‘Dawn raid’ drills may become de rigueur as Chinese authorities swoop

In the summer of 2014 the National Development and Reform Commission (NDRC) raided a number of foreign companies suspected of violating Beijing’s Anti Monopoly Law (AML). At the same time, senior executives at the Chinese operations of a large multinational were meeting to deliberate a demand from the authorities that they change their pricing policies.

The company’s chief financial officer and legal counsel argued that there was no legal basis for the instruction, and recommended rejecting it. According to one person familiar with the deliberations, they were overruled by a more senior colleague who said: “Don’t talk to me about rule of law, this is China.”

The company’s China pricing policies were duly adjusted and the company’s operations — unlike those of many of their competitors — were never raided or fined.

Such fraught exchanges have become increasingly common at the offices of multinationals in China since 2013, when the NDRC handed down a landmark series of fines on infant formula manufacturers accused of violating the 2008 AML.

Coupled with similar investigations by the State Administration of Industry and Commerce, which also governs aspects of the AML, and even police investigations into allegedly criminal behaviour such as bribery, foreign companies are confronting a broader array of regulatory risks than ever before in the world’s second-largest economy.

Some attribute the sea change to a natural evolution of China’s regulatory environment. “It’s such a young system that every day you’re coming across a new area where the rules haven’t been written,” says Nick Beckett, a Beijing-based lawyer with CMS Cameron McKenna.

“It’s a good time for lawyers.”

Many lawyers are advising their corporate clients in China to implement — and practice — a kind of “dawn raid drill” in anticipation of uninvited regulatory visits. Companies, they say, should have designated employees tasked with raising the alarm to senior executives, who in turn manage the response.

Mr Beckett says many companies “try to control the flow of information” to investigators but advises that they do so in a helpful manner.

Susan Ning, a competition lawyer with King & Wood Mallesons in Beijing, adds that it is especially important to make a record of the information provided. That can at least help companies better understand the thrust of the investigation.

Companies should not expect to be presented with a warrant that has been issued after careful deliberation by a judge. They may well receive only an “investigation notice”.

A company contending with a raid has, in a large sense, already lost at least half the battle. Once the NDRC or other regulatory officials confirm that they are investigating a company, it is extremely unlikely for them not to follow through with a finding of fault.

A raid, especially if news of it leaks via the official Xinhua news agency or other state media outlets, only makes it that much more difficult for regulators to back down. After that, Mr Beckett says, “it is a damage limitation process”.

As a result, adds Erick Robinson at Rouse, the international law firm, it is essential that companies or their lawyers have close connections with regulators, which could enable them to nip problems in the bud before they turn into a full-blown scandal.

The opacity and presumption of guilt that often surrounds regulatory investigations in China can trigger a defensive reaction from western companies more familiar with adversarial judicial systems, in which it is expected that firms and individuals will fight for their rights.

That can give rise to corporate reactions ranging from “it’s not fair” to “how can they think this?”, which often only further antagonises investigators.

Chinese criminal and even political “show trial” cases offer foreign investors an important insight into the workings of the country’s judicial system.

In a tradition dating back not just to the early years of rule by the Chinese Communist party, but also to imperial times, remorse and confessions are rewarded with leniency. Hence the pattern of frequent state news broadcasts of suspects “confessing” to police accusations about various crimes long before any official hearing dates, in what to western eyes appears a gross violation of judicial due process.

In their desire to avoid any entanglement with China’s regulatory apparatuses, some foreign companies have begun to make proactive “applications for leniency”.

The best example of this was the NDRC’s finding last year against 12 Japanese auto parts companies for alleged price collusion. In a repeat of Japanese cartel cases previously prosecuted in the US and the European Union, the parts suppliers admitted to conspiring to fix prices to their automaker customers.

According to people familiar with the investigation, the case came about after one of the Japanese companies reported the behaviour to the NDRC in return for leniency.

For the supplier in question, it turned out to be a very effective way of avoiding much more severe sanctions, while other companies that were not as proactive and co-operative ended up paying stiff financial penalties.