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Common in China, Kickbacks Create Trouble for U.S. Companies at Home

By Peter S. Goodman
Washington Post Foreign Service
Monday, August 22, 2005

SHANGHAI -- For multinational companies grappling with stagnant sales, China has become a magnet for investment and a huge potential market beckoning with growth. Yet the lure of China profits combined with pervasive local corruption is tempting foreign companies and managers and bringing them into conflict with U.S. anti-bribery laws.

In interviews, China-based executives, sales agents and distributors for nine U.S. multinational companies acknowledged that their firms routinely win sales by paying what could be considered bribes or kickbacks -- often in the form of extravagant entertainment and travel expenses -- to purchasing agents at government offices and state-owned businesses.

The sources, who spoke on condition of anonymity for fear of jeopardizing their businesses, said such payments are usually funneled through distribution companies or public-relations firms to minimize the chance of prosecution by the Justice Department and the Securities and Exchange Commission, which enforce the U.S. Foreign Corrupt Practices Act.

"It's normal industry practice," said a salesperson at a unit of a major U.S.-based technology company with a substantial retail presence in China.

American business leaders often describe their China operations idealistically, suggesting that their presence here will compel Chinese competitors to adopt more ethical business practices. But in one key regard, the dynamic operates in reverse, with U.S. companies adopting Chinese-style tactics to secure sales, as they compete in a market in which Communist Party officials routinely control businesses, and purchasing agents consider kickbacks part of their salary.

Managers of U.S. companies say they are caught in a dilemma: They are answerable to shareholders on Wall Street and home offices that demand a piece of an increasingly lucrative Chinese market. Yet they are also held to account at home by the Department of Justice and the SEC.

"It's a different market, and you can face unrealistic expectations," said Kathryn L. Buer, who said she was fired last year as head of Asia-Pacific operations for Datastream Systems Inc. after she unearthed problems with how the South Carolina software company had been booking sales in China.

Buer recently settled a whistleblower lawsuit she filed against Datastream following her termination. Last month, the Nasdaq stock market delisted Datastream shares after the company failed to file earnings reports on time.

Zhu Jianhua, Datastream's interim China manager from May to July of 2004, said the company had booked revenue after signing contracts without actually delivering goods. Sales agents also used liberal entertainment funds to win business. In one instance, he said, his staff had arranged to fly a buyer to the United States for training, tacking on a tour of New York. "I stopped it," he said. "That's not right."

Datastream President C. Alex Estevez said he would not comment on personnel matters. "Datastream has a strong interest in developing business throughout Asia and the Pacific Rim, including China," Estevez said. "In doing so, we intend to use proper and legal means."

Fueling the aggressive play is the growing recognition that China -- long a graveyard for the dreams of foreign investors -- is finally yielding profit.

"Companies are seeing some of their fastest growth in China, and it's profitable growth," said Kristin J. Forbes, a former member of the White House Council of Economic Advisers and now a professor at MIT's Sloan School of Management.

Writing last year in the China Economic Quarterly, journalist Joe Studwell called 2003 "the best year in at least a century for making money in China." Studwell, author of "The China Dream" and an articulate skeptic of business prospects in China, crunched data filed by mainland China and Hong Kong affiliates of U.S. publicly traded companies, concluding that their China earnings rose from $1.9 billion in 1999 to $4.4 billion in 2003.

But just as the late-1990s technology bubble in the United States fostered a free-money and rule-bending mentality, a series of corruption cases involving U.S.-based multinationals underscores the pressures managers face to make good on the Chinese bonanza.

In December, the Justice Department announced that InVision Technologies, a California-based manufacturer of airport security screening systems, had agreed to pay an $800,000 penalty as part of a settlement after admitting that its distributors in China, Thailand and the Philippines had bribed government officials to gain sales.

In a separate settlement with the SEC filed in February, InVision -- since acquired by General Electric Co. -- paid a $500,000 penalty and surrendered $589,000 in profits. According to the SEC settlement document, in April 2004 InVision paid $95,000 to a Chinese distributor even though it knew of a "high probability" that the agent would use some of this money to pay for foreign travel for government officials to complete the sale of some $2.8 million in security equipment for a state-controlled airport in the southern city of Guangzhou.

