International Businesses Operating in China Need to Consider Whether to Self-Report to the New Anti-Corruption Beast on the Block, Says Tom Moore

Pharmaceuticals & life sciences 40 China’s corruption clampdown

International businesses operating in China need to consider whether to self-report to the new anti-corruption beast on the block, says Tom Moore

Visiting his company’s joint venture manufacturing facility in Northern China, a foreign-national CFO notices a photo of what appears to be an employee hanging up in reception. The caption, however, is written in Chinese characters, which he does not understand. The American director notices the same photo hanging up in the main office, and again as he visits the shop floor and the canteen. His curiosity finally gets the better of him “and he asks his host: ‘Who is this guy and why is his picture hanging up everywhere? Is he the employee of the month?’” “His Chinese host, while slightly embarrassed, says ‘no. He stole from the company and today he’s being executed’.” It’s a client tale Brinton Scott, a partner at Winston & Strawn in Shanghai, retells to explain, all too literally in this scenario, a well-known Chinese proverb: that one must kill a chicken in order to scare the monkeys. Chinese businesses and the national authority often use this method to send a message to the “monkeys”, those high up on social and economic branches, that they’d better behave themselves…or else. The monkeys have typically avoided the wrath of law enforcers, with examples made of the chickens on the ground instead. Commercial Dispute Resolution NOVEMBER-DECEMBER 2013 41

DEALING WITH THE BADCOP

But the times they are a-changing. the iceberg for a government that has The Chinese bribery investigation into UK- made it clear there will be action”. headquartered pharmaceutical giant GSK is With international drug manufacturers, the offering of a monkey to a Chinese public including Sanofi, Novartis, AstraZeneca, tired of corruption. New Chinese president Xi Eli Lilly and Bayer, having been visited Jinping has made tackling corruption a priority by Chinese officials, the Ministry of Public during his first year in office and senior officials Security’s statement that it “should learn have increasingly fallen subject to investigation. from the practice of other countries in China’s prosecutorial agencies have imposing astronomical fines” will send investigated 129 senior officials in the first eight a shiver down the sector’s spine. months of 2013, according to the country’s GSK, which already holds the record main prosecution agency, the Supreme for the biggest fine in pharma history after People’s Procuratorate. That list includes: Bo settling illegal drugs marketing charges Xilai, the former Communist Party chief for with US authorities for USD 3 billion Chongqing whose infamous corruption trial last year, looks likely to land another made headlines around the world; former large fine if the Chinese authorities put railways minister Liu Zhijun, who was given a a strong enough argument together. suspended death sentence for corruption and Amy Sommers, a partner at K&L Gates abuse of power in July; and alleged bribe taker in Shanghai, says that “in the US, the Liu Tienan, who was sacked as the deputy FCPA has brought in billions of dollars of chief of China’s economic planning agency. revenue, and if Chinese regulators are able The monkeys now face the same fate as the to secure lower drug prices and revenue chickens, and Scott, who has lived and worked from fines, it would be seen as a big win”. as a lawyer in China for 18 years, says that The regulator is certainly on the front the country’s first high-profile investigation foot. GSK has opened its books to the of a foreign business will not be the last. authorities and promised to slash drug prices. Mark Reilly, the company’s former head of Side effects operations in China, has also returned to The regulatory focus in China is, for China to assist the investigation after flying now, firmly fixed on the pharmaceutical to the UK when the allegations emerged. sector. Scott says “GSK is the tip of Multi-million and possibly multi-billion 

