Last spring, Swiss pharmaceutical giant Novartis AG paid $25 million to the SEC to settle Foreign Corrupt Practices Act (“FCPA”) charges relating to its operations in China.  According to the SEC’s internal administrative order, Novartis subsidiaries in China bribed government-affiliated doctors and healthcare professionals—who qualify as “foreign officials” under the FCPA—to increase sales of their products.  The Swiss company and its Chinese subsidiaries are subject to the FCPA’s jurisdiction because Novartis trades on the New York Stock Exchange.

The FCPA is an important but little understood U.S. statute that can severely impact any business that operates internationally.  The FCPA prohibits U.S. persons, companies, and issuers—such as Novartis—from, among other things, bribing or attempting to bribe a foreign official to secure an improper business advantage.  FCPA violations can result in steep criminal and civil fines, imprisonment, reputational harm, and a host of other ills.  The recent Novartis settlement highlights one of the most common FCPA pitfalls: travel and entertainment expenses.

The FCPA allows companies to pay for “reasonable and bona fide” expenditures of government officials, specifically referencing “travel and lodging expenses.”  But when do travel and entertainment expenses become unreasonable and subject to sanction under the FCPA?  Companies often struggle with this question.

In the case of Novartis, many of the problematic expenses were made in connection with otherwise reasonable expenditures.  For instance, in 2009, Novartis’ Chinese subsidiary sponsored 20 Chinese healthcare officials to attend a clinical conference in Chicago.  While paying for foreign officials to attend an educational conference may be reasonable, paying for purely recreational activities, such as an excursion to Niagara Falls, is not.  The subsidiary also paid for the spouses of the officials to travel to the United States and provided them with $150 in “walking around” money.  In another example, in 2011, a Chinese travel company submitted invoices to Novartis totaling $25,000 in connection with healthcare officials giving lectures to other officials.  But the invoices were recorded as legitimate expenses without any confirmation that Novartis’ subsidiary organized the lecture or that any healthcare officials actually attended the lectures.

Companies paying for the travel and entertainment of foreign officials must do so cautiously and ensure that all expenses are related to a legitimate purpose.  For instance, if your company is seeking authority to build a manufacturing facility in a foreign country, it may be perfectly legitimate to fly the approving officials to the United States to tour a similar facility.  However, it would violate the FCPA to fly those officials to the United States to tour the facility for one hour, but pay for five nights in a luxury hotel and three rounds of golf.  In that case, the travel and entertainment expense is vastly disproportionate to the business purpose.

Not only did Novartis improperly induce the healthcare officials to prescribe its products through the use of travel and entertainment, but the company improperly recorded these payments as legitimate selling and marketing costs, violating the FCPA’s “books and record” provisions.  According to the SEC, Novartis violated Section 13(b)(2)(A) of the Exchange Act requiring issuers to keep accurate books and records, as well as Section 13(b)(2)(B) requiring issuers to devise and maintain a system of internal accounting controls sufficient to detect and prevent the making of improper payments to foreign officials.  Be aware that even if the DOJ and SEC cannot bring a charge for violating the FCPA’s anti-bribery provisions, there may be sufficient evidence to demonstrate a violation of the books and record provisions.  Undocumented or vague reimbursement descriptions for travel and entertainment expenses may indicate an underlying corrupt payment.

Novartis is not the first, and certainly will not be the last, healthcare company to come under scrutiny for providing gifts, travel, and entertainment to employees of state-owned hospitals in foreign countries.  In 2012, as part of a deferred prosecution agreement, Pfizer paid $15 million to settle similar FCPA charges in connection with its subsidiaries’ activities in Eastern Europe and Russia.  Travel and entertainment expenses are among the most challenging FCPA issues, in part, because they are commonplace and because the FCPA does not provide bright-line rules for what constitutes reasonable expenses.

As with any item “of value,” travel and entertainment expenses may not be given with a corrupt intent, meaning that the expenses are not part of a quid pro quo for any particular official action.  Companies should always err on the side of transparency and prudence, and keep in mind that what may be reasonable in the United States may not necessarily be reasonable in a foreign country.  Companies should always ensure that the travel and entertainment are proportional to the legitimate business purpose and avoid paying the expenses of officials’ family members.  All travel and entertainment expenses should be well documented and accurately reported in the company’s books and records.  Companies should never provide foreign officials with cash, and payments for inappropriate activities, such as the cover charges at strip clubs paid by Novartis’ subsidiary, should be avoided.  In today’s global business environment, companies must be vigilant to ensure that their travel and entertainment practices align with regulatory requirements.