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Scams are a daily occurrence in China, with most being minor though pesky annoyances you learn to recognise and avoid. However, they are also surprisingly common in the higher financial rungs of Chinese society. Here are five of the biggest Chinese scams to hit the news in recent years.

1) Xu Beihong fake portrait sells for $11.4 million
All is not what it seems in the murky world of Chinese art auctions.

Put up to auction by Beijing Jiuge Auctions last year, a portrait by the famous artist Xu Beihong of his wife, Jiang Biwei, sold for $11.4 million. The young girl in the painting stands naked against a burgundy backdrop, one leg bent, an elbow crooked behind her back. Her eyes downcast, she looks shy and uncomfortable. A note from his son, Xu Boyang, on the back of the painting attests that it was by his father, although the artist died in 1953.

But Wang Yanqing, a 66-year-old painter from Inner Mongolia, told another story.

"It's totally laughable," he said. "That picture doesn't look anything like Xu Beihong's wife." He said the picture was one of several painted by art students in his class at the prestigious Central Academy of Fine Arts (CAFA) in 1983, 30 years after the artist's death. The model was a peasant farmer. He was one of those students who painted her, and his memory is crystal clear.

"At that time, it was very difficult to find nude models, so we painted the same ones over and over, and it was boring," he remembered. "Suddenly this new model came — a young girl from the south who'd never modelled before, and everyone was very excited. We all wanted to draw her, so almost 20 of us crowded into the same room. It was one of my most successful pictures. I still have it in my studio."

Indeed, the subject in his painting is identical to the one that sold for $11 million, except for the angle. Four other classmates have produced pictures of the same girl, in the same pose, with the same backdrop. As Wang points out, it's an impossible coincidence and he and his classmates later published an open letter to stop the forgery circulating on the open market.

This case is a common one in the field. Problems such as bribery, non-payment and the aforementioned consignment of fake goods can lead to problems at all stages of the auction process and are rife in China. Many industry insiders think auction laws need changing, but it remains to be seen how soon, or if at all, this will happen.

2) Alibaba scam – employees make it happen
In July last year, Chinese police arrested more than 36 people charged with duping overseas buyers of more than $6 million, by posing as buyers on the e-commerce website Alibaba. The crux of this scam was the "Gold Supplier" programme, which sought to make foreign buyers more comfortable doing business with Chinese suppliers. Suppliers in this programme were supposed to be vetted to ensure that they were who they said they were.
Alibaba's website stated:

"...all Gold Supplier members have had their identities authenticated and verified by a reputable third-party security service provider. This means that the Gold Supplier member's company registration details have undergone a thorough check to make sure that the entity is real and legitimate."

But the Gold Supplier status was only as meaningful as the quality of the supplier screening. And therein lay the source of Alibaba's crisis. The company discovered that some of its own employees had been assisting or allowing fraudsters to set up Gold Supplier accounts to defraud buyers. In a statement, the company admitted:

"About 100 sales people, out of a field sales force of about 5,000, as well as a number of supervisors and sales managers, are directly responsible in either intentionally or negligently allowing the fraudsters to evade our company's authentication and verification measures and systematically establish fraudulent storefronts on the international marketplace. The investigation concluded that the pursuit of short-term financial gain at all cost had tainted parts of our sales organisation, risking serious damage to our company's core values."

According to Jack Ma, Alibaba's founder, "We must send a strong message that it is unacceptable to compromise the company’s culture and values."

The company therefore sacked its CEO and COO, pretty much the only option in the circumstances.

According to the company, 2,300 Gold Suppliers who signed up for Alibaba in the past two years committed fraud, and the average fraud claim was valued at less than $1,200.

That was a relatively small portion of the overall number of suppliers doing business on Alibaba, and a relatively small claim size given the volume of business facilitated through the site, but the fact that at least some of the fraudsters were apparently aided by Alibaba employees threatened the company's credibility in a big way. After all, if you couldn't trust that there was a real difference between a Gold Supplier and a free Alibaba supplier, you really couldn't trust Alibaba.

The company said the arrests were made following a 40-day investigation early last year. Alibaba subsequently introduced strict procedures in an attempt to prevent a repeat of such cases and later stated fraud claims fell by more than 70%. That wasn’t before the whole sorry episode had cost the company millions of Yuan in compensation payments.

3) Longtop scam – fraud willingly backed by Chinese banks
Longtop Financial (LFT), a popular Chinese software company, was exposed as a colossal fraud last year .The "cash balance" on Longtop's balance sheet, it turned out, was fake – a fiction created by the company's managers and helpers.

The Longtop fraud followed other China stock frauds that have made many of Wall Street's best and brightest look like fools. It has also increased the scepticism of American investors toward Chinese companies.

