Doing Business in China: Third-Party Intermediary Payments Can Get a Company in Trouble under Anti-Corruption Laws

News & Insights
Dec 14, 2015

When companies enter into China, third-party partners and/or agents, such as consultants, distributors and brokers, are most often sought out and relied upon to establish the necessary local footholds and to navigate cultural and business barriers encountered in doing business there. Third-party agents, with ample local resources, are able to provide companies with fast and meaningful results for ad hoc transactions or business expansion. In many other instances, third-party partners and/or agents are necessary to access end customers as potential customers are spread across hundreds of second- and third-tier smaller cities. In certain business sectors, companies might not always have the licenses or certifications that enable them to sell directly to customers.

However, pairing with third parties can be risky. Under the U.S. Foreign Corrupt Practices Act (“FCPA”) or China’s anti-corruption laws, companies and individuals can be liable for the bribes made by third-party intermediaries on their behalf. The risk may become even more acute in China, because many Chinese industries are government owned or operated and the U.S. is broadly defining “foreign officials” for enforcement purposes to include employees within such industries, such as employees in the health care and banking sectors. In this way, Chinese enforcement actions—even actions that do not involve “government officials” under Chinese law—are being turned into FCPA enforcement actions that do involve “foreign officials” under U.S. law. Thus, as Chinese anti-corruption cases continue to increase, the result may be an increase of FCPA enforcement actions implicating U.S. companies who have paired with third parties in China.

I. FCPA Enforcement Actions in China

The FCPA prohibits any improper payments made to “any person, while knowing that all or a portion of such money or thing of value will be offered, given, or promised, directly or indirectly” to a foreign official. The U.S. Department of Justice (“DOJ”) and U.S. Securities and Exchange Commission (“SEC”) joint Resource Guide to the FCPA clearly states that “[t]he fact that a bribe is paid by a third party does not eliminate the potential for criminal or civil FCPA liability.”

The vast majority of FCPA enforcement actions involve the use of third-party intermediaries. Third-party risks continue to be highlighted in 2014 and 2015 FCPA enforcement actions in China. Both Avon and Bruker Corp., the two 2014 corporate enforcement actions in China, involve third-party intermediaries. So does the 2015 SEC corporate enforcement action Mead Johnson Nutrition, which targeted a sales and marketing trading practice common in China. Third-party risks are also allegedly involved in the ongoing FCPA investigations of GlaxoSmithKline, Harris Corp, Panasonic Avionics, PTC Inc., Rolls Royce and Sensata Technologies for their conduct in China.

These recent cases show that U.S. companies cannot assume that the way they structure their relationships with third parties in China will allow them to avoid FCPA liability.

In Mead Johnson Nutrition, Mead Johnson agreed to pay $12 million to settle the SEC’s books-and-records and internal-control charges in an administrative cease-and-desist proceeding. Mead Johnson’s subsidiary in China (“Mead Johnson China”) allegedly made improper payments and gifts to health care professionals to recommend the company’s product to new and expectant mothers through third-party distributors. Mead Johnson China’s employees allegedly funded improper payments through “distributor allowance” funds that were allocated to distributors as discounts for marketing and distributing the company’s products in China. According to the SEC cease-and-desist order, although the funds “contractually belonged to the distributors, certain members of Mead Johnson China’s workforce exercised some control over how the money was spent, and certain Mead Johnson China employees provided specific guidance to distributors concerning the use of the funds.” Mead Johnson Nutrition raises important questions for U.S. companies about situations in which distributors are able to achieve discounts that free up funds for improper bribes unbeknownst to the company while the company in fact has no—or only remote—control over the funds. In Avon, Avon entered into a deferred prosecution agreement with DOJ and agreed to pay $135 million to settle the books-and-records and internal-control charges by DOJ and SEC. Avon’s China subsidiary (“Avon China”) pleaded guilty to bribing Chinese officials by falsifying records and retaining a consulting company as a conduit to make improper payments to Chinese government officials. Avon China’s executive retained a consulting company purporting to provide services for “crisis management,” “government relations,” and to “coordinate with public securities authorities.” However, these services were “memorialized in a scant two-page contract.” Avon China “did not conduct any due diligence” on the company, “nor did they require it to comply with the Code of Conduct of Avon . . . even though [the consulting company] was retained specifically to interact with government officials on behalf of Avon China.”

In Bruker Corp., SEC charged that Bruker violated the internal controls and books and records provisions when its subsidiary made improper payments to state-owned entities to obtain sales contracts, which enabled it to realize $1.7 million in profits. Partly under the bribe scheme, a Bruker office in China paid more than $111,000 to Chinese government officials under 12 “suspicious collaboration agreements contingent on state-owned enterprises providing research on Bruker products or using Bruker products in demonstration laboratories, while the agreements did not specify the work to be provided in order to be paid and in fact no work product was actually provided to the Bruker office by the enterprises.”

In 2014’s GlaxoSmithKline case, the record-high corporate fine case in China, the UK Pharmaceuticals firm GlaxoSmithKline was fined $490 million by a Chinese court for paying out bribes to doctors and hospitals in order to have their products promoted. According to the allegations, the company colluded with hundreds of travel agencies and consultancies to channel as much as 3 billion yuan (roughly equivalent of $490 million dollars) in bribes to doctors and health care professionals in China over six years. The Chinese investigations attracted the attention of U.S. authorities, which are reportedly investigating the company for FCPA-related violations in China and other countries.

II. A New Era of Cross-Border Enforcement

Another challenge that compounds the FCPA risks of U.S. companies doing business in China is that FCPA’s coverage in China is particularly sweeping, even though it only prohibits bribery to foreign officials. Under the FCPA, “foreign officials” are defined expansively to include any personnel of an “instrumentality” of a foreign government, including, inter alia, government-owned or government-controlled businesses and enterprises. In the Chinese context, this definition covers most basic utilities, financial, infrastructure, and health care service providers, such as banks and hospitals. SEC enforcement actions in both Mead Johnson Nutrition and Bristol Myers Squibb, another 2015 FCPA case in China resulting in a settlement of $14 million, stemmed from bribes made by the companies’ Chinese subsidiaries to health care professionals in hospitals that are owned or controlled by local governments. Had these corrupt schemes not occurred in China, but in a country where health care is not government owned or controlled, they probably would not be subject to FCPA scrutiny.

China’s domestic laws do not necessarily consider employees of these sectors as government officials, particularly those low ranking employees. In contrast to Mead Johnson Nutrition and Bristol Myers Squibb, health care professionals in Chinese hospitals who merely prescribe medicine and provide medical treatment to patients would not be deemed to be government officials, where no government functions are involved. However, commercial bribery to these sectors is prohibited by China’s anti-bribery laws. China’s increasing aggressiveness in enforcing its laws against commercial bribery may be a catalyst for DOJ and SEC to enforce FCPA violations against the same entities. The GlaxoSmithKline case exemplifies such cross-border enforcement, where investigations start locally and then extend worldwide. We are closely watching to see whether such cross-border cooperation between enforcement authorities will continue and become a trend in anti-corruption enforcement between the two countries.