What Are Your Company's New Disclosure Obligations in China? Potential Anti-Corruption Compliance Implications

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1 April 2015 Practice Group: Foreign Corrupt Practices Act/Anti- Corruption What Are Your Company's New Disclosure Obligations in China? Potential Anti-Corruption Compliance Implications By Amy L. Sommers, Cecillia Dai, and Aqua Huang 1 In 2014, China adopted regulations intended to update and streamline company periodic reporting obligations. The regulations include a new obligation for compulsory interim disclosure of penalties imposed by PRC regulators that has implications for companies wider disclosure and compliance regimes. The State Council of the People s Republic of China promulgated the Interim Regulation on the Public Disclosure of Enterprise Information ( 企业信息公示暂行条例 ) (Interim Regulation) in August. The Interim Regulation, together with a series of implementing rules (New Rules) 2 issued by the State Administration for Industry and Commerce (SAIC), the PRC government agency charged with regulating business enterprises, took effect on October 1, Together, they had the effect of reforming the previous laborious annual inspection system by introducing a new set of reporting and disclosure requirements. Aiming to reduce tedious formalities and increase transparency, all the requirements specified in the Interim Regulation, as well as the New Rules, apply to all enterprises incorporated in China, including foreign-invested enterprises (FIEs). This alert explains in detail the what, when, and how of enterprise disclosure, including how to keep off the SAIC blacklists. Enterprises Compulsory Disclosure Obligations Through both annual reports and real-time disclosure, the Interim Regulation requires enterprises to disclose certain enterprise information in the Enterprise Credit and Information Public Disclosure System (Disclosure System), which is a public accessible online system available at What May be Easier? Annual Reporting Under the Interim Regulation, between January 1 - June 30 of each year, enterprises will submit an annual report to the relevant local SAIC counterpart in the locality where the enterprise is registered (collectively AIC). This company- prepared submission replaces the 1 The authors wish to thank United Kingdom anticorruption compliance colleagues Christine Braamskamp and Laura Atherton for their contributions respecting implications of the New Rules for corporate entities subject to jurisdiction in the United Kingdom. 2 The New Rules include the following regulations issued by the SAIC on August 19, 2014: (i) Interim Measures for Random Inspection of Information Published by Enterprises ( 企业公示信息抽查暂行办法 ), (ii) Interim Measures for the Administration of the List of Enterprises with Irregular Operations ( 企业经营异常名录管理暂行办法 ), (iii) Interim Provisions on the Public Disclosure of Information regarding Administrative Sanctions Imposed by the Administration for Industry and Commerce ( 工商行政管理行政处罚信息公示暂行规定 ), (iv) Interim Measures for Annual Reporting by Individual Entrepreneurs ( 个体工商户年度报告暂行办法 ), and (v) Interim Measures for the Publication of the Annual Reports of Special Farmers Cooperatives ( 农民专业合作社年度报告公示暂行办法 ).

2 previous AIC annual inspection regime 3 and presents a new focus on post-registration supervision. Respecting the submitting enterprise, the annual report must contain the following information with respect to the relevant enterprise. 1. Contact information including mailing address, postal/zip code, contact numbers, addresses, etc.; 2. Operational status information: commencement of operations, whether in suspension, in liquidation, etc.; 3. Investment information: investment in establishing other enterprises, acquisition of equity interests in other enterprises; 4. Subscribed capital contributions and paid-in capital contributions by shareholders, capital contribution schedule and method of contribution, and other information in the case of limited liability companies or joint stock companies; 5. Information on changes in equity interests, such as equity transfers in the case of limited liability companies; 6. Online website information or the name of an online store, website address, and other information relating to online operations (if applicable); and 7. Number of employees, total assets, total liabilities, guarantees provided to outside parties, total shareholders' equity, total operating revenue, revenue generated from the enterprise s principal business, gross profit, net profit, and total tax payable. 4 While disclosure of all the information under items 1 6 is mandatory, enterprises are entitled to select whether to disclose the information under the item 7. If an individual or other enterprise would like access to the information about an enterprise described in item 7, they may request the relevant enterprise to disclose such information, and the decision whether to do so is subject to such enterprise s consent. It is worth noting that financial statements are no longer required in order to complete the annual reporting procedure 5, which represents great progress and a reduction in administrative burden as compared with the previous annual inspection system described above. What May be More Challenging? Real-Time Disclosure In addition to the annual regular disclosure, enterprises are also required to disclose or update through the Disclosure System information that may affect their good standing or creditworthiness within 20 days after such information becomes available. Under the Interim Regulation, the AIC is obliged to monitor such real time disclosure and will demand 3 In the past, all enterprises (including FIEs) were required to be annually inspected by AIC. The annual inspection, which sometimes included a physical inspection by AIC personnel at the company s premises, aimed at assessing whether each enterprise was validly established and duly operated in compliance with PRC law. To complete the prior annual inspection process, FIEs had to submit a broad range of materials and documents (including audited financial statements). Preparation of the materials for the annual inspection could be time consuming. After reviewing the complete application documents, AIC would affix inspection chops on the duplicate of an enterprise s business license. A company that failed to pass an annual inspection would be ordered to correct its noncompliance within a specified time. Failure to make corrections could result in penalties that could include revocation of the enterprise s business license. 4 Information under items 1, 2, and 6 shall be the most updated as at the time of submission, while information under other items could be consistent with the status of the last day of the preceding year. 5 Although the submission of the annual audited financials is no longer the statutory requirement, the enterprises may still need annual financial audit for internal management and other business consideration. 2

