The Foreign Corrupt Practices Act: A Minefield for US Companies in China

The FCPA consists of anti-bribery provisions and accounting control provisions. The anti-bribery provisions apply to "US persons", a term that is defined in the statute to include: all business entities organized in the United States; all individual US citizens and residents; all companies listed on US stock exchanges, including foreign issuers; and foreign persons acting within the United States. The accounting control provisions apply only to publicly listed companies, which also include foreign issuers.

The US Department of Justice (DOJ) administers the anti-bribery provisions of the FCPA.³ These provisions prohibit "US persons" from paying or offering to pay "anything of value" to any "foreign official" with the "corrupt purpose" of obtaining business with any person. There are several important terms here, each of which is open to interpretation. Exactly what "US persons" are covered? What is "something of value"? Who is a "foreign official"? When is a purpose "corrupt"? There are also limited exceptions to the statutory prohibitions permitting, for example, reimbursement for reasonable promotional expenses and "facilitative" or "grease" payments to obtain routine bureaucratic cooperation in matters like customs clearances. But the basic idea is straightforward: US companies, US individuals, and foreign companies listed on US stock exchanges cannot bribe foreign government officials to obtain business or preferential government treatment that assists in obtaining business.

The US Securities & Exchange Commission (SEC) administers the FCPA's accounting control provisions.⁴ These statutory provisions and the implementing SEC regulations also raise many technical questions of interpretation.⁵ But, again, the basic idea is straightforward: US public companies, including foreign issuers, must accurately report all financial data in their books and records, including bribes. They cannot hide bribes in other accounts or disguise them with euphemisms.⁶

The penalties for violating the FCPA's anti-bribery prohibitions are potentially severe.⁷ Individuals face criminal fines up to $250,000 and imprisonment up to five years.⁸ Companies may be fined up to $2 million for each violation. Federal law allows even higher "alternative" maximum fines equal to twice the gain to the defendant or the loss to third parties resulting from the violation.⁹ Both companies and individuals are also subject to civil fines. Other potential sanctions on companies include disqualification from US government contracting and the denial of export licences. The SEC may seek additional civil penalties for violations of the accounting provisions.¹⁰

The commercial consequences of violating the FCPA can be equally serious. The internal investigations necessary to bring a company back into compliance are costly and time-consuming. Public companies will generally need to disclose violations, with attendant damage to reputation and goodwill. Local businesses in the country where the violations occurred, particularly businesses with government ties, may shun a US company that has publicly admitted to bribery, even if the company has taken appropriate remedial measures in the meantime. In some cases, there may also be the risk of shareholder lawsuits in the United States.

Corruption in China

Governmental corruption is widespread in the developing world. Although China is by no means the worst offender, corruption in China is a serious problem.¹¹ In February 2004, the secretary of the Central Commission for Discipline of the Communist Party of China (CPC) reported that between December 2002 and November 2003 174,580 Chinese officials were disciplined for violating anti-corruption laws or policies, including more than 6,000 at the provincial level and 21 at the ministerial level. Of these, nearly 8,700 were expelled from the party and criminally prosecuted, including six at the ministerial level.¹² In the previous five-year period, 846,150 CPC members were punished for corruption.¹³ And those were just the ones who were caught; the actual incidence of corruption is likely much greater than even these figures suggest.

There are many diverse causes of corruption in China. China's recent economic development has been among the most dramatic in world history, and rapid economic change of this sort inevitably presents fertile ground for official graft. China's development has also involved widespread privatization of state assets, presenting numerous opportunities for the misappropriation of state-owned resources. Additionally, profound economic changes have coincided with the decentralization of political decision-making and law enforcement, further loosening the reins of executive control. Judicial institutions remain underdeveloped and subject to political influence. China's poorly paid government officials are highly vulnerable to corruption in this environment, especially when government leaders proclaim that "to get rich is glorious" and officials see others (including recent colleagues) enriching themselves. Whatever its root causes, corruption in China occurs despite stringent bribery laws and penalties. Article 389 of the Criminal Code provides that "giving money or property to a state functionary in order to obtain an illegal benefit is bribery". Article 385 is directed at officials who receive bribes and proscribes "taking advantage of [an official] position to extort money or property from another person, or illegally accepting another person's money or property in return for securing benefits". Those paying the bribes and the state functionaries receiving them may be incarcerated for five to ten years and, in "exceptionally serious cases", up to life.¹⁴ The most serious instances of corruption may be "economic crimes" that can constitute capital offences; a number of senior government and CPC officials have been executed for corruption in recent years.¹⁵

The Criminal Code is supplemented by administrative regulations that prohibit government officials from accepting bribes¹⁶ or gifts¹⁷. Violations are punishable by dismissal from office and other administrative penalties.¹⁸

All Chinese government officials are also members of the CPC and subject to its disciplinary procedures. As part of its most recent anti-corruption effort, the CPC published comprehensive internal supervision regulations in February 2004.¹⁹ The party's Provisional Regulations on Internal Supervision contain a comprehensive list of offences. These regulations form a veritable catalogue of all the ways in which an official can abuse public position for private gain. Penalties include dismissal from all positions within the party or from the party itself; hence, effectively terminating a government career in a country where party membership is a prerequisite to gaining an official position.

