Scammers love operating internationally because it makes them more difficult to track and it also makes suing and collecting more complicated as well. International scams also seem to work better than domestic scams because the person being scammed too often thinks this is just how things are done in foreign country X because they do not actually know how things are done in foreign country X. Crossing borders increases confusion stemming from a lack of knowledge regarding language, culture, and regulation. All this combines to make international scams widely popular. In this post we discuss some of the more common scams and, most importantly, we discuss how to avoid getting scammed.
Many years ago, I read a great article entitled, How British firms built a pyramid scheme in China that lost millions. The article is about a massive scam that used a London address to convince Chinese investors to invest millions into what now appears to have been a wholly fake currency hedge fund:
A London address helped draw Chinese investors to EuroFX. But the venture was not regulated in the UK. It was a scam that flourished in the gaps between national systems.
The scammers encouraged investment in EuroFX, a great sounding company name but a company that in fact may never even have existed. Needless to say, the scammers made the company look great by, among other things, using a prestigious London address and by printing “full-color Chinese brochures, seen by Reuters, which predicted fat returns”:
For an investment of $10,000, investors could expect a return of 6 percent a month. For $100,000, that climbed to 12 percent. A few months later, a separate EuroFX product offered up to 16 percent to anyone who invested $250,000.
The brochures boasted that EuroFX had 13 years’ experience in foreign exchange trading.
In fact, there was no company called “EuroFX.” Its brochure said EuroFX was a brand name for Euro Forex Investment Ltd. This was a dissolved company that an Australian businessman, Bryan Cook, had bought only the month before, according to Eurofinanzza, the company formation agent which arranged the transaction.
The mere fact the company was run by Europeans was enough for many of its Chinese investors:
He invested 800,000 yuan ($120,000), he said. He did not understand foreign exchange, but believed the scheme was regulated: “I trust Europeans not to lie to me.”
Other Chinese investors who put money into EuroFX also told Reuters they did so because Euro Forex Investment Limited was a company registered in Britain. They assumed it was regulated by Britain’s financial authorities.
It was not.
1. Cognitive Dissonance
I have seen more than my share of scams. Scammers love conducting scams that cross borders because merely crossing a border usually increases confusion stemming from a lack of knowledge regarding language, culture, and regulation.
When I was in college, I read David Halberstam’s The Best and the Brightest as part of an international politics course. Wikipedia does an excellent job distilling the book in the following paragraph:
The Best and the Brightest (1972) is an account by journalist David Halberstam of the origins of the Vietnam War….The focus of the book is on the erroneous foreign policy crafted by the academics and intellectuals who were in John F. Kennedy’s administration, and the disastrous consequences of those policies in Vietnam. The title referred to Kennedy’s “whiz kids”—leaders of industry and academia brought into the Kennedy administration—whom Halberstam characterized as arrogantly insisting on “brilliant policies that defied common sense” in Vietnam, often against the advice of career U.S. Department of State employees.
My professor used the book as a platform for discussing the relevance of cognitive dissonance to politics. Cognitive dissonance is the following:
Leon Festinger (1957) proposed cognitive dissonance theory, which states that a powerful motive to maintain cognitive consistency can give rise to irrational and sometimes maladaptive behavior.
According to Festinger, we hold many cognitions about the world and ourselves; when they clash, a discrepancy is evoked, resulting in a state of tension known as cognitive dissonance. As the experience of dissonance is unpleasant, we are motivated to reduce or eliminate it, and achieve consonance (i.e. agreement).
As someone who is constantly contacted by people in the midst of being defrauded, I have become convinced it is their efforts to achieve cognitive consistency that often lead to their getting scammed. They so much want to believe they have entered into a good deal that they rationalize everything that should be telling them to get out. Sadly, this drive for cognitive consistency becomes stronger the deeper one has dug into the deal. The more one has already spent, the more one wants to believe they have not just flushed away their money and the more willing they are to ignore key indicators that they have.
When I first started practicing international law and would get contacted by people whom I suspected were being defrauded I would flat out give them my opinion on this, without charging a thing. But after doing this maybe twenty times and getting nothing but anger back in return maybe nineteen times, I started clamming up. The final straw was when a 66-year-old farmer from rural Missouri sent me an email of his drop-dead gorgeous Russian “girlfriend” of about 22 years old who was on her way to Missouri to marry the farmer. But she was being held up at the airport because the Russian authorities were requiring her to put up a $15,000 bond to make sure she would eventually return to Russia. The farmer asked me if this made any sense to me and I immediately told him it did not make any sense at all and he was being scammed. The farmer then accused me of being jealous because he was marrying such a gorgeous woman and the scam was clearly being perpetrated by the Russian authorities, not by his girlfriend.
