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The Monaco Memo and China’s Social Credit System amplify past misconduct

Companies face increasing risks in their operations in China and beyond due to both the continued development of China’s social credit system and recent changes announced by the U.S. Department of Justice.

In October 2021, in what is now commonly referred to as the “Monaco Memo,” the DOJ announced several policy changes that reinforced the DOJ’s recent messaging that white-collar enforcement will be a top priority in the coming years. The changes provide prosecutors with greater ability to demand cooperation from corporations, punish repeat corporate misconduct, and request the imposition of an independent monitor.

Notably, the Monaco Memo revised the DOJ’s Principles of Federal Prosecution of Business Organizations (commonly known as the “Filip factors”), which set forth 11 factors U.S. prosecutors should consider when deciding whether to pursue criminal charges against corporate defendants and how best to resolve cases. Previously, one of the factors required prosecutors to assess a corporation’s past misconduct only if the misconduct was similar to the conduct at issue in the instant investigation. In the wake of the Monaco Memo, however, prosecutors are now required to consider all of the corporation’s prior misconduct, including “any prior domestic or foreign criminal, civil, or regulatory misconduct,” even if the prior misconduct is completely unrelated to the issue that the DOJ is currently considering.

Different factors may affect how much weight the DOJ affords the prior misconduct, including, but not limited to, the recency of the prior misconduct, similarity between the prior misconduct and current conduct, severity of the prior misconduct, the involvement of prior management, and whether the company has effectively remediated and implemented an effective compliance program. Complicating this further is that the Monaco Memo suggests that prosecutors could also consider misconduct that was “discovered” during prior enforcement actions, which raises the question of whether companies need to disclose uncharged conduct during negotiations with the DOJ.

Businesses that operate in China have already been grappling with this widening scope of prior misconduct that may affect current interactions with enforcement agencies. As we detailed in our post in September 2019, China has been developing a social credit system (SCS) since 2014 through which the Chinese government collects information and rates companies across a wide range of areas (e.g., data transfers, finance/taxes, environment) and then can reward or sanction companies based on that information and rating. The SCS is also an information-sharing system where local government authorities must share information with a national database called “Credit China,” some of which is also accessible to the public.

Through this hub, the SCS enables over 40 participating government agencies in China to share information about non-compliant conduct, which could potentially result in joint sanctions by agencies and increased risk of other complications, such as obtaining approvals for licensing or higher frequency of inspections) in unrelated areas of business.

China’s SCS poses even more risk to companies than the Monaco Memo because — unlike negotiations with the DOJ where companies will likely have the opportunity to engage in dialogue with the DOJ about their prior misconduct — China’s SCS automatically shares information about non-compliant conduct across Chinese government agencies without input by the company. In addition, a company’s social credit in China can also be impacted by the social credit of key personnel, such as the legal representative or senior management, and of key business partners, such as joint venture partners. As a result, companies operating in China may need to consider tracking their own violations and those of their key employees and business partners. This also means that companies with low SCS scores may face higher transaction costs when identifying and dealing with business partners.

Significant uncertainty remains in the United States regarding how the Monaco Memo’s expansion of what is considered relevant prior misconduct will play out in practice when interacting with prosecutors. Similarly, although prior misconduct is already shared among different authorities in China, the information-sharing systems of the SCS are still under development, so it is unclear how extensively and efficiently information is currently shared among Chinese government agencies.

However, in light of the increased impact prior misconduct can have when interacting with regulators, companies will need to continue to be attentive to compliance issues and develop an integrated compliance system that addresses risk across a range of areas. Companies may put themselves in the best position to negotiate with regulators in the U.S. and China by cataloging all misconduct, regardless of severity or type, in a centralized system and then assessing the impact that each violation might have on current or future discussions with Chinese or U.S. government authorities. Although many companies already consider prior misconduct, whether detected or not, as part of their compliance-related risk assessments, ensuring that such conduct is considered in risk assessments is of even more importance after these developments.

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Helen Hwang and Eric Carlson co-lead Covington & Burling’s Asia compliance and investigations practice. Both are fluent in Mandarin and specialize in investigations and anti-corruption compliance, with a particular focus on China.  Audrey Zhi, an associate in Covington’s Shanghai office specializing in anti-corruption compliance and investigations and regulatory compliance for life science companies, provided research assistance for this post.

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