A new study published by Control Risks, an international business risk consultancy, echoes a few of my previous posts on corruption and the general findings of many development economists- when the economy falls, corruption rises. The report, “Corruption, Compliance and Change” argues that, instead of overhauling current financial and regulatory models, the global economic crisis may actually reinforce systems that inherently support fraudulent practices while enforcing regulations which have historically resembled a Band-Aid on a broken leg. Control Risks has predicted the following:

• More scams. We can expect further spectacular cases of large-scale fraud and corruption as the crisis continues to unfold. First, the strains of the recession will continue to expose frauds that are sustainable only in expanding markets. Secondly, at a time of financial desperation, companies will be all the more tempted to take greater risks, for example by paying bribes to outmatch their competitors. However, dramatic though they may be, these fraud and corruption cases do not represent fundamental change.
• Tighter regulation. The inevitable consequence both of the scams and of the deeper policy failures that contributed to the crisis has been repeated calls for tighter regulation. However, in the anti-corruption field, these demands reinforce an existing trend rather than creating something new. All the major industrialized states now have laws against foreign bribery that are similar to the US Foreign Corrupt Practices Act (FCPA). The question that really matters is how effectively these laws are enforced.
• Inconsistent and uneven enforcement. The answer, even now, is that the application of anti-corruption laws will remain highly inconsistent. We can expect a continuing trend towards tighter enforcement in the US and, to varying degrees, in other Western countries as well as Japan. In this respect the world is genuinely – albeit gradually – changing. However, partly for political reasons, the pattern of enforcement will remain highly uneven, both among the industrialized countries and still more in developing and transition economies.

Data citing increases in FCPA cases really drives the point home:

In 2007, 38 FCPA matters were initiated by the US Department of Justice (DoJ) and the Securities and Exchange Commission (SEC) followed by 25 in 2008, and show no sign of losing momentum. In late May 2009, Mark Mendelsohn, the deputy chief of the DoJ Fraud Section, reported that as many as 120 companies were currently under investigation on suspicion of FCPA violations, compared with 100 at the end of the previous year.
Source: “Corruption, Compliance and Change” by Control Risks

Overall, this report by Control Risks is an insightful and worthwhile read. I particularly enjoyed the graph detailing the nature of bribery demands in China during 2007-2008, as originally reported in a recent Trace International Bribeline China Report.

Coincidentally, China Briefing just released a new feature article, US Businesses, China and the Foreign Corrupt Practices Act, which provides a fair overview of the FCPA-related challenges Western companies face when entering the Chinese marketplace. I was, however, a bit troubled by their statement that “the benefits of investment in China far outweigh the risks presented by the FCPA, so long as the proper precautions are taken.” They may have been better off conveying that a defense of “I wasn’t aware of the laws” never holds up in court. Given that anti-corruption policy seems to be a very hot topic these days and one close to my heart, I’m going to make a few predictions of my own for the second half of 2009:

• Another high-profile US-China case like Garth Peterson’s will likely come to light over the next six months.
• An excess of 180 US companies will find themselves under investigation on suspicion of FCPA violations.
• It is possible that at least one US-employed China powerbroker and/or rainmaker will find themselves under scrutiny for corruption-related activities.
• An increase in “missing” corrupt officials (like GOME’s Huang Guangyu) is inevitable; so too are further talks on an extradition treaty between the US and China.
• Run of the mill “under the table” activities between foreign business professionals, Chinese partners, and local officials will be prosecuted in much higher numbers as Hu Jintao marches forward with his anti-corruption campaign and, given political tensions, far more attention will be paid to cases involving Western companies in China.

 If you’ve been reading this blog for a while, I’m about to sound like a broken record… Corruption is simply the largest impediment to China’s development. However, it is no longer an issue confined to China’s boundaries, nor one that can be neatly defined and addressed on Western terms. That stated, if you are doing business in China, keep the last prediction close to your own heart and follow the law. I know times are tough, but is ten years in prison and a massive fine really worth expediting paperwork or landing that deal?