In May, the SEC resolved a case against Diagnostic Products Corp., a Los Angeles-based medical equipment firm, with the firm surrendering $2 million in profits. The SEC charged that between 1991 and 2002 the company's Chinese subsidiary, DePu Biotechnological & Medical Products Inc., handed out $1.6 million in bribes to doctors and other workers at state-owned Chinese hospitals to generate business.

The payouts "were made with the knowledge and approval of senior officers of DePu," the SEC said in a notice of enforcement proceedings. DePu's office in Tianjin did not respond to calls.

In March, Chinese media reported that the head of state-owned China Construction Bank, Zhang Enzhao, had been detained on corruption charges. He remains under investigation and house arrest.

A lawsuit filed in Monterey County, Calif., alleges that Zhang and his associates took $1 million in bribes disguised as consulting fees from a U.S.-software company, Alltel Information Services, while also accepting a golf outing to Pebble Beach. In exchange, Alltel Information Services, then a division of Alltel Corp., walked away with contracts worth $176 million from the bank, the lawsuit claims. The suit was filed by Grace & Digital Information Technology Co. Ltd., a Chinese company that asserts its own contract for the bank's software business was breached because of the bribes.

In a reply filed in federal court in San Jose, Jim N. Wilson, former executive with Alltel Information Services -- since purchased by Fidelity National Financial Inc. and renamed Fidelity Information Systems -- dismissed the allegations of bribery as "completely false." In an SEC filing on Aug. 9, Alltel Corp. said the SEC had opened an informal inquiry into the matter. Alltel did not respond to requests for comment about the SEC probe.

Last year, Lucent Technologies Inc., the giant telecommunications firm, sacked its China president and chief operating officer along with a marketing executive and finance officer after what the company described as "internal control deficiencies" that could violate the Foreign Corrupt Practices Act.

Chinese media reported that the executives were found by internal auditors to have bribed officials at state-owned telecommunications companies. Lucent declined to furnish details, asserting that it is cooperating with federal investigators.

The sources at U.S. companies and Chinese distribution firms said the Lucent case was hardly unusual. Most companies that engage in such practices limit their exposure to prosecution by cutting intermediary firms into their sales, leaving it to distributors to close the deal, the sources said.

But using middlemen as conduits for payments does not insulate U.S. and U.S.-listed companies against American anti-corruption statutes, said Patrick M. Norton, managing partner of the Beijing office of the law firm O'Melveny & Myers LLP.

The Foreign Corrupt Practices Act's anti-bribery provisions, which carry criminal penalties of up to five years in prison for individuals and fines reaching $2 million for companies, specifies that "U.S. persons" are forbidden from paying or offering to pay "anything of value" to a "foreign official" with a "corrupt purpose" of gaining business. Norton said the Justice Department has been interpreting the statute to include bribes paid by foreign companies and agents on behalf of U.S. companies.

"Willful ignorance is not a defense," Norton wrote in the journal China Law & Practice last year. "U.S. businesses in China are responsible under the FCPA for ensuring that their agents do not do indirectly what the U.S. businesses are prohibited from doing directly."

Nevertheless, such behavior appears common. "What happened at Lucent is happening at all the big tech companies," said a senior manager at a distribution company that sells products for Hewlett-Packard Co. He said H-P cuts his company in as a means of lubricating deals without handling the money directly.

"This happens 90 percent of the time on H-P's Unix business," the distributor said. "The bosses at H-P know the situation."

In a written statement, H-P said it uses distribution companies "to effectively expand coverage" across China, adding that the company operates "in a legal and ethical manner around the world."

"We are unaware of any specific examples of inappropriate behavior by our partners at this time," the statement continued. "Should proof be provided to the contrary we will clarify and pursue the matter, and follow up with appropriate action."

Most kickbacks are handled as rebates that land in a communal fund inside the government agency or company responsible for the purchase, to avoid making individuals vulnerable to corruption charges, sources said.

"The fund is for the department's use," said a former executive for a major U.S. technology company. "It pays for vacations to Las Vegas and Hong Kong, visits to hostess bars, gifts for spouses. Everybody knows about this."

Staff Researcher Richard Drezen in New York and Special Correspondents Eva Woo and Jason Cai in Shanghai contributed to this report.

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