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Doing sticky business in China

When Pasadena-based Avery Dennison wanted to build its road and traffic business in China a few years ago, it hired people like Lily Tang. The Beijing homemaker had an asset the company craved: political connections.

Tang’s husband, Chen Qi, is a senior official at the China Communications and Transportation Assn., a quasi-governmental group led by former ministers. That connection, said current and former Avery managers in China, helped the company win contracts for thousands of dollars’ worth of government projects.

In one case, according to interviews and a copy of a signed contract reviewed by The Times, Avery received an order to supply $375,000 worth of reflective safety products for highway jobs in Tianjin, east of Beijing, and paid a commission of about 8% to an enterprise operated by a friend of Chen’s.

Chen’s friend, Guo Longjun of Beijing, said he had passed the money on to “experts,” whom he wouldn’t identify.

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Such payments may be part of an ongoing federal investigation into whether Avery violated the Foreign Corrupt Practices Act, which prohibits U.S. businesses from bribing foreign officials.

Avery reported possible violations on its own in 2005. It characterized them as relatively minor and said it had taken corrective measures. Though it is by no means the only U.S. company involved in a corruption investigation of its business dealings in China, its experience provides a case study of the pitfalls American firms face as they try to capture a piece of the Chinese market.

Justice Department officials say enforcement of the FCPA is second only to fighting terrorism in terms of priority. Currently, at least 91 cases are open, triple the number four years ago, according to a report issued last month by Shearman & Sterling, a New York-based law firm that tracks FCPA cases.

China is getting more attention. Of 25 criminal prosecutions under the law in the last two years, six involved activities in China -- the largest number after Iraq and Nigeria. Among the companies involved were Lucent Technologies, which agreed to pay a $1-million penalty for supplying about 315 trips to the U.S. by Chinese officials. The company recorded some of them as “factory inspections,” but they were in fact visits to places such as Disneyland, Las Vegas and the Grand Canyon, the Justice Department said.

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The trips, plus educational expenses for a Chinese government employee, were valued in the millions of dollars, federal officials said. At stake were contracts worth at least $2 billion.

Such cases show that China is no longer just the world’s factory floor; its size and its push to accelerate domestic spending make it an alluring market in its own right.

‘It’s risky’

Corruption, though, is a pervasive problem in China. The Communist Party leadership, seeing the lawlessness as a threat to its survival, is cracking down. From 2003 to 2007, officials investigated almost 20,000 commercial bribery cases involving state workers, China’s procurator-general reported. The amount involved is about $500 million.

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Avery, with $6.3 billion in sales last year, triggered the federal investigation by reporting possible FCPA violations. It said the matter involved a small number of local employees in its reflective-materials business who might have made improper payments and that it could incur fines or other penalties.

Since then, Avery has opened new manufacturing facilities in China, as well as its first stand-alone research center outside the United States -- even as it places a new emphasis on business ethics. The company’s Chinese payroll has ballooned to 14,000, about 40% of its global workforce.

But the possible corruption case has proved anything but small. Sales in the reflective-materials unit have plunged. Avery has pushed out at least eight employees and managers. Several other senior staff members have quit in frustration.

Among them was Timothy Li, 58, who resigned as business development director of Avery’s reflective and graphics division in Asia, based in Hong Kong. He said he had warned regional bosses about using consultants and other questionable tactics to secure contracts.

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“I told them it’s risky and I don’t like to do these kinds of things,” Li said in an interview, his voice rising and his arms clenching his chest.

Avery declined to comment about the Tianjin highway project or specific individuals, noting that personnel matters are confidential and that the investigation is ongoing.

But a company spokesman, Laurence Dwyer, said, “Avery Dennison is committed to conducting its business with honesty and to the highest ethical standards in all our businesses and in every region of the world.”

U.S. firms are widely considered to operate with higher ethics than Chinese and Western competitors -- in large part because of stringent laws such as the FCPA, which took effect in 1977, and the Sarbanes-Oxley Act of 2002.

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Still, in the last couple of years, Chinese state-run media and court records have identified such U.S. business icons as IBM, McDonald’s and Whirlpool as companies connected to bribery cases in China.

Like Avery, more American companies are reporting possible FCPA violations by their own employees. In October, cosmetics company Avon Products Inc. said it had begun an internal investigation to determine whether its China operations had incurred illegal travel, entertainment and other expenses.

Intermediaries

Faced with the choice between bribing officials and losing business, some U.S. firms have turned to middlemen, often from Hong Kong or Taiwan, to grease the wheels for them. And they often set aggressive targets for their Chinese employees without making it clear that certain behavior is prohibited in reaching those goals, said Amy Sommers, a Shanghai-based attorney for Squire, Sanders & Dempsey who has advised clients and conducted workshops on the FCPA.

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Avery, best known for making labels and self-adhesive products, entered the Chinese market in 1995, and its pressurized labels became common on consumer goods such as Tsingtao beer and Zest shampoo. But the company had bigger ambitions.

In July 1999, it bought Stimsonite Corp., a Chicago-area maker of highway safety products with a growing operation in China.

