Finance Magazine (Caijing Magazine) : Is It Bribery, or Business As Usual in China?
Is It Bribery, or Business As Usual in China?
2007-09-20 Caijing Magazine
German and U.S. investigations of multinational Siemens have helped pull back a curtain to reveal common business practices in China – from kickbacks to phony consultants – considered unethical and often illegal in western countries.
By staff reporters Li Qiyan and Zhang Zhuo
German industrial conglomerate Siemens is a respected and well-liked corporate citizen in China, but its reputation has been shaken by allegations of unethical business transactions in connection with a Shanghai investment.
The emerging case that threatens to tarnish Siemens China – a company with 46,000 employees at 130 facilities and 2006 sales topping 50 billion yuan – points to wide gaps between declared corporate ethics policies and real-life business practices in China, and differences between Chinese and western legal strategies for tackling company corruption.
Moreover, the Siemens investigation now led by prosecutors in Germany and regulators in the United States – but apparently ignored by authorities in China – sheds light on the prevalence of bribery in Chinese business deals in a variety of industries, including the power and medical sectors.
“Bribery in China doesn’t stop with Siemens,” a sales manager at a foreign power equipment company bluntly told Caijing. In fact, he said, practices considered shady in the West are common on the mainland.
Responding to the latest graft allegations in August, Siemens China CEO Dr. Richard Hausmann said the company does not tolerate bribery but that some bad eggs could be expected in any company with such a large workforce. He confirmed that 20 employees had been fired over the previous year for “improper actions,” although not all the firings were related to corruption.
Siemens began taking preventative measures to fight corruption two years ago, Hausmann said, by requiring all procuring “middlemen” to sign agreements promising they would not use bribes or other improper means to secure orders.
But a Caijing investigation found that businesses get around such ethics agreements through contacts with two types of middlemen, including “agents” who pay bribes to win contracts, and so-called “consultants” who operate as overseas shell companies to handle under-the-table transactions.
Siemens’ trouble in China began in August, when allegations appeared in the German media. The weekly newsmagazine Der Spiegel described evidence of three, alleged bribes paid through an account with the number 220030 and keyword “Waigaoqiao” – a coal power generating company in Shanghai. Six payments totaling 4.1 million euros were deposited into the account at Neue Bank in Lichtenstein after September 1998. Der Spiegel speculated that the money may have been earmarked for illegal payments linked to a Waigaoqiao contract.
The account may give investigators evidence that the German company used illicit Chinese middlemen to win the contract.
In the past, Siemens has explained that it uses middlemen to do business at its facilities around the world. They help company managers, mainly Germans, who often lack local market experience because they are transferred to a new location every three or four years.
Caijing learned that Siemens China has used consultants and, more commonly, agents as company middlemen.
An agent’s job is to market Siemens products in one region and receive a commission based on orders. But according to a source, many agents pay kickbacks to customers to encourage them to buy Siemens products.
A Siemens insider said the company generally seeks out people familiar with a certain industry or government department to serve as middlemen. Under legal arrangements, these middlemen receive commissions based on the size of the contract they acquire.
In many situations, however, companies refer to their middlemen as business consultant firms, even though they are nothing more than shell companies.
A former Siemens employee said the company’s sales representatives usually sign so-called “business consulting agreements” with these shell companies, agreeing to one contract-one commission deals. Such consultant agreements were quite popular at Siemens, the source said.
Internal audits have turned up other mysterious accounts similar to account 220030, a source from Siemens’ auditing department told Caijing. These accounts were set up overseas in Hong Kong, Macao and other areas.
“These mysterious accounts always have the fingerprints of middlemen,” the auditor said.
Unlike agents, consultants generally work with large-scale projects such as power generators and electric power lines.
According to a Siemens China report, the company in 1998 signed a contract worth 500 million German marks with the owners of the Shanghai Waigaoqiao Power Plant, which had just started operating as China’s largest, single-unit power plant.
In February 1999, the Chinese government’s State Development and Planning Commission approved the plant’s second phase – the installation of two, 90-megawatt coal-fired power units provided by Siemens (China) Ltd. Power Group.
The total investment for the second phase exceeded 10 billion yuan. The plant’s registered capital of about 3.5 billion yuan was shared by state-owned Shenergy Group and Shanghai Municipal Power Co., which each held 40 percent, and East China Power Group Corp., with a 20 percent stake. Loans from and obtained through the World Bank provided additional funds. The Industrial and Commercial Bank of China contributed domestic financing. Foreign-made equipment was purchased through bids.
In general, according to a Siemens source, a sales representative will find a few – and always more than one – trustworthy shell firms to act as consultant middlemen. These trusted contacts rarely change and register as companies outside China, with offshore bank accounts. Rather than provide actual consulting services, they arrange “service fees” that can be used to pay kickbacks, the size of which varies according to value of product sold.
At one time, consultant fees required signatures from different managers according to fee size. Now, most agreements are signed solely by Siemens China’s chief financial officer. Few staffers have access to these consultant agreements outside the internal auditing staff.
