From Yulun Jiandu via Hexun.com, translated by CDT (A case study that alerts people who have or want to do business in cities even like Shanghai):

Xiao Jilin is the head and chairman of a plastic toys and products factory in Chongming (island) County of Shanghai. But Jindu company was run by his deputy Lu Qingren, a Chongming local who was the vice president and one of the board directors.

Since the formerly township-owned toy maker was incorporated into a stock holding company in 1999, Xiao and other board members were not receiving any dividends, even though he connected the company to overseas orders totaling 20 million yuan in four years. He figured the company should at least turn out a profit of 2 million yuan, based on a conservative profit margin of 10%.

Suspecting pocketing company funds on the part of Lu, Xiao filed a case at Shanghai Municipal Police Department, which asked the county (island) branch to investigate. The result, as the investigation report says, Lu was found of financial wrongdoings but the local police refused to bring him to justice, on grounds that there is insufficient evidence that Lu had the intention to steal company money.

The case, therefore, was shelved for more than a year and is still up in the air.

The former toy maker on the island of Chongming almost died when its main customer broke up in pieces in 1992. In 1995, manager Lu learned of Xiao, who was doing international trade in the industry, and paid a visit to Xiao’s home and invited him for a visit. Xiao’s help, especially with orders from foreign buyers, largely turned the corner for the dying factory.

Business boomed, and in 1999 township government, owner of the factory, decided to sell the company to Xiao, who invested for an 80% stake in the company out of total 170,000 initial equity. Lu got a 20% stake, under the township government’s arrangement.

But until fall of 2004, Xiao and other board members didn’t receive any dividends while he kept bringing orders from overseas worth a total 20 million yuan. The board asked for numerous times about checking the books, but Lu got away with producing them with all sorts of excuses. When Xiao and other finally saw the accounts, there weren’t good profits booked there. It was learned that Lu may have cooked the books with accountants he hired. And people gossiped about that Lu had purchased two properties in Chongming and Pudong worth a combined 3 million yuan at least.

In March 2005, the board decided to report the case to the city police’s economic criminal department. An investigation, mandated by the city to the county police, did find quite some unaccounted for entries involving faked names to claim salaries and undetailed expenses, etc.

However, the county police in late July last year verbally passed a message to Xiao that the case was dismissed because, although there were “material components” of the alleged charge of stealing company funds, there wasn’t enough proof of Lu’s “deliberate intention” to illegally seize the money.

Xiao was advised to file a suit in the local court. But the court pass the buck by saying the case was a criminal one and the police was the one to handle.

Early this year, Lu’s lawyer went to Xiao’s home and presented a settlement proposal on behalf of Lu, who the lawyer said has spent up his money bribing local officials.

An unidentified person who works for the local police told the reporter some clues about why Lu can get away with justice. “How come us Chongming county police arrest Chongming people?” he said. “Even the chief of economic investigation unit of city bureau and other two deputies are from Chongming too.” With that, a mysterious smile. [Full Text in Chinese]

UPDATE: CDT recieved following information from Schylling Associates on December 15, 2006:

Dear CDT,

I am writing on behalf of Schylling Associates, Inc., a company which had been doing business with John Xiao, the ‘victim’ depicted in the said article. Jack Schylling, the founder and president of Schylling Associates, started John Xiao in business in 1995 and did business with him until Xiao ignited a business dispute with Mr. Lu, the ‘criminal’ and consequently ruined our business relationship with him.

Prior to the dispute, since we trusted and respected Xiao as our agent for tin toys in Shanghai, we never placed orders directly with the factories. Mr. Schylling visited the factories many times and developed friendly relationships with everyone he met at the factories. Even after Xiao started his fight against Lu for reasons Xiao cannot explain clearly to us to this day, we decided to keep trusting him and staying with him. However soon communications from Xiao became inconsistent and interrupted . The orders and shipments were delayed or never completed. We had to send a consultant and lawyers to investigate the issue. Meanwhile, Mr. Lu reached out to us and told us the story from his perspective. Then we caught Xiao selling our products in Canton Fair, through trading agents and even on his own website (www.tintoyjohn.com). Schylling is a registered trademark in both the US and China. Xiao’s conduct seriously violates our intellectual property right. Moreover, he refuses to return the molds and tooling for the toys designed and paid for by Schylling. This is simple theft. We are now suing Xiao in the Chinese court, along with many other companies we later discovered that were also cheated by Xiao.

