MAY 28, 2020 BY TOM FOX
In today’s edition of Daily Compliance News:
MAY 28, 2020 BY TOM FOX
In today’s edition of Daily Compliance News:
How important is due diligence on those with whom you are doing business? Why does it matter if a company is owned or controlled by a foreign government or a political party member of a foreign government? Under the Foreign Corrupt Practices Act (FCPA) such persons are covered persons and any US entity which pays bribes to such covered persons violates the FCPA. This issue is particularly true in China. Moreover, a couple of recent developments have shown just how hard it is to know whether you are doing business with a covered person when doing business with a Chinese corporation.
Recently Raymond Zhong touched on this in a New York Times (NYT) piece, entitled “Who Owns Huawei? The Company Tried to Explain. It Got Complicated”. This article gives some interesting hints as to why corporate ownership can be so murky in China and why any US company doing business in China must begin with the assumption that any Chinese business is owned or, at the very least, controlled by the Chinese government, making any business transaction in China subject to the FCPA.
Zhong began by citing to a recitation made by Jiang Xisheng, the chief secretary of Huawei’s Board of Directors, to a small group of reporters on Thursday. The goal was to help explain the company’s ownership after two American researchers wrote a report accusing Huawei of being misleading about the issue. Zhong reported, “Mr. Jiang’s explanation boiled down to this: On paper, he said, Huawei is owned by a labor union that solicits donations from employees when their colleagues have health problems and the like. The union also supervises the company basketball club”.
Just like that, one of the world’s largest hardware companies is owned by its employees. Sounds like a good old Employee Stock Ownership Plan (ESOP). But it got even better from there, as “Huawei showed reporters on Thursday what it described as evidence of its independence: a big blue book, kept behind glass and under lock and key in a drab white room at the company’s headquarters in Shenzhen, a southern Chinese city. Within its 10 volumes are said to be the names of all the Huawei employees who hold “restricted phantom shares” in the company — proof, the company says, that no piece of Huawei is owned by the Chinese government.”
First of all, anyone who believes that bald-faced statement should probably Not Pass Go and go directly to the jail of supreme inanity. Xisheng went on to state, “The union has no influence over the company’s business operations. It does, however, supervise after-work activities for employees. That basketball club, for instance. The badminton and table tennis clubs, too.” While “Huawei’s union is registered with the Shenzhen city government’s union and pays dues. But the municipal union has no influence over the Huawei union’s operations or the company, Mr. Jiang said.” Of course, since the Union has no influence over the company there is no need for such messy paperwork as Board meeting minutes or other indicia that a true corporation exists.
All of this double speak and obstruction came after two researchers who wrote a report “questioning Huawei’s ownership — Christopher Balding, a professor at Fulbright University Vietnam, and Donald C. Clarke, a Chinese law expert at George Washington University — say Huawei’s virtual stock program “has nothing to do with financing or control” and is “purely a profit-sharing incentive scheme.”” So, if you sign a contract with Huawei, just whom are you doing business with going forward?
Another NYT story, reported by Li Yuan and entitled “Jack Ma, China’s Richest Man, Belongs to the Communist Party. Of Course”, reported that the Chinese Communist Party itself had identified Ma as a party member. That’s right, the founder of Alibaba Group and the richest Chinese is a card-carrying member of the proletariat. Last November, “The party’s official People’s Daily newspaper included Mr. Ma, executive chairman of the Alibaba Group and the country’s most prominent capitalist, in a list it published on Monday of 100 Chinese people who had made extraordinary contributions to the country’s development over the last 40 years.” One can almost hear him leading the chant, “Workers of the world unite! You have nothing to lose but your chains.”
Clearly under the FCPA, Party member Ma qualifies for FCPA coverage as the FCPA specifically incorporates politicians, political parties and candidates for political offices as foreign government officials for purposes of the Act. In the 2012 FCPA Guidance it states, “The FCPA’s anti-bribery provisions apply to corrupt payments made to (1) “any foreign official”; (2) “any foreign political party or official thereof ”; (3) “any candidate for foreign political office”; or (4) any person, while knowing that all or a portion of the payment will be offered, given, or promised to an individual falling within one of these three categories. Although the statute distinguishes between a “foreign official,” “foreign political party or official thereof,” and “candidate for foreign political office,” the term “foreign official” in this guide generally refers to an individual falling within any of these three categories.”
Additionally, politicians and political parties are incorporated into the FCPA through the accounting provisions of the FCPA. As further stated in the FCPA Guidance, “Additionally, individuals and entities can be held directly civilly liable for falsifying an issuer’s books and records or for circumventing internal controls. Exchange Act Rule 13b2-1 provides: “No person shall, directly or indirectly, falsify or cause to be falsified, any book, record or account subject to [the books and records provision] of the Securities Exchange Act.” And Section 13(b)(5) of the Exchange Act (15 U.S.C. § 78m(b)(5)) provides that “[n]o person shall knowingly circumvent or knowingly fail to implement a system of internal accounting controls or knowingly falsify any book, record, or account ….”. The Exchange Act defines “person” to include a “natural person, company, government, or political subdivision, agency, or instrumentality of a government.”
The opaqueness of Chinese corporate structures is more than simply the inscrutable Far East. When presented with such answers as those from Huawei, there is simply no way for a US company to know precisely the ownership structure to ascertain if even doing business with such persons is legal or violates some sanctions or other rule. Of course, believing there is no government control, ownership or party membership can also lead to violating the FCPA.
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© Thomas R. Fox, 2019
We are back with our fan favorite Oscar movie month. During the month of February each year, we look at Oscar-winning Best Pictures and consider the leadership lessons we glean from our viewing. This month we look at three: No Country for Old Men, The Sting and The Last Emperor. In this episode of 12 O’Clock High, a podcast on business leadership, Richard Lummis and I take at the 1987 Best Picture winning film, The Last Emperor. Some of the highlights were:
The bribery and corruption case of GlaxoSmithKline PLC (GSK) 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 role of a Board of Directors is becoming more important and more of a critical part of any effective compliance program.
In an article in the NACD Directorship, entitled “Corruption in China and Elsewhere Demands Board Oversight”, Eric Zwisler and Dean Yoost noted that as “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? Since 2010, over 25% of all FCPA enforcement actions have derived from China.
Corruption can be endemic in China. Further FCPA enforcement actions have made clear that Chinese businesses are quite adept at appearing compliant while hiding unacceptable business practices. A Board of Directors 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 Guidance, the authors believe that a “board must ensure that the human resources committed to compliance management and reporting relationships are commensurate with the level of compliance risk.” So if that risk is perceived to be high in a country, such as China, the Board should follow the prescription in the Guidance which states “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.
Third parties generally present the most risk under a FCPA compliance program and that as much as 95 percent of reported FCPA cases involve the use of third-party intermediaries such as agents. However, in China all potential opportunities retain some level of compliance related issues. As joint ventures and the acquisition of Chinese entities are important business strategies for many western companies, it is important to have Board oversight in the mergers and acquisition process.
The authors understand that “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 or Bribery Act, 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 cite back to the FCPA Guidance and its prescribed due diligence in the pre-acquisition stage as a key to this dilemma. But those guidelines also make clear that post-acquisition integration is a must to avoid FCPA liability if the illegal conduct continues after the transaction is completed.
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 believe that “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
Show Notes for Episode 25, week ending October 7, 2016-the Krakow Edition