Doing business in the People's Republic of China (PRC) is rapidly becoming commonplace for U.S. companies. However, when it comes to the Foreign Corrupt Practices Act (FCPA), U.S. companies and their foreign subsidiaries cannot afford to assume that they can conduct business as usual there. Although U.S. companies and third parties acting on their behalf may provide gifts and entertainment to commercial clients as a means to lure or keep business, state ownership or control of many of the largest businesses and industries in the PRC can make that conduct illegal under the FCPA. While these problems exist in many other countries and regions of the world, the rapid growth of U.S. participation in business and industry in the PRC and the sheer size of the PRC economy make U.S. companies particularly vulnerable to FCPA violations. Cultural issues and corruption in the PRC further compound the problem. U.S. companies cannot insulate themselves from these risks by operating through a foreign subsidiary or agent. Indeed, such entities frequently are a source of FCPA liability for U.S. companies that engage them. To ensure compliance, it is critical to develop, implement, and monitor internal controls that recognize the unique problems in the PRC before those problems create a need to consider self-reporting and/or remedial measures, or lead to enforcement actions.

Provisions of the Foreign Corrupt Practices Act
The antibribery provisions of the FCPA can be found at 15 U.S.C.§ 78dd et seq. They prohibit corrupt payment (and offers, promises or authorizations of payments) of anything of value to a foreign official to influence his official actions in violation of his duty, to secure any improper advantage, or to induce the foreign official to use his influence to affect an official action—in order to obtain or retain business or direct business to some other person.The latter requirement, known as the "business purpose test," is read very broadly and may include just about anything that is advantageous to a business' bottom line.

The FCPA applies to U.S. citizens, nationals or residents and virtually any entity that has its principal place of business in, or is organized under the laws of the United States, "issuers," i.e., entities, U.S. or foreign, that have a class of securities registered under Section 12 of the Securities Exchange Act of 1934 or are required to file periodic reports with the SEC pursuant to Section 15(b) of the Act, and to foreign persons or entities acting within the territory of the United States. It also applies to conduct by third parties acting on behalf of such persons or entities.

The FCPA prohibits corrupt payments to any foreign official, regardless of rank or position. The term "foreign official" includes officers or employees of foreign governments as well as any department, agency or instrumentality thereof. It also includes any person acting in an official capacity for or on behalf of any government, department, agency or instrumentality. Employees of state-owned or controlled entities should be presumed to be foreign officials under the FCPA.

While the FCPA does not directly govern the conduct of foreign subsidiaries of U.S. companies acting wholly outside of the United States, U.S. businesses violate the FCPA if they have knowledge that a subsidiary or an entity acting on their behalf is engaging in conduct contrary to the FCPA. The term "knowing" includes conscious disregard, willful blindness and deliberate ignorance. This is important because it means that the mere existence of "red flags" can give rise to liability for failure to investigate them.

The FCPA's books and records provisions are located at 15 U.S.C. § 78m. They apply to issuers and require that their books, records and accounts be made and kept in reasonable detail so that they accurately and fairly reflect their transactions and the dispositions of their assets. These requirements extend to majority-owned subsidiaries, including those outside the United States.

The FCPA's internal controls provisions require issuers to devise and maintain a system of internal accounting controls that, among other things, provide reasonable assurances that transactions are executed in accordance with management's general or specific authorization. Thus, controls must be adequate to protect against off-book accounts and disbursements and other unauthorized payments, including payments in violation of the FCPA. For example, in a recent settlement agreement between InVision Technologies and the U.S. Department of Justice, the failure of InVision to devise and maintain a system of internal controls with respect to foreign sales activities sufficient to assure compliance with the FCPA, and to that extent, provide reasonable assurances that InVision's transactions, including foreign transactions, were executed in accordance with the authorization of InVision management, served as a basis for liability under the FCPA.

