Paper Tigers: Recent Settlements Show Companies Operating in China Need to Do More to Enforce FCPA Policies
Amid a recent flurry of Foreign Corrupt Practices Act (“FCPA”) settlements announced by the U.S. Department of Justice (“DOJ”) and U.S. Securities and Exchange Commission (“SEC”) were two settlements relating to the provision of improper gifts, hospitality and travel to Chinese government officials.
- On February 4, SciClone Pharmaceuticals, Inc. (“SciClone”) entered into a $12.8 million administrative settlement with the SEC to resolve charges that it provided weekend trips, vacations, gifts, expensive meals, foreign language classes, and entertainment to Chinese healthcare professionals in order to obtain sales of SciClone products.1 SciClone employed third parties, including travel agents, to make many of the improper payments, and though it conducted an investigation into a single third party in 2008, it failed to uncover or remediate the “widespread” misconduct within the company.
- Close on the heels of the SciClone settlement, on February 16, technology company PTC Inc. (“PTC”) and two related Chinese entities paid a total of $28 million pursuant to a non-prosecution agreement (“NPA”) with the DOJ2 and an administrative order by the SEC3 to resolve charges relating to the provision of sightseeing and tourist activities, and improper gifts and entertainment, to Chinese government officials with which the company was seeking business. Third parties, referred to as “business partners,” allegedly organized and helped conceal the leisure travel. Though leisure travel and excessive gifts were forbidden by PTC’s compliance policies, PTC’s three separate investigations into allegations relating to PTC’s business partners did not reveal the full scope of its improper activities.
The facts of these settlements are in many ways unremarkable: companies operating in China have struggled for years with rogue third parties and their own employees providing excessive gifts, entertainment and other benefits. The SciClone and PTC settlements show, however, that even companies that have put in place FCPA policies and procedures are not immune from compliance challenges and regulatory scrutiny. Rather, companies must do more than rely on generic FCPA policies and procedures, and basic due diligence efforts to prevent and detect violations. Specifically:
- Policies Alone Are Not Enough – PTC had a gifts and entertainment policy that imposed monetary limits, documentation, and approval requirements. Despite this policy, between 2009 and 2011, according to the SEC, PTC-China sales staff provided at least $274,313 in improper gifts and entertainment. SciClone also appears to have had a gifts and entertainment policy in place. Neither company, however, had an independent compliance or audit function that routinely monitored compliance with these policies. Without vigorous enforcement of their policies, employees routinely violated them.
- Supervision of Third Parties Goes Beyond Due Diligence – Third parties played a major role in the corrupt activities alleged against both PTC and SciClone. Though it appears that both companies conducted at least some due diligence on the government affairs consultants and travel agencies involved in the conduct, they failed to supervise the activities of these third parties in any meaningful way. According to the SEC’s Order, SciClone did not require its third parties to provide documentation of educational events to ensure they had an appropriate business purpose or that the events actually occurred. Similarly, PTC’s third parties were able to conceal payments for leisure travel as payments for legitimate services because PTC did not independently verify that such services actually had been provided. Companies operating in China long have been on notice of the risks posed by third parties such as travel agents. Beyond basic due diligence, companies must continue to supervise and monitor these agents vigilantly.
- Feeble Investigations Hamper Compliance Efforts – According to settlement documents, both PTC and SciClone conducted investigations relating to gifts, entertainment and the use of third parties in their Chinese operations. These investigations failed to uncover the full scope of misconduct at both companies, and it appears that the illicit schemes continued even after the investigations.
- Compliance Culture Is Crucial – At both companies, numerous employees appear to have been aware of the misconduct. According to the SEC’s Order, providing improper benefits to doctors was “known and encouraged” by managers at SciClone. At PTC, employees in both the U.S. and China were aware that Chinese officials were spending additional days in the U.S. for tourist activities. Without a strong compliance department or a culture of compliance within each company, misconduct was allowed to continue unchecked.
SciClone’s alleged misconduct—which the company neither admits nor denies—is detailed in the SEC’s Cease-and-Desist Order.4 The Order states that the alleged wrongdoing was perpetrated in China by employees and managers at a Hong Kong affiliate of SciClone Pharmaceuticals International Ltd. (“SPIL”), a wholly-owned Cayman Islands subsidiary of SciClone. Specific corrupt activities alleged in the Order include luxury travel and entertainment with little or no educational or other business purpose, lavish gifts and meals, and widespread falsified expense reports supported by fake fapiao (a type of Chinese tax receipt) that allegedly masked potentially fictitious events, doctored honoraria agreements, and duplicative meetings.
