REGULATIONS
Anti-Corruption Regulations Q&A: Education, Good Governance Help Companies Mitigate Risk
May 2, 2006
Elizabeth Johns

"In my experience, companies with a strong reputation for good corporate governance receive fewer demands for bribes." -Alexandra Wrage ARTICLE TOOLS Print Version Reprints RECENT ARTICLES Different cities, same customers China is the region's top stop for exporting Improving wire transfers Quantifying your banks' performance

In 2001 when Alexandra Wrage founded Trace International, a nonprofit that provides anti-bribery due diligence and compliance training to multinationals and the intermediaries that service them, North American companies were relatively new to the Chinese business landscape. Now that many have operated in China for several years, she is hearing more sophisticated compliance questions and observing best practices.

A former international counsel for an aerospace and defense company, responsible for their Foreign Corrupt Practices Act (FCPA) compliance, Alexandra Wrage saw a role for a neutral non-profit entity that had no stake in any one deal, one that was committed to increasing commercial transparency more generally.

"TRACE International can say things to companies and to government officials that no single company can easily say on its own behalf," Wrage says.

Now five years old, TRACE has begun to repeat training in countries the firm went into a few years ago, including China. The audience may be more or less the same, she says, but when a company has been operating in an emerging market for five years or more, the level of sophistication of its questions and overall interest in this issue become much higher (See Q&A below).

Generally speaking, the FCPA prohibits corrupt payments to foreign officials for the purpose of getting or keeping business. The U.S. Department of Justice enforces the rule, coordinating with the Securities and Exchange Commission (SEC), and interprets it broadly to include payments through intermediaries. For example, it is unlawful to pay a go-between if it is known that some of that payment will make its way to a foreign government official.

And while the person making or authorizing the payment must have a corrupt intent, the payment need not actually take place. Even the offer of a corrupt payment can be a violation, with fines up to $2 million.

There are certain exceptions for the small payments needed for obtaining permits, processing visas, loading or unloading cargo and the like, known as "facilitating payments.

With Intermediaries, Cost In a Good Compliance Program

Most companies choose not to have employees in all regions in which they market their services or products -whether because of expense, risk mitigation, or simply because they want to test a market before committing resources. In these cases, companies generally turn to commercial intermediaries, Wrage says. They may work through sales representatives that sell on a commission basis, consultants that work for a flat hourly or monthly fee, or through resellers, distributors or contractors.

Jason Matechak, an attorney with Reed Smith LLP in Washington, D.C., told ChinaForum that for U.S. companies operating in China or shipping from China, using an intermediary might add to the company's bottom line, but might also increase a company's risk of an enforcement investigation. This is especially true where companies rely on customs brokers or other foreign agents.

"Companies might think their first line of defense is to blame the agent. But don't get into a situation where you have to do that," Matechak said. "Understand who the agent is, what their business model is, what their practices are -conduct proper due diligence."

It's often with contractual issues that companies get into trouble, and this might involve arrangements with sales reps and consultants.

"While third-party compliance efforts may require a significant investment in company resources at the outset of a major international business transaction or a new line of international business activities, the long-term gains in avoiding the FCPA penalties and negative press attention are well worth the investment. Companies need to cost in and count on a good compliance program."

Even well-known companies have found themselves vulnerable. In a January filing with the SEC, global consulting firm Bearing Point reported that internal control problems in the company's China operations resulted in potential exposure under the FPCA. An internal audit committee investigation found that a former subcontractor of Bearing Point China may have made inappropriate payments to employees of state-owned enterprises.

Core Values More Difficult Outside Headquarters

The advantage of using intermediaries is having access to someone who understands the local market, speaks the local language and can navigate through the local regulatory requirements. The disadvantage is that the intermediary may not fully understand or embrace the business practices of the company's headquarters.

"In my experience, inappropriate payments that violate the FCPA tend to result from companies acquiescing to demands, whether direct or indirect, by government officials. Few companies arrive in a country and look around for government officials to pay-off," Wrage says.

"Companies operating in China are routinely approached for payments of this kind and some agree."