Risk Factors of Doing Business in the PRC
Two factors require those doing business in the PRC to pay special attention to the FCPA. First, many major businesses in the PRC are state-owned or state-controlled even if some portion of their shares are owned by other entities or publicly traded. In the PRC, many PRC-based businesses are operated under the supervision of the State-owned Assets Supervision and Administration Commission of the State Council (SASAC). The SASAC performs the function of a state owner, representing the state as shareholder in a company. Thus, employees of many PRC businesses and industries may be considered foreign officials for purposes of the FCPA.

Second, local agents or partners are often critical to successfully obtaining business in the PRC and may be necessary, if not mandated, conduits to the PRC government. Such "relationship" companies pose significant FCPA risks because their primary purpose is often to do nothing but favorably influence the government entity from which business is being sought, and because their fees are frequently based on a percentage of the contract price rather than on any work they have actually done. While PRC laws prohibit bribery or other payments of cash or property and prosecutions are on the rise, corruption is still widely recognized as pervasive in the PRC. The large commissions that are often paid to such agents that successfully procure business from state-owned or controlled entities create incentives for those agents to make improper payments and also provide a means by which corrupt payments can be made to foreign officials. The acts of these agents can be imputed to U.S. companies or issuers if they fail to investigate "red flags," such as large commissions for minimal or no work or other indicators of improper conduct, or if illegal payments result from a failure of the U.S. company or issuer to conduct adequate diligence of agents acting on their behalf (or on behalf of a foreign subsidiary) as part of their internal controls process.

Traps for the Unwary: Inside Information and Client Expenses
It is critical to understand that in the PRC (and other countries with significant government control of businesses) the FCPA can reach what would otherwise be purely commercial and often permissible business incentives. This creates a trap for unwary subsidiaries or agents of U.S. companies engaging "foreign officials" in the PRC, often in a manner in which they are accustomed to in the PRC. Two concerns that may not be easily detected, despite internal controls that focus only on bribery in the traditional sense, are access to inside information and paid client travel.

Inside information—securing an improper advantage—In 1998, the FCPA was amended to prohibit the securing of any improper advantage in obtaining or retaining business through corrupt payments. Companies must be wary, therefore, of plying employees of PRC businesses for information about their employers' business needs. For example, if a state-owned enterprise is soliciting bids for new business and keeping certain information about competitors' bids or budgeting confidential, providing or promising an employee anything of value to induce him or her to provide that confidential information may violate the FCPA.

Foreign companies doing business in the PRC often use local companies, some of which are small and may employ only a few retired employees of a potential client, because of their relationship (or claimed relationship) with employees of state-owned enterprises. These companies may represent that they can help obtain business or information about the client or a specific procurement that will help to obtain business. The contracts at stake can be very lucrative with substantial commissions due to such agents if a contract is awarded. There is, therefore, an incentive for such agents, which may have very little in the way of expenses, to make payments (with the expectation of earning a large commission in return) to secure a business advantage, for instance, either by obtaining critical inside information or making a bribe. Because even close monitoring cannot always prevent an FCPA violation under these circumstances, companies that choose this path should recognize that they are accepting an increased risk of criminal or civil action by U.S. authorities.

Potential concerns for benchmarking and training trips—Another special concern in the PRC, one that is easy to overlook in typical compliance efforts, is client travel for benchmarking and/or training in other countries. It is well known by companies doing business in the PRC that PRC businessmen value the opportunity to gain exposure to similar businesses outside of the PRC. Under some circumstances, providing such an opportunity can violate the FCPA. For example, per diem payments, side trips, entertainment, extravagant accommodations, gifts, and built-in vacation days can give rise to liability under the FCPA. Such trips may be built into contracts with PRC companies, though the contract may not spell out the amount of the contract value to be contributed to such overseas travel and/or may provide little or no details about the mutual expectations for such travel. This can create an environment in which FCPA violations can be unwittingly committed.

