By John M. Hynes

In the past, we have reported on a number of Foreign Corrupt Practices Act ("FCPA") developments and have furnished subscribers with a primer on the FCPA. The latest developments in this area relate to an investigation of the motion picture industry and its activities in China.

On April 26, 2012, Reuters reported that the US Securities and Exchange Commission ("SEC") recently sent letters of inquiry to several prominent movie studios seeking information about their dealings in China that may constitute violations of the FCPA. Later reports indicate that the letters were sent to Twentieth Century Fox, Paramount Pictures, Sony Pictures, Universal Pictures, Walt Disney Studios, Warner Bros., and Dreamworks Animation.

Background of the SEC Inquiry

While the specific nature of the alleged improper payments has not been disclosed, the SEC letters of inquiry reportedly focus on potential unlawful payments to the state-owned China Film Group ("CFG"), which has historically controlled the Chinese film market. The CFG, however, has denied any involvement in the inquiry.

This inquiry comes at a time when the Chinese film industry is booming. In 2011, Chinese box office revenue grew about 35% to $2.1 billion, most of which was generated by 3D films. On the heels of this growth, in February 2012, the CFG eased restrictions on the entry of foreign films into China, exempting 14 premium format films (e.g., 3D films) from the limit of 20 foreign films per year. Perhaps not coincidentally, the CFG passed these relaxed restrictions soon after China’s Vice President, Xi Jinping, visited Washington, DC and Los Angeles in February 2012.

Hollywood studios have taken advantage of the growing Chinese film industry, inking a wave of deals both before and after the CFG eased its foreign film restrictions. For example, in 2011, Dreamworks’ Kung Fu Panda was the highest grossing animated movie in China, raking in about $100 million in box office sales. Moreover, in February 2012, Dreamworks announced its plan to build a production studio in Shanghai with some of the largest media firms in China. Disney has also taken advantage of the favorable film industry climate in China, recently announcing that the next Iron Man film will be co-produced in China pursuant to an agreement among Disney, its Marvel Studios unit, and China’s DMG Entertainment.

FCPA Industry Sweeps

This inquiry is the latest in a series of so-called "industry sweeps" conducted by US regulators designed to root out potential FCPA violations across particular business sectors. The SEC and Department of Justice ("DOJ") have been known to launch wide-ranging FCPA investigations into multiple companies when they have reason to believe that the alleged conduct represents a pattern or practice within the industry. Because industry sweeps are often triggered by perceived wrongdoing within only one particular company, the Government may investigate companies without any evidence or specific allegations of wrongdoing.

Over the past decade, the U.S. Government has devoted significant resources to FCPA industry sweeps. For example, the SEC recently launched inquiries into at least 10 financial services firms regarding whether they made improper payments in seeking investments from sovereign wealth funds. The SEC and DOJ have also recently been conducting FCPA investigations into various pharmaceutical and medical device companies, including Johnson & Johnson, Pfizer, and Merck. Johnson & Johnson agreed to pay $70 million to settle the allegations against it. Additionally, in 2007, the SEC and DOJ began launching FCPA investigations involving at least seven oil and gas companies, including Panalpina World Transport and Transocean, resulting in more than $230 million in disgorgement, fines, and penalties.

FCPA Enforcement Activity Leading Up to Movie Industry Sweep

The movie industry sweep comes as no surprise to many due to recent FCPA enforcement activity involving the film industry and the Government’s longstanding focus on potential FCPA issues in China. In September 2009, a federal jury in Los Angeles convicted two Hollywood film executives – Gerald and Patricia Green – of substantive FCPA violations and conspiracy to violate the FCPA for paying approximately $1.8 million in bribes to the former governor of the Tourism Authority of Thailand in exchange for contracts to operate the annual Bangkok International Film Festival worth more than $13.5 million. Both executives were sentenced to six months in prison.

Additionally, while the growing Chinese economy offers a wealth of opportunities for American businesses, China has long been a primary focus of the U.S. Government’s FCPA enforcement efforts. The prevalence of state-controlled entities coupled with widespread corruption and questionable business traditions makes China an FCPA trap for unwary American businesses. Indeed, between 2006 and 2011, about 9% of all FCPA enforcement actions involved activity in China.

What this All Means for Companies in the Film Industry

The SEC’s strategy in sending letters of inquiry to multiple movie studios suggests that it is taking an industry-wide approach to this matter. As such, companies and individuals across the entire film industry could be at risk and should react accordingly. This risk is not limited to major movie studios, as the FCPA applies to a broad range of entities and individuals. Indeed, the recent uptick in FCPA enforcement actions against individuals, including the convictions of two film executives discussed above, suggests that the Government may eventually seek FCPA charges against individuals involved in the alleged illegal activity as well as the companies. In addition to disgorgement, fines, and penalties faced by both individuals and companies, individuals can face lengthy prison sentences for violating the FCPA.

Companies can take various steps to ensure that they are prepared if and when the Government comes knocking on their door. While it is always advisable to have a robust and effective FCPA compliance program in place, it is even more important now for companies in the film industry to ensure that their compliance programs are up-to-date and being properly implemented so that they can gain credit if the Government launches an investigation. This is especially true for film companies with dealings in China, as these companies are on the SEC’s radar. To this end, film companies should consider a privileged review of their FCPA compliance programs by outside counsel to ensure that they include all the components that the Government deems necessary, including anti-corruption policies and procedures, training and communication, third-party due diligence, anti-corruption contract clauses, internal accounting controls, auditing of program effectiveness, and response to improper conduct and remedial action.

At-risk companies should also consider a privileged internal review by counsel to determine whether any FCPA issues exist and, if so, decide whether to disclose the issues to the Government. While companies can earn cooperation credit for self-disclosing potential violations, the question of whether and what to voluntarily disclose to the Government is a complex decision involving both risks and rewards for the company. Irrespective of whether a disclosure is made, however, launching a preemptive internal review will allow the company to stay ahead of the Government and be best prepared in the event that the Government initiates its own inquiry.