Business Intelligence from Dezan Shira Associates
With the news that the U.S. Securities and Exchange Commission has established an office in San Francisco to specifically examine FCPA violations, and as we mentioned in our article on guanxi last week, it is prudent to examine what the Foreign Corrupt Practices Act is and how it impacts American businesses operating in China. It is definitely not an issue that can just be merely tossed into an employment manual, simply because even just dealing with third party brokers between a U.S. business and a Chinese entity can also lead to FCPA violations.
In this article, we examine in detail the Foreign Corrupt Practices Act of 1977, an act all U.S. businesses operating in China need to be very familiar with now that greater attention to the issues is being paid by the SEC.
The FCPA prohibits the corrupt payment of money or bribes to foreign officials for the purpose of keeping or maintaining business. The FCPA also links in with several other U.S. acts, providing for federal prosecution of violations of state commercial bribery statutes. The FCPA requires U.S. listed companies to meet their accounting provisions, which are designed to operate in parallel with the anti-bribery provisions of the FCPA and require corporations to make and keep books and records that accurately and fairly reflect the transactions of the corporation and to devise and maintain an adequate system of internal accounting controls.
The basic requirements of the FCPA are fairly straightforward. Rather, it is the cultural traditions and the common business practices that lend a layer of complexity to enforcement of the FCPA with respect to business done in the Peoples Republic of China. This includes issues over guanxi. While some business practices may be considered entirely acceptable, or even expected, in the course of doing business in China, these practices can often be a violation of the FCPA and are subject to steep fines and jail time in the United States. Companies subject to the FCPA may find themselves faced with making the decision between losing business and violating the FCPA. Violators face the prospect of criminal sanctions, civil sanctions, and injunctions. Criminal sanctions against corporations and other entities can exceed fines of one million dollars. Sanctions against individuals may reach five years in prison and fines of US$100,000.
American companies hoping to retain business in China, as well as American companies with the desire to enter the market, face an imperfect and dubious business environment with respect to the FCPA. However, with meticulous planning, careful oversight, and the proper tools violations of the FCPA can be avoided. The mounting prominence of Chinas position in the world markets is undeniable. Certainly the benefits of investment in China far outweigh the risks presented by the FCPA, so long as the proper precautions are taken. With an annual growth in the GDP of 9 percent for the last 26 years and an increasingly attractive environment for foreign direct investment, foreign companies cannot afford to ignore the opportunities for investment. However, companies subject to the FCPA must be aware of several particular risks that are posed by doing business in China.
A potential violation of the FCPA would include the following elements:
- An act by an individual, corporation, or other business covered by the FCPA
- An offer to give something of value
- To a foreign official
- With corrupt intent
- To obtain or retain business
There are two categories of persons under the FCPA: issuers and domestic concerns. An issuer is essentially a listed company that has filing requirements with the Securities Exchange Commission the enforcing agent with respect to FCPA for issuers. A domestic concern is an individual or any form of business organization not registered with the SEC. The U.S. Department of Justice has enforcement responsibility with respect to domestic concerns. As defined by the Justice Department the FCPA potentially applies to any individual, firm, officer, director, employee or agent of a firm, and any stockholder acting on behalf of a firm. It is vital that individuals or companies considering doing business or currently doing business in China understand that they are likely subject to the standards of the FCPA.
With respect to an offer to give something of value, there is no materiality to this act. It is illegal to offer anything of value as a bribe, including cash or non-cash items. Any promise, offer, or authorization of payment for the purposes of persuading a government official to aid in obtaining or retaining business is prohibited. The actual payment does not need to be successful; rather it is the mere intent to bribe that violates the FCPA. In addition, non-monetary gifts, entertainment expenses, and travel expenses are also prohibited.
There are multiple important and convoluted exceptions to the prohibition of payments to foreign officials. However, these exceptions must be handled very carefully for a multitude of important reasons.
In general, the FCPA allows American businesses to make payments to foreign officials that are lawful under the written laws of the foreign country. Unfortunately, in the context of China, this has the potential to place American companies in a position where they must decide between violating the FCPA and losing Chinese business. China does have written anti-bribery laws on the books; these laws limit the value of gifts that can be given to government officials to RMB200. However, the laws are poorly enforced and are routinely violated by Chinese and foreign companies. Whereas these foreign companies may face limited risk in their routine violation of these laws, companies subject to the FCPA will face stiff penalties from American authorities if they succumb to the more traditional practice of ignoring the anti-bribery provisions. As a result, American companies may be less competitive than their counterparts who are subject to weak or poorly enforced anti-bribery laws. In turn, the desire to increase a companys competitiveness in the face of such adversity may tempt violation of the FCPA and its anti-bribery provisions. It is vital that companies avoid any such violations. Many companies thrive in China despite these competitive disadvantages. Furthermore, the Justice Department has been increasingly willing to prosecute for violations of the FCPA, and a prosecution will likely result in substantial monetary fines and possible jail time. However, it should also be noted that as the Chinese government has so much involvement in its domestic companies, the extent to what a foreign official can be may also be extended to the officer of a Chinese state-owned enterprise, even if he or she is not directly employed by a Government department per se.
A similar dilemma arises with respect to payments made in the furtherance of legitimate business promotion. The FCPA allows for a company to make reasonable expenditures for expenses incurred in the process of promoting products or services. This includes reasonable travel expenses, and certain entertainment expenses. Where an American company pays for travel expenses on behalf of a foreign official, two important requirements must be satisfied. The payment must be reasonable, and it must clearly be for the purposes of promoting or demonstrating a product or service. With respect to entertainment expenses, expenditures have been subject to the RMB200 limit that is applied to gifts.