Now when I get these, I am far more circumspect and my usual response is that for us to be able to help, we need to be paid x dollars to conduct our own due diligence regarding the players and the deal. And here’s the thing: on the rare occasions when these people do pay us for the due diligence and our due diligence (pretty much every time) shows they are being scammed, they believe us. What’s the difference? They have a stake in believing us because they paid us. In other words, it takes a countervailing cognitive consistency desire to overwhelm the previous one.
Not long ago, a medical doctor wrote me attaching what at first glance looked to be a fake Chinese government document and wanted to know whether the Chinese government charges a $15,000 fee for X. My response was that I didn’t know whether that particular branch of the Chinese government charges a $15,000 fee for X but I very much doubted it. I then said our China lawyers would be happy to check that out for him at our regular hourly rates but that at first glance the document he sent me looked like a fraud and I was concerned he might be getting scammed. His response was to essentially question my abilities for not knowing off the top of my head what some (obscure) government agency charges for some (obscure) action and to essentially demand I make up for my ignorance by telling him who he can talk to who actually knows these things. I very nicely suggested he should keep trying with other China attorneys. Cognitive dissonance.
2. Representative scams
The following are representative of some of the scams our international lawyers have seen over the years:
- Company documents showed a subsidiary in the Marshall Islands, yet always spelled the country as Marshal Island. It had no such subsidiary. Why would a company not know how to spell one of its locations correctly? I mean, come on.
- Company claimed to have a multi-million dollar account at a non-existent bank. It was a bank in Australia and five minutes on Google revealed the bank did not exist. We did the search because we thought the bank’s name (an Ocean not contiguous with Australia) was very strange for a bank allegedly in Australia.
- Company claimed to have a branch office in a particular city, yet its documents on that branch office (including supposed government documents) put that city in the wrong province. Again, come on.
- Company claimed to be bringing in twice as much product as physically possible on a particular ship. When I first saw the amount of product involved I thought “this must be a massive ship.” I then thought, gosh, I didn’t realize Cambodia had ships of this size. So I spent about five minutes checking out this particular ship on the Internet and quickly realized it was not nearly large enough to carry the cargo it claimed it had carried.
- Company claimed to have been shipping out product on a particular ship that did not exist during the first few years when the product was allegedly being shipped.
- Company claimed to have won an IP lawsuit in a country’s Supreme Court (they produced the Supreme Court’s decision and everything), but there had never been such a case. Had a lawyer friend check this out in the applicable country (Russia).
- Saw a judgment from a federal judge in Florida and the court’s order struck me as funny. So I did a search on the judge and learned there was no such judge in the court listed on the order.
3. Dissecting a scam
Earlier this year, a company sent me some documents to get an estimate on what we would charge to represent it on a deal. Within ten minutes I wrote back saying we would not be interested in representing it on the deal because the alleged Chinese company was a scam. I instead suggested this company retain us to conduct basic due diligence on the company to determine its bona fides. The potential client (who no doubt had dollar signs in its eyes) seemed a bit offended and sought to challenge my suspicions of fraud. My response to his challenge (with some key identifiers changed) was as follows:
I spent less than ten minutes looking at just the proposed contract you sent me and from that one document and in that short amount of time I noticed the following:
1. If a Chinese company is named China, it is a State Owned Entity (SOE) and so it pretty much must be huge. It is unlikely that sort of company would have reached out to you out of nowhere for a $350,000 order when there are so many other potential sellers in other countries (including within China) it could have contacted. This makes no sense.
2. The Chinese company with this name is in the X business. Why would a company in the X business be looking to buy Y product? This makes no sense.
3. The bank is in Shenzhen. The company is in Shandong Province. It would be like you in Nashville using a small bank in Seattle for your banking. This makes no sense.
4. Your contract is not a contract at all. Standing alone, this is not a sign of fraud but it does not make sense for a large company (which this company purports to be) to send out a document like this because it is not even close to being a real contract.
After the American company got over its anger at my questioning their deal (which they saw as the start of something really big), they had us conduct due diligence on the Chinese company and the situation and within a week, they too were convinced they were being scammed. No deal, but no massive losses either.
4. How to NOT get China scammed
So what’s the trick to not getting scammed?
The first thing to do to avoid getting scammed is to have the right attitude and that means you must question and doubt EVERYTHING. Why would a legitimate Chinese company in Shenzhen contact you for an oil and gas deal when you are just a school teacher in Vermont? Why would an oil and gas company be located in Shenzhen anyway (it’s possible, but not likely)? Why is a Chinese company contacting you out of the blue to make a $3 million purchase of your widgets when there are 3,000 other widget companies and when you have never previously made a sale for more than $30,000? How can this Chinese company charge $11 per widget when everyone else is charging at least $22? And after you have compiled your list of questions and doubts, do not pay a penny (other than perhaps to your own investigator) until you truly have compelling answers to all of your questions.
