PwC Risk Management Seminar...PwC Seminar - Reputational Due Diligence Private & confidential 4 At...

PwCRiskManagementSeminar

ReputationalDueDiligence:AqualitativelookatChinesestakeholders

28February2017

PwCSeminar-ReputationalDueDiligence

Private&confidential 2

Agreed–thereareriskstoaddressinChina

ThankyouforattendingPwCIsrael’sRiskManagementseminar.Iamhappytosharethesedetailednotesforyourreference.

Yourbeingattheseminarisatestamentofthegrowingawareness(orperhapsacceptance)thatthereareriskstoaddressinChinadespitethesometimesoverwhelmingurgencytojumprightintothe“potofgold”thatsomeconsidertheChinesemarket.OneoftheriskstoconsiderisChinesebusinesspartners.

WhileChinacontinuestoopenuptotheworld,still,inmanycasesforeigncompaniesarerequiredbyChineselawtopartnerwithaChinesecompanyinordertodobusinessthere.Inothercases,itmaynotbelegallyrequired,butitmightbesmart.

Theterm“businesspartner”asusedthroughoutthesenotesandthepresentationslidesreferstoacompanyorindividualsomehowworkingonaforeigncompany’sbehalfinChina.

ThepresentationgaveabriefoverviewofthehistoryanddynamicsofChinesebusinesspartnership,thendiscussedthedetailsofbusinesspartnerassessmentusingReputationalDueDiligence.

BusinessPartner

Manufacturer

Distributor

Agent

Investor

GeneralManager



Inthe1970sthen-leaderDengXiaopingstated,“Socialismdoesnotmeansharedpoverty”.ThisisarguablythestartofthechangethatmadeChinaasweknowittoday.

Sincethen,China’seconomyhasundergoneanintensetransformationinthespanofroughlyageneration.Naturally,thenatureofChineseandforeigncompaniespartneringanddoingbusinesstogetherinChinahasalsoundergonetransformation.

Chinahasevolvedintoadifferentera

Socialismdoesnotmeansharedpoverty.

–DengXiaoping

“

“



AtthebeginningofChina’sintenseeconomicgrowth,foreigncompaniescamein,theirpocketsfullofmoney,builtfactories,hiredChineseworkerstomaketheirproducts,andwasessentiallyacatalystforChina’shugeeconomicgrowth.

Inthetimeupuntiltoday,therewasachangefromworkingforforeigncompaniestoworkingwithforeigncompanies.

Today,Chinaistheonewithitspocketsfullofmoneyanditislookingtoinvestbackintoitsowneconomicgrowth,mainlybypurchasingforeigntechnology.

Atthestart• Foreignershavemoney• Catalystforeconomicgrowth

Today• Chinahasmoney•  Investsinforeigntechnologyforeconomicgrowth

Chinahasevolvedintoadifferentera



IsraelandChinaareaperfectbusinessmatch.Israelhasahugeamountofinnovationandtechnology,andChinahasahugeamountofmoneyandmarketsize.

JustlastyeartheChineseVicePremierLiuYandongcametoIsraelandexpressedthat“[China]hopesthatmoreIsraelientrepreneurswillundertakeprojectsinChina”inavarietyofindustries(TimesofIsrael).

HerstatementillustratesthetransformationthatbusinesspartnershiphasseeninChina;Israelicompanies(oranyothernationality)arenotgoingtoChinatouseacheapworkforcefortheirowngains.TheyaregoingtoChinatopartnerwithaChinesecompanytomakemoneyandbettertheChinesesocietytogether.

Asbusinesspartners,Chinesecompaniestodaygenerallyhavesophisticatedbusinessacumen.Actingasthe“Chinaside”ofyourbusiness,theyhavethelocalresourcesandimportantly,culturalunderstanding,whichtheycaninterpretforyouorjusttakecareof.

Intermsofriskmanagementthough,keepinmindthatnotallChinesebusinesspartnersarecreatedequal.

Aperfectmatch

:)

ChinaandIsrael



InparallelwiththesheernumberofpeopleinChina,thenumberofpotentialbusinesspartnersthereisalmostastronomical.

Likeinallcountries,inChinathereare“goodguys”whoarehonestandtrustworthy,andthereare“badguys”whohaveasagoaltotakeyourmoney(orIP)anddisappear.

The“goodguys”willmakeyousuccessful.Theywilltakeyoutothepotofgold.TheywillallowyoutheluxuryofconductingyourbusinessinChinawithoutworryingaboutmicrodetailsthatyoumightnotevenbeawareofthere.

Ontheotherhand,the“badguys”willgiveyouthesamesenseofcomfortandsecuritybutintheendwillleaveyouwithyourpocketsemptyandyourheadspinning,wonderingwhatwentwrongandwhen.