Yet China's corruption problems persist despite these criminal, administrative and political penalties, and in the face of repeated government anti-corruption campaigns. CPC Secretary General Hu Jintao confirmed earlier this year "the country's corruption situation remains severe, and the anti-corruption task remains arduous".²⁰

Complying with the FCPA in a Developing Country

US businesses and businessmen in China face many of the same FCPA problems that arise elsewhere in the world. These problems are not unique to China, but may have an important impact on a US company's ability to conduct its business there.

Who Is Covered by the FCPA?

The FCPA does not apply directly to companies that are organized outside the United States. Similarly, no provision of the FCPA makes a US company directly liable for improper payments by a foreign subsidiary, even a subsidiary that is majority owned and controlled. The DOJ takes the view, however, that a US parent company "may be liable [for acts of a foreign subsidiary] if it authorizes, directs or participates in the activity in question".²¹ This liability encompasses acts of which the parent company knew and approved and acts of which it "should have known". In other words, wilful ignorance is not a defence; companies are expected to take reasonable measures to detect and prevent violations by their subsidiaries. Both the DOJ and the SEC expect that publicly listed companies will use good faith efforts to ensure FCPA compliance by their foreign subsidiaries. They also presume that a parent company can control at least its majority-owned subsidiaries. Further, any individual US citizen or resident who acts on behalf of a foreign subsidiary is personally liable under the FCPA. This liability extends to both employees at the parent corporation and those seconded to the subsidiary.

By these standards, most US companies must assume that their business activities in China are covered by the FCPA. All US companies and individuals doing business directly in China (e.g., through a representative office) are subject to the bribery provisions of the FCPA, and all listed US companies are subject to the accounting provisions as well. Most US companies investing in China through subsidiaries use either wholly foreign-owned enterprises (WFOEs) or majority-owned Sino-foreign joint ventures (JVs). Even when it holds only a minority investment in a JV (e.g., in industries where foreign majority ownership is barred by law), a US parent company typically includes significant corporate governance protection for its minority rights in the applicable contractual arrangements and can use those provisions to exercise some control over company policy. As a result, the DOJ and SEC will expect most US companies to cause their subsidiaries in China to conform to the FCPA and will hold them liable for failure to do so. Most US companies also direct the most important business activities of their Chinese subsidiaries from US headquarters and second US nationals or residents to senior positions in their Chinese subsidiaries. These individual employees will all be personally subject to the FCPA's requirements and prohibitions in any event.

The FCPA also applies to all "issuers" of securities as defined by the US securities laws.²² In the last decade or so, about 50 Chinese companies have listed on the US exchanges (generally in the form of American Depositary Receipts in offshore holding companies). In the first half of 2004 alone, eight companies listed. These companies are now "issuers" and, accordingly, are "US persons" subject to both the anti-bribery and the accounting control provisions of the FCPA. The application of these US statutory requirements to Chinese companies operating in China raises particularly difficult issues, which are discussed below.

Responsibility for Local Agents and Partners

Doing business in China generally entails the use of local partners and agents. In most Sino-foreign JVs, responsibility for dealing with local government officials and obtaining necessary approvals is typically not in the foreign investor's hands but lies with the Chinese partner. Even for WFOEs, it is often necessary to use local intermediaries with the right guanxi to obtain necessary government approvals. Also, for many years foreign companies in China have been barred from engaging directly in import/export transactions and from distributing products that they do not manufacture within China.²³ As a result, sales in China (including sales to government agencies) often require a complex web of local agents and independent middlemen.

As in other countries, US businesses in China are responsible under the FCPA for ensuring that their local agents and partners do not pass on part of their remuneration to government officials in exchange for business - or, to phrase it another way, for ensuring that their agents do not do indirectly what the US businesses are prohibited from doing directly. US authorities will expect US companies to make a good faith effort in this regard by performing reasonable due diligence on their agents and partners, obtaining appropriate representations and warranties in contracts, and, where possible, checking the agents' books and records. Language and cultural barriers, however, as well as the opacity of many Chinese government approval procedures, may make compliance with these requirements unusually demanding in China.

Expense Reimbursements

Most companies have a legitimate interest in bringing current or potential customers to their facilities to demonstrate products and technologies. The FCPA recognizes this interest by exempting from the prohibitions of the Act "reasonable and bona fide expenditures, such as travel and lodging expenses, incurred by or on behalf of a foreign official .... and directly related to (A) the promotion, demonstration, or explanation of products or services, or (B) the execution or performance of a contract with a foreign government or agency thereof".²⁴ These principles seem simple, but it can be complicated in practice to determine whether particular expenditures are, for example, "reasonable and bona fide" and "directly related" to "promotional" activities.

Overseas trips by Chinese officials or SOE officers have been especially problematic for many US companies. Until recently, Chinese officials have had few opportunities to travel abroad and have often wanted to take full advantage of the opportunities that do arise. They have sometimes pressured their hosts to arrange side trips to tourist destinations, often bringing their spouses along as well. Chinese officials are sometimes displeased to learn that, because of FCPA constraints, the host company expects them to pay personally for such side trips or spousal costs. These kinds of problems might become less prevalent as Chinese officials have more opportunities for international travel, but they seem too engrained in the culture of Chinese officialdom to go away entirely.

Competing on an Uneven Playing Field

The FCPA was enacted in 1977, and for many years the US was the only country with laws prohibiting its companies from paying bribes in other countries. In 1998, however, most OECD members adhered to the OECD Anti-Bribery Convention,²⁵ which obligates the parties to enact laws with prohibitions similar to those of the FCPA.²⁶ Over 100 countries have also signed the new U.N. Convention against Corruption, which requires parties to amend their domestic laws to prohibit a wide range of public and private sector corruption.

