Piercing the Great Wall of Corporate China

Preface We’ve performed forensic due diligence in China for over a decade. During this time we’ve learned that China is a unique due diligence environment that’s unlike any we’ve encountered in other parts of the world. What makes it unique is that Chinese businesses play by a different set of rules. Checklists and procedures, previously used in performing due diligence on companies in other parts of the world, simply aren’t effective in China. Culturally, socially, and philosophically, Chinese businesses function differently from those in the West and in other Asian nations. As a result, in order to pierce the great wall of corporate China, a new set of procedures and methodologies was needed when performing forensic due diligence on Chinese companies. We use the term forensic due diligence for a reason. Forensic due diligence is due diligence that goes deeper under the covers. It essentially believes that you’re guilty until proven innocent, and that any numbers and facts presented during the due diligence process have to be corroborated and verified to a higher standard before being accepted. Standard due diligence, in contrast, uses a one size fits all rulebook which may vary little from country to country. This approach doesn’t always work when evaluating Chinese companies. As a result, serious deficiencies within these companies are often overlooked and business decisions are therefore based on inaccurate information. Consequently, this has resulted in a belief that no due diligence process could ever uncover all the deficiencies and fraud within a Chinese company. We want to change that perception. We’ve incorporated our established procedures and methodologies into Piercing the Great Wall of Corporate China. In doing this we’ve taken into account the realities of how Chinese companies function and operate, as well as interact with the Chinese government. We’ve experienced firsthand the great wall of secrecy that Chinese companies try and place around themselves. This has been largely effective at preventing those less experienced in performing forensic due diligence from discovering the innermost workings within a Chinese company. Few organizations and individuals, in our opinion, currently have an effective process that allows them to accurately conduct comprehensive due diligence on a Chinese company. The few that do perform their forensic due diligence and keep their discovery and evaluation process proprietary to their organization. In Piercing the Great Wall of Corporate China we’ll provide those who want to conduct forensic due diligence on Chinese companies the benefit of our experience as partners in one of the largest and most recognized forensic due diligence organizations in China. We’ll provide you with the evaluation tools and associated information needed to successfully analyze a Chinese company from a whole new perspective, enabling you to finally pierce the great wall of corporate China. Introduction In 2009 a rash of fraudulent business practices by Chinese companies began to surface. Almost every day one could open a newspaper and find new allegations of financial irregularities, or the non-existence of significant corporate assets that previously appeared in the audited financials of a US listed Chinese company. Soon no one believed that any public or private Chinese company was honest, or that their financials could be trusted. Over the course of the next two years 50 China-based companies were delisted from US securities exchanges. The value of Chinese stocks plummeted, investors lost billions of dollars, and foreign financing for Chinese companies soon dried up. Performing forensic due diligence on Chinese companies for as long as we have, we both knew that what the newspapers were now reporting had, in fact, been going on for a substantial period of time. We’d performed forensic due diligence on scores of Chinese companies, and managed to uncover these same types of issues over the years on a multitude of the companies that we examined. A question we’re frequently asked is why, if Chinese companies have all these problems with the transparency of their financials and other books and records, and commit outright fraud by claiming assets they never owned, don’t investors just bypass companies in China and invest their funds in businesses within countries they do trust? The answer to that question is that not all Chinese companies have inaccurate financials, and they don’t all commit fraud. The image of Chinese companies has largely been painted by the press with a wide brush which seems to envelop all Chinese companies, many of which have accurate financials and don’t commit fraud. The task of those who want to conduct business with a Chinese company is distinguishing between the two. As to the question of why someone should become involved in China, Jack Welch, former Chairman and CEO of General Electric, summed that up best when he stated: "If GE's strategy of investment in China is wrong, it represents a loss of a billion dollars, perhaps a couple of billion dollars. If it is right, it is the future of this company for the next century." China, as the world’s manufacturing hub, as a land of 1.3 billion consumers, and as a country that’s shown double digit growth for three decades, is simply too important to the economic future of most companies to ignore. Many companies and individual investors choose to participate in this growth by acquiring, investing in, or forming a partnership with a Chinese company. Therefore, forensic due diligence assumes a critically important role in providing the information on which they can base their decision. As we’ve previously mentioned, philosophically, culturally, and business-wise Chinese companies seem to operate on a different plane than businesses in most other countries. The primary reason for this is that China has historically been an isolationist country which was cut off from interaction with the global business community for all but the last thirty-five years. During this isolation Chinese society and businesses have developed their own morality, ethics, cultural leanings, and business practices. Western cultures, in contrast, developed their norms of business behavior, and an ethical and moral equilibrium in international dealings with one another, over a period of centuries. As a result, and as previously mentioned, the methodology of performing forensic due diligence in China can vary widely from that performed in other countries. What we provide in Piercing the Great Wall of Corporate China is the comprehensive knowledge base necessary to successfully perform forensic due diligence on Chinese companies. In addition, we’ve made an assumption that those taking advantage of our knowledge in this area would already have basic accounting and business skills. They would therefore supplement that existing knowledge base with our methodology and procedures. If you want to perform due diligence in China, Piercing the Great Wall of Corporate China will provide you with the tools necessary to delve deeper into the business and financial fabric of a Chinese company and understand the obvious, and not so obvious, factors that make performing accurate and comprehensive forensic due diligence on a Chinese company so challenging.