By Control Risks

Multinational companies in China are not strangers to internal investigations into employee and third-party malfeasance, using significant compliance, legal, audit and forensic resources. However, traditional investigative approaches are increasingly going awry, leading to financial and reputation damage. Poorly executed investigations in China fail to contain potential compliance, regulatory and business continuity problems, and can often increase the risk of scrutiny from government investigators, disrupt supply or distribution chains, and disgruntle employees. Here are some recent examples:

  • Business continuity: A China General Manager (GM) was terminated for embezzlement based on whistleblowing complaints and substantial evidence. The company announced his termination “for gross misconduct” to all employees to send a strong message about compliance. The GM retaliated, stole the company chops and business license, and paralyzed the company from conducting critical contractual and financial transactions. He continued to represent himself to employees and customers as the GM, and it took the company nearly six months to negotiate a settlement and get the business running again.
  • Reputation: The US headquarters of a China subsidiary terminated 27 distributors for fraud. In response, the distributors used WeChat to criticise the company for illegal business practices. Customers quickly stopped their orders and the company was forced to reinstate the distributors (even though the fraud was proven) and negotiate subsequent separation agreements. It took nine months for the company to recover.
  • Financial: A European conglomerate acquired a Chinese company and retained the former owner as GM. Subsequently, the growth rate was not as expected and investigations determined that the GM was diverting business to a competing company he had established. The company fired the GM, who then locked them out of the operation and moved molds and equipment to his own factory as well as clients. Headquarters eventually had to negotiate a sale back to the GM at a fraction of the original purchase price.
  • Regulatory: On the advice of external counsel, a European company terminated a number of potentially corrupt sales agents. Aggrieved, one of the agents, who had strong political connections, passed details of corrupt activities to the local authorities who commenced an investigation into the company. As part of the negotiations with the regulators, the company had to agree to a settlement with the agent.

When the solution is the problem

Such situations are, understandably, frustrating for a foreign company’s management: they initiate an appropriate investigation and take action when they find credible evidence.

How does the suspect get the upper hand and throw the company into a tailspin? The traditional linear approach to an investigation is causing problems because it does not account for unique features of China’s business and legal environment:

  • Tolerance of conflict of interest: The notion that “everyone is making some money on the side, so I should too” lives on in China. Conflicts of interest, establishing competing companies, and committing financial fraud are still very common in China. Often, the perpetrators do not see their actions as unlawful and have an extreme reaction if that income is taken away. Conflicts of interest become a critical business continuity issue when the supply or distribution chain is dependent on the businesses of the fired employee.
  • Face: The need to maintain a personal reputation and high standing amongst peers, customers and employees – and the severe reactions if that reputation is threatened – is an important but often overlooked motivator. In particular, senior managers who have engaged in fraud and embezzlement will often work hard to clear their name by publicly blaming the company.
  • Relationships: While guanxi is not as important as it once was in order to succeed in business in China, well connected employees can use the full extent of their political influence to cause problems such as delays in licensing renewals, triggering tax, safety and environmental investigations, or stopping shipments through customs.
  • Labor laws favor the employee: It is extremely difficult to fire employees in China, even for cause. This often makes fraud a “punishment-less crime.” Chinese employees often distrust official arbitration and legal processes and if cornered, they can lash out against the company or attempt to secure additional compensation through nefarious means because there are few repercussions.
  • High threshold required for police intervention: China’s police, the Public Security Bureau, are typically understaffed in Tier-1 cities and are rarely interested in investigating cases of employee misbehavior. It is difficult for companies to use the threat of criminal charges as either a carrot or stick to ensure compliant behavior.
  • Heavy reliance on hard-copies: Without the hard copy of the business license or company chop, it is difficult to conduct business. Employees know this and often take these items in a crisis.

The objective is to recover

A typical objective of an investigation is to find evidence of wrongdoing and take action. However, the objective should be to ensure business continuity and improve overall conditions and operations. Because these situations can quickly devolve into a crisis, Control Risks recommends a “recovery-led” approach when planning and conducting an internal investigation. Unlike the traditional linear technique, the recovery-led approach places primary focus on business continuity, takes into account the unique challenges of operating in China, and adds a few critical steps.

From the beginning, the alternative investigative approach is preventative, rather than reactive.

  • Step 1: It begins by taking the suspicions and thinking through all the various undesirable outcomes.
  • Step 2: Plan an investigation to prevent worst-case scenarios. The approach considers the suspected individual and what damage they might do to the organization. This step determines what crises could happen. For example, the potential for disruption is quite different if the suspect is a senior commercial leader versus a finance manager.
  • Step 3: To ensure a holistic assessment, the investigation includes internal and external sources. The most damaging evidence is often found by discretely talking to people in the market.
  • Step 4: After the evidence is gathered, it is critical to not proceed immediately to action, but rather, assess the risks, and the pros and cons of each action.
  • Step 5: Put plans in place to mitigate risks.
  • Step 6: Take action


In each of the case studies above, the companies dismissed the suspects without a plan. When companies take a “recovery-led” approach to investigations, the problem – though challenging – is ultimately resolved in the best long-term interests of the company.


About the author: Control Risks is an independent, global risk consultancy specialising in political, integrity, and security risk. They help some of the most influential organisations in the world to understand and manage the risks and opportunities of operating in complex or hostile environments. For questions or further information, please contact [email protected] or [email protected]


Posted by Control Risks