Bribery in Today's China

Since the late 1990s, companies conducting business in China have experienced a surge in enforcement of anti bribery legislation, ranging from significant enforcement of Chinese domestic laws to FCPA for U.S. companies. As an example of the enforcement activity by the Chinese government, the country's Central Discipline and Inspection Committee takes action against approximately 180,000 officials annually, with an estimated 15%-20% of them for corrupt activities. This past April, the UK passed the Bribery Act, which imposes severe penalties on British violators for any bribery, not just those of government officials, in China and worldwide. In-house counsel for corporations conducting business in the world's fastest-growing market should take heed of these legislative and enforcement shifts, as well as the slowly evolving cultural mores in the new China.

Today's China is experiencing what I call a “corruption dichotomy.” There's a Chinese proverb that illustrates the historical blind eye to corruption: “The mountains are high; the emperor is far away.” That notion was recently quantified by Dr. Pei Minxin of Carnegie Endowment for International Peace, who estimated that corruption in China amounts to about 3% of GDP and that the chances of getting caught, convicted and being jailed for bribery is also about 3%. But concurrently, China has enforced some of the world's most stringent penalties for those found guilty of corruption. Cheng Kejie, former vice-chairman of the Standing Committee of the National People's Congress, was tried and executed for accepting bribes. The mountains still may be high, but the long arm of Chinese officials is growing longer.

Anti-Bribery Legislation Impacting Business in China

The Chinese government has a labyrinth of laws, administrative directions and rules designed to thwart bribery and corruption. But it is fair to say that such regulations have heretofore not been enforced with the appropriate rigor. This is due in part to the often vague wording and intent of some laws, which can leave key issues subject to interpretation. However, this situation is shifting in step with changing social mores regarding corruption, as well as increased scrutiny by international governments on the behavior of their corporations with regards to bribery and corruption.

In China, securing an “official position” was historically viewed as a license to enrichen oneself, friends and relatives. Even organized crime was involved in the illicit trading of official appointments, often in collusion with government representatives. This collusion between officialdom and organized crime became more transparent during the recent Chongqing organized crime trials, which resulted in law enforcement, judiciary, government officials and triads being convicted and sentenced to lengthy prison terms and even death.

However, despite such cases, successful detection and conviction of bribery is an exception rather than a rule. As noted earlier, only 3% of bribery cases are detected and offenders punished. For centuries Chinese society has taken a pragmatic view that that individual behavior is governed by how one perceives the net gain advantage in engaging in any activity. So with regard to bribery, many still believe the financial or social benefits outweigh the risks.

With a GDP expected to grow by 8% in 2010, according to Morgan Stanley Asia, foreign investors and businesses realize that the benefit of investing, manufacturing, innovating and selling in China. On the other hand, the cost of improperly assessing, evaluating and managing the risks of bribery and corruption cannot be over emphasized. In December 2008, the German engineering company Siemens paid $1.6 billion in fines and penalties to the U.S. and German governments for fraud violations, some of which took place in China.

Over the last decade, LECG China's forensic accountants and investigators have worked on many of the FCPA and other anti bribery offence investigations in the country and worked on numerous compliance and preventative programs such as FCPA health checks, due diligence and fraud audits (including the Siemens case). The experience has proved that companies that do not perform full due diligence on joint venture partners, M&A targets and business partners in China, including their distributors, agents, subsidiaries, third parties and intermediaries, are exposing themselves not only to huge financial costs, but damage to reputation, brand and ability to continue to conduct business successfully. Anti-corruption efforts must include a robust and effective compliance programs designed to detect and deter bribery and instill ethical and responsible business practices.

A compliance program cannot be bought off the shelf, but rather must be carefully designed and customized to the nature of the industry, exact locations of operations, size and composition of workforce, financial and accounting regulatory regime and other unique risks and circumstances of the business environment. Such a compliance program should be guided primarily by the root causes of corrupt and unethical behavior. The fraud triangle originally conceived by Dr. Donald R. Cressy proposes that in every situation of fraud, and by extension bribery, there are three factors that are present. Therefore any fraud and bribery reduction program should address the following factors.

Prevention, Detection and Challenges

Not only is bribery rampant in China, but people can be quite adept concealing their tracks and frustrating investigation and compliance monitoring efforts. While the universal investigative attributes of attention to detail, lateral thinking and thoroughness are as important as anywhere in the world, in China, a thorough knowledge of local business practices, language, culture, accounting practices and risks is essential.