One of the classic tactics of a scammer when asked tough questions is to give complicated and convoluted answers. And then when you hint at wanting an answer you can actually understand, the scammer seeks to paint you as an idiot and/or a bad person for not trusting them. Do not fall for either. Chinese companies spend weeks, sometimes months, conducting due diligence on their potential counter-parties and you doing the same will be viewed by legitimate Chinese companies as a sign of your savvy and your intelligence, not your moral failings. As for your being made out to be an idiot, just remember how you will feel like much more of an idiot after you are scammed than if you prevent a scam. Oh, and if you don’t understand how the business or the deal is going to operate, that, standing alone — fraud or no fraud — is a great reason for you to just walk away.
The second key to not getting scammed when dealing with a China company is to make sure you are actually dealing with a China company. Though our percentage estimates vary, all of the China lawyers in my firm estimate that at least half the time when a Western company is scammed by a “Chinese company,” the company is either not Chinese at all or they are not a company at all because they have never actually registered with the Chinese corporate authorities. Just confirming you are dealing with a real registered Chinese company greatly lowers your chances of getting scammed.
Generally, with Chinese companies, we recommend the following as a sort of minimum.
The first thing you do is ask the Chinese company to send you a copy of its business license. Do not be afraid to do this. Chinese companies do this all the time. If the Chinese company refuses to send this to you, walk away.
You then have someone fluent in Chinese and with knowledge about Chinese business licenses examine the one you have been sent.
Our China attorneys typically look for the following:
To determine whether it is real or not. This is done by comparing the information on the business license provided with the corresponding information on the relevant Chinese government website — usually the local State Administration for Market Regulation. If the business license you have been provided is fake, you walk away.
To see when the company was formed. We like to compare what the real business license says against what we were told (by email or whatever) and also what the Chinese company says on its English language and its Chinese language website. If different years are given in different places, we get suspicious and we ask more questions.
To see where the company is located. We like to compare this against both what we were told (by email or whatever) and also against what the Chinese company says its English language and its Chinese language website. If there are different addresses in different places, we get suspicious and we ask more questions.
To see what the scope of the Chinese business is, as listed on its registration. If the scope is “consulting” and our client thinks it will be ordering five million dollars of widgets from a factory, we get really suspicious. Looking at the scope is a good (though not always fool-proof) way to determine whether you are dealing with a manufacturer or a broker.
To see the amount of registered capital. If the amount is too low, the odds are good that it is not a manufacturer. If the amount is really high, the odds are good that this is a big company. Note that this information is not going to be as commonly listed in the future.
Lastly, you should go visit the Chinese company or send someone you truly trust to do so — if this is possible.
Doing the above is not enough due diligence for big deals, but it is a relatively fast, relatively cheap way to at least get some sense about the Chinese company with which you are thinking of doing business and it oftentimes will be enough to let you know whether or not you wish to conduct additional due diligence or just walk away. Most of the time if a Chinese company clears the above hurdles, it makes sense to do a somewhat deeper dive due diligence on them along the lines we describe here.
I advocate doing some or all of the following with any deal you do with China, or really anywhere else in the world for that matter:
Construct your own fraud scenario. Ask yourself how the Chinese company could have staged everything it has shown you. Did it switch the factory signs before you arrived, so it looks like it owns the factory, rather than someone else? Did it paint the old machinery to look new? Is the person with whom you are speaking really a PwC accountant, or just someone paid $100 to pose as one? Our China lawyers regularly encounter fake factories, fake Chinese lawyers, fake documents, fake accountants, fake foreigners, fake owners. . . .
Focus on the operations. Look carefully at the Chinese company’s operations. Why does the company have only 100 boxes in storage when it claims to be selling 5,000 widgets a week? How can the company make 5,000 widgets a week with only enough of x material to make 100 total? Why did the company have a completely different set of employees on the same day and time two weeks apart? It pays to visit two or three (or more) times — a good fraudster can put on a show, but they are unlikely to be able to do it the same way each time. Watch for the subtle differences.
Get the official records yourself. Use your own people to get the Chinese company’s official corporate records from the official Chinese government sources. Though doing this is neither inexpensive nor easy, information gleaned from the official government records can often be helpful. Then compare the official records with the documents the Chinese company gave you. This is key.
Take company-provided introductions with a grain of salt. Speak with your target Chinese company’s vendors, neighbors, employees, and customers, especially those you find on your own. When talking with people to whom your target Chinese company has introduced you, take everything that is said with a grain of salt. It is not difficult for an unscrupulous company to buy someone’s loyalty for the duration of a meeting or a phone call and this sort of thing goes on all the time. And again, do you really know whether these people are as claimed? We love sending our own people to just hang out around the Chinese company for a week or two as it is amazing what they can learn just by watching and by talking with employees and others in the vicinity.
