Anti-employee Control Fraud

By William K. Black

Apple has released a report on working conditions inits suppliers’ factories.  It highlightsa form of control fraud that criminology has identified but rarelydiscussed.  I write overwhelmingly aboutaccounting control fraud because it drives our recurrent, intensifyingfinancial crises.  The primary intendedvictims of accounting control frauds are the shareholders and thecreditors.  Other private sector controlfrauds target customers (e.g., George Akerlof’s 1970 article on “lemons”), andthe public (e.g., the unlawful disposal of toxic waste, illegal logging, andtax fraud). 

Anti-employee control frauds most commonly fall infour broad, but not mutually exclusive, categories – illegal work conditionsdue to violation of safety rules, violation of child labor laws, failure to payemployees’ wages and benefits, and frauds based on goods and loans provided bythe employer to the employee that lock the employee into quasi-slavery.  Apple has just released a report on itssuppliers that shows that anti-employeecontrol fraud is the norm.  Remember,fraud is hidden and is often not discovered and Apple did not have an incentiveto make an exhaustive investigation. Apple calls its inquiries “audits” and it is apparent that most of itsinformation comes from reviewing written and electronic records at itssuppliers.  That is exceptionallyrevealing.  The suppliers know that theycan defraud their employees with such impunity that they don’t even bother toget rid of records that prove their frauds. Apple has resisted making public its suppliers and the report refused toidentify which suppliers committed which violations – often for years despiterepeated, false promises to end their anti-employee control frauds.  Two other facts are evident (but notreported).  First, Apple rarelyterminates suppliers for defrauding their employees – even when the fraudsendanger the lives and health of the workers and the community – and even whereApple knows that the supplier repeatedly lies to Apple about these fraudulentand lethal practices.  Second, it appearsunlikely in the extreme that Apple makes criminal referrals on its supplierseven when they commit anti-employee control frauds as a routine practice, evenwhen the frauds endanger the worker’s and the public’s health, and even whenthe supplier repeatedly lies to Apple about the frauds.  Apple’s report, therefore, understatessubstantially the actual incidence of fraud by the 156 suppliers (accountingfor 97% of its payments to suppliers).

“The company said audits revealed that93 supplier facilities had records indicating that more than half of theirworkers exceed a 60-hour weekly working limit. Apple said 108 facilities didnot pay proper overtime as required by law. In 15 facilities, Apple foundforeign contract workers who had paid excessive recruitment fees to laboragencies.
And though Apple said it mandatedchanges at those suppliers, and some facilities showed improvements, inaggregate, many types of lapses remained at levels that have persisted foryears.”

The New YorkTimes, Wall Street Journal, and theWashington Post articles on the Apple report are all lengthy, but none ofthem has any input from a criminologist and each of the articles misses most ofthe significance of the report.  I havealready brought out several of these deficiencies.  The most fundamental flaws, however, have todo with why anti-employee control fraud is the norm at Apple’s suppliers andwhy the suppliers typically don’t even take the inexpensive efforts necessaryto avoid holding a paper trail that makes the frauds obvious even to a notterribly vigorous audit that they know is coming. 

If there is one single thing that drives uswhite-collar criminologists around the bend it is the implicit assumption thatfraud cannot be common.  There is, ofcourse, no logical (or experiential) reason for this belief.  Nevertheless, it is a common belief and amongeconomists it is a virtually universal dogma. Economists have a tribal taboo against even using the word “fraud” todescribe individual frauds.  The surestway to be considered an un-serious economist is to use the “f” word to describefrauds by elite economic actors. Economists’ taboo is particularly bizarre because it is economic theory,developed by a Nobel Laureate that explains why fraud can become endemic.  George Akerlof, in his famous article onmarkets for “lemons” (largely describing anti-customer control fraud),explained the perverse “Gresham’s” dynamic in 1970.  

“[D]ishonest dealingstend to drive honest dealings out of the market. The cost of dishonesty,therefore, lies not only in the amount by which the purchaser is cheated; thecost also must include the loss incurred from driving legitimate business outof existence.” 

Anti-employee control fraud creates real economicprofits for the firm and can massively increase the controlling officers’wealth.  Honest firm normally cannotcompete with anti-employee control frauds, so bad ethics drives good ethics outof the markets.  Companies like Apple andits counterparts create this criminogenic environment by selecting least-cost –criminal – suppliers who offer components at prices that honest firms cannotmatch.  Effectively, they hang out a sign– only the fraudulent need apply to be suppliers.  But the sign is, of course, invisible andcannot be introduced in court so Apple and its peers also get deniability.  They are shocked, shocked that its suppliersare frauds that cheat their employees and put them and the public’s health atrisk in order to make a few extra yuan ordong for the senior officers.  