China was laying down thousands of miles of roads a year and needed reflective pavement markers and sheeting materials for signs. Millions of new cars were hitting the streets; the license plates needed reflective film.

But Minnesota-based 3M Co. had gotten there first. Avery’s effort went nowhere until it hired Ding Yong, a Shanghai native with a round face and easy manner.

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One of his first successes was to beat out 3M and NCI of Japan for contracts to put reflective sheets over the seals on the sides of police cars.

The winner was to be decided largely by the Public Security Ministry’s Traffic Management Research Institute. In early 2003, Avery’s managers in China hired as a marketing rep Dong Qiping, an institute employee whose wife was vice director of the department in charge of the project.

Avery won the first of the contracts, for about 13,000 cars in Shandong province in eastern China. It was a bonanza for the Pasadena firm and the institute. According to interviews and internal Avery sales reports viewed by The Times, the arrangement worked this way:

Avery received vinyl sheets from its factory in Chicago at about $10 per square meter (1.2 square yards).

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The materials were sold for about $27 to a contractor who cut and prepared the reflective sheets. Avery bought back the prepared products from the same contractor for $50 a meter, then offered them for $62 to a company owned and operated by the Public Security Ministry.

However, Avery returned $10 per square meter in the form of a “commission,” allowing government officials to pocket that money, said a former manager familiar with the deal. Avery made at least $300,000 on the deal, according to company sales reports.

Representatives of the institute and the company associated with the Public Security Ministry would not comment on the deal.

Slippery slope

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In China, it isn’t unusual for a government agency to own profit-generating companies to raise money for research and other efforts. But their legal structures, finances and relationship with government officials are murky.

“They are in a gray area and very likely breed corruption,” said Hu Xingdou, an economics professor at the Beijing Institute of Technology.

During 2003 and 2004, it became common for Avery managers to retain Chinese “consultants” to secure contracts in exchange for a share of the proceeds. One was a midlevel Public Security Ministry official who said he could connect Avery with a state-owned truck manufacturer in northeastern China that needed red-and-white reflective stickers for the backs of trucks.

Avery’s expense accounts also showed lavish spending on entertaining clients, according to people who recorded the reports.

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By summer 2004, things were changing. On a Friday morning in September, Ding said, he was called to the 11th-floor conference room of Avery’s offices in southwest Shanghai. Sales were running at triple the pace of two years earlier, and Ding thought his superiors might want to renew his contract. Instead, Avery sent him packing.

Shortly afterward, lawyers from Latham & Watkins in Los Angeles became regular visitors at the company’s offices in Shanghai. With others, they interviewed employees and combed through expense reports, contracts and e-mails.

In early 2005, Avery managers in China were instructed to get Dong, the institute employee, off the payroll within a week. Avery paid him about $10,000 to leave, said a former manager who was involved in the matter. Dong, reached by phone, said the amount was a little less, but he declined to comment further.

Three months later, two of Avery’s senior managers in Hong Kong, including the Asia-Pacific head of reflective materials, were removed, as was the division’s finance director in Shanghai.

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With Ding gone, Avery’s arrangement to supply reflective materials for police vehicles ended. The same materials that Avery sold for $62 per square meter eventually went for as little as $12, according to Avery salespeople and competitors.

Driving ambitions

In building relations and cutting deals with Chinese officials, local employees said, they took their cues from management in Pasadena, which wanted to rapidly expand in China, retaining high-level consulting help and spending extensively on entertainment. And, Ding argued, entertaining was a big part of courting customers in China.

“You cannot just do PowerPoint presentations,” he said.

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After Avery reported possible FCPA violations, few employees could recall any more costly dinners, and the company has since stepped up its monitoring of and training in ethics standards in China. Included are workshops, regular e-mails and a wallet-size laminated card with a code of conduct and the number of an international hotline printed in English and Chinese.

James Durree, Avery’s vice president in charge of business ethics, downplayed the problems in China.

“It is common in China to do business based on relationships,” he said at the company’s offices in Pasadena. “That’s fine, but we want it to be disclosed.” Durree stressed that China wasn’t a special case.

The troubles didn’t completely go away. In the summer of 2007, it ordered three employees at its reflective-materials unit to stop work because of ethics concerns, according to a copy of a letter Avery sent them.

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Peter Zhu, 48, said investigators kept asking him about a seminar he helped arrange in 2005 at a luxury hotel. Avery paid for the three-night stay and meals for two dozen guests, including four officials of state enterprises, Zhu said, adding that his bosses at Avery had approved the outing and guest list but later used the event against him.

Exasperated by constant pressure, Zhu said, he agreed to leave the company last fall after Avery paid him the rest of his contract, plus two months’ extra salary, a total of about $40,000. He said Avery did not cite any evidence of improper behavior.

Johnson Jiao, 44, held on to his job until May. Now employed at a new company in a similar industry, Jiao looks back bitterly at his three years with Avery.

“All my values were blurred,” he said. “I didn’t know what was right or wrong.”

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don.lee@latimes.com


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