(Financial) Fraud in China: How to Avoid Portfolio-Disrupting Scams

02
Oct

When it comes to financial crimes committed within China, the laws at least (even if the efficiency of the authorities with respect to applying them can sometimes be questionable) are very strict and as such, a valid case can be made that a strong legislative disincentive exists. But as far as laws that pertain to scamming foreigners are concerned… let’s just say the legislative framework is multiple orders of magnitude more lenient.

Therefore, quite a few “ethically challenged” entities end up deciding that the risk to reward ratio associated with defrauding foreigners is appealing enough to warrant giving it a shot. A relevant example to this effect is represented by reverse merger scams. In other words, scams which revolve Chinese companies taking over defunct US businesses so as to give US investors a gateway to investing in the Chinese company in question.

As straightforward as it may seem, what ended up happening in several cases was nothing short of financial fraud. Simply put, the Chinese company reported huge earnings in the United States through the entity it now controlled, earnings which had nothing whatsoever to do with the less than stellar reality. In China, however, the real earnings were reported. Eventually, US investigators (many of which were incentivized by the short positions they were holding) cross-referenced the US and Chinese “books” and realized that the US numbers were nothing more than fiction. Even more so, “on the ground” reports frequently revealed that the Chinese businesses were barely functioning, with their headquarters either empty or filled with deteriorated equipment.

A recipe for disaster.

On the other end of the spectrum, due to for example US-Chinese political equations such as those mentioned in a previous article or simply fundamentals in general, US-Chinese joint ventures represent one of the top opportunities in China at this point in time. However, for Western investors to be able to take advantage of them, a very thorough due diligence process is required because scams unfortunately run rampant.

This is because:

  1. The legal framework is sometimes less than clear and certainly nowhere near strongly worded enough to constitute a robust deterrent when it comes to Chinese entities interested in defrauding Western (rather than Chinese, as mentioned at the beginning of this article) investors
  2. Even if laws are broken, the Chinese authorities aren’t always sophisticated or, frankly, competent enough to take meaningful action and especially do so quickly
  3. On the other side of the fence, the authorities of Western nations such as the United States have been pretty much caught off-guard by this phenomenon, with not enough of an infrastructure in place to catch fraudulent projects in their infancy

Therefore, potentially interested Western investors find themselves in a bit of a risk management predicament. Should they simply stay away and potentially miss out on career-altering returns or should they dip their toes in these sometimes murky waters, knowing that many dangers lie ahead? As far apart as the two scenarios may seem, there is a common denominator: the fact that Western entities that have “boots on the ground” in China (in other words, entities that work with people/companies in China which help them throughout the due diligence process with numbers and information impossible to get ahold of by non-Chinese individuals or companies) are in an excellent position to succeed.

To put it differently, the likelihood of doing well as someone who let’s say lives in the United States and wants to invest in Chinese assets from the comfort of his own home and without outside assistance is on the low side. There are simply too many unknowns and, to be blunt, you do not have the infrastructure necessary to make genuinely informed decision without contacts in China.

This is where ChinaFund.com shines.

We have precisely the boots on the ground necessary to provide you with everything you need in terms of due diligence expertise. If you are interested in analyzing a company’s “books” thoroughly with the help of someone who specializes in the Chinese market, our multi-jurisdiction accountant who specializes in China is here to help. If you need hands-on research which involves someone physically visiting a location so as to provide much-needed intelligence, we can either do this directly or put you in touch with the proper entity. Whatever you may need to realistically assess the prospects of a certain China-related investment, we are here for you. Simply get in touch by visiting the Consulting or Contact section of ChinaFund.com and we will do our best to help.

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