The Bank of China's Black Hole

How $480 million disappeared from one of the country's biggest banks

Regulators in China, Hong Kong and the U.S. are painfully aware that scandal is rattling Bank of China, one of the mainland's four biggest banks. One case goes right to the top. Former Chief Executive Officer Wang Xuebing is now detained for alleged misconduct in the matter of a $23 million loan. The fraud, which involves the bank's New York office, has just forced the bank to pay Chinese and U.S. authorities a $20 million fine.

But scandal is not just stalking the executive suite at Bank of China. Details are now coming out of a theft at the bank that makes the Wang case look like a financial footnote. Almost half a billion dollars are missing from the bank's accounts, and police in China, Hong Kong, and Canada are trying to find the money and the bank executives who allegedly masterminded the scam. While they look, the integrity of China's banks is bound to get a serious knock just as the country enters the World Trade Organization. The thefts are raising troublesome questions about China's ability to regulate its financial system, even as that system is being thrown open to the forces of the free markets.

The tale starts at Kaiping Sub-Branch of Bank of China. While Kaiping is a prosperous manufacturing town in Guangdong province, the branch itself seems an unlikely place from which to engineer a major international financial scam. Set in one of the town's only skyscrapers, the branch's empty lobby and trickle of customers make it look more like a monument to its managers' egos than a commercial enterprise.

But the Kaiping Sub-Branch is now the focus of a probe involving dozens of investigators on two continents. For it was through Kaiping that a group of Chinese bank executives allegedly diverted millions from Bank of China over a nine-year period starting in 1992 and ending last October. Senior Bank of China executives believe that when the damage is toted up, the loss will total some $480 million. Only about $75 million has been accounted for so far, and much of that appears to have been lost in the crash of the Hong Kong real estate and stock markets after 1997. A Hong Kong police source says of the probe: "It's a big one."

Hong Kong investigators believe that the theft involved Bank of China branch staff in Kaiping and Guangzhou, capital of Guangdong, along with accomplices in Hong Kong and Vancouver, where some of the money now resides. Four people have been arrested in Hong Kong and charged with "dealing in property known or believed to represent the proceeds of an indictable offense." Their arrests were made in October, but details of the cases have just come out in documents filed in a Canadian court. Meanwhile, Canadian police may be looking for three other suspects who Hong Kong authorities believe fled to Vancouver, including the purported mastermind of the scheme, a former Kaiping branch manager named Fan Xuchao.

The Kaiping case casts a harsh light on Beijing and Hong Kong regulators, who allowed the leakage of Bank of China funds to go on for almost a decade without detection. David T.R. Carse, deputy chief of the Hong Kong Monetary Authority, defends his agency, saying money laundering is a "global problem" and that Hong Kong has stepped up its surveillance of the banking system in recent months.

In setting up their operation, the Kaiping gang allegedly used a scam common among Chinese companies in the go-go 1990s, when China-linked stocks boomed on the Hong Kong bourse. Many mainland Chinese set up so-called "window" companies to speculate in stocks and real estate in Hong Kong--China's window on the rest of the world. In local parlance, window companies that indulged in such speculation were "stir-frying" investments. According to investigators, Fan and his confederates cooked up a storm.

Some of the window companies were legal, while many occupied a gray area. All had to contend with strict Chinese laws against moving money from the mainland. Often, funds were diverted from mainland companies and banks by employees who wanted to play the markets. Those who "borrowed" this way would pay their employers back if they made money. If not, the scamsters relied on creative accounting to cover their tracks.

In the Bank of China case, Hong Kong authorities allege that Fan started skimming money in the early 1990s, when he worked at the Kaiping branch. In 1999, he was promoted to a managerial job at the Guangzhou regional headquarters. From 1999 until he fled last October, Hong Kong authorities assert, he conspired with two managers at the Kaiping branch, Xu Guojun and Yu Zhendong, to steal almost $75 million. What happened to the $405 million that disappeared before Fan's promotion isn't yet clear.

Fan's principal Hong Kong window company, authorities say, was Ever Joint Properties, founded in 1993. Fan is said to have recruited a relative, Hui Yat-sing, to set up Ever Joint. Hui was arrested in Hong Kong in October, along with his wife and two others. Contacted through a spokesperson, Hui refused to comment. The lawyers of the other arrested suspects couldn't be reached.

Much of the money deposited at Ever Joint moved on to other accounts at elite financial institutions. According to court documents filed in Vancouver, Fan and his partners had deposit and brokerage accounts at Hong Kong branches of ING Bank, Standard Chartered Bank, Fortis Bank, UBS, and HSBC Broking Securities. Contacted by BusinessWeek, Standard Chartered said it is cooperating with police on the case. The other banks refused to comment.

Fan and company invested millions of dollars in Hong Kong stocks--apparently with disastrous results. Ever Joint's biggest stock position was in Leading Spirit High-Tech Holdings Ltd., a China stock that has plunged 99% from its 1997 high. The group also bought a stake in tycoon Richard T.K. Li's Pacific Century CyberWorks Ltd. Worth $4 million when the stock peaked two years ago, the stake is now valued at $321,000.

The Bank of China's loss was not discovered until the three main suspects, Fan and his bank cohorts, Xu Guojun and Yu Zhendong, fled China, apparently last October. Though Hong Kong police believe they're in Canada, the Royal Canadian Mounted Police say they have not yet made an arrest. An RCMP spokesman says, however, that the agency is examining a "roomful of documents that may have evidence of alleged wrongdoing" by the trio. Canadian bank accounts containing a total of $3.8 million have been frozen. Accounts in Hong Kong containing an unknown amount of money have also been frozen.

The Kaiping case has given added impetus to attempts by Bank of China Chairman Liu Mingkang to install more sophisticated risk management measures. But the explosion of bank corruption won't be ended easily. Part of the problem is that Chinese bankers receive pitifully small salaries by international standards. The top execs at China's four major banks typically make just $3,600 to $4,350 a year. Fan, of course, made much less. "You have government officials controlling substantial amounts of resources, and you pay them almost nothing," says an adviser to several mainland enterprises. "It provides an incentive for people to steal." Unfortunately, that incentive is working all too well.

Corrections and Clarifications The name of a Bank of China employee was misstated in "The black hole" (International Business, Feb. 4). The correct name is Xu Chaofan, not Fan Xuchao.

By Mark L. Clifford in Hong Kong and Petti Fong in Vancouver, with Miguella Lam in Hong Kong, Alysha Webb in Shanghai, and Dexter Roberts in Beijing

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