Fraudulent suppliers, therefore, have compellingincentives to locate in nations and regions in which they can commit fraud withimpunity.  The best way to evaluate thefraudulent CEOs’ view as to the risk of prosecution for their frauds is toobserve whether they take cheap means of hiding their frauds.  When the CEOs do not even bother to avoidcreating a paper trail documenting their frauds one knows that they view therisk of prosecution as trivial.  Nationsthat are corrupt, have weak rule of law, weak or non-existent unions, poorprotections for workers, a reserve army of the impoverished, and have fewresources devoted to prosecuting elite white-collar crime provide an idealcriminogenic environment for firms engaged in anti-employee control fraud.  The ubiquitous nature of anti-employeecontrol fraud (and tax fraud) in many nations explains why U.S. industries havebeen so eager to “outsource” U.S. jobs to fraud-friendly nations.  Companies like Apple also discovered long agothat Americans often made poor senior managers in these nations because theyobjected to defrauding workers.  Not aproblem – there are plenty of managers from other nations that have no suchethical restraints.  Foreign suppliersrun by Asian managers are increasingly dominant.

The endemic nature of anti-employee control fraudalso demonstrates an important technical point. The wages reported in the most fraud-friendly nations are substantiallyoverstated because workers work far longer hours without receiving thecompensation to which they are entitled. Their hourly rate is much lower than reported, which means that the wagegap between U.S. and the most fraud-friendly nations is significantly greaterthan reported.  U.S. firms that haveforeign suppliers in these nations are well aware of this data bias and maketheir outsourcing decisions based on the real (much larger) wage gap.            

TheHarm to Employee and Consumer Health is Grave

The NYT article notes that it was badpublicity in the U.S. that finally forced Apple to make greater disclosuresabout its suppliers’ frauds.
“The calls for Apple to disclosesuppliers became particularly acute after a series of deaths and accidents inrecent years. In the last two years at firms supplying services to Apple, 137employees were seriously injured after cleaning iPad screens with n-hexane, atoxic chemical that can cause nerve damage and paralysis; over a dozen workershave committed suicide or fell or jumped from buildings in a manner thatsuggests a suicide attempt; and in two separate blasts caused by dust frompolishing iPad cases, four were killed and 77 injured.”
“Apple found that 62 percent of the 229 facilitiesit inspected were not in compliance with the company’s maximum 60-hour workpolicy; 13 percent did not have adequate protections for juvenile workers; and32 percent had problems with the management of hazardous waste.

One supplier was caught dumping wastewater at anearby farm. Another had a total lack of safety measures, creating “unsafeworking conditions,” the report found. Five facilities employed underageworkers.

The company in the past had refused to divulge itsfull supplier list even as it became standard practice for multinationalcorporations to do so after the public outcry in the 1990s over labor problemsat Nike factories in developing countries.

Apple’s change of heart follows a highly publicizedstring of factory worker suicides in 2010 and deadly explosions in two Chinesefactories in 2011.”

The WSJ emphasized this chillingfinding:

“The report also found 24 facilities conducted pregnancytests and 56 didn’t have procedures to prevent discrimination against pregnantworkers. Apple said that at its direction, the suppliers have stoppeddiscriminatory screenings for medical conditions or pregnancy.”

The article does not make this point explicitly, but these firms conductthese tests in order to unlawfully coerce their pregnant employees to haveundesired abortions in order to obtain and keep their jobs.

ForeignAnti-employee Control Fraud harms U.S. Workers

These frauds take place abroad, but they harm employees in the U.S.  Mitt Romney explains that Bain had to slashwages and pensions to save firms located in the U.S. who had to meetcompetition from foreign anti-employee control frauds.  The damage from foreign anti-employee controlfrauds drives the domestic attack on U.S. manufacturing wages.  Bad ethics increasingly drive good ethics outof the markets and manufacturing jobs out of the U.S. and into morefraud-friendly nations. 

A final caution is in order because each of the major articles on the Applereport failed to mention it.  CEOs whoare willing to routinely defraud their workers and expose them to grave threatsto their health are exceptionally likely to commit other forms of controlfraud. 

Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives. 

 Follow him on Twitter: @WilliamKBlack

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