Category: Guest Posts

Domestic Preference And China’s Accession To The WTO’s GPA: Implications For FCPA Enforcement

Today’s post is from Ken Chan, a Senior Analyst with Beijing Orient Business Investigation Company (here).

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“Given the major role played by the government in Chinese economy, it comes as no surprise that some multinational companies, with inadequate internal control, might fall foul of the Foreign Corrupt Practices Act (“FCPA”) when doing businesses in China. Less understood is the exposure under PRC Government Procurement Law for dealing with local government entities. China’s eventual accession to the WTO’s Agreement on Government Procurement (“GPA” – here), where the US and EU are current signatories, will also have implication for FCPA enforcement in the region.

Enforcement statistics indicate that most FCPA actions concerning conduct in China occur during the course of securing sales contracts from state-owned companies, as well as government entities like hospitals. It should be noted that in the latter case, the PRC Government Procurement Law (promulgated in 2002) is applicable. According to Article 10 of the law, government entities must use domestic goods and services, unless they are not available or cannot be acquired on reasonable commercial terms.

For example, in 2008 Siemens and AGA Medical were subject to FCPA enforcement actions for paying bribes in connection with the sale of medical devices to hospitals in China. And yet, while both companies ran afoul of the US anti-corruption law, they and their peers regularly evade enforcement under the local procurement law. It is unlikely that medical devices supplied by Siemens or AGA Medical fell into the exception categories of Article 10, since suppliers of competitive items are less prone to use bribery means to win contracts.

In fact, it is widely known that Article 10 of PRC Government Procurement Law is not strictly enforced. The reasons for this are threefold:

1. The absence of a legal or authoritative definition of the term “domestic”; 2. The absence of penalties for non-compliance; and 3. The absence of implementing regulations to support the statute.

As a result, today foreign companies effectively participate in the government procurement market in China without restrictions. US multinationals, with their well-known brands and superior products, are among the strongest competitors in the information technology, pharmaceutical and industrial equipment sectors.

However, in recent years there has been mounting pressure from local entrepreneurs in China, requesting the government to impose a genuine domestic preference practice in public procurement. It is argued that the same domestic preference practices are currently adopted by other developing countries (e.g. Buy Brazilian Act) and developed countries (e.g. Buy American Act and EU Utilities Directive). As a result, the Chinese government is enacting the Implementing Regulations of PRC Government Procurement Law, with a draft version issued on 11 January 2010.

Domestic forces are not the only ones shaping the government procurement market in China. International pressures are also at work. On 19 June 1997 China began the accession process for the WTO’s Agreement on Government Procurement, a multilateral agreement that today has over 40 signatories. Signatories are obligated to open their government procurement markets to companies from other signatories. China’s third accession offer, submitted on 30 November 2011, places the procurement activities of its central government agencies, as well as selected provincial and municipal agencies, within the GPA’s ambit. Once China becomes a party of GPA, foreign companies from signatory countries will enjoy treatment no less favorable than domestic companies when contracting with specified government agencies.

These developments in government procurement practices present important implications for FCPA enforcement in China. First, if the “buy local” movement has its way, then an increased preference for domestic sources would limit foreign firms’ access to the government procurement market. With fewer multinationals (and, by extension, companies with US anti-corruption law exposure) competing for government business, FCPA violations could fall as a result.

Since GPA accession would allow foreign bidders to take part in some PRC government contracts, it may provide more rooms for FCPA violations. Nonetheless, on the other hand, GPA would impose an obligation on China to implement fair and transparent tendering processes for government contracts. The attendant increase in public scrutiny may reduce the instances of bribe giving, bribe taking and other corruption practices.”

In The Classroom

Included in the mission of FCPA Professor is to foster a forum for academics who are increasingly covering Foreign Corrupt Practices Act or related content in the classroom.

Today’s post is from Jeffrey Klink.  Klink, a former Assistant United States Attorney, is the CEO of Klink & Co. (here) a global consultancy engaged in anti-bribery compliance initiatives for publicly held and private businesses, including training, due diligence, policies and procedures, and investigations.

As evident from his post, Klink also teaches a course on anti-bribery compliance at the University of Pittsburgh Katz Graduate School of Business.

