View from China: Shanghai Confidential

Investigations of multinationals suggest it's time to take a close look at internal controls in the People's Republic.
Wu ChenApril 1, 2007

A colorful embezzlement scandal has toppled political and business leaders in Shanghai and elsewhere in China as the country launches a major drive to stop white-collar crime. For CFOs of multinational corporations, the drama has played out at arm’s length. But a highly publicized series of sting operations targeting multinationals in January may cause that comfortable distance to vanish.

Call it “Shanghai Confidential.” The dragnet started last summer, when government investigators disclosed that $474 million had been siphoned from Shanghai’s pension fund for illegal loans and payoffs. The scandal led to the arrest of the former Communist party chief of Shanghai and dozens of prominent businesspeople.

The anticrime sweep is unfolding as the Party debates whether policies encouraging freewheeling capitalism have gone too far, inciting greed and corruption. In the lore of modern China, Shanghai is the hotbed of this type of commerce. Even so, to foreign-company CFOs, this seemed a dustup that involved Chinese companies and politicians exclusively. Despite several China-related cases brought under the Foreign Corrupt Practices Act (FCPA), the Chinese government has been reluctant to scrutinize foreign multinationals for bribery. That changed on January 19, when a government investigative unit detained 22 employees at seven multinationals for taking bribes worth a total of $515,000, all in Shanghai. The companies included McKinsey, ABB, and McDonald’s.

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Risk-management advisers to foreign companies say the sweep was a warning. Steven Vickers, CEO of Hong Kong–based consulting firm International Risk, sees it as a signal that multinationals won’t be exempt from any crackdown. But staying clean won’t be easy. The open secret is that it is extremely difficult to control the illegal payoffs that are common currency of business in the People’s Republic.

Even if U.S. companies strictly comply with the FCPA, it may not be enough. Long-standing (but rarely enforced) Chinese anti-bribery laws establish a lower threshold for amounts considered bribes than the already stringent FCPA. This gives authorities great leeway to charge companies with bribery should they choose to investigate.

Unfortunately, multinationals have been lulled into a false sense of security because bribery is so common. Some, particularly foreign investment banks, have adopted the tactic of putting a former official with powerful guanxi — ties — on the payroll to protect them against shifting political winds. The recent probes targeting such officials show that this is a perilous way to manage risk. Going forward, only tried-and-true methods — employee education, vigorous internal risk assurance audits by independent parties, and whistle-blower mechanisms — will provide adequate cover.

Wu Chen is editorial director of CFO China.