January 2012, Week 4


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Anti-employee Control Fraud
By William K. Black
New Economic Perspectives
January 17, 2012

Apple has released a report on working conditions in its
suppliers' factories.  It highlights a form of control
fraud that criminology has identified but rarely
discussed.  I write overwhelmingly about accounting
control fraud because it drives our recurrent,
intensifying financial crises.  The primary intended
victims of accounting control frauds are the
shareholders and the creditors.  Other private sector
control frauds target customers (e.g., George Akerlof's
1970 article on "lemons"), and the public (e.g., the
unlawful disposal of toxic waste, illegal logging, and
tax fraud).

Anti-employee control frauds most commonly fall in four
broad, but not mutually exclusive, categories - illegal
work conditions due to violation of safety rules,
violation of child labor laws, failure to pay employees'
wages and benefits, and frauds based on goods and loans
provided by the employer to the employee that lock the
employee into quasi-slavery.  Apple has just released a
report on its suppliers that shows that anti-employee
control fraud is the norm.  Remember, fraud is hidden
and is often not discovered and Apple did not have an
incentive to make an exhaustive investigation.  Apple
calls its inquiries "audits" and it is apparent that
most of its information comes from reviewing written and
electronic records at its suppliers.  That is
exceptionally revealing.  The suppliers know that they
can defraud their employees with such impunity that they
don't even bother to get rid of records that prove their
frauds.  Apple has resisted making public its suppliers
and the report refused to identify which suppliers
committed which violations - often for years despite
repeated, false promises to end their anti-employee
control frauds.  Two other facts are evident (but not
reported).  First, Apple rarely terminates suppliers for
defrauding their employees - even when the frauds
endanger the lives and health of the workers and the
community - and even where Apple knows that the supplier
repeatedly lies to Apple about these fraudulent and
lethal practices.  Second, it appears unlikely in the
extreme that Apple makes criminal referrals on its
suppliers even when they commit anti-employee control
frauds as a routine practice, even when the frauds
endanger the worker's and the public's health, and even
when the supplier repeatedly lies to Apple about the
frauds.  Apple's report, therefore, understates
substantially the actual incidence of fraud by the 156
suppliers (accounting for 97% of its payments to

	"The company said audits revealed that 93
	supplier facilities had records indicating that
	more than half of their workers exceed a 60-hour
	weekly working limit. Apple said 108 facilities
	did not pay proper overtime as required by law.
	In 15 facilities, Apple found foreign contract
	workers who had paid excessive recruitment fees
	to labor agencies. And though Apple said it
	mandated changes at those suppliers, and some
	facilities showed improvements, in aggregate,
	many types of lapses remained at levels that
	have persisted for years."

The New York Times, Wall Street Journal, and the
Washington Post articles on the Apple report are all
lengthy, but none of them has any input from a
criminologist and each of the articles misses most of
the significance of the report.  I have already brought
out several of these deficiencies.  The most fundamental
flaws, however, have to do with why anti-employee
control fraud is the norm at Apple's suppliers and why
the suppliers typically don't even take the inexpensive
efforts necessary to avoid holding a paper trail that
makes the frauds obvious even to a not terribly vigorous
audit that they know is coming.

If there is one single thing that drives us white-collar
criminologists around the bend it is the implicit
assumption that fraud cannot be common.  There is, of
course, no logical (or experiential) reason for this
belief.  Nevertheless, it is a common belief and among
economists it is a virtually universal dogma.
Economists have a tribal taboo against even using the
word "fraud" to describe individual frauds.  The surest
way to be considered an un-serious economist is to use
the "f" word to describe frauds 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 on markets for
"lemons" (largely describing anti-customer control
fraud), explained the perverse "Gresham's" dynamic in

	"[D]ishonest dealings tend 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; the
	cost also must include the loss incurred from
	driving legitimate business out of existence."