• An anti-bribery compliance framework should allow unfettered inspection of company books and records, digital environment data and interviews of staff and any other people who can provide insight and explanation. Therefore, the framework must clearly define what can and can't be done and by whom. This must be communicated through training and absorption measured through continual monitoring systems. Even if the foreign headquarters has a sophisticated compliance framework, it may not be customized to the Chinese environment or the spirit and meaning of the content lost in translation.
• Because of the traditional blind eye to fraud, there is rarely anything surprising about a “surprise” audit; managers and employees are likely to be prepared or pre-warned when forensic accountants are venturing from a foreign country. Investigators and forensic auditors working in China are very familiar with the local style of passive resistance, non-confrontational obstruction and generally giving investigators and auditors the “run-around.” But local market experience, investigative acumen, and knowledge of local customs and policy can thwart local efforts to impede investigations.
• Vague or nonexistent corporate policy on audit rights, particularly in the case of third parties or intermediaries, can also limit investigators' access to people and records. Third parties are often vital in a company's market penetration and distribution strategies, but these partners can present a significant fraud risk because of their government connections or experience in “gaming” the system. Or even more blatantly, agents have been known to refuse to agree to audit provisions outright.
• State secret protection laws and Chinese citizen data privacy statues may result in limited or no access to employee's workstations, laptops and other digital storage devices. In other instances, data housed outside China is not admissible for litigation or discovery purposes. Private data is often maintained on company computers, or vice versa, providing an excuse not to allow the imaging of hard drives and examination of data that may contain evidence or the digital “smoking gun” of bribery or the knowledge and collusion in such activity.
• Interviewing is a key component of any investigation, and all too often key managers and employees fail to appear, keep changing appointments at the last moment, or do not allow sufficient time or appropriate facilities to conduct the interviews effectively.
• In regard to FCPA or Bribery Act compliance, employees, and especially third parties, may refuse to sign compliance terms and conditions or memoranda. Indeed Chinese citizens in the China may have some justification as these are foreign laws, the jurisdiction of which does not impact Chinese citizens.
• Multiple sets of accounts are still a commonplace occurrence in China. For example, during a recent investigation of a Shanghai subsidiary of a U.S.-listed company, our forensic accountants uncovered 12 different versions of accounts in various forms and guises.
• Because of the traditional mores related to bribery and corruption, the areas of business development, marketing, sales, and any areas touching customers or government (including state-owned-enterprises) should receive particular attention. More specifically, accounts such as travel, entertainment and gifts, charitable and other contributions, lobbying, business development, consultants' fees, commissions (“huikou” and “ yongjin“), and anything of value paid or connected to agents or third parties can uncover corruption red flags.
• A historical trend in China is the creation and use of purposely ambiguous or outright misleading source documentation, generally referred to as “fa piaos” (receipts). The trade in fake fa piaos is significant, and testing transactions is challenging and time-consuming for forensic investigators. Often, bribes such as providing lavish entertainment or gifts to officials will be claimed as an expense, but the description will be altered on the fa piao to something more innocuous. Although it is not uncommon to see large bribes paid through expense claims, bribery normally requires the creation of slush funds to pay them. While corrupt management's aim is to isolate such accounts and keep them secret through some kind of misstatement or fraud scheme, it is often “whistle-blowing” letters that reveal the existence and process of the fraud. As such, there is a need for the company to establish an ethical reporting hotline and fraud response plan as part of any compliance framework.
• Another historical impediment to dealing with fraud is the proliferation of “off-books” works in the country. These business intelligence enquiries usually involve the gathering of information from public domain open sources (like the Internet and subscription databases), government and company records that require authorization by an approved entity such as a local law firm, and perhaps most importantly, interviewing industry sources and knowledgeable people. Unlike the U.S. and EU, open source data in China is generally unreliable. Personal interviews, therefore, are often essential in verifying accounting entries or transactions, but require reliable and trusted sources. The value of this intelligence and evidence is obvious, but the risks related to matters involving PRC government officials, data privacy, corporate and state secrecy laws, and handling of sources of largely subjective intelligence cannot be over emphasized.

Conclusion

I believe the Chinese government does have the goal of eradicating corruption, as evidenced by changes in law, enforcement policy, and some high-profile actions. But one must remember that these actions are very recent in a country where the notion of corruption is different than many occidental cultures, and the history of such activity transcends at least 1000 years.

With the proper view to the future, and a well-established understanding and appreciation of the Chinese culture, I believe this corruption dichotomy can be resolved.

Rupert Utley is the Managing Director, LECG Greater China. A former Big 4 forensics and disputes partner and former Royal Hong Kong police officer, he has worked in China since 1987 and speaks English, Mandarin and Cantonese.

Since the late 1990s, companies conducting business in China have experienced a surge in enforcement of anti bribery legislation, ranging from significant enforcement of Chinese domestic laws to FCPA for U.S. companies. As an example of the enforcement activity by the Chinese government, the country's Central Discipline and Inspection Committee takes action against approximately 180,000 officials annually, with an estimated 15%-20% of them for corrupt activities. This past April, the UK passed the Bribery Act, which imposes severe penalties on British violators for any bribery, not just those of government officials, in China and worldwide. In-house counsel for corporations conducting business in the world's fastest-growing market should take heed of these legislative and enforcement shifts, as well as the slowly evolving cultural mores in the new China.

Today's China is experiencing what I call a “corruption dichotomy.” There's a Chinese proverb that illustrates the historical blind eye to corruption: “The mountains are high; the emperor is far away.” That notion was recently quantified by Dr. Pei Minxin of Carnegie Endowment for International Peace, who estimated that corruption in China amounts to about 3% of GDP and that the chances of getting caught, convicted and being jailed for bribery is also about 3%. But concurrently, China has enforced some of the world's most stringent penalties for those found guilty of corruption. Cheng Kejie, former vice-chairman of the Standing Committee of the National People's Congress, was tried and executed for accepting bribes. The mountains still may be high, but the long arm of Chinese officials is growing longer.

Anti-Bribery Legislation Impacting Business in China

The Chinese government has a labyrinth of laws, administrative directions and rules designed to thwart bribery and corruption. But it is fair to say that such regulations have heretofore not been enforced with the appropriate rigor. This is due in part to the often vague wording and intent of some laws, which can leave key issues subject to interpretation. However, this situation is shifting in step with changing social mores regarding corruption, as well as increased scrutiny by international governments on the behavior of their corporations with regards to bribery and corruption.

In China, securing an “official position” was historically viewed as a license to enrichen oneself, friends and relatives. Even organized crime was involved in the illicit trading of official appointments, often in collusion with government representatives. This collusion between officialdom and organized crime became more transparent during the recent Chongqing organized crime trials, which resulted in law enforcement, judiciary, government officials and triads being convicted and sentenced to lengthy prison terms and even death.

However, despite such cases, successful detection and conviction of bribery is an exception rather than a rule. As noted earlier, only 3% of bribery cases are detected and offenders punished. For centuries Chinese society has taken a pragmatic view that that individual behavior is governed by how one perceives the net gain advantage in engaging in any activity. So with regard to bribery, many still believe the financial or social benefits outweigh the risks.

With a GDP expected to grow by 8% in 2010, according to Morgan Stanley Asia, foreign investors and businesses realize that the benefit of investing, manufacturing, innovating and selling in China. On the other hand, the cost of improperly assessing, evaluating and managing the risks of bribery and corruption cannot be over emphasized. In December 2008, the German engineering company Siemens paid $1.6 billion in fines and penalties to the U.S. and German governments for fraud violations, some of which took place in China.

Over the last decade, LECG China's forensic accountants and investigators have worked on many of the FCPA and other anti bribery offence investigations in the country and worked on numerous compliance and preventative programs such as FCPA health checks, due diligence and fraud audits (including the Siemens case). The experience has proved that companies that do not perform full due diligence on joint venture partners, M&A targets and business partners in China, including their distributors, agents, subsidiaries, third parties and intermediaries, are exposing themselves not only to huge financial costs, but damage to reputation, brand and ability to continue to conduct business successfully. Anti-corruption efforts must include a robust and effective compliance programs designed to detect and deter bribery and instill ethical and responsible business practices.

A compliance program cannot be bought off the shelf, but rather must be carefully designed and customized to the nature of the industry, exact locations of operations, size and composition of workforce, financial and accounting regulatory regime and other unique risks and circumstances of the business environment. Such a compliance program should be guided primarily by the root causes of corrupt and unethical behavior. The fraud triangle originally conceived by Dr. Donald R. Cressy proposes that in every situation of fraud, and by extension bribery, there are three factors that are present. Therefore any fraud and bribery reduction program should address the following factors.

Prevention, Detection and Challenges

Not only is bribery rampant in China, but people can be quite adept concealing their tracks and frustrating investigation and compliance monitoring efforts. While the universal investigative attributes of attention to detail, lateral thinking and thoroughness are as important as anywhere in the world, in China, a thorough knowledge of local business practices, language, culture, accounting practices and risks is essential.

