Doing Business in China: Mitigating FCPA Compliance Risk After the Rio Tinto Verdict

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1 ALBANY AMSTERDAM ATLANTA AUSTIN BOSTON CHICAGO DALLAS DELAWARE DENVER FORT LAUDERDALE HOUSTON LAS VEGAS LONDON* LOS ANGELES MIAMI NEW JERSEY NEW YORK ORANGE COUNTY ORLANDO PALM BEACH COUNTY PHILADELPHIA PHOENIX SACRAMENTO SAN FRANCISCO SHANGHAI SILICON VALLEY TALLAHASSEE TAMPA TYSONS CORNER WASHINGTON, D.C. WHITE PLAINS Strategic Alliances with Independent Law Firms** MILAN ROME TOKYO ZURICH Doing Business in China: Mitigating FCPA Compliance Risk After the Rio Tinto Verdict Introduction Emerging in recent years as a global economic power, China offers a wealth of opportunities to multinational corporations looking to tap into the country s lucrative market for goods and services. However, the combination of intense competition for China profits, prevalence of state-controlled entities in key industries, widespread corruption and business traditions create a regulatory minefield that many U.S. companies find difficult to navigate. Overzealous business development efforts may implicate the United States Foreign Corrupt Practices Act of 1977 ( FCPA ), 1 which imposes civil and criminal penalties on U.S.-listed companies and individuals for bribing, or offering to bribe, foreign government officials in an effort to obtain or retain business. The recent verdict by a Chinese court finding four executives of a high-profile international mining company guilty of bribery and theft of commercial secrets may signal that China s aggressive prosecution of its anti-corruption laws is shifting its focus to multinational companies operating on its soil. This case underscores the significance of a comprehensive and rigorous FCPA compliance program for U.S. companies doing business throughout the world, and especially in China, where the consequences for noncompliance can be severe. Background of the Rio Tinto Case On March 29, 2010, a Shanghai court found four employees of British-Australian mining conglomerate Rio Tinto guilty of accepting bribes and stealing commercial secrets. 2 The jail sentences issued were some of the harshest ever handed down against senior executives at a multinational company with operations in China. Rio Tinto s general manager of Chinese sales, an Australian national, received a sentence of 10 years in prison, while his Chinese-national colleagues received prison sentences ranging from 7 years to 14 years. The four employees, who were initially arrested on charges of espionage and stealing state secrets, confessed to accepting bribes but denied stealing commercial secrets. Rio Tinto, which was not charged in the case, immediately announced it would terminate all four employees, citing clear evidence that they had accepted approximately $13.5 million in bribes. The mining company stated that its own internal investigation did not uncover any evidence of wrongdoing and concluded the illegal activities were conducted wholly outside our systems. 3 These corruption charges came amidst contentious negotiations of iron ore prices between Rio Tinto and the Chinese government. The company is one of China s top suppliers of iron ore an essential component to steelmaking, one of the country s key strategic industries. Some believed the arrests were political retribution for Rio Tinto, which scrapped a proposed investment of $19.5 billion from one of China s biggest state-owned mining companies merely one month before the employees detention. 4

2 The court stated that the Rio Tinto employees took bribes from private Chinese steelmakers in exchange for supplying them with iron ore at better prices than they could get from state-owned steel mills. The court further held that the defendants illegally obtained confidential information from executives of a major Chinese steelmaker which detailed China s negotiating position in iron ore price discussions and the production plans of key Chinese steelmakers, and then passed that information to negotiators for Rio Tinto. The Shanghai court also announced that the Chinese steelmakers that delivered the bribes to the four Rio Tinto executives would also be prosecuted. 