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Gap between law and practice in multinational compliance and ethics program in China

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US SEC-regulated firms responding to the Sarbanes-Oxley Act (2002) and the 2004 revised Organizational Sentencing Guidelines (also here) must now include China’s Company Law in their Chinese operations as "starting January 1, 2006 every new foreign-invested enterprise in China establish the position of "supervisor"":

The position of supervisor derives from European corporate law and the institution of the supervisory board in a two-tier board structure. Many civil-law jurisdictions, such as Japan, Taiwan, Mexico, Brazil, Italy, and Spain, have adopted this model of corporate law and a supervisory board...

[A] limited liability company must establish one or more supervisor positions. (Almost all foreign-invested companies are limited-liability companies, and those that are not are still subject to a supervisor requirement.)...

The supervisor’s principal function is that of an independent watchdog to prevent and detect violations of law. [A] supervisor is to review the performance of the company’s directors and senior management in their official duties and propose the dismissal of directors and senior management who are found to have violated the law, regulations, or the company’s Articles of Association.

The supervisor also has the authority to examine the financial affairs of the company and to investigate irregularities in the company’s operations. And a supervisor has authority to require a director or senior manager to rectify his conduct if it has damaged the interests of the company... [Implementing a Compliance And Ethics Program in China, Torbert, ETHIKOS, July/August 2007]

When a colleague, Preston Torbert, first advised me of this forthcoming analysis of a compliance and ethics program in China that sought to bridge US and Chinese law, my snap response was cheeky:

I think that I could more easily change my carbon-based, oxygen breathing system to a silicon-based, ammonia breathing system, but I will be certain to keep an open mind. [email]

But Torbert's analysis does merit reading as he offers a checklist on the role of Supervisor in a compliance and ethics program in a Foreign-invested Enterprise (FIE) in China as an outcome of exploring four topics:

  1. What specific functions of a compliance and ethics program could a supervisor perform?
  2. What disqualifications do Sarbanes-Oxley and the revised Sentencing Guidelines impose on the selection of personnel to oversee or implement a program, and what disqualifications does Chinese law impose on the selection of a person to be a supervisor? Do these disqualifications conflict with or complement each other?
  3. The Commentary to the Sentencing Guidelines suggests that organizations model their compliance and ethics program on well-regarded programs and best practices of similar organizations. What are the best practices in Chinese companies that are also subject to a supervisor requirement?
  4. What is the experience regarding supervisors in Chinese subsidiaries of U.S. companies since January 1, 2006 when supervisors were required? Given that the position of supervisor is common to the company law of some civil-law jurisdictions, what is the experience in such jurisdictions with supervisors in subsidiaries of U.S. companies?
     [Implementing a Compliance And Ethics Program in China, Torbert, ETHIKOS, July/August 2007]

After reading Torbert's legal analysis, my field comments were as follows:

The supervisor and his "monitoring and auditing" function is the perfect sinecure for institutional espionage, and will be used as such. Isolation (a "Chinese Wall"?), not integration [of the supervisor in the SEC-side], has merit. More on that below.

I would deeply investigate the hiring/posting procedure for this individual posted to my firm. Furthermore, I would look beyond the due diligence on the person hired/appointed to my firm and into the community of supervisors so as to detect patterns (provenance, history, relationships, et al). I would expect to find some interesting undisclosed linkages.

As China is a land of too many, not too few, laws this position further permits discretionary corporate and individual embarrassment or interruption whenever it suits the needs of the CCP. [Discretionary traps await even those of the highest probity.]

The Chinese will welcome extending the supervisor's role so long as it improves Chinese access into corporate information but will restrain it should that expansion reveal information that the state wishes to remain cloaked or cooked.

I maintain that you cannot do business in China, profitably or otherwise, without violating the FCPA. See: A Chinese Catch-22: the implausibility of plausible denial. I think that I am on reasonable ground that SOX compliance will be equally compromised and that the US entity must immediately begin some form of risk factoring to limit its exposure.

I submit that the supervisor role must be held distinct from your SOX compliance officer as the supervisor is "their guy" in so many ways, tangible and intangible, and you need to insure that the SOX compliance officer is "your guy."

I do not believe that the supervisor can be an "independent private inspector general," full stop.

