For multinational companies grappling with stagnant sales, China has become a magnet for investment and a huge potential market beckoning...

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SHANGHAI, China — 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.

China-based executives, sales agents and distributors for nine U.S. multinational companies have 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 (FCPA).

“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.

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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 Buer, who said she was fired last year as head of Asia-Pacific operations for Datastream Systems after she unearthed problems with how the South Carolina software company had been booking sales in China.

Chinese corruption

Recent cases involving China and U.S.-based multinational corporations:

2004: Lucent Technologies fires its China president and several other top officers after Chinese media report that internal auditors had found that the executives had bribed officials at state-owned telecommunications companies.

December 2004: InVision Technologies, a California manufacturer of airport-security screening systems, pays an $800,000 fine after admitting that its distributors in China, Thailand and the Philippines bribed government officials to gain sales.

May 2005: Diagnostic Products, a Los Angeles-based medical-equipment firm, surrenders $2 million in profits to settle a case in which the Securities and Exchange Commission charged the company’s Chinese subsidiary with handing out $1.6 million in bribes at state-owned Chinese hospitals.

August 2005: The SEC opens an informal inquiry after a lawsuit filed in Monterey County, Calif., alleges that the head of state-owned China Construction Bank and his associates took $1 million in bribes disguised as consulting fees from a U.S. software company, Alltel Information Services.

Buer recently settled a whistle-blower lawsuit she filed against Datastream after 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.”

Blossoming market

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 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 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 — 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.

Last year, Lucent Technologies, 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 FCPA.

Chinese media reported that international auditors found that the executives had 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.

No protection

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

The FCPA’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.

He said HP cuts his company in as a means of lubricating deals without handling the money directly.

“This happens 90 percent of the time on HP’s Unix business,” the distributor said. “The bosses at HP know the situation.”

In a written statement, HP 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.”