There is little evidence, however, that such multilateral initiatives have had much impact on non-US companies doing business in China. If other governments have penalized, or threatened to penalize, their companies for engaging in bribery in China, they have done so quietly. This may change as other countries more rigorously implement their Anti-Bribery Convention undertakings.²⁷ In the meantime, however, the general sentiment in the US business community in China is that US companies must compete on an uneven playing field. Many US companies feel that the FCPA bars them from engaging in activities that, however improper, they feel are necessary to obtain business in China, while their competitors from Europe, Japan, and elsewhere appear to act with impunity.

The competitive impact of these conditions varies between economic sectors. Products with distinguishing quality, prominent brand names and technological or other unique features raise fewer difficulties. The problems are greatest where products are relatively commoditized, and well-placed gratuities to the right government officials can be decisive in making sales.

FCPA Problems with Chinese Characteristics

The foregoing problems are serious for many US companies doing business in China, but they are not qualitatively different from those in many other developing countries. Some FCPA problems, however, bear distinct Chinese characteristics.

The "Foreign Official" Problem

The FCPA prohibits payments to "foreign officials", who are defined to include any "officer or employee of a foreign government or any department, agency, or instrumentality thereof, ... and any person acting in an official capacity for or on behalf of any such . . . instrumentality".²⁸ "Foreign official" thus clearly encompasses, as it would in any country, government officials with authority to award contracts, approve investments, or discharge similar functions. The DOJ has also interpreted the phrase "officer or employee of a foreign government . . . instrumentality" to encompass officers and employees of commercial enterprises that are wholly government-owned.²⁹ This has significant consequences in China because, despite extensive privatization in recent years, a large part of the Chinese economy remains in state hands in the form of state-owned enterprises (SOEs).

Application of the FCPA to officers and employees at SOEs is consistent with Chinese law, which defines "state functionary" broadly. Article 93 of the Criminal Code, for example, defines "state functionary" for purposes of the criminal bribery laws to include "all personnel of state organs", and specifically includes personnel at state-owned "corporations" and "enterprises". The recent CPC Regulations on Disciplinary Penalties likewise apply to all party members appointed to positions at SOEs.³⁰

The officers and directors of SOEs are generally appointed by the government entity or entities that "own" or control them. Appointment procedures vary to some extent from locale to locale, but all involve some form of joint decision making by government and CPC entities. If the company's equity is in the form of "state shares", those shares will be held by a government entity at a central, provincial or local level, and the company's officers and directors will be appointed by the government at that level. Many SOEs also issue "legal person shares" that are held by other SOEs, which will then also have a role in the appointments. The appropriate level CPC committee will play a central role in these appointments because most (or all) of the appointees to senior positions at the SOE will be party cadres.³¹ In every SOE, moreover, there is a CPC organization that parallels many management functions. All of the officials in the party committee at the SOE are appointed by the CPC, and all, therefore, are "officials of a foreign political party" within the terms of the FCPA. Many individuals wear both company and party hats - e.g., the CEO may also chair the CPC committee.³²

A US company must assume that virtually everyone acting for an SOE (at least an unlisted SOE - see below) is a "foreign official" for FCPA purposes. This includes the officers and directors at most of China's large SOEs. Indeed, entire sectors of the Chinese economy remain almost entirely state-owned or controlled (such as hospitals and medical institutions, and transportation companies). In addition to officers and directors, any SOE "employee" (the term used in the FCPA) in a position to influence the award of business should also be considered a "foreign official" within the scope of the Act.³³

As a result, many business relationships that would be considered wholly private elsewhere are public in China and bring the FCPA into play. An action that would be a commercial bribe in most countries - objectionable in its own right, to be sure, and subject to criminal penalties under local law - is thereby transformed into a potentially serious crime in the US as well.

Listed SOEs: More Questions than Answers

Many hundreds of SOEs are now listed on either domestic or foreign stock exchanges, and their status as "foreign government instrumentalities" for FCPA purposes is less certain. The ownership structures of these SOEs vary considerably. In some cases, the state retains a majority of the equity in the company and has the right to appoint a majority of the company's board and some, if not all, senior management. In others, the state may have only a minority equity interest and correspondingly limited board rights, or the state's interests may be limited by shareholder agreements, bylaws or other corporate governance instruments.

The status of officers and directors of SOEs listed only on a Chinese exchange will generally resemble that in non-listed SOEs. With few exceptions, the state retains a majority, non-listed interest in the equity of domestically listed companies. As one recent research study has concluded

"[T]he companies that are listed on China's stock exchanges are mostly SOEs. They have strong links with the government, especially local governments, and their boundaries with their parent [state-owned] groups are relatively new and often artificial."³⁴

The government entities (or other SOEs) that control a domestically listed SOE may thus appoint the company's officers and directors in consultation with the CPC, as described above. Tenev and Zhang concluded that 70% of the directors of domestically listed companies in China were appointed by the government or the party.³⁵

Under these circumstances, the DOJ and SEC would likely view state-owned or controlled, domestically listed SOEs as "foreign government instrumentalities" for FCPA purposes and treat the officers and directors of those companies as "foreign officials". Whether SOEs that are not state-owned or controlled would be similarly treated is less clear. It may reasonably be questioned whether an SOE that is not state-owned or controlled can properly be deemed a "foreign government . . . instrumentality". Nevertheless, the officers and directors of an SOE who have been appointed by government or party entities are presumably operating at the direction of those entities, at least in certain respects. Hence, these individuals may have the ability to influence the awarding of business contracts at some companies. The question is not, therefore, free from doubt.

