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The Foreign Language of Fraud: U.S. Companies Are Especially Vulnerable in China

If your company has Chinese operations or plans to start doing business in China, you face many challenges—not the least of which is fraud. Language and cultural barriers, geographic distance and rudimentary government regulations mean that Western companies often fall victim to both familiar schemes and variations not encountered at home.

Recognize the signs

Most basic types of fraud experienced in China are the same as those found in other countries, as are the tools to fight them. U.S. companies might need to recalibrate their tools to fight local variations of occupational fraud.

Lack of government oversight, for example, makes it easy for employees to set up companies that compete with their foreign-owned employer—often using that company's technology and other resources. Also, employees may use their employer's assets to secure loans for themselves, which is easy to do when local authorities rarely have the resources to verify assets pledged as collateral.

Supply-related schemes, such as billing foreign investors for more than the cost of goods and services or falsifying production records and charging foreign employers for products not manufactured are also common. When books and records are thousands of miles away, in an unfamiliar language and in a country where accounting standards are still evolving, it can be difficult to know whether discrepancies are a result of sloppy bookkeeping or outright fraud.

Have a policy—and implement it

Although Western companies rate fraud as a significant risk in China, they don't appear to be taking steps to minimize the risk, according to a 2006 Ernst & Young survey. Even in markets where fraud is known to be common practice, only 32% of staff are trained to recognize the difference between facilitation fees and corrupt payments, the survey found. What's more, 25% of employees receive no training in how to implement anti-fraud policies—even when policies exist and are communicated.

At many companies, there are significant discrepancies between the anti-fraud policies U.S.-based management believes are in place and the reality as practiced by local operators. Chinese managers who are compensated based on their ability to minimize costs might be tempted to falsify records or workplace conditions, as well as financial dealings.

Know your partners

One preventative measure is to proceed cautiously into the Chinese market. Before you set up shop, consult financial and legal experts knowledgeable about Chinese regulations and culture to assess the feasibility of and risk involved in your plans.

Once you've set up operations in China, avoid relying too heavily on local managers. Keep at least one U.S. manager on-site to monitor day-to-day activities, and enlist the help of independent auditors to regularly review the books rather than relying exclusively on the trustworthiness and knowledge of internal accounting personnel.

Finally, make sure your internal controls and anti-fraud policies are implemented and enforced. Poor management-employee communication and insufficient training can sabotage even the most effective program, both need to be an ongoing part of every anti-fraud undertaking.

Remember your priorities

In the wake of recent food contamination scandals and the international scrutiny involved in hosting the 2008 Summer Olympic Games, the Chinese government is actively working to clean up fraud. But it's likely going to take some time. So, even if you're eager to take advantage of new and seemingly limitless opportunities in China, approach them with caution—and a fraud prevention plan.

Questions about fraud?
Contact Brian Langham at 312-980-2990.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.