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When I agreed to create and teach a course on anti-bribery compliance for the University of Pittsburgh, Katz Graduate School of Business, I was excited but wary.  I worried that students would not really have an interest in global compliance issues like I do.  Would eyes glaze over when we talked about training, pre-acquisition due diligence, and third-party risk?  Let’s be honest, for many, the mere mention of the word compliance brings to mind organizational mandates from afar, on-line courses that no one likes or pays much attention to and reams of unread paper in corporate handbooks.  My concerns were misplaced. Not only were the students interested, but many had real world experience with corruption, in countries with emerging markets.

My supportive colleagues at Pitt advised me, at most, that I could anticipate 12-15 students to enroll in the course, but, be prepared for a course cancellation if there were fewer.  In the end, there were 24 students from the MBA and the Masters in Accounting Programs enrolled in the class. The University asked me to teach this course again in the fall.

For the course textbook, I used a book that my colleague, Tracy Pastrick and I, put together for a course we created for the Pennsylvania Bar Institute in 2011 with the catchy name “The Foreign Corrupt Practices Act”.   For the class, I supplemented that book with resources made available by Transparency International, the Organization for Economic Cooperation and Development, this web site (FCPA Professor), and Shearman & Sterling’s excellent web site.  I encouraged students to read the Financial Times and the Economist, as well as the Wall Street Journal to stay abreast of the most recent bribery cases.

We studied cases of import, like Innospec, Nature’s Sunshine, the many Siemens cases, and focused on keeping topical issues in sight, like the Africa Sting cases.  We talked about the current investigation into bribery at News Corporation, and the ongoing problems in the BRIC nations. We discussed the several years old Hermitage Capital debacle in Russia, where a U.S. investment fund had its offices raided by corrupt law enforcement officials as part of a successful scheme to obtain a $200 million tax refund.  That the Russian lawyer for Hermitage Capital, Sergei Magnitsky was brutally beaten to death in prison simply because he opposed the corruption in Russia, was eye-opening.

As a class project, each student was required to perform a detailed analysis of the risks associated with an organization entering a specific country with less than stellar Transparency International ratings.  We chose 12 countries and talked about the importance of third-party due diligence, hospitality and entertainment, typical schemes involving third parties and bribes, and secondary problems related to cross-border transportation of goods, taxes, environmental regulations, permits, and inspections.

I also wanted the students to understand the compliance costs suffered by multinational businesses, including my perspective as a former DOJ prosecutor, on the unfairness of certain DOJ and SEC positions.  We discussed the pros and cons of self-reporting.

One of the critical issues we focused upon was the human cost of bribery and corruption.  It seems that the topic of the human costs associated with corruption and bribery is missing from FCPA conferences; after all, this was the reason for the creation of the FCPA in the first instance and it is an issue worthy of review and discussion.

One of my students, a Bosnian who had fled the country during its civil war in the early 1990’s, had the class spell-bound as he recounted paying bribes to leave his country and illegally flee to Germany.   This student recounted how the country was and still is completely corrupt, with literally a handful of elites in Bosnia controlling all wealth by cheating their fellow citizens out of every opportunity, large or small, through corrupt activities.  It was a tragic, but well-told tale.

A Chinese student studying at Pitt gave a great presentation about the corruption risks, but also the rewards of doing business in China.  She had a unique perspective on corruption in China, including bribery in education (not unusual to have to pay to go to a good school), bribery in business (land acquisition often involves bribes), but also the opportunities.  She noted how many companies had successfully entered China and the growth of the Chinese middle class.

Many of the students in the class worked full-time for large global businesses and were attending school on a part time basis to obtain advanced degrees.   These students generously shared their experiences with me and the class during our discussions.  When I asked whether any of the students had ever taken on-line compliance training courses, there was a loud universal groan.  The consensus from the class was that no one paid much attention to on-line compliance courses. The standard way of taking an on-line compliance course seemed to be to occasionally click on a key to allow the training course to progress, so that it would soon mercifully end.

Ultimately, the class was about global business and the fact that opportunities are often found in places where corruption and bribery flourish.  Providing the students with a global perspective, not only about corruption and bribery, the underbelly of the global economy, but also about rewards and global career opportunities, made teaching the course worthwhile.

