Changes at home and abroad may leave you wondering how to weed out corruption and promote compliance. John Church sheds some light across three major jurisdictions

Earlier this year, Chinese procurator-general Cao Jianming delivered his report to the National People’s Congress with a degree of pride – he’d been busy.

Prosecutors had clamped down on civil servants who abused their power for personal gain or took bribes – 7,366 people in administrative law enforcement were investigated along with 2,395 in the judiciary system, Cao said. A whopping 2,524 officials above the level of county head were targeted, with 198 at the prefectural level and even seven miscreants at ministerial level.

In addition, China has been active in cracking down on commercial bribery, a trend that experts say will continue this year. “A strong stand in terms of stepping up law enforcement aimed at punishing commercial bribery can be anticipated. Thus, if your company is operating in China, the chief enforcement risk you face vis-à-vis PRC regulators in 2012 will be that of commercial bribery, with the unwelcome possibility of FCPA [US Foreign Corrupt Practices Act] enforcement as an exacerbating consequence,” notes K&L Gates in its annual outlook titled Global Government Solutions 2012.

Corruption and lack of effective compliance systems are two sides of the same coin, and the latter has been in evidence in the US of late. Scandal after scandal regarding inadequate compliance and due diligence involving financial reports and disclosures for listed Chinese companies in the past year has prompted a de facto delisting bailout by the China Development Bank, which is throwing US$1 billion into assisting Chinese companies seriously wounded by the scandals to exit the stock market.

With many such companies losing more than half their value, it’s no surprise that only one Chinese company has listed in the US so far this year as opposed to more than 60 in the three years previous. Compliance has been problematic and costly, and experts say expect more US exits and more Hong Kong listings as a result.

Left unchecked, the economic fallout from corruption and non-compliance will eventually come home to roost. Top officials are no doubt aware of this. Premier Wen Jiabao in March pledged to improve government transparency, describing corruption as the “most crucial threat to the ruling party,” which might undermine the country’s political foundations if not dealt with properly.

Perceptions of corruption

Differing views on just what bribery and corruption entail and how deep the roots remain in China’s corporate landscape are reflected in the opinions of some of China’s most respected law firms, and of overseas experts.

corruption1Zhu Xiaodong, a partner at Tian Yuan Law Firm, says cultural perceptions cannot be ignored. “It has been accepted as a practice in China for thousands of years to do business that way – you help me, I help you. That’s the way China has done business. In the minds of Chinese businesspeople, this is not immoral. It is just an expression of thanks. International law is different, and that is bribery for the company is corruption. But in China, that is not always the case.”

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For Jiang Liyong, a partner at Gaopeng & Partners, corruption and compliance can sometimes be boiled down to sectors. “Some industries should pay attention, [because] It really depends on the industry. For example, the consumption industry is OK because you sell the products to the general consumer and you don’t need to bribe them in order to buy shampoo.

“But for some industries, especially if your client numbers are limited, such as producing equipment for a nuclear power station, or a fast train, or for medical equipment, or public entities, it’s a very small number of competitors, and very few customers, so in order to beat the competition there is bribery. I think it is quite common in China, but also in foreign countries.”

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Susan Munro, a partner at Steptoe & Johnson in Beijing, says: “I think it is important to bear in mind that China is a relatively new legal jurisdiction. Clearly you have had a business environment that has been very aggressive, expansionist, that has driven this tremendous economy, [so] inevitably you’ve got a little disconnect between the legal structure and the business reality. Having said that, China itself is clearly aware of the risks of corruption and the requirement for a sound legal structure.”

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Munro adds that as China tries to strengthen the rule of law, those old business practices need to be curbed because they have started to have an economic impact.

“Eventually, when they get out of hand, they reduce the efficiency of the economy,” she says, “and I think that’s what China has recognised. For several years now, it’s been taking steps to improve the criminal legal environment in relation to defining what constitutes a crime or an administrative violation, and enforcement. Also, the Chinese Communist Party itself has taken great initiatives to try and curb corrupt activities by government officials. I think we can see the results of those initiatives now.”

