China: Extra grip

The government’s tougher stance on corruption has triggered investigations into multinationals’ practices and spurred a market for compliance advice

Last month, the world’s economists, market analysts and keen China-watchers had their eyes firmly fixed on Beijing, where China’s top leaders gathered during a four-day conference to make important decisions on the country’s next round of reform.

During the meeting, known as the third plenum of the 18th central committee of the Communist Party, more than 60 key reform measures across 15 areas were adopted and the full details were unveiled in a 20-page master plan after the meeting. It proposes wide-ranging and sweeping changes across broad swathes of the country’s economic, social and public sector systems, dealing with many critical issues and challenges facing China as it moves into the next stage of development.

China

The reform agenda with a target date of 2020 has received largely positive feedback from international observers, who generally consider it as “bold” and “ambitious”.

Among many important proposals, it calls for tougher measures to curb corruption and an independent and fair judiciary system. The two motions are undoubtedly fundamental to China’s economic reform and growth.

A flurry of recent high-profile trials against corrupted officials, such as former top politician Bo Xilai, and investigations on multinational companies over bribery claims, such as British pharmaceutical giant GlaxoSmithKline (GSK), have showed the world its determination.

However, the intense global headlines about foreign companies being investigated by Chinese authorities over bribery allegations have created fears among global companies and foreign investors, worrying that they may be the targets of the enforcement actions.

“The view that the government is targeting western companies is too simplistic. There’s lots of evidence showing that in the competition space there are more enforcement actions against Chinese companies than non-Chinese companies. Even in the pharmaceutical sector, there are also investigations against Chinese companies,” says Geoff Nicholas, Freshfields Bruckhaus Deringer’s co-head of global investigations.

“It’s good to crack down on improper conduct, but it creates additional risks for businesses. In the longer term, having a better understanding on where China draws the line in terms of its enforcement activity is helpful to foreign companies.”

Having spent most of the past year in Hong Kong and China, Nicholas has come to understand first hand the rapidly shifting landscape of regulatory enforcement in China and its growing importance.

“It’s important to recognise that when we look at regulatory enforcement, may it be over competition issues, bribery allegations or data securities matters, Chinese authorities have the ability to bring enforcement to action if they are so minded. Investigations driven by China may now lead to foreign companies being subject to investigations in the US or UK. As a result, it’s been an increasingly important part of our global compliance and investigations practice,” Nicholas adds.

Evolutionary changes

Cases such as the GSK bribery probe (see box, below) in the summer have certainly drawn global attention to China’s heightened anti-corruption and anti-bribery efforts. But lawyers working on the ground have noticed an overall increase in regulatory enforcement action across all areas of law in recent years.

“It’s fair to say this is not a sudden change. It’s been much more of an evolutionary change than revolutionary,” says Michael Hickman, senior international counsel of Chinese firm Haiwen & Partners in Shanghai.

“A range of regulators have taken a higher level of enforcement activity, from investigating price fixing by producers and combating commercial bribery to cracking down on false advertising and ensuring full social security package are made to employees by companies,” explains Hickman.

One of China’s competition regulators, the National Development and Reform Commission (NDRC) is among the most active enforcement agencies. In July, it announced plans to investigate 33 Chinese domestic pharmaceutical companies and 27 international pharmaceutical companies operating in China with respects to the prices of their products. The State Administration of Industry and Commerce (SAIC) is the main agency overseeing unfair competition practices in China. In August, it also launched a three-month campaign to crack down on commercial bribery, IP infringements, anti-competition and commercial frauds. The SAIC investigations were reportedly focusing on food, drugs, healthcare, petroleum and telecommunications sectors.

Facing greater regulatory scrutiny and potential dawn raids, companies in China are in need of greater legal assistance in this emerging practice area. A number of international and Chinese firms have been engaged by corporate clients to conduct internal audits and investigations, review and improve compliance programmes, risk profile analysis as well as design crisis management guidelines and procedures for employees to follow in the event of an inspection by the regulators.