Li Xinde’s report by no means painted a just, thorough and accurate picture of what really happened. Li never interviewed Lu or us during his investigation – assuming there was one. Yet the article tries to present all the charges against Lu as facts. Articles targeting on government corruption easily win sympathy in China. However such sympathy should not be abused at the expense of truth. A big irony of the article is that Xiao never revealed in the article or to Mr. Li (maybe he did) that his step-father is the retired Deputy Chief of the Shanghai Police Bureau. If Mr. Li spend some time investigating what Xiao’s step-father did during this dispute, he may be able to write a more interesting anti-corruption article. If anyone had political connections it would be, more likely than anybody else, Xiao through his stepfather.

We obtained and sent the original Chinese article to Mr. Lu for comments. He did point by point and we translated his comments in English. I am attaching the article with inserted comments. We would be uplifted to see this attached document as an updated version of the original article be published in CDT website as an attempt to right the wrong.

Thank you for your assistance with this matter. Please let me know if you have any questions.

Best regards,

Schylling Associate, Inc.
306 Newburyport Turnpike
Rowley, MA 01969, U.S.A

SHANGHAI CHONGMING POLICEMANS
SHELTER THE LOCAL CRIMINAL SUSPECT

Xiao Jilin is the head and chairman of Shanghai Jindu Plastic Travel Products Company, in Congming, Shanghai. His deputy, Lu, a convicted criminal, is protected by the local government because he is from the suburb of Shanghai while Xiao is from the central city of Shanghai. [Comment by Mr. Lu Qingren: Xiao filed a report with the Shanghai Police accusing me of Post Encroachment. Shanghai Policy appointed Chongming County Policy to further investigate the report.
According to China’s judicial system, there are three steps to determine the nature of a case: first, the police investigate the case and gather evidence. Basing on the preliminary opinion from the Police, the procurator is to further investigate the case. If the procurator decides that the case can be established, the case will be filed to a local court. After going through the proper court procedure, the judge issues a verdict. Only then may a suspect be considered as a criminal.
After receiving Xiao’s report, the local police quickly organized an investigation team to gather and analyze evidence. The result of the investigation was that I was innocent. The case was dropped. Xiao was unsatisfied with the result and pleaded the procurator to supervise the police investigation. The procurator called for and reexamined all the investigation materials, and again, dropped the case. Therefore, Xiao’s report did not even succeed in establishing the case at the police. He absolutely has no ground in accusing me of being a criminal. He is simply slandering.
In addition, I have no relatives at the Chongming Police as what Xiao fabricated in the article. However I should point out that Xiao’s father-in-law is the retired depute chief commander at the Shanghai Police. His father-in-law used his former title to “supervise” the investigation process and visited the Chongming Police several times. The Chongming Police had to brief him on the investigation and repeatedly explained to him the reason that the case was not established. Therefore, Xiao has no ground in accusing Chongming Police of sheltering me as a criminal. If I were guilty, no governmental organization would be ale to shelter me forever. ]

On August 28th, we interviewed Xiao. [I was never interviewed by whoever this “we” were nor given any chance to provide my perspective in this case. Should such an extremely one-sided “news” story as this one be given any credibility?] The following is what he experienced with Lu and with the various government organizations.