Goodguys

Badguys

Notallbusinesspartnersarecreatedequal



Traditionally,foreigncompanieshaveconductedduediligencerelyingsolelyuponpaperworkstatingfactsandfigures,sometimescoupledwithvisitstoChinaandgoodold-fashionedgutfeelings.

WhilefactsandfiguresmaybegoodindicatorsofaChinesebusinesspartner’son-paperprofile,thefactsandfiguresalonerarelyuncovermorequalitativethings,likehowthecompanyactuallyconductsbusiness,reportsofunethicalbehavior,concealedbusinessinterests,orthatapotentialinvestoractuallydoesn’thavethecapitaltobackuptheiroffer.

NowadayssomethingcalledReputationalDueDiligence(“RepDD”)canbeusedtoreasonablyunderstandwhetherabusinesspartnerisa“goodguy”ora“badguy”.“Reasonably”,becausenomatterhowmuchresearchyoudo,youcan’tpredictthefuturebehaviorofhumanbeings.

Traditionally

Factsandfigures

Possiblevisits

Gutfeelings

Nowadays

RepDD

Qualitativelook

“On-paper”profilevsactual

Separa&ngthe“good”fromthe“bad”



WhatisRepDD?

RepDDgoesbymanynames:“reputational”,“integrity”,“enhanced”,or“qualitative”duediligence,orevensometypeof“intelligence”.UltimatelyRepDDidentifiesindicationsofredflagsthatthebusinesspartnerisoneofthe“badguys”.

RepDDsupportsothertypesofduediligenceinthatitcomparesthebusinesspartner’son-paperprofilewithitsreal-lifeactivity.Itidentifiesanycontradictionsbetweenhowthebusinesspartnerhaspresenteditselfonpaperandhowitactuallybehavesandexistsintherealworld.It’salsothedifferencebetweenwhattheyhavetoldyoutheydoandwhattheyreallydo.

RepDDcanfocusoneithercompaniesorindividualsbutusuallyblendsthetwo.Intheendpeopleareultimatelybehindcompanies.InChinaspecificallythereisapositioncalledLegalRepresentative,whichmustbeanaturalperson.Thispersonisthepersonificationofsortsofacompanyandispresenttorepresentthecompanyduringanylegal-relatedmatters.

RepDDisariskmanagementtool.

• Whatifyourbusinesspartnerhasalabyrinthofrelatedcompaniesthatyoudidn’tknowabout?WithoutRepDDyoulikelywillnotfindoutaboutthesecompaniesandthereisariskthat,forexample,yourIPmaybepassedaroundtherelatedcompanies.WithRepDD,youwilllikelyfindoutabouttherelatedcompaniesandyouwillhaveanopportunitytoprotect

What•  IDredflagsfor“badguys”

•  Riskmanagement

•  Unearths“truestory”

•  Strengthensnegotiations

When/Why•  Preventive-On-boarding-Monitoring-Papertrail

•  Reactive-Suspectedwrongdoing-Litigation

How•  Investigativemindset

•  “Manual”work

•  Publicallyavailableinfo

Who•  Chinaspecialists•  Nativeunderstandingofculture

•  Publicallyavailableinfo

Reputa'onalDueDiligence



yourIP.Itmightjustbeaquestionoftighteningyourcontract’sconfidentialityclause.• WhatifthebusinesspartnertoldyoutheyareatopdistributorofyourproductinChina?

Yousawtheirbigshinyofficesandluxurycars,butwithRepDDyoufindouttheyarea3-personintermediaryagency.

• Whatifthebusinesspartner’scompanychopdoesn’tmatchthecompanyregistrationinfo?Thissoundssimple,butitcouldhavelegalimplicationsdowntheroad.

RepDDlooksbeyondthesurfacetounearthabusinesspartner’s“truestory.”

Inadditiontobeingariskmanagementtool,RepDDtendstoalsostrengthennegotiationswithChinesebusinesspartnerswiththeknowledgeyouobtain.

WhenandWhydoyouconductRepDD?

TherearetwogeneralpointsintimethatyouwoulddoRepDD:beforebadthingshappen,asapreventivemeasure;andafterbadthingshappen,asareactivemeasure.

RepDDasapreventivemeasure

• Businesspartneron-boardingCheckingoutthebusinesspartnerbeforeyouenteringintocontract.

• BusinesspartnermonitoringMakingsurethebusinesspartnerhasn’tchangedsinceyouenteredintocontractwiththem.

PreventiveRepDDanswersquestionslike:

• Whatistheownershipstructure/whoistheultimateowner?• Doesthecompanyshowsignsofactuallyoperating?

• Doesitlegallyexist?

• Doesanythingcontradictwhatthebusinesspartnerhastoldyou?

• Doesthebusinesspartnerreallyhaveexperienceinmyindustry?

• Arethereanyoutsidebusinessintereststhatwouldberiskytome?• Doestheinvestorreallyhavethemoney?

