Doing Business in China Should Be “Scary”

china2Lauren Connell, Managing Associate at The Volkov Law Group, joins us again for another posting on corruption risks in China.  Her profile is here and she can be reached at [email protected].

A little fear is healthy. It will keep you vigilant and aware. At this point if corporate compliance departments are not a little fearful of doing business in China then their managers and employees are not doing their jobs.

Novartis’ $25 million FCPA settlement involved two China-based subsidiaries. Only a few weeks before that, PTC Inc. paid $28 million for actions involving travel and entertainment for Chinese foreign officials. I could keep going; the list literally goes on and on.

Looking forward, the FCPA settlement landscape is going to look much the same. 28 of the 84 companies that have publicly disclosed some sort of FCPA investigation (according to mentioned China in connection with the disclosed facts. That is a full third of all ongoing investigations. This number is staggering.

Companies are reacting. Bristol-Myers Squibb recently announced that it is eliminating “certain initiatives” in China. These changes are widely reported to be curtailing travel and entertainment spending, eliminating paid speaking engagements for doctors, and reducing or eliminating the sponsorship of medical associations due to red flags. Taking these steps may soon become the standard.

A Perfect Storm

Doing business always requires managing risks. Doing business in China requires managing a “perfect storm” of risks:china

  • State-Owned Entities. Although the percentage of state-owned entities’ share of economic output has been steadily decreasing since the late 1970s, they are still major players in banking, transportation, telecom, construction, oil and gas, and healthcare. State-owned entities are so prevalent in China that multinational companies seeking to develop relationships in China may not even know that seemingly private companies are actually state-owned entities or have other close government ties.
  • Broad Definition of “Foreign Official.” We have witnessed  the SEC and DOJ applying a “foreign official” definition that seems to be continually expanding , when the DOJ prevailed on its interpretation of ate-owned “companies” as being an instrumentality of the government.  For drug and device companies, their sales teams interact on a continuing basis with foreign officials.
  • Culture of Gift Giving. Companies seeking to enter or succeed in China are faced with a culture where gifts are an expected part of doing business. Managing expectations of potential customers, while at the same time managing gift and entertainment policies that address an often-gray area of when a gift “crosses the line,” pose unique challenges.
  • Gray Market Income. Chinese doctors are underpaid and generally unhappy with their working conditions. Doctors expect to supplement their meager salaries with “gray market income” –payments in return for their prescribing decisions. Although officially forbidden, it is common. Companies seeking to do business with professionals in China may find themselves being compared to other companies that are offering rebates, kickbacks, or other incentives to utilize their products or services.
  • Conflation of Leisure and Business Travel. China only recently relaxed its restrictions on private Chinese citizens traveling outside of Mainland China, and many Chinese are seeking opportunities to travel to the US and other tourist destinations. Leisure travel that tries to disguise itself as business travel, such as a trip to a US company for one day within a ten day sightseeing tour of the US, have been the target of many recent enforcement actions.

Build a Compliance Program that Can Weather the Storm

With this mix of risks, companies should absolutely be scared of doing business in China, but that doesn’t mean they shouldn’t engage in business at all. Companies should leverage their fear and make sure that their anti-corruption compliance programs are targeted to mitigate these risks.

  1. Train your high-risk employees. Anyone doing business in China should receive regular anti-corruption training targeted to their operational functions. Sales people should be trained on proper v. improper gifts and entertainment while accounting department personnel should be trained to recognize suspicious circumstances, such as an invoice without sufficient detail.
  1. Communicate your expectations geographically. While an anti-corruption compliance program is global in scope, target communications to geographic regions that reflect the risks faced. Make your employees in China aware that you know about the culture of gift giving – and that you can support them to stay on the right side of the law.
  1. china3Conduct Due Diligence. Although opaque corporate, criminal, and investigative records in China pose significant difficulties in conducting sufficient due diligence, that does not mean it cannot be done. Take the time to thoroughly vet your third party business partners, incorporating reference-checking policies. Pay special attention to an entity that does not seem to have any corporate history and dig down until you discover beneficial owners.
  1. Be Proactive. Audit frequently. Make sure policies and procedures are being followed, as training and communication are useless if no one actually implements your internal controls. Look for trends that might be indicative of fraud.
  1. Change Your Policies. Some policies may be too risky or too open for exploitation, especially in high-risk countries. If a policy cannot be administered properly , it may be time to consider banning that activity for the time being.

While you will never be able to fully eliminate the risks of doing business in China, you may be able to mitigate them to make doing business in China a little less scary.

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