A Q&A Regarding FCPA Insurance

Previous posts (here and here) have discussed FCPA insurance.  One of the industry participants offering this new product is Marsh (see here for its FCPA Corporate Response).

In this Q&A, Machua Millett (Senior Vice President and General Partner Liability Product Leader at Marsh) answers questions about FCPA Corporate Response as well as other issues presented by FCPA insurance.  Prior to joining Marsh, Millett practiced law at Skadden Arps, Bingham McCutchen and Edwards Angell Palmer & Dodge.

Why is FCPA insurance needed?  What was your “ah-ha” moment in developing this product?

FCPA investigation costs insurance is needed because existing insurance products were leaving companies and their employees largely unprotected against one of their major potential liabilities in conducting international business. Our “ah-ha” moment came after one too many clients had come to us seeking an insurance solution, and we had to tell them that no comprehensive FCPA investigation costs insurance product existed.  So we collaborated with an A-rated insurance company to create and launch a solution.

Describe in detail the product Marsh is offering.

The product, exclusively available through Marsh, is called FCPA Corporate Response. It is an insurance policy that funds investigation costs resulting from any regulatory investigation by any regulator in the world concerning alleged bribery of a government official.

The four main pillars of the policy are the definitions of Investigation Costs, Claim, Insured, and Wrongful Act.

Investigation Costs includes all fees and expenses of attorneys, experts, consultants, accountants, auditors, and any other professionals a company typically hires in the course of conducting or defending itself against an anti-corruption investigation.  This definition is significantly broader than most directors and officers liability (D&O) policies, which generally cover only attorneys’ fees. This is not by accident. In our experience, companies caught up in an FCPA investigation incur significant accounting and consulting fees in addition to legal fees, and we wanted all such investigation costs covered by this policy.  It is important to note, however, that this policy only covers investigation costs.  It does not cover settlements, judgments, damages, wages/salaries, fees of directors/officers/employees, costs of compliance/remedial measures or fines and penalties, (most of which would de deemed uninsurable by insurers, regardless).

Claim includes any civil, criminal, administrative and/or regulatory investigation or inquiry brought by any U.S. or foreign regulator, with the trigger broadly defined to include any written notice of such investigation or inquiry.  In addition to this broad claim trigger, the policy also provides pre-claim inquiry coverage for internal investigations.  This means that any investigation costs incurred as part of a company’s internal investigation prior to regulatory involvement is covered on a retroactive basis when a company self-reports or a regulatory investigation or inquiry is otherwise initiated.

Insured includes all entities and individuals that might be implicated as part of an FCPA investigation of a company, including all subsidiaries, affiliates, directors, officers, employees, foreign equivalents, consultants, agents and independent contractors.  These last three categories are of particular importance, as nearly 80 percent of FCPA investigations arise from the activities of such third-party agents and independent contractors, who are often not treated as insureds under standard D&O policies.

Wrongful Act means: any actual or alleged violation of the FCPA, including criminal bribery allegations and civil recordkeeping allegations; and any actual or alleged violation of any other law, treaty, regulation or act that, but for geography, would also constitute a violation of the FCPA.  The definition of Wrongful Act is quite broad in terms of geography, potentially-implicated conduct, and potentially relevant laws. However, it is important to note that the policy’s coverage does not extend to aspects of foreign corruption laws like the U.K. Bribery Act that are broader than the U.S. FCPA. In the case of the UKBA, the two most relevant examples would be the UKBA’s prohibition of commercial bribery and lack of an exception for facilitation payments. Where an investigation under a foreign statute involves both FCPA-type allegations (bribery of a government official) and non-FCPA-type allegations (say commercial bribery), investigation costs would have to be allocated between covered and uncovered aspects of the investigation.

The policy contains only two exclusions, both of which are directed toward the simple idea that a company cannot buy insurance for a burning building. The first exclusion bars coverage for a prior or pending investigation and the second exclusion bars coverage for any matter that was known at a truly corporate level — by the general counsel of the Named Insured — at the time of application for the policy and later develops into a regulatory investigation or inquiry.  It is also relevant in this regard to note that just as a company may not buy insurance for a burning building, it may not purchase a burning building and expect coverage under the policy. Although the policy provides automatic coverage for new subsidiaries, coverage only applies to wrongful acts that occurred after the acquisition. Transactional risk insurance products do exist that can be used to mitigate acquisition risks around FCPA issues.

The FCPA contains both anti-bribery provisions and books and records / internal controls provisions.  The latter provisions are generic in scope and don’t require foreign conduct to be implicated.  Does the product cover the range of circumstances in which the FCPA books and records and internal controls can be implicated?

As mentioned before, FCPA Corporate Response does provide investigation costs coverage for both anti-bribery and books and records and internal controls.  Anything that is a violation of the FCPA, or would be but for geography, will trigger the policy’s definition of wrongful act.

One of the reasons for the increase in FCPA enforcement is the increase in corporate voluntary disclosures, an event which often prolongs FCPA scrutiny for many years and results in lucrative professional fees for those involved in the investigation and disclosure.  Will FCPA insurance increase the number of corporate voluntary disclosures on the theory that the downside of corporate voluntary disclosures (longer period of scrutiny which leads to higher professional fees) will be covered?

We have had some people comment that the policy seems to create an incentive to self-report, both generally because the company has the investigation costs insurance, but more specifically to trigger coverage for internal investigation costs.  While this may be, I find it somewhat hard to believe that the existence of the policy will prevail over other considerations; after all, the policy does not cover FCPA fines, penalties, or remedial measures.  However, the policy certainly doesn’t create any disincentive against self-reporting.

Will FCPA insurance lead to more aggressive business conduct in foreign markets?

I don’t think so.  Again, the policy does not cover fines and penalties and other costs that we have seen reach the hundreds of million of dollars. The policy covers investigation costs.  FCPA Corporate Response is most certainly not meant to be a replacement for a robust FCPA compliance program at a company, but instead is meant to be a compliment or backstop to such a program based on the realization that no compliance program, no matter how robust, can prevent the rogue activities of one employee or independent agent

A Q&A With Claudius Sokenu On “Where Else”

Why do FCPA investigative fees often reach tens of millions of dollars?  Why does FCPA scrutiny (from the point of disclosure to the point of resolution – if any) often last two to four years and perhaps longer?  In part, it is because of the “where else” question.

The “where else” questions often works as follows.  A company voluntarily discloses conduct to the DOJ/SEC that occurred in country x that could implicate the FCPA.  Before the DOJ/SEC agree to resolve any enforcement action, the agencies will often ask something to the effect – if the conduct occurred in country x, convince us that similar conduct did not also occur in countries a, b, c, etc.  The lawyers on the receiving end of the “where else” question don’t mind being asked because the “where else” question often leads to a world-wide review of their client’s operations around the world.

I first started writing about “where else” in 2009, see here, and most recently wrote about “where else” here.  As a former FCPA practitioner I was on the receiving end of the “where else” question and conducted resulting world-wide reviews on behalf of corporate clients.

The “where else” question is asked in nearly every FCPA enforcement action.  How does one know?  Read the resolution documents.  For instance, the Magyar Telekom resolution documents states that the company conducted a “thorough global internal investigation concerning bribery and related misconduct.”  The Tenaris resolution documents cites that company’s “voluntary investigation of the Company’s business operations throughout the world.”  The Tyson resolution documents state that all of the company’s wholly-owned overseas production facilities were “subjected to rigorous FCPA reviews.”  Numerous other examples could also be cited.

Claudius Sokenu is a leading FCPA practitioner at Arnold & Porter (see here).  As a former SEC FCPA enforcement attorney, Sokenu has both asked the “where else” question in the context of an FCPA inquiry and has been on the receiving end of the “where else” question as an FCPA practitioner.  His views on “where else” first caught my attention in this 2011 interview with The Metropolitan Corporate Counsel and he expands on “where else” in the below Q&A.

What percentage of FCPA enforcement actions that you have been involved in have resulted in the “where else” question being  asked?

In my time as a regulator at the Securities and Exchange Commission’s Division of Enforcement and in private practice, the “where else” question has been asked in  virtually every single FCPA matter in which I have been involved.  I have asked  it and it has been asked of me.

