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ICG Risk Blog - [ A Chinese Catch-22: the implausibility of plausible denial ]

A Chinese Catch-22: the implausibility of plausible denial


If you or your firm does business in China, successfully or relentlessly in pursuit of profit, your firm and likely yourself or one or more individuals in your reporting stream is guilty of violating the US Foreign Corrupt Practices Act (FCPA). The only barriers to discovery are a Chinese arrest of your counterparty for reasons internal to the Chinese, perhaps an anti-corruption drive or an official's fall from favor, and a US warrant against you or your firm for actions with Chinese entities that are deemed illegal under US law.

In a perfect Catch-22 (also here), it is highly likely that you can't even operate in China without violating the Act, especially so when one understands the pervasive nature of purchasing favor in China, even among Chinese. Rich Kuslan offers a nice introduction (and also has a good money laundering series, parts 1, 2, 3):

The idea that one must buy favor permeates Chinese society, even down to the lunch offered by a family member asking for assistance. But bribery and the [FCPA] do not mix well. Since most commercial transactions can not be accomplished in China without the former, in one form or another, the latter tends to suffer when sales figures must be met. As to the actual payment of moneys, most corporations in China who fork it over do not do so directly, but instead make use of third (and fourth) parties -- often foist upon them by potential customers, but sometimes selected. Payments may be made within China or even overseas through a wide range of entities that may help mask the payment. One can be as sure of crisp US $100 bills in a satchel as often as numbered Swiss accounts.

An important note: the use of agents does not necessarily shield the American executive from prosecution. Actual knowledge that a payment or a promise to pay will be forwarded to an official is not required: constructive knowledge -- you "should have" known, given the facts -- can make the exec just as liable.

And is it even debatable that [Zhang Enzhao at China Construction Bank] is an official for the purposes of the FCPA, when the CCB is a quasi-governmental organ of the state of China? The [principal purchaser] in China remains the state. How does the exec defend foregoing a big sale to a quasi-governmental organ and a payment to its key decision-maker in a market your headquarters believes will save the company?

For those of us with a long history with the FCPA, 1998 separates what many call FCPA I and FCPA II. The essence is plausible deniability in connection to a prohibited act. Among the "Prohibited foreign trade practices by domestic concerns" there had long been statute, to wit:

(3) any person, while knowing that all or a portion of such money or thing of value will be offered, given, or promised, directly or indirectly, to any foreign official, to any foreign political party or official thereof, or to any candidate for foreign political office, for purposes of-- influencing... inducing...

The 1998 amendments to what is now called "FCPA I" strengthened the definition of "knowing" such that "FCPA II" removed plausible denial with:

(A) A person's state of mind is "knowing" with respect to conduct, a circumstance, or a result if--
(i) such person is aware that such person is engaging in such conduct, that such circumstance exists, or that such result is substantially certain to occur; or
(ii) such person has a firm belief that such circumstance exists or that such result is substantially certain to occur.

All accounts indicate that DoJ is ramping up its enforcement efforts. In 2005, Assistant Attorney General Christopher Wray flagged a rise in FCPA cases:

Even today, attitudes toward that kind of conduct vary widely among executives around the world and, unfortunately, right here at home. Some folks persist in thinking that bribery is just a cost of doing business in certain countries. The problem is, these bribes undermine exactly what the Corporate Fraud Task Force is intent on restoring: public confidence in the integrity of American business. Under-thetable bribes distort the playing field and hide the truth from the public...

First, the SEC has significantly stepped up enforcement of the FCPA's civil provisions against publicly held companies... Second, we're seeing more cooperation from anti-bribery investigators and prosecutors around the world. That kind of cooperation is essential because these are often tough cases to make. Evidence of the bribe is often located abroad - sometimes in the very country whose officials have been bribed. And these matters are almost always politically sensitive. Our investigators rely on the good graces and cooperation of our international partners... Finally, we're seeing many more companies disclose FCPA violations voluntarily [as] companies are getting the message that we're serious about rooting out illegal corporate conduct...

As a theater operator, I'd often seen the situation that Rich describes as:

[When] senior management passes out copies of the FCPA -- with the notation in biro "read this and make sure you do not violate this law," [it] does not mean they care whether you violate the law, but just that they don't.)