The FCPA risk in China is heightened by the inherent lack of transparency. A government official as defined by the FCPA includes not only traditional government employees and officials, but members of the Communist Party and employees of state-owned enterprises. Information is not always available on the latter categories.

In some cases, it may not be immediately apparent whether a local company providing private sector services is in fact state-owned. If it is, every employee is a government official under the FCPA, and every payment, including lavish gift-giving or hospitality, is a possible violation of the FCPA.

Although Wrage thinks most U.S. companies understand the FCPA risk inherent in operating in China, the importance each places on that -meaning their risk tolerance- varies dramatically. Some companies send in teams of lawyers and accountants in an attempt to control all transactions and ensure no "slippage" to bribery. Others shrug and claim it's a cost of doing business in China. "The latter category should be aware that the U.S. enforcement authorities are prosecuting these cases at an increasing pace," Wrage says. They also should know that China has the death penalty for bribery.

"In my experience, companies with a strong reputation for good corporate governance receive fewer demands for bribes," Wrage says. That's because bribe takers tend to be opportunistic. If there are two companies with vastly different reputations, the company thought to be an easy target will find a queue of government officials outside its door with hands outstretched, she says.

Best Practices

In terms of best practices, Wrage says companies need robust written policies, translated into the local language, and this certainly isn't limited to China. Companies should provide in-person training so local hires have an opportunity to ask questions, as well as an internal helpline so employees worried about their own conduct or the conduct of colleagues can ask questions or report wrongdoing without fear of reprisal.

Finally, Wrage says the penalties for violations should be stated clearly and enforced even-handedly. "Policies without associated penalties accomplish nothing and tend to breed cynicism amongst employees and commercial intermediaries," she says.

Effective internal controls can not only deter wrongdoing because employees and intermediaries fear they'll be caught, but can uncover wrongdoing after the fact and enable companies to take remedial action as appropriate.

Carefully selected, vetted and trained intermediaries can play an important role for companies seeking to expand their presence internationally and can become important and valuable local partners. It should be noted, however, that the great majority of FCPA cases involve a commercial intermediary who -acting alone or under instruction- was the conduit for bribes to local government officials.

In its five years that TRACE International has been growing, it has in fact seen a gradual but positive change among Western companies operating in China. "Building better business practices is a slow process, but the situation is improving and we're seeing real evidence of that improvement," Wrage says.

WHAT COMPANIES ARE ASKING

Alexandra Wrage of TRACE International provided examples of some of the questions she hears today:

Q: We have a policy against bribery, but we have one government official who is insisting that we work with a particular intermediary in-country. We've conducted due diligence and the intermediary seems to be okay, but we're uncomfortable with the request.

A: This is a 'red flag' under the FCPA. It may turn out to be okay, but requires additional scrutiny. Is the government official requesting this intermediary because he's very knowledgeable and responsive to customer demands or because he always kicks back for of his commission to the official?

Q: What can we do about 'involuntary gift-giving or hospitality'? We invited senior officials for a fairly modest dinner, but they arrived with an entourage, including family members, asked the waiter for the "special" wine list and start ordering $200 bottles of wine. We wanted a good, reasonable working dinner, but we were stuck with a $1,500 bill.

A: We hear stories like this a lot. It can hardly be a bribe without the requisite corrupt intent, but if this happens often, it will be deemed to reflect poor internal controls or lack of commitment to the policy. Write it up in a memo and learn from it ... and take them to lunch next time!

Q: We do a lot of business in China. The FCPA says we can't make payments to foreign government officials, but we can't even tell who they are? We worry that commissions and discounts we use for marketing could actually be bribes if given to the wrong person.

A: This is a very significant problem in China. "Government official" includes employees of state-owned entities. It isn't always clear whether an apparently private sector entity in China is in fact state-owned and records generally aren't publicly available. "Government official" also includes members of the Communist Party who don't always identify themselves as such. When you combine this information with the fact that China has the death penalty for bribery, the best course of action is to assume that everyone you're dealing with is a government official until you can verify otherwise.

Source: Alexandra Wrage, Trace International.

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