Foreign Execs in China Face Questionable Charges

Stern Hu drove a hard bargain against China. And yet, as the Australian citizen in charge of Rio Tinto's China office, some Chinese steel-mill officials across the negotiating table from him still had kind words for him. "Integrity" is used by friends to describe Hu. Yet he was arrested July 5, at the prickliest moment of protracted negotiations over iron-ore pricing, and state media began batting around words like "spy," "state secrets," and "bribery" in reference to his work for the Anglo-American mining giant.

The "Rio Tinto spy case," as it is now known in China, is the highest-profile example of a foreign executive being slapped behind bars in China. But Hu is not alone. Hundreds of foreign nationals have found themselves behind bars in China when their companies ran afoul of Beijing's interests. And their lesson to international businessmen is not that they should play by the rules; it's that it won't matter if they do.

Among the 50 or so American citizens who've experienced something similar was California businessman and medical-equipment supplier Jude Shao. In 1998, he was sentenced to 16 years on charges of fraud and evading $393,000 in taxes. There was no credible evidence to support the charges; Shao wasn't even allowed to meet his lawyer until less than a week before his hearing. The real reason for his detention was his refusal to bribe a tax auditor, say classmates of Shao at Stanford Businese School who mounted an intense lobbying campaign.

Almost exactly a year ago, Shao was released on parole to join his family in Shanghai—apparently by Chinese authorities worried that his continued detention would tarnish the imminent Beijing Olympics. Even today, Shao is not free. As a condition of his parole, until 2013 he needs police permission before speaking to foreigners, and he cannot leave Shanghai.

One outfit that worked hard to secure Shao's release was the San Francisco-based Dui Hua Foundation, which mainly focuses on the plight of Chinese political prisoners. Founder John Kamm, himself a CEO turned activist, says Shao's experience illustrates "the perils of doing business in China. The same arbitrary system that jails people for political reasons also jails them for business reasons."

Most cases of foreigners detained in China for alleged economic crimes unfold at the grass-roots level, way below the paygrade of Stern Hu. Expat factory managers have been held hostage by disgruntled Chinese business rivals; some have had to lock themselves in barricaded offices, under siege by angry workers who've been laid off. Unrelated to Rio Tinto, the Australian government had warned of kidnappings and hostage-takings in a travel advisory for China-bound visitors that said, "There has been an increase in the number of incidents in which Australians and other foreigners, often factory managers, have been held against their will at their workplace." But the scale of the Rio Tinto probe is unprecedented. Police have cast a much wider dragnet than usual. Very senior officials in the state-run iron and steel sector have been detained. Dozens of functionaries are being questioned. The industry is in shock.

Chinese officials announced that Hu and three of his local staff were charged with stealing state secrets, spying, and causing "great harm" to China's economic interests. Allegedly they bribed their Chinese counterparts to receive confidential documents giving them an advantage in the sensitive iron-ore pricing talks. Included in their economic-intelligence haul, according to one state-run publication, was China's bottom-line iron-ore price, plus every steelmaker's inventory, production cost, schedule, and manufacturing details.

Hu's company was already non grata among local media, who heaped angry diatribes upon Rio Tinto when, just a month earlier, it rejected a planned $19.5 billion deal with China's state-owned firm Chinalco. So when Chinese officials and Australian suppliers reached a tense deadlock in negotiations over iron-ore import prices, the crackdown began. China is the world's biggest consumer of iron ore, partly to produce steel for its booming construction and automotive industries. Beijing had been juggling increasingly contentious talks between the world's big three producers—Rio, BHP Billiton, and Brazil's Vale Do Rio Doce—who together provide nearly three fourths of China's iron-ore imports.

Hu's plight is sending shivers through foreign executives who'd been scrambling for a piece of the hot business action in China. On July 12, Australian Foreign Minister Steve Smith said Chinese authorities gave no evidence to support the espionage charges, and he warned of "implications for the international business community." His colleague, Financial Services Minister Chris Bowen, predicted that the Big Chill could spread throughout the foreign business community.

The point isn't that every jailed expat executive working in China ran a squeaky-clean business. Almost certainly, they didn't. The point is that we may never know the truth because Beijing's judicial system can't remotely keep up with the growing complexity of Chinese business and politics. The lack of transparency in the Chinese legal system—rampant corruption in courts and law enforcement and inconsistent implementation of legal procedures—means that, in China, law is subordinate to politics. Rio Tinto shows that China's murky state-secrets law can be used as a weapon against CEOs as easily as it is used against political dissidents.

As Sinologist John Frankenstein of City University of New York puts it, China's system can "legitimately interfere in any business deal at any time under any context." In other words, the conventional wisdom in the business world that only political rabble-rousers need worry about the China's crooked courts is a myth. Tycoons doing business in China, beware. You may be a hotshot negotiator—expertise in hostage negotiations and China's criminal code might come in handy, too.