South China Morning Post Investigation Details How “Consultants’” Assist Chinese Factory Owners to Evade Labor Laws

It is no surprise to companies with robust anti-bribery and anti-corruption programs that doing business in China poses high risks of bribery.  A variety of Foreign Corrupt Practices Act (FCPA) resolutions by the U.S. Department of Justice, as well as a bevy of Chinese prosecutions and convictions of senior officials and corporate executives, provide specific examples of long-running systemic corruption.  What is not always clear from most public reporting on corruption in China, however, are the deeply embedded institutional practices and techniques that contribute to the maintenance of systematic corruption.

A January 22 report in the South China Morning Post presents the result of a detailed investigation that examined the relationships between so-called “consultants” and factory owners in China.  These relationships involve “consultants” who advise factory owners on how to flout labor laws through various means.

One consultant told a Post reporter who was posing as a factory owner looking to sell goods to Western buyers, “As long as you cooperate, keep the troublemakers out of the factory on inspection day, and make sure workers follow our guidance on answering questions, we will guarantee you pass.”  Such consultants’ services reportedly range “from basic coaching of workers on how to answer auditors’ questions, to the provision of additional record books – such as a modified set for auditors claiming that all workers are paid in full, on time, and for any overtime worked.”

Other services that the consultants offer include:

  • Arranging “for a particularly friendly auditor to inspect, at a time of the factory owner’s choosing, to ensure that the facility is well-prepared.”
  • Using software “that can conjure up documents for a full team of seemingly legitimate factory workers and records in 90 seconds, including in cases where the actual workers are not of age or do not have the proper documentation, or where time sheets may not be kept, or may be in conflict with China’s labour laws.”  One Chinese consultant, “who documented his activity over 2016 and 2017 on a Chinese blogging site, fabricated an entire suite of documents on employee attendance, payroll and training for a paper-packaging factory in Dongguan.”  At another factor, the same consultant covered for underage workers by going to a nearby print shop “to doctor their identity cards before auditors could see them, telling the auditors that the previous employee list was an ‘input mistake’.”
  • Bringing auditors “to a ‘show factory’ – someone else’s plant that is more likely to meet Western-set standards,” or erecting temporary walls in factories to conceal deficiencies.

The most common practice described in the Post investigation, however, was bribery.  Each of five Chinese consulting firms that the Post interviewed stated that “a bribe would be necessary to pay off the auditor – many of which are from well-known international companies – and get access to accredited platforms that could open doors to supplying some of the world’s top brands.”  A representative of one such consultant said that “For auditors from one firm, you give them a red packet stuffed with cash on the inspection day. Auditors from another firm dare not take the red packet at the scene, so we would transfer the money to them one week before inspection day.”

A variant of this practice, according to a Hong Kong-based supply chain consultant, is for the auditor to tell the factory owner, “’I have forgotten my watch, a Rolex, in your factory – once you return it to me, I will ensure that your factory passes’.”

The Post report also suggests that one factor that may contribute to the growth of these
consultants is the growth of audit-sharing platforms.  These platforms, which “allow member companies to share data on ethical standards at thousands of factories globally,” “are commonly used by brands to minimise audit duplication and improve conditions across the supply chain.”

Although a large company may request that a platform accredit a particular supplier, the platform operators do not conduct the audits themselves, but have a third-party auditor conducts the inspection.  “[I]f the factory passes, the supplier is accredited and uploaded to the platform for one or two years. This opens the door to hundreds of potential buyers – each of which can commission spot-check audits to confirm the inspection is legitimate, but industry sources say these checks are not done as commonly as they should be.”

The Post also reported that a database of more than 5,000 audits conducted in China in 2020 showed that more than 90 per cent of factories audited by third-party auditors for one well-known set of platforms “were not transparent in their documentation and had falsified record-keeping for worker pay, working hours and overtime, suggesting they pose a greater risk of cheating on inspections.”

Although fraudulent documentation and corruption are known to be longstanding problems in China, the Post report should prompt companies depending on Chinese factories’ production of goods to revisit their supply-chain due diligence processes, and to scrutinize any audits that provide positive inspection reports.  In many cases, the practices that the report describes result in “production-line workers enduring marathon shifts without being paid properly, working for weeks on end without a day off, and not being given insurance coverage as required by Chinese law.”  Companies that turn a blind eye to these kinds of abuses risk violating not only labor laws, but anti-bribery and corruption laws in China and other countries.

First Circuit Court of Appeals Rejects Trump Administration Reading of Wire Act

In the U.S. Department of Justice’s toolbox for combating organized crime, one of the oldest (and least used) tools is the federal criminal offense known as the Wire Act.  The Act makes it a felony for anyone,

being engaged in the business of betting or wagering knowingly uses a wire communication facility for the transmission in interstate or foreign commerce of bets or wagers or information assisting in the placing of bets or wagers on any sporting event or contest, or for the transmission of a wire communication which entitles the recipient to receive money or credit as a result of bets or wagers, or for information assisting in the placing of bets or wagers . . . .

