Settlement agreements, such as non-prosecution agreements (NPAs) and deferred prosecution agreements (DPAs), have come to play a central role in resolving corporate criminal cases, including bribery cases. These settlement mechanisms are thought to improve overall enforcement by encouraging companies to voluntarily disclose wrongdoing and cooperate with investigators, in order to avoid the reputational and economic harm that would come with a criminal prosecution. The United States pioneered the use of NPAs and DPAs, but variants on these mechanisms have been adopted by many other countries as well (see here, here, and here).
The People’s Republic of China has also begun to explore a version of this mechanism. After some initial pilot programs at the local level, in June 2021 the Supreme People’s Procuratorate Office, together with eight other top authorities, promulgated Guiding Opinions on Establishing a Mechanism for Third-party Monitoring and Evaluation of Corporate Compliance Programs for Trial Implementation (or, more succinctly, the “Non-Prosecution for Compliance” mechanism). This mechanism, which can be used to resolve bribery cases as well as cases involving other types of corporate crime, resembles the NPA mechanism used in the United States: If a company accused of criminal violations admits wrongdoing, cooperates with the government’s investigation, agrees to pay certain fines, implements a compliance program that satisfies the requirements of the procuratorate office, and is overseen by a third-party monitor for up to one year, then prosecutors will agree not to prosecute the company, thus sparing the company not only the risk of criminal conviction but also the costs associated with defending against a criminal prosecution.
But there’s a big difference between the U.S. NPA system and the Chinese version: The U.S. (and other countries, like the U.K.) have used NPAs and DPAs to settle major cases against giant firms. In China so far, prosecutors (in the ten provinces and municipalities that piloted the NPA system) have only concluded NPAs with small and medium enterprises (SMEs), and have done so only when the offenses involved were minor crimes (those for which the responsible persons may be sentenced to less than three years in prison, the lowest permissible punishment for most crimes). This enforcement approach gets things exactly backwards: While the availability of NPAs can be very helpful in combating corruption and other crime in large companies—by giving those companies stronger incentives to disclose and cooperate, and by inducing them to enhance their compliance systems—offering NPAs to SMEs adds little value and is costly to the government. Rather than offering NPAs only to SMEs, as seems to have been the approach of Chinese prosecutors thus far, it would be better if SMEs were deemed ineligible for NPAs.
- First, while the prospect of receiving an NPA creates better incentives for big companies, the availability of NPAs is unlikely to alter the behavior of SMEs in desirable ways. For a big company, the costs of criminal prosecution are very high—investigation and litigation can be lengthy and intrusive (nearly all relevant directors might be detained), the reputational damage can be considerable, the company may lose substantial amounts of business, and so forth. Faced with the prospect of such significant impairment to the company, the corporate leadership has good reason to self-disclose and cooperate in order to avoid criminal prosecution. SMEs are often less concerned about these consequences of prosecution, because the value of the corporate entity as such may simply be much lower. A big company’s leadership is more likely to care about avoiding damage to the company than an SME’s leadership, and so the prospect of an NPA will have a greater effect on the former than the latter.
- Second, offering self-disclosing companies the possibility of an NPA is much more likely to induce disclosure if the company leaders—the ones who decide whether to disclose—are not themselves likely to be implicated in the unlawful conduct. This is more likely to be the case for big companies—where most senior executives (except for the ones involved in the crime) often learn about unauthorized wrongdoing committed by lower-level employees and middle managers—than for SMEs, where the same people who engaged in the wrongful conduct are also often the ones deciding whether to disclose. (Importantly, under China’s criminal law, when a company is prosecuted, there are always individuals who are held liable. Even if the company is spared prosecution, the responsible individuals can still be, and often are, prosecuted.) Putting this point together with the previous point: The leaders of large companies will often care a great deal about protecting the company, and worry less that they personally will be prosecuted if company wrongdoing becomes known; by contrast, the leaders of SMEs often care little about the survival of the corporate form, but worry that any government investigations into company wrongdoing will expose them to personal criminal liability. For these reasons, offering NPAs to SMEs is far less likely to induce desirable changes in behavior than offering NPAs to big firms.
- Third, the Chinese NPA system typically requires the corporation entering into an NPA to agree to substantial investments in compliance system improvements, overseen by a third-party monitor. While this approach makes sense for large firms, it tends to be wasteful and inefficient as applied to SMEs. SMEs lack the money and manpower to implement effective compliance functions, so they are more likely to adopt cosmetic compliance policies that could be easily abandoned after the monitoring period. Moreover, in practice the cost of third-party monitoring is often borne by the procuratorate office, because SMEs lack adequate resources. It is puzzling why prosecutors should spend taxpayers’ money to help delinquent SMEs avoid prosecution without getting anything valuable in return.