• An anti-bribery compliance framework should allow unfettered inspection of company books and records, digital environment data and interviews of staff and any other people who can provide insight and explanation. Therefore, the framework must clearly define what can and can't be done and by whom. This must be communicated through training and absorption measured through continual monitoring systems. Even if the foreign headquarters has a sophisticated compliance framework, it may not be customized to the Chinese environment or the spirit and meaning of the content lost in translation.
• Because of the traditional blind eye to fraud, there is rarely anything surprising about a “surprise” audit; managers and employees are likely to be prepared or pre-warned when forensic accountants are venturing from a foreign country. Investigators and forensic auditors working in China are very familiar with the local style of passive resistance, non-confrontational obstruction and generally giving investigators and auditors the “run-around.” But local market experience, investigative acumen, and knowledge of local customs and policy can thwart local efforts to impede investigations.
• Vague or nonexistent corporate policy on audit rights, particularly in the case of third parties or intermediaries, can also limit investigators' access to people and records. Third parties are often vital in a company's market penetration and distribution strategies, but these partners can present a significant fraud risk because of their government connections or experience in “gaming” the system. Or even more blatantly, agents have been known to refuse to agree to audit provisions outright.
• State secret protection laws and Chinese citizen data privacy statues may result in limited or no access to employee's workstations, laptops and other digital storage devices. In other instances, data housed outside China is not admissible for litigation or discovery purposes. Private data is often maintained on company computers, or vice versa, providing an excuse not to allow the imaging of hard drives and examination of data that may contain evidence or the digital “smoking gun” of bribery or the knowledge and collusion in such activity.
• Interviewing is a key component of any investigation, and all too often key managers and employees fail to appear, keep changing appointments at the last moment, or do not allow sufficient time or appropriate facilities to conduct the interviews effectively.
• In regard to FCPA or Bribery Act compliance, employees, and especially third parties, may refuse to sign compliance terms and conditions or memoranda. Indeed Chinese citizens in the China may have some justification as these are foreign laws, the jurisdiction of which does not impact Chinese citizens.
• Multiple sets of accounts are still a commonplace occurrence in China. For example, during a recent investigation of a Shanghai subsidiary of a U.S.-listed company, our forensic accountants uncovered 12 different versions of accounts in various forms and guises.
• Because of the traditional mores related to bribery and corruption, the areas of business development, marketing, sales, and any areas touching customers or government (including state-owned-enterprises) should receive particular attention. More specifically, accounts such as travel, entertainment and gifts, charitable and other contributions, lobbying, business development, consultants' fees, commissions (“huikou” and “ yongjin“), and anything of value paid or connected to agents or third parties can uncover corruption red flags.
• A historical trend in China is the creation and use of purposely ambiguous or outright misleading source documentation, generally referred to as “fa piaos” (receipts). The trade in fake fa piaos is significant, and testing transactions is challenging and time-consuming for forensic investigators. Often, bribes such as providing lavish entertainment or gifts to officials will be claimed as an expense, but the description will be altered on the fa piao to something more innocuous. Although it is not uncommon to see large bribes paid through expense claims, bribery normally requires the creation of slush funds to pay them. While corrupt management's aim is to isolate such accounts and keep them secret through some kind of misstatement or fraud scheme, it is often “whistle-blowing” letters that reveal the existence and process of the fraud. As such, there is a need for the company to establish an ethical reporting hotline and fraud response plan as part of any compliance framework.
• Another historical impediment to dealing with fraud is the proliferation of “off-books” works in the country. These business intelligence enquiries usually involve the gathering of information from public domain open sources (like the Internet and subscription databases), government and company records that require authorization by an approved entity such as a local law firm, and perhaps most importantly, interviewing industry sources and knowledgeable people. Unlike the U.S. and EU, open source data in China is generally unreliable. Personal interviews, therefore, are often essential in verifying accounting entries or transactions, but require reliable and trusted sources. The value of this intelligence and evidence is obvious, but the risks related to matters involving PRC government officials, data privacy, corporate and state secrecy laws, and handling of sources of largely subjective intelligence cannot be over emphasized.

Conclusion

I believe the Chinese government does have the goal of eradicating corruption, as evidenced by changes in law, enforcement policy, and some high-profile actions. But one must remember that these actions are very recent in a country where the notion of corruption is different than many occidental cultures, and the history of such activity transcends at least 1000 years.

With the proper view to the future, and a well-established understanding and appreciation of the Chinese culture, I believe this corruption dichotomy can be resolved.

Rupert Utley is the Managing Director, LECG Greater China. A former Big 4 forensics and disputes partner and former Royal Hong Kong police officer, he has worked in China since 1987 and speaks English, Mandarin and Cantonese.