Liu Xingyan, a senior partner at S&P Law Firm, expands: “Things are really changing, and becoming better, for three reasons. First, the government is more closely supervising, and a lot of new laws and rules are being published to deal with [corruption]. Second, the media and the internet – people have more access to information, issues can spread very quickly, so that gives pressure for the government to deal with these issues. Third, business is more mature than before.”

Chris Cox, a partner at Bingham McCutchen, the president of Bingham Consulting and a former chairman of the US Securities and Exchange Commission, is impressed by efforts to control corruption but sees chasms between the regulations in China and the US.

“Last year’s Chinese anti-corruption amendment [Amendment Eight to the Criminal Law], and stepped-up Chinese efforts to crack down on bribery in both offshore commercial transactions and domestic transactions, shows that this is becoming an increasing area of focus for Chinese authorities,” he says. “We are very far away, however, from harmonising the US and Chinese rules in this area, which further complicates an already difficult enforcement challenge for the Chinese authorities. In the meantime, the best protection for US companies is strict controls to comply with both Chinese and US laws.”

Violet Ho, senior managing director at Kroll Advisory Solutions, also comments on disparity. “Anti-corruption is one of the biggest strategic initiatives of the Chinese government. But often there is a gap between what they are doing inside the border and internationally.”

Richard Ma, a partner at TransAsia Lawyers, says the view that China does not have comprehensive anti-bribery legislation reflects a “misunderstanding”. “China does have a very comprehensive code. For example, the 1997 Criminal Law has a comprehensive section regarding corruption or bribery issues. Some of the concepts and provisions, I would say, are quite similar to those under the FCPA and the UK law and to a certain extent the penalties are even more [comprehensive].

“That’s one of the topics that we always pass to foreign investors, and in particular US and UK investors. For example, the definition of a government official – China has a very broad and general definition of government officials, essentially equivalent to that under the FCPA. And the types of bribe … which might be offered to government officials – it is also very similar to those concepts under the US law.”

Recent upgrades

The laws are being continually upgraded, some with evident determination. One example is prepaid cards, which have grown in popularity in recent years and have also been linked to money laundering, corruption and tax evasion. Between May and November last year, the issuance of opinions by the State Council General Office, draft rules by the People’s Bank of China and draft Rules on the Administration of Single Use Commercial Prepaid Cards by the Ministry of Commerce are testament to a strong government will to regulate. The draft rules impose significant compliance obligations on card issuers for this popular form of gift giving including the following:

  • Real-name registration requirement – issuers must register the identity of anyone who purchases cards with an aggregate value exceeding RMB10,000 (US$1,580);
  • Prohibition against cash purchases – corporate purchases of RMB5,000 or more and individual purchases of RMB50,000 or more may be made only by bank transfer and the purchaser’s bank account number must be registered;
  • Five-year record-keeping requirement – issuers must maintain records of the information collected under the above two points for a minimum of five years; and
  • Limits on card value – the value of a branded prepaid card is capped at RMB5,000, while the value of a generic prepaid card is limited to RMB1,000.

“It has already been issued, and is already enforced,” says Jiang at Gaopeng & Partners. “I checked it, and I found the enforcement of this rule is good, because now if you buy a card they will ask for your ID. If you are a corporation, they will ask you to show the business licence, and also usually they do not issue a big amount for the card … so I think it is a very practical but important rule, I want to emphasise this, I think this is a very smart rule.”

The Eighth Amendment to the Criminal Law, which came into effect on 1 May last year, is another item of recent interest. The amendment adds a new type of crime – offering bribes to foreigners. It provides that persons “offering properties to officials of foreign governments or of international organisations to seek improper commercial interests shall be sentenced to not more than 10 years of fixed-term imprisonment or criminal detention”. However, the amendment doesn’t provide a definition of foreign officials or officials of international organisations.

Chinese legislation

China’s anti-corruption regime is essentially embodied in the Criminal Law; the Anti-Unfair Competition law (AUCL); the Opinions on Several Issues and Application of Law concerning the Handling of Criminal Cases of Commercial Bribery; and the Provisional Measures on Prohibition of Commercial Bribery.

