I took part in an interesting event organized by the European Chamber of Commerce in China, with the participation of 3 members of EY’s Fraud Investigation & Dispute Services department.

Are you worried about shady practices taking place inside your company, or in some of your suppliers’ factories? This article is for you.

Here are common ways fraudsters can get money out of a manufacturing operation:

• In the factory construction phase: using grade B concrete instead of grade A concrete, etc.;
• Diversion of business to a company owner by a decision maker;
• Inflated price of tooling, or investment for new tooling that is actually never made (old tooling still in use);
• Abusing the warranty and declaring products as defective (but keep using them, maybe in another facility);
• Inflating the costs of some materials purchased and then getting a kickback — in China this is a question of “how much”, nearly never of “whether this is the case”;
• Inflating the cost of the canteen (usually a cash-based opertation) and then getting a kickback.

Chances are, your supply chain includes several of these issues… The notes I took (coming from EY’s presentation) are reproduced below. I hope it’s useful.

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1. The three types of fraud, and a few examples

Asset misappropriation

• Inventory theft
• Cash theft
• Conflicts of interest – for example giving business to a supplier owned by a decision-maked in the company at a markup, or conversely selling at a discount to a related company

Corruption

• Bribery
• Kickbacks – a purchaser gets a supplier to give a kickback
• Illegal gratuities – pretty close to kickbacks
• Economic extortion – harming a vendor if they don’t accept to do what is listed above

Fraudulent statements

• Financial – recognizing certain transactions as revenue in order to hit revenue goals
• Non-financial

2. How to prevent fraud & bribery

Limit the opportunity to commit fraud

• Bidding process for vendor process — insist on it, even if the Customs of PSB officials recommend one vendor
• Limit access to information inside the company
• Job rotation

Identify the pressures some employees are feeling

• Whistleblower policy, and proper assurance that this process will protect the whistleblower — it is much better than seeing people go straight to the police
• Counselling – have an open door for discussing issues
• Making sure compensation and bonuses are perceived as fair

Make fraud an undesirable act

• Code of conduct
• Related terms in the employment contract

3. How to detect fraud & bribery

Look out for warning signs

• Sole suppliers
• Abnormally high prices paid to suppliers
• Long outstanding receivables
• Do regular stock counts and analyze discrepancies
• Visible change in the lifestyle of some employees

Get some data from your IT system

• Reports on amendments of base data
• Reports on deleted transactions
• Reports on credit notes
• Reports on user logons

4. What do do if you find something?

An in-depth investigation might not find hard evidence. And the process to do this legally and effectively may be quite heavy (notarizing the evidence, imaging the computer in order to keep the files unchanged, turning the computer to see some info in web-based QQ/Wechat accounts, etc.).

There are other ways to minimize fraud, such as rotating employees among different functions.