Case study: Governance issues and mitigating fraud risk in China

A service provider had two offices – a main office in Beijing and a branch office in Shanghai. The Shanghai branch had two mid-level employees, but there was little oversight and one of these employees had a great deal of autonomy. This employee provided professional services to clients and had responsibility for issuing invoices to the clients, preparing the branch office accounts and arranging payments. This employee was also responsible for managing the company’s documents and chops.

Following an internal management change, Sovereign was asked to go to the branch office and audit the books and review the internal processes. As part of this review, we took the following actions directly:

• Took control of all the chops and key documents;
• Reviewed any allowances recorded and paid out;
• Reviewed all invoices sent out in previous years;
• Reviewed the internal banking ledger and compared it to the originals (having taken control of the chops we could request the complete transaction history from the bank).

During the internal review we noticed transactional inconsistencies and unnecessary cash withdrawals. We contacted the clients with whom this employee interacted and cross-checked the invoices sent out.

As a result of our analysis, it came to light that the employee had been:

• Using petty cash for personal expenses;
• Sending out invoices to clients that requested them to pay fees to a personal account;
• Personally engaging with current clients outside the company;
• Falsifying bank account statements to disguise these actions.

Sovereign found that over 200,000 RMB had been stolen from the company through this employee’s actions. After a two-year legal action and by using the information provided by Sovereign, the company was able to recover a majority of the funds stolen.

How can you ensure this does not happen to your operations in China?

Key points:
– Never allow one individual to control the chops or any statutory documents;
– Never allow one individual to control payments and internal accounting;
– Never allow one individual to be responsible for issuing invoices.

Foreign invested enterprises with small operations in China often give employees a substantial amount of autonomy – and often with little or no oversight. At best this can create opportunities for fraud. At worst this can put your entire investment in China at risk.

The ultimate responsibility for preventing and detecting fraud rests with an organisation’s management and staff. The only sure-fire way a company can be certain it is properly addressing fraud risks is to put fraud risk assessment and response on the board’s agenda. Complacency is not a luxury that foreign invested enterprises with operations in China can afford. It is essential to take a proactive approach to governance issues and mitigating fraud risk.