Speak with the Chinese company’s competitors. Competitors with real businesses can and usually will tell you about their competitors, but, of course, any information gleaned this way should be taken with at least a bit of salt as well.
Do not delegate. Use your own trusted network to gather information on your potential Chinese counter-party. If you don’t have such a network, get one. If you can’t get one, don’t do the deal.
In How to Spot a Fraudulent Chinese Company, we described some of the things we look for to determine the legitimacy of a Chinese company listed on foreign stock exchanges for investors that have retained us because they are concerned about the value of their investment. Our lawyers’ first step in these situations is to determine whether the Chinese entity is an empty shell. If the Chinese entity is an empty shell, there is no value in China to protect and further analysis of the company is a waste of time. We described this analysis as follows:
We have done this research so many times we have developed a three-step test to determine whether a Chinese company is a fraud. We look at the annual or quarterly report of the Chinese company and if it meets these three tests, it is virtually certain to be a complete fraud, with no operations, no assets and no funds in the bank. The three indicia of fraud are as follows:
1. The company has a large amount of cash in the bank. We often see supposed cash holdings greater than 50% of the company’s annual gross revenues. Interest rates at Chinese banks are very low and legitimate Chinese companies do not usually keep large amounts of their cash in interest-bearing bank accounts. Usually the supposed large cash account is accompanied by bogus explanations explaining why the Chinese entity is unable to repatriate the funds to its investors as dividends. Later investigation usually reveals that these funds were never actually deposited in the bank. That is, these large deposit accounts are simply falsified. The odd thing is that auditors will normally verify that the accounts are real. Once the fraud has been exposed, we have asked auditors what they did to verify the account. They usually state that they relied on reports from the management of the company. In China, the only way to verify the authenticity of a bank account is to arrive at the bank unannounced and look at the computer screen while standing BEHIND the counter as the clerk makes an unplanned query. Virtually no bank in China will allow this, which means that audit verifications of Chinese bank accounts are typically of no value.
2. The company reports profit margins in excess of 30%. We often see fake companies report profit margins of 50%. Doing business in China is difficult and we have never seen a legitimate Chinese company with profit margins even approaching this level, not even state-owned monopoly companies. These high margins are then the explanation for why the company has so much free cash; they are so profitable they are printing money. The claim is that they have some unique product or some technical monopoly. In our experience, these claims are never true, as just a few minutes of careful thought would reveal.
3. The company is formed as a VIE (variable interest entity) when it is operating in a business sector where foreign investment is not restricted and the VIE structure is not required. A VIE makes sense only when a foreign-invested company intends to operate in a restricted sector such as the Internet. This is why Baidu, Sina, and Alibaba were organized as VIEs. But most Chinese business sectors are open to foreign investment. When a company that operates in manufacturing or retail sales chooses to organize as a VIE, they oftentimes have done so planning to commit fraud against the foreign investors.
I cannot resist closing out this post by talking about how to avoid getting caught in what I see as perhaps the two most common, most insidious scams of all: The China bank switch scam and the butchering the pig scam.
The bank switch scam is where someone hacks into either your computer or that of your Chinese counter-party and then sends you an invoice (and you actually do owe the money) directing you to make payment to a bank account held by the scammer, not by your Chinese counter-party.
In The China Bank Switch Scam: The Coronavirus Edition we discuss this scam in more detail and advocate engaging in the following actions to prevent it from happening to you:
1. Get to know someone in particular at your supplier and get that person’s phone number and call that person if you have any concerns. Alternatively, call the landline number at your factory.
2. Get your supplier’s bank account information in advance and ask them to refer to “bank account information document” on their invoices, rather than listing out full bank details every time.
3. Check your bank account every day, maybe even twice a day. If you catch a wire early enough you can sometimes stop it.
4. Do a first small wire to confirm the account.
5. If possible, pay your Chinese suppliers to their bank accounts in mainland China as that is generally safer than paying them overseas, be it Hong Kong, Taiwan or anywhere else. This is true not just for scam prevention reasons.
6. Have a special procedure set up with your suppliers for confirming bank account changes .
7. Have an internal procedure for confirming all payments over a certain amount.
8. Get an insurance policy that covers computer hacking or fraud and make sure it covers this sort of scam. Our lawyers have actually had good luck convincing insurance companies that they need to pay off on such policies.
We wrote about the butchering the pig scam less than a month ago, so rather than summarize that blog post here, I urge you to go here and read it. And urge you I do, because this is by far the most common scam we are seeing these days.
Anyone have any additional scam prevention tips? If so, please share them in your comments below.