Thursday, September 11, 2014

Reporting Fraud: An Uphill Battle, Especially in China

We often hope to see the people committing fraud receiving punishment. Unfortunately, this is not always the case. A recent New York Times article by Floyd Norris reports that Kun Huang spent two years in a Chinese prison – not because he committed fraud, but because he detected it. The consequences for reporting fraud are not generally quite as severe as they were for Mr. Huang, but they do often include ridicule and other challenges for many whistleblowers. While reporting fraud is an uphill battle, especially in China, it is definitely one that is worth fighting.

Mr. Huang researched companies that were newly listed on the United States’ and Canada’s stock markets. Over time, the company he worked for gained a reputation for detecting fraud in Chinese companies, and they published a list of those companies online. Mr. Huang researched Silvercorp, a mining company with its largest mine in China. They filmed trucks leaving the mine and sampled ore that fell off of the trucks, which led them to publish a report stating that Silvercorp couldn’t be doing as well as it had reported, due to the volume of trucks leaving the mine and percentage of silver in the rock.

Mr. Huang reported his findings, but instead of the Chinese government rewarding him for discovering fraud in a company, he was arrested and spent two years in prison. When Mr. Huang was originally arrested, the officers questioning him continually received phone calls and then demanded further information about his investigations.  Mr. Huang “believes [the calls] were from Silvercorp officials.” In China it appears that Silvercorp had a lot of influence over the judicial system and over what the punishment would be for people who tried to report fraud or anything negative about their company. If Silvercorp has this much power to manipulate the government to help them cover fraud, are there other companies in China doing the same thing? Can financial reports from Chinese companies be trusted? The SEC apparently has similar questions, because earlier this year it banned the Big 4 accounting firms from auditing U.S.-listed Chinese companies. By suspending firms from auditing U.S.-listed Chinese companies, this could lead to the companies not be able to trade because investors won’t have the data they need in order to trade. Perhaps the SEC does not want some of these companies’ stock to be listed in the United States. Floyd Norris said the following in another article about audits done in China:

“The board [The PCAOB] has found small American firms that were certifying Chinese audits that they basically did not do. And Chinese affiliates of the major firms have audited, and approved, financial statements of Chinese companies that turned out to be fraudulent. That does not prove their audits were badly done — good audits can miss frauds — but it does provide an indication that improvements may be necessary.”

It is clear from these accounts that there are definitely issues in the reporting and auditing of financial statements in China. As Floyd Norris said, “China has shown more hostility to those who found the frauds than to those who committed them.” And after the imprisonment of Mr. Huang, it appears as if the Chinese government would prefer to hide the problems rather than to fix them.

In the United States, the government does not punish the whistleblower for reporting fraud, and there are not nearly as severe of consequences as there can be in China, but there are still potential challenges for blowing the whistle on a company in the United States. A few years ago an airline pilot posted about security flaws he felt airports weren’t addressing, and “a team of six federal agents and Placer County sheriff's deputies arrived at the pilot's home to take the pilot's FFDO handgun and badge.” In another well-known instance, Sherron Watkins reported fraud at Enron, and because of the fraud that was committed thousands of employees at Enron lost their jobs. While she did the right thing, she was subsequently treated with hostility by many people within the company. Despite their good intentions, many whistleblowers lose their jobs and experience other negative social consequences.

Although the whistleblower is often treated with just as much animosity—if not more—as the fraudster themselves, it is worth it to report fraud. Even though Mr. Huang spent two years in prison, the reports that his company published led to seven companies being delisted from the United States stock market, three of which the S.E.C. has filed fraud suits against. Because those companies were delisted, investors around the world will be protected from relying on falsified financial statements. In addition to helping investors have reliable information, many whistleblowers are also compensated with large monetary awards.

If you have noticed fraud and are thinking about reporting it, have the courage to do the right thing, but be prepared and understand the potential challenges coming your way. Reporting fraud is an uphill battle, but it is definitely one worth fighting. Be grateful that in the United States reporting fraud is much easier than in China. Learn more about whistleblower protection programs in the United States and the rights you have by following this link.

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