Cigarette Smuggling

Standard 26 August 2004 – Vanson Soo

A hearing has been adjourned into four senior executives, including the deputy chief executive officer of blue-chip Shanghai Industrial Holdings, for their alleged involvement in a HK$116 million cigarette smuggling case.

Further arrests are likely in the probe by the Independent Commission Against Corruption, which is investigating another 16 suspects, an ICAC spokeswoman said.

The four executives, who were arrested in Hong Kong in February, appeared in Eastern Magistrates’ Court on Tuesday, charged with laundering HK$50.3 million from suspected cigarette smuggling and corrupt activities.

They include Shanghai Industrial deputy chief executive and executive director Lu Dayong.

Lu, 57, is also chairman of Nanyang Brothers Tobacco, the wholly owned, cigarette-making arm of Shanghai Industrial, which makes the top-selling Double Happiness cigarette brand in China.

Hong Kong-listed Shanghai Industrial is one of the mainland’s biggest listed conglomerates, a behemoth with interests ranging from dairies, property and tobacco to microchips and cars.

When the company went public in 1996, it was oversubscribed 158 times and helped to ignite a massive boom in China shares. Its market capitalisation is HK$12.8 billion.

The other three are director Ko Kit, 35, sales manager Chan Kai-san, 36, and former director Lin Jianding, 38 – all of Hang Chun Trade Development.

No pleas were taken and the case was adjourned to November 23. The four were released on bail ranging from HK$100,000 to HK$500,000 each.

The executives were among 20 arrested by the ICAC for alleged involvement in cigarette smuggling activities.

At the time, the ICAC said it had charged an individual with accepting HK$11.4 million in bribes in connection with the smuggling of 116 containers of cigarettes into China.

ICAC investigators also said the alleged bribes – ranging from HK$18,000 to HK$150,000 per container of cigarettes – had been paid since last December by at least six syndicates in return for the continued supply of cigarettes, which were smuggled through Southeast Asia to China. According to the mainland magazine Caijing earlier this year, the import plan of China National Tobacco Import and Export Corp (CNTIEC) showed the Nanyang Brothers Tobacco factory in Tuen Mun was limited to exporting only 24,720 units of cigarettes, each worth 4,000 yuan (HK$3,772), to the domestic market in the first half of 2004.

Although their official export value was supposed to total no more than 100 million yuan, the ICAC discovered the December, January and February shipments alone exceeded that, the magazine claimed.

Shanghai Industrial spokesman Derek Fung said Lu has been suspended from all his executive duties since February 27.

The group said recently the case will not have any material impact on its operations.

Fung said although Nanyang Brothers Tobacco is a subsidiary of Shanghai Industrial, he does not know how the three Hang Chun employees are related to Nanyang Brothers Tobacco, except that they are probably business partners.

Lu, who graduated from the Party School of Shanghai in industrial enterprise management, was previously deputy general manager of Shanghai Tobacco Holdings and director of Shanghai Cigarette Factory.

Caijing said Lu has more than 35 years’ experience, mostly in Shanghai, in the tobacco industry.

Bloomberg records show that Lu held 0.28 per cent of Shanghai Industrial shares in December last year.

Shanghai Industrial is expected to release its interim results on Monday. Its shares closed 0.75 per cent higher at HK$13.50 on Tuesday.

News.gov.hk – 23 August 2004

A tobacco executive and three others have been charged for allegedly laundering $50.3 million, believed to be proceeds of suspected cigarette smuggling and corrupt activities.

Nanyang Brothers Tobacco Chairman Lu Dayong, 57, Hang Chun Trade Development Director Ko Kit, 35, Hang Chun Sales Manager Chan Kai-san, 36, and former Hang Chun Director Lin Jianding, 38, will appear at Eastern Magistracy tomorrow to face a joint holding charge under the Organised & Serious Crimes Ordinance.

The charge alleges that between December 1 last year and February 23, the defendants conspired together to deal with sums of money, knowing or having reasonable ground to believe the money, in whole or in part, directly or indirectly, represented proceeds of an indictable offence.

Independent Commission Against Corruption enquiries have found the money was allegedly generated through corruption and smuggling.

Inquiries into the corruption aspects of the case are underway.

