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Private Equity firms, Hedge Funds and overzealous investors in Chinese companies beware. Needless to say I wasn’t surprised or disappointed when learning that “Hedge Fund Guru” John Paulson of Paulson & Co. lost a cool half a billion dollars on a Chinese company called Sino-Forest, listed on the Toronto exchange, after a report from the research firm Muddy Waters exposed significant reporting fraud at Sin0-Forest.

Now for those of us who are in the Jungle (China) on a daily basis, we could have saved Paulson a lot of money and Muddy Waters a lot of time and told everyone from the beginning to expect fraud and overstatement of resources, assets, and earnings and to do due diligence.

Then after you’ve done it, do it again and again. Yes there are good companies in the Jungle, with solid earnings, accurate financial statements and transparency and I am sure the opportunities for investment and stock trading can be promising. But, it is never what it really seems here in the Jungle and best to remember and dream about due diligence. The following from the editorial page of the South China Morning Post as always for your reading pleasure.

Investors need to have faith restored in companies being brought to market

The cloud of doubt over Chinese companies listed on the world’s stock markets is getting ever darker. Values took another dive last week after it emerged that American hedge fund guru John Paulson had suffered massive losses by ditching his entire stake in the Toronto-listed mainland firm Sino-Forest, accused by a short-seller of faking timber holdings.

His move has added to the damage caused by a series of scandals that have wiped billions of dollars off the market value of companies and damaged their credibility, regardless of whether they have been implicated.
But it is wrong to point the finger at suspect companies alone. Those who bring questionable firms to market should also be under the spotlight. Those are the investment banks, accounting firms, institutional investors and lawyers who vouch for the firms that are trying to list on stock exchanges. Just as during the global financial meltdown three years ago and the dotcom bubble of 2000, it is obvious that they have not done their homework. A number of firms that have doctored their books have been able to list.

A point is fast approaching where investors are unsure who they can trust. Large state firms and small private ones alike are being shunned. The values of many have plunged at least 20 per cent, and some by as much as 60 per cent, in the past few weeks alone. Quick action is needed by companies and the government to shore up credibility.

But a public relations blitz, in which firms make themselves as transparent as possible, and a concerted effort by authorities to improve domestic accounting practices are only part of the solution. Investors also have to have faith in the foreign entities that sign off on audits, underwrite initial public offerings and promote companies as sound deals. Conflicts of interest that abound have to be taken out of the process. Foreign stock exchanges seeking to attract mainland companies must also meet their responsibility to investors.

Steve Dickson wrote a great article entitled China Due Diligence. Not Optional – that I will steal and copy at length. His article appears on the China Law Blog. The blog is a must read for all doing business in China.

• Most companies are not aware that due diligence is required whenever you do any kind of business with a Chinese company. If you do not already know the Chinese company with which you will be conducting business, you must confirm that the company really does exit and that you are dealing with the actual company and not an impostor.

Substitute Chinese with Korean and we have a good article for this blog.

I had a client contact me asking for advice on how to collect a debt of USD 150,000. I first asked the client for the name of the debtor and he gave me the name JH Park. I asked if he had any other information and he said he had an email address. How the heck can you send someone USD 150,000 without any information on the person?

He noted that he saw the website and I noted that the website has only an email address and the name JH Park. I felt really bad for this guy and agreed to try to dupe the “JH Park” into revealing more information, but of course the man was too smart to fall for our fishing exercise. Thus, we are left with a fake gmail account and a name that is more common than Joseph Smith in Utah.

Steve seems to experience the same issues I experience working in Korea.

• It is easy in China to fake company seals, business cards, bank accounts and even a website. The unsuspecting foreigner makes a deal with the impostor and sends funds to the bank account. Product never arrives. The foreigner contacts the well established Chinese company and that company truthfully responds by saying “we have never heard of you.” It turns out the foreigner had been dealing with a fake, virtual company the entire time. This happens all the the time in China. Trust me when I tell you we see instances of this at least once a month.

Please, my friends at the China Law Blog and I have said numerous times, please do your due diligence. Read the below articles and one can get a better sense of what due diligence actually means.

• Doing Business in Asia: Due Diligence, Agreements, Attorneys and Street Smarts
• Listen to My Mother: JVs in Korea (Translated from Korean)
• Debt Collection Cases in Korea on the Rise: Due Diligence Brother

I love Steve Dickson (in a Philadelphia way), since he is the smartest guy on the other side of the Yangtze and one of the most interesting and creative thinkers in law. I know, enough of the brown nosing. Hope he invites me one day to meet him in China. His blog may be found at: www.chinalawblog.com and the article may be found HERE.

We have a phrase in Texas, something about the difference between a steer and a cow, I don’t remember how it goes, but it’s kind of like the British one – Pennywise and Pound Foolish.

This can be used to describe those who try to save a few dollars (used to be a penny back in the 1600′s) and it ends up costing them a lot more in the long term. Old Chinatex gets a lot of enquiries from people and companies that want to do business in Asia-Pacific. They think that just because factories makes stuff real cheap here in China, that things like quality legal counsel should also be cheap.

As many of you may know, Hong Kong and it’s neighbor city in China (Shenzhen) are two of the most expensive cities, as ranked by Mercer, in the world and that while making stuff is still cheap, helping those who make stuff keep their money is not.

Now, I know what you are thinking “those *#!% lawyers” – well that’s what you will be saying if you trust somebody who is not a lawyer or even worse, a local lawyer to handle your matter. Reminds me of one of the first legal matters I witnessed here in China. Foreign (U.S.) company comes to China to build a entertainment facility in a shopping mall. Against the advice of those who know better, they hire a local lawyer for numerous reasons – one of them being he is cheaper. Unbeknownst to them, the lawyer was good friends with the lawyer for the shopping mall and they had struck a deal where the savings to the shopping mall owner from the negotiations would be shared equally between the two lawyers and the mall owner. True story and I fear not a rare one.

Now, Old Frank has been helping people in Hong Kong and China who are in trouble and who don’t want to be in trouble and who want to make good money and keep it – for many years. I don’t want to see y’all be Pennywise and Pound Foolish when having somebody advise you on your business, which to many of you is your life. Better just be careful, make sure you get references if you have any doubt who you are hiring and expect to spend what you would spend in your country for similar quality services.