China: Conducting Compliance Investigations In China: A New Regulatory Environment

Last Updated: 24 August 2015
Article by Todd Liao and Michelle J. Shapiro

Introduction

Peter Humphrey and his wife were indicted by a Shanghai court on August 8, 2014 for illegally obtaining and selling private information of Chinese citizens. The private information included residential addresses, family member information, car ownership records and real estate records. The couple operated ChinaWhys Co. Ltd., a private investigation firm that offered investigatory services to corporations and law firms doing business in the People's Republic of China (the "PRC" or "China").

At the time of their arrest, the couple were investigating Chinese citizens on behalf of GlaxoSmithKline ("GSK"), the UK pharmaceutical company. The arrest came days after Chinese authorities publicly leveled bribery allegations against GSK, which hired investigators to determine the identity of the person(s) that disclosed the bribery scandal to Chinese authorities and GSK executives. This arrest is indicative of a shift in China's regulatory landscape toward tightened privacy compliance regulations and proactive enforcement of data privacy violations with respect to Chinese citizens.

The following article highlights certain lessons that can be learned from the Humphrey case and provides practical advice for navigating the risks associated with internal investigations in China.

Lessons from Humphrey's indictment

Humphrey and his wife were arrested and prosecuted pursuant to Article 253 of China's Amendments to Criminal Law (VII) ("Article 253") which bans "stealing or illegally obtaining, by any means, personal information". Although Humphrey and his wife are the first foreign nationals to be arrested by Chinese authorities for trading in "illegal personal information," at least 126 people have been arrested in Shanghai for similar violations over the past five years.

In China, personal information is protected under various laws, including the constitution, and civil and criminal laws. While an overarching personal data protection law has been in the drafting phase since 2003, it is unclear when the law will be enacted. Prior to the changes to Article 253, the scattered data privacy provisions protected a citizen's right to a general freedom of communication, security and privacy, but did not cover basic personal information. Article 253 helps fill the regulatory void in respect of the protection of basic personal information. In addition, Article 253 provides Chinese courts with an effective tool to scrutinize due diligence and investigation practices conducted in China insofar as such processes involve the collection of "personal information".

Prior to Humphrey's indictment, the "standard practice" for conducting an investigation in China involved outsourcing the due diligence investigation to professional due diligence firms, such as Humphrey's. As a result of the changing laws regarding personal data protection, there will now be more scrutiny on how information regarding Chinese individuals and companies is obtained. Humphrey's case highlights the risks of holding or relaying personal information of Chinese citizens and demonstrates that companies obtaining such information without proper authorization may face legal penalties, including criminal prosecution. In light of Humphrey's indictment and China's changing regulatory landscape, multinational corporations ("MNCs") that depend on due diligence checks to avoid running afoul of corruption legislation (such as the US Foreign Corrupt Practices Act (the "Act")) may need to alter investigative techniques to comply with PRC law.

Conducting investigations in China

Pitfalls and roadblocks in data collection

As noted above, PRC regulations on personal data protection are scattered and complicated, which may pose pitfalls for investigators and anti-corruption professionals that are unfamiliar with PRC law. For example, the existing laws do not have a unified definition of "personal information" in the non-internet context. The absence of clear guidance on what constitutes personal information or other key subject matter creates a layer of uncertainty for an MNCs' investigation efforts in China. Humphrey and his wife's case exemplifies this risk, as both admitted they were unaware of the newly enacted laws regulating their industry.

In addition to knowledge of data privacy law, familiarity with local practices and national policies issued by the government is an important component of MNCs' investigations in China. Before January 2013, due diligence firms were able to freely retrieve corporate records from the Administration of Industry and Commerce (the "AIC"), which is the governmental authority that keeps financial and ownership information on all companies in China. The Chinese government recently restricted access to this information after several media and investment informational companies published sensitive information regarding the fraudulent schemes of Chinese companies and political figures. This restriction has severely impaired the ability for MNCs to conduct comprehensive due diligence on the ownership interests of potential joint-venture partners, merger and acquisition targets, vendors, state-owned entities, foreign officials and politically exposed persons.

In light of the changing regulatory landscape and compliance roadblocks described above, it is imperative that investigation firms possess a comprehensive understanding of PRC data privacy laws, properly define the scope of investigation and obtain meaningful investigative materials through legitimate means.