5 Overview of the Foreign Corrupt Practices Act The Rio Tinto verdict comes as multinational companies encounter increasingly strict oversight into their business dealings worldwide, with the U.S., China, other industrialized nations and developing countries all expanding enforcement of their respective anti-corruption rules. In this environment of intense regulatory scrutiny, U.S. companies seeking to do business in China and other foreign markets must understand the prohibitions of the FCPA. In general, the FCPA prohibits companies and their agents from making corrupt payments to foreign government officials for the purpose of obtaining or retaining business. The FCPA consists of anti-bribery provisions and accounting provisions, described in greater detail below. Anti-Bribery Provisions Under the anti-bribery provisions, any issuer, domestic concern or foreign person in the United States is prohibited from paying money or giving anything of value directly or indirectly to a foreign official for the purpose of obtaining or retaining business. The person making or authorizing the payment must possess corrupt intent, and the improper payment must be intended to induce the foreign official to misuse his position to wrongfully direct business to the payer or to any other person. An issuer is a corporation that has issued securities that have been registered in the United States or is otherwise required to filed periodic reports with the Securities and Exchange Commission ( SEC ). 6 Issuers also include foreign companies, such as Rio Tinto, that issue American Depositary Shares ( ADRs ) which trade on a U.S. exchange. The term domestic concern is broadly defined, encompassing any business that has its principal place of business in the United States or is organized under the laws of the United States. 7 An individual who is a citizen, national or resident of the United States is also considered a domestic concern. 8 U.S. citizens or residents who violate the FCPA on behalf of foreign companies may be liable as domestic concerns. A foreign person which may be a foreign individual or foreign company is covered by the FCPA if he/it causes an act in furtherance of a corrupt payment to take place within the territory of the United States. Accounting Provisions The accounting provisions of the FCPA apply only to issuers and have two components: the books and records and internal controls provisions. They require issuers to (1) keep books and records that, within reasonable detail, accurately reflect the issuer s transactions and (2) develop and maintain a system of internal accounting controls sufficient to provide reasonable assurances that the issuer properly accounts for all assets and transactions. 9 The purpose of these requirements is to prohibit accounting practices aimed at concealing corrupt payments and ensuring compliance with financial reporting standards. Unlike the anti-bribery provisions of the FCPA, unlawful intent is unnecessary to establish a violation of the accounting provisions; mere negligence is sufficient.

3 Enforcement and Penalties The Department of Justice ( DOJ ) is responsible for all criminal enforcement and for civil enforcement of the anti-bribery provisions with respect to domestic concerns and foreign companies and nationals. The SEC is responsible for civil enforcement of the anti-bribery and accounting provisions with respect to issuers. Corporations and other business entities are subject to a criminal penalty of up to $2 million for each violation of the FCPA s anti-bribery provisions, and officers, directors, employees, agents and other individuals may be fined as much as $100, Individuals can face up to five years imprisonment for each violation, or up to 20 years for certain willful violations. 11 The maximum fine may be increased to $25 million for corporations and $5 million for individuals in the case of certain willful violations. 12 In addition, under the Alternative Fines Act, these criminal fines imposed under the FCPA may be increased to twice the benefit obtained by reason of the offense or twice the loss to any other person. 13 Companies are prohibited from paying the criminal and civil fines that may be imposed on their officers, directors, employees, or agents. 14 In addition to these significant criminal fines, companies and individuals convicted of an FCPA violation may also face disgorgement of ill-gotten profits, exclusion or debarment from certain federal procurement opportunities, loss of export licenses, and suspension or debarment from the securities industry. Violation of the FCPA may give rise to a private cause of action for treble damages under the Racketeer Influence and Corrupt Organizations Act (RICO), as well as the institution of asset forfeiture proceedings by U.S. enforcement agencies. Permissible Payments and Affirmative Defenses The FCPA contains an exception to the anti-bribery prohibition for facilitating payments. 15 The exception applies to payments made to facilitate or expedite performance of a routine government action performed by a foreign official. 