Business, Crisis Management, Development, Government, Law China Briefing, Control Risks, corruption, extradition, FCPA, Garth Peterson

This week, Boston-based firm Bain Capital secured a $418 million investment to acquire a minority stake in GOME, China’s second largest electronics retailer. GOME has seen its fair share of global news coverage following the November 2008 arrest of its founder and ex-chairman, Huang Guangyu, over allegations of share-price manipulation linked to drug manufacturer Jintai Group, which was controlled by his elder brother. In the months surrounding police investigation into Huang’s activities, GOME’S share price tanked and speculation of bankruptcy began to circulate. Despite its tarnished reputation, from a profit-sharing perspective Bain Capital’s move to acquire an 18 percent stake in GOME may prove to be a very lucrative one; as reported by Bloomberg.com, shares rose 69 percent in Hong Kong following the announcement of investment by Bain and Merrill Lynch has upgraded the stock to “buy” from “underperform.”

While Bain has structured the GOME deal to protect itself from liquidity concerns with nearly half of its investment reported to be in the form of seven-year convertible bonds, the US private investment firm does not have any management control built into its contract, despite entitlement to three non-executive positions on the board. And, although the deal does possess incredible potential for Bain over the long-term, Huang Guangyu’s corruption legacy will be difficult to extricate from the company’s reputation and among the employees who have remained with GOME. White collar crime in China bears little resemblance to what we’re accustomed to in the West, which is often carried out in secrecy and among a few slick actors involved in the financial services industry. Under China’s traditions of guanxi and “rule of man,” “under the table” practices span all sectors via interwoven business and personal networks as pervasive and shared activities which are too often deemed acceptable by all parties involved.

Given these characteristics, it is difficult to believe that the purge of Huang Guangyu has wiped the slate clean for GOME; Chinese entities that have been linked with corruption have a pretty significant rate of being repeat offenders. While the risks involved in partnering with a company that only months ago found itself under the spotlight of a globally-recognized graft scandal may be miscalculated by a Western-born manager with relatively little experience in the Chinese marketplace, it can be pretty safe to assume that Bain knew exactly what kind of arrangement it was walking into. Jonathan Zhu, Bain’s Managing Director who secured the investment is not just another corporate cowboy trying to lasso a sweet deal in a foreign market. Zhu is actually a Shanghai native who, prior to assuming his position with Bain, served as CEO of Morgan Stanley’s China division- which is also no stranger to corruption scandals. Zhu has an impressive professional history of leading a number of high-profile initial public offerings in China; an online biography cites China Construction Bank, Ping An Insurance, China Shipping Container Lines, China Meng Niu Dairy, China Telecom, China Unicom, Sinopec, China Eastern Airlines, Shanghai Industrial and Beijing Enterprises among them. It is also a fact that the majority of these companies have made headlines for illicit activities, which is unsurprising given the intense crackdown by the CCP in recent years.

Another fact- corruption is endemic in China business and Western-owned firms like Bain need deal makers like Jonathan Zhu to forge successful investments with a comprehensive understanding of the risks involved. As a native-born Chinese with significant experience on both sides of the globe, Zhu has a few highly sought after capabilities that can only come with being born in China, receiving an education at top US institutions (Cornell and Harvard Business School), and simultaneously maintaining identities on both hemispheres. Considering the Huang Guangyu case and the traditions he may have left behind in the offices of GOME, does Bain’s stake come with potential problems down the road? Without a doubt. On the upside, a foreign presence in a Chinese-run company like GOME may lead to better risk management controls overall while encouraging increased accountability among individual employees. With this in mind, the GOME-Bain deal led by Zhu might yield positive returns far beyond the stock market. Of course, there are other possible outcomes. I’m hoping for the former, but we’ll just have to wait and see.

Did Bain make a smart move in securing a minority share in GOME? Is corruption still an issue, now that Huang Guangyu is out of the house? Do American firms which possess Chinese-born deal makers have an advantage in the China market? Have your say in the comments section!

Business, Culture, Development, Government Bain, Business, china, corruption, GOME, Huang Guangyu, Jonathan Zhu