A1--Corporate Fraud in China--Mazars_Greater China_article--AC 140904
1. UPDATE ON
CORPORATE FRAUD IN CHINA
September 2014
Having emerged as the world’s second largest
economy, after the U.S.A., China remains an
attractive and growing market which presents
great opportunities to multinational companies
for development and expansion. However, due to
the unique relationship or “guanxi” oriented social
culture (i.e. developing connections with people
of influence), doing business in Mainland China is
not easy and often comes at the cost of fraud and
corruption.
In the old days, multinational companies without
much personal relationships or connections built
up with local government officials typically found
it difficult to operate their branches in China, and
accordingly state-owned enterprises dominated
the market.
Overthepastdecades,moreandmoremultinational
companies shifted their production lines and
supply chain to Mainland China. Some of them
focused closely on establishing their businesses
and achieving high profitability in the new market
but failed to put in a strong internal control system
to combat frauds. In recent years, a growing
number of enforcement actions have been taken
against multinational companies in connection to
fraudulent trading activities, irregular business
conduct and/or bribery/corruption involving their
Chinese counterparts and/or the local government
officials.
In December 2009, UTStarcom Inc. (“UTStarcom”),
a U.S. listed telecommunications company based
in California, was charged by the U.S. Department
of Justice and the Securities and Exchange
Commission with violation of the Foreign Corrupt
Practices Act of the U.S.A. It was discovered
that UTStarcom had paid employees of their
Chinese customers (including state-owned
telecommunications firms) for trips to attend
“training sessions” in the U.S.A., which turned out
to be no more than sightseeing activities in Hawaii,
Las Vegas and other tourist attractions.
Another major corporate fraud scandal reported
was in relation to the British drug maker
GlaxoSmithKline (“GSK”) in July 2013. GSK
China was accused of offering bribes to local
medical practitioners, government officials,
Mazars is an international,
integrated and independent
organisation, specialising
in audit, accounting, tax and
advisory services.
We rely on the skills of more
than 13,800 professionals in
the 72 countries which make
up our integrated partnership.
2. hospitals and others through the accounts of
some travel agencies. This was an example
of an indirect bribery scheme whereby a third
party was engaged to channel funds for bribery.
Very often, senior management of multinational
companies were under the mis-conception that
third party payments of bribery did not extend to
the multinational companies. This perception was
totally wrong and, most importantly, detrimental to
the reputation of business internationally.
Again, in August 2013, the leading French food
products manufacturer Danone Dumex was fined
RMB 172 million by the Chinese government for
price fixing. Investigations discovered that the food
company had contracted with distributors to fix the
resale prices of their products, thereby violating
local legislation including the Anti-Monopoly Law.
Anti-corruption has always been the top priority of
the Chinese government’s reform policies. Since
2013, the anti-corruption campaign of President
Xi Jinping (习近平) has sent a clear message to
the public that the new Chinese government is
determined to crack down heavily on fraud and
corruption. Recently, we have witnessed some
high-profilecasesinwhichtopChinesegovernment
officials and senior management of state-owned
enterprises were placed under scrutiny and
disciplinary actions.
One of the new measures in the Chinese
government’s anti-corruption campaign is to cut
down lavish and extravagant expenditures on
dining, transportation, gifts and entertainment, etc.
At the corporate level, it has been a common fraud
to misuse funds for personal interest or bribery
by way of expense reimbursement schemes,
such as making fictitious claims or requesting
reimbursement of personal expenses as if these
were incurred for business purposes.
Mazarshasextensiveexperienceinhelpingclients
to investigate such frauds and irregularities in
their business operations in China.
We set out below some of our actual cases:
CASE 1
We were engaged by the head office of a
multinational company to investigate a general
manager of its China operations. The general
manager was suspected of having abused his
power at the company’s expense for his own
benefit. In our investigation, we reviewed the
accounting records, interviewed company staff and
other relevant parties and conducted searches on
some suspicious companies and other parties. It
was found that the general manager instructed the
accountants to adjust the company’s accounting
entries to reduce the amount he owed to the
company. The general manager was also found to
have approved payments to himself, reimbursed
club memberships held in his own name and other
personal expenses, without prior approval from
the senior management at head office.
Fictitioussalaryrecordswerealsofoundasacover-
up for payments made to the general manager.
Furthermore, without any bidding process, service
contracts were awarded to companies owned by
his spouse and close friends.
Additionally, the general manager had set up a
competing company without the knowledge of
head office. A non-interest-bearing loan had
been granted by the general manager on behalf
of the company to the competing company. In
total, losses suffered by the company from these
various frauds amounted to RMB 4 million. Based
on our findings, we made recommendations to
the company and provided options for the client,
including legal action against the general manager
to recover the losses suffered.
3. CASE 2
An anonymous email from a whistle-blower alleged
that a sales manager had been claiming personal
expenses from the company as business-related
expenses. We analysed the expenses reimbursed
to the manager against his business trips schedule
and found that taxi fares and hotel accommodation
expenses were allegedly incurred during days on
which the manager was not on business trips. We
also discovered that some of the invoices submitted
by the manager were fake while others were
related to personal groceries and food expenses.
The expenses supported by the fake invoices were
comingled with the business related expenses such
as business lunches or client conferences. We
submitted our findings to the company and made
recommendations for appropriate disciplinary and
legal action against the manager.
In conclusion, a robust internal control system is
necessary and reasonably expected by regulators
to be implemented to protect a business from
financial loss arising from fraud, theft and other
dishonest acts, misconducts or omissions. In order
to achieve a long term and sustainable business in
China and to protect the interests of investors and
other stakeholders, it is important for companies
to set up and implement effective internal control
policies and procedures as well as to enhance
corporate governance for prevention and detection
of frauds.
We would strongly recommend senior
management to practice the rule of thumb “trust
but verify!”. Regular health-checks by forensic
accountants will also assist senior management to
identify fraud risk areas before it is too late. The
reputational risks to companies of not doing so can
be very costly.
Annie Chan
Managing Director,
Forensic and Investigation Services
Mazars Hong Kong, China
