NEW ENERGY: New Energy Car Cheats Deserve Strict Punishment

Bottom line: Beijing should mete out stiff punishment, including big fines and jail sentences, for companies that fraudulently obtained subsidies under the government’s program to promote new energy vehicle development.

Chery accused of fraud in new energy car scandal

What started as a wave of criticism against new energy car makers for producing mediocre products that nobody wanted is rapidly becoming a major scandal, with reports that many of those companies submitted fake information in order to get lucrative government subsidies. The scandal netted major car makers King Long and Chery last week, and reports have emerged that even industry leader BYD (HKEx: 1211; Shenzhen: 002594 )may be suspected of illegally obtaining government grants.

Such trickery is an extension of another trend that sees Chinese companies rush into unfamiliar sectors that Beijing has targeted for development, often resulting in a flood of mediocre or inferior products into the market. Such rushes not only create big market disruptions, but also result in huge sums of wasted investment and slow down development of emerging industries.

The latest instance of using faked information to receive government subsidies is a clear case of fraud, a criminal act, and should be treated with not only major fines but also prison time for guilty individuals. China historically has been reluctant to mete out such punishment, especially to state-run companies that comprise many of the guilty parties in the latest scandal.

But in this case Beijing should take the important step of imposing big fines and putting individuals who knowingly committed the fraud behind bars.

Beijing has already taken such actions against big foreign companies guilty of similar crimes, handing out major fines and criminal charges to the likes of US chip giant Qualcomm (Nasdaq: QCOM) and British drug maker GlaxoSmithKline (GSK) (London: GSK). Taking similar aggressive steps against Chinese perpetrators would show that they are subject to equally strong punishment for similar misdeeds, and would send a strong signal that criminal acts by any company are unacceptable.

Development of the new energy car industry has become one of Beijing’s major priorities in recent years, as it seeks to clean up China’s polluted air and cultivate an important new high-tech sector that can become a global leader. As part of its program to achieve that aim, it has handed out billions of yuan in subsidies to help car makers develop new products over the last few years.

Suspicious Acceleration

The industry finally seemed to be gaining traction last year, though suspicions quickly arose that the sales explosion was being fueled by faked and manipulated data and sales. One investigative report in the influential Caixin showed that many car makers rushing into the new energy vehicle production would have been loss-making or only marginally profitable without their big government subsidies.

Responding to the suspicions, the Ministry of Finance launched its own probe and last week announced some of the first results, including accusations of fraud against 5 automakers including Chery and King Long. (English article; Chinese article) The ministry’s report said the 5 had fraudulently applied for and received more than 1 billion yuan ($150 million) in government subsidies, representing about a third of all grants awarded to date.

In addition to demanding return of the government grants, the finance ministry also meted out 374 million yuan in fines and revoked the license of one of the companies. Other reports said that a Tianjin unit of industry leader BYD might also be among the companies suspected of wrongdoing, though the company said it hadn’t received any such notification. (Chinese article)

As the shake-up unfolded, the China Association of Automobile Manufacturers, the nation’s leading trade association, slashed its forecast for new energy vehicle sales this year by nearly half. CAAM said it now expects China to log 400,000 new energy vehicle sales this year, versus a previous forecast for 700,000 at the start of the year. (Chinese article) The new figure would represent a sharp slowdown from last year, when new energy vehicle sales more than quadrupled to about 330,000 units.

Beijing should be commended for taking action to punish offenders who committed fraud, though the fines are relatively inconsequential for such large companies. As the investigation moves forward, investigators should consider much bigger action like the nearly $1 billion fine imposed on Qualcomm for anti-competitive behavior last year, and criminal charges against several GSK executives stemming from the company’s massive use of bribes to sell its drugs.

Such actions could bankrupt some of the automakers and put not only company but also local government official behind bars, disruptive actions that might cause some hesitation in Beijing. But such high-profile moves would be highly symbolic, and could become a powerful deterrent for both private and state-run companies that might consider similar behavior in the future.

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