According to Clifford Chance’s 2012 Guide to Anti-Corruption Legislation, China’s anti-bribery rules are mainly found in the AUCL and the Criminal Law. The AUCL covers bribes paid to business operators or their staff. Unlike the AUCL, the Criminal Law sets out minimum thresholds that trigger criminal liability (at least RMB10,000 offered by an individual or RMB200,000 by an entity), although those thresholds do not apply to bribes to government officials under certain circumstances.

The Criminal Law applies beyond national boundaries, as do the FCPA and the UK Bribery Act. The AUCL may also apply abroad when both payer and receiver are incorporated in China, but investigations of overseas transactions are not common.

Having adequate compliance procedures in place is not a defence under the Criminal Law, an aspect shared with the FCPA, although for the latter this may be factored into determinations of whether to prosecute and may support reductions in penalties.

What do the recent upgrades in the US and UK mean for China and what do in-house counsel and law firms – both those working with Chinese outbound investors and state-owned enterprises (SOEs) and those representing inbound interests and domestic companies – need to know about them?

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K&L Gates’ Global Government Solutions 2012, authored by Amy Sommers and David Zhang, says today’s interconnected and global enforcement landscape poses a new kind of risk – that a commercial bribery investigation in one location could trigger enforcement in another. The report says many goods and service providers that are typically private enterprises in Western economies are SOEs in China.

“Thus, for example, a PRC commercial bribery investigation of potentially improper payments by personnel of the China branch of a US-headquartered airline services provider to a Chinese airline [most of which are state-owned] could draw the attention of US law enforcement officials and spark an FCPA investigation of the same set of circumstances.”

Zhan Hao, executive partner at Grandall Law Firm, notes an interesting procedure he says is called the “follow-up investigation”. “That means, maybe a target company has just been given punishment in a foreign jurisdiction, then the Chinese government takes advantage of such evidence to follow up and initiate another investigation. Just recently, some of my clients faced this threat of such a Chinese investigation.”

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He Fang, a partner at Jun He Law Offices, agrees. “Some cases are initiated in the US. The US imposes fines first, then the Chinese government follows. So I guess some cases are initiated in other jurisdictions first.”

The FCPA

Cox at Bingham McCutchen cites historical reasons for the biggest hurdle posed by the FCPA. “When the [act] was written, Congress did not have China’s SOEs in mind. The act was passed to police the sort of conduct that had been the subject of high-profile congressional hearings in the 1970s, which uncovered bribes paid by US corporations to government officials in Honduras, West Germany, Italy, the Netherlands and Japan. In those economies at that time, there was a relatively clear separation between the roles of government officials and private businesses.”

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He says the situation in China today is very different. “There is a deliberate blending of the roles of government officials and business executives. Therefore, [officers of] SOEs are likely to be foreign officials under the FCPA. It is a source of great legal confusion for businesses working with SOEs in China, that their business dealings take on a dual character – at once they are dealing with a corporate officer and a government official.

“For the business subject to the FCPA, it is not possible under the law to try to compartmentalise these roles, and take the position that the business was only dealing with the SOE official in his role as a corporate officer. The entirety of the Chinese official’s responsibilities must be considered.”

Cox points to section 78dd-2(a)(1) of the act, which makes it an offence to pay money to any covered official, or even to promise to pay money, without actually doing so. The purpose of the payment must be to influence the person in his official capacity. In 78dd-2(a)(2), that same prohibition explicitly covers political party members, and this certainly would include the Communist Party.

“So a business subject to the FCPA may find that an otherwise routine business transaction could subject them to civil or criminal liability in the US,” he says. “Moreover, this is possible even though all of the business conduct in question takes place outside the US. There is a view, which I have often heard expressed in China, that a separate corporation operating solely in China is not covered. But if that separate corporation is a subsidiary of a US parent, it is still covered by the FCPA if the subsidiary is consolidated into the parent’s financials.

“Finally, expenditures inside the US are not exempt. The FCPA covers all payments, no matter where made, for an improper purpose, not just payments made outside the US. Also, companies frequently forget the books and records requirements of the act. It is not just the payments that are covered, but how they are accounted for and recorded in the books and records.”

 Innocent customs like holiday gifts can be a problem under the FCPA.

Innocent customs like holiday gifts can be a problem under the FCPA.

