????For several years now, the internet firm Alibaba-Taobao has been one of the most prominent Chinese companies on the planet—thanks both to its success and to its brash, charismatic founder and chairman, "Jack O' (Yun) Ma, who started the online commerce company in 1999. Its business-to-business platform, Alibaba.com, went public on Hong Kong's stock exchange in 2007 and raised $1.7 billion—at the time the second biggest internet IPO ever, behind only Google (GOOG). Its online consumer sales company, Taobao, went mano-a-mano with eBay (EBAY) and effectively ran the global giant out of China a few years ago.
????Yesterday for the first time, Alibaba hit a big public bump in the road: It reported that 2,326 high volume sellers who pay a fee to the company to pedal their wares on the site – "gold suppliers," as they're called—defrauded customers over the course of two years, with the assistance of nearly 100 Alibaba.com employees. Ma said the sellers were organized "fraudsters." As a result of the scandal, Alibaba.com CEO David Wei, and his deputy, COO Elvis Lee, both resigned yesterday. Neither, the company stressed, are implicated in the fraud; both were falling on their swords to accept responsibility. (Japanese style corporate accountability comes to China.)
????Wei, 40, had joined Alibaba in 2006 and oversaw the successful IPO. He also helped Ma execute the vision of Alibaba.com as a destination for customers outside of China to buy from small and medium-sized companies operating inside the country. Ma, to be sure, has become as publicly associated with his company as Steve Jobs or Bill Gates have with theirs. (His company's annual "Alifest" is practically a revival meeting for Alibaba-Taobao users, and the waif-like Ma is their inspirational leader.) But Wei was his polished deputy, and he unfailingly projected an image of calm competence.
????The scale of the fraud amounted to about $1,200 per incident, totaling around $2.8 million, and thus is "immaterial", as John Spelich, vice president for international corporate affairs says, from an earnings standpoint. That is probably the only bright spot in this scandal for Yahoo (YHOO), whose Chinese operations are run by Alibaba's parent company, of which it owns 39%. The Alibaba group's stock price in Hong Kong today fell more than 8%. Of course, what makes the scandal a huge deal for Alibaba—and why the company has gone to extraordinary lengths to snuff it out—is the apparent involvement of insiders on the sales staff in perpetrating the fraud. Either willfully or out of negligence, the Alibaba sales people "helped organized Chinese criminal rings establish Alibaba.com 'Gold Supplier' storefronts so they could pose as legitimate businesses in order to defraud buyers," according to an account of the scandal the company published on a website it runs.
????In an e mail to employees, Ma went further. He said the company's internal investigation team members "knowingly allowed fraudsters to become [Gold Suppliers] so that they could 'make their numbers' and receive commission income.'' (It is unclear as of yet if any of the insiders received payments from any of the fraudsters.)
????Garden variety fraud on e-commerce sites is not uncommon, of course. Yesterday, on a web site called Alibaba168.com, where buyers and sellers exchange information about their experiences on the site, there was an account of an Alibaba customer in Xinjiang, in far western China, who paid 12,000 renminbi (about $1,846) to buy a bunch of walnuts from a supplier, which he then hoped to turn around and resell at a profit. The buyer did not execute his transaction via Alipay, Alibaba's Paypal equivalent, instead forwarding the money direct to the seller. He was ripped off.
????Alibaba says the scope of the fraudulent activity in the cases that led to Wei's resignation, which in many cases involved the "sale" of low priced consumer electronics products, "appeared to be within the risk range for e-commerce sites in general." The problem for the company is that all of the customers defrauded were outside of China, and, as Spelich says, the company's "raison d'être," its founding mission, was to link Chinese sellers with buyers abroad (Alibaba is now trying aggressively to lure sellers in India and elsewhere to use the site.)
????Several years ago, the first time I ever interviewed Ma, he spoke in his usual passionate tone on the one issue he saw as key to whether e-commerce would take off in China in general, and at Alibaba-Taobao in particular: "Trust," he said. Meaning, customers had to trust in the quality of goods they were going to be able to buy online, but more importantly, they had to be confident they were not going to be fleeced by faceless sellers using the Internet to perpetrate their fraud. And all this in a country where, shall we say, business ethics are still something of a work in progress.
????It turns out that fleecing is precisely what was happening for two years—with the aid of a handful of Ma's own employees. (Again, Alibaba employs 5000 sales people, and around 100 were involved in the fraud, the company says.) Which explains why the company has reacted so strongly, and so publicly, to an episode that, by the numbers, seems to be but a minor scandal. As Wei's stunning resignation yesterday demonstrates, it's not. As Jack Ma understood from the beginning, if the customers can't trust Alibaba, then Alibaba isn't going have many customers.
