The United States Department of Justice (DOJ) is cracking down even further, this time by extending FCPA liability to improper acts performed by a company’s China joint venture. Professor Michael Kohler writes of this in RAE Systems Held Liable For The Acts Of Its Subsidiaries’ Joint Venture Partner.
Koehler leads off his post by emphasizing how far the DOJ is going by prosecuting United States companies for the acts of its China joint venture:
If every company voluntarily disclosed that its distant subsidiaries and/or its distant subsidiaries’ joint venture partners provided minor things of value (such as a notebook computer, kitchen appliances, and business suits) to someone deemed a “foreign official” by the enforcement agencies, then instead of 15 to 20 core FCPA enforcement actions per year, there would probably be something like 150 to 200 FCPA enforcement actions per year.
If every issuer voluntarily disclosed that its internal controls were imperfect as to distant subsidiaries or its distant subsidiaries’ joint venture partners, and that such distant entities failed to follow issuer instructions or issuer provided training and guidance, then instead of 15 to 20 core FCPA enforcement actions per year, there would probably be something like 1,500 to 2,000 FCPA enforcement actions per year (recognizing that the FCPA’s books and records and internal control provisions equally apply to domestic operations).
Koehler summarizes the facts behind a recent DOJ case in which RAE Systems agreed to pay approximately $2.95 million in fines and disgorgement:
Pursuant to a three-year non-prosecution agreement [NPA], RAE Systems acknowledged its “knowing violations of the internal controls and books and records provisions” of the FCPA “arising from and related to improper benefits corruptly paid by employees of two joint ventures majority owned and controlled by RAE Systems to foreign officials of departments, agencies, and instrumentalities” of the Chinese government.” Pursuant to the NPA, RAE Systems agreed to pay a $1.7 million penalty.
According to the NPA, RAE Systems “had significant operations” in China organized “under a holding company called RAE Asia, headquartered in Hong Kong.” RAE Systems “sold products and services in mainland [China] primarily through second-tier subsidiaries organized as joint ventures with local Chinese entities.
One of the joint ventures is RAE-KLH (Beijing) Co., Limited (“RAE-KLH”). RAE Systems acquired a 64% stake in RAE-KLH in 2004 and upped the stake to approximately 96% in 2006. The other joint venture is RAE Coal Mine Safety Instruments (Fushun) Co., Ltd. (“RAE-Fushun”). In 2006, RAE Systems acquired a 70% interest in RAE Fushan.
Both RAE-KLH’s and RAE Fushun’s financial results were included in the consolidated financial statements that RAE Systems filed with the SEC.
According to the NPA, “a significant number of RAE-KLH’s and RAE Fushun’s customers” in China were “government departments and bureaus and large state-owned agencies and instrumentalties.” The NPA states as follows. “The Lanzhous City Honggu Mining Safety Bureau, for example, was a government customer. Other government clients included regional fire departments, emergency response departments, and entities under the supervision of the provincial environmental agency, among others. Accordingly, officers and employees of a significant number of RAE-KLH’s and RAE Fushun’s customers were ‘foreign officials’ within the meaning of the FCPA …”.
The NPA then contains a heading that states, “RAE System’s Knowing Failure to Implement Systems of Effective Internal Controls at RAE-KLH and RAE Fushun Post Closing.”
The NPA talks of how RAE company documents “suggest RAE was aware that KLH sales personnel were making kickbacks or otherwise engaging in questionable sales tactics with its customers.” The NPA cites a RAE Systems document stating “we knew this risk all along and have accepted it upon entering the JV deal.” The NPA also states that though “RAE Systems did provide some FCPA training to RAE-KLH personnel and did tell RAE-KLH personnel to stop paying bribes and providing other improper benefits…such steps were half-measures” and “RAE Systems did not impose sufficient internal controls or make sufficient changes to high-risk practices.”
The NPA also describes how”RAE Systems did not conduct pre-acquisition corruption due diligence of RAE Fushun” but that given RAE’s System’s experience with KLH described above, the high-risk nature of the location, and the existence of numerous government customers, pre-acquisition corruption-focused due diligence was merited. “Improper business practices had occurred at RAE Fushun before the acquisition and continued post-acquisition, as RAE Systems failed to implement an effective system of internal controls at RAE Fushun.”
The NPA concludes that “RAE Systems knowingly failed to implement a system of effective internal accounting controls at RAE-KLH and RAE Fushun….”
If you are doing business in China, particularly via a joint venture or a recent acquisition, I urge you to read Koehler’s full post.
I see this as just yet another benefit of going it alone in China. Do you agree? Do you see this ruling impacting the creation of China joint ventures or slowing down U.S. company acquisitions of Chinese companies? I do not think it will have much impact on those things, but I do see it as likely to lead to United States companies increasing their due diligence and becoming even less willing to assume a “see no evil, hear no evil” approach to their China businesses.