Think it’s easy to stay out of jail? John MacLellan doesn’t. He is the regional finance director of Microsoft for Asia, and responsible for ensuring watertight compliance with the U.S. Foreign Corrupt Practices Act (FCPA) in China, a law that exacts strict penalties for giving or taking bribes in overseas operations.
Microsoft boasts a robust internal compliance program and conducts frequent internal audits. Under extraordinary circumstances, MacLellan can call in an accounting ‘black ops’ team to blow through any office in the Middle Kingdom with impunity, seizing hard drives and riffling desks. Yet recent cases have marked a new urgency in the U.S. government’s enforcement of the law, and this keeps him up at night.
“In the U.S., there’s a very clear definition of who the government is,” he says. “But in China, when you’re elected, your family could be in power, too.” You might find yourself treating a customer to a business dinner, he says, without knowing that the old guy at the end of the table is really representing the government. Under the FCPA, this might constitute bribing a public official — a sure way to end up in the corporate penalty box, a very costly place to be. “We face a large number of very complex deals in China,” MacLellan says, “and because of the size and influence of the government, we’re exposed from the start.”
Adventures in Draconia
The FCPA may well be America’s legislative draconian sleeper. Enacted in 1977, the law has yielded just four convictions in the past 29 years. But prosecutions by the Department of Justice (DoJ) are accelerating.
What’s changed is not the law itself but the environment surrounding it. The increasing dependency of U.S. companies on foreign profits to boost growth is putting executives under pressure to do whatever it takes to hit targets. The Sarbanes-Oxley law, with its risk-control provisions and reporting requirements, has also made it more likely that an uncovered bribe or kickback will end up on a material weakness report, damaging a company’s reputation. Another feature of the new environment is an increased aggressiveness by prosecutors and regulators. According to Owen Pell, partner with White & Case, the New York-based international law firm, the number of reported investigations into possible violations, both government-initiated and self-reported, has increased since 2002, with 22 new investigations launched between 2004 and 2005. “These increases can be explained by more robust U.S. regulatory enforcement in the wake of U.S. domestic corporate scandals,” says Pell, “some notable problems at large non-U.S. companies, and increased efforts at coordinated international actions to combat corruption generally.”
The dearth of convictions can be misleading, because most cases end up in settlement. Since 1990, Pell says, the DoJ has prosecuted 49 individual defendants and corporations. Of those, 27 were resolved though plea agreements. Of the 38 dispositions handed down by the Securities and Exchange Commission since 1990, most resulted in agreements to avoid future violations, while some have ended in fines and disgorgements of profits. Disgorgement is an appropriately nasty legal term for a monetary penalty based on an estimation of the profits that resulted from a bribe to gain business.
Recent prominent cases have set precedents for tougher penalties. These include cases of bribery at an oil-services subsidiary of ABB, the Swiss-Swedish engineering group; a security equipment unit of GE, the U.S. industrial conglomerate; and Titan Energy, a U.S. energy company. The ABB case formed a particular watershed. Involving bribes to a government official in Nigeria, the company detected the offense and reported it to the DoJ. ABB pled guilty, but was socked with a $10.5 million penalty by the DoJ in a criminal conviction. Following that, the SEC won a $5.9 million penalty under a settlement in civil court. During the case, ABB paid for 43,000 hours of lawyers’ time, at up to $400 per hour. An ongoing component of the SEC settlement requires an independent monitor to be hired by the company to oversee compliance with the FCPA. Usually the FCPA monitor is a lawyer from one of the big international firms, a high-priced internal schoolmaster whose job it is to ensure the company has robust compliance programs. “Monitors are often ex-prosecutors,” says Manny Alas, co-head of PricewaterhouseCoopers’ global FCPA practice in New York. “They act as parole officers within the company to fix the compliance program.”
New pressure to comply with the FCPA is being felt just as keenly by overseas companies listed in the U.S. “I’ve had at least three separate sessions with the lawyers explaining the rules,” says Mark Keithley, senior vice president at Nasdaq-listed PCCW Global, the international unit of Hong Kong’s oldest phone company. “[They] emphasize a change in the way the law is being enforced.” One of these changes involves tighter control over what Keithley classifies as marketing costs. “They can now be looked at as a potential inducement or bribe,” he says.
So Be Good
China has not loomed large in the U.S. caseload, but that is changing fast. The discovery of questionable Chinese transactions has a way of emerging when companies launch a global FCPA audit. Lucent, the U.S. telecommunications company, was hit with an investigation into alleged bribes to an influential Saudi official connected with the telecom industry. The case sparked a global internal audit of business practices by the company, leading to the dismissal of four Chinese employees in 2004, including the president and chief operating officer of Lucent’s Chinese business, as well as a marketing executive and a finance manager, under suspicion of giving bribes to win contracts.
To put things in perspective, China is no Nigeria — but it’s no Singapore, either. In an annual index that tracks how business people perceive corruption in 156 countries, China landed in 78th place, not the worst in Asia, but one place behind Laos and far behind Malaysia. Given that China surpassed the United Kingdom in January to become the world’s fourth-largest economy, being beat out by poverty-stricken Laos could hardly make economic officials blush with pride. Singapore was deemed the world’s fifth-cleanest environment for doing business. Iceland ranked first.