- Fourth, giving prosecutors unchecked discretion to reach NPAs with SMEs invites favoritism and corruption, as lower-level prosecutors can use NPAs as a way to effectively pardon SMEs. This problem is far more likely with respect to SMEs, because the cases are too unimportant for the public to pay attention or care. It is considerably harder for a prosecutor to strike a sweetheart NPA deal with a giant company in a highly publicized investigation.
Supporters of granting NPAs to SMEs typically contend that this is a way to save these companies from going under. Those taking this position emphasize that many SMEs lack basic compliance awareness, and argue that the government can and should use the NPA regime to help SMEs establish basic compliance programs. But this argument is flawed for the reasons explained above. More generally, the government should not reward companies that have already benefited from bribery or other crimes with a second chance and a government-funded compliance upgrade. This approach disadvantages those SMEs that complied with the law in the first place, and invested their own resources to develop effective compliance systems. If the government wants to invest its resources in helping SMEs to improve their compliance systems, there are plenty of other ways for the government to do so, for example by granting tax subsidies to SMEs that invest substantially in improved compliance programs.
China’s NPA regime, which is still in its infancy, has so far been targeting the wrong firms, spending its limited budget monitoring unknown small firms that made one-off bribes. China should instead focus on using the NPA mechanism with respect to big companies, where this mechanism holds the greatest promise.
Thanks for your post, super interesting. Do you think it’s possible that the unofficial approach here is to focus on SMEs as a means to build institutional competence and know-how, and to then move on to larger firms in the future? This approach could achieve a degree of deterrence (kill a few chickens to scare the monkeys), and also allow the compliance departments of large firms to acquire a sense of how regulatory agents function. Alternatively, do you think that hesitance to target larger entities could be due to the State-ownership of those entities, or some other political factor?
Also, I am not sure that I agree with your point that an NPA is unlikely to influence SME behavior, or your point that the directors of SMEs care less about the survival of a corporate entity. There are presumably all types of people in charge of SMEs and so blanket statements like this seem untenable. Presumably, the directors of those companies would face significant career hurdles if a company under their stewardship is found guilty of bribery. The fourth point is especially interesting. I wonder if there are many examples of this happening in China or elsewhere.
Thanks Sam for your great insights!
I completely agree that it’s important to build institutional know-how at this stage. My concern is that targeting SMEs cannot attain that goal. SMEs are structurally different from larger companies. At least in China, many SMEs are family businesses, owned and operated by the same people, and lack basic corporate governance structures that are present in larger firms. So the lessons for SMEs may not be that helpful for larger firms, because regulatory agents might interact with SMEs and larger firms with different approaches, and have completely different expectations for their compliance and cooperation.
Also, it might be true that settling with large Chinese SOEs is more complicated, because they are subject to special rules and considerations only applicable to them (the comment below provides a helpful secondary source on this topic). But there are plenty of major companies in China that are privately owned (e.g., Evergrande) and can be a target for the “experiment”.
On your next point, I agree that people attach different meanings to their companies, and some owners of SMEs might even feel it important to keep the corporate form at all costs. But in general, people in charge of SMEs in China are more likely to abandon the “corporate shell” if keeping it means spending more money and manpower. (The Supreme People’s Procuratorate of China actually acknowledged that they face a lot of difficulties incentivizing SMEs to adopt compliance programs, because “owners of SMEs prefer to restart their businesses by deregistering the companies and establishing a new one, than to spend the money and resources on compliance programs.” https://www.spp.gov.cn/spp/llyj/202103/t20210331_514458.shtml)
The last point is more of a future-looking question for China. As the NPAs are quite new, I haven’t found any corruption cases yet. But I’ll keep an eye on this and update later if any. Thanks for raising this point!
I believe there are reasons that the SPP has focused on SME compliance. You might take a look at what one of my students wrote on the greater background for SOE’s and compliance https://stllawreview.com/index.php/2021/08/06/chinese-soes-corporate-compliance/#post-1650-_Toc76908317
Thanks for the source! It’s very helpful.
There is a question of social justice when little companies are not allowed to get away with murder, while big companies and their bosses can do that
It’s a profound question. And I hope we have better ways to address this concern (than the current NPA regime).