In China, the Dangers of Due Diligence; Background checks, audits and other investigations are just part of doing business in most countries, but in China those jobs can pose big risks

September 13, 2013

In China, the Dangers of Due Diligence


SHANGHAI — When Peter Humphrey and his wife, Yu Yingzheng, appeared on Chinese national television recently, handcuffed and wearing orange prison vests, it was the first time in more than a month that family and friends had seen the British-American couple, well-known figures in the foreign business world here. But any sense of relief was tempered by what they saw next: Mr. Humphrey, his face electronically blurred, his head bowed, confessed to a crime and apologized to the Chinese government.The broadcast not only stirred immediate alarm among foreigners in China, but also cast a light on a murky corner of business life in the world’s most dynamic economy. Until they disappeared in July, Mr. Humphrey and Ms. Yu ran ChinaWhys, one of many firms in the hush-hush industry of consultants and investigators in Beijing, Shanghai and Hong Kong that promise to guide foreign corporations through China’s opaque and often treacherous business environment.

The companies sell services that are considered essential to doing business in China, including background checks, financial audits, fraud investigations and trademark protection. In most of the world, such work is fairly mundane. But in China, where public records are limited and corruption is rampant, it can be tricky and dangerous.

The arrests of Mr. Humphrey and Ms. Yu on charges of illegally acquiring private personal information, and the recent jailing of several other business researchers on similar charges, suggest the risks are rising. Taken together with the bribery investigation against GlaxoSmithKline, the increasing pressure on American car companies to lower their prices here, and the not-so-veiled threats against American technology companies to subcontract to Chinese companies, China appears to be throwing new obstacles in the way of foreign companies doing business in China.

A spokesman for Bayer HealthCare, a pharmaceutical company based in Germany, said on Friday that Chinese officials had begun investigating the company’s China operations for “a potential case of unfair competition.”

Representatives from a local office of China’s State Administration for Industry and Commerce visited one of Bayer’s offices at the end of August, said the spokesman, Oliver Renner. He added that Bayer would investigate any accusations of violation of corporate policies and “take full responsibility for appropriate measures.”

It is unclear whether the investigation into Bayer is related to the ones that Chinese officials have opened into GlaxoSmithKline and other foreign pharmaceutical companies. Earlier this year, Chinese officials also investigated makers of infant milk powder for price fixing; most of the companies under scrutiny were foreign ones. Officials fined several of the companies the equivalent of millions of dollars, and the companies said they would pay the fines.

Foreign investors — hedge funds, private equity firms and multinational companies — typically hire consulting firms like ChinaWhys to investigate potential partners and employees or keep tabs on current ones.

The goal is to uncover wrongdoing that could hurt investments, things like a hidden relationship with a supplier or a fraud that could sink a publicly listed company.

“Unfortunately, even as due diligence into the integrity of domestic enterprises in China has become more important in the light of perceived widespread fraud and misrepresentation, access to records has become even more difficult,” said John Kuzmik, a consultant and former partner-in-charge of the law firm Baker Botts in Hong Kong. “Investigators are working in a very gray and somewhat dangerous environment.”

China has yet to develop a comprehensive system for collecting and assessing individual credit histories, or even accessing criminal or land records, Mr. Kuzmik said. And last year, the government began clamping down on access to corporate and household registration documents.

Indeed, much of the business going to these firms comes from Western lawyers, who must perform due diligence on Chinese deals for their clients but are wary about getting their hands dirty in the process.

“We work with private investigators but we don’t want to know where they get the information,” said a lawyer in a major American law firm in China.

Because the rules about access to corporate and other records are uncertain — the police and the courts themselves are susceptible to outside influence — the greatest risk may be an investigation of an individual with the means to retaliate.

That appears to be what happened to Huang Kun, a Canadian investigator who is in a Chinese jail and is expected to face criminal charges after helping prepare a negative report about Silvercorp, a mining operation that suffered a 20 percent fall in its share price on the Toronto stock exchange after Mr. Huang’s work was released.