Recent US rulings have confirmed the Department of Justice’s view that bribes paid to SOEs are bribes paid to a foreign official. So what do general counsel for SOEs need to know about this development?

“An important aspect of the definition of an improper payment under the act is that it covers not only bribes to obtain business, but also bribes to ‘retain’ business,” Cox says. “So a company that won its business entirely properly from an SOE customer will still have its actions scrutinised after the fact. In addition, the FCPA covers not only direct payments, but also indirect payments.

“As a result, even if a business’s own employees are entirely compliant with the FCPA, it is required to exercise due diligence in dealing with third parties working with them on a project.”

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He continues: “China’s legal precepts and national customs, as well as its blending of the roles of business and government, differ from the paradigms under the FCPA. The act covers not only bribes but also ‘anything of value’ given to a government official for an improper purpose.

“This is where local customs, such as holiday gifts or transportation, can be implicated, even though they may appear quite normal to the SOEs involved.”

Munro at Steptoe & Johnson runs this scenario. “If an SOE or any other Chinese company or individual invests overseas, and if it tries to pay a bribe to a US official, it’s caught by its own laws – the amendment to the Criminal Law. In terms of any illegal act performed within the US, that is a violation of domestic US law. That’s not an FCPA issue.

“It would only become an FCPA issue, say, if any Chinese company invested in a US company, and … that US subsidiary company then sought to bribe a foreign goverment official (as defined under the FCPA). That violation could have an impact on the Chinese parent company.”

Despite differences between the laws in the US and China, Cox also sees similarities. “The main similarity is that it is now a criminal offence for Chinese citizens and Chinese companies to pay bribes to non-Chinese government officials, and to officials of international public organisations. The mirror image of this is one of the cornerstones of the FCPA as well.”

The UK Bribery Act

Andrew Halper, a partner at CMS Cameron McKenna in London, says the UK Bribery Act should also be of great interest to Chinese businesses operating internationally. First, because “it is fair to say that it creates what is arguably the world’s harshest anti-corruption regime”.

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It establishes four new offences, which are expressed simply, and thus it will now be easier to find oneself in clear violation of the law. The act makes it an offence to pay bribes or to offer to pay bribes, as well as to request or receive bribes. Corrupt “intent” is not always required to be found in violation of the act.

“In addition, unlike the FCPA, under the UK Bribery Act corrupt activities include ‘B-2-B’ [business to business] and not just ‘B-2-G’ [business to government officials],” Halper says.

“Significantly, in order to be guilty of breaching the act, it is not necessary for corruption to be carried out on British soil, as long as there is a business activity or significant connection with the UK. Anyone performing services for your organisation anywhere in the world can make you automatically criminally liable for corruption if you carry on business in UK.”

Halper says companies with a UK presence will now have to review their business practices, since many common business practices – facilitation payments, for example – may be caught by the application of the act if not carefully structured.

%e6%af%94%e8%be%83%e3%80%8a%e7%be%8e%e5%9b%bd%e5%8f%8d%e6%b5%b7%e5%a4%96%e8%85%90%e8%b4%a5%e6%b3%95%e3%80%8b%e4%b8%8e%e3%80%8a%e8%8b%b1%e5%9b%bd%e5%8f%8d%e8%b4%bf%e8%b5%82%e6%b3%95%e3%80%8b-us-fcpa-veTransparency International UK in June released a Guidance for Due Diligence in Mergers, Acquisitions and Investments as a practical guide to the UK Bribery Act and related international legislation.

Prajakt Samant, a partner at McDermott Will & Emery in the UK who has studied the Guidance, says it places a strong emphasis on taking a proportionate approach when undertaking anti-bribery due diligence. “It acknowledges that in some circumstances, the due diligence exercise may need to be completed post-completion of a deal,” he says.

“This is a pragmatic approach, which recognises that commercial exigencies may, on occasion, take precedent. What it is not intended to do is absolve a company altogether from undertaking any due diligence.”

Samant says preliminary analysis of the act suggests liability-related failures in due diligence on the part of an acquirer may occur where there is current or continuing bribery by the acquired target company. “This would be of particular interest to Chinese investors interested in acquiring or merging with UK companies, and would heighten the need for thorough due diligence,” he advises.