Given the propensity of DoJ to prosecute corporately and individually, I think that it is no longer be sufficient to attempt to remain at arm's length while leaving subordinates at risk. Given the FCPA risks of doing business in China, I think that it will be increasingly difficult to satisfy Rich's admonition:

If you have not seriously considered it before, now is the time to give serious consideration to the value of risky behavior in light of the demands presented by the FCPA, the DOJ and, now, it appears, the Chinese government.

My export sales operated extensively under FCPA I. I think it reasonable to assume said work would not pass FCPA II scrutiny for plausible denial. By the same token, I do not believe that any current Chinese operation could withstand the rigorous scrutiny of FCPA II. The result is discretionary enforcement waiting to happen from either Chinese or US authorities; the counterparty becoming collateral damage to the exposure.

General comments on compliance with FCPA and other statutes

My commercial dealings in Central and South America, Africa, the Middle East, India, and Indonesia painted an intriguing picture of financial compensation through a 'supply chain' of actors in which one could obey FCPA I with modest effort. Most interestingly, China was not then an issue for us as we possessed a high value technology (Computer Aided Design (CAD)) slowly emerging from embargo coupled with then nascent commercial IP collection. In fact, we had competing suitors within China to secure a commercial relationship with us. (The issue rose to the point that these competing groups would, in turn, call me to the embassy in Washington to berate me for dealing with the other party.) Contrasting our preferential treatment, even in the 80s, I saw what happened when the Chinese considered a product more a commodity than a specialty. The commercial terms offered to those vendors were immediately tough.

I have a special memory of the landing of the first space shuttle, STS-1 Columbia, on 14 April, 1981, as I spent the day in Brasilia being hit up for a bribe by a government functionary who became increasingly more exasperated and blunt as I feigned no understanding of his real request. I could afford to be politely obtuse as I already had the means to get our systems past the clutch of Brazilian customs. One would have to be derelict not to understand the empire that was Brazilian customs, or to be unaware of the elegant apartment blocks outside Rio that housed ostensibly low level customs officers. The fact that my client was another government agency made no difference to customs, but it did offer a workaround. We shipped the systems to an airbase in the US where it was transferred to a Brazilian military aircraft which delivered the equipment to an airbase within Brazil. A domestic flight back to the coast outflanked Brazilian customs. One may surmise that there were costs associated with that transit but they were opaque to me and were considered acceptable by all local parties on our side.

Save for the Republic of South Africa (RSA) then under Apartite government and possessed of its own special issues, there was no country in Africa that was free of extralegal payment demands. I sympathize with anyone doing business on the continent as, even with layers of intermediaries, I would not like to endure an FCPA II deniability cross-examination. Regardless of your opinion of FCPA, it is does limit freedom of maneuver by US firms, advances US extraterritoriality, and makes it easy for states such as China gain a commanding position in state to state agreements on the continent. By contrast, French extralegal efforts in the energy sector were easier to deal with as they could be threatened with exposure if they did not limit certain activities.

Reflecting on my operations on many continents, I again submit that FCPA II and its tightened rules on plausible deniability puts a tier of managers, and likely their companies, in a Catch-22, i.e., if you are truly competent at your craft in the region, you will know things that violate FCPA II.

I also believe that the US government can, and has, regularly put commercial firms in the breach between US diplomatic intent and FCPA and export guidelines. Citing private notes from 2004, I submit my commercial experience in the Republic of South Africa (RSA) as an example of skimming the rim of plausible deniability in FCPA I and other statutes:

On my [first] commercial visit to RSA, I was to make a presentation to CSIRO [Commonwealth Scientific and Industrial Research Organisation] in Johannesburg, [with] some 600 in attendance. My [demonstration choice] was a kinematic model of an M-60 machine gun [that I had built to show 3-D interference checking as the round was stripped and chambered - not an easy thing to do with the wire frame models of the day]. I had memorized enough Afrikaans to open the presentation and then shifted to English. My distributor said that the hall [fell] silent... No one instructed me to take military examples. It was just my reading of the reality on the ground...

