Inside Phoslock Environmental Technologies’ implosion amid bribery, mismanagement allegations

On a spring evening in 2020, a startling email arrived in the inbox of the chief executive of Phoslock Environmental Technologies, an Australian company that had wooed thousands of investors with its pitch to clean up the world’s polluted waterways using a stroke of local scientific ingenuity.

While the email’s wording was clunky, the meaning to Phoslock boss Lachlan McKinnon seemed clear.

If Phoslock was to maintain its rise from share market darling to blue-chip stock, it needed to pay special “commissions” to Chinese Communist Party officials: those who had been appointed President Xi Jinping’s “river and lake chiefs” and who were responsible for driving his much-vaunted environmental and anti-pollution agenda.

“Most government capital projects in China come with commissions,” the Phoslock Chinese manager said in his October 12 email to McKinnon.

“This is illegal but it exists naturally … they need cash to pay,” he continued, adopting the tone of a teacher chiding an ignorant child.

McKinnon responded in kind: “I want to state clearly, we will not be entering or be part of any illegal deals, commissions or other forms of payoffs. This is not acceptable in any way, and for a publicly listed company in Australia completely unauthorised. It will not be tolerated.”

McKinnon and Phoslock’s chief financial officer, Matt Parker, promptly sacked the manager.

Days earlier, the duo – who had both been at Phoslock for less than a year – had announced the sudden departure of two board directors, including a wealthy and well-connected Chinese businessman called Zhigang Zhang.

The pair also disclosed to the market that an internal investigation had uncovered evidence of fraud including “false accounting” and “misappropriation of funds”.

In time, they would also call in Australian authorities, including the federal police.

The Australian Financial Review described the company’s public admissions as a “bombshell” but the full story of Phoslock’s subsequent implosion has never been told.

It has stayed hidden, concealing a tale of suspected misconduct and governance failings far more egregious than that described in Phoslock’s ostensibly candid public announcements.

A cache of thousands of internal emails leaked to this masthead reveals a staggering array of alleged wrongdoing and repeated red flags that the company’s governance system missed until the arrival of new senior executives in mid-2020.

The files show highly suspicious payments were regularly sought and paid, including to win major contracts in China and shake off an investigation into an accidental death. Some overseas staff privately confessed that they had paid bribes to secure work, the leaked files reveal.

Many millions of dollars of share options were distributed in highly dubious circumstances, raising separate questions of suspected bribery and unfair treatment of Australian investors, whose ownership was diluted by the transactions.

The files show that even while it was extolling its green credentials to the world, Phoslock allegedly made illicit payments to dump dirty water and pay off environmental inspectors.

“The scale of alleged corruption involving Phoslock is jaw-dropping,” the head of Transparency International Australia, Clancy Moore, said after reviewing some of the leaked documents.

“The company’s fortunes appear at least partly built on suspected corporate misconduct, dodgy payments and poor governance.”

If that is so, it raises questions not only for the company’s former board and senior managers, especially given the company has effectively collapsed and is set to be sold for a fraction of its once $1 billion value. The rise and fall of Phoslock also puts a spotlight on Australian authorities.

Many years after the suspect transactions occurred, including some in relatively plain sight, and more than two years after Parker and McKinnon reached out to police and regulators, there has been no substantive law enforcement or regulatory action.

This masthead is not suggesting any individual is guilty of any crime, a finding that can only be made by a court in the event the federal police, corporate watchdog and Commonwealth prosecutors believe there is enough evidence to pursue a case.

But Phoslock appears to have joined a growing list of Australian companies that, despite efforts from dedicated federal agents, face investigations that often stall due to legislative gaps, poor resourcing, competing police priorities, glacial prosecutorial decision-making and other legal roadblocks.

The only individuals to so far pay a price in connection to Phoslock’s suspected wrongdoing are its 6000 or so Australian investors.

“Australia’s enforcement of alleged foreign bribery involving our companies is simply not working,” says Moore.

“After years of federal government inaction, it’s now up to the Albanese government to do far more to combat suspected corporate crime.”

Xingyun Lake derives its name from the dance of moonlight upon its expansive surface. For Phoslock, the lake in south-western China glistened for another reason.

By mid-2019, the Australian company was a few weeks into a trial at Xingyun involving the use of its special CSIRO-designed clay product. The clay absorbs phosphorous from water, ridding it of algae and pollutants. If it worked in China’s moonlight lake, it was a sign Phoslock’s investors would make significant profits.

One of them was Phoslock’s most influential backer, Australian business veteran Laurence Freedman. Freedman’s appointment as the chairman of Phoslock in 2011 was the start of a new chapter in an already storied life of great wealth and visionary business acumen.

Freedman was a past master at commercialising innovation, one of a pair of dashing businessmen who “democratised sharemarket investing while riding the 1980s bull market” by giving regular investors the chance to access complex financial products. His already significant personal fortune expanded after he sold his shares in the Ten Network in the mid-2000s, having guided it out of receivership years earlier.

By 2019, he was Phoslock’s greatest spruiker, proselytising the company’s mission to resuscitate polluted lakes and waterways all over the globe and citing the clean-up of The Serpentine in London’s Hyde Park before the 2012 Olympics. According to Freedman, a huge pipeline of work for the company across China’s vast network of waterways beckoned.

The market lapped up Freedman’s vision, with headlines describing Phoslock “riding a surging wave” as its China business grew. Its stock price tripled in value in the first half of 2019 as its shareholder registry increased from 3000 to more than 6000. By October 2019, it was one of the top 300 publicly listed companies in Australia and was predicted to soon join the ranks of the ASX 200.

The company’s success was also evident in the waters of Xingyun Lake. There, it had, according to Phoslock, delivered “outstanding results” while proving to Chinese authorities that the product was “simple to apply, with no adverse effects on fish, plant life or humans”.

“We are helping China rejuvenate and fix the country’s water bodies through ethical and sustainable treatment solutions,” Freedman told business reporters in 2019.

Freedman may not have known it, but investors weren’t being told everything about Phoslock. Others in the company held dark secrets. This became clear in mid-2020, when the company’s auditors, KPMG, began interviewing staff about a series of unusual transactions in China.

Leaked confidential excerpts of transcripts of interviews between KPMG and Phoslock’s senior Chinese staff reveal a series of startling admissions. One of the most concerning involved a manager who admitted the Xingyun Lake project was secured only after a shady side deal involving a middleman and “senior government official”.

According to a confidential outline of his interview, the Phoslock employee “refused to reveal the identity of the agent and the senior government official” involved in the illicit transaction, explaining “the use of agents is illegal”.

But he disclosed that “it was not possible to win work without entering into such arrangements” and revealed that a kickback of 3000 yuan ($600) was being paid for every tonne of Phoslock clay used at Xingyun Lake. The arrangement totalled an estimated $1.7 million in “commissions”.

There is no evidence or suggestion that Freedman knew of this apparent bribery. In fact, the Chinese manager claimed the kickbacks were disguised as a payment for labour hire. Still, there were warning signs for those running and overseeing the Australian business.

Emails from as early as 2017 reveal Phoslock’s Chinese managers were brazen about providing benefits to Chinese government officials to buy influence. Australian-based executives, led by managing director Robert Schuitema, were repeatedly copied into correspondence that raised red flags.

There is no suggestion or evidence that Schuitema ever personally directed the payment of a bribe. But the leaked emails reveal he should have been firmly on notice that his managers in China were prepared to bend the rules in a country known to host entrenched corruption.

For instance, in September 2017, Schuitema was told by a Chinese manager via email that rather than paying employees their overtime wages, Phoslock could avoid its legal obligations by cultivating a relationship with a local government official who “will protect us” when the company crossed “red lines”.

“The employee should not force us to follow the labor law, we would be like a tied crab. They will bully the foreign company,” the Phoslock manager told Schuitema when justifying a plan to provide benefits to the official.

Schuitema was also told in writing that gift cards would be used to pay just over $1200 to the “director of labor union bureau” and “to the leader of the police station” after 12 sacked employees arrived at a Phoslock site demanding unpaid wages.

Leaked emails document a payment of $21,000 – covered up via a backdated invoice – to secure an inflated Chinese government refund on an investment of $100,000. Emails reveal the $21,000 was paid “for relationships” with an “officer [who] can help us to get the money back”.

“Obviously they need commission on this task,” stated the email from a Phoslock manager in China.

In response to this email, Schuitema replied: “I understand – approved.”

The Chinese Phoslock manager later disclosed to KPMG in his confidential interview that “he withdrew cash from his bank account and provided the cash to government officials”.

In May 2018, an uninsured truck that was meant to be used only at Phoslock’s Chinese factory left the premises and ploughed into a motorcycle, killing a man and injuring his female passenger. Accounting records reviewed by this masthead suggest a Phoslock subsidiary set aside about $215,000 to manage the fallout from the death. A senior Phoslock employee in China told KPMG some of this money was used as “cash for payment of bribes to police to prevent them from pressing criminal charges”.

