The Unintended Consequences of Rapid Growth
The excitement over selling goods and services to one of the fastest growing economies in the world can lead western companies to focus exclusively on growth without essential infrastructure and controls in place to manage the risk doing business in China requires. While rapidly establishing a footprint in China may be critical for your business, there are a number of steps you can take to avoid unintended regulatory, criminal and civil exposure, as well as the potential loss of essential IP. In this article I will cover several key areas of potential exposure a company can subject itself to and how to mitigate that risk.
Step 1: Know Your Customer
All too often western businesses are unaware of the sheer magnitude of State Owned and/or Controlled businesses operating within China. Once a business becomes State Owned and/or Controlled, different rules apply to doing business with that entity. In particular, if the company is based in the US, or a US person is making the contact, the Foreign Corrupt Practices Act comes into play, and there can be civil and criminal sanctions for violating the Act. The United Kingdom has its own equivalent, “The UK Bribery Act,” which in many cases is more stringent than the FCPA. In addition, China has its own set of laws for doing business with their government, both nationally and provincially. Finally, there may also be other extraterritorial laws that extend into China and govern business conduct within China that we will not cover here.
The danger of not knowing your customer begins when sales people, third party agents, or other less visible employees (e.g. service technicians, purchasing, etc...) engage with these entities. More often than not, these business are contacted without the representatives of the western companies knowing the entity is state owned or controlled. These businesses are often not advertised as owned or controlled by the Chinese government, and their names do not indicate that they have a governmental connection. Unfortunately, and critically, legal and compliance departments often never have the opportunity to vet these businesses and provide specific guidance to the employees before contact is made.
Sales organizations often move very quickly and have little incentive to ensure their prospects or customers are vetted by compliance and legal professionals. The consequences of running afoul of these laws can result in jail time, civil penalties, unwanted attention from media outlets, as well as loss of reputation and shareholder ire.
The Fix: Establishing a clear, documented process for vetting prospects and customers is absolutely critical to avoiding the unintended consequences of doing business with a State Owned or Controlled business. In addition, aligning incentives for salespeople and third party agents is critical to shaping their behavior in the field and how closely they adhere to the established process. Your company can decide whether to implement a carrot or stick approach to ensuring your employees or third party agents follow the established procedure, but consistency and adherence to the procedure must be a priority.
Step 2: Know Your Vendors
China has an incredible number of goods and services available to provide a growing enterprise with whatever they need, whenever they need it. However, making sure your company understands who owns the entity you’re doing business with, as well as whether there are any connections between your vendors and employees, will be critical to maintaining transparency while avoiding conflicts of interest and potential sanctions or other unintended consequences.
Many western companies simply on board vendors with a simple credit check. Often this responsibility falls to the Finance Department. Unfortunately, the Legal and/or Compliance Departments are unaware of who the company is doing business with at any given time. These vendors are often given physical access to company buildings and in some cases to the company’s computer network to facilitate protected communications.
It is absolutely critical to know whether a vendor has connections to the Chinese government, is partially owned by an employee or an employee’s relative, has been involved in civil or criminal misconduct (e.g. selling to Iran in violation of US sanctions, civil or criminal misconduct, other reputational issues that could harm you company). These issues are far more common than you would think and very easily remedied.
The Fix: Since Finance and Compliance often have responsibility for on boarding and due diligence of vendors, making sure they have put in place an established process for vetting these vendors will minimize the issues companies face in this space. Unfortunately I’ve conducted dozens and dozens of investigation stemming from due diligence failures and the unintended consequences of simple onboarding can make front page news in the Wall Street Journal.
Step 3: Know Your Employees
As companies scale in China, it’s critical to thoroughly vet your employees. The folks coming into your company will be your greatest assets in China as well as your greatest risk. They will also have access to your IP, company secrets, and other information you don’t want walking out your back door. Verifying they are who they say they are, have the required credentials, and whether there is anything in their past that would disqualify them for a particular position (e.g. an accountant with a fraud conviction, etc.) is absolutely necessary. These checks are performed routinely in other countries, but often overlooked by western companies doing business in China.
Step 4: Taking the Next Step in Mitigating Business Risk
Incorporating the first three steps into your finance, compliance and legal programs will substantially reduce your business risks in China. However, if you are able to cross reference the data collected during each of these steps on a continuous basis, you will be able to better track and anticipate issues as they arise, and in some cases, before they even happen. Ideally, this type of analytic review and analysis can be rolled out globally as the more data you are able to incorporate, the more visibility you will have to emerging business risk around the world.
China is an incredible market for western goods and services, as well as one of the most established manufacturing bases in the world. However, the key to doing business in China is to build out a compliance infrastructure that anticipates the issues outlined above, to maintain vigilance, and to never forget that China has its own way of doing business that is very different from the West.