China's counterfeiters aided by Western firms' weak response

AP News
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Posted: Dec 18, 2015 8:33 AM
China's counterfeiters aided by Western firms' weak response

WENZHOU, China (AP) — Alex Theil lost his innocence the day an envelope landed on his desk. It was filled with money from a counterfeiter of Toyota auto parts he'd busted, mistakenly delivered to him by a lawyer hired to help with the raid.

Theil was running the office of the Pinkerton detective agency in Guangzhou, China. With the arrival of the bribe — meant to ensure against future raids — his faith in an ordered universe in which investigators fight crime instead of committing it began to unwind. Fifteen years and thousands of anti-counterfeiting raids later, he concluded that the envelope he received was not an exception: It was the norm.

"I thought we were all the good guys working against the bad guys," he said. "It's not that simple."

An Associated Press investigation published last week uncovered systemic fraud in China's anti-counterfeiting industry. Major multinational companies, blind to problems on the ground, unwittingly paid investigators who themselves manufactured or sold counterfeit goods. In other cases, investigators colluded with the very counterfeiters they were supposed to expose.

Fraud in the anti-counterfeiting industry goes well beyond luxury fashion goods, and has impacted products that can be dangerous — including auto parts, pharmaceuticals and critical electrical components, the AP found.

Western companies share the blame, because many have bought into a system that facilitates widespread fraud, according to more than a dozen lawyers, law enforcement officials and private investigators interviewed by the AP. One of them is Theil, who has spent years trying to figure out a way to fix the system.

Many firms treat counterfeiting as a minor cost of doing business in China. Few spend the money required to tackle the powerful, hidden networks that drive China's multibillion-dollar counterfeiting juggernaut. And few are willing to talk about the issue publicly. Of 11 companies the AP approached for comment, only one agreed to discuss the problem of investigative fraud.

"We are not getting any closer to fixing the problem," Theil said. "If our own industry wouldn't be a major part in keeping it going instead of fighting it, counterfeiting would have been eliminated a long time ago."

The failure of major Western brands to better manage fraud is not just a waste of money. It also makes it easier for dangerous fakes to slip into global supply chains, and creates more work for U.S. Customs and Border Protection.

Stephen Long, deputy chief officer for the port of New York/Newark, oversees dozens of inspectors who spend their days in four New Jersey warehouses, combing through tens of thousands of boxes stacked in aisles that run the length of two football fields, looking for fakes.

"The sheer volume is overwhelming," he said, adding that counterfeiters have grown more sophisticated over the years, crafting elaborate smuggling strategies and perfecting their ability to churn out near-perfect copies.

The problem begins in places like Wenzhou, a city 460 kilometers (285 miles) south of Shanghai and one of the darker corners of China's economic miracle. Locked-up shop houses and weedy lanes mask a booming trade in counterfeit goods.

Liushi China Electronic City is situated beside a thin, murky river in Wenzhou. The vast marketplace is well-known for selling fake electrical components. Inside, women sat behind row after row of glass counters tightly packed with electric switches, circuit breakers, power cords and copper cable. An empty police car was parked outside.

Three vendors at the market offered to sell the AP counterfeit circuit breakers. "Do you want real or fake? The prices are totally different," was the first question one shopkeeper asked. She said she could source fake ABB, Siemens and Schneider circuit breakers for export and provided a price list and the phone number of an agent to expedite customs clearance. Another man was selling unlabeled circuit breakers, but said he'd be happy to stick an ABB logo on the device and export it.

As enforcement has gotten better in China, Theil has seen counterfeiters fragment their supply chains. Most subcontract illegal work to a shifting array of smaller, substandard workshops, effectively decentralizing their risk and making criminal cases more difficult to lodge, he said.

An hour south, in Rui'an, which bills itself as the spare parts city of China, thin chimneys blew black smoke from crude aluminum smelters. An industrial, metallic smell singed the air. Sweating, Theil walked down a broken road, past a rusted-out truck. He paused before a workshop in a low concrete building. Inside, a man pulled shiny metal parts from a clanging, old machine and tossed them on the floor.

"These are probably camshaft tensioners," Theil said. "They are very expensive. They are also quite crucial because if the tensioner breaks, the engine will probably overheat and there is a risk that it will actually end in a burning engine."

One worker, who spoke on condition of anonymity because he feared retribution, said the auto parts factory in Rui'an where he used to work simply hid the counterfeits when government inspectors came around.

When the local government officials offered cash rewards for whistleblowers, he said some people refused to bite, worried that the officials themselves were secretly working with counterfeiters.

Wenzhou officials did not respond to requests for comment.

