Fraud prevention, Due Dilligence and Know your Customer (KYC) in China

Fraud prevention, Due Dilligence and Know your Customer (KYC) in China


The People’s Republic of China has attracted a huge number of foreign companies to enter the market since opening the doors of foreign investment four decades ago. Many foreign owned companies make excellent business in China, however, equally many are cheated out of their technologies, business and profits by a variety of fraud, either internal, external, or criminal actions, the most recently in cyberspace.

Proper legal compliance, constant monitoring and proper compliance and Supervisor work are answers to fight fraud and crimes in China, and these matters cannot be overlooked by prudent investors and corporate leadership.

Experience has shown three level approach to fraud prevention which target internal, external and cyberspace threats.Remedies are presented below.

One – Internal Fraud by Business Partners, Personnel or Staff

Corporate internal fraud can be caused by business partners or own company personnel, and,therefore, proper partner due diligence checks and personnel background checks are to be performed before engaging in China into any business dealings, activities or employment relationship.

Today, most of the key cities in China have good online records on Chinese or foreign corporate establishments and businesses.Performing a basic background check on your proposed business partners, their legal existence, registered address, key personnel, registered and paid-in capital is a relatively easy task.

However, a thorough due diligence check requires much more efforts in cases where such information is needed from prospective business partners such as in Joint Venture Companies, M&E or investment projects.

Organizational,internal and insider risks and fraud related to own employees and staff are unfortunately common in China. Every foreign company should pay close attention to internal fraud and own personnel actions at their recruitment and work process to minimize unpleasant consequences of internal fraud.

Employment Handbooks are now obligatory for Foreign Invested Companies in China. Properly made Handbooks shall include clear references to the corporate codes, effects of fraudulent behavior and legal rights to check any possible criminal records and performances with previous employers.

In case internal fraud is suspected, it is important to react fast and gather evidence before it is destroyed. In China, evidence must be properly notarized in case of any court actions are planned. Evidence based to serious matters should be immediately reported to police for proper handling and later use in courts. In less serious matters, evidence provides employees bargaining power at labour contract termination negotiations.

Two – External Fraud and Monitoring Programmes

In contrast to internal fraud, external fraud concerns about third-parties such as government officers, customers, supplies, logistics and delivery companies and similar entities by over-charging, building-in commission structures or other form of fraud.

In China, both customers and suppliers are fast to take advantages of their clients who are not aware of Chinese business practices, local payment methods, quality control and intellectual property protection. Therefore, foreign companies entering to China are well advices to take proper actions to reduce their risk exposure to external fraudulent practices.

In sourcing operations, purchasing managers shall conduct proper supplier due diligence and investigation on each prospective supplier. This includes visits to their physical premises and checking their records at China Company Registry and Chinese court system for any litigation outcomes and black listing by Chinese officials as well as obtaining references from existing foreign customers.

Experience has shown that nothing is better protection in China than properly formulated Manufacturing, Sales and Purchase Contract with clear supplier obligations, clients rights, choice of law and dispute settlement mechanism with related Purchase Order details including possible defects, non-delivery or any Breach of Contract.

However, foreign investors must understand that external fraud control mechanisms are not working if proper fraud prevention and contract management programs are not fortified with monitoring systems and fast response strategies.

Three – Cybercrime, Money Laundering and Know Your Customer Review

Today, much business is performed over the internet in China. This opens opportunities for internet fraud and crimes where fraudsters are disguised as business partners or suppliers delivering goods to companies or most recently sending fake invoices and wrong bank information to unsuspecting companies.

To protect themselves and safeguard vital company data, foreign companies shall enact proper policies and insist employees and staff to follow strictly these company data management and security protocols. Company personnel may only use company provided hardware and software products to prevent unauthorized hacking and entry to company data bases and information.

Moreover, the use of private equipment shall be banned for company business since the Chinese data privacy protection may complicate the collection of work-related information from personal laptops or mobile phones.

Money laundering is under radar of Chinese authorities and an effective method to protect any foreign company from legal problems in China is to conduct proper Know Your Customer (KYC) assessment related to prospective key business partners, alliances and investors for anti-money laundering issues, industrial espionage and IP infringement risks.

Finally, every corporate leader in charge of Legal Compliance, internal and external audit and cyberspace safety should understand the need of constant reviews, monitoring and need of engage knowledgeable third-party resources to perform legal and regulatory compliance, due diligence, fraud prevention or cyberspace inspections and supervisor audits in China since regular statutory audit by CPA companies provide very little protection against these fraudsters.

Internet definitely has made China business and supplier search effective in China but supplier face-to-face meetings, factory visits and third-party quality inspections can not be overlooked even though much of the business is run in electronic form.


Jari E. Vepsäläinen



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