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Is SEC a bull in pic biz’s China shop?

Big elephant in the room at 'Going Broke' panel

When the Beverly Hills Bar Assn. had a recent panel on doing business in China — called, in a tinge of irreverence, “Breaking Into China Without Going Broke” — there was a big elephant in the room.

“On a practical matter, we are actually in the middle of a negotiation with one of the major studios, and it is presently on hiatus until this dark cloud of SEC inquiry is sort of taken care of,” he said. “That has nothing to do with us as a company, and it has more to do with [studios] trying to get their ducks in a row, trying to understand how to deal with China, how to properly deal with it under the rules and regulations.”

What is at stake, he said, is missed opportunities.

“In a worst-case scenario, China can become like a Japan or a Bollywood where eventually they end up being able to cater to consumers with their own product in such a way that they really don’t need the United States product,” he said. “So obviously we have a little bit of a ticking clock to figure this out.”

That is, of course, the Securities and Exchange Commission inquiry into the studios’ dealings with Chinese officials. In April, studio sources revealed that they had received letters from the feds, ostensibly with a focus on whether there were instances of bribery in the often vexing quest to get pics approved as part of China’s strict quota system.

While all signs pointed to any investigation being in the early stages, what was clear by experts on the panel is that there was ample reason for concern.

Bethany Hengsbach, partner at Sheppard Mullin Richter & Hampton, called it a “perfect storm” that has been brewing in China, with a culture of gift-giving as part of business deals; heavy government involvement in all sectors of society, including China Film Group; and a drive by U.S. firms to not miss out on the opportunity for huge growth. All of that is intersecting with the U.S. government’s stepped up enforcement of the Foreign Corrupt Practices Act, which prohibits payment of bribes or anything of value to foreign officials as a way to secure business.

The feds, she noted, have in recent years taken a hard line on enforcement, ending in heavy fines on corporations and, in some cases, individuals going to jail. The scrutiny extends not just to business transactions, but to the way that records are kept, such as accounting for a bribe or a kickback as a “sales commission” or a “marketing payment.” “The government hates the excuse that everybody tries to use, which is ‘Everybody’s doing it. I didn’t know.’ Those aren’t going to fly anymore,” she said.

The government also has taken a broad interpretation of the statute, so the definition of what is a bribe extends to the intangible, like scholarships or tax benefits. A concern privately expressed by some industry attorneys is that producer credits would fall into such a category.

The SEC is mum on where it is in its inquiry and what it is doing, but the letters of inquiry are a sign that the feds are “doing an industry sweep of the studios, and it is focused on the entertainment industry much like it has focused on the pharmaceutical industry in the past, much like it has focused on other industries,” Hengsbach said.

“The government likes to do that because they get more bang for their buck,” she said. “They learn how an industry works and it is easier for them to enforce it that way. The industry is definitely on the government’s radar.”

Chris Fenton, president of DMG Entertainment Motion Picture Group, the Chinese company that is partnering with studios on major projects, fears that it’s putting a hold on co-ventures.

He cited Chinese emphasis on guangxi, the relationship, in which establishing trust and aligned interests are of utmost importance, as well as the idea that a deal will make both parties come out looking good. Instances of bribery are “usually utilized by people who don’t have the access that they need, the understanding of who these officials are or who the key decisionmakers are. …They need that bribe or whatever they are using the gift to get that access or to get that person’s ear.”

This is not to say that such evidence has turned up in the studios’ case, or even how wide the scope is, but past industrywide inquiries, like that of the pharmaceutical business, have led to fines or settlements. As Hengsbach said, “It is rare for an extremely robust investigation to turn up nothing.”

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