Lack of Due Diligence Re China Sub Yields FCPA Charges for Parent

Doing business in high risk areas of the world requires additional diligence to avoid corruption issues. The SEC’s latest FCPA settlement is an example of an action where the parent company took proactive steps, but they proved insufficient. In the Matter of Nu Skin Enterprises, Inc., Adm. Proc. File No. 3-17556 (Sept. 20, 2016).

Nu Skin Enterprises manufactures and markets cosmetic and nutritional products largely through direct selling or multi-level marketing. Its wholly owned subsidiary, Nu Skin (China) Daily Use & Health Products Co. Ltd., is based in Shanghai, China.

The Direct Selling Laws in China prohibit the direct selling, multi-level commission structure used by the firm in the United States. The company adopted its model, using primarily retail outlets. Nevertheless, the Direct Selling Laws provide that before a business such as Nu Skin China can operate, the firm must receive direct selling licenses at the national, provincial and city level.

In 2013 Nu Skin China held an unauthorized promotional meeting in a city despite the fact that it did not have a store or a direct selling license. Representatives of the Administration of Industry and Commerce for the province discovered the meeting and opened an investigation. Nu Skin China was subsequently informed that the agency had enough evidence to establish unauthorized activity.

The firm was concerned about the prospect of charges on its long term ability to obtain the required licenses. Firm employees decided to initiate a charity project in the province to influence the outcome of the investigation. A Party Official was contacted to suggest a charity. The official proposed a charity which at that point in time did not have a branch in the province, although the official was associated with the entity. The official also at one point was the superior of the agency head.

Subsequently, the agency informed the company that it would be charged along with certain employees. A fine would be imposed. The Party Official was requested to intervene in return for a one million RMB donation to the charity. Nu Skin China also requested that its parent expedite recommendations to a U.S. college for the child of the Party Official – a request had previously been made but languished.

The China subsidiary alerted its parent of the donation but not its purpose. The parent proposed that the subsidiary consult with U.S. counsel because of the high risk of a possible FCPA violation in the country. After consultation with counsel, anti-corruption language was inserted in a draft of the papers with the charity. In the final version that clause was omitted. The parent did not request to see the final version of the papers.

Following a ceremony involving the charity and the Party Official, the donation was made. The payment was not properly characterized in the books. Subsequently the agency declined to prosecute. The parent company failed to devise and maintain a reasonable system of internal accounting controls over its subsidiary, according to the Order: “Specifically, given the well-known corruption risks in China, Nu Skin US. did not ensure that adequate due diligence was conducted by Nu Skin China with respect to charitable donations to identify links to the government or political party officials and to prevent payments intended to improperly influence . . .” such persons, contrary to the FCPA. According, the Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B).

To resolve the matter the firm consented to the entry of a cease and desist order based on the Sections cited in the Order. It also agreed to pay disgorgement of $431,088 – the amount of the fine initially proposed by the agency — prejudgment interest and a penalty of $300,000.

Program: The Future of Insider Trading: The Supreme Court and Salman (here).