“We’ve been practising in regulatory, compliance and white-collar crime areas for some years, but the number of enquiries and instructions from clients have grown exponentially since the leadership change in March,” says MWE China Shanghai partner Henry Chen.

“Food, pharmaceuticals and a number of other consumer industries are highly targeted areas for the regulatory enforcement actions, as the Chinese public’s interest in food safety and health care is at an all-time high. There is also a political dimension to it as the new leadership wants to be seen taking actions on critical issues,” Chen says.

Although the war against corruption sends a positive signal, Chen notes that there are concerns over whether the government can stick to the enforcement in a consistent and persistent manner instead of just during political campaigns.

“If the regulators only investigate and punish a number of selected companies, then it will create an uneven playing field. It will have a catastrophic impact on the picked companies, as they are in very competitive industries. If their competitors can get away when they commit similar misconduct to gain market share and clients, there won’t be real changes in business practices,” he says.

Another key change Chinese firms have noticed since the beginning of this year is that they are increasingly among the first port of call when clients get in an urgent situation. Previously, Chinese firms were more often called in by US or UK law firms to advise them on the Chinese aspect of investigations launched by foreign regulators.

“Investigations initiated by Chinese regulators have now led to global companies being investigated in the US and the UK. That rarely happened before. In the past, there were mostly investigations initiated outside of China with Chinese activity being looked at,” says Hickman.

“This last year has seen a real shift in how the dynamics work. It’s terribly interesting. There are both challenges and opportunities for Chinese firms to help people move Chinese regulatory concerns to the front of the table along with UK and US regulations.”

In the case of GSK, when the Chinese police, known as the Public Security Bureau (PSB), and the SAIC initiated the investigation in July, the British company instructed both Chinese firm Jun He and US firm Ropes & Gray to assist it with the investigation as well as to carry out an independent review into the alleged bribery by the senior executives in its Chinese operations. In September, US authorities reportedly launched investigations against GSK for violation of the Foreign Corrupt Practices Act (FCPA) in China following the Chinese allegations.

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Change for everyone

Many multinational companies have been operating in China for decades and the vast majority of them have already established rigorous compliance policies in China. But the changing dynamics of the enforcement scenes will trigger these companies to review and revise their existing systems.

“Companies need to pay great attention to laws and regulations and pay attention to grey-area business practices that were acceptable before. The mentality of ‘we’ve been doing this for years’ and the compliance concept needs to be adjusted,” says Baker & McKenzie Shanghai-based partner Michelle Gon.

“It’s no longer just about ticking all the boxes. Internal audits and training need to be conducted regularly to ensure the adequacy of the compliance programmes and detect non-compliance issues before the regulators. A robust internal reporting and whistle-blowing process is also important.”

An effective anti-bribery and corruption programme will require companies to respond to specific industry and business models, as each industry has its own set of risks.

“Companies need to include internal management controls and dealings with third parties in its compliance policy,” says Beiing-based King & Wood Mallesons partner David Tiang, who was previously the general counsel of Walmart Asia.

As evidenced in several recent cases, outsourcing corruption through a third party, such as travel agencies, event organising companies and consultants, is a common practice in China. But this approach could breach the FCPA, UK Bribery Act and Chinese law.

“The lessons we have learned from recent cases is that we need to conduct due diligence on third parties and business partners as well as to check carefully on payments and expenses made to those entities. Companies can no longer turn a blind eye to what the money is actually being used for,” Tiang added.

In addition to assisting companies in dealing with investigations, Tiang has also been instructed by multinational companies to conduct compliance due diligence on service providers, distributors and business partners.

On an even higher level, recent high-profile cases have sounded the alarm for global and local management to rethink their approach in managing growth as well as risk control in China.

“Non-compliance will have serious consequences and cause significant financial and reputational damage. Companies need to encourage good and ethical behaviour with rewards. Therefore revenue growth shouldn’t be the only criteria to performance review and instead contribution to compliance needs to be added to the performance assessment matrix,” Gon adds.

