In Asia, there is a popular fidelity claim involving the person-in- the-middle scheme. These schemes have increased as more foreign companies enter the market in Asia due to the rapid economic growth and significant consumer market. Language differentials, lack of access to sales channels, requirements of joint ventures, ownership and control by citizens of the country make these schemes popular.
The Types
Generally, there are two types of person-in-the-middle schemes. The first type of scheme involves the foreign company selling products to Asia. The second type of scheme involves the foreign company selling products from Asia. “Equity joint ventures” are one of the main types for direct investment in China and are regulated by Chinese law. Overseas parties are allowed to invest at least 25% of the entire registered capital in cash or trade property rights. Foreign companies often partner with representatives familiar with the language and culture (person-in- the-middle) to facilitate the sales or purchase transactions. The person-in- the-middle could be involved in either 1) the sales or 2) the purchases schemes.
In the sales scheme, the foreign company hires employees familiar with the Asian market to conduct research or search for potential Asian buyers to sell the products for the foreign companies. Most of the person-in- the-middle sales schemes are related to a creation of a company by the Asian employee the foreign company thinks is the end user. In actuality, the Asian employee creates a company that buys the products from the foreign company and resells the products to an Asian company at a higher price and retains the difference.
The second method involves the foreign company buying goods. The Asian employee is to obtain the best purchase price for the foreign company. The Asian employee provides false cost information to the foreign company and buys the product for a higher price from one Asian company, ignoring fair bidding and arms- length transaction. The Asian employee receives kickbacks from the Asian seller.
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Policy Issues
When the victim of a person-in- the-middle scheme, the foreign companies file employee theft claims under
their policies. Most of the employee theft policy language reads as follows:
- EMPLOYEE THEFT
We will pay for loss of or damage to “money”, “securities” and “other property” resulting directly from “theft” committed by an “employee”, whether identified or not, acting alone or in collusion with other persons.“Theft” means the unlawful taking of “money”, “securities”, or “other property” to the deprivation of the Insured.
The named insured is generally the foreign company. Typically, the following exclusions are addressed in the employee theft policy language:
Exclusions
- Indirect LossLoss that is an indirect result of an “occurrence” covered by this policy including, but not limited to, loss resulting from:
- Your inability to realize income that you would have realized had there been no loss of or damage to “money”, “securities” or “other property”.“Theft” means the unlawful taking of “money”, “securities”, or “other property” to the deprivation of the Insured.
The definition of employee:
- “Employee”:
- “Employee: means:
- Any natural person:
- While in your service and for the first 30 days immediately after termination of service, unless such termination is due to “theft” of any dishonest act committed by the “employee”;
- Who you compensate directly by salary, wages or commissions; and
- Any natural person:
- “Employee” does not mean:
- Any agent, broker, factor, commission merchant, consignee, independent contractor or representative of the same general character not specified in Paragraph 5.a.
- “Employee: means:
The policy excludes “indirect loss”, such as the inability to realize income that the foreign companies would have realized had there been no loss of or damage to “money”, “securities” or “other property”.
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Internal Controls
When trying to sell products to Asian countries, many foreign companies partner with local distributors in Asian countries. The local distributors serve as customer liaisons. The foreign companies often sign an agreement with the local distributors. The agreement generally includes the appointment, obligations of the distributors and product-related information. Typically, the distributors report to the management of the foreign companies with information about the quantity of products and the price the potential Asian customers are willing to pay to purchase products. Due to the language barrier, the foreign companies sometimes hire their own personnel, generally an individual who is familiar with Asian languages, to oversee and evaluate the information provided by the local distributors. In some cases, the personnel hired by the foreign companies work in collusion with local distributors by providing false information.
For example, the personnel who are hired by the foreign companies (employee of the foreign companies) can conspire with local distributors to inform the management of the foreign company the Asian customers would buy the product for USD $80.00. The foreign companies would sell the products to local distributors for USD $72.00, allowing the local distributors to earn a 10% profit, or USD $8.00. In reality, the local distributor would sell the products to Asian customers at USD $120.00. The local distributor would, realize a profit of USD $48.00 ($120.00 – $72.00). Had there been no conspiracy, the local distributors would only realize a profit of USD $12.00 ($120.00 – $108.00). By conducting a conspiracy with the foreign company’s personnel, the local distributors realized an additional profit of USD $36.00 ($48.00 – $12.00).
Coverage Analysis (Indirect vs. Direct Losses)
Generally the employee theft coverage excludes “indirect loss”, including loss resulting from the insured’s inability to realize income they would have realized had there been no loss of or damage to “money”, “securities” or “other property”. If the foreign company filed an employee theft claim against the personnel or employee due to the conspiracy between the employee and the local distributors, at issue will be whether the foreign company incurred a direct loss or indirect loss due to the conspiracy. If the foreign companies sold their products to local distributors at a price lower than the cost of the products, the foreign companies would incur a direct loss. If the foreign companies sold their products to local distributors at a price higher than the cost of the products, the foreign company would not incur a direct loss. The loss of revenue or the inability to realize income had there been no conspiracy between the personnel hired by the foreign company (person in the middle) and the local distributor is an indirect loss.
