compliance. “You need to be able to look at Justice in the eye and say, ‘What else could I have done?’”

Employee training can also be a challenge, especially with local employees. Chinese executives working for an American company might have trouble complying; they may find it embarrassing not to throw cash around when entertaining local clients. Some may see the imposition of FCPA rules as cultural imperialism and insist on doing things their way. The rules, and the reasons the rules exist, must be explained, and employees in a position to violate them must be brought around to following them.

“The education has to be more than just: ‘Don’t do it,'” Deming says.

Outsourcing your bribes by hiring a local “consultant” who secures contracts or permissions is no longer a viable option either. If a local partner’s fee appears high, it is not enough to assume that is simply the cost of doing business in China; the local firm must be thoroughly investigated, and the American company needs to determine whether a bribe is hidden somewhere in that fee. Ignorance is not a defense, and the U.S. authorities are honing in on these arm's-length relationships as areas for scrutiny, lawyers say.

“The big misunderstanding is that there is an easy way around it,” Deming says. “One thing the prosecutors look for is head-in-the-sand defense.”