Brussels, 9 July 2004

The European Commission, together with 10 Member States of the European

Union1 and Philip Morris International (PMI), today announced a multi-year

agreement that includes an efficient system to fight against future cigarette

smuggling and counterfeiting and which ends all litigation between the

parties in this area. Through the Agreement, Philip Morris International will

work with the European Commission, its anti-fraud office OLAF, and law

enforcement authorities to help in the fight against contraband, including the

rapidly growing problem of counterfeit cigarettes. The agreement includes

substantial payments by Philip Morris International, which could total

approximately USD 1.25 billion over twelve years. “I welcome the conclusion

of the negotiations of this important agreement. This agreement is to the

advantage of the EU to protect its financial interests,” said Commission

President Romano Prodi. “This Agreement represents a major step forward

in the battle against contraband and counterfeit cigarettes,” said

Commissioner Michaele Schreyer, responsible for budget and the fight

against fraud “We believe that it will enhance the ability of the European

Commission and the Member States to combat the illegal trade in cigarettes,

which results in the loss of substantial tax and customs revenues each year.

Contraband and counterfeit products cheat everyone: governments,

consumers and legitimate businesses”, she added.

Fight against counterfeit

The Commission and the EU Member States point to several reasons why they view

expanded anti-counterfeit and anti-contraband efforts as requiring significant priority.

Among other reasons, the European Community and the Member States are losing

hundreds of millions of Euros in unpaid taxes from counterfeit cigarettes. In addition,

counterfeit and other forms of contraband create a parallel illegal supply chain that

invades and compromises legitimate distribution channels and competes unfairly

with genuine products distributed through legitimate channels.

Over the last few years, the incidence of contraband Philip Morris cigarettes has

been greatly reduced, but during the same time period, counterfeit cigarettes have

become a growing threat to the European Community and the Member States. The

Commission has therefore announced that it will build on existing efforts to combat

the illegal trade in cigarettes by:

– Vigorously investigating cigarette counterfeiting in close cooperation with the

Member States and law enforcement officials in critical locations worldwide;

1 Belgium, Finland, France, Germany, Greece, Italy, Luxembourg, Netherlands, Portugal,

and Spain.

2

– Targeting and interrupting the production of counterfeit cigarettes with the goal

of preventing counterfeit cigarettes from being introduced into the European

Community; and

– Recording and pursuing seizures of counterfeit cigarettes in the European

Community to identify the source of the product and other relevant information.

Fight against contraband and money laundering: Know your

customers and tracking and tracing

The Agreement builds on the efforts of all parties and introduces new and innovative

procedures to combat the diversion of Philip Morris International’s products into

contraband channels in Europe and around the world. Today’s agreement reflects

the reality that success in defeating the contraband and counterfeit cigarette trade

can be aided greatly through a joint agreement whereby major manufacturers like

Philip Morris International and European law enforcement combine their resources

and enhance their coordination in combating contraband and counterfeiting.

In addition to Philip Morris International’s already existing fiscal compliance policy,

the Agreement contains strong provisions, approved by all parties, which provide

them with a mechanism for the long-term prevention of any large-scale smuggling of

genuine Philip Morris cigarettes in the European market. The Agreement requires

Philip Morris International to build on its existing review process for selecting and

monitoring customers, to enhance its capabilities to track and trace certain

packaging, and to provide expanded support to European law enforcement in its

battle against the illegal trade in cigarettes. Under the Agreement, Philip Morris

International agrees to continue limiting its sales to volumes commensurate with

legitimate market demand. The Agreement also incorporates and builds into a

comprehensive contractual framework Philip Morris International’s existing antimoney

laundering policies.

Historically, a key concern for the European Community has been the introduction of

contraband cigarettes into the European Community. For that reason, the European

Community has taken aggressive action to address cigarette smuggling. European

law-enforcement efforts have resulted over the past several years in the reduction of

the amount of cigarettes that enter the EU as contraband. The European

Commission has determined that constructive agreements, such as this Agreement

with Philip Morris International, are a useful tool in addressing these issues.

The initiative includes far-reaching product tracking procedures that will facilitate law

enforcement efforts to determine the point at which any genuine product is diverted

from the authorised sales channel. Consistent with the Agreement, Philip Morris

International will mark certain packaging with information indicating the intended

market of retail sale, mark “master cases” of cigarettes with machine-scannable

barcode labels, and implement other procedures useful for the tracking and tracing

of its products.

These obligations embody the first major joint tracking and tracing initiative and are

consistent with the anti-contraband provisions of the WHO Framework Convention

on Tobacco Control.

Payments under the Agreement

The European Community and ten Member States will receive substantial payments

over a number of years. The amount of Philip Morris International’s payments under

the Agreement will vary based on a number of factors, and could total approximately

USD 1.25 billion.