3 correction by enterprises failing to make timely disclosure. Information requiring disclosure includes: 1. Changes of capital subscription or contribution, including amount, schedule, and method of contribution; 2. Equity change information, such as equity transfer in a limited liability company; 3. Information on the granting, change, and renewal of administrative permits or licenses; 4. Intellectual property rights pledge registration information; 5. Information on administrative penalties received; or 6. Other information required to be disclosed according to law. 6 Item 5 is particularly noteworthy because one of the key pieces of legislation the AIC is charged with enforcing is the Anti-Unfair Competition Law, which addresses various kinds of impermissible competitive conduct, include commercial bribery. In recent years, the AIC has been extremely active, both nationally and at the local level, in conducting enforcement actions involving allegations of commercial bribery. Implications on Relevant Anti-Corruption Rules in Other Jurisdictions? Because of the degree to which China s economy retains strong elements of state ownership, kickback schemes that are viewed as involving 'commercial bribery' under PRC law could potentially implicate the U.S. Foreign Corrupt Practices Act (FCPA) and relevant United Kingdom antibribery legislation and practice. The FCPA does not include a voluntary disclosure obligation for offenses, but the prospect of complying with the mandatory Disclosure System in China could present companies subject to the FCPA with a dilemma regarding how to handle the question of making parallel disclosure to U.S. regulators. Similarly, for businesses subject to UK jurisdiction, the new disclosure requirement in China might have implications under UK law and practices. A UK register exists for corporate entities convicted of an offence in the United Kingdom. This register can also be accessed by the public. However, the register is not well known, and even less well used, perhaps because of the rather cumbersome procedure for access, which involves an application under the Freedom of Information Act. The China register may also be of use for companies defending actions in jurisdictions where there is a rule against double jeopardy, such as in the United Kingdom. The company may be able to point to an administrative penalty having already been imposed in China in respect of facts that are also being investigated by, for example, UK authorities under their extra-territorial jurisdiction to investigate and prosecute bribery and corruption offences. Prosecuting authorities however, will likely argue that an administrative penalty is not the same as a pre-existing criminal conviction. The stronger argument may be that it would not be in the public interest to punish a corporation twice. 7 6 It is unclear what information may fall under item 6. The practice in Shanghai and Beijing is that there is no need to file the other information unless expressly required by other law. In general, there is no such requirement in practice at present. 7 Query whether the decision by multiple jurisdictions in major anticorruption enforcement actions brought in the last decade to pursue prosecutions against the same company for the same conduct (such as in the actions brought against Siemens and BAE Systems) may suggest that that enforcement authorities are not adverse to multiple prosecutions when the subject matter may involve corruption. 3