The act has potentially aggressive, extra-territorial, reach. This is also important for Chinese companies, given their growing international and outward investment interest. Any company that carries out a business, or part of a business, in the UK can be caught. The UK Bribery Act, however, does list compliance as a defence for corporate offences.

Comparing the UK, US and Chinese legislation, Munro says the FCPA in many ways resembles Chinese law in that it’s not trying to pin down every particular circumstance where a bribe or a corrupt act might arise.

“It expresses certain principles and that give the regulator room to define how those principles are implemented, which is actually quite similar to China,” she says.

“The UK Bribery Act takes a different approach. It’s not about statements of broad principle. It seeks to pin down a number of different corruption scenarios and it applies to both domestic bribery and corruption, and international, whereas the FCPA is solely targeted at corruption outside the US.

“So the approach of the FCPA is different to that of the UK Bribery Act. Having said that, the same types of corruption can be caught by both acts.”

Foreigners beware

Another development in China, says Luka Lu, a partner at Capital Associates in Beijing, is foreign entities have lost their favoured status of years past and are now fair game for all kinds of disadvantage, even if they are squeaky clean.

UK, US and Chinese legislation each apply their own types of pressure.
UK, US and Chinese legislation each apply their own types of pressure.

“What I see is when the authorities fine a foreign investment company and a Chinese company, the foreign company will say ‘did we do wrong?’ and if they did, they are willing to pay and solve the matter. The Chinese company will say ‘no matter if we did wrong or not’, they will try to use PR [personal relationships], maybe payments under the table, maybe finding some high-ranking official, and other ways. So the authorities won’t get very much out of the Chinese companies.

“A lot of the local authorities, sorry to say, they have KPI [key performance indicators] to collect [a certain amount] of money every year. Especially at the end of the year, you see they are very eager to go out and to fine because of this KPI thing. So, of course, if it is easier to get [money] out of a foreign company than the Chinese company, [they] go to the foreign company.”

Perhaps bearing out her claim, the K&L Gates annual outlook cites an estimate by the Anbound Group, a Beijing-based consultancy firm, that over 60% of the total corruption investigations in the 10 years prior to 2009 involved foreign companies.

Adds Brian Beglin, chief representative of Bingham McCutchen’s Beijing office: “I would hazard a guess that 60% of bribery in China does not involve foreign companies. So, it suggests that if you are a multinational doing business in China, you’re going to be subjected to a higher level of scrutiny for various reasons, than perhaps for purely domestic companies.”

Some of that scrutiny may be warranted. Lu observes that blurred lines concerning conflict of interest are often a problem. “Right now we are handling a huge case of a foreign investment company with a foreign CEO. He set up a company as a supplier to his company without disclosing that to the board.

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“And they used all the resources of the company to support this supplier … So he actually put all the human resources into building this company, and asked his company to buy the machinery for the company and add IT … a computer IT system – he managed to build a kingdom.

“Then suddenly headquarters heard a little bit about it, and they started to check. So we checked everything. He did it really well, he really hid it very well, so that from all perspectives you could not see his name anywhere. We eventually found out he owns 90% of the offshore company that owns 100% of the Chinese [supplier] company.

“With conflict of interest, we have handled many cases where employees … they have their spouses working for the competitors’ company, or their spouses working for a supplier. According to foreign standards you need to disclose this company or get prior approval, but in China the law is not that detailed, it doesn’t really cover this, it only covers senior management, like the CEO.”

For the most part, though, the view seems to be that foreign expertise may be the best way to fix internal compliance problems in Chinese companies.

Liu at S&P Law Firm points out the problem for SOEs. “The private company’s business purpose is very clear, to get the project and make the money, and their system is much more flexible,” she says.

A conflict of interest can set an alluring trap for foreigners and locals.
A conflict of interest can set an alluring trap for foreigners and locals.

“But for the SOE, they face double supervision – by the business leaders, and at the same time they are supervised by the government … I don’t think there are so many SOE managers who want to face the risk of breaking the law, but I do agree that they need more [compliance] training, because of the complexity of the international business law system, and I think one way to solve this problem is to let more international firms work together [with SOEs], to give them [compliance] training.”

