Shaun Z Wu, Daniel S Lee, Ryan Middlemas and Jae Joon Kwon, Kobre & Kim
This is an extract from the third edition of GIR's The Practitioner’s Guide to Global Investigations. The whole publication is available here.
Monitorships are common in the United States and elsewhere, but in East Asia this is not yet the case. Generally, monitorships are initiated by a regulator or prosecutor, or out of a court's express order. Alternatively, they could be the result of internal corporate compliance needs. Regardless of the types or origins of monitorships, a growing global emphasis on legal and ethical compliance has led to their proliferation.
In the United States, monitorships are routinely imposed as a condition of certain orders or negotiated terms, such as deferred or non-prosecution agreements, and appointing a monitor has become increasingly popular in other jurisdictions, notably the United Kingdom. In East Asia, on the other hand, there is not a historical practice of monitorships. However, in an increasingly globalised market, East Asian businesses and organisations are not immune to monitorships and the issues they raise.
This chapter considers the application of monitorships in an East Asian context and their impact on East Asian organisations. We will also consider some of recent examples of the first monitorships imposed by governmental authorities in the region, in what may be the start of an emerging trend.
Domestic monitorships: growing compliance emphasis
As demonstrated by the increase in prosecutions and enforcement cases over the past 10 years since the 2007–2008 financial crisis, there is a growing emphasis on legal and ethical compliance in East Asia, and companies have struggled to meet the constantly evolving regulatory compliance requirements in the region. However, it is extremely rare for East Asian regulators and prosecutors to reach out to independent private parties to evaluate and monitor the subject organisation's level of compliance. There are numerous reasons why East Asia has not traditionally adopted this mechanism.
The primary reason is that the legal regime in most East Asian jurisdictions does not provide for the appointment of a monitor. Often, there is no procedure for the regulator or enforcer to settle a case; the government can simply decide to exercise its powers, bring a prosecution before a court or drop the investigation. At the cultural level, governmental authorities are reluctant to have a private party conduct an oversight role to ensure compliance and many view this as the government's responsibility. Also, there are various mechanisms in place that effectively achieve – or strive to achieve – the same goals that monitorships in the United States are seeking to achieve.
For example, in South Korea, the Financial Supervisory Service (FSS) monitors financial institutions pursuant to its four-part examination process, namely 'off-site monitoring', 'pre-examination preparation', 'on-site examination' and 'post-examination action'.
FSS examiners analyse financial and operational reporting from financial institutions, evaluate quantitative safety and soundness measures, and work to identify areas of weaknesses and risks in need of supervision or action.
FSS examiners make quarterly and annual examination plans for examination of financial institutions. The examination plans set financial institutions (and branches) to be selected, the types of examination to be carried out (full-scope and targeted), the tentative dates, the number of examiners to be assigned, and the scope of the examination activities.
FSS examiners perform full-scope and targeted examinations of financial institutions. They conduct full-scope examination to evaluate financial institution's overall financial, management, operational and compliance performance. A targeted examination is limited in scope and is intended to address a narrow range of supervision matters and concern, such as incidents of irregularity and unsound business activity.
According to the result of the FSS examiners' examination, the administrative sanctions may be imposed on the subject financial institution and individuals involved in serious violations of laws and regulations.
South Korea's legal regulations demand that listed companies with total assets of more than 500 billion won and financial institutions should have one or more compliance officers responsible for duties related to abiding by the above compliance guidelines. Even if compliance officers are not appointed by government, the mandatory compliance system helps to achieve the same goals that monitorships seek to achieve.
Foreign monitorships in an East Asian context
With these systemic cultural differences, it remains unclear whether East Asia will consider adopting the monitorship mechanism in the near future. Meanwhile, we are also seeing the emerging trend of foreign government-imposed monitorships affecting parties based in the region becoming increasingly common.
Monitorships in the United States tend to be driven by three key areas: financial sector compliance; public protection, such as consumer safety or environmental standards; and criminal law compliance (e.g., corruption, sanctions or money laundering). In East Asia, US-ordered monitorships tend to be driven by the third category. This is a natural trend, given that almost all US-ordered enforcement actions in East Asia have been criminal in nature.
Despite the frequency of criminal enforcement actions from the United States, there were few notable cases of monitorships in the region until 2017, when the United States imposed a monitorship on Chinese telecommunications giant ZTE Corporation, one of the first examples of a high-profile monitorship imposed in East Asia. The following is a sequence of events surrounding the monitorship.
ZTE relied on US-produced components for its smartphones and computer networking gear. By exporting its technology to Iran and North Korea, ZTE was found to be in violation of US sanction agreements. As a result, the United States forbid American companies from selling components to ZTE and its subsidiary, cutting off the company's supply to critical parts for its networking gear and smartphones from American companies such as San Diego-based chipmaker Qualcomm.
ZTE settled with the United States in March 2017, agreeing to pay fines of $890 million and accepting a monitor appointed by the District Court. A denial of American companies' export privileges was suspended based on ZTE's promise to implement the agreement. However, in April 2018 the United States alleged ZTE was failing to comply with the agreement, and once again cut American exports to the Chinese company. ZTE's ability to be supplied key products from American companies was shut off for three months, threatening bankruptcy for the company. Ultimately, ZTE agreed in June 2018 to pay additional fines of $1 billion and allow the US Department of Commerce to send a monitor to watch its business practice.
Subsequently, the monitorship term was extended from 2020 to 2022, and the powers of the monitor were expanded to police ZTE to the same degree as that of a second monitor appointed by the US Department of Commerce. Other conditions of the monitorship included replacing ZTE's entire board of directors and senior leadership.
From China's perspective, the appointment of a monitor and the imposition of the other strict measures in the ZTE case were a major intrusion into a key business. This reaction shows how countries should consider the symbolic significance of a foreign-appointed monitor when applied in a different cultural context. As an example, consider the reverse situation: if China were to appoint a Chinese citizen as a monitor to oversee all compliance activities of a major listed company in the United States, the decision would likely face stiff opposition from a number of different American stakeholders. While there is no suggestion that China will introduce such a mechanism, this is the context in which the monitor's role must be carried out when appointed to oversee an East Asian party.
Other issues in monitorships over Chinese companies could include Chinese state secrets. The current China–US trade war may see increased focus on the conduct of Chinese parties, with greater enforcement activity being conducted under US sanctions law, FCPA, etc. ZTE may become a model for further monitorships to come.
Panasonic Avionics Corporation
Panasonic is another example of a monitorship imposed in the East Asian context. In 2007, a US-based subsidiary of Panasonic that produces in-flight media systems, Panasonic Avionics Corporation (PAC), hired a foreign official as a consultant, paying him over $875,000 over a six-year period while the consultant did little work for PAC. The payments were then accounted for in Panasonic's books and records as legitimate consulting expenses. Further, PAC employees concealed the use of certain sales agents who did not pass internal diligence requirements, formally terminating their relationship with these agents but secretly continuing to use them by re-hiring them as sub-agents of another company, subsequently hiding over $7 million in payments to at least 13 agents.
By providing false representations with the payments made to these consultants and agents to Panasonic, PAC led its parent company to falsify its books, records and accounts. Subsequently, the US Department of Justice (DOJ) charged PAC for violating the accounting provisions of the Foreign Corrupt Practices Act (FCPA) with respect to retaining consultants for improper purposes and concealing payments to third-party agents.
PAC entered into a deferred prosecution agreement with the DOJ on 30 April 2018 for this violation, agreeing to pay criminal penalties of $137 million and retain an independent corporate compliance monitor for at least two years. Further, in a related proceeding, the US Securities and Exchange Commission (SEC) filed a cease-and-desist order against Panasonic, and the latter entered into an administrative agreement with the former to disgorge $143 million as part of the resolution.
East Asian monitorships in an international development bank context
A further field in which monitorships have been seen in an East Asian context is through quasi-governmental organisations, particularly international development banks such as the World Bank. As China continues to implement its 'One Belt, One Road' initiative to finance a network of infrastructure in numerous jurisdictions in the region, the East Asian Infrastructure Investment Bank (AIIB) – developed by China to partly finance this initiative – will grow to ever-increasing levels of financing activity. It remains to be seen whether the AIIB will follow the World Bank and other development banks in adopting a compliance guideline framework including a provision for a compliance monitor where there are compliance concerns.
Monitorships in a development bank context arise where the recipient of funding from an international development bank or the participant in a project funded by an international development bank is found to be, or suspected of having been, involved in a breach of a law, compliance failure or inadequate standards of integrity. A development bank may subject the party to oversight by a monitor for a period of time as a condition of continued access to funding. This differs substantially from a monitorship in a prosecution context, where the monitorship may be imposed conditionally as part of a deferred prosecution agreement.
The clearest example of monitorships of this kind are those imposed by the World Bank. All parties involved in a World Bank investment project are subject to the World Bank Procurement Regulations for Borrowers (the Procurement Regulations). The Procurement Regulations outline standards required of borrowers, and prohibit fraud, corruption, collusion, coercion and obstructive practices. A breach of any of these provisions may result in a sanction imposed by the World Bank. The default sentence, and the most commonly imposed, is 'debarment with conditional release'.
A debarment with conditional release prohibits a subject from access to World Bank loans for a specified period of time, with access to loans to be restored at the conclusion of the period, if certain requirements are met. These requirements commonly include the introduction of a more robust compliance framework, to be verified by an independent monitor before the entity's debarment can be lifted.
