As further evidence of US FCPA enforcement focus on China, in December 2009 UTStarcom, Inc. (“UTSI”) agreed to pay a $3 million settlement to the SEC following charges that the company knowingly engaged in routine and systematic bribery of Chinese, Mongolian, and Thai officials. The UTSI case is insightful in that it identifies several common corrupt practices engaged in by foreign companies operating in China.

Background

UTSI is a Delaware corporation, headquartered in California with the majority of its operations in China. UTSI’s China operations are conducted through a wholly owned subsidiary UTStarcom China Co., LTD (“UTS-China”). From 1995 to 2004, over 75 percent of UTSI’s sales were to government controlled telecommunications companies in China. The prohibited conduct alleged in the SEC complaint begins in 2002 and continues through 2007.

U.S. Visits for Employees of Chinese Government Customers

The SEC’s complaint alleges that UTSI sponsored all expense paid sight-seeing trips for Chinese public telecom employees under the pretense of training visits. Foreign companies’ sponsorship of overseas travel opportunities for Chinese employees has long been common practice. Historically, employees of Chinese state owned businesses were poorly compensated, thus a major incentive for doing business with foreign enterprises was the promise of foreign travel. Travel opportunities, such as site visits and inspections, were often built into contracts and accepted as a known cost of doing business with Chinese state-owned enterprises.

While compensation has improved, Chinese state-owned businesses still seek to include foreign travel provisions in contracts and may pressure a foreign party to minimize work on these visits so as to create paid vacations for their employees. Reasonable accommodation of these requests may be acceptable so long as visits maintain a substantial business purpose–the general rule of thumb being that at least 70 percent of any visit should be dedicated to business-related activities.

From 2002 to 2007, UTSI allegedly spent $7 million on more than 200 “training trips” for Chinese state-owned telecommunications employees. Little documentation was retained regarding these trips. According to the SEC, there were no UTSI facility visits or other trainingrelated components to these visits. In fact, the SEC complaint alleges that these trips were purely recreational visits to popular tourist destinations where UTSI had no facilities. UTSI did, however, include these trips as training expenses in its financial statements. As UTSI’s stateowned telecommunications customers fall within the FCPA definition of “Instrumentalities,” these visits constitute conduct prohibited by the Act.

Paid Executive Training Programs

In addition to employee site visits, the SEC complaint alleges that between 2002 and 2004, UTSI paid for executive training programs at U.S. universities attended by managers and other employees of government customers in China. UTSI spent more than $4 million on travel, tuition, room and board, field trips to tourist destinations, and cash allowances between $800 and $3,000 per person. While UTSI accounted for the cost of these programs as marketing expenses, the programs covered general management topics and were not specifically related to UTSI’s products or business.

The complaint further alleges that UTSI senior management believed that these training programs helped UTSI obtain or retain business. The SEC bases this assertion on evidence that management directly approved increases in the budget for these programs for employees of UTSI’s largest customer, a Chinese government-controlled telecommunications company. Much like the employee site visits, the executive training programs paid for by UTSI violate the anti-bribery provisions of the FCPA. Moreover, UTSI management’s direct decision to increase the budget allocation for executive training programs for their largest customer demonstrates the requisite intent to manipulate government officials.

Employment Benefits to Customers and Customer Family Members

The SEC complaint further alleges that UTSI offered sham full-time employment in the U.S. to certain government customers and their family members, in some cases sponsoring permanent U.S. residency applications. In at least three cases, UTSI paid these individuals for a period of two years each as if they were real employees, even though they never worked for UTSI in any capacity. UTSI fabricated annual performance reviews which were placed in personnel files, improperly accounted for payments to these individuals as employee compensation and falsely stated that these individuals were full-time employees on U.S. residency applications. Payments under the guise of employment compensation fall clearly within the realm of FCPA prohibited conduct. In addition, the sponsorship of immigration applications carries substantial value, particularly for Chinese citizens, and is likely to constitute bribery under the broad language of the FCPA7.

Gifts and Entertainment Expenses

In addition to indirect payments, the SEC complaint alleges that as part of a 2004 UTSI bid for a sales contract to a government-controlled telecommunications company in Thailand, UTSI’s general manager in Thailand spent nearly $10,000 on French wine and $13,000 on other entertainment expenses. According to the SEC, records indicate that UTSI’s former Executive Vice President and CEO of UTS-China approved the payments.

Consultants and License Fees  

The SEC complaint alleges that in 2005, UTSI’s Executive Vice President and CEO of UTSChina authorized a payment of $1.5 million to a Mongolian company for purported consulting services. UTSI’s Board of Directors was informed that the $1.5 million was a license fee paid to the Mongolian government. In turn UTSI accounted for the entire amount as a license fee. No records were maintained to demonstrate what, if any, services the consulting company performed for UTSI.

According to the SEC, the actual license fee was only $50,000. According to the complaint, this was not a case of willful ignorance or carelessness on the part of UTSI management but intentional. The SEC further alleges that the UTSI Executive Vice President knew full well that the $1.5 million was not a license fee and that a portion of the fee was used to make payments to Mongolian government officials to help UTSI obtain a favorable ruling in a license dispute.

Later, in 2007, UTSI allegedly hired and paid $200,000 pursuant to another purported consulting agreement, this time in China. Again, payment was accounted for as a consulting expense but no records were maintained describing what services were provided. The SEC alleges that UTSI utilized this sham consulting company to pay bribes of $200,000 to obtain a contract from a Chinese government customer. In both instances, under the third-party payment provisions of the FCPA, UTSI did not insulated itself from the conduct of the consulting companies.

Conclusions

While the pattern of conduct alleged by the SEC in the UTSI case suggests that UTSI management willfully bribed foreign officials, the case does identify several pitfalls that unwary U.S. companies may encounter absent willful intent. The FCPA’s definitions for “value,” “knowledge,” and its treatment of third-party payments are important to consider when doing business abroad. In China in particular, below-market employee compensation at state-owned enterprises paired with a business culture driven by Guanxi and gift-giving create an atmosphere ripe for potentially costly mistakes. Training and other visits for government employees must have a legitimate business purpose and be adequately documented. Furthermore, careful due diligence is required in the selection of local agents and consultants, as the “knowledge” standard imposes a positive duty to determine their reputation. Finally, the FCPA’s record keeping and internal controls provisions should be taken into account when building a business in China.

  • Careful due diligence review of Agents is required to avoid potential problems and to establish a defense that any bribe paid was without the company’s knowledge.  
  • Services rendered by foreign consultants should be adequately documented.  
  • Customer/client employee inspection and training visits should follow the 70 percent rule or some other rule of reason and require adequate documentation.  
  • This is not the first FCPA case involving China in these troublesome areas and it will probably not be the last. U.S. enforcement authorities are paying special attention to China; U.S. companies doing business with China should be on guard.