Case Studies of Fraud in China - Association of Certified ...€¦ · Source: Anonymous Analytics Tianhe Report – September 2014 . Business Model Overly complex management structures

Case Studies of Fraud in China

Behind the Financials

17 November 2014

■ Brief Introduction

■ Setting the Scene

■ Overview of Red Flags for China Companies

■ Risk Groups

■ How to Mitigate Risk

Agenda

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FTI Consulting: A Leader Among Leaders

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FCN Publicly traded

$2.2 BLN NYSE listed enterprise value

1982 Year founded

4,200+ Employees worldwide

450+ Senior Managing Directors

2 Nobel Laureates

10/10 Advisor to the world’s

top 10 bank holding

companies

95/100 Advisor to 95 of the

world’s top 100 law

firms

55/100 55 of Fortune 100

corporations are clients

16 Experts in 16 industry

specialties

78 Offices in 78 cities around

the globe

Advising Across a Global Economy

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We deploy more than 3,100

professionals in 26 countries from

every major financial centre to every

corner of the globe so that we can

serve our clients wherever

challenges and opportunities arise.

Asia Pacific

Australia

Brisbane

Gold Coast

Melbourne

Perth

Sydney

China

Beijing

Guangzhou

Hong Kong

Shanghai

India

Mumbai

New Delhi

Indonesia

Jakarta

Japan

Tokyo

Philippines

Manila

Singapore

Europe, Middle

East, Africa

Belgium

Brussels

France

Paris

Germany

Berlin

Frankfurt

Ireland

Dublin

Qatar

Doha

Russia

Moscow

South Africa

Cape Town

Johannesburg

Spain

Madrid

United Arab

Emirates

Abu Dhabi

Dubai

United Kingdom

London

Stirling

Latin America

Argentina

Buenos Aires

Brazil

Rio de Janeiro

São Paulo

Caribbean

British Virgin Islands

Cayman Islands

Colombia

Bogotá

Mexico

Mexico City

Panama

Panama City

North America

Canada

Calgary

Toronto

Vancouver

United States

Annapolis

Atlanta

Baltimore

Boston

Brentwood

Charlotte

Chicago

Coral Gables

Dallas

Denver

Great Neck

Houston

Indianapolis

Los Angeles

McLean

Miami

Mountain View

New York

Oakland

Pasadena

Philadelphia

Phoenix

Pittsburgh

Portland

Princeton

Red Bank

Rockville

Roseland

Saddle Brook

San Francisco

Santa Barbara

Seattle

Tucson

Walnut Creek

Washington, D.C.

Wayne

West Palm Beach

Winston-Salem

Global Risk and Investigations

FTI Consulting’s Global Risk and Investigations Practice is the leading provider of comprehensive business risk solutions including

reputational due diligence and other business intelligence, fraud and corporate investigations, data forensics and electronic evidence

recovery, brand protection, the strategic management of intellectual property and crisis containment services in Asia.

Whether the task is to determine the reputation and suitability of a business partner, untangle a complex fraud scheme, investigate

allegations of bribery or contain a business crisis, the aim of FTI Consulting is to provide our clients with critical information, insight and timely

solutions for informed decision-making.

The teams of seasoned professionals of our Global Risk and Investigations Practice in Asia are drawn from backgrounds in senior law

enforcement, academic and economic research, forensic accounting, information technology and investigative journalism.

What We Do

“Most corporate

investigators are

privately held and

publish little

financial

information…But

these days many

consider the best

in the business to

be FTI Consulting,

which also

happens to be the

only publicly

traded firm of any

size.”

Corporate intelligence:

The bloodhounds of

capitalism

The Economist

5 January 2013

Business Intelligence

Investigative due diligence

Pre-IPO due diligence

Political and business risk

assessments

Competitor assessments

Business intelligence in

corporate contest situations

Post transaction monitoring

Other business intelligence

and analysis

Fraud and Corporate

Investigations

Fraud investigations

FCPA and other corruption

related investigations

Asset searching

Data forensics & electronic

evidence recovery

Conflict of interest

investigations

Litigation support

Cyber crime investigations

Pre-employment integrity

investigations

Insurance claim investigations

Brand Integrity

Strategic management of

intellectual property

Investigations into IP losses

Investigations into licensing

disputes

Counterfeit investigations

Grey-market and parallel

trading investigations

Market surveys

Coordination of IP

enforcement

Printer packaging forensic

investigations

Royalty audits

Trademark agency

Other Risk Mitigation and

Consulting Services

Crisis containment consulting

Ethics hotline management

Employee exit risk

management

Threat assessments

Contingency planning

Security risk audits

Anti money laundering

consulting

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Setting the Scene

Country Risks

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…But Really Fraud is Everywhere

Common Methods Overview

Definition of occupational fraud

■ “The use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of

the employing organisation’s resources or assets.”

■ Asset Misappropriation

■ Bribery and Corruption

■ Financial Statement Fraud (e.g. earnings manipulation, fictitious transactions etc.)

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Source: Association of Certified Fraud Examiners

Common Methods Overview

Overstatement of revenue

■ Revenue overstatement may be from different forms of collusion, timing and recognition issues or outright

fake sales.

