Getting Serious About Compliance

by: Kilpatrick Townsend

BY E.W. GENTRY SAYAD
March 1, 2016

Growing number of SMEs beefing up compliance to keep up

“Should I get on a plane?” a panicked legal representative asked me recently. “What is my exposure?” The questions were prompted by an anonymous tip on his company’s hotline alleging that senior management were aware of and/or participated in several instances of bribery. Aware of the penalties handed out to multinational companies (MNCs) and other recent cases, he was quite concerned about the potential liability should any of the allegations turn out to be true. Fortunately, following an investigation of the claims, we were able to determine that the allegations were without merit and concluded that the legal rep could rest easy. Furthermore, we were satisfied that the company had in place a strong compliance program and that measures were in place to help mitigate the company’s exposure should they experience future claims.

That scenario has been all too common over the past couple of years following tough enforcement actions by the United States and other western authorities and now, more and more, strict scrutiny by Chinese authorities implementing their crackdown on corruption and under their anti-competition regime.Last month, the American Chamber of Commerce Shanghai (AmCham Shanghai) released its 2016 China Business Report. Among the major risks and challenges to doing business in China, corruption and fraud was cited by 67 percent of respondents. Furthermore, 28 percent of respondents believe that the risks to businesses posed by enforcement actions increased in the last year. In particular, several industries, including pharmaceuticals, medical devices, life sciences and the real estate and construction sectors reported higher exposure and resulting impact from government investigations.

The report also generally cites rising costs in China. The rise in costs can be attributed to a number of factors, especially labor, but one component we observe regularly with our clients in nearly every industry is the rising cost of compliance. Increased costs of compliance are no longer a burden borne mostly by large MNCs. Traditionally, MNCs had the resources to generate global compliance programs that they could apply to China, although even these are refined and beefed up versions of what they looked like five years ago.

More significant is the impact of compliance on small and medium-sized enterprises (SME). In the past, SMEs were not on the radar of enforcement authorities when it came to corruption and certainly anti-monopoly issues. Today, the headline investigations still involve large corporations for the most part, but increasingly, we see smaller enterprises at risk of exposure in the today’s stringent climate.

In the past year, we have seen a dramatic increase in the development of compliance programs for SMEs. New entrants to China are coming in with a new concern and awareness that they could become a target of one of the many Chinese enforcement agencies. Also, because investigations now may target individuals, something not seen several years ago, legal reps are insisting that their company have a compliance program in place. As most smaller enterprises don’t have the internal resources to develop these programs, they look to third-party providers for legal and accounting resources, as well as risk management firms if and when internal investigations become necessary.

Hotline
At a minimum, a compliance program will include internal documents such as employment agreements, company handbooks and codes of conduct that spell out company rules and clearly define conduct which is prohibited and grounds for termination. These have to be carefully drafted in such a way that should employees act in a manner that violates the company rules and/or law, that the termination will satisfy China’s labor laws. Also, as part of a good compliance program, employees should receive regular training about relevant corruption laws from home, including the Foreign Corrupt Practices Act of 1977 (FCPA) and the UK Bribery Act, as well as China’s laws on bribery and the anti-monopoly law.

These trainings should be done live, as on-line training does not provide the same impact and employees are often able to ignore it or take it after learning the answers from someone who has taken the training before. Furthermore, companies should have mechanisms in place so that misconduct can be reported and necessary investigation of claims can be undertaken, e.g. anonymous hotlines for reporting and clear language in corporate documents that addresses employees’ personal data and give the company a sound basis to investigate internally.

As a result, smaller companies are facing increased costs to create and maintain these programs. This is true not only in China, but in other jurisdictions where the business climate presents compliance challenges. Even large MNCs are enhancing their programs and increasing their trainings both for anti-corruption and for anti-trust. The China Business Report states that there may be some perception that enforcement regulation may be softening; however, a significant percentage of respondents noted an increase in risk to their businesses. Last year alone, there were over 300 merger and acquisition cases filed with Ministry of Commerce of the People’s Republic of China (MOFCOM). That number was inconceivable even two years ago.

While the business report for the most part refers to corruption and anti-monopoly enforcement as high risk, legal companies must be aware of and adapt to China’s ever changing regulatory scheme. Among many other things, companies must be familiar with Chinese labor laws, dispute resolution options and enforceability of contract terms. Even within the context of the anti-monopoly law, the three agencies charged with anti-monopoly enforcement, MOFCOM, the National Development and Reform Commission (NDRC) and State Administration for Industry and Commerce (SAIC), have all released new or are in the process of drafting new regulations within the last year.

Large MNCs have made the most headlines, but it is clear that China’s antitrust authorities are targeting a number of industries, including all types of tech and automotive companies, and are not only going for large companies based on size and perceived monopolies, but are also looking at industry players who engage in price fixing.

Stay abreast
As these regulations are often amended and because the regulatory scheme is still not transparent, companies have to keep up with the changes and take steps to lower their exposure. Additionally, the authorities are in the process of creating new regulations directed at intellectual property (IP) rights, which necessarily will impact the structure of license agreements and a company’s ability to exercise its IP rights or seek IP protection in China. It is incumbent on companies of all sizes to keep abreast of these changes either through reliance on their own legal resources or regular interaction with outside counsel.

There are many other legal developments not addressed in this article of which companies must be aware and for which they will need to allocate appropriate resources. While our legal rep mentioned earlier was fortunate not to find himself in a risky situation, many of China’s new laws are imposing to foreigners. Several individuals have been detained or arrested in the last year under new and broadly worded regulations. Even lawyers are at risk (enter all lawyer jokes here).

Recently, a Swedish citizen was detained just before getting on a flight to Thailand. He has been charged with subversion based on his operation of a non-governmental organization (NGO) which trains Chinese lawyers and which is subject to the new regulations set forth in China’s NGO law released last year. None of us want to be in the headlines. Spending the time to know about the laws relevant to your business and to put sound programs in place is the best way to avoid that risk.


E.W. Gentry Sayad is Partner and Co-Chair of the Asia Practice at Kilpatrick Townsend & Stockton LLP Shanghai Rep. Office (USA). He focuses primarily on international transactions, the Foreign Corrupt Practices Act, compliance issues and issues relating to intellectual property.
Originally published in American Chamber of Commerce in Shanghai’s Insight, March 1, 2016. 

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