Tough measures

Companies, both in the state-owned and private sectors, are not the only ones to feel the heat of stronger enforcement actions. Some of China’s largest firms, including Dacheng, JunZeJun and Jingtian & Gongcheng, are among the first to have been affected, as the country’s stock markets regulator gets tough on accounting fraud in the domestic market.

The China Securities Regulatory Commission (CSRC) has fined Dacheng a total of RMB1.5m (£154,000) for inadequate due diligence and misrepresentation on the proposed 2012 IPO of Xindadi. The IPO was terminated and the company and its advisers investigated by the CSRC after allegedly falsified data was found in the prospectus. 

The four Dacheng lawyers who worked on the IPO were also fined RMB100,000 each, with one banned for life from providing securities legal advice.

Beijing firm JunZeJun was fined a total of RMB1.8m (£184,000) for similar violations in the IPO of Tianneng Technology, which was also terminated. The firm’s two lead lawyers on the transaction were fined RMB50,000 each.

The penalties imposed on the firms, alongside accountants and underwriters in the two transactions, were announced in November following a year-long investigation by the CSRC.

In a separate case, capital markets specialist Jingtian & Gongcheng is currently being investigated by the CSRC for its role in the IPO of Henan Tianfeng Energy-Saving Panel, which was also allegedly subject to accounting frauds.

Since the beginning of this year, the CSRC has taken tough measures to curb accounting frauds and disclosure violations in domestic IPO applications. From January to October, it ordered an unprecedented tough review of last year’s financial results for all current IPO applicants in an effort to weed out unqualified candidates and enforce tighter requirements on information disclosure from the companies and their financial and legal advisers.

As a result, the CSRC announced on 11 October that 268 of the 622 reviewed IPO applications were terminated, or 30.5 per cent of the 800 applications.

“There is steady increase in enforcement across the board. If that continues, China may eventually have a more transparent and easy-to-navigate regulatory environment. But this won’t happen overnight and will take a whole lot to achieve,” says Hickman with cautious optimism.

Many will agree with Hickman in that this is a long process and an inevitably development as China becomes a more sophisticated jurisdiction and a world powerhouse. There may be many short-term challenges and obstacles during the journey, but the importance of the market will drive people to embrace them rather than shy away from them.

The case of GlaxoSmithKline (GSK)

In July, China’s Public Security Ministry issued a statement accusing GSK of bribing doctors to prescribe their drugs and to raise prices of their drugs. The Chinese authorities alleged that GSK made “illegal” transfers, amounting to RMB3bn (£323m) to travel agencies and consultants since 2007. The police started criminal investigations involving several senior executives in GSK’s offices in Changsha, Shanghai and Zhengzhou over bribery. The investigation is ongoing.

In responding to the allegations, GSK issued a statement in July, saying: “GSK has zero tolerance for any behaviour of this nature.

“GSK shares the desire of the Chinese authorities to root out corruption. These allegations are shameful and we regret this has occurred. We will cooperate fully with the Chinese authorities in the investigation of these new allegations. We will take all necessary action required by the outcome of this investigation.

“In the meantime, we are taking a number of immediate actions. We are reviewing all third party agency relationships. We have put an immediate stop on the use of travel agencies that have been identified so far in this investigation and we are conducting a thorough review of all historic transactions related to travel agency use. We also intend to conduct a rigorous review of our compliance procedures in China.”

The British pharmaceutical giant instructed Chinese firm Jun He and US firm Ropes & Gray to assist it with the internal review and regulatory investigation.

Enforcement action in numbers

Total amount of alleged briberies made by GSK’s China units:

£323m

Number of anti-corruption and anti-bribery filed by public prosecutors across China in the first eight months of 2013:

18,282

Total amount of fines imposed on six infant formula producers, including Danone Dumex and Fonterra, for
price fixing:

$110m

The prosecution threshold for a corporate offender for government official bribery offence:

$32,000

The number of pharmaceutical companies in China investigated by the NDRC in the summer in respect to pricing:

60

Key figures: China 

GDP: $8.3trn

Population: 1.4bn

Life expectancy at birth: 75

Unemployment: 4%

Source: World Bank, National Bureau of Statistics

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