According to the Order, the company’s misconduct was widespread and overt. Sales representatives openly referred in their reports to gifts, trips and other benefits aimed at increasing prescriptions. On multiple occasions, the company sponsored a number of high-prescribing doctors (referred to by company employees as “VIP clients”) and hospital officials to attend the annual Qingdao Beer Festival. While there, participants enjoyed “golf in the morning and beer-drinking in the evening.” On another occasion, a regulatory affairs specialist hired by the company arranged for two Chinese officials to travel to Greece, purportedly to attend a conference solely devoted to a new medical device over which the officials had licensing approval authority. When the officials were unable to obtain travel documents in time for the trip, the specialist changed tactics—and instead provided the officials with at least $8,600 in gifts. These expenses were reimbursed to the specialist in two payments, one of which was approved by the senior vice president of SPIL.
Indeed, the knowledge and participation of company managers and executives regarding alleged corrupt activities is a recurring theme in the SEC’s Order. One sales manager is quoted as characterizing the use of gifts, expensive meals, vacations, and entertainment as “luring [doctors] with the promise of profit,” while reports detailing improper activities were allegedly provided to senior management of SPIL and even encouraged by certain managers. Also, in March 2010 SPIL held its annual sales meeting on the island of Hainan, a “resort destination,”5 with senior management from SPIL in attendance. According to the Order, VIP clients were hosted on the island over the weekend preceding the sales meeting without any educational component to their stay.6
Another significant aspect of SciClone’s alleged misconduct was the frequent use of third parties, including the regulatory affairs specialist noted above as well as the “routine hiring” of local Chinese travel agencies. The use of such companies—who often are accused of providing luxury travel and other improper benefits disguised as legitimate conferences, seminars, and other events—has become a staple of recent China-related corruption allegations. Here, SciClone’s travel vendors were alleged to have arranged sightseeing trips to the Grand Canyon and Disneyland in the United States and to Mount Fuji in Japan. While these trips appear to have been devoted at least in part to educational purposes, the Order characterizes the educational component as “minimal in comparison to the sightseeing or recreational activities.” According to the SEC, SciClone’s due diligence on these travel agents was insufficient, and there was a lack of control over the events they helped to organize.
SciClone’s resolution of the SEC’s charges includes disgorgement of $9,426,000, prejudgment interest of $900,000, and a civil monetary penalty of $2,500,000. In addition, the settlement includes an undertaking to provide the SEC with periodic reports at no less than nine-month intervals over the course of a three-year term. These reports are to detail the status of the company’s remediation and compliance enhancements, as well as disclose any credible evidence of additional questionable or corrupt payments. According to SciClone’s press release regarding the SEC settlement, the DOJ also completed its related investigation and declined to pursue any action.7
PTC’s misconduct is described in detail in an SEC Cease-and-Desist Order8 and in the Statement of Facts accompanying PTC’s NPA.9 According to the SEC’s Order, between 2006 and 2011, PTC improperly provided leisure travel, gifts and hospitality to its customers, Chinese government officials employed by state-owned entities (“SOEs”) controlled by the government of China. The SEC alleged that many of these improper payments were funneled through local Chinese companies, referred to by PTC as “business partners.” PTC, which designs, manufactures and sells computer aided design and product lifecycle management software, engaged these business partners as part of its efforts to pursue contracts with Chinese SOE customers.10 The business partners who had “long standing relationships” with Chinese government officials, assisted PTC in identifying potential customers at SOEs, facilitated the sales process, and provided additional services outsourced by PTC. Despite the high-risk nature of the business partners’ services, the SEC alleged that PTC did not perform anti-corruption due diligence on the companies. According to the NPA, PTC sales staff also had broad discretion in setting fees with the business partners, including commissions or “influence fees” paid to the business partners when they successfully aided PTC in obtaining contracts.
The SEC alleged that during contract negotiations, Chinese government officials frequently would ask PTC to provide them with travel to the U.S. PTC China sales staff agreed to provide the trips, ostensibly for demonstrations of PTC’s products at PTC’s Massachusetts headquarters, but “primarily for recreational travel to other parts of the United States.” PTC China, a business partner and the Chinese official would agree to a travel budget and incorporate the travel budget into the contract price or into the business partner’s commission. These travel costs were not disclosed in the final contracts signed by PTC and the SOEs. PTC China and its business partners also generated fake invoices and took other steps to avoid detection of the travel costs by PTC.
PTC allegedly provided leisure travel in connection with site visits to international destinations including New York, Las Vegas, Los Angeles, and Honolulu. Numerous sightseeing excursions are referenced in the NPA and in the SEC’s Order, including tours of landmarks, golf outings, and visits to outlet malls. According to the NPA, in total, PTC paid over $1.1 million for 24 recreational trips for over 100 Chinese government officials.
In addition to funding leisure travel, PTC also allegedly provided approximately $275,000 in inappropriate gifts and excessive entertainment to Chinese officials. According to the SEC’s Order, gifts provided by PTC ranged in value from $50 - $600 and included personal electronics, gift cards, wine and clothing. These gifts contravened applicable limits and approval requirements imposed by PTC’s compliance policies.