More generally, the corporate governance of SOEs listed on Chinese exchanges is changing rapidly. Many of the larger, more successful companies are encouraged to operate independently of the government, and there is considerable pressure both to require independent directors on corporate boards and to impose a duty to exercise an independent business judgment even on directors appointed by government entities or the party. The officers and directors of many of these companies also insist that they exercise a high degree of independence even if the government is their ultimate shareholder and had a role in their appointment. Whether listed SOEs with such a corporate governance structure should at some point no longer be deemed "foreign government instrumentalities" is another open question.

Further complications arise with respect to SOEs that have listed shares in the Hong Kong or, more particularly, US markets. Some of these companies still trade only a minority of their shares on the HK or US exchanges; a majority of the shares remain state-owned or controlled. In other cases, the company listed on the US exchange may be an offshore holding company whose principal operating assets are in China. Chinese government entities may hold shares in the offshore, listed parent company or may continue to hold onshore "state shares" in the operating Chinese subsidiaries. At least some of the officers and directors of such companies, both in China at the operating company and offshore at the holding company level, are appointed by the same combination of government and CPC procedures discussed above. It is possible that the DOJ and SEC would consider at least the state-owned or controlled companies as "foreign government instrumentalities", and their officers and directors as "foreign officials" for FCPA purposes.

Note, however, that in the performance of their corporate duties most of the officers and directors of these companies are subject to the laws of the country in which the company is organized (e.g., the BVI or Bermuda) and the securities laws and exchange rules of the jurisdiction in which the company is listed (the US or Hong Kong). Even if the individuals have been appointed by Chinese government entities, these laws and rules may impose significant constraints on their ability to act as Chinese "officials". The US-listed companies, moreover, are themselves treated as "US persons" subject to the FCPA (see above). It would be anomalous, to say the least, if by virtue of Chinese government equity interests in the companies, they could be treated as both "US persons" and "foreign government instrumentalities" for purposes of the FCPA.

Thus, there are many complications raised by the various ownership and corporate governance structures of Chinese SOEs that have listed their shares abroad. The DOJ and SEC have not been required thus far to interpret the applicability of the FCPA to any of the possible scenarios. In the absence of such interpretations, it is difficult to state with confidence precisely what rules apply. Each case may have specific factual circumstances that could be determinative. These uncertainties place a difficult and, in many respects, unfair compliance burden on US companies that have to deal with Chinese SOEs.

Chinese Anti-Corruption Laws: The Gap between Theory and Practice

China's anti-corruption laws are generally congruent with the FCPA. A "payment to a foreign official" that violates the FCPA will almost certainly violate both the Chinese Criminal Code and the CPC's Regulations on Disciplinary Penalties as well. In theory, therefore, Chinese businesses following Chinese law and US businesses trying to follow both Chinese law and the FCPA should be operating by the same standards. China's enforcement of its laws is highly capricious, however, and this confronts US businesses with a very different reality.

As the central government's repeated anti-corruption campaigns vividly illustrate, many of China's anti-corruption laws are simply not enforced in practice. Decentralization of China's administrative structure is perhaps the greatest single factor in this regard. There are undoubtedly many Chinese officials at various levels of the government who strive to enforce China's anti-corruption laws and policies. But actually enforcing those laws and policies is another matter entirely in China's huge, diffuse economy. Local governments and officials often have direct or indirect financial interests in businesses in their districts. Police and other enforcement officials may themselves have such interests or may be as corrupt as the officials they are charged with supervising. The Chinese press is full of stories of local corruption that the central or provincial authorities seem to be unable or unwilling to control.

In other instances, failure to enforce the corruption laws against Chinese companies is, in effect, government policy, although the government would not admit this. China's health care industry, for example, employs tens of thousands of doctors, nurses, technicians and other medical personnel. Pay in the government health sector, however, lags far behind compensation in the private sector. Doctors and other medical personnel therefore often try to supplement their incomes. They may arrange for their hospitals to enter into procurement contracts at inflated prices to finance personal kickbacks, accept "consulting fees" from supplier companies, or resell medical supplies purchased for the institution. (Such resales typically involve reusing medical supplies intended for single use and selling off the resulting excess inventories for their personal accounts-a practice that raises serious public health, as well as corruption, issues.) These practices are all illegal. They are also widely known and often tolerated by a government that cannot or will not increase salaries in the health care industry to the levels necessary to retain leading professionals.

Chinese law enforcement authorities turn a blind eye in these situations out of consideration for the interests of the Chinese recipient of the unlawful payment. In many instances, they may be willing to turn that same blind eye regardless of whether it is a Chinese or a foreign company that is making the illicit payment. There may thus be no more risk that the applicable Chinese laws will be enforced against a US company than against a local Chinese company. Because of the FCPA, however, the US company still faces a significant risk under US law. The FCPA does, to be sure, authorize as an affirmative defence to its prohibitions any payment "that was lawful under the written laws and regulations of the foreign official's . . . country". But therein lies the rub: such payments, although tolerated locally, are plainly not lawful under China's "written laws and regulations". US law thus bars US companies from making payments in China that are in theory also barred under Chinese law but are condoned in practice.