Using a phony consulting company to transfer money is, in reality, a direct way for the seller to bribe the buyer and allow a major corporation to dodge a country’s anti-corruption laws. After a buyer and seller reach a secret order – a kickback agreement — the corporation pays a “business consulting fee” to the shell company, which in turns transfers the cash to the buyer.
Standard Business Practice
A “Standard Business Consulting Agreement” between Siemens and a “business consultant” obtained by Caijing uses vague language to define services provided by a consulting company. Another internal document from Siemens lists questions to be addressed prior to signing such an agreement. This document states that a business consultant’s “scope of services should eliminate wording, such as ‘impact on the awarding of contracts’ and ‘maintaining customer relations,’ which might be regarded as a violation of the terms of applicable laws and regulations.”
According to the agreement, the consulting company would be paid for “all services provided by the consulting company (including all expenses that may occur).” What services would be provided and what expenses might be generated were left unclear.
The agreement clearly stipulates that “the business consultant, in carrying out its activities during the period, will comply with all laws and regulations applicable to Siemens and the consultant, especially regarding anti-corruption laws or regulations applicable to either side or the parent company.”
Additionally, the consultant must pledge that “there were no private, business, or any other relations with government officials in the country in which a service was provided. The risks that come from such a relationship or affiliation can possibly cause the business consultant to take measures that may affect any formal decision involving both parties.”
As it was explained to Caijing, this sort of contract – in which Siemens can deny responsibility for the actions of its business consultant partners — is similar to company contracts with local agents.
“Siemens’ business in China is quite extensive, and the range of products is equally vast. Sales operations can’t be generalized as one model,” said a Siemens spokesperson in Beijing who asked not to be named. “Take business consultant contracts for instance. There are certain, legitimate fees that occur, and then there are those that are designed to conceal illicit money transfers.”
Siemens has conducted broad, internal investigations of contracts over the past two years, a company insider said. The main goal is to guarantee that existing contracts contain wording that complies with accepted norms and are signed by personnel of appropriate rank.
The internal investigations are one sign that corruption scandals have had a far-reaching impact on Siemens’ development. But other companies are also under the microscope. Some analysts think bribery is so widespread and expensive that a thorough investigation at Siemens could send shockwaves through a number of industries.
The German company also risks following the path of U.S.-based Lucent Technologies, which fell from favor in China after a 2004 bribery scandal. Lucent China fired four, high-level managers, yet the division’s reputation still has not recovered.
Some say Siemens’ image on the Chinese market has already been damaged. “Continuing to work with Siemens will take a lot of guts,” said one power industry insider.
Legal Proceedings, Unspoken Rules
German prosecutor Christian Schmidt-Sommerfeld, a Munich attorney investigating the Siemens case, told Caijing that a formal indictment could be announced before year’s end. Additional evidence has been uncovered while the investigation continues, he said, and the first to be charged in the case might be a former Argentinean employee of Siemens.
A U.S. investigation is also intensifying. In February, Siemens disclosed that the Department of Justice was investigating allegations of illegal conduct. Washington’s regulatory Securities and Exchange Commission is also conducting an informal inquiry.
In China, however, it appears no legal storm is brewing. Schmidt-Sommerfeld said German prosecutors have received no inquiries from their Chinese counterparts.
But bribery in China’s power industry has been exposed on numerous occasions. According to a May report by the State Electric Regulatory Commission, some 8,899 cases had been uncovered and 17.1 million yuan seized from individuals and companies. The National Electric Power Industry conducted an anti-bribery campaign between August 2005 and March 2007. In that period, investigators detected 121 commercial bribery cases involving 44 million yuan.
But other industries are affected as well. Bribery in the pharmaceutical industry, for example, is said to be more widespread than in the power sector. And many small companies skip the business consultant system altogether by taking a direct route to bribes and kickbacks.
A sales representative for a company that makes lubricating oil for power plants explained the many palms he must grease before closing a deal. First, he has to bribe the plant’s director and engineers so that they will tell superiors about the need to replace lubricating oil. Next, separate bribes are handed out in the procurement department and mid-level management. Finally, the purchase is approved, but only after every factory level has received its cut.
Sales representatives must also pay regular attention to “guanxi maintenance.” Guanxi is the Chinese word for the relations between people, and it’s generally conducted according to an unspoken agreement through which cash or expensive gifts are regularly sent to customers.
“Kickbacks are also sent to sales representatives after each sale,” the oil company sales representative said. “If there’s a problem with one link in the chain, the whole thing falls apart. Every single department must be brought into the fold.”
Such a system multiplies the costs of goods. Take lubricant oil for example. A distributor pays about 2,000 yuan per barrel and sells it to a power plant for up to 8,000 yuan. “Getting in with a power plant may take a year’s time, but once you’re in, sales will continue for several years as long as guanxi is well maintained,” the salesman said.
Insiders point out that small companies use direct bribes and kickbacks because China has neither the anti-corruption infrastructure nor legal norms common in many western countries. Moreover, Chinese industries and regulators have grown accustomed to the practices.
“This sort of situation is really nothing new,” said a power company employee. “It happens every day.”
So why was Siemens singled out in a case that could soil its sterling reputation in China? “They were stupid,” the power company employee said. “How could they use a project name as the code for their bank accounts?”
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