For foreign business people in China, corruption is an increasing concern. A recent poll of U.S.-owned businesses by the American Chamber of Commerce in Beijing showed that 72 percent feel that corruption in China is unacceptably high. In addition, more than half of the respondents believed that corruption is getting worse.
Experts say it’s easy to get blindsided by an uncovered bribe discovered too late. One way this can happen is inheriting a problem via an M&A transaction. Hong Kong-based Neil Torpey, a partner at international law firm Paul, Hastings, Janofsky & Walker, who advises Asia-based corporates on compliance regulations, recalls a purchase by a U.S. client company of a firm based in Macau. After a general lecture on compliance, an employee in the accounting department of the acquired firm approached the general counsel of the acquirer and asked if the FCPA liability he was referring to included invoicing a major customer for 30 percent of the actual price of the goods to avoid taxes and then splitting the tax savings between officers of both companies off the books. It spurred an internal investigation that likely saved the company an investigation under the FCPA. As scandalous as this sounds, Torpey cautions this situation represented a lucky draw. If the question had not been asked, he says, the kickbacks and creative accounting would have gone undetected, thus placing the acquiring company under enormous risk.
For Goodness’ Sake
Alas of PricewaterhouseCoopers says that CFOs should ensure that full compliance with the FCPA covers a complex range of activities. He or she must guarantee that books, records, and accounts reflect transactions accurately and give a true picture of the state of the company’s assets. The CFO must set up a system that shows that employees’ spending of company money has direct management approval. The CFO must make sure that the books are audited at regular intervals. In a double-whammy, the Sarbanes-Oxley law requires disclosure of any FCPA violations. If a material weakness is found in an audit, then the CFO must ensure public disclosure of the deficiency, audit-committee oversight, and active scrutiny by the legal department.
So here’s how MacLellan is able to catch up on a little sleep. His first line of defense is education. “Every single employee has to go to classes,” he says. “They have to take a test and record the fact that they’ve passed.”
He makes it a regular practice for an internal-audit group to check for irregular dealings. If a suspicion is serious, he has the option to bring in those ‘men in black’ — an independent group operating within the company, acting as a global audit SWAT team set up originally to ensure compliance with Sarbanes-Oxley. Finally, employees are encouraged to report any questionable activities via a hotline to Redmond, Washington, Microsoft’s hometown. The most common type of call comes from employees overseas tagging possible FCPA violations. “It’s the biggest driver of feedback on the hotline,” says MacLellan.
Of course, not all companies have Microsoft’s resources. Alas and Torpey advise companies to run due diligence checks for potential FCPA violations on a regular basis in China operations. A small industry of investigative firms has emerged to address the need. Hong Kong-based investigative group International Risk has performed several audits for FCPA violations as due diligence amid M&A transactions. But Steven Vickers, its founder, urges CFOs to “[make] sure things are in order before the toothpaste has to be put back in the tube.” Increasingly, he’s been asked to check that China operations have safeguards against unscrupulous business practices. He also advises background checks on third parties, such as suppliers and consultants. When an FCPA violation emerges, it may be difficult to prove that such partners were involved in arms-length transactions. He stresses the need for documentation that can prove a transaction was legitimate. But, like MacLellan, he accentuates the importance of education and judgment over the prescriptive approach. “A strong moral grounding in the company is more effective than the most detailed legalistic approach,” says Vickers.
So far, according to MacLellan, the approach has been working. “Have I seen situations where the commercial reality is so questionable that I have to intervene? Yes. Have I ever seen actions I regret from this company? No.” He aims to keep it that way.
To Give or Not to Give
M&A forms one arena for potential conflicts with the Foreign Corrupt Practices Act in China. But everyday business dealings are rife, as well. John MacLellan, regional finance director of Asia for Microsoft, notes: “Business practice conducted in China is tailored deal by deal. It’s up to you to determine what’s right or wrong.” He adds: “It’s not like the law says that when you’re playing golf, you can pay for the game, but you mustn’t pay for the limo, and don’t bet on the score for the hole.”
Confusingly, the law does allow some room for what might be deemed bribes under any circumstances — gratuities given to government officials for performing essentially clerical duties. Examples of this might include payoffs for customs clearance, vehicle registration, visa renewal, police protection and utilities service. It’s up to the CFO to decide which payments are appropriate and which involve an unseemly transaction to influence an official to win business — a grey area never easy to negotiate.
Peter Humphrey, managing director, ChinaWhys, an investigative firm and risk management consultant in Shanghai, concurs. “It’s a very human exercise,” says Humphrey, “not just a balance-sheet exercise.” The human factor, he says, comes in understanding the culture of business in China and knowing how to draw the line in common business dealings. There are many standard practices in China that might put CFOs in danger — or not. It is common, for example, to give hongbao, or red envelopes — gift-giving of small amounts of money to friends and acquaintances during the Lunar New Year.
Many Chinese companies are not used to non-Chinese business standards and may have relatively weak internal controls and little transparency or internal corporate reporting. In this environment, common features of Chinese accounting can draw the suspicion of foreign investigators. A fa piao is a generic receipt often used in China that does not specify the relevant transaction, and as a result, may raise suspicions regarding potential corrupt activity. Similarly, a chop, or stamped seal, that is commonly used in lieu of a signature, can be misused to issue checks or loans.
“The question,” says Pell, “is whether sufficient internal controls are in place to prevent abuses.”