Originally intended to attack organized crime’s involvement in interstate bookmaking and sports betting, the Wire Act became a subject of interest to some Members of Congress who perceived it as a potential vehicle to address Internet gambling.  A 2011 opinion by the U.S. Department of Justice’s Office of Legal Counsel (OLC) sought to put that broad construction to rest. It concluded that the Wire Act did not apply to Internet and out-of-state sales of lottery tickets because those sales did not involve sporting events or contests.

In 2018, however, the OLC effectively overruled its 2011 opinion with a new opinion that concluded, based on a crabbed reading of the Act’s text, that the Act’s prohibitions “are not uniformly limited to gambling on sporting events or contests.”  This opinion immediately called into question the legality of state lotteries operating online.  Even as the Justice Department twice extended the forbearance period for enforcement of the Wire Act, in 2019 the U.S. District Court for the District of New Hampshire held, in a legal challenge by the New Hampshire Lottery Commission and one of its vendors, that the Wire Act’s ambit was limited to sports gambling.

On January 20, a panel of the U.S. Court of Appeals for the First Circuit affirmed the District Court’s ruling, holding that the Act’s prohibitions “apply only to the interstate transmission of wire communications related to any ‘sporting event or contest.’”  After determining that the Commission had standing to bring the lawsuit and that the issue was ripe for judicial resolution, the Court stated that “the text of section 1084 [is] not entirely clear on the matter at hand,” and found “that the government’s resolution of the Wire Act’s ambiguity would lead to odd and seemingly inexplicable results.”  It further noted that “the legislative history contains strong indications that Congress did indeed train its efforts solely on sports gambling.”

Although the First Circuit’s decision does not bind other circuits, its analysis of the Act and its legislative history appears sound and therefore would carry substantial weight in other federal courts.  Moreover, the Justice Department in the Biden Administration is unlikely to petition for certiorari to the U.S. Supreme Court, thereby bringing the litigation to an end.  At some later date, the Department is also likely to have OLC revisit the issue, which could lead to withdrawal of the 2018 OLC opinion and reinstatement of the 2011 opinion as the official guidance for federal departments.

For those reasons, the First Circuit opinion should provide substantial comfort for state lotteries conducting online sales.

United Arab Emirates Takes Steps to Counter Money Laundering

Over the past year, the United Arab Emirates has been the focus of sustained public criticism for failure to adopt and implement effective anti-money laundering (AML) measures.  For example, in April 2020, the Financial Action Task Force (FATF) issued a Mutual Evaluation Report that acknowledged “significant improvements” that the UAE had made to its AML/Counter Terrorist Financing (CFT) system in recent years, but also noted that “[t]he risk of criminals being able to misuse legal persons in the UAE for ML/TF remains high” and deemed it “a major concern that the UAE authorities do not recognise the importance of using the full range of sanctions (particularly fines and barring orders) to create a dissuasive environment.”

More recently, the United Kingdom’s Treasury and Home Office issued a national risk assessment on money laundering and terrorist financing that described the UAE as “an attractive location for those who also wish to launder the proceeds of crime from abroad – overwhelmingly foreign nationals using UAE systems, rather than Emirati nationals themselves.”  It credited the UAE with “continu[ing] to enact its programme of reforms to improve its AML/CTF regime in line with FATF’s recommended actions.” At the same time, it stated that the deficiencies that FATF identified “expose the UAE, and other countries, to abuse by international controller networks which continue to launder the proceeds of crime to and from countries including the UK.”

In the face of these criticisms, in the last four months the UAE has taken additional steps to improve its AML/CFT regime.  First, on September 25, 2020 the UAE central bank stated that “[t]o mitigate the risk of financial crimes . . . banks are urged to put more efforts toward combating money laundering and financing of terrorism.”

Second, on November 24, the UAE Ministry of Economy announced the development of a strategic plan to support efforts to combat money laundering practices within the UAE, as well as the establishment of an Anti-Money Laundering Department within the Ministry.

Third, the UAE Minister of Justice issued a series of ministerial resolutions to set up special federal courts in four emirates to handle money laundering cases.  Each court reportedly will have minor, major, and appeals circuits to hear money laundering crimes.

Fourth, the Minister of Justice also announced that 200 law firms in the UAE had failed to comply with AML procedures and were suspended from practicing for one month. Those suspensions were to be lifted once those firms fulfilled their obligations.  Seven other law firms were also fined AED 100,000 (US $27,229) each for AML violations.

These measures indicate that the UAE appears to be making genuine efforts to improve its AML/CFT system.  The UAE will need to sustain that commitment in the coming year to continue to bring that system to maturity.

Recent Six-Figure Funds Transfers to U.S. Right-Wing Groups Raise Compliance Concerns

In the wake of the January 6 insurrectionist attack on the United States Capitol, and the threat of right-wing extremist groups conducting armed protests in state capitals across the United States, one of the many questions that law enforcement agencies across the United States are now actively exploring is whether such groups are largely self-funding or are receiving more substantial funds from other sources.

