Business, the honest way: six measures to prevent fraud

Experts refer to China as a high-risk market for fraud. Can you trust your agent, your suppliers, even your own staff in China? Maybe, maybe not, says Thibaut Minot, fraud prevention expert at Dezan Shira & Associates. Club China Helpdesk asked him to elaborate on the risks and the countermeasures. 

Does fraud happen to foreign businesses in China?  

Thibaut Minot of Dezan Shira & Associates: “Definitely. An example: after receiving internal reports about accounting irregularities at its Chinese branch, a French automotive parts manufacturer learned from an external audit that the Chinese GM was secretly embezzling money from the company. Auditors found a significant mismatch between the value of the products shipped out of the warehouse compared to the company’s sales figures. In secret, the GM offered customers enticing discounts if they were willing to forego a formal tax invoice and pay the company through Alipay. The Alipay account in question was linked to personal bank accounts opened in the General Manager’s name – the man successfully stole several million RMB undetected.” 

Does fraud always look as spectacular as this?  

“Fraud can happen in many ways. Small companies with a small China team should be concerned about the proper segregation of duties, for instance, with all things related to cash receipt and cash disbursement. If the same person initiates and approves e-banking payments, or if one individual holds both the company chops and the corporate check book, there is a real risk of the occurrence of cash theft or fraudulent disbursements.  

“Companies running large teams should carefully monitor the local payroll system, or otherwise risk being subject to fraudulent payroll and reimbursement schemes.” “Also, trading and manufacturing companies performing sourcing activities in China should pay special attention to their supplier selection and management strategies. Such companies are prone to the collusion of their sourcing team with suppliers against the promise of bribes, or witness their local management select the companies of friends and relatives to act as suppliers. These examples of conflicts of interest are common in China.” 

What can a company do to prevent fraud?  

“There are six measures a business can take to keep the risk of fraud small.  

First: When starting a new business venture in China, it is vital to embed internal control mechanisms within the company’s governance structure. A clear segregation of duties sets the foundation for an effective reporting line, allowing shareholders to have better supervision and control over their China operation in the long term. 

Second: monitor custody of company chops. On an ongoing basis, the shareholders should monitor whether each person is fulfilling their duty in accordance with the company’s Articles of Association and PRC Company Law. Likewise, in China, careful consideration should be awarded to the assignment of the custody of the company chops - the all-important seals or stamps. In effect, whoever holds the company chops is de facto granted authority to act in the company’s name. 

Number three: For trading or manufacturing companies, implementing internal controls related to inventory management is essential. Having an automated warehouse management system could significantly limit the incidence of inventory misappropriation, while physical stock takes should also be performed periodically to verify the accuracy of electronic data and reduce the risk of employees tampering with the system. 

Four: for the sales department, price ranges for different products should be firmly set. A sale outside the set range, should be requested to secure additional approval from a senior manager. This dampens the potential for cash theft or collusion with customers.  

Five: a segregation of duties regarding cash management is absolutely essential to limit the incidence of cash theft. The responsibility to initiate and approve e-banking requests, for instance, should be separated. One practical solution could be for the finance manager at HQ level to hold the e-banking token required to approve payments. Likewise, the cashier holding the corporate check book should not have free access to the company chops; otherwise, that employee would have the opportunity to initiate payments at the bank undetected.” 

“And finally, sixth: check your key personnel at the hiring stage as well as your potential business partners prior to entering into important commercial agreements. HR managers in China should verify the candidate’s criminal record, perform a face-to-face interview early-on in the interviewing process (or a video call if the recruiting manager cannot physically travel to China), ask to see the degrees and certificates, as well as request references from past employers and actually contact these persons. Similarly, foreign companies should conduct a discrete investigation of perspective suppliers, including a review of the Administration for Industry and Commerce (AIC) company records, a verification of the business’ financial performance, and asking for references from existing customers. Make sure you meet the potential supplier face-to-face prior to signing a deal and to visit the supplier’s factory, or otherwise appoint a trusted person or third-party agent to do so on your behalf. Unfortunately, foreign companies have been deceived by their Chinese suppliers, such as in the non-delivery of goods upon purchase, the delivery of goods of unsatisfactory quality, or internet fraud from the part of fraudsters disguised as suppliers.” 

Dezan Shira & Associates is a business, legal, tax, accounting and payroll firm, with offices in China. 


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