This disparity between the legal risks for US and local companies exacerbates the uneven playing field problem discussed above. A US company may find it very difficult to compete with local Chinese businesses in China that can pay kickbacks to customers with impunity, while the FCPA restrains the US company from doing so. If foreign competitors are not similarly restrained by the laws of their own countries, it may be the US company alone that is unable to compete in a given market.

The Gift-giving Conundrum

Chinese administrative regulations prohibit officials from receiving "gifts", which are defined as cash, anything of value or any benefit. This includes gifts in a "disguised form", such as compensation for attending fictitious meetings.³⁶ The CPC's Regulations on Disciplinary Penalties are even more comprehensive, and prohibit any official from accepting "any gift that might affect his impartial exercise of a public function" without, as elsewhere required, registering receipt of the gift and surrendering it to the state.³⁷ The Regulations on Disciplinary Penalties also enumerate a broad range of banned gratuities, including: acceptance of property or labour without payment;³⁸ payment for the education of an official's relatives abroad;³⁹ and even "acceptance of a dinner offer that might affect the impartial performance of a public function".⁴⁰ Some officials also confirm that they are instructed not to accept invitations to play golf because the green fees and related costs are considered exorbitant and potentially corrupting. Internal CPC regulations indicate that gifts with a value of Rmb100 should be registered; gifts valued at more than Rmb200 should be surrendered; and an individual official should, in any event, receive gifts in a single year totalling no more than Rmb600.⁴¹

China, however, has long traditions of both gift-giving and conspicuous entertainment. The limitation that gifts to officials should not exceed Rmb200 is openly ignored. Major Chinese companies-indeed, most Chinese law firms-routinely make much greater expenditures to entertain officials. The suggestion that a dinner for Chinese officials should be no more than Rmb200 per person is typically met by incredulity in any meeting with Chinese businessmen. There is undoubtedly a point at which the Chinese parties feel that a culturally acceptable gift or entertainment is crossing the line into an improper bribe, and that point varies from official to official and company to company. There is no doubt, however, that the culturally acceptable practice in this area is at variance with the puritanical standards in the CPC regulations.

This, too, poses a serious problem for US companies seeking to do business in China. Government officials and business contacts at SOEs will expect US companies to follow local standards in gift-giving and entertainment, particularly because they consider the US companies more affluent than the local ones. But while Chinese companies may ignore the official gift limitations in the expectation that they will not be enforced, US companies that do so risk violating the FCPA. The FCPA only allows promotional and entertainment expenditures to the extent permitted by China's "written laws and regulations", even though such written measures are observed solely in the breach. Whether restraining US firms from more lavish gift giving or entertainment harms business is difficult to say. At a minimum, it remains a source of continuing embarrassment in relations with government officials and SOE executives, who may consider US businesses as ungenerous and impolite.

New "US Persons" Subject to the FCPA

Chinese Companies Listed in the US

As noted above, more than 50 Chinese companies have listed on US exchanges over the last decade. Most were originally SOEs. Indeed, the Chinese government still permits many SOEs to trade only a small part of their shares and itself retains a controlling interest. Such companies in China will inevitably have an intricate web of relationships with government officials and other SOEs. The officers and executives of these companies are accustomed to operating in a Chinese business environment where, as we have seen, corruption is rife, and the companies' principal operations will continue to be in that environment. It will be extraordinarily difficult for these companies to change their corporate cultures or to cause their Chinese employees - particularly senior cadres appointed by the government and CPC - to conduct themselves in China in accordance with standards legislated in the US. Local Chinese business partners may pressure these listed companies into practices that remain widespread in China but violate the FCPA. In short, it is reasonable to anticipate that many of these listed Chinese companies will sooner or later run afoul of the FCPA by conducting Chinese business according to local business practices.

The domestic activities of listed Chinese companies will, to some degree, remain opaque to US law enforcement authorities. Nevertheless, they must still meet US securities law disclosure and accounting requirements, and they can expect much closer scrutiny from US securities regulators than that to which they are accustomed. Further, these internationally listed companies will face an increasingly competitive environment even within China; their competitors will have every incentive to identify and report potential violations of US law.

Chinese Businesses Organized in the United States

Another new and rapidly expanding category of businesses involved in Chinese trade and investment consists of companies established in the United States by Chinese-born individuals who are US citizens or permanent residents. Such companies often capitalize on linguistic and cultural skills to carve out niches in US-China trade or investment. But it is precisely this ability to function in the Chinese business milieu that may create FCPA problems. Although many of these companies are run by sophisticated (often Western-educated) entrepreneurs who are accustomed to US laws and business practices, many others are not. The latter may be particularly susceptible to pressures to conform to local business practices and the expectations of government officials. Most of these businesses are not publicly listed and thus not subject to the FCPA's "books and records" requirements. Nevertheless, these companies and the individuals who own and manage them are subject to the anti-bribery provisions. Many of these enterprises may not even be aware that they remain subject to potentially severe criminal and civil penalties under US law when they are conducting business in China.

Complying with the FCPA in China

China is, then, a very difficult environment in which to operate within the constraints of the FCPA. Nevertheless, US companies can minimize their risks if they anticipate these problems.