Two recent sets of news reports indicate that the latter is a genuine cause for concern.  First, on January 15, multiple news media reported that a French computer programmer “transferred more than $500,000 in Bitcoin to far-right activists” shortly before his suicide.  The programmer reportedly sent approximately $250,000 in Bitcoin to Nick Fuentes, a far-right activist who participated in the Capitol insurrection.  In total, the Bitcoin transfers went “to 22 addresses, including many belonging to American far-right activists and organizations.”  NBC News subsequently reported that the FBI is investigating the Bitcoin transfers.

Second, on January 18, the Times of Israel reported that a $100,000 grant was made through a San Francisco-based Jewish federation to the Tea Party Patriots, a conservative activist organization that reportedly helped to organize and promote the rallies that preceded the January 6 riot.  Organizers of the insurrection stated that the Tea Party Patriots helped to fund the rallies, although the Tea Party Patriots denied doing so.

The donation was apparently an example of donor-advised funds, which the Times of Israel described as “a system of funding that allows philanthropists to give donations to the causes of their choice via their local Jewish federation.”  Subsequently, the San Francisco federation stated that it would monitor its donor-advised funds.

These developments indicate that the legacy of the Trump Administration, which includes responsibility for fomenting the Capitol riot, poses policy challenges for companies, as Matt Kelly recent wrote, but legal and compliance challenges as well.  U.S. financial institutions should immediately take three steps to address those challenges.

First, financial institutions need to review whether any of their accountholders have affiliations with extremist or insurrectionist organizations, and if so, to conduct enhanced due diligence and take other actions as appropriate.  Second, they need to increase their monitoring of funds transfers from foreign-based accounts to the accounts of such organizations.  Third, they should actively explore using their authority, under section 314(b) of the PATRIOT Act, to share information with each other concerning substantial funds transfers that could constitute financial support for domestic terrorist activities.

In addition, companies in other industries need to identify any donations they may have made to organizations whose agendas appear to extend beyond wholly peaceful protests and advocacy to support for insurrection and violent attacks on public officials and institutions, and to end those donations.  Failure to do so could subject a company not only to reputation risk, but to more severe consequences if law enforcement authorities should trace those donations to groups who engage in violent insurrectionist or extremist activities.

Japanese National Police Agency Reports on COVID-19 Cybercrime Cases in First Half of 2020

As numerous countries around the world continue to grapple with the COVID-19 pandemic, it is important for governments and law enforcement to maintain a steady and comprehensive focus on the trends in COVID-related crime.  While reported rates for crimes involving physical force, such as assaults and property crimes, have dropped this year in multiple countries such as the United States, Canada, France, and the United Kingdom,  a number of those countries have also seen substantial increases in reported rates for cyberattacks and other cybercrimes exploiting the pandemic.  For example, Canadian firms reportedly have been “bombarded” by COVID-related cyberattacks, and the Federal Bureau of Investigation has reported on upsurges in COVID-related online fraud and various categories of cyberattacks (malware, phishing, and ransomware).

One country that is seeing a marked disparity between the reported incidence of physical crimes and COVID-themed cybercrimes is Japan.  This past summer, the Japanese National Police Agency (NPA) released statistics showing that for the first half of 2020, Japan was “on course to set a record for the fewest criminal cases in a postwar year,” with an overall 15.4 percent decrease in crime compared to the first half of 2020.

On October 1, however, the NPA released statistics showing that in the first half of 2020, police across Japan had handled 608 COVID-19 cybercrime cases. The principal categories of those cases included the following:

  • Face Mask Order Fraud: 286 cases (47 percent) were fraud cases that involved members of the public failing to receive face masks that they had ordered online.
  • Government-Benefit Fraud: 155 cases (25 percent) were apparent fraud cases in which people were sent suspicious emails, from alleged mobile phone companies, that instructed recipients to apply for government-offered cash benefits via a website link.
  • Credit-Card Theft: 55 cases (9 percent) involved the theft of credit-card data that would-be purchasers of face masks had provided.
  • Obstruction of Business: 57 cases (9 percent) involved obstruction of business, “such as false information posted online claiming that infected people were in certain eateries.”  Some of these cases reportedly led to police action.
  • Malware: The NPA also confirmed multiple cyberattacks on companies, which included hackers reportedly posing as a public health center and urging email recipients to open files attached to those emails.

In addition, the NPA reported a total of 885 fraudulent-money transfer cases in the first half of 2020 involving Internet banking services, with losses totaling approximately ¥512 million (US$4.8 million).  The NPA indicated that a majority of those cases involve cybercriminals falsely representing themselves as financial institutions or parcel delivery firms and urging victims to access phishing sites where their personal data can be stolen. Japanese police reportedly have arrested a small number of individuals who fraudulently applied for government funds intended to assist businesses during the pandemic.  So far, however, there are no indications that Japan, or any other country for that matter, can successfully track and apprehend a significant number of those responsible for COVID-related online crimes.