China's new wave of regulatory enforcement: what multinationals need to know

The Global Anticorruption Perspective

Since Xi Jiping became China’s leader this year, the PRC has seen the launch of an unprecedented, sweeping government campaign to tackle corruption. 

The wave of enforcement action against corrupt officials that started with the arrest of the enormously powerful former Chongqing Party Secretary, Bo Xilai, has since surged on. Most visibly, Liu Zhijun, head of the once powerful Ministry of Railways, was sentenced to death for corruption in July; then Mr. Bo was tried and sentenced to life in prison; and then, in early September, state-run media reported that Jiang Jiemin, the former chairman of state-run PetroChina, China's largest oil company, would be investigated for “suspected serious disciplinary violations.”i

The private sector is feeling the heat too

As we can clearly see it here in Beijing, the government's focus is not limited to public officials. In recent months, government authorities have brought a spate of regulatory and investigative enforcement actions against companies in the private sector  – including both multinationals and Chinese companies. 

Notably, the sector that is likely to feel these actions the most is life sciences, but other sectors are being affected too.

Recent government activity includes the following.

1.    New regulations issued by the State Council, which came into effect in May 2013, impose tougher market entry requirements on infant formula manufacturers. The new rules require manufacturers to own their own milk sources and forbid them to outsource production or use several brand names for the same infant formula. This has already led to a number of dairy farm companies being acquired by Chinese infant formula brands.

2.    One of China's anti-monopoly regulators, the National Development and Reform Commission (NDRC), announced in July 2013 that it is investigating 33 Chinese domestic pharmaceutical  companies and 27 international pharmaceutical companies operating in China (or their Chinese agents) with respect to the production costs of some of their products. The implication here is that the price of these pharmaceutical products is too high, burdening China’s public health insurance scheme.

3.    Reports have appeared of recent anti-bribery investigations against a number of international players in the pharmaceuticals industry led by the Chinese police, the Public Security Bureau (PSB) and the State Administration of Industry and Commerce (SAIC).ii

4.    In August 2013, the SAIC announced that it had launched a broad, three-month investigation into unfair competition practices in China. This will cover commercial bribery, IP infringements, anti-competition and commercial frauds. While the SAIC did not mention any specific industries, state-run media has reported that the investigation will target various sectors, including petroleum, telecommunications, banking and automobiles

What does all this mean for multinationals operating in China?

In the past, government anti-bribery enforcement action would principally target government officials found taking bribes, rather than the companies that actually paid the bribes to these officials. The latest investigations, however, are different.  For instance, those accused of receiving bribes are still being targeted, but so are those accused of giving bribes.  Moreover, the campaign is vast, involving many government authorities and agencies (NDRC, PSB and the SAIC), which appear to be coordinating their enforcement actions concurrently.  There have been no shortage of rumours coming out of the China market in the past month about the number of foreign companies targeted by the government and the factors that prompted these investigations.iii 

It is important to note that these regulatory enforcement actions are being driven by many intertwined social, political and economic factors.  Not least, the Chinese public's interest in food safety and health care is at an all-time high, and people are becoming more willing to criticize corrupt behavior. China's new leadership, eager to prove itself to the Chinese public and to establish a strong mandate to govern, now seems more willing to increase its regulatory oversight on certain high-priority industries.

These points are essential:

  • Among the likely target industries are food, health care, real estate and construction, and telecommunications.
  • Greater regulation and stronger enforcement action is likely to continue into the second half of the new leadership's first five-year term in office (ending in 2017).
  • This is likely to mean that practices traditionally viewed as grey areas will be targeted and ultimately punished.

An overview of the PRC’s regulatory regime

Companies with a robust regulatory and compliance program and effective crisis management protocols should be in a strong position to respond to such government enforcement action.  However, international companies operating in China should review and update their approach to regulatory affairs and compliance in China.

This means ensuring that appropriate procedures and controls and preventive measures are embedded proactively across the entire business (and not just as a response to a crisis). These controls should be specifically designed to respond to the PRC's regulatory regime

With this in mind, we outline below for your reference an overview of the PRC anti-bribery regime.

Official bribery offenses

The PRC's anti-bribery regime criminalizes “official bribery” and “commercial bribery” offenses, as well as “administrative commercial bribery” offenses. Under the PRC's Criminal Law, an "official bribery" offense is committed when the offender (who can be an individual or a corporation) offers property, kickbacks or service fees to any State Working Personnel (SWP) in return for an improper benefit. Under PRC law, a bribe would include cash, property or other benefits (such as a cash card, shopping card, membership card or travel).