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Li Gang, a partner at Zhonglun W&D Law Firm, agrees. “We respect and appreciate the multinational companies for transparency in their financial reports,” he says. Most of the MNCs [multinational companies], when they have been listed overseas, the regulations require this transparency, and we see the value of it.

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“For the PRC, internal risk management is always the most important thing, and this is where PRC companies should learn from the MNCs.”

A roadmap for compliance

In a world where businesses more and more require compliance across jurisdictions, defining a workable system need not be as complex as you might think. Brian Beglin, co-managing partner of Bingham McCutchen’s Beijing office and a principal at Bingham Consulting, which provides strategic and public policy advice on cross-border and multijurisdictional matters, says in order to tackle compliance and imbed a workable system “you really need to have a complete programme focusing on specific aspects of how to enforce what is essentially a scheme of ethics”.

First, Beglin says, there has to be a policy that is articulated clearly. Then you need somebody in charge of it who has credibility with, and access to, senior management. “Then you need to train people, and the training needs to talk about the policy. It needs to explain the importance of it, to explain the mechanisms that exist, how to live with it, and in the best of cases, as you take this training exercise on the road to the various facilities of the organisation, you want to involve local management in the training, so it doesn’t become a top-down exercise, it becomes a generic exercise locally.”

Beglin points to lessons that emerged from the Enron scandal and subsequent Sarbanes-Oxley Act in the US. “One was … how management gets control of the information and the activities within its organisation, because the further you get from any centre, the harder it is to maintain that. One thing came of that whole push to improve management controls is establishing a whistleblower mechanism, and in order for that to be effective, it needs to have credibility, it needs to have trust. People who are going be a whistleblower need to know that there is not going to be retaliation and that their complaint is not going to disappear into a black hole.

“Another thing that a company should do is have a rapid response team that’s in place so that when something comes through the system, you’re not running around trying to figure out how best to address it, you have a mechanism that’s been articulated internally – who gets involved, how your general counsel’s office gets involved – you’re not creating the wheel at a time when you need the most flexibility. Another important aspect is you need an appropriate disciplinary response to proven episodes of violation of the policy. If you really want a policy that works, you need to have a disinterested application of the discipline that’s evenly applied. Another thing that’s important is you need to do some testing, you need to do some auditing of your system from time to time, to make sure things are working properly.

“So, there is a lot of work and there is a lot of management time and there is a lot of management resources, and because it’s not something which is driving sales or driving the bottom line … it’s easy enough to understand why people give it short shrift. But if you want to be successful in it, you really need to implement the entire package, not just respond to isolated events.”

Susan Munro, a partner at Steptoe & Johnson in Beijing, says most US multinationals have strong compliance programmes already, but the question is how rigorously they are enforced. “There are practical problems. Particularly because most of the US cases relate to cases where distributors are used. The company may be able to control its own employees but it may have difficulties controlling third parties, for example distributors of its products. For the purpose of the FCPA [Foreign Corrupt Practices Act], those distributors could be agents of the company and the company can, in certain circumstances, incur liability through the corrupt activities of its agents. That’s a big problem, because the fact is that with a large country, you need a huge distribution network and that distribution network is likely to give rise to risk.

“A more interesting case perhaps is that of Chinese companies that are listed in the US. Their corporate culture remains Chinese but they are exposed to US jurisdiction. They tend to be slightly more at risk in terms of US compliance violations because generally their corporate culture is a domestic Chinese business culture and they are doing domestic business.

“These days when a Chinese company lists in the US, a compliance programme is usually put in place. However, the key thing is that the company has to continue to operate that programme going forward, therefore it has to be accessible so that it can. Sometimes we see situations where a company has a state-of-the-art compliance policy, but it’s so state of the art that managers in China cannot easily understand it. And then maybe the board does not contain American citizens. Maybe it’s people who are not so sensitised to the US regulatory environment, and the company doesn’t do regular compliance checks. Or does not do them to the level required. It does its business. It generates its profits, but there are risks.”

Munro adds that plaintiffs’ lawyers are scrutinising reverse takeover companies and the financial statements of US-listed Chinese companies. “Historically we haven’t seen class actions in relation to FCPA matters – but this has now changed,” she says.