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According to Chinese astrology, 2012 was the year of the dragon. The rapid uptick of Chinese investment in U.S companies as well as IPO’s of Chinese-based businesses on U.S. Exchanges bore this out. 2013 is the year of the snake. If the SEC and DOJ continue to bring enforcement and criminal actions against US companies and professional firms doing business in China and Chinese businesses seeking capital in the U.S. at the same rate it did in 2012, the endemic danger of doing business with or in China will continue to poison this brand of economic expansion.
According to the China Global Investment Tracker, Chinese investments in the U.S. totaled $54.2 billion for January 2005 through January 2013, breaking a record in 2012 with completed deals worth $6.5 billion. Chinese-based businesses have frequently raised money in the U.S. through reverse mergers of small U.S. companies, a strategy used to bypass the more rigorous requirements of an initial public offering. As of June 2011, 83 Chinese companies became listed on US exchanges through reverse mergers.
Politics aside, Chinese investment in either direction has been fraught with problems. ABC News reports that since 2010 more than 70 Chinese companies have been delisted or left NASDAQ and the New York Stock Exchange because of suspected fraud. Since 2009, the SEC has brought forty civil actions against Chinese companies listed on major American stock exchanges. The SEC is now directing its investigative efforts to the firms serving as middle men, such as Rodman & Renshaw, the investment bank formerly chaired by General Wesley Clark. Rodman & Renshaw, which promoted many Chinese deals, shut its brokerage business doors in September 2012, in part because of the reports that many of the Chinese companies it had been promoting were suspected of fraud.
The administrative proceedings brought by the SEC against the Chinese affiliates of BDO, Ernst & Young, Deloitte Touche, KPMG, and PricewaterhouseCoopers last month highlight the real problem with doing business with China: secrecy and state-mandated lack of transparency. Deloitte, one of the accounting firms charged, said it best, “The SEC has long been aware that the China Securities Regulatory Commission forbids China-based audit firms to produce audit work papers directly to the SEC, and yet the SEC chose to allow China-based companies to sell securities in the United States despite those restrictions.”
The Chinese government forbids Western access to audit work papers and other documents, even when performed by US based service firms or on behalf of US investors, on the grounds that the audit papers may reveal state secrets. This refusal has strained diplomatic relations between the US and China but no resolution has been found to date. Revelations of recent state-sanctioned hacking against US news outlets show how far China is willing to go to find out who is sharing it considers to be its secrets.
Similarly, the same brand of background investigation and due diligence that have become commonplace outside China is illegal. Chinese data privacy and other laws make it a crime to disclose “state secrets” and as the accounting firm cases show, the Chinese courts’ definition of “state secrets,” is extremely broad.
How does one do business involving China then?
As with any effective due diligence, it is imperative to work with people who know the “locals.” While China remains behind the west in widespread creation and dissemination of public information about companies and individuals, Chinese corporations are required to make Delaware-type filings with its Administration for Industry and Commerce, and patent, trademark, and customs filings are available online. Many litigation files are public information as well, some even online. Proprietary databases available to research firms working in China contain personal information about Chinese nationals, too, including family history and province of origin.
There also is a Chinese internet presence, including social networks. Monitored or not, there is a wealth of information on the Chines web and no law prohibits mining this information.
More important, however, is having a network of trusted individuals familiar with the region or industry where you are doing business and the reputations and histories of the companies or individuals with whom you intend to do business.
Whether it is the year of the dragon or snake, access to data and intelligence is critical to doing business in China.
Guidepost Solutions has worked in Asia for over thirty years and has ongoing relationships with Hong Kong based business intelligence firms doing business in China. Guidepost is particularly well-suited to conduct the types of due diligence inquiries necessary to give US investors and partners comfort.