16 Examples of such actions include obtaining permits, licenses or other official documents; processing governmental papers such as visas and work orders; providing police protection or mail services; providing phone, power and water services; and loading, inspecting, storing or transporting cargo. Affirmative defenses available under the FCPA are: (1) the payment was lawful under the written laws of the foreign country; and (2) the payment was a reasonable and bona fide expenditure related to the promotion of a product or performance of a contractual obligation. The FCPA defendant has the burden of demonstrating that the payment in question meets these affirmative defense requirements, so qualifying expenses should be properly authorized and documented. Compliance Risks Unique to China Business Operations China s expanding wealth and rapid economic growth have presented a myriad of opportunities for multinational companies seeking to do business there. Compliance with the FCPA while maintaining a business presence in China, however, presents unique risks given the prevalence of state-controlled enterprises, cultural traditions and the use of agency relationships. Foreign Officials. A key element of an FCPA anti-bribery violation is the broad application of the term foreign official, which includes any officer or employee of a foreign government or any department, agency or instrumentality thereof... or any person acting in an official capacity for or on behalf of any such government or department, agency or instrumentality Despite the increase in privatization, a substantial amount of companies in China s leading industries are state-controlled or state-owned enterprises ( SOEs ). U.S. enforcement agencies consider employees of these companies regardless of title, rank or position -- to be foreign officials and interaction with such personnel will be governed by the anti-bribery provisions of the

4 FCPA. Chinese SOEs are commonly found in key industries that are typically wooed by entrepreneurial multinational companies, such as aviation, oil and gas, telecommunications, and healthcare. Unlike the more obvious bribery scenario involving direct bribes to a government representative, FCPA risks in China become complicated by this broad classification of a foreign official an individual who can take the form of a telecommunication executive, steel mill manager, aviation engineer or physician. Gifts. Another major issue to consider in assessing FCPA compliance risk in China is the impact of cultural norms and traditional business practices. Long-held Chinese traditions of gift-giving and business entertainment raise red flags in the new regulatory environment. For example, in Chinese business culture the monetary value of a red packet gift given to customers is deemed very important as it measures the strength of a business relationship. Traditions such as this prove problematic for U.S. companies seeking to gain business opportunities from government officials and business executives at SOEs. Chinese officials often ignore gift-giving restrictions in this competitive business development environment, often leaving U.S. companies (and their agents) with the Hobson s choice of either losing the business opportunity, or potentially violating the FCPA and Chinese criminal law. 18 In fact, China-based executives, sales agents and distributors for U.S. multinational companies have previously acknowledged that their firms routinely win sales by paying what could be considered as bribes or kickbacks generally in the form of extravagant entertainment and travel expenses to foreign officials at state-owned enterprises. 19 These payments are usually funneled through distribution companies or public relations firms to minimize the chance of prosecution by the U.S. enforcement agencies. 20 Third Party Intermediaries. Foreign individuals, representatives or entities that act as agents of issuers or domestic concerns are also subject to the FCPA. The FCPA prohibits the channeling of corrupt payments through these third party intermediaries, with the knowledge that the payment will go to a foreign official. In this context, the DOJ interprets the term knowing to include conscious disregard and deliberate ignorance. Third party intermediaries covered by the FCPA include agents, joint venture partners, consultants, distributors and other representatives. Accordingly, outsourcing potentially corrupt payments to a foreign official that are funneled through a local agent does not offer protection from FCPA scrutiny (or Chinese law for that matter). In China, local agents are often utilized to gain access to, and favorably influence, the state-controlled enterprise from which the multinational company is seeking business. The potential risk for FCPA violations is exacerbated by the fact that many intermediaries are incentivized by commissions that are paid on the basis of a percentage of the contract price won. 21 Anti-Bribery Enforcement by the U.S. and China Stricter FCPA Enforcement by U.S. Enforcement Agencies In January 2010, the SEC announced the creation of a unit focused exclusively on FCPA enforcement, utilizing tactics such as targeted sweeps and industry-wide investigations. The SEC also pledged enhanced coordination with the DOJ and their regulatory counterparts in other countries. Nearly one week after this announcement, in an operation that was the largest single investigation and prosecution against individuals in the history of FCPA enforcement, 22 executives were arrested and indicted in a high-profile sting operation at an arms industry trade show in Las Vegas. These executives were charged with scheming to bribe foreign officials to obtain and retain business. Assistant Attorney General Lanny Breuer later commented that this extraordinary enforcement action dubbed Catch-22 demonstrated the DOJ s newly aggressive focus on the prosecution of individuals. Breuer stated that extensive jail time for individuals should make clear to every corporate executive, every board member, and every sales agent that we will seek to hold you personally accountable for FCPA violations. 