www.cdr-news.com Pharmaceuticals & life sciences 42 China’s corruption clampdown

 dollar fines on UK and US companies in China could force a rethink in fine sizes Prosecutors across China elsewhere. The top ten fines collected by US authorities under the Foreign Corrupt investigated 22,617 cases of Practices Act amount to USD 3.52 billion alone. Should China look to match its tough corruption between January and financial penalties, the US may begin to feel it is paralysing its domestic companies. August 2013, a 3.6% increase Take Yuan once a month on the same period last year One China-based lawyer, who wants to remain anonymous, says the challenge facing the country’s pharmaceutical sector looms large, as its “health service wouldn’t function without bribes”. He explains: “The reality is that doctors in with the regulators. “You’re not China don’t make enough money on their excused for what’s happened in the salaries, particularly in the more rural areas past, so the question for corporations of the country. No matter what happens in is this: do I self-report?” says Scott. the GSK case, payments to doctors in some shape or form are going to have to continue to Good cop, bad cop keep the Chinese health service functioning. Pharmaceutical firms considering When people are happy to receive bribes, self-reporting would be entering the you also have people happy to pay them.” unknown. While the Shanghai partner Gareth Morgan, a pharmaceuticals says that “although China’s civil code partner at Winston & Strawn in London, itself is well developed, its application and believes the GSK investigation “calls the interpretation are problematic”. There credibility of the UK’s anti-corruption is no system in place in China whereby regimes into question as there are territories companies can openly seek regulatory where bribery is still endemic”. The London advice or follow published policies. lawyer says he is increasingly being Scott explains: “The issue in China is approached by drug companies struggling the application and interpretation of to gain market share in jurisdictions the civil code. There is no stare decisis, where “paying bribes is how it works”. unlike in the UK or the US, which means He adds: “The predicament facing in-house Chinese courts are generally not required lawyers is whether to act as a whistleblower to apply previous interpretations by when they’re aware that the reason they other courts to a current case. Instead don’t have any market share is because they they are generally free to interpret the are refusing to pay bribes.” Pharmaceutical civil code as they please and this creates firms now taking a closer look for symptoms a lot of angst for general counsel.” of corruption in their Chinese operations The current anti-corruption drive will also be considering their relationship is in its infancy, and companies and their legal advisors will need to devise strategies sensitive in their dealing with the Chinese state. Jeremy Summers, head of Slater & Gordon’s business crime and regulation group, says that 80.8% of China’s 22,617 multinationals used to dealing with US and UK regulators will have defined processes for investigating such conduct. corruption cases during the He says Western companies “will need to take steps to better understand first eight months of 2013 were the cultural imperatives of China and its investigatory techniques if classified as serious, there is to be a prolonged campaign against corrupt practices”. up 5.7% on the previous year A London-based regulatory partner, Commercial Dispute Resolution NOVEMBER-DECEMBER 2013 43

who was conflicted out of being named, says “the feeling from GSK is that the Chinese regulators are a much scarier cop than 30,938 the US Department of Justice and the UK Serious Fraud Office”. She adds: “The SFO and the DoJ interview witnesses in their people were homes and in their offices with lawyers present. They wouldn’t just detain a load of senior executives, which is what the Chinese authorities did. Compliance lawyers always talk about the SFO, investigated the DoJ and the US Securities and Exchange Commission; now we have to factor in another regulatory beast, and that beast behaves for corruption in different ways to how our regulators conduct investigations.” While the SFO and the DoJ conduct investigations of their by Chinese own into GSK, the compliance partner says the company’s “bending down on its knees and capitulating” before the Chinese authorities between authorities is “not a sustainable way of dealing with your January and August investigations and this won’t happen before every regulator”.

Steroid Stretch Armstrong 2013, 3.8% The Central Commission for Discipline Inspection of the Chinese Communist Party has overall responsibility for tackling more than in the corruption. It has mainly targeted Chinese concerns in the past, but Summers says the change in Chinese corruption tactics same period last year means “there may now be a need for the West to attempt more active engagement with the party apparatus”. (Other state bodies include the Asset Supervision and Administration Commission and the National Development and Reform Commission.) In the UK, there is a relentless drive by the investigative agencies to create more and better avenues for cooperation with their counterparts overseas. This desire stems from the need to enforce the Bribery Act without the same investigatory resources the DoJ has at its disposal. There has been a steady stretch of the UK’s regulatory arm, backed by new legislation. The Crime and Courts Act 2013 amends the Proceeds of Crime Act 2002 to allow UK agencies to seek to forfeit assets abroad, while the new Organised Crime Strategy indicates that UK investigative agencies will seek to extend mutual legal assistance agreements, with the UK having recently 7,080 cases of negotiated Asset Sharing Agreements with the UAE and China. While the UK courts don’t rule out the admissibility of corruption in China were evidence, even if it is unlawfully obtained, one London lawyer who wanted to remain unnamed says that the “cowboy and disclosed via tips from the police state type of investigation” conducted by the Chinese authorities writes a question mark over any shared evidence. public during the first eight The uncovering of corruption by Chinese authorities will hand the SFO and the DoJ the perfect opportunity to conduct their months of 2013 own investigations and obtain their own evidence. US- and UK- headquartered law firms are shaping up for a permanent fight against corruption in China by hiring partners in the region. There may also be a knock-on effect in London and in Washington, DC. The approach of western law firms to China is changing, and the merger of SJ Berwin and King & Wood Mallesons is evidence of that shifting strategy. “There is an acceptance that the job isn’t done properly by the western law firms that invariably head up their Asia practice with expats. You need domestic advice from indigenous lawyers that know the system and know their way around the system,” says Morgan. Boxed out statistics from Monkeys and chickens are set to be killed in equal the Chinese Supreme measure. International law firms need to adapt to deliver. n People’s Protectorate