Phoslock also had a series of dubious dealings with China’s officious Environmental Protection Administration.

“The EPA comes to our factory every 2 weeks, every time I will receive a problem list and deadline for the corrective actions,” a Phoslock Chinese manager wrote in an email.

“Plan to invite them [to] a dinner … Give EPA some gift/Card/ Cash.”

For a company whose business was cleaning up canals and lake, the leaked Phoslock files reveal a willingness to make payments to dump dirty water. In August 2018, a Chinese Phoslock manager described needing several thousand dollars to handle “EPA reporting for waste water discharging issue”.

“I need some gift and good meals with all kinds of local government leaders,” the manager’s email stated.

Three months later, another request was emailed to Phoslock’s Australian headquarters seeking money to fund “gift cards” for “leader of the local government, leader of police, leader of EPA, leader of central government”.

At least one significant suspect payment was made to discharge polluted water. On September 17, Phoslock sent $150,000 to a labour hire company about 2000 kilometres from its factory. The payment was made after a Phoslock senior employee in China emailed Schuitema to request funds for “relationships”.

When he was later interviewed by auditors, the same Phoslock manager claimed the labour hire company that received the $150,000 “was designated by government officials” and that “a certain portion of the payment was used to pay off government officials”.

Schuitema declined to answer questions or be interviewed by this masthead, although he said in a text message that he had “no knowledge of any unlawful behaviour” or did not know of any alleged “bribery payments” involving Phoslock.

But the leaked emails and internal company investigations suggest Schuitema knew that, at the very least, his Chinese staff were paying commissions to win contracts in a manner that should have raised potential bribery risks.

In January 2019, a Phoslock employee emailed Schuitema about the “need to pay 3-5 per cent cash/commission to the intermediary, the spokesman of the government leaders” to secure a new contract.

Schuitema responded by writing, “the only rule I have is that any commission is only paid when PET [Phoslock] receives full payment from the customer”.

Commissions are only permitted under Australian criminal law if they are legitimately due in return for a genuine service. But if benefits are offered or provided, be they in the form of commissions or gifts, to influence a foreign government official to obtain a business advantage, then the benefit may be considered a potential bribe.

When Schuitema was informed in another email from a Phoslock manager in China that “bad leaders” in the local branch of the Chinese Communist Party were stalling Phoslock’s expansion plans but that “at least 1M cash” had been set aside to deal with project problems, Schuitema responded: “Fully understand – let’s discuss in Sydney.”

In April 2020, Schuitema wrote in an email that “Commission to third parties are clearly very important – if we don’t pay these, projects are unlikely to proceed”.

Confidential emails also reveal that Freedman was also sent documents that flagged potentially suspect commissions. In October 2019, he received an email from a Chinese company figure that disclosed how the Xingyun Lake clean up, along with another remediation project, involved “a rebate of RMB3000/ton for the middle man”.

In a separate document sent to Freedman, commission payments were listed in a spreadsheet as “refunds”.

When contacted by this masthead, Freedman denied any knowledge of wrongdoing but, like Schuitema, declined to answer questions and hung up when pressed about the company’s conduct in China.

“I’m not prepared to … discuss this with you,” he said.

The company’s senior Chinese employees were more forthcoming when confronted by auditors.

In one interview, a manager told KPMG that “he was aware of payment of bribes to police” paid by Phoslock, and that he suspected illicit payments had been made to secure “certain projects in the pipeline”.

Another Chinese employee explained the “arrangements” involving middlemen and commission payments “were illegal” and thus disguised.

After interviewing multiple Phoslock employees, KPMG identified two dozen water projects in China potentially infected by suspect commission deals. As the company was expanding, so was its war chest to fund questionable payments. By late 2020, KPMG estimated that key Pholsock projects involved paid or planned suspect commission deals of up to $10 million and advised that further investigations were required to understand the true value of potentially dodgy deals.

“These payments may potentially be considered as bribes in breach of various anti-corruption legislation, including in China, Australia, the US Foreign and Corrupt Practices Act and/or the UK Bribery Act,” KPMG’s report warned of the more suspicious commission transactions.

Anti-corruption expert Clancy Moore says the leaked documents make it clear that Phoslock’s Australian managers should have known its China arm was engaging in risky conduct.

“The reference in company documents to middlemen and commission payments in a corruption-prone jurisdiction such as China should have led to immediate measures to guard against fraud and bribery,” says Moore.

“It appears Phoslock did little to guard against these risks until its more recent management team arrived.”

It was only after the arrival of managing director McKinnon and chief financial officer Parker at the company in mid-2020 that the practice of paying or offering large commissions was finally banned.