• Doesmyfuturegeneralmanagerhaveacriminalhistory?

PreventiveRepDDisalsousefulformakingapapertrail,eitherforyourcompany’sinternalpolicies,orforlegalreasons.Somecompaniesmaybesubjecttocertainregulationsintheirhomecountry,suchasanti-bribery/corruptionlaws,antimoneylaunderinglawsoreventaxlaws.Dependingonyourcompany’shomecountrytheselawsmayreachyouinChina.Forexample,severalcountrieshaveanti-briberylawsthatrequireyouto“reasonably”understandyourChinesebusinesspartner’sactivityandhowitpertainstorisksofbribery.WhenagovernmentagencycomesknockingatyourdoorsayingyouareengaginginbriberyviayourChinesebusinesspartner,incertainjurisdictionsitmaybeastrongdefenseargumenttopresentarecentRepDDreportstatingthatatthetimeofresearchtherewerenoindicationsthatthebusinesspartnerwasofhighrisk.(Basedonmy



observations,pleasedonottakeaslegaladvice).

RepDDasareactivemeasure.

Unfortunately,sometimesunpleasantsurprisesdohappenwithChinesebusinesspartners.

ReactiveRepDDmaybeconductedtocometotermswithwhathappenedorunderstandingwhy,orperhapsitmightbeastartingpointfordevelopinginternalpoliciestolowerriskofthesamethinghappeningagain.

PerhapsthebiggestreasonforreactiveRepDDissuspectedwrongdoing.Thisismyprimaryexperience,andthemostcommonthemeis“undisclosedbusinessinterests”.Theseareextremelyeasytomissinothertypesofduediligence,onChinesecompaniesspecifically.TherearenumerouscaseswhereownersofChinesecompanieshaveregisteredrelatedcompaniesinfamilymembers’names.Chinesehusbandsandwivestypicallydonothavethesamelastnames.Sothroughoutafamilythisleavesmuchopportunitytoestablishagroupofcompaniesthatappearunrelatedbutthatareactuallyquiteclose-knit.ThisisanexampleofwherethequalitativeaspectofRepDDcomesin.

Peopletendtoleavetracesofthemselveseverywhere,especiallyintheageoftheInternet.RepDDpractitionerswillusethesetracestoconnectthedotsandfindfact-basedinformationconnectingrelatedindividualsandcompanies.

ReactiveRepDDmayalsobeusefulinprovidinginformationinlitigationproceedings.Generallyspeakinganddependingonmanyfactors,RepDDfindingsmayserveassomesortofsupportforalegalargumentintheformofacharacterprofileofthebusinesspartnerorrelatedindividuals.(Basedonmyobservations,pleasedonottakeaslegaladvice).

HowdoyouconductRepDD?

RepDDisaqualitativelookatacompany,sousinganinvestigativemindsetwhiledoingtheworkiskey.

RepDDinChinaisconducteddifferentlythanitwouldbeinotherpartsoftheworld.Thereasonsarebothpracticalandlegal.

Practicallyspeaking,RepDDinChinaislargely“manual”work,meaningthereisnosoftwarethatwilleffectivelyrunasimplesearchwiththecompanyorindividual’snameandbringupallrelevantinformation.ThisworksinsomeplacesintheWestbutnotinChina.“Manualwork”requiresfirstfindingpuzzlepiecesthenputtingthepiecestogether.

Alsopracticallyspeaking,whateverinformationisavailableinChinamaybeprovideddifferentlythaninotherpartsoftheworld.InformationtendsnottobecentralizedinChinabutisorganizedonacityorprovincialbasis.Evenwithinofficialcorporateorlegalrecords,acertaincategoryofinformationavailableinoneprovincemaynotbeavailableinanotherprovince.

Further,theapproachtoRepDDonindividualsinChinaisdifferent.Thisisbecausethereare



relativelyfewnamesfortherelativelylargepopulation.Toquantifyit,therearearound1.5billionChinesepeople.Around22%ofthepopulationhasoneofthreelastnames:Li,Wang,orZhang.That’s330millionpeople(aboutthepopulationoftheUS),andthat’sonlymainlandChinese.AddtothatHongKong,TaiwanandotherSoutheastAsianChinesenames.SearchingaChineseperson’snamealonereturnsliterallymillionsandmillionsoffalsepositivesthathavenothingtodowiththeindividualbeingresearched.Ittakesculturalunderstandingandinvestigativeskillstonarrowdownthefalsepositivestogetanykindofmeaningfulinformation.

Legallyspeaking,RepDDinChinaisconducteddifferentlybecauseoflawsprotectingwhatiscalled“personalinformation”andwhatiscalled“statesecrets”.IntermsofRepDD,informationshouldcomefrompublicallyavailableinformationsources.ThereareRepDDfirmsthatobtainwhatisconsiderednon-publicallyavailableