Take great care in choosing partners

Corruption remains a big issue in China and U.S. companies seeking to expand in the region need to be wary of its ramifications, including Foreign Corrupt Practices Act violations, experts say.

Whether it's self-dealing, phantom suppliers, kickbacks, intellectual property theft or inappropriate dealings with governmental officials, crime and corruption are risks companies face when operating in China, they say.

"Corruption is a huge issue. It's systemic," said Donald Forest, a managing director of Sierra Asia Partners, a Washington-based consulting firm that assists companies wanting to invest globally. China has "a relationship-based society and culture...and certain influences are going to be asked for and expected."

Indeed, in western China in particular, "the hand of the state tends to be heavier," making it difficult sometimes "to tell where the state ends and the enterprise begins," which "obviously raises FCPA sensitivities," said Frank Hawke, chairman of greater China for Kroll Inc. in Beijing. He was referring to the 1977 U.S. federal law, which bars bribery of foreign officials, requires companies to maintain records that accurately and fairly represent the company's transactions.

"You really have to be very careful who you're getting in bed with," said Cy Quadland, a New York-based managing director and leader of Marsh Inc.'s private equity, mergers and acquisition practice in Asia. "You're liable to set up a (Chinese) company and find your partner is taking your intellectual property and setting up a company five miles down the road and doing the same thing you are and buying supplies from your own supplier."

Mr. Forest said he has seen "disasters" in which U.S. companies have used Chinese intermediaries to conduct general business negotiations and, unbeknownst to the U.S. company, various payments are being made under the table. "And that's completely outside of what's allowed under the Foreign Corrupt Practices Act," he said.

According to the 2006 corruption perception index by anti-corruption coalition Transparency International, China received a CPI of 3.3; that compares with 9.6 for Finland, which had the lowest level of perceived corruption among the 163 countries surveyed, and 1.8 for Haiti, which had the highest.

"A lot of companies get into trouble in China. You've got to understand that if (U.S. companies) have, and invariably they will have, local Chinese professionals representing them--the company's credo, the company's standard operating procedures, the company's code of conduct, corporate governance, best practices--all of that needs to be ingrained and it needs to be accepted. There has to be constant training and constant reminding" to the local Chinese staff, Mr. Forest said.

"You have hidden liability, and I've seen some horror stories where it all boiled down to corporate governance and not paying attention to the code of conduct," he said.

Mr. Hawke, though, warns that Chinese culture in many respects is "very different" from Western culture. As such, "a U.S. company cannot simply translate its compliance policies and procedures into Chinese and expect them to have the same effect as in the U.S. The entire approach must be tailored to the Chinese environment."

In addition, internal and external audits must be "active and independent," Mr. Hawke recommends. Unfortunately "smart fraudsters know how to manipulate audit trails, so a strong and active security function is also vital," he said.

But China is making progress on corruption, Mr. Forest said.

"I think the Communist party is a lot more attuned to how pervasive it is. They realize that it robs the economy and undermines more legitimate business environment. And that's progress to me," he said.