Inside the auto parts factory, the AP found worn plastic baskets bulging with metal parts. People worked silently at hulking, grimy machines, some of them jerry-rigged with Sprite bottles. The light was weak, the walls stained. When an AP team began asking questions, the journalists were asked to leave.

Over the years, first at Pinkerton and then as director of Asia-Pacific investigations at General Motors, Theil saw photos of officials, counterfeiters and investigators all toasting each other at a lavish banquet. People he himself hired tried to extort protection money from counterfeiters. He spoke of corrupt investigators, armed with inside information gleaned from their work with in-house brand protection staff, teaching counterfeiters how to make fakes indistinguishable from genuine items.

It was a dangerous game. Theil said one man sent to bust up a counterfeiting ring that made fake GM spark plugs was kidnapped and dumped on the side of the road, half-dead with blood all over his face.

By 2008, Theil concluded that the only solution was to take an entirely new approach to anti-counterfeiting.

He left GM and founded an investigations firm called Harvest Moon. He recruited a team of local investigators in counterfeiting hotspots across China, offering to double, even triple, people's salaries. But he still had trouble recruiting local informants: Eighty percent of the people he approached walked away once he insisted on going on raids himself, he said.

"They'll make five crooked cases quicker than one profitable one," Theil said. "Once they realized it was too difficult to cheat us, they weren't interested anymore."

Most companies outsource anti-counterfeiting work to investigators who are paid on volume. More cases mean more money, creating powerful incentives to cheat in an industry with little oversight. Theil insists on a fixed salary to break the destructive habit of paying on commission. That allows him to treat raids as tools for gathering intelligence, rather than a way to get paid.

"Only when you know who is the boss can you start doing more than producing case figures," he said.

Harvest Moon's offices are located in an unremarkable building in an unfashionable part of Shanghai. His staff — all Chinese but one — works behind unruly stacks of paper in a long room with stained gray carpet. Tucked in a candy-pink storage room are samples of recently seized fakes, including airbags and steering components.

Theil picked up a hammer and pried open a crate of counterfeit auto grills.

"A grill is the face of the car," he said. "If the plastic breaks in a certain fashion, it could become like a knife. If that would hit a person in the wrong place, you could kill somebody with it."

Of the steering components, he said, "If they break, you might lose steering capability. The wheels fly off. You fly off."

In November, Theil flew to Beijing to present the findings of over a year of investigative work for a key new client, Siemens AG. In a conference room at Siemens' towering glass China headquarters, he clicked through 40 PowerPoint slides. He did not present bar graphs showing ever-rising numbers of raids. He did not brag about how many items he had seized.

Instead, he made a map.

The map showed the reach of a single, family-run network of counterfeiters, which produce fake versions of Siemens connectors — key mechanical components in machinery that automate industrial processes, like assembly lines. The family, Theil said, controls 28 shell companies and dozens of distributors scattered across China. He also explained how the bosses had insulated themselves from legal risk, leaving it to others to actually stick the Siemens logo on the counterfeit goods.

Beat Weibel, Siemens' chief intellectual property counsel who flew in from Munich for the meeting, liked what he saw.

"Everybody was quite impressed," Weibel said. Now the challenge is to develop a legal strategy that can, "really break them and really hurt them. That's different than just raiding shadow factories and shops."

Theil's approach is still an experiment for Siemens. It costs more and success is not certain or even easy to measure.

Running raids may cost several hundred thousand euros (dollars) a year. Filing three to five criminal lawsuits in China pushes costs into the millions, Weibel said.

That's one big reason most companies continue to blindly pay investigators to do more raids, fueling a cycle of corruption that has, so far, left the powers behind China's empire of fakes largely untouched.

"Everything is paid by the innocent or stupid Western companies that believe with this activity they will really solve the problem. They don't," Weibel said. "They nourish the system."

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AP photographer Ng Han Guan in Wenzhou, researcher Fu Ting in Shanghai and correspondent Alexandra Olson in New York contributed to this report.

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Follow Kinetz on Twitter: http://twitter.com/ekinetz

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For the past year, AP's investigative reporter in Shanghai, Erika Kinetz, has been examining the illegal economies behind China's global expansion. For other stories in this occasional series, see:

Money laundering investigation stymied by China, Italy says

http://bit.ly/1IVFogK

Chinese counterfeiter finds a comfortable life in California

http://bit.ly/1NcgInW

AP Exclusive: Chinese banks a haven for web counterfeits

http://bit.ly/1lQ02cI

Who's investigating fake Chinese goods? Fake investigators

http://apne.ws/1Q3pbOo