Trap

In August 1986, Lu was the head of a township-owned toy factory, which provided tin toy manufacturing service to Shanghai Number 2 Toy Factory. In 1992, Shanghai Number Toy Factory went bankrupt and Lu’s business took a nosedive with it. In August 92, the government restructured the business and named it Jindu Factory and pointed Shi Wengao [Mr. Shi was the assistant head of the factory in charge of technology. He is still working as the director at the Punching department. He is able to testify for me.] as the head of the factory. Lu took over the operation of Jindu as a contractor.
With no business at all, desperate Lu contacted then toy exporter Xiao in 1995 asking for business. Since then, Xiao brought over five million yuan of business to Jindu every year. During these years, Jindu had no other business. [During 1996 and 1997 when my factory just established business relationship with Xiao, the business volume was small. Even during the best years the business never exceeded five million RMB per year.]
Lu became the legal representative of Jindu in June 1997. The local government pursued Xiao to acquire this factory to secure their long-term use of Xiao’s resources. In 2003, Xiao invested RMB 136,000 in the factory and obtained 80% of its shares; Lu, RMB 34,000, 20% shares. Xiao became the legal representative and Chairman of the board. The factory land and buildings were leased from the local government.
[It is absolutely untrue that Xiao invested any money in the factory. The only benefit he brought to the factory was orders he received from a company called Schylling Associates in the U.S.
Jindu factory used to be a collective enterprise, which belonged to my town Wuxiao. Because of its ineffective management, the town government decided that it should be converted into a privately owned enterprise just as many other collective enterprises in 1999 have undergone. I was at the time the head of the factory, thus the town government agreed to transfer the ownership to me.
However according to the policy concerning collective ownership transfer, if a collective enterprise becomes privately owned, the new enterprise has to be in the form of a corporation in which the local government retains a portion of the shares and no less than eight previous employees purchase the remaining shares. However in order to ensure a smooth and fast transition that did not effect the workers and to minimize the amount of the paperwork and red tapes involved, the town office didn’t follow the policy strictly but allowed a nominal purchase and distribution of the shares among “eight employees”. All paperwork was finished within one day. Therefore though on paper there were eight shareholders, but in actuality, I was the only one that invested all the money; the other seven at that time did not even know they became nominal shareholders. The town government knew clearly that I was the only real shareholder.
Xiao admitted during the police investigation that he did not invest any money during this ownership transformation and that the only relationship he had with me was that he sent orders to my factory. I still have a copy of this investigation report. I paid the portion that was supposed to be his investment and never asked for or got repayment from him. The local police interrogated the then Party Secretary of the Town, Mr. Shi Jianxin, the Town Head, Mr. Du Songquan, the Director of the Ownership Transformation Committee, Mr. Guo Jiarong and Mr. Yang Xiaoqing, etc. who helped me get all the paperwork approved in one day. The conclusion the police reached was that I was the only real shareholder that actually purchased the entire available shares. All the purchase receipts are kept in my town’s historical archive. The other seven shareholders, including Xiao, were only nominal shareholders, whose names appeared on the ownership transfer documents only to make up for the number of shareholders required by the government regulation. Furthermore, under the new government policy concerning joint-stock companies, all nominal shareholders, those who were given instead of actually purchasing shares, are not considered to be shareholders anymore. Thus it solidifies the fact that Xiao is not a major shareholder of the Jindu Factory. He does not own the factory.

Profit Myth

Although the orders Xiao brought to Jindu exceeded RMB 20 million from 1999 to 2004, Lu’s financial report showed almost no profit for these years. The factory accountant complained many times that Lu ordered him to put false numbers in the records. [Every order my factory got was from Xiao. The price he quoted was always extremely low. Thus the profit for the factory was low. It is untrue that we cooked the book.] Meanwhile, it was reported that Lu bought two luxury houses in Chongming and Pudong, total value over three million yuan. [I only purchased one house in Chongming for a little bit over RMB 100, 000 when the housing price was low. The house was purchased through mortgage.]

On March 3, 2005, the board made the decision to report this situation to Shanghai Public Security Bureau for investigation.

