risk management in the prc - the international law firm of

Risk Management in the PRCBrinton M. ScottWinston & StrawnShanghai Representative Office

07 March 2013

© 2013 Winston & Strawn LLP

© 2013 Winston & Strawn LLP

An international law firm

© 2013 Winston & Strawn LLP

Looking Through the Fog

There is an ancient Chineseproverb 雾里看花 (to look atflowers in the fog), i.e., to seesomething that appears to bebeautiful in the fog, but, whichturns out differently in the lightof day)

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Is such risk unique to China?

Much of following applies across Asia and, indeed, many other parts of theworld

• Size matters – problems in China reverberate globally• Supply chains – increasingly complex• SOEs – when are you dealing with government ?

(Answer: more than you know)• State – it can be very EFFECTIVE when it needs to be

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This is a GLOBAL problem

What is FRAUD ?

“A knowing misrepresentation ofthe truth or concealment of amaterial fact to induce another toact to his or her determent.”Black’s Law Dictionary:

Source: An Inside Look at Bernie Madoff's Life in Prison -- New York Magazinenymag.com

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Emerging Asia is High Risk

• Supply chain rife with family and friends• Conflict of interest not well understood• Compliance – of all kinds – lacking• Corruption at many levels of society• Lower to middle managers 'on the take'• Political connections paramount• Recruitment/tendering process tainted • Collusion with partners and/or suppliers • Evolving legal environment• Multiple sets of accounts• Cash is king• Counterfeit documents• 'Agents' commonly used B Ramalinga Raju, former chairman of

Indian outsourcing giant Satyam, who isaccused of one of India’s biggest corporatefrauds.

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Kick-backs

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IP Protection & Licensing

Theft of Intellectual Property

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Improving ?

Over 300,000 government officials punished for corruption since 2009 – to name a few…

- Bo Xi Lai – Party Secretary, Chongqing- The head of CIETAC- CEO of Sinopec- Party Secretary of Shanghai- Chief of FDA (executed)- Party Chief, Ministry of Culture- Party Chief, Qingdao City- Mayors of Shenzhen (2)- General Manager, China Natl Nuclear Corp- Exec Director, Guangdong High Court- Vice Chairman China Mobile- Vice Chairman China Development Bank- Chairman Beijing Capital Airport (executed)- Head Economic Crime, Public Security Bureau- Vice President, Supreme Peoples Court- Founder & President of Shenzhen Airlines (2)

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Cause I: Corporate structures

• State-owned enterprises- Poor pay- Opportunities for corruption and embezzlement

• Publicly-listed companies- Often state-owned or family controlled- Accounting irregularities

• Private entities - Lack of transparency - Everything is a family business - Multiple sets of accounts

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Cause II: Macro Environment

1. Limited transparency (financial, ownership, property rights)2. Corporate governance and compliance – a huge 'cultural gap':

- Related party transactions, conflicts of interest, kickbacks, agents, entertainment, tax evasion, "contacts not contracts"

- State owned ("OPM") and Family business 3. Evolving regulatory environment which can be capricious and selective4. Relatively high levels of bureaucracy, corruption, and/or political interference5. Local management 'tribes'6. Entities run as private or political 'piggy banks'7. Political ties / positions used for influence (political – business nexus)8. Unreliable judicial / law enforcement systems

- Civil law doesn't protect; 'white collar crime' not a priority9. Asset monetization - brands, client information10. Vendors…and sub-vendors (vicarious liability)

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Causes—Lax Enforcement

Chinese authorities are often reluctant to address theseissues, as they are usually considered internalcompany control or management issues

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Cause III: it takes two to tango

Behavior of MNCs in the world's fastest growing market leaves them open to malfeasance and fraud….

• Policies & training take back seat to recruitment / rapid growth / profits

• You can't enforce a policy staff are not conversant with !

• Poor internal controls (chops)

• High turnover in foreign managers – managing 'up'

• No screening of staff, vendors, etc.

• Empower junior employees with limited experience and relatively low salaries

Multinationals in China (KPMG 2007)

67% of MNCs in China have no: - Internal audit- Fraud risk assessments- Fraud awareness/anti-fraud training

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Chinese laws are well

developed

(a) Increased "awareness" in

recent years

(b) Civil system

No separation of powers

The crash at Wenzhou. The Rail Ministry had been determined to buildseventy-five hundred miles of high-speed railway more quickly than anyonethought possible.http://www.newyorker.com/reporting/2012/10/22/121022fa_fact_osnos#ixzz2JGf4QW3I

What Can I Do?

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Employees

• Confidentiality, non-solicitation, non-compete, IP and other undertakings

• Searches

(a) Persons and property

(i) The PRC civil law

(ii) The PRC criminal law

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Employees

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(b) Workplace Theft—What to do?

(i) Avoid running afoul of civil or criminal liability by, e.g.:(1) No personal property allowed on the worksite

(2) Check email regularly

(3) Keep your company chops safe

(4) Separate your company and financial chops

(ii) If you suspect an employee, call the PSB and request a search on the spot

(iii) Take civil action where theft is discovered – send a strong message

Employees

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CONTRACTING WITH THIRD PARTIESIssues to consider when contracting in China

(a) With whom are you contracting—Many Chinese entities are State Owned?

(b) FCPA, Bribery Act, & Chinese Anti-Bribery Legislation

(c) Choice of law and venue

(d) Testing, inspection and rejection

(e) Non-compete and confidentiality

Third Parties

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• CONTRACTING WITH THIRD PARTIES

Third Parties

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Points to consider when licensing IPR in China include:(a) Registration?

(i) Trademarks(ii) Patents(iii) Copyright(iv) Trade secrets

(b) Are appropriate quality control and related processes in place to protect your IP?

(c) Do not allow a licensee to register your trademark under any circumstances(d) Litigation(e) Termination(f) Derivative works

IP Licensing and Protection

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US-China Business Council recommendations:(a) "Go on the defense"

(i) Keep a close eye on competitors

(b) And the offense(i) Be prepared to take legal action

(ii) Advocate aggressively

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Bernie Madoff ran a 'family business' that successfully defrauded some of the world's largest banks- Basic conflict as broker/dealer and investment advisor

- Family run …brother was counsel, niece head of compliance

- Audit by a 3 man firm

- Secretive, 'we are special'

- Prior investigations, public warnings over ten years

• Before giving someone your money (partnering, contracting, hiring..) you need to vette their background…even if they

a/ are a member of your club, dialect group, school alumni…b/ has a friend or relative in government, politics or filmsc/ was profiled in a glossy magazine or on CNBC

There are ALWAYS signs …

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Thank you!