Do you believe the “where else” question was appropriate in these instances?

In some instances it was entirely appropriate for the SEC, the Justice Department, and other regulators to ask the “where else” question.  In others, however, the allegations did not support a “where else” question and it appeared to be more of a fishing expedition and boiler plate question than a well-reasoned question under the facts.  “Where else” is a reasonable and appropriate question when the alleged misconduct appears to be systemic and/or the company under investigation appears to lack the controls necessary to prevent the payment of bribes to foreign government officials.  It is not, however, an appropriate question where it is intended to force companies to conduct multi country internal investigations with little more than the uninformed hunch of a government official who has little or no experience in how businesses work around the world.

The “where else” question could logically be asked in any DOJ or SEC investigation regardless of substantive area of law.  Do you believe the “where else” question is asked more frequently in FCPA enforcement actions
compared to say antitrust, tax, or environmental enforcement actions?  If so, why?

Because the “where else” question is often raised behind closed doors in private conversations between government and counsel, it is difficult to be certain, but yes, I do believe the question is asked more frequently in FCPA enforcement investigations.

This is not entirely unreasonable given the nature of the FCPA.  First, the scope of the FCPA’s jurisdiction, by definition and necessarily, covers the entire world.  And unlike antitrust laws, for example, which have some extraterritorial application but are primarily concerned with the impact on U.S. markets, the FCPA’s primary focus is on actions occurring abroad.  Second, it is not always unreasonable to think that the insufficient (or nonexistent) internal controls that facilitated bribe payments in one country will have the same effect elsewhere. Taking these two factors together, one could reasonably conclude that the FCPA is uniquely amenable to the “where else” question.

That is not to say, of course, that the “where else” question will always be appropriate in the FCPA context or that it will never be relevant elsewhere.  For example, a discharge of pollutants in one of a company’s many U.S. plants may very well justify a widespread environmental audit.  Expanding the scope of investigation in such a case would depend on whether the discharge was the result of, say, incompetent employees hired under criteria used nationwide, as opposed to a once-in-a-generation weather event.  In the former case, a widespread audit would likely be called for, whereas in the latter it likely would not.  The fact is, in the FCPA context, the vast majority of cases have resembled the first scenario – i.e., systematic defects whose effects could arise anywhere – and thus broad investigations have often made more sense than localized ones.

Of course, a somewhat more pessimistic reason for the “where else” question’s predominance in the FCPA context would involve the issues that you’ve written about extensively in your papers and on your blog. Namely, a case law scarcity that causes risk-averse corporate defendants to cooperate regardless of the cost, and government agencies who have the mostly unchecked power (and possibly incentive) to exploit a corporation’s position to cobble together the largest possible fine. Overall, I expect both of these possible frameworks are at play.

DOJ or SEC asks the “where else” question in the absence of any meaningful check or judicial oversight.  What is the remedy?

If I had been asked a year ago whether there was any meaningful check or judicial oversight with respect to the “where else” question, I would almost certainly have replied that there was not.  Given the government’s assorted setbacks in the past year, however — the overturned Lindsay Manufacturing convictions, the O’Shea acquittal, the Africa sting case acquittals and mistrial — it is possible that a potential check is emerging.  Until recently, the government’s near-perfect track record has given them the power to unilaterally dictate the terms of a defendant’s “voluntary” cooperation.  It stands to reason that once defendants have some hope of a positive outcome at trial, the parties’ negotiating positions will not be so lopsided and a company will be able to resist, without fear of reprisal, an unreasonable demand to expand the investigation.

Another possible remedy, although perhaps a more improbable one, would be a revision not to the FCPA itself, but instead to the agencies’ internal guidelines.  This revision would make clear that cooperation credit should not be withheld in situations where the company declines to expand its investigation in the absence of some specific and articulable facts pointing to wrongdoing there.  This “reasonable suspicion” language is, of course, less demanding than the probable cause required for a warrant, but it is at least enough to prevent the blind fishing expeditions that happen now.

Both of the above scenarios will likely require another high-profile setback or two, but as we’ve seen over the past year, those are certainly not out of the question anymore.

The Elusive Mr. Kozeny