Disbarment from access to World Bank financing and the remedies imposed by, for example, the appointment of an independent compliance monitor, are recognised and enforced by certain other multinational development banks through an agreement known as the Agreement for Mutual Enforcement of Debarment Decisions. Whether through this mutual recognition procedure or under its own integrity regime, some other multinational development banks impose a similar integrity regime, which may include the appointment of an independent monitor. In East Asia, these institutions include the Asian Development Bank.
Two further development banks in the region that broadly follow the World Bank model in their policy objectives are the China Development Bank (CDB) and the Asian Infrastructure Investment Bank (AIIB). The CDB has not to date adopted a sanctions regime that allows debarment of a potential borrower, with provision for the appointment of a monitor to allow a borrower to regain borrowing privileges. This may be because the CDB's mandate is purely domestic.
By contrast, the AIIB's mandate is significantly more international. Founded by China in 2016, the AIIB has authority to fund projects throughout the Asia-Pacific region and receives funding from member nations throughout the world. As a result of the AIIB's multilateral structure, it is perhaps not surprising that the AIIB adopts a sanctions and debarment regime broadly based on the World Bank model, including maintaining an extensive list of entities debarred from accessing AIIB funding as a result of a compliance failing.
What we have not yet seen emerge in relation to the AIIB is a mechanism for debarred entities to be rehabilitated and subsequently regain their borrowing privileges. As the AIIB has only been in operation for three years at the time of writing, it may be that the bank has not yet had an opportunity to develop an arrangement of this kind. As the AIIB continues to build out its institutional structure in the coming years, it will be interesting to observe whether the AIIB continues to follow the World Bank model by imposing independent monitorships as a condition of a party being removed from the bank's list of debarred entities.
East Asia-imposed monitorships: an emerging trend?
While monitorships mandated by governmental authorities have not traditionally been a feature of legal and regulatory regimes in the region, there are some signs of East Asian authorities adopting the concept of monitorships. It is perhaps not unexpected that this trend has been seen in Singapore and Hong Kong – two international financial centres with common law legal systems, which maintain particularly close links with key western economies such as the United States.
The appointment of an independent monitor to oversee rectification efforts following a compliance breach is standard practice in many western financial regulatory regimes. Now that the monitorship concept has been employed in Singapore, the practice will form part of the repertoire of Singapore regulatory authorities to employ in future cases.
A further example of the adoption of the independent monitor concept in Singapore is in the competition or antitrust context. The Competition and Consumer Commission of Singapore (CCCS) has the power to issue an 'interim measures direction', imposing conditions on the grant of approval for a transaction such as a merger. As a condition of approving a recent acquisition of ride-hailing app Uber's Southeast Asia business by competitor Grab, the CCCS imposed a requirement for an 'independent monitoring trustee' to be appointed.
The monitor's role is to supervise the newly merged business's compliance with a number of operational and legal restrictions imposed by CCCS. In the case of the Uber/Grab transaction, these conditions included maintaining certain pre-merger pricing, terminating some pre-existing exclusivity agreements and restrictions on access to operational data held by Uber. Monitorships in this context vary somewhat to the traditional format in that here the monitorship is forward-looking – the monitor's role is to pre-emptively ensure compliance with transaction approval conditions, rather than following a breach.
The concept of monitorship is also gaining ground in Hong Kong. There are no explicit legislative provisions permitting Hong Kong regulators to enter into deferred prosecution agreements (which would commonly require the appointment of a monitor). Nevertheless, despite the lack of a specific statutory footing, Hong Kong regulators have regularly found a means of replicating the effect and requiring the appointment of an independent consultant akin to a monitor.
Unlike the United States, East Asian jurisdictions have not traditionally adopted the concept or practice of monitorships to provide independent oversight and verification of compliance with obligations. This may well be due to a lack of a procedural mechanism in many East Asian legal systems equivalent to a deferred prosecution agreement, as well as a relative cultural reluctance to entrust a traditionally governmental oversight role to a private party. Nevertheless, monitorships imposed by authorities outside of the region – yet affecting East Asia-based parties – have become increasingly common. Monitorships imposed by quasi-governmental authorities, particularly international development banks, are a further avenue by which the concept of monitorship in the region has become more widely adopted. Both categories are likely to see further growth, and additional instances of the imposition of monitorships in East Asia.
Although at a relatively nascent stage, monitorship regimes organically developed in the region are beginning to spread their wings, particularly in East Asian jurisdictions that maintain a common law legal system and strong links with jurisdictions such as the United States where monitorship is more common. Overall, we are at an interesting point in time as the monitorship concept slowly emerges in East Asia.
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