The SEC also alleged that PTC’s compliance policies and internal controls were inadequate. PTC allegedly undertook three separate investigations of potential compliance issues in China, including investigations into possible corruption involving its business partners, but failed to identify and stop the problematic practices. PTC also did not have strong risk-based local policies and procedures relating to gifts and entertainment. For example, PTC’s Code of Ethics and Anti-Bribery stated that employees should use “good taste” and consider “customary business standards in the community” when providing business entertainment.
PTC agreed to pay $11.858 million in disgorgement, $1.764 million in prejudgment interest, and $14.54 million in criminal penalties in connection with the settlement. According to the NPA, PTC received partial credit for its cooperation with the DOJ’s investigation, but significantly did not receive full voluntary disclosure credit because it did not fully disclose the extent of the company’s problems. According to the NPA, PTC received partial cooperation credit of “15% off the bottom of the Sentencing Guidelines fine range for their cooperation with the Office’s investigation.” At the time of PTC’s initial disclosure in 2011, PTC “did not voluntarily disclose salient facts known to PTC Inc.” Only after the DOJ independently discovered additional facts and brought them to PTC’s attention did PTC make a full disclosure. PTC also received settlement credit for the “extensive remedial measures” including enhancements to PTC’s compliance program that it put in place following discovery of the misconduct.
The similarities between the fact patterns in both cases are striking and instructive. These matters illustrate the continuing challenges faced by U.S. companies that attempt to comply with the FCPA while doing business in China, and highlight regulators’ continued focus on corruption in China. In both cases, the government found FCPA violations based only on gifts, travel and entertainment. Companies should study the conduct cited by the SEC and reevaluate their current gifts, travel and entertainment policies against the problematic conduct in these two cases. In addition to formal policies, companies also should ensure that they have robust oversight, analysis and auditing of risk areas like travel and entertainment. Moreover, companies should ensure that their compliance departments are adequately training employees on anti-corruption policies and taking steps to assess whether corporate policies are being followed.
Both cases also involved the use of well-connected third parties to arrange leisure travel for government officials. Little due diligence was performed on these high-risk government affairs and travel vendors, posing risks that have been underscored in other recent China-related FCPA matters. If they have not already done so, companies operating in China should conduct a careful evaluation of travel agents and other high-risk vendors, including robust due diligence procedures and careful monitoring and oversight of expenses.
Finally, it is notable that both SciClone and PTC stumbled out of the blocks with respect to their bribery investigations. Regarding SciClone, a 2008 internal investigation into the activities of its regulatory affairs specialist appears to have been extremely narrow in scope and did nothing to address far more widespread misconduct allegedly underway during this time period. And as described in PTC’s NPA, the company initially failed to convey the full extent of the company’s problems, making a full disclosure only after the DOJ independently discovered additional facts. While these missteps may have contributed to relatively higher settlement amounts agreed with the SEC, their impact on the DOJ’s action (or, in the case of SciClone, the lack thereof) is less clear.
As the SciClone and PTC settlements make clear, FCPA controls that are not vigilantly monitored and vigorously enforced will do little to protect companies from regulatory oversight. If policies and procedures are no more than words on paper, they are toothless paper tigers.
1 SciClone Pharmaceuticals, Inc., Exchange Act Release No. 77058 (Feb. 4, 2016), https://www.sec.gov/litigation/admin/2016/34-77058.pdf.
2 Non-Prosecution Agreement, Parametric Technology (Shanghai) Software Co. Ltd. and Parametric Technology (Hong Kong) Limited (Feb. 16, 2016), http://www.justice.gov/opa/file/824911/download.
3 PTC Inc., Exchange Act Release No. 77145 (Feb. 16, 2016), https://www.sec.gov/litigation/admin/2016/34-77145.pdf.
4 SciClone Pharmaceuticals, Inc., Exchange Act Release No. 77058 (Feb. 4, 2016), https://www.sec.gov/litigation/admin/2016/34-77058.pdf.
5 The Order does not specify where on Hainan the alleged meeting was held. Hainan is a large island province off the southern coast of China with a population of approximately 9 million.
6 With respect to managers, it also is notable that the SEC Order specifies that SciClone’s remedial efforts included disciplining employees who violated the company’s policies, as well as their managers.
7 SciClone Form 8-K, “SciClone Announces Final Resolution with the Securities and Exchange Commission and the Department of Justice” (Feb. 4, 2016), http://files.shareholder.com/downloads/SCLN/1553297383x0xS880771-16-129/880771/filing.pdf.
8 PTC Inc., Exchange Act Release No. 77145 (Feb. 16, 2016), https://www.sec.gov/litigation/admin/2016/34-77145.pdf.
9 Non-Prosecution Agreement, Parametric Technology (Shanghai) Software Co. Ltd. and Parametric Technology (Hong Kong) Limited (Feb. 16, 2016), http://www.justice.gov/opa/file/824911/download.