4 This is in line with European Union case law, and aligns with the UK test that there must not only be sufficient evidence to convict, but that it is also in the public interest to bring the case. Government s Disclosure Requirements and Supervision The Interim Regulation and New Rules also impose disclosure obligations on government authorities. Through the Disclosure System, the AIC must publish enterprises basic registration and filing information, such as enterprise name, address, registered capital, business scope, legal representative, equity, and pledges of movable property, as well as administrative penalties. Other governmental authorities must disclose information relating to granting, change, and renewal of administrative permits or licenses and administrative penalties, but may choose whether to disclose via the Disclosure System. In other words, agencies other than the AIC may disclose such information through their own separate systems. One of the New Rules aims is dedicated to governing the disclosure of administrative penalties by the AIC. Currently, Tier 1 and Tier 2 cities like Beijing, Shanghai, Shenzhen, Xiamen, and Haikou are publishing new penalty information on their online platforms, while continuously uploading old punishment notice records at the same time. 8 Besides the disclosure obligation, local AICs act as the supervisors of the disclosure and reporting process. Under the Interim Regulation and New Rules, enterprises are requested to make reporting and disclosure on their own initiative. AIC will not check every disclosure by every company, but will carry out random inspection against at least 3% of all enterprises within the local jurisdiction or based on whistleblower reports, will conduct investigations as to the authenticity of certain disclosures. Legal Consequence for Violations Failure to fulfill the reporting and disclosure obligations imposed under the new system can result in penalties. Under the Interim Regulation and New Rules, an enterprise will be placed on a list of irregular operation for (i) failure timely to submit annual reports, (ii) failure to make corrections of real-time disclosure as ordered, (iii) concealing the truth or providing false information in its disclosures, or (iv) failure to be contacted via the registered domicile or business premise information provided by enterprises. Within three years after being listed, an enterprise may apply to be removed from the list of irregular operation if it rectifies the misconduct. However, if the violation is not corrected or lasts for three consecutive years, the enterprise will be put on a blacklist disclosed to the public through the Disclosure System. The legal representative or person in charge of a blacklisted enterprise may not serve as the legal representative or person in charge of any other enterprise for a period of three years. Further, the Interim Regulation requires local government and authorities to establish a sound credit restraint mechanism to restrict or ban enterprises on the list of irregular businesses or the blacklist from government procurement programs, project bidding or tendering, state-owned land use rights, awards of honorary titles, and so forth. As the Interim Regulation is relatively new, as of the date of this writing, there is no officially established credit restraint mechanism rolled out by local governments. 8 Taking Shanghai as an example, Shanghai AIC has set up a special system on its official website to publish administrative penalty imposed by Shanghai AIC. The system provides full text of penalty notices and is available at: 4

5 Conclusion and Advice The impetus to the Disclosure System is reportedly coming from China s national government, which is encouraging government agencies to share information through the system. Although it is still too early to draw conclusions as to the true transparency of the new disclosure requirements, one thing is for sure: enterprises operating in China are both facing greater compliance requirements and more exposed to credit and/or compliance testing. The launch of the Disclosure System suggests that access in China to reliable information for diligence and credit-check purposes will be improving in the coming years, a development to applaud. From an international perspective, this could prove a useful tool for those wishing to conduct due diligence on a Chinese incorporated entity. At the same time, the requirement to disclose administrative penalties, at a time when the AIC is actively initiating commercial bribery enforcement cases, means that companies subject to the FCPA or UK law need to consider the potential implications of disclosure in China on their stance vis-a-vis disclosure to U.S. and/or UK regulators. Authors: Amy L. Sommers amy.sommers@klgates.com Cecillia Dai cecillia.dai@klgates.com Aqua Huang aqua.huang@klgates.com Anchorage Austin Beijing Berlin Boston Brisbane Brussels Charleston Charlotte Chicago Dallas Doha Dubai Fort Worth Frankfurt Harrisburg Hong Kong Houston London Los Angeles Melbourne Miami Milan Moscow Newark New York Orange County Palo Alto Paris Perth Pittsburgh Portland Raleigh Research Triangle Park San Francisco São Paulo Seattle Seoul Shanghai Singapore Spokane Sydney Taipei Tokyo Warsaw Washington, D.C. Wilmington K&L Gates comprises more than 2,000 lawyers globally who practice in fully integrated offices located on five continents. The firm represents leading multinational corporations, growth and middle-market companies, capital markets participants and entrepreneurs in every major industry group as well as public sector entities, educational institutions, philanthropic organizations and individuals. For more information about K&L Gates or its locations, practices and registrations, visit This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer K&L Gates LLP. All Rights Reserved. 5