As CoCom (Coordinating Committee for Multilateral Export Controls) was then governing export licenses to COMECON states, the PRC and other states considered suspect for embargoed use or diversion, I became aware of what I described as a special tilt towards certain governments based upon the degree of difficulty or permissiveness in securing an export license.

I came to see a very favorable tilt towards Pretoria that was at odds with then current state department pronouncements which in hindsight could have been at odds with FCPA:

I [believe that I] was party to a special tacit arrangement to RSA in the late 70s and early 80s [during] which my firm received a blanket $7 million export license to Pretoria for all our CAD/CAM systems. Export seven million and reapply for another seven. [At the same time] COCOM was raking me over the coals on a case by case basis to export technology that was then five year old to the PRC and Czechoslovakia. The RSA economy could not justify sole commercial use of our size of CAD systems [then 75K USD per station]. Every thing we sold was dual use. I took down [unclass] demo models based on proof of function for China Lake [Weapons Test Center], Draper Labs, as well as for the French Superphénix (SPX) reactor series. [In the case of the Superphénix demo, I later learned that I had] sold the CAD systems that went into Valindaba [enrichment] and Pelindaba [weapons design and production] along with enough spares to build a third... Almost every prospect meeting had me presenting to folks who asked questions but never identified themselves. I never took down a commercial example. Things got looser over time as I surmised that my distributor was advising clients that I was not a hostile.

A valid end-use certificate came up from Joberg for every system, and while we did not visit RSA client installations save, if memory serves, for a small manufacturer of excavating equipment, one had to ponder ultimate use. We later learned that this small excavator manufacturer which had purchased a one-terminal system to design tungsten carbide cutters for excavators also designed and fabricated tungsten carbide cores for armor piercing rounds. As noted, everything seemed to be dual use, a functional capacity mandated, as it turned out, by Pretoria as part of its policy of autarky. I would not liked to have been under FCPA II for those efforts. I think it all too easy for an enterprising attorney to build a case of breaching plausible denial.

As an aside, in defense of export license sales to contested states such as the PRC and Eastern Europe (Bulgaria was a major site of advanced design and manufacturing for the USSR):

I even testified at the Pentagon to a foreign technology diversion group telling them how the Soviets, Czechs, and even the Chinese were already making LSI scale chips by stitching together designs produced by a UK system supposedly limited to PCB (Printed Circuit Board) design density. [The process was utter simplicity: the chip design was sectored such that each segment would fit the PCB system, and each sector had defined I/O points to adjacent sectors. Giving up some silicon was an easy trade for otherwise unattainable low volume military production.] They were astonished. Another sign of the fallacy of looking for a mirror-image enemy with mirror-image technology/weapons/tactics. [My testimony] may have made them smarter but it did not ease my export licenses. If memory serves, this was when Richard Perle was in his heyday at export [control].

China's Crackdown on Corruption Still Largely Secret
By Edward Cody
Washington Post
December 31, 2006

Charges of Bribery in a Chinese Bank Deal
New York Times
November 29, 2006

Rare Look At China's Burdened Banks
New York Times
November 15, 2006

The Cost of "Free Trade" in China: Corruption and the FCPA
Posted by Richard at 4:07 PM
Asia Business Intelligence
November 8, 2006

China's bank corruption doesn't faze investors
The multi-million-dollar scandals are a footnote in the floats, write Tom Mitchell and Justine Lau
Tom Mitchell and Justine Lau
The Australian-FT Business
June 05, 2006

Basics of the Foreign Corrupt Practices Act
What Every General Counsel, Transactional Lawyer and White Collar Criminal Lawyer Should Know
By: Robert W. Tarun
Latham & Watkins
April 2006 Edition

FEBRUARY 25 , 2005
Note: Mr. Wray frequently speaks from notes and may depart from the speech as prepared.

Opinion Procedure Release No .: 04-03
Foreign Corrupt Practices Act Review
June 14, 2004

Anti-Bribery Provisions of The Foreign Corrupt Practices Act
[Redline comparison of FCPA to the final version of  S. 2375]
§ 78dd-1. Prohibited foreign trade practices by issuers
1998 Amendments

Foreign Corrupt Practices Act (FCPA)
Department of Justice, Criminal Division

Gordon Housworth

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