22 As for corporations, Breuer emphasized that the DOJ would seek guilty pleas or bring criminal charges when the corporate conduct is egregious, pervasive, and systemic, or when the corporation fails to implement compliance reforms, changes to its corporate culture, and undertake other measures designed to prevent a recurrence of the criminal conduct. 23 Mark Mendelsohn, Deputy Chief of the DOJ s Fraud Section and

5 the architect of that agency s FCPA enforcement program, went even further in a subsequent speech, theorizing that FCPA enforcement could soon be classified as a national security issue given the belief shared by some government officials that some corrupt payments may be linked to terrorism. 24 Recent FCPA Investigations Involving U.S. Companies With Operations in China As part of its global anti-corruption efforts, the U.S. has stepped up its investigation of multinational companies, including those operating in China. The following are examples of some recent FCPA investigations relating to U.S. companies doing business in China: In April 2010, cosmetics giant Avon Products Inc. suspended four executives, including the president, chief financial officer and top government affairs executive at its China unit, pending an internal investigation of bribery allegations in China. 25 The fourth suspended employee was a senior executive in New York who was Avon s head of internal audit until the middle of last year. In June 2008, Avon began investigating its operations in China amidst allegations that company representatives purchased trips to France, New York, Canada and Hawaii for Chinese government officials with ties to Avon's business. In October 2008, the company announced that it had contacted the SEC and DOJ to advise both agencies of its internal investigation. In July 2009, the company expanded the probe to review its practices related to FCPA and related U.S. and foreign laws in additional countries. In July 2009, Control Components Inc., a California-based valve-maker, pleaded guilty to FCPA violations for paying bribes to officials and employees of various foreign state-owned companies in approximately 36 countries, including China, Korea, Malaysia and the United Arab Emirates. As part of the plea agreement, Control Components agreed to pay a criminal fine of $18.2 million, adopt and maintain a comprehensive antibribery compliance program, retain an independent compliance monitor for a three-year period, and serve a three-year term of organizational probation. 26 China s Crackdown on Corruption Pledging a severe and systematic crackdown on corruption, in 2007 Chinese President Hu Jintao enacted measures for China s new anti-corruption campaign. 27 These actions focused on ethics education, procedural reform, and enhanced enforcement of key offenses and high-level suspects. 28 At first, Chinese authorities appeared to focus much of its disciplinary effort on employees of state-owned entities rather than on personnel from multinational companies. Severe punishment was dispensed to offenders, including the execution of the former chairman of a state-owned airport holding company after he was convicted on bribery and embezzlement charges. 29 The arrest, conviction and sentencing of the Rio Tinto employees, however, may signal a new benchmark in corruption enforcement by China. Given the growing trade tension between the China and U.S., U.S. companies must be aware of the possible severe sanctions against them and their employees should Chinese government officials characterize alleged wrongdoing as implicating state secrets under China s expansive interpretation of laws regulating the export of confidential information. This is significant because bribes are often given to government officials in exchange for access to confidential information that provides a negotiating advantage in dealing with state-owned enterprises. In addition to subjecting the company and individual to the harsh discipline of Chinese law, such corrupt payments also likely violate the FCPA as they would constitute an act to secure an improper advantage for the purpose or obtaining or retaining business. 30