Optional governance

This was also when the lid was lifted on the dubious distribution of millions of performance share options, an exercise that made millionaires of select figures, even though they had no obvious connection to the Australian company.

Performance options are common and typically enable employees to buy shares at an agreed price in the future but only if they help their employer reach revenue or other targets. In business-speak, once this performance bar is reached, the options are said to have vested and can be bought at what the employee hopes is a discount to the open market price.

For most of Phoslock’s unwitting Australian investors, the company’s decision to grant 50 million in performance options that could be exercised only if the company hit certain Chinese sales targets may have warranted minimal scrutiny.

But KPMG thought otherwise. Its confidential internal audit concluded in late 2020 that huge chunks of these employee options might have been allowed to vest by Phoslock even though “the performance conditions were not actually met”.

Even more curious was the identity of some of those who received what would become very valuable shareholdings. (Some option holders became millionaires, with one pocketing a gain in share value of $4.5 million. All up, option holders made at least $22 million profit.)

The leaked company files reveal millions of options were given to figures who had never worked for Phoslock.

Schuitema insisted via text message to this masthead that the performance targets for the options were met in a “very transparent” fashion.

But Schuitema’s leaked emails suggest he was privately concerned about why people not employed by the Australian company were making significant profits.

In one email, Schuitema wrote: “The intention of the options is to reward and retain Beijing employees … [this] is not happening.”

There is no suggestion Schuitema knew who the final recipients of the options were, but the leaked internal company files suggest that another influential company figure did.

The man who held ultimate sway over who was given the lucrative options was one of Phoslock’s most senior figures – its deputy chairman, Zhigang Zhang.

Zhang was not only a Phoslock director but a part owner of a Chinese water and environment company called BHZQ, a firm Phoslock was cultivating as a lucrative customer. BHZQ is no ordinary business. It is ultimately controlled and majority-owned by the Chinese Communist Party.

The leaked emails and financial records suggest that the options may have been used to convince figures within BHZQ or the Chinese Communist Party to give contracts to Phoslock. Put simply, the options may have been another form of “commission” payment: an inducement to secure work.

The files show Phoslock options ended up with several BHZQ executives, as well as with Zhang’s friends and relatives, including a “son-in-law of an old friend of Mr Zhang”. Another of those who was earmarked for a parcel of options was described as having “wide EPA and local government connections” that Phoslock needed “on our side.”

Another person given options was described in an email as “the second generation of a Chinese official” who had “said that he can assist us get projects from the government”.

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When his own parcel of options vested, Zhang made an estimated profit of at least $6 million.

Months later, the share price had plunged more than 80 per cent, from $1.50 to 24¢, as the business was buffeted by the pandemic. It would never recover after Phoslock’s newly appointed executives, McKinnon and Parker, halted trading in the company’s shares and alerted investors to their discovery of serious financial irregularities.

In November 2021, the pair revealed to investors they had agreed to share information with the Australian Federal Police. By then, Zhang and Schuitema had resigned from the company and Freedman had retired as chairman.

In a joint statement given to this masthead, McKinnon and Parker said ongoing investigations limited their ability to speak publicly but stressed they had uncovered alleged wrongdoing and called in police, keeping investors informed throughout.

Transparency International’s Moore says that while it is rare and commendable for a company to dob on itself, the failure of the company’s previous management team to act on red flags is troubling.

Also of concern, he says, is the slow pace with which Australian authorities are pursuing the case, albeit due to some obstacles outside the AFP’s control, such as legislative gaps.

In a statement, the AFP said it was committed to combating foreign bribery and “strongly supports” proposed reforms to remove the “impediments” it currently faces in progressing inquiries.

Moore says the Albanese government needs to do much more to ensure police and prosecutors can more effectively combat alleged corporate crime and suspected foreign bribery, noting that key reforms remain stalled in the Senate.

“Given what we know about the track record of prosecutions and investigations in this country, it will take years for Phoslock to face any meaningful accountability,” says Moore.

“The saga of Phoslock suggests Australia is choosing to look the other way when regulating the sharemarket. There is little incentive to blow the whistle and little deterrence for wrongdoers.”

According to governance expert Dean Paatsch, the ASX and Australia’s corporate watchdog ASIC appear to have missed obvious warning signs that Phoslock was up to no good.

“The repeated failure of regulators to properly investigate dubious transactions has meant that shareholders were not protected,” says Paatsch.

“Phoslock’s conduct may well become a case study not only of alleged corporate wrongdoing, but of how companies can seemingly get away for years with doing the wrong thing.”