The Chinese government’s recent crackdown on alleged bribery and corruption of local officials by multinational pharmaceutical companies could signal a broad trend toward elevated scrutiny of all foreign corporations operating in the country—and provides an even greater incentive for companies to identify and implement anti-corruption practices focused on China’s unique business and legal culture.

Elevated Compliance Risks, Elevated Compliance Duties

The international pharmaceutical industry is the latest commercial sector to face increased scrutiny in China. A major investigation of a leading pharmaceutical company has allegedly uncovered evidence of what Chinese authorities have characterized as “widespread, prolonged corruption” and has generated considerable publicity. The investigation marks the latest in a recent surge of aggressive inquiries by the Chinese government into foreign companies, targeted at alleged violations ranging from bribery to price-fixing.

This new trend is a worrying development for international companies operating in China, and a signal that the sporadic crackdowns may finally be coalescing into a new reality of permanently elevated scrutiny by the central Chinese government. This “new normal” will increase the need for proactive policies, procedures and diligence by international companies, which have traditionally faced significant compliance pressures and risks, mainly from non-Chinese laws such as the United States’ Foreign Corrupt Practices Act and the United Kingdom’s Bribery Act.

Background

In early July 2013, the government of the People’s Republic of China (PRC) announced a milestone investigation into GlaxoSmithKline Plc. (GSK) that has allegedly uncovered bribery involving millions of U.S. dollars that were funneled through more than 700 travel agents and other third parties over the last six years. More than 20 GSK employees, including high-level executives, have been detained by the police, and international travel restrictions have been imposed on at least one foreign executive. Notably, the government has indicated that the investigation uncovered signs that other pharmaceutical companies may have illegally given incentives to doctors and other hospital staff, or bribes to government officials and medical associations.

The exact trigger for the GSK inquiry is currently unknown, but there has been wide speculation about a variety of motives for the timing and targets of the case including a desire to reduce healthcare costs. Regardless of the cause of the investigation, the case is expected to spawn a significant, industry-wide investigation and crackdown, in which the PRC government will be targeting foreign pharmaceutical companies with official “requests,” unannounced visits and dawn raids. Indeed, at least one other company has acknowledged being visited recently by government investigators in connection with this investigation.

Our Observations

Concealed From the Government, Hidden From the Home Office

GSK’s response to the investigation has been clear and public. The company has stated that its global headquarters was not aware of the bribery in China, and has reaffirmed its zero tolerance policy for compliance violations.

Certainly, the PRC—as evidenced by the statements of Gao Feng, a top official in China’s Ministry of Public Security—seems to believe “bribery is part of the strategy” of pharmaceutical companies and has expanded its investigations to other multinationals in China. This raises concern that a culture of compliance may not be as strongly embedded in companies as one would hope, or, at minimum, such a culture is not perceived as strongly embedded. The China operations of multinationals often experience significant turnover and have increasingly shifted to a local-hire model. The shift to local hires is due to a variety of factors, including new social security requirements, food safety concerns, increasing pollution and a rise in perceived hostility towards foreigners. As key positions change hands for whatever reason, multinational companies can expect that local teams, in their efforts to impress corporate leaders, may be guided more by sales results than compliance with regulations, supervisory controls and policies dictated by global headquarters.

Recommendations

In the wake of the Chinese government’s launch of a new round of aggressive investigations, multinational companies should begin scrutinizing their operations more carefully to ensure that their policies are well understood, and look for signs of potential bribery being carried out by their employees. To do so, they should truly localize their global compliance policy and program to specifically address their local operations in China, including the development and implementation of the following:

  1. Thorough and complete Foreign Corrupt Practices Act (FCPA) risk-based due diligence for mergers with, and acquisitions of, Chinese local companies
  2. Thorough due diligence review of third-party business partners, including but not limited to agents, distributors, consultants and travel agents
  3. A robust compliance program covering all critical functions, including sales and marketing personnel as well as compliance, legal, finance and human resources staff
  4. A well-run ethics helpline with active follow-up to all complaints and queries
  5. Ongoing compliance training for local management as well as employees
  6. Periodic compliance audits and immediate remediation as necessary

To fully benefit from these compliance efforts, multinationals should consider engaging professionals with the following skills and strengths:

  1. Familiar not only with FCPA requirements but also PRC anti-corruption laws and regulations
  2. Possess a deep understanding of Chinese business culture, along with a command of the unique nuances of compliance challenges in China, and able to to identify and formulate effective responses to new and innovative forms of bribery and corruption
  3. Specialized in dealing with Chinese government investigations appropriately and licensed in China

The insights of such professionals would be helpful in minimizing risk and potential consequences, including reputational damage and executives’ liability.

Ultimately, as the current anti-corruption campaign illustrates, global compliance measures superimposed upon China’s unique business environment are not enough. A truly effective compliance program for China needs to be one that identifies and addresses the issues arising out of local business and legal culture.

John Z.L. Huang and Leon C.G. Liu, MWE China Law Offices lawyers