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38%

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Types of Fraud Schemes

Source: Deloitte Review of SEC Enforcement Releases 2000-2008

Common Methods

■ Creating excessively complicated and hard to untangle related-party transactions

■ Deliberately opaque companies in general, particularly in regards to corporate governance and internal

controls

■ Reporting phony bank balances (occasionally with the collusion of the bank itself) or using short-term

transfers to mislead auditors

■ Inflating the value of assets

■ Creating fake customers

■ Creating fake facilities, offices and staff numbers

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Substantive fraud typically requires collusion with third

parties, from other companies to regulatory authorities

Overview of Red Flags for China Companies

Comparisons

■ Companies with a short track record – although beware of potentially misleading comparisons

■ Unusually high margins in comparison to peers

■ Unusually fast growth

■ Insufficient tax paid in comparison to reported profits

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Source: Anonymous Analytics Tianhe Report – September 2014

Business Model

Overly complex management structures and unclear shareholder relationships

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Concerns Over Auditors and Quality of Financial Statements

Why audit doesn’t work

■ Auditors are a watchdog, not a bloodhound

■ Specific set of limited procedures to verify balances, not investigate potential misconduct

■ Audits seen as a commoditised, cheap, limited value adding process

Send out the debtor confirmation Check bank statements for receipts Verify against company records

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Orient Power Electronic Ltd HKD JOURNAL LISTING Page *** Printed 01/01/2006 16:20

Journal Type: ALL Journal Source: ALL Journal Number: ALL Entry Period: 01/2004

To: 12/2004

------------------------------------------------------------------------------------------------------------------------------------

Lne Account Account Name Trans Date Debit Credit Account A n a l y s i s C o d e s

No. Code Reference Due Date Description Amount Amount Period CO/BK TRANX CUST Model CUTY

Asset Asset Name Sub Code V/I/D

------------------------------------------------------------------------------------------------------------------------------------

Journal Number: 0024761 Type: BKRF Name: Entry Date: 24/03/2004 Source: G13

3 12017A C/A-Standard Chartered 26/03/2004 3,568,720.00DR 03/2004

BR0400230 26/03/2004 ADVICE SALES OF MATERIAL

4 8L010S Lucky Way Enterprise Ltd. 26/03/2004 3,568,720.00CR 03/2004

BR0400230 26/03/2004 ADVICE SALES OF MATERIAL

Risk Groups

Operational Risk

Corporate Governance

■ Close examination of the ownership of the company is crucial

■ Are they related? What is the full extent of the personal and professional connections between

management, directors and shareholders etc.?

■ Are they qualified?

■ How and why did they get into the industry?

■ Where did their first million come from?

■ Have there been several changes to management over time?

■ Any sudden changes?

■ What other business interests do management have?

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Operational Risk

Business models and financials

■ Continual shifting of investors’ focus by changes in business lines and new ventures

■ Serial acquisitions of other firms, particularly if these appear to be designed to make it difficult for an

independent observer to trace company acquisitions over time

■ Discrepancies between State Administration of Industry and Commerce (“SAIC”) filings and overseas

filings…READ the small print!

■ Filings that are delayed or entail different auditors

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Reputational and Regulatory Risks

■ Has the company been involved in any civil litigation, past or present?

■ Has the company been involved in any disputes with industry peers, local enterprises, associations,

industrial parks etc.?

■ What about disputes with staff? Or customers?

■ Has the company been involved in any environmental disputes?

■ Trademark and patent infringements?

■ Are key principals at the company currently under investigation by local regulatory authorities? Or more

seriously, the Party itself?

■ Have any fines or sanctions been levelled against the company and/or its key principals?

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How to Mitigate Risk

Risk Evaluation System

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Risk Evaluation System (Cont.)

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Risk Evaluation System (Cont.)

Comprehensive Due Diligence

Investigative research and public records checks

■ There is a lot of information available in the public and semi-public domain in China

■ Press reports, trade journals, industry associations, corporate postings, local and provincial government

announcements etc.

■ Social media: industry-specific blogs, forums, profiles (professional and personal), advertisements etc.

■ Corporate records from the SAIC

■ Court records from district level up to Supreme Court

■ Bribery and Corruption database

■ Patents, land registration, tax payments, even hotel stays

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Reputational DD

Financial Statements Review Commerical & Legal DD


Discreet inquiries

■ So-called human intelligence – can be invaluable in getting information between the lines

■ Industry associations, regulatory authorities, local bureaus

■ Industry peers, competitors, clients, suppliers, logistics partners

■ Former employees, industry analysts, journalists

■ (Discreet) site visits are often a crucial element of inquiries and can be extremely useful in verifying the

existence of facilities and assets, and establishing levels of activity within

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Site Visit Example One

25 Confidential – Not For Further Dissemination


Site Visit Example Two

26 Confidential – Not For Further Dissemination

First Discreet Visit Overt Visit Follow up Discreet Visit

We observed that the signage of the

gas station reads Gas Station in our

initial discreet visit

During our overt visit, we observed

the gas signage was covered with a

banner which reads the name of the

Company

We identified the same gas station

in our subsequent discreet visit. We

note that the banner has been

removed


Confidential – Not For Further Dissemination

Site Visit Example Three

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A close up photograph






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We observed CNPC signage at the

office building next to Gas Station 1

Similar to the roof of gas station,

the office building adjacent to the

gas station has a banner which

reads the name of the Company

The banner had been removed

during our subsequent discreet visit




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We note that the gas pumps had

company stickers placed on them

during our overt visit; no Company

stickers were observed on the gas

pumps during both our discreet

visits




30


Five of Gas Station 3’s official

documents hanging on the back

wall

Observed different set of

documents were found on the office

wall

No picture available




31


We observed business permits

hanging on the lobby wall

During our overt visit, the business

permits were removed from the

same wall

No photograph in office interior

available




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Questions?

Thank You and please contact me at

[email protected]

mailto:[email protected]

Documents

Case Studies of Fraud in China - Association of Certified ...€¦ · Source: Anonymous Analytics Tianhe Report – September 2014 . Business Model Overly complex management structures