3

The Agreement also includes an initiative whereby PMI has agreed to make

payments in the event of future seizures in the European Community of its genuine

products above defined quantities. These payments will be made without regard to

fault or wrongdoing by Philip Morris International. If other Member States sign the

Agreement, including the new Member States, they will also be entitled to receive

these payments.

Ending past disputes

While all these provisions are forward-looking, the Agreement also contains the

parties’ resolution of all past disputes relating to contraband cigarettes. In particular,

the Agreement also brings to an end all litigation between the European Community

and the ten Member States and Philip Morris International relating to contraband

cigarettes. The Agreement also resolves Philip Morris International’s case against

the European Commission pending on appeal before the European Court of Justice.

The Commission is always prepared to have discussions with manufacturers who

are willing to commit the necessary resources to improve ways to combat illegal

trade in their products and associated criminal activity, such as money laundering.

Producers also have a responsibility to fight illegal trade in their products. This

Agreement should therefore serve as a model for other cigarette companies.

Background

In the negotiations with Philip Morris International, the Commission represented the

European Community and the ten Member States. The Legal Service and OLAF

conducted the negotiations for the Commission.

http://europa.eu.int/comm/dgs/olaf/index.htm

Elisabeth Werner: 02/295 95 06

By Staff Reporter Lu Yanzheng – 20th March 2004 – Caijing

Lu Dayong, chairman of Nanyang Brothers Tobacco (NBT), was recently arrested by the Independent Commission Against Corruption (ICAC) in Hong Kong. Lu was suspected of involvement in cigarette smuggling.

The news came as a surprise to the industry. Qi Mijia, vice manager of Huangpu division at Shanghai Tobacco (Group) Corp., said: “Lu Dayong is a smart man, hard-working and well-paid. Personally, I don’t believe he would under any circumstances help others smuggle.”

But the fact is that Lu was arrested by ICAC in one of its recent efforts to combat smuggling.

Based on information it had received, ICAC arrested 20 people on February 23, including Lu. Three days later, ICAC announced that the suspects might have been involved in HK$ 116 million (US$ 14 million) worth of cigarette smuggling.

Lu is accused of taking HK$ 11.4 million (US$ 1.4 million) in bribes and helping smugglers obtain cigarette sales quotas. The other 19 arrested include two employees of NBT and board directors members or employees in other five companies.

Shanghai Industrial Investment (Holdings) Co. Ltd (SIIC), a famous red-chip company listed on the Hong Kong Stock Exchange (HK00363), wholly owns NBT. Lu is the managing director and deputy CEO of SIIC. Feng Qiming, spokesman of SIIC, told Caijing on March 8 that “presently Lu is only a suspect and ICAC’s investigation is still underway; no accusation has been made, and the board will not take any actions for now.”

However, on SIIC’s website, Lu Dayong’s name has already been removed from the list of managers. SIIC, whose stock transactions were suspended on February 27, made an announcement confirming Lu’s suspected involvement in “bribery” and suspension of Lu’s positions in all of the group’s companies. On March 1, SIIC’s stock resumed trading, but its price declined more than 10% in 3 days.

According to the ICAC’s investigation report, Lu has taken bribes from at least six smuggling groups since December 2003. For each container of smuggled cigarettes, Lu took bribes between HK$ 18,000 (US$ 2,169) and HK$ 150,000 (US$ 18,072). Altogether Lu was alleged to have taken HK$ 11.4 million (US$ 1.4 million) for helping to smuggle 116 containers of cigarettes. In an effort to hide the transactions, Lu and other suspects registered several companies to receive bribe money.

ICAC found HK$ 2 million (US$ 256,000) in cash and six luxurious watches in Lu’s bank coffer. ICAC suspects that Lu received the cash and watches as bribes.

In the import plan of China National Tobacco Import & Export Corp. (CNTIEC), NBT’s factory in Hong Kong should export only 24,720 units of cigarettes to the domestic market in the first half of 2004. Roughly, one unit of export is worth 4000 yuan (US$ 482) and the total amount is only 100 million yuan (US$ 12 million). Based on the ICAC’s discoveries, the value of cigarettes smuggled in December, January and February alone already exceeded that amount. It is unclear why NBT’s sales system reported no effects from the huge waves of smuggled cigarettes flooding its market.

According to Feng Qiming, most cigarettes produced by NBT’s Hong Kong factory are sold in the mainland market. NBT’s major business with the mainland is the export and sale of its own Double Happiness brand cigarettes. NBT itself cannot export cigarettes made in China or trade other Chinese brands. Therefore, a large number of smuggled cigarettes would have an enormous negative impact on NBT’s legal sales channels in the mainland.

A sales agent of NBT in eastern China told Caijing that under normal procedures, a tobacco company chooses agents following a formal appraisal system. If the tobacco company finds that a sales agent owns smuggled cigarettes, the company will immediately disqualify the agent in order to prevent harmful effects on its normal sales channels. Under such a system, if cigarettes produced by NBT were smuggled into the mainland market, NBT’s representatives in the mainland should have felt the impact and tracked the smuggled cigarettes. But surprisingly, it appears as though NBT did not feel any shock from the huge number of smuggled cigarettes on the market.

ICAC accused Lu of helping smugglers obtain cigarette sales quota and taking bribes in return. The cigarette sales quota is related with NBT’s sales system: NBT gives different sales quota to its partners according to their different qualifications. Since the quota is controlled by NBT itself, there exists the possibility of internal corruption and serious management defects.

Lu, aged 56, has worked in the tobacco industry for more than 35 years, mostly in Shanghai.

Unsurprisingly, Lu’s suspected involvement in this smuggling case has negatively impacted SIIC. SIIC is 58% controlled by Shanghai Industrial Investment Group, a window corporation of Shanghai in Hong Kong and a veteran red-chip company. On March 12, the stock price of SIIC was HK$ 18.45 (US$ 2.22) per share, down 10% from HK$ 20.5 (US$ 2.47) on February 27, when its stock transactions were temporarily suspended.

Feng said that SIIC might release a report in April to better explain the event.

SCMP A3 – February 28, 2004 – BENJAMIN WONG

Shanghai Industrial (Holdings) has confirmed one of its directors has been suspended following an ICAC probe into a multimillion-dollar cigarette smuggling case.

Without naming the director, the company said the man was an executive director of the company and executive deputy CEO.

He was suspended from all his duties and trading in the company’s shares were suspended at the company’s request.

A source said the director worked for the Nanyang Brothers Tobacco Company – a wholly owned subsidiary of Shanghai Industrial (Holdings) – which makes the Double Happiness brand.

The statement from Shanghai Industrial said it had formed a committee to “ensure normal operations at Nanyang Tobacco”.

The Independent Commission Against Corruption arrested a senior Nanyang executive after he allegedly took $11.4 million in bribes to facilitate several smuggling syndicates’ operations.

The investigators said with the man’s help, the six syndicates smuggled cigarettes worth $116 million into the mainland via Southeast Asia.

A further 19 people were also arrested in connection with the case.

Suspect accused of taking more than $11m in bribes to help syndicates smuggle cigarettes worth $116m into the mainland

South China Morning Post, February 27, 2004, page A1 -BENJAMIN WONG

A senior executive of a state tobacco manufacturer owned by the Shanghai Industrial (Holdings) conglomerate has been arrested by the ICAC for allegedly helping several syndicates smuggle $116 million worth of cigarettes into the mainland.

The Independent Commission Against Corruption believes the executive was paid more than $11 million in bribes for giving the smugglers preferential treatment in supplying his company’s cigarettes.

An ICAC statement described the firm as a wholly owned subsidiary of a listed Hong Kong company. Sources confirmed it was the Nanyang Brothers Tobacco Company, producers of the famous Double Happiness brand.

A spokesman for Shanghai Industrial said last night the company had been notified about the case and was monitoring its developments. But he refused to confirm whether the company was involved in the case.

The ICAC alleges that with the executive’s help, the syndicates managed to buy 116 containers of cigarettes from the company. It alleges the executive knew the cigarettes would be smuggled into the mainland. The tobacco manufacturer had offered to help investigators, the ICAC said.

The ICAC believes the executive was bribed by six syndicates and received between $18,000 and $150,000 for each container of cigarettes.

In addition to the senior executive, the ICAC arrested 19 others – 12 men and seven women aged between 20 and 50.

Two of the suspects are the executive’s associates, two are employees of the tobacco manufacturer, 11 are employees of five other companies and four are suspected smugglers.

The officers also seized more than $2 million of the suspected bribe money, as well as jewellery and watches. The operation, code-named “Golden Dragon”, began on Monday.

Sources said the money and goods were found in a safe belonging to one of the two arrested associates of the executive.

The investigators believe several companies were set up by the suspects to transfer the bribe money and cover up their activities.

The ICAC believes the cigarettes supplied to the syndicates were ultimately smuggled into the mainland via Southeast Asian countries.

All those arrested have been released on bail.

Investigations are continuing.