The prosecution threshold for a corporate offender is either:

1.    the amount of the bribe is more than RMB200,000 (US$32,000) or

2.    if the amount is less than RMB200,000 (US$32,000) but more than RMB100,000 (US$16,000), then a certain additional condition is required.iv

The elements that make up a criminal official bribery offense are: 

  • That the recipients of the bribes would be considered SWPs
  • There is an offer of property, kickbacks or service fees in return for an improper benefit, or for the assistance to obtain such benefit
  • The amount involved meets the required threshold above and
  • There is corrupt intent to bribe the SWPs.

One example: an offender, in connection with certain economic activities, violates certain state regulations by giving rebates to a state-owned enterprises (SOE), and the rebates are deliberately described inaccurately  in company accounts to conceal their real purpose.

PRC law defines SWPs as people who:

  • perform public services in the legislative, administrative or judicial agencies, or the military
  • perform public services in SOEs, institutions or civil organizations – many international companies operating in China regularly conduct business with SOEs
  • have been assigned by the government or SOEs to non-state-owned enterprises, institutions or civil organizations to perform public services (e.g., a deputy general manager of a Sino-foreign joint venture company who has been sent to the JV by the Chinese party which is an SOE) or
  • perform public services according to law.

Commercial bribery offenses

A criminal commercial bribery offense is committed in the PRC when the improper conduct does not involve an SWP but instead a private person - for example, a company bribing an individual in another company in return for an improper benefit.

The prosecution threshold to determine commercial bribery for a corporate offender is the same as that for public bribery. In order for an act of commercial bribery to be considered a violation of the Criminal Law, the following criteria have to be satisfied:

  • an offer of property must have been made to a member of a company or enterprise
  • in return for an improper benefit, or for the assistance to obtain an improper benefit
  • the amount of the bribes involved for a corporate offender (which can be charged as an accumulated amount) is above RMB200,000 (US$32,000) and
  • there is corrupt intent on the part of the offender.

Administrative commercial bribery offenses

Apart from the criminal offenses mentioned above, PRC law also prohibits companies from offering cash or property through "other improper means" for the purpose of selling or purchasing goods.v This is an administrative offense which targets commercial bribery from an administrative enforcement perspective.

There is no expressly stated, definitive threshold about what constitutes an administrative commercial bribery offense. The SAIC is the administrative authority in charge of handling administrative investigations and sanctions, and it has great discretion in determining what constitutes an offense. Generally, prohibited conduct may include off-the-book discounts, kickbacks, rebates and commissions, among them non-cash payments in kind such as consulting fees, promotional fees, sponsorship of tours or seminars inside or outside of the PRC, service fees, research fees or the writeoff of such fees.

As there is also no definition of "other improper means" in an administrative commercial bribery offense, the key is to ensure that rebates, discounts and commissions are properly accounted for and recorded and that they relate to justifiable business activities. Given the discretionary powers of the SAIC, if certain expenses are not properly recorded in the company's accounts, then the lack of accounting, or false accounting, might lead the SAIC to treat such spending as commercial bribery.

Examples of activities that could be construed as commercial bribery by the SAIC:

  • lavish dinners repeated over a period of time and vaguely recorded in company accounting as an "entertainment expense"
  • payments to a customer that are recorded as a "gratuity"
  • a fake order – a payout that creates the appearance of a sale or that inflates sales figures

These are the penalties in China for such administrative offenses:

  • Administrative commercial bribery conducted by an employee shall be deemed as the act of the employer and
  • Administrative commercial bribery is punishable by fines (ranging from RMB10,000 / US$1,600) to RMB200,000/ US$32,000) and
  • More onerously, and in addition, cancellation or suspension of the company’s business license to operate in China and confiscation of any gains deemed to have been obtained through the illegal activity.

For more information about anti-corruption enforcement in China and to learn about creating an appropriate compliance program, please contact Sammy Fang in Beijing.

 


i This is the government phrase for corruption-related investigations.

ii The SAIC (and its local offices) is an administrative body responsible for company filings and monitors business conduct of companies operating in China. It also has a mandate to investigate certain anti-monopoly law violations, as well as administrative commercial bribery infringements.

iii Chinese weibo (microblog) users say that these anti-bribery investigations were prompted by allegations from whistleblowers.

iv The bribes are offered in order to obtain an illegal benefit; or the bribes are offered to more than three people; or the bribes are offered to leaders of the Communist Party, or members of government departments, judicial departments or administrative enforcement departments; or the conduct causes significant losses to the interest of the country or society.  There are no specific regulations or judicial interpretations defining what an "illegal benefit" is. 

v This is provided principally under the PRC's Anti-unfair Competition Law.