Compliance Programmes

The best way to deal with the FCPA is to set up a corporate compliance programme that minimizes the risk that improper payments will be made in the first place. Most companies address FCPA issues through general compliance programmes along with US export control rules, the Sarbanes-Oxley Act and other US statutes with extraterritorial effect. A typical compliance programme involves two elements: clear written guidelines that are made available to all personnel operating in China; and effective training of all personnel, particularly sales and accounting personnel.

Particular attention must be paid to training in China. Most US companies operating in China will primarily use local staff for sales because of their obvious cultural and linguistic advantages. The same is often true for in-house accountants. Many of these Chinese nationals will be accustomed to an environment where unlawful payments or extravagant gratuities are common and will not be familiar with the FCPA. Many will also be aware that, as often as not, Chinese law enforcement authorities ignore transgressions of similar Chinese laws. It is, therefore, very important to design training programmes that are sensitive to the Chinese operational environment and can deal realistically with problems that confront employees in their day-to-day businesses. US companies in China will also wish for many reasons to improve the accuracy and transparency of their accounts. The need to comply with FCPA accounting control provisions provides an added incentive to be sure that local accountants fully understand the company's requirements in this regard.

A well-designed compliance programme can minimize the potential for FCPA violations to occur in the first place. Equally importantly, if violations do occur, having an effective compliance programme in place will minimize the risk to the company. US law enforcement authorities recognize that problems sometimes arise even in the best companies and are inclined to be less severe with those companies that have attempted to minimize the problems by taking prophylactic measures.

Appropriate Contracting Procedures

Companies can also protect themselves from FCPA problems by paying careful attention to FCPA issues in their contracts. This will generally entail, in the first instance, the inclusion of standard representations and warranties in contracts with agents and distributors affirming that the local party understands the FCPA obligations of the US company and confirming that it will not engage in actions that would cause the US company to violate those obligations. There are many boilerplate contract terms that may be used for this purpose, which vary considerably in their clarity and comprehensiveness. Ideally, many US companies will also wish to have access to the books and records of their Chinese agents and distributors to ensure that the latter are not engaged in improper activities and to be able to prove this if questions do arise. Chinese parties, particularly government entities, often resist accepting FCPA clauses of any sort in their contracts as a matter of principle because they find the extraterritorial application of a US law objectionable. Under these circumstances, negotiating terms that will give sufficient comfort to the US company and that are still satisfactory to the Chinese party can be difficult.

Dealing with Questionable Payments

Potential FCPA problems that do arise need to be dealt with on several levels.

First, no matter how good the FCPA training and how detailed the internal guidelines, it will not always be clear to employees whether particular activities give rise to a problem or not. Most employees are not lawyers; they are generally sales people or accountants. A company must, therefore, have a system in place that permits employees to raise potential problems with those who can answer them. In at least some instances, the people involved in the potential transgressions may be the reporting employee's own supervisors or others in a position to engage in retribution. The reporting system must permit access to someone who can ensure that the identity of the reporting person is protected. Some companies give this function to in-house attorneys. Some have "hot line" systems that permit reports or telephone calls (anonymous if necessary), which can initiate an investigation without disclosing the source of the information.

If the company's internal procedures establish that there is a reasonable possibility that a violation has occurred, it will be important for the company to act promptly and thoroughly. US enforcement authorities are less likely to impose severe penalties on companies that can show that they investigated the problems quickly and took remedial action. Delays in an investigation, or investigative procedures that tip off potential violators, may permit the destruction of evidence or the coordination of testimony. In some situations, law enforcement authorities may infer that this was done intentionally.

FCPA investigations are most often conducted by outside counsel, typically working in conjunction with in-house attorneys and sometimes an internal audit office. Outside counsel can be expected to have the necessary independence to ensure a thorough, professional investigation. There is also the potential risk of directly or indirectly related lawsuits, e.g., a shareholders' derivative action if FCPA violations have occurred and the value of the company's shares has diminished as a result. If the investigation is properly conducted by outside counsel, client-attorney privilege will generally prevent the disclosure of the investigative details to third parties, even in litigation.

Counsel will then report to the company's board of directors and will ordinarily make recommendations for remedial actions. If there is any reason to believe that members of the board are involved in the activities under investigation, a separate sub-committee, e.g., of independent directors, may be authorized to take charge of the investigation and make decisions on behalf of the company. Remedial actions may include steps directly related to the investigation itself: e.g., termination or censure of employees who have acted improperly; or termination of agents or customers who have acted improperly. Other measures may be more long-term, e.g., additional FCPA training for staff or improved procedures for the handling of potential FCPA complaints.

If violations have occurred, it will also be necessary for the company to decide whether to disclose the violations voluntarily to the DOJ or the SEC. There is no obligation for the company to turn itself in. In some instances it may be reasonable to conclude that the transgressions were relatively minor and the remedial actions sufficiently prompt and effective that the company itself is unlikely to be held liable if the matter is disclosed. In other instances, however, the better course of action may be voluntary disclosure on the theory that law enforcement officials will be understanding of companies that have identified problems, acted to remedy the problems, and also sought to ensure, through consultations with the government, that the company has properly brought itself back into line with the law. Conversely, failure to disclose violations of the FCPA voluntarily runs the risk that the government will learn of the problems from other sources, e.g., a competitor or a disgruntled employee, and be much less sympathetic.