Again, these clearly articulated and strictly enforced laws may conflict with common Chinese business practice. While the Chinese written anti-bribery laws may be more consistent with the FCPA, they are more restrictive than actual Chinese custom. Therefore, Chinese companies may expect American companies to comply with custom, and these companies may face a loss of business in the absence of compliance. In particular, entertainment is a significant part of Chinese business culture. However, where entertainment involves foreign government officials, which is a common occurrence in China, expenditures by American companies must comply with the Chinese written laws that limit gifts to RMB200. These expenditures may be far less than what is expected from Chinese companies and the individuals representing those organizations. It is vital that companies subject to the FCPA resist the pressure to exceed these limits, despite the potential loss of business.
American authorities have strictly interpreted these exceptions to the FCPA. In particular, even where an American company claims legitimate business expenses, individuals and companies have been prosecuted for expenditures that appear to be intended to influence a foreign official rather than to demonstrate a product or service. They have also strictly enforced the requirement that gifts and entertainment expenditures must comply with the Chinese written anti-bribery laws; these expenditures cannot exceed RMB200. Furthermore, travel expenses that are not strictly reasonable may be considered bribes. For these reasons, in order to avoid serious consequences, it is crucial that companies carefully review any payments that are made under an exception to the FCPA.
In order to violate the FCPA, the offer must be made to a foreign official. For purposes of the FCPA, foreign official is broadly defined. Anyone working for a government-owned or managed institution or enterprise (including doctors, lawyers and accountants) is considered a foreign official. As mentioned, this includes employees of State Owned Enterprises and their subsidiaries. Any businessperson that also serves a foreign governmental agency is a foreign official. Essentially any person acting in an official capacity for the government will fall within the definition. In addition, employees of international organizations are also considered to be foreign officials under the FCPA. Any U.S. business operating in China must pay particular attention to this broad definition, as many Chinese business people serve in dual-capacities as government officials. Ignorance of the persons status does not provide exemption from prosecution for a violation of the act.
Significant problems may arise from this entanglement of Chinese business and government. China is rife with state-owned enterprises. This creates an inherent and significant risk in doing business in China. American companies that choose to work closely with SOEs must be particularly careful that they are not making payments that would typically be considered proper but, due to the nature of the SOE, are actually in violation of the FCPA. In addition, it is important to note that many successful businessmen in China, even those not associated with an SOE, have ties to the Communist Party and may be considered government officials for the purposes of the FCPA. Given the Justice Departments inclination to broadly interpret the provisions of the FCPA, when evaluating a potential business partner, it is vital that American entities carefully evaluate the status of the company or individual with respect to the Chinese government.
In addition, American companies or individuals who enter joint ventures with foreign partners, as well as those who hire foreign agents or distributors in China, must be extremely cautious of the vicarious liability that they may face as a result of a third partys violation of the principles set forth in the FCPA. According to the Justice Department, an American company will be subject to liability under the FCPA if it makes payments to an intermediary third party with the knowledge that such payments will go to a foreign official for corrupt purposes. Conscious disregard is enough to satisfy the requirement; if the American company is aware of a high probability that such payments will occur, the knowledge requirement will be satisfied.
More importantly, a joint venture partner, agent, or distributor will be considered an intermediary third party for purposes of the FCPA. Therefore, any violation of FCPA standards by one of those parties could result in the American company being vicariously liable under the FCPA. This notion, in particular, has a significant impact on American companies doing business in China. In addition to the existing intertwined relationships between Chinese government and business, American companies must also exercise enough caution to ensure that none of their business partners are violating the FCPA as well. This can be difficult for several reasons, not the least of which is the notion that compliance with the FCPA can create a competitive disadvantage. As a result, it is unlikely that any third party will be strongly inclined to agree to comply with American law. However, in the absence of such compliance, the American company may face liability.
The corrupt intent element encompasses the notion of a benefit given or offered to persuade a foreign official to misuse their position or authority through action or inaction and it includes quid pro quo arrangements. Quid pro quo generally assumes the benefit is given with reasonable expectations of some official favor in return. The quid pro quo does not need to have been executed nor does the foreign official need to be able to deliver personally. Again, note that the U.S. government does not need to establish the defendant knew their conduct violated the FCPA. Any offer, payment, promise, or authorization of payment to a foreign official with the intention of securing an advantage in obtaining or retaining business is prohibited by the FCPA.
With respect to the final element, it does not matter whether there is an existing business relationship with the foreign official. Any offer of value to the foreign official to acquire business or to prevent the loss of business is covered by the act.
American companies face significant barriers in navigating the Chinese business landscape while simultaneously respecting the laws established by the Foreign Corrupt Practices Act. Chinese custom can and will often conflict with American law, and businesses may be forced to surrender some competitive advantage in complying with the FCPA. It is important that these companies aggressively monitor company practices and carefully examine potential and existing relationships in China in order to avoid violations of the FCPA and the strict sanctions that may follow.
Dezan Shira & Associates is a fully licensed accounting practice in China and offers business advisory, tax accounting, due diligence, payroll and audit services for multinational clients in China. The firm works with U.S. licensed practices to assist with the provision of FCPA compliance within internal systems in the United States and China, and can also provide due diligence or internal audit services in China should wrongdoing be suspected. Please contact the practice in full confidence at firstname.lastname@example.org. The firms brochure may be downloaded here.