Workplace data seizure

As a part of an internal investigation, MNCs will typically review data that is saved on the company's computers or servers, as well as hard copy documentation. In the course of such review, MNCs may gain access to the personal information of employees or third parties. In the context of China's strengthening data privacy regime, MNCs should be prudent in dealing with personal data.

PRC law specifies that employers must keep the personal data of all employees confidential and prohibits the disclosure of personal data of any employee.1 PRC laws do not provide clear guidance as to how this regulation should be implemented. Therefore, it is advisable for the company to establish its own rules regarding the protection of employee information. For example, the employer may require that all employment contracts and employee manuals include a clause that computers issued to employees may only be used for work-related matters and must not contain any personal information. The employment documents may further provide that the employer (or its overseas parent) may access the computers, emails and other work-related documents of employees and use any information located thereon. An employment contract and employee manual containing the foregoing provisions could be used as evidence of the employee's prior consent to the employer's use of personal information.

In an internal investigation, it is recommended that the employer ask the employee to identify whether his/her computer and documents contain personal information. If no personal information is identified by the employee, it may be argued that the employee cannot make privacy claims for information used by the employer. If, on the other hand, personal information is identified by the employee, and the employee's consent to the employer's use of personal information has not been obtained, such information can be excluded from the investigation.

Although the aforementioned advice may help avoid a violation of China's privacy laws, it is still advisable to delete all ID numbers and bank information collected during an investigation. If the employer wishes to provide personal information to third parties (e.g. the overseas parent company or governmental agencies), prior consent of the employee should be obtained. In any event, disclosure of employee personal information by the employer to the public must be avoided.

Document review and protected information

When the investigation reaches the document review phase, it is necessary to ensure that all documents are kept in China, and all electronic data rooms are hosted in China. In an investigation into alleged violations of the US Foreign Corrupt Practices Act ("FCPA"), before documents required by the US government or third parties are transmitted outside of China, the MNC should consider whether the information sought is protected by PRC law. State secrets, trade secrets and bank secrets are common forms of protected information. The MNC also needs to demonstrate it has undertaken measures to prevent disclosure of the protected information.

  • State secrets - PRC law prohibits a company or individual from disclosing information considered to be a state secret. PRC authorities take an expansive view of information that may be deemed a state secret; even information relating to the internal policies and procedures of a State Owned Entity ("SOE") may be considered state secrets under PRC law. The China subsidiaries of MNCs in possession of potentially sensitive information (e.g. communications or agreements with SOEs and parties in sensitive industries such as telecommunications, banking, information technology, energy and natural resources) may want to consult with its legal counsel in advance to determine if any of the information could be designated a state secret. This may reduce exposure to adverse consequences for unlawful disclosure and strengthen an objection to disclosure in US proceedings.
  • Trade secrets - It is typical in an FCPA investigation conducted by the US government for the US government to request internal company emails, documents and information containing confidential and proprietary company information. Before producing such information, China subsidiaries of MNCs should consider whether it includes trade secrets owned by it or a third party. If owned by a third party, disclosure of trade secrets may be prohibited by PRC law. If owned by the China subsidiaries of MNCs, an objection to disclosure may also be raised based on attorney-client privilege. The information may still be discoverable if the requesting party can show the information is not privileged, is relevant and necessary to the litigation, and may not be obtained by other means. In this case, the China subsidiaries of MNCs may ask the Chinese court to issue a protective order to prohibit public disclosure and use of the information for any purpose other than the litigation.

Interplay between PRC Anti-Bribery Law and the FCPA

PRC law criminalizes the act of "giving money or property to any employee of a company or enterprise or other entity...for the purpose of seeking illegitimate benefits."2 If the amount is "relatively large," violators "shall be sentenced to fixed-term imprisonment of not more than three years or penal labor. If the amount involved is excessive, violators "shall be sentenced to fixed-term imprisonment of not less than three years but not more than 10 years, and shall, in addition, be fined." Moreover, if an entity commits such a crime, it will be fined, and the persons who are directly in charge and responsible for the crime will be punished accordingly.