6 Mitigating Risk Through a Comprehensive Compliance Program The process for ensuring FCPA compliance when doing business in China is similar in many ways to compliance programs instituted by U.S. companies operating in other countries. Some of the recommended steps that companies can take to mitigate compliance risk in China and worldwide include the following: Enact a Comprehensive FCPA Compliance Program. A comprehensive and company-wide internal compliance program is the cornerstone of an FCPA risk mitigation strategy. If a FCPA violation occurs, the existence of a competent compliance program will be considered as a mitigating factor by U.S. enforcement agencies in determining whether to charge a company and the extent of any penalties. Compliance programs should be adopted and tailored to fit the risks specific to the countries in which the company operates. Evaluate Third Party Risks. The majority of FCPA enforcement actions involve improper payments made indirectly through intermediaries. U.S. enforcement agencies focus on the methodologies that U.S. companies use to detect high-risk third parties and their dealings. Accordingly, U.S. and local counsel should be retained to review the nature of such agency relationships; certify that agents comply with the company s FCPA policy and with applicable local laws; employ a due diligence methodology to determine whether the agent interacts with government officials; and review compensation arrangements. Training and Education. A company should implement its FCPA compliance policy by identifying international and domestic employees for appropriate training, including the following high-risk employees: sales and marketing personnel; employees that interact with government officials; personnel charged with maintaining agency relationships; human resource personnel with international responsibilities; and appropriate legal and finance personnel. Holding live training sessions with relevant personnel is an effective method to disseminate the FCPA compliance program, particularly in locations abroad such as China. Identify State-Owned Enterprises That Are Current or Prospective Clients. Companies with operations in China should maintain a list of existing and prospective customers that are state-owned or state-controlled. The list can be used to design effective internal controls for supervising employees and agents interacting with foreign officials from these SOEs and to scrutinize related travel and entertainment expenses. Due Diligence in M&A Transactions. The DOJ policy is that acquiring companies must implement a robust FCPA due diligence plan in order to mitigate the risk of enforcement action based on the theory of successor liability. Accordingly, due diligence activities should include a comprehensive assessment of the target s internal controls, compliance program, third party relationships, and dealings with foreign officials. Appointment of Chief Compliance Officer. Another effective compliance protocol is the establishment of the Chief Compliance Officer position. This person generally reports directly to the CEO of the company and to the Audit Committee of the Board of Directors. The Chief Compliance Officer is usually responsible for the implementation and oversight of all of the company s compliance policies, standards and procedures established under the compliance program. This GT Alert was prepared by Gary D. Anderson, a shareholder in Greenberg Traurig s Washington D.C. office. Questions about this information can be directed to Mr. Anderson at (andersongd@gtlaw.com) or to your GT attorney.

7 1 15 U.S.C. 78dd-1, et seq. 2 James Areddy, Chinese Court Sentences Rio s Hu to 10 Years, Wall Street J., Mar. 29, Id. 4 David Barboza, Unusually Stiff Sentences Given In Rio Tinto Case, N.Y. Times, Mar. 29, Id U.S.C. 78dd-1(a) U.S.C. 78dd-2(h)(1) U.S.C. 78dd-2(h)(1)(A) U.S.C. 78m(b)(2) U.S.C. 78dd-1 et seq.; 18 U.S.C U.S.C. 78dd-1, 78ff U.S.C. 78ff(a) U.S.C. 3571(d) U.S.C. 78ff(c)(3) U.S.C. 78dd-1(c) U.S.C. 78dd-1(b), 78dd-2(b), 78dd-3(b) U.S.C. 78dd-1(f)(1) 18 Patrick M. Norton, The Foreign Corrupt Practices Act: A Minefield for U.S. Companies in China, 18 China Law & Practice 15 (2004). 19 Peter S. Goodman, Common in China, Kickbacks Create Trouble for U.S. Companies at Home, Wash. Post, Aug. 22, Id. 21 Daniel Margolis and Brent Carlson, Mitigating FCPA Risks While Doing Business In China, Bloomberg Corporate Law Journal, Vol. 4, No. 117 (2009). 22 Bruce Carton, DOJ and SEC Go All Out to Stop Fraud, Compliance Week, Mar. 9, Id. 24 Id. 25 Ellen Byron, Avon Suspends Four Executives Amid Bribery Probe, Wall St. J, Apr. 13, Control Components Inc. Pleads Guilty to Foreign Bribery Charges and Agrees to Pay $18.2 Million Criminal Fine, U.S. DOJ Rel. (Jul. 31, 2009). 27 Xinhua, President Hu Charts Path in Anti-Corruption Drive, 28 Id. 29 Michael Wines and Mark McDonald, Former Beijing Airport Director Is Executed, N.Y. Times, Aug. 8, U.S.C. 78dd-1, et seq.

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