Conclusion

FCPA problems in China will not go away soon. All US companies must be attentive to these problems or face the risk of incurring severe penalties that may cripple their business in China (and potentially elsewhere). US companies can provide themselves with significant protection if they put a comprehensive compliance programme in place beforehand and if they are prepared to act promptly and effectively to remedy any problems that do arise.

Endnotes

1 See 15 USC. §§ 78m(b), 78dd-1, 78dd-2, 78dd-3, 78ff(a), (c). For a thorough analysis of the FCPA, see O'Melveny & Myers, LLP, The Foreign Corrupt Practices Act (5th ed., 2004).

2 See Associated Press, 11:23 AM ET, April 6 2004. The "deficiencies in foreign operations" in China surfaced during an internal audit the company conducted in response to bribery claims made against its operations in Saudi Arabia.

3 The anti-bribery provisions appear in separate statutory sections applicable to "issuers" (15 USC § 78dd-1), "domestic concerns" (§ 78dd-2) and "persons other than issuers or domestic concerns" (§78dd-3). The operative prohibitions are virtually identical in the three sections.

4 See 15 USC § 78m.

5 The FCPA amended the Securities Exchange Act of 1934 by adding Section 13(b)(2)(A), which requires "every issuer" that must register its securities with the SEC under the Exchange Act or otherwise make periodic reports to the SEC to "make and keep books, records and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer"(15 U.S.C. § 78m(b)(2)(A)). SEC Rule 13b2-1 adds that "[n]o person shall directly or indirectly falsify, or cause to be falsified, any book, record or account subject to section 13(b)(2)(A)".

6 Transparency in reporting transactions of this kind also facilitates enforcement of US tax laws since proper commissions are a deductible expense while bribes are not.

7 See 15 USC §§ 78dd-2(g), 78dd-3(e), 78ff(c) (civil and criminal penalties). See also 18 U.S.C, § 3571(b)(4) (allowing maximum fines higher than those specified in the original FCPA code sections).

8 Companies may not indemnify their officers and employees for such fines.

9 See 18 U.S.C, § 3571(d) (alternative maximum fines based on gains to defendant or losses to third parties).

10 See 15 U.S.C. §§ 78ff(c), 78u(d)(3).

11 In 2004, Transparency International gave China a corruption score of 3.4 on a scale of 1 (most corrupt) to 10 (least corrupt). China ranked 66 out of 133 countries on that index (with number 1 being the least corrupt). See Transparency International, Global Corruption Report 2004 177 (2004), available at http://www.globalcorruptionreport.org.

12 See "Party Watchdog Vows to Fight Corruption," Xinhua News Agency, February 23 2004, available at http://www.china.org.cn/english/2004/Feb/88114.htm.

13 See "Six Corrupt Senior Officials Sentenced in 2003," Xinhuanet, March 10 2004, available at http://english.pladaily.com.cn/special/e2004lh/zyxw/31.htm. From 1992-97, 669,300 were reportedly punished.

14 Criminal Code of the People's Republic of China (中华人民共和国刑法), revised and effective as of October 1 1997, Articles 383 and 390. The "seriousness" of an offence generally relates to the amounts of bribes involved. For example, if a state functionary receives bribes of more than Rmb100,000, at least ten years' imprisonment or life imprisonment should be imposed, and the property of the defendant may be confiscated. Other factors, such as the defendant's conduct and the harm to society, affect whether the case is "serious" or "exceptionally serious". There are also specific proscriptions of bribery in the PRC Invitation and Submission of Bids Law (中华人民共和国招标投标法), effective January 1 2000, which apply to all public tenders and bids in China.

15 For instance, the China Daily (December 30 2003) reported that Wang Huaizhong, the former provincial vice-governor of Anhui province, was sentenced to death for accepting bribes totalling Rmb5.17 million and holding large amounts of assets for which he could not account. On October 11 2001, the People's Daily reported that Mu Suixin, a CPC official and former governor of Shenyang province, was sentenced to death with two years' reprieve, and his deputy, another CPC official, was sentenced to be executed.

16 See Article 31 of the Provisional Regulations for State Public Servants (国家公务员暂行条例), promulgated August 14 1993.

17 See Regulations Prohibiting State Administrative Agencies and Their Personnel from Presenting or Accepting Gifts in Performing Official Duties in China (国家行政机关及其工作人员在国内公务活动中不得赠送和接受礼品的规定), December 1 1988.

18 See the Provisional Regulations Regarding Administrative Sanctions for State Administrative Personnel Who Commit Corruption and Bribery (国家行政机关工作人员贪污贿赂行政处分暂行规定), September 13 1988.

19 See Central Committee of the CPC, Provisional Regulations on Internal Supervision (中国共产党党内监督条例 (试行)), December 31 2003 and the Regulations on Disciplinary Penalties (中国共产党纪律处分条例), December 31 2003.

20 See "Party Enhances Internal Supervision," PLA DAILY, February 18 2004, available at http://english.pladaily.com.cn/english/pladaily/2004/02/18/20040218001009_TodayHeadlines.html.

21 DOJ, Foreign Corrupt Practices Act Anti-bribery Provisions (updated March 15 2002), available at http://www.usdoj.gov/criminal/fraud/fcpa/dojdocb.htm. (February 1992).

22 See 15 USC §§ 78m, 78dd-1.

23 These rules are rapidly changing as a result of China's WTO commitments, but many of the complex sales and distribution structures that use local middlemen remain in place.