Two affirmative defenses included in the FCPA permit some leeway in the area of client travel and merit some discussion: (1) the payment, gift, offer or promise of anything of value that was made, was lawful under the written laws and regulations of the foreign official's country, and/or (2) the payment, gift, offer or promise of anything of value that was made, was a reasonable and bona fide expenditure, such as travel and lodging expenses, incurred by or on behalf of a foreign official, party, party official or candidate and was directly related to (A) the promotion, demonstration or explanation of products or services, or (B) the execution or performance of a contract with a foreign government or agency thereof. However, because these are affirmative defenses, the burden is on the party subject to the FCPA to establish that they apply.

Companies and executives contemplating a defense based on the contention that bribery is commonplace in the PRC and part of the business landscape, should reconsider reliance on that justification, because it is the law of the host country that controls, not the customary practice found there. While a detailed review of PRC laws is beyond the scope of this article, some overarching points should be noted.

Although PRC laws on bribery are perceived as vague, complex and lightly enforced, these laws prohibit most conduct that violates the FCPA and even commercial bribery that does not involve a state-controlled entity. While "gifts" may be provided to state workers, PRC rules and regulations require any gift that might affect an official's impartial exercise of his public function be turned over to the state. These regulations even prohibit the acceptance of a dinner offer that might affect the impartial performance of a public function. The PRC also is a signatory to the recent United Nations Convention Against Corruption, which requires FCPA-like laws be put into place. Therefore, before attempting to rely on any de minimis gift exceptions or other practices purportedly permitted in the PRC, an opinion from a reputable PRC law firm should be obtained.

Complicating matters for U.S. companies doing business in the PRC is the fact that anticorruption laws and regulations are reportedly ignored and compliance met with "incredulity" by PRC businessmen. The FCPA's affirmative defense does not, however, take into consideration the customs and practices in the foreign official's country. Therefore U.S. companies and their subsidiaries cannot take comfort in any perceived PRC customs allowing or even encouraging such practices.

U.S. companies also must be circumspect in attempting to take advantage of FCPA provisions permitting reasonable and bona fide expenditures "directly related" to promotion efforts and contract performance. For example, while large per diems are likely to be held to be in violation of the FCPA, small per diems could still technically be deemed a violation. Expenses for entertainment, side trips, vacation days or per diems that are not called for by the contract may not be deemed to be directly related to the contract provisions. Even if the contract contains details about travel costs, companies must still be wary that the expenses are bona fide. For example, large per diems or extravagant accommodations to certain high-level officials under contract may still be viewed as kickbacks. It may not be enough to expressly note that the client is paying for such expenses, as it could be argued that the contract price was artificially inflated to accommodate otherwise improper expenses, particularly where influential officials are included in such travel. In many cases, contracts do not provide details or amounts allocated for such trips. In such cases, all expenses will likely be deemed as being borne by the U.S. subsidiary. If such expenses are not reasonable and directly related to a bona fide business purpose, the risk of violating the FCPA would appear to be significant.

Conclusion
For U.S. companies or issuers seeking to succeed in the global marketplace, doing business in the PRC is fast becoming an essential part of the business plan. Companies doing business in the PRC will find themselves courting business from what appear to be commercial customers or clients and their employees, but, in reality, many of these will be state owned or controlled entities, and their employees will be deemed to be foreign officials under the FCPA. This creates a trap for the uneducated and the unprepared. Increased FCPA enforcement efforts by the U.S. government and reporting requirements under Sarbanes-Oxley make avoiding FCPA violations essential for affected businesses. An internal investigation into possible FCPA violations can be quite expensive, and those costs grow with the scope of previously undetected problems. And the penalties for violations can be staggering—in the millions of dollars in fines and disgorgement of profits. Common sense, therefore, dictates that PRC business plans incorporate controls to ensure that the U.S. companies and issuers and third parties working on their behalf be in compliance with the FCPA from the outset, and that any deficiencies leading to violations are identified and remedied as early as possible.

One final note—while these concerns must be addressed when doing business in the PRC, similar problems can arise in any nation in which there is significant state ownership or control of businesses, or certain business sectors are controlled by the government. Additionally, companies that infrequently conduct business with government-controlled entities must be wary of the critical distinction between doing business in the commercial and government sectors.