By Ben Hirschler
LONDON, July 19 (Reuters) - With more compliance officers inChina than in any country bar the United States, Britishdrugmaker GlaxoSmithKline Plc seemed well-positioned todo things right.
But despite conducting up to 20 internal audits in China ayear, including an extensive 4-month probe earlier in 2013, GSKbosses were blindsided by police allegations of massivecorruption involving travel agencies used to funnel bribes todoctors and officials.
The scale of funds signed off by GSK to pay travel agenciesfor organising educational medical meetings has triggered heateddebate, with some saying such spending would have lookedlegitimate but others arguing it should have raised alarmsinside GSK and at its external auditor PricewaterhouseCoopers.
GSK, which has described the allegations as "shameful", hasdeclined to comment on specific shortcomings in internalprocedures. PwC declined to comment on the case, citing clientconfidentiality.
Britain's biggest drugmaker, which has some 7,000 staff inChina, has now hired Ernst & Young to conduct an independentreview of its systems in China, as well as sending top-levelexecutives to see how an alleged web of bribery worth up to 3billion yuan ($489 million) was missed.
One possible reason, according to consultants who haveworked for GSK as well as current and former employees, likelylies in both the care with which payments were kept off GSK'sbooks and the senior level of the Chinese managers involved.
As the alleged bribes went through the accounts of thetravel agencies, rather than GSK, and many of the individualamounts may not have been material, the issue was unlikely tohave been picked up by auditors or head office, some accountancyexperts maintain.
"You'd look at invoices and expenses, and it would all looklegitimate," said a senior executive at one top accountancyfirm. "The problem with fraud - if it is good fraud - is it iswell hidden, and when there is collusion high up then it is verydifficult to detect."
The failure comes despite GSK carrying out as many as 20internal audits annually within different areas of its Chinesebusiness, each of which typically uncovers around five employeesinfringing processes in some way, one source familiar with thematter said.
MEDICAL EDUCATION OR BRIBE?
Four senior Chinese executives from GSK have been detainedby police, including vice president and operations manager LiangHong, who told Chinese state television how he channelled moneythrough travel agencies by arranging medical conferences, someof which were never held.
Continuing medical education (CME) has long been a majorarea of investment for drug companies as they seek to encouragedoctors to use their products by taking them to meetings wherethe latest advances in medicine are discussed.
In the United States and western Europe, such CME fundingfor doctors is now tightly controlled. But there is littleoversight in emerging markets.
Industry experts say the GSK case shows the hazards facingpharmaceutical companies in China, where a culture of givinggifts is deep-rooted and doctors rely on payments forprescribing drugs to supplement their meagre incomes.
That makes China a particularly tricky jurisdiction in whichto impose head-office ethics, according to Lincoln Tsang, apartner at the London offices of law firm Arnold & Porter.
China is also probing potential malpractice at other firms,with Belgium drugmaker UCB visited by Chineseauthorities this week.
GSK says its global code of conduct applies just as much inChina as anywhere else and it has zero tolerance of bribery.
Getting the internal audits rights is not straightforwardfor multinational companies - especially if high-up individuals,who auditors expect to be onside, turn out to be involved in theconspiracy because that is the local culture.
"There is a disconnect between the global decision makersand the guys running things on the ground," said Jeremy Gordon,director of China Business Services, a risk management companyfocusing on China.
"It's about initially identifying red flags and thensearching for specifics."
TRAVEL AGENCIES "USED LIKE ATMS"
Still, other auditing experts are asking why and whether GSKauditors failed to comb through the Chinese unit's marketingexpenses. They say that one red flag was the number of chequesbeing written to travel agencies for sending doctors to medicalconferences, although this may have been blurred by the factthat CME accounts for a huge part of drug industry marketing.
Nonetheless, it was an obvious area for suspicion, accordingPaul Gillis, author of the China Accounting Blog and also aformer PwC partner.
"Travel agencies are used like ATMs in China to distributeout illegal payments. Any company that does not have theirinternal audit department all over travel agency spending isnegligent," he said.
On Monday, GSK said it had put an immediate stop on the useof travel agencies identified so far by Chinese investigatorsand was reviewing all historic transactions.
The official Xinhua news agency said on Thursday thatauthorities in Shanghai had suspended the business of theShanghai Linjiang International Travel Agency, one of thebusinesses linked to GSK.
These travel agencies may have been a blind spot for GSK,auditing experts said. Previous charges of corruption that wereraised by a whistleblower, and which GSK said earlier this yearwere without foundation, did not involve agencies.
China currently accounts for just 3.5 percent of GSK drugsales but demand is growing fast - up 17 percent last year - andthe company is investing heavily, with more than 7,000 staff inChina, as well as five factories and a research centre.
In the wake of the scandal, analysts at Berenberg bank saidGSK was likely to have to implement a disruptive overhaul of itsChinese commercial organisation.
Glaxosmithkline (GSK)