China’s Ongoing Battle with Illegal Fundraising


In order to quell some of the worst practices of the shadow banking sector, the Chinese government has embarked on another Anti-Illegal Fundraising Publicity Campaign. This is an attempt to clearly lay out regulations on the topic, which were further illuminated in the Supreme People’s Court March 25 document on the treatment of illegal fundraising criminal cases, and is part of ongoing efforts by the Interagency Anti-Illegal Fundraising Taskforce, which was established in 2008. In this article, we consider the current focus of illegal fundraising and then ask: What kind of problem is illegal fundraising, and how can we analyze it in the context of shadow banking?

Illegal fundraising is the gathering of funds from the public for financial purposes, classified by the Supreme People’s Court under the thirteen most common types of fraudulent projects, from using funds to supposedly sell commodities to holding rural “Investment Fairs” to borrow at high interest rates for the purported purpose of building supermarkets. What the thirteen types of projects have in common is that they use false advertising for nonexistent or exaggerated projects, while promising high returns. These crimes are punishable by death, as evident in several high profile cases, including those of Zeng Chengjie, who raised funds for real estate development, and Liu Haiyan, who owned an investment company and used funds for speculation.

The latest focus of illegal fundraising is more sophisticated than that in previous cases. Liu Zhangjun of the China Banking Regulatory Commission noted that crowd funding and peer-to-peer lending are potential illegal fundraising models of particular concern. In these models, lenders often do not know their borrowers, and borrowers do not know their lenders. The internet funding companies are often unauthorized to engage in lending practices. Risk control and truth in advertising may be abandoned in some cases, leading to consumer fraud.

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Despite these new methods of defrauding customers, illegal fundraising has been going on for some time, since the rise of private enterprise in the nineties. Given the constrained nature of the banking system, which continues to lend to larger and state owned corporations, small and medium enterprises, as well as individuals, have been forced to turn to sources of funding outside of the formal sector. Most of the fundraising activity for smaller, private entities has been for highly productive purposes, such as working capital, while a relatively small percentage of the activity arose for the purposes of defrauding the public. Since the nineties, we have heard of cases in which Ponzi schemes or illegal fundraising organizations arose and individuals lost their savings.

For example, Jianjun Li, a noted scholar on Chinese shadow banking, wrote in his 2006 book about the (still relatively early) case of Yang Fengxiang, who was the leader of an agricultural association board that was originally established to assist farmers with funding the planting trade and agricultural technology. From 1996 through 2000, Yang illegally accepted deposits and loaned some of the funds to small enterprises that were revealed to be fraudulent. After Yang declared bankruptcy in 2000, he was arrested and sentenced to fines and imprisonment.

This type of illegal activity has only increased since, as China’s economy has grown. Over 2,000 cases have been addressed yearly since 2005, and 3,700 cases were handled in 2013 alone. In September 2013, an online investment website run by Hong Kong Jinyu Hengtong Investment Management Ltd was shut down after losing 10 billion RMB ($161 million) in investor money. The wealth management product the website offered promised a monthly return of 45 percent. Investors, with few other investment outlets, have often been lured by the shadow banking sector, which has promised far better returns than those on bank deposits, which are often negative once inflation is taken into account.

The shadow banking sector has been popular for that reason. The formal sector is constrained both in terms of the supply of funds to smaller and riskier entities, and in terms of returns to investors. Therefore the shadow banking sector has attracted many participants. The sector is diverse, ranging widely from curb lending to trust asset securitization, and it is difficult to monitor. Because shadow banking channels are so varied, financial criminals are able to seek out the least regulated areas in which to conduct their business. While some types of funds are used in an immoral fashion, such as in unproductive property developments, other funds are used for illegal purposes, such as for personal consumption. The more closely the user of illegal funds is aligned with the procurer of illegal funds, the more potential there is for legal repercussions to ensue.

For example, we have seen a flagging coal company’s owner throw a large wedding celebration for his daughter while defaulting on his trust loans. Xing Libin, founder of Liansheng Resources, borrowed a total of 1 billion RMB ($165 million) from Jilin Trust and spent $11 million on a celebration on Hainan Island. Xing later applied for debt restructuring at a local court, and Jilin Trust warned investors that Liansheng faces problems with repayment of its debt. Xing faced no legal repercussions as a result of his behavior. By contrast, in a very public case, Wu Ying, or “Rich Sister,” was indicted for taking $55.7 million from investors on behalf of her company, Bense Group. She had spent some of the money on cosmetics, clothing and luxury cars.

The general rule of thumb in these cases may be that the less formal the type of fundraising carried out within the shadow banking sector, the more at risk it is of being pursued as an illegal fundraising case. Although fraudulent fundraising imposes enormous costs on the public, productive finance within these less formal channels should still be clearly differentiated from unproductive finance. This will allow smaller enterprises to continue to operate and bolster China’s large economy. Some liberalization of the banking sector would also be welcome, in the former of higher deposit rates and the extension of bank loans to small and medium sized enterprises. The more that can be gained by clearly legal means, the better off all economic participants will be.

Follow Sara Hsu on Twitter @SaraHsuChina.

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