Investigation

Following Shanghai Public Bureau’s command, Chongming Detective Department immediately sealed Jindu’s all financial records. Shanghai Zhongshi Accounting Firm was pointed as the auditor for the legal investigation of this case.

On 30 March 2005, Shanghai Zhongshi Accounting Firm presented its findings in Zhongshi (2005) No. 133 Report:

1. The book value of factory profit from 1 August 1999 to 31 December 2004 is RMB114,565.72 [Because Xiao brought down the price so much that my factory’s profit margin was very thin. Therefore the cumulative profit was only RMB 114,565.72.]
2. From July 2001 to December 2004, Lu took RMB 205,000 under 12 fabricated names as employee wages. [This RMB 205,000 were salaries in lieu of the mold making fees for the past several years.]
3. During 2002 to 2004, Lu took cash RMB161,000 for employee bonus but the actual distributed amount was RMB 135,400. Lu pocketed RMB25,600. [As the head of the factory, my salary was merely RMB 1000/month. My other compensation was in the form of bonus.]
4. 12 July 2004, Lu transferred RMB300,000 for purchasing Jindu factory building as his personal property. [I did purchase the building for RMB 300,000. This money is still in the account of the Baozhen Town Finance Office.]
5. RMB278,706.37 sales income not reported. [I gave the products to Xiao, but Xiao never paid me. How could I recorded anything as sales income?]
6. Large amount of false receipts for transportation expenses.

[Xiao never showed the Schylling orders directly to us. He decided the price unilaterally. All money coming to the factory came from him. He was the one who decided when to pay, how much to pay to whether or not to pay at all. All payments were in the form of checks. He still owes the factory about RMB 600,000 for about thirteen shipments of toys from July 2001 to July 2005. This RMB 600,000 does not take into account the mold fees he also owes me.]

The Government System

On 26 July 2005, Chongming Police Bureau concluded that Lu committed a crime as illegal possession on work position because of item 2, 3, 4 in this report. However, there is not enough evidence to prove he had the motivation for the crime. Therefore it is a factory’s internal personality conflict problem. They rejected this case.
Xiao’s lawyer presented this case to Chongming Court for a civil law suit. The response was this was a criminal case and should be handled by the Public Security Bureau. Xiao contacted Chongming Monitory Bureau but was shocked by their response: Lu’s action did compose the crime, but his mind did not! [In Xiao’s opinion any governmental organizations, including the Shanghai Police, the Chongming Police, the Procurator and the Court, were corrupted if they didn’t go his way.]

Corrupted Government

In January 2006, Lu’s lawyer came to Xiao’s home and asked Xiao to settle with Lu. He revealed that Lu had spent a large amount of money on the local government and that was why he could get away. Now he was spending even more after the auditor’s report came out. The head of the local government once asked Lu’s lawyer to bend the law to protect Lu. He had no choice but following orders because his wife works for the government under these people. [This is untrue.]

When we visited Chongming Public Security Bureau, an officer (unwilling to reveal his name) told us: “Xiao is from the central city (of Shanghai), and Lu is one of us Chongming (Shanghai suburb) islander. Of course we protect Lu. How could we arrest our own Chongming people? There is no way Xiao could win in Shanghai, because the head of Shanghai investigation department is from Chongming, and so are the two deputies.” [This is untrue.]

American, Innocence or Not?

Lu is still using Xiao’s facility manufacturing toys for an American company (named Schylling Associates, Inc.*) [All machinery was purchased when the factory was founded in 1985, except for some small pieces that I purchased later.] Xiao never invested in any machinery or facility – in short, Xiao never invested a penny in the factory. Now he thinks that all the molds that he still hasn’t paid for are his and is suing me in order to get the molds. I will try my very best to protect the molds for Schylling. I consulted my attorney and he suggested that the best defense is offense and that that Schylling counter sue Xiao for the ownership of the molds. Schylling already provided me with copies of Xiao’s pro forma invoices for the molds and records of all corresponding payments from Schylling to Xiao.]

* No reporter ever contacted anyone at Schylling Associates.