24 15 U.S.C. §§ 78dd-1(c)(2), 78dd-2(c)(2), 78dd-3(c)(2).

25 Convention on Combating Bribery of Foreign Public Officials in International Business Transactions, December 17 1997, 37 I.L.M. 1 (entered into force February 15 1999).

26 The OECD reported that, as of June 2004, 27 of 36 parties to the Convention had submitted implementing legislation. See OECD, Steps Taken and Planned Future Action by Participating Countries to Ratify and Implement the Convention on Combating Bribery of Foreign Public Officials in International Business Transactions 1 (June 2004), available at http://www.oecd.org/dataoecd/50/33/1827022.pdf. It appears that several other countries have enacted implementing legislation but have not yet filed that legislation with the OECD.

27 There is some evidence that European governments are beginning to enforce corruption laws against their nationals. In June 2004, the Norwegian National Authority for Investigation and Prosecution of Economic and Environmental Crime (Okokrim) fined Statoil ASA 20 million kroner (US$2.9 million) for corruption in a consulting deal in Iran. In May 2004, the British Ministry of Defence began investigating allegations that BAE Systems, Britain's largest defence contractor, paid over 60 million pounds in bribes to prominent Saudis in return for arms deals. The Financial Times (March 23 2004) reports, however, that UK authorities conduct few such investigations despite numerous allegations of overseas bribery and despite the availability of statutory authority enacted pursuant to the OECD Bribery Convention. Similarly, Transparency International reports that Japan has taken no actions in this regard and that Japan's 1999 statutory prohibition of overseas bribery has been criticized for including numerous loopholes, including the exclusion of all subsidiaries of Japanese companies. See GLOBAL CORRUPTION REPORT 2004, supra note 12, 200.

28 15 USC §§ 78dd-1(f)(2)(A), 78dd-2(h)(2)(A); 78dd-3(f)(2)(A).

29 See US Department of Justice, FCPA Review Procedure Release No. 93-1 (Apr. 20, 1993)(quasi-commercial entity "wholly owned and supervised by the government of a former Eastern bloc country . . . is an instrumentality of the foreign government for purposes of the FCPA").

30 See, e.g., Regulations on Disciplinary Penalties, Articles 84, 89 and 91 (on prohibitions applicable to SOEs).

31 The directors and principal representatives of an SOE are appointed by the state-owned investment entity or enterprise that holds the equity interest in the SOE. The board then appoints management, typically party members as well. See Central Committee of the CPC, Outline for Deepening the Cadre Personnel System Reform (深化干部人事制度改革纲要), June 23 2000. As a matter of practice, however, the directors and senior management of prominent SOEs are often appointed by the Central Committee of the CPC itself or by the provincial committee of the CPC.

32 CPC rules anticipate that the head of the party committee at an SOE will sit on the company's board and, conversely, that most of the directors, supervisors, managers, and labour leaders of the company will also sit on the party committee. See Central Committee of the CPC, Decision on Major Issues Concerning the Reform and Development of State-Owned Enterprises (中共中央关于国有企业改革和发展若干重大问题的决定), September 22 1999.

33 Note the inclusion in the FCPA's definition of "foreign official" of "any person acting in an official capacity for or on behalf of any such . . . instrumentality". See 15 USC §78dd-2(h)(2)(A).

34 S. Tenev & C. Zhang, World Bank and the International Finance Corporation, Corporate Governance and Enterprise Reform in China 75 (2002).

35 Idem at 83.

36 Regulations Prohibiting State Administrative Agencies, supra note 18.

37 Regulations on Disciplinary Penalties, supra note 20, Article 74.

38 Ibid, Article 72.

39 Idem.

40 Ibid, Article 80.

41 See Measures Concerning Registration and Disposal of Gifts Accepted or Received from Contacts in China by Personnel of Central Party and Government Agencies (关于中央党政机关工作人员在国内交往中收受礼品登记和处理办法), issued jointly by the Government Offices Administration of the State Council and Government Offices Administration under CPC Central Committee, September 2 1995. See also, Shanghai CPC, Measures of Shanghai for Implementing the "Rules Concerning Effecting Registration System for Gifts Accepted or Received from Contacts in China by Personnel of Party and State Agencies" (上海市实施《关于对党和国家机关工作人员在国内交往中收受的礼品实行登记制度的规定》的办法) June 21 1995 and Notice of the General Office of CPC Shanghai Committee and General Office of Shanghai Municipal Government for Forwarding the "Notice of Shanghai Disciplinary Committee and Shanghai Supervision and Inspection Committee Concerning Reiteration on Prohibition of Leading Cadres from Receiving and Accepting Cash or Securities" (中共上海市委办公厅，上海市人民政府办公厅转发《市纪委，市监察委关于重申领导干部不准收受与公务有关的现金和有价证券的通知》的通知), December 29 2000 (requiring that all gifts of less than Rmb200 but more than Rmb50 be registered; that all gifts over Rmb200 be turned in, and that no cash or securities be accepted); Zhejiang Province CPC, Implementation Opinions for Effecting Registration System for Gifts Accepted or Received from Contacts in China by Personnel of Party and State Agencies (关于对党和国家机关工作人员在国内交往中收受礼品实行登记制度的实施意见), July 10 1995 (which contains the same basic rules except that gifts of less than Rmb200 need not be registered).