Anti-employee control fraud creates real economic
profits for the firm and can massively increase the
controlling officers' wealth.  Honest firm normally
cannot compete with anti-employee control frauds, so bad
ethics drives good ethics out of the markets.  Companies
like Apple and its counterparts create this criminogenic
environment by selecting least-cost - criminal -
suppliers who offer components at prices that honest
firms cannot match.  Effectively, they hang out a sign -
only the fraudulent need apply to be suppliers.  But the
sign is, of course, invisible and cannot be introduced
in court so Apple and its peers also get deniability.
They are shocked, shocked that its suppliers are frauds
that cheat their employees and put them and the public's
health at risk in order to make a few extra yuan or dong
for the senior officers.

Fraudulent suppliers, therefore, have compelling
incentives to locate in nations and regions in which
they can commit fraud with impunity.  The best way to
evaluate the fraudulent CEOs' view as to the risk of
prosecution for their frauds is to observe whether they
take cheap means of hiding their frauds.  When the CEOs
do not even bother to avoid creating a paper trail
documenting their frauds one knows that they view the
risk of prosecution as trivial.  Nations that are
corrupt, have weak rule of law, weak or non-existent
unions, poor protections for workers, a reserve army of
the impoverished, and have few resources devoted to
prosecuting elite white-collar crime provide an ideal
criminogenic environment for firms engaged in anti-
employee control fraud.  The ubiquitous nature of anti-
employee control fraud (and tax fraud) in many nations
explains why U.S. industries have been so eager to
"outsource" U.S. jobs to fraud-friendly nations.
Companies like Apple also discovered long ago that
Americans often made poor senior managers in these
nations because they objected to defrauding workers.
Not a problem - there are plenty of managers from other
nations that have no such ethical restraints.  Foreign
suppliers run by Asian managers are increasingly

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

The Harm to Employee and Consumer Health is Grave

The NYT article notes that it was bad publicity in the
U.S. that finally forced Apple to make greater
disclosures about its suppliers' frauds. "The calls for
Apple to disclose suppliers became particularly acute
after a series of deaths and accidents in recent years.
In the last two years at firms supplying services to
Apple, 137 employees were seriously injured after
cleaning iPad screens with n-hexane, a toxic chemical
that can cause nerve damage and paralysis; over a dozen
workers have committed suicide or fell or jumped from
buildings in a manner that suggests a suicide attempt;
and in two separate blasts caused by dust from polishing
iPad cases, four were killed and 77 injured." The
Washington Post article noted: "Apple found that 62
percent of the 229 facilities it inspected were not in
compliance with the company's maximum 60-hour work
policy; 13 percent did not have adequate protections for
juvenile workers; and 32 percent had problems with the
management of hazardous waste.

One supplier was caught dumping wastewater at a nearby
farm. Another had a total lack of safety measures,
creating "unsafe working conditions," the report found.
Five facilities employed underage workers.

The company in the past had refused to divulge its full
supplier list even as it became standard practice for
multinational corporations to do so after the public
outcry in the 1990s over labor problems at Nike
factories in developing countries.

Apple's change of heart follows a highly publicized
string of factory worker suicides in 2010 and deadly
explosions in two Chinese factories in 2011."

The WSJ emphasized this chilling finding:

	"The report also found 24 facilities conducted
	pregnancy tests and 56 didn't have procedures to
	prevent discrimination against pregnant workers.
	Apple said that at its direction, the suppliers
	have stopped discriminatory screenings for
	medical conditions or pregnancy."

The article does not make this point explicitly, but
these firms conduct these tests in order to unlawfully
coerce their pregnant employees to have undesired
abortions in order to obtain and keep their jobs.
Foreign Anti-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 slash
wages and pensions to save firms located in the U.S. who
had to meet competition from foreign anti-employee
control frauds.  The damage from foreign anti-employee
control frauds drives the domestic attack on U.S.
manufacturing wages.  Bad ethics increasingly drive good
ethics out of the markets and manufacturing jobs out of
the U.S. and into more fraud-friendly nations.

A final caution is in order because each of the major
articles on the Apple report failed to mention it.  CEOs
who are willing to routinely defraud their workers and
expose them to grave threats to their health are
exceptionally likely to commit other forms of control

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.


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