China is not like other places and thus attempting to extend supervisory performance trends to Chinese soil is fraught with peril. The utility, value and threat of the supervisor's role has to be evaluated within current Chinese conditions. [email comment]

These are not idle issues as SEC-regulated firms can find themselves in either a regulatory breach or suffering a loss of Intellectual Property (IP) and operational strategy, or both. Whereas Sarbanes-Oxley and similar US statues are used to provide transparency to the global investor and regulator alike, the law in China is used more to further the aims of the state and thereby state entities and commercial entities fulfilling state goals (as simple as revenue and growth) will, if history is any guide, be favored over foreign firms.

The foregoing comments notwithstanding, I know Torbert to be a very practical attorney as his A Peek into the Black Box on contract negotiation, noting the perils of moving between Chinese and English texts, is highly recommended.

His concluding recommendations on dealing with the ever-present ambiguity between two very different languages and cultures were excellent, yet sadly, those who have yet to be stung will think that a second translation mark-up, a cover note on likely ambiguities and their implications, a back translation with recourse and a side-by-side length comparison are surely overkill and too costly. These are the same individuals who say 'We didn't even plan on making enough time for that,' presuming that is sufficient justification for skipping this rigor even if it was thought to be needed.

Even with Torbert's excellent steps, I have seen cultural and commercial issues make a hash of the best agreement, but his process embedded in an open-eyed understanding of the agreement on offer manifestly improves the chance of succeeding. His comment about the destructive power of successive ambiguities reminded me of my maxim that the two overriding reasons for the failure of a joint venture, merger, or any organizational initiative (in any venue and between any countries/ethnic groups) are:

  • Failure to set and reset mutual expectations
  • Failure to build and maintain a sustaining relationship

When either or both of these needs are breached, the venture will be allowed to flounder onto one of the three "rocks of convenience" - finances, technology, and operations. I hold it as a given that whenever either party gets a surprise that it is a direct indication of an expectation failure and should be a call to action to find out why and prevent it from happening again.

Borrowing the concept of Confidence Building Measures (CBMs) that are a staple of nuclear weapons bargaining for force reductions, my process goals are designed to create interactions that set realistic agendas and expectations, and to develop a relationship that once built, is validated and renewed.

As we are an extension of the legal side, working closely with attorneys in discovery and due diligence efforts, I can say that if Torbert's style of contract definition were embedded in my clients' behavior, our work would be easier.

I can only hope that his guidance vis-à-vis the role of Supervisor equally threads the operational needle of pursuing legitimate business in China without falling afoul of two vastly different intents at supervisory ethical oversight.

Inquiry Threatens Ex-Leader of Securities Agency
By NEIL A. LEWIS
New York Times
August 16, 2007

Implementing a Compliance And Ethics Program in China
By Preston M. Torbert
ETHIKOS
Twentieth Anniversary Issue July/August 2007
NOTE: Not yet accessible online

A Peek into the Black Box
Preston M. Torbert
China Business Review
July-August 2006

Company Law of the People's Republic of China (revised in 2005)
Updated: 2006-04-17 10:09
ChinaDaily
(Adopted at the Fifth Session of the Standing Committee of the Eighth National People's Congress on December 29, 1993. Revised for the first time on December 25, 1999 in accordance with the Decision of the Thirteenth Session of the Standing Committee of the Ninth People's Congress on Amending the Company Law of the People's Republic of China. Revised for the second time on August 28, 2004 in accordance with the Decision of the 11th Session of the Standing Committee of the 10th National People's Congress of the People's Republic of China on Amending the Company Law of the People's Republic of China. Revised for the third time at the 18th Session of the 10th National People's Congress of the People's Republic of China on October 27, 2005)

ORGANIZATIONAL SENTENCING GUIDELINES: THE NEW PARADIGM FOR EFFECTIVE COMPLIANCE AND ETHICS PROGRAMS
JAMES E. BOWERS, EDGARDO RAMOS, SABINO (ROD) RODRIGUEZ III, HELEN HARRIS, CHRISTOPHER V. BECKMAN
National Legal Center for the Public Interest
ISSN 1089-9820
ISBN 0-937299-46-4
ISBN 1-930742-56-8
Volume 8, Number 11
November 2004

Preventative Measures against Criminal Conduct Have Wide Ranging Benefits
By Paula J. Desio
November 2004

Gordon Housworth



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