The PRC criminal law applies to all PRC citizens, wherever located, all natural persons of any nationality within China, and all companies, enterprises, and institutions organized under PRC law (including PRC domestic companies and Sino-foreign joint ventures, wholly owned foreign entities and representative offices). Thus, a subsidiary of an MNC could be prosecuted for paying bribes to any employees of any companies or entities, regardless state-owned or private organizations; or to either PRC or non-PRC government officials.

When investigating a possible bribery scheme in China, it is necessary to consider the interplay between the elements of China's commercial bribery laws and the FCPA. Violations of anti-corruption provisions of PRC criminal law can in many instances also be violations of the FCPA, and vice versa. China's increasing aggressiveness in enforcing its laws against commercial bribery in cases involving the Chinese operation of US-based MNCs will likely lead to an increase in the number of FCPA enforcement actions against those same MNCs. PRC enforcement actions are often highly publicized to create a deterrent effect in China and to signal the Communist Party's lack of tolerance for commercial corruption; however, the public dissemination of information may also alert the US Department of Justice and/or Securities and Exchange Commission, which may then initiate their own investigations.

Compliance considerations for the Chinese healthcare industry

To ensure compliance with the FCPA, medical companies operating in China should make certain that physicians, hospital administrators, researchers and other professionals do not receive any form of kickbacks. This is because the Chinese healthcare sector has historically been dominated by public institutions such as public hospitals/clinics, public universities, government funded research institutions, testing labs and pharmacies. As such, interacting with healthcare professionals employed by these institutions can create an FCPA risk for MNCs that are not properly educated.

In addition to compliance with the FCPA, healthcare companies should ensure that their business practices are in line with PRC law. China has adopted several measures to combat corruption with respect to drug manufacturers, drug trading enterprises and medical care centers. As such, internal investigations conducted by healthcare companies should cover commercial bribery relating to the purchase and sale of drugs and medical equipment and the offering of property or other benefits to personnel or staff of medical care entities in exchange for sales or to influence doctors' medical prescriptions.

Conducting an independent check on identified issues and third party business counterparties through public information sources is an important aspect of the due diligence process. Although China's public information search system is not robust, informational releases from relevant PRC government agencies, such as the National Bureau of Corruption Prevention, can be valuable resources. Lists of convicted bribers are available for public review at most provincial-level bodies. The municipal health bureaus also compile blacklists of companies caught violating the anti-bribery laws, which can serve as a good resource for MNCs' due diligence on potential business partners. If public information is unavailable, employing a private investigator may be a last resort, but should be closely supervised by legal counsel given the current regulatory climate in China.

Disciplinary actions against local employees

MNCs operating in China should have a strategy and procedure for investigating and addressing potential bribery involving its employees.

Under PRC law3, an employer may take disciplinary action against, or terminate an employee, if the employee violates the company's internal policies, provided that such policies (i) do not violate PRC laws, (ii) were adopted by the employer through consultation with the relevant trade union or employee representative(s), and (iii) have been made available to the employee in advance. As such, it is good practice for MNCs to specify in their internal policy and compliance training materials the possible disciplinary actions that may be taken against employees for violating company policies relating to the FCPA and other applicable anti-corruption laws. Additionally, the potential for disciplinary action should be emphasized when the MNC conducts anti-corruption training sessions, so that employees cannot claim that they are unaware of such policies. In the event that disciplinary actions need to be taken against employees, caution will be required to ensure that the investigation is properly conducted and documented in a manner that minimizes disruptions to the workplace.

Conclusion

Although China's regulatory environment has been changing over the past few years, the indictment of Humphrey and his wife highlights the government's intent to enforce privacy laws and the corresponding need for MNCs to proactively take measures to bring their internal investigations into alignment with these laws. In order to do so, MNCs would be well advised to retain legal counsel with a working understanding of these laws, Chinese culture and business practices. By ensuring that investigations are conducted in compliance with China's privacy and other applicable laws, MNCs can continue to conduct due diligence necessary for them to adhere to foreign and local anti-corruption laws.

Footnotes

1 See The Regulation on Employment Service and Employment Management, effective January 1, 2008.

2 See Article 164 of the PRC Criminal Law.

3 See Article 39 of PRC Employment Contract Law and Article 19 of Interpretations of Supreme People's Court on Several Issues Relating to Laws Applicable for Trial of Labour Dispute Cases.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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