The Trump Administration’s trade war with China has highlighted the risks of both doing business in China and investing the Chinese companies which come to America to raise capital. Yet this has been a long-known and outstanding problem in the anti-corruption enforcement world. The 2014 bribery and corruption case of GlaxoSmithKline PLC (GSK), which resulted in a $490 million fine for the firm, resonated across the corporate globe. While many questions are still unanswered, one that seems to be at the forefront of the inquiry was where was the GSK Board of Directors? This matter demonstrates that the role of a Board of Directors is becoming more important and more of a critical part of any effective compliance program.
In a NACD Directorship article, entitled “Corruption in China and Elsewhere Demands Board Oversight”, Eric V. Zwisler and Dean A. Yoost note, “Boards are ultimately responsible for risk oversight” any Board of a company with operations in China “needs to have a clear understanding of its duties and responsibilities under the FCPA and other international laws, such as the U.K. Bribery Act”. Why should China be on the radar of Boards? From 2010-2019, over 25% of all FCPA enforcement actions derived from China, that’s why.
FCPA enforcement actions have made clear that numerous Chinese businesses have proven adept at appearing compliant while hiding unacceptable business practices. A Board should be aware that a well-crafted compliance program must be complemented with a thorough understanding of frontline business practices and constant auditing of actual practices, not just a paper compliance program. This means that both monitoring and auditing should be visible to the Board.
Echoing one of the Board’s roles, as articulated in the FCPA Resource Guide, the authors believe a “board must ensure that the human resources committed to compliance management and reporting relationships are commensurate with the level of compliance risk.” If that risk is perceived to be high in a country, such as China, the Board should follow the FCPA Resource Guide’s prescription:
The amount of resources devoted to compliance will depend on the company’s size, complexity, industry, geographical reach, and risks associated with the business. In assessing whether a company has reasonable internal controls, DOJ and SEC typically consider whether the company devoted adequate staffing and resources to the compliance program given the size, structure, and risk profile of the business.
To help achieve these goals, the authors suggest a list of questions that they believe every director should ask about a company’s business in China, which include:
- How is “tone at the top” established and communicated?
- What procedures are in place to identify and mitigate fraud, theft, corruption?
- What local training is conducted on business practices and is it effective?
- Are incentives provided to promote the correct behaviors?
- How is the detection of improper behavior monitored and audited?
- How is the effectiveness of the compliance program reviewed and initiated?
Third parties generally present the most risk under a compliance program and that as much as 95 percent of reported FCPA enforcement actions involve the use of third-party intermediaries such as agents. However, in China all potential opportunities retain some level of compliance related issues. JVs and the acquisition of Chinese entities are important business strategies for many western companies, it is important to have Board oversight in the M&A process.
The authors understand “non-compliant business practices and how to bring these into compliance is often a major and defining deal risk.” But, more importantly, it is a company’s “inability to understand actual business practices, the impact of those practices on the core business, and effectively dealing with a transition plan is one of the main reasons why joint ventures and acquisitions fail.” So even if the conduct of an acquisition target was legal or tolerated in its home country, once that target is acquired and subject to the FCPA, such conduct must stop. However, if such conduct ends, it may so devalue the core assets of the acquired entity so as to ruin the business basis for the transaction.
The authors conclude by articulating that many Boards are not engaged enough to understand the way that their company is conducting business, particularly in a business environment as challenging as China. They believe that a Board should have a “detailed understanding of the business if it is to be an effective safeguard against fraud or corrupt practices.” They remind us that not only should a Board understand the specific financial risks to a company if a FCPA violation is uncovered; but perhaps more importantly the “potential impact on the corporate culture and the risk to the company’s reputation, including the reputations of individual board members.” Finally, the authors note, “effective oversight of corruption in China will only become increasingly more important”. That may be the most important lesson for any Board collective or Board member individually to take away from the ongoing GSK corruption and bribery scandal.
Three key takeaways:
- China presents the highest FCPA risk and after GSK, domestic law corruption risk as well.
- Chinese companies have been adept at hiding corrupt business practices from their western owners.
- A Board must be cognizant of these risks and enhance their risk management process in China and other high-risk jurisdictions.