Law Blog

I can remember about 5 years ago here in the Jungle (Shenzhen, China). There was a new bar street that had just opened, and while there were about 7 bars, only one was relatively modern and western, and ultimately, the only one with customers. As the shopping mall to which the bar street was attached became more popular, so did the other bars, only because there was nowhere else to go. It’s the law of numbers in China, especially in cities like Shenzhen where there is so much money and relatively little culture.

But, this isn’t about lamenting the few choices or lack of culture in Shenzhen, China, it is about the discussion I had with one of the small bar owners, who almost never had any customers. The bar had a bad name and a picture of a dodgy kangaroo (it didn’t even look like a kangaroo) and was supposedly an Australian wine bar. In turns out one of the owners who put in most of the money lived in Australia and the bar was run by the other two owners who happened to be very clever sisters.

I asked one of the sisters one evening why they didn’t have any customers, and if she would like me to bring in some friends to make the place more popular. She emphatically said it wasn’t necessary because they were trying to make the bar lose money so that the absentee partner would accept a fraction of his initial investment in a sale to the sisters. She said that they knew the bar street was going to be really popular – and eventually it was standing room only every night – and that she and her sister would share all the profits. He eventually acquiesced, as he didn’t spend much time in China and had no idea what was really going on, and the rest is history.

I haven’t seen the sisters in quite awhile, but, I imagine them driving one of those new Mercedes SL Class Roadsters that are a dime a dozen here in the Jungle, smiling all the way to the VIP counter at the Bank of China.

One of the people I most respect in the world once told me, “nothin’ is ever what it seems.” That lesson is driven home to me every day that I spend here in the Jungle. I always tell my clients in China and anyone that will listen, do as much due diligence as you possibly can, peel back the layers of the onion until you reach the core, take your time, never be in a hurry and then once you make the investment or hire the factory or the distributor or the general manager, never stop doing due diligence. Never, never, never. That is if you really want to make money.

The post is by Frank Caruso. Frank Caruso is the head of the China Law Group at IPG Legal and has lived and worked in Shenzhen of over 12 years.

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.