Some are convinced that something similar happened to Mr. Humphrey and Ms. Yu.

An arrest like Mr. Humphrey’s is “never about the legal issues. It’s always about who has an interest in suppressing information,” a Western consultant in Beijing said.

Dan David, co-founder of GeoInvesting, a Pennsylvania company that investigates Chinese companies listed on American stock exchanges, said the decision by the Chinese to single out Mr. Humphrey was particularly unfair given that he and other investigators were trying to protect United States investors.

“Keep in mind that we are not talking about filming or hidden camera interviews, but basic background checks, and the government of China puts you in jail,” Mr. David said.

Mr. Humphrey, 57, who is British, and Ms. Yu, 60, who is a Chinese-born, naturalized American, fit easily into the orbit of private investigators who must be part gumshoe, part financial analyst. Mr. Humphrey, who first came to China in 1979, had a long career as a foreign correspondent with Reuters, including in Central Europe. Ms. Yu is an accountant.

Mr. Humphrey was the founder of the Shanghai chapter of a Texas-based group, the Association of Certified Fraud Examiners, and gave a lengthy presentation last year at a conference in Hong Kong about how his company operated. Among his pieces of advice: “Think like the fraudsters.”

ChinaWhys, which kept modest offices in Shanghai, had about 10 employees, according to Xinhua, China’s state-run news agency.

Its clients included manufacturing, hotel and real estate companies and, most notably, GlaxoSmithKline, the pharmaceutical giant, which the Chinese government has accused of widespread bribery of Chinese doctors.

A Glaxo spokesman said Mr. Humphrey was never an employee of the company, but declined to say for how long or under what circumstances ChinaWhys did work for the company.

Acquaintances of Mr. Humphrey said they believed that Glaxo had asked Mr. Humphrey to find out if the company was in compliance with the Foreign Corrupt Practices Act.

In the CCTV report last month, a uniformed Shanghai police officer, Lu Wei, said the couple had collected the personal household registrations of Chinese citizens, known as hukous, automobile and homeownership records and details of cross-border travel.

The couple paid $130 to $163 per item of illegally obtained information, which they packaged into reports they sold for over $16,000 each, making about $980,400 annual profit, the report said.

It seemed likely that Mr. Humphrey and Ms. Yu were caught because they failed to adapt after the rules of the road changed last year.

That was when the Chinese government tightened access to corporate records at state industry and commerce bureaus, which give information about company structure, and made hukous virtually off-limits, several Western consultants said. The powerful Ministry of Public Security controls hukous, which are important to investors because they are often the only way to verify that someone is who he or she claims to be.

Many investigators stopped seeking hukous after a subsidiary of Dun & Bradstreet was charged in September 2012 by the Shanghai public prosecutor with “illegally obtaining private information from Chinese citizens.” Four employees were sentenced to up to two years in jail.

Mr. Humphrey appeared to be aware of the new limitations and wrote about them earlier this year on the Web site of the fraud examiners group.

“In February 2013, the government issued strict new rules to restrict access to what it called ‘personal information,’ ” he wrote. “I find this a step backwards that will make due diligence and catching fraudsters harder. We will have to be even more creative from now on.”

He described the consequences of failing to conduct proper due diligence, and cited the disastrous acquisition of a Chinese company, Siwei Mechanical Electrical Engineering, by Caterpillar last year.

“If Caterpillar had done the kind of due diligence” combining accounting with background investigation, retrieval of corporate records and discreet supporting inquiries, “it might have spotted the fraud before doing the deal,” Mr. Humphrey wrote.

There was no word from the Chinese authorities about when or whether Mr. Humphrey and Ms. Yu would be put on trial. The British Embassy in Beijing said it was concerned that Mr. Humphrey was “publicly interviewed about the details of his case, which is currently under investigation and has yet to come to trial.”

People with knowledge of the case said Mr. Humphrey was being held in the Shanghai Detention Center in Pudong.

The American Embassy in Beijing said consular officers had visited Ms. Yu on a regular basis since her arrest and would continue to do so.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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