Unlike some of the more famous American-company frauds in recent years – Enron, Worldcom – it turned out that Longtop had institutional help in perpetrating its fraud. The reason Longtop was able to fend off sceptics for so long, despite multiple analysts arguing that it was a fraud, was that Chinese banks were complicit in the scam.

According to an extraordinary letter that Longtop's auditor, Deloitte, sent the company when it quit, Longtop's banks sent out fake statements attesting to the company's fake cash balances. It wasn't until Deloitte's examiners actually physically visited the banks, and talked to other employees at the banks, that the fraud was discovered. And even then Deloitte employees were restrained at the bank and made to give up all the incriminating files they had unearthed!

The Longtop fraud fooled some of smartest hedge funds and mutual fund investors in the country. It fooled the New York Stock Exchange. It fooled the investments banks that underwrote Longtop's stock – and defended it until its dying breath, claiming all sorts of "due diligence" designed to set investors’ fears to rest. And, for a long while, it fooled Deloitte>.

It serves as a good reminder that all you really may be investing in when you invest in any stock, are just black marks on a page.

4) Sino-forest scam – the art of wiping out all traces
Last year Muddy Waters (a firm which specialises in exposing Chinese stock fraud) announced coverage on Sino-Forest (TRE.TO), a Chinese timber company with a strong sell and $1 price target-citing fraud.

The newsworthy thing about this was that large trading institutions were fooled, not just retail investors. Paulson & Co., a New York based hedge fund and one of the largest in the US, was the largest shareholder with 34.7 million shares, which on the morning of the announcements by Muddy Waters was valued at $624 million. At the close of trading on the same day, the stake was only worth $501 million and the shares later fell to only $6 each. Ouch.

Some of the highlights from Muddy Water’s report made for fairly grim reading:

• TRE was one of the rare frauds committed by an established institution. In TRE’s case, its early start as an RTO [Recovery Time Objective] fraud, luck and deft navigation enabled it to grow into an institution whose "quality management" consistently delivered on earnings growth.
• TRE, which was probably conceived as another short-lived Canadian-listed resources pump and dump, was aggressively committing fraud since its RTO in 1995.
• The foundation of TRE’s fraud is its convoluted structure whereby it runs most of its revenues through "authorised intermediaries". AIs supposedly process TRE’s tax payments, which ensures that TRE leaves far less of a paper trail.
• On the other side of its books, TRE massively exaggerated its assets. TRE overstated its Yunnan timber investments by approximately $900 million.
• TRE relied on Jaakko Poyry (a consultancy firm in the energies and resources sector) to produce reports that gave it legitimacy. Since TRE provided fraudulent data to Poyry, the reports did nothing to ensure that the company was legitimate.

The moral of this story being: if something seems too good to be true, it probably is.

5) Puda coal scam – like the cup and ball trick
The aggressive government mandated consolidation of the coal mining industry beginning in 2009 coincided with the darkest days of the world financial crisis. PUDA management either had to become a consolidator, requiring massive additional capital, or else dispose of its coal businesses. 

Management, lead by Chairman Ming Zhao, made the decision to pursue aggressive growth by becoming a consolidator. Zhao transferred the ownership of PUDA’s sole Chinese operating entity, Shanxi Puda Coal Group Co. Ltd ("Shanxi Coal") to himself in 2009 without shareholder approval, according to official government filings. Then, in 2010 Zhao sold 49% and pledged the other 51% of Shanxi Coal to CITIC Trust Co. Ltd, a Chinese private equity fund, for 245 million RMB ($37.1 million). Zhao then recklessly leveraged Shanxi Coal by borrowing 3.5 billion RMB ($530.3 million) from CITIC at an incredibly high 14.5% annual interest rate (including fees) to finance the development of its coal mines. PUDA shareholders were completely unaware of these transactions that decimated the value of its U.S. listed shares.

The average of the valuation CITIC paid ($1.91) and the book value of PUDA’s investment in Shanxi coal ($3.41) was $2.66. Due to the 2009 and 2010 audited finances that could no longer be relied upon, and more importantly the complete lack of internal control, Chairman Zhao was able to steal the company, selling half of it (pocketing the proceeds), and then pledging the other half to a Chinese PE fund.
 

One expert commented at the time: "even if Shanxi coal can grow its profit by 80% in 2011 to $61.2 million, this growth is insufficient to cover 2011’s $76.9 million interest expenses."
 

Related links
How To: Avoid Employment Scams in China
China Bar Scam: Hot Girls, Fake Wine and Big Bucks
Common Scams in China (Pt.3): The Tea Scam

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Keywords: Chinese scams biggest scams in China frauds in China Alibaba scandal China corruption China