Issue 6 - December 2011
The Asian Tiger’s Camouflage
Once fraud is revealed, investor losses can be sudden and dramatic. When considering Asian investments, look beyond the audited financials.
A prominent British lord justice once remarked that the role of an auditor is that of a watchdog — not a bloodhound. Despite the reality of this observation, investors still often rely primarily on audited financial accounts to confirm the soundness of Asian companies they plan to invest in. Unfortunately, this approach can lead to sudden and dramatic losses.
A few recent headlines underscore the danger:
- The Carlyle Group lost $105 million after the Hong Kong Securities and Futures Commission suspended trading in China Forestry Holdings and brought criminal charges against its CEO.
- Shares of China Natural Gas plunged 59% after the company “restated earnings.
- Paulson & Co., one of the world’s largest hedge funds, lost more than $550 million after financial fraud was revealed at Sino-Forest.
Investors aren’t always cognizant of the role of audit firms. These firms primarily serve to verify documentation behind financial statements, not probe for evidence of fraud. Many investors also make the perilous assumption that an Asian company listed on the Hong Kong, New York or other established exchange meets the same standards of disclosure as Western companies listed there. Moreover, investors don’t usually have the resources needed to investigate a maze of jurisdictions and languages to verify a company’s claims.
But the next big corporate failure has already happened. It just hasn’t surfaced. When considering Asian opportunities — particularly in emerging markets such as mainland China, India, Indonesia, the Philippines and Thailand — investors need to conduct deeper and broader due diligence, beyond just reviewing audited financial statements. They need to scrutinize corporate governance and business structures, and examine in depth what lies behind the assets on the books.
What to Look For
Investors should dig deeply into these issues to vet opportunities and protect their interests.
Corporate Governance
Look carefully at corporate governance structures. An Asian company may not have the clean segregation of duties between board, CEO and management that is common in the West. Family relationships and personal networks play an enormous role in Asia. In many ways, these relationships hold the society together. Reciprocal obligations with extended family, or even someone who hails from the same village or town, can be a counterweight to the more objective business decisions expected in the West. Many publicly traded companies, for example, began as family-run enterprises. Family and friends may sit on boards or even audit committees. It is also not uncommon for the head of a family to be both CEO and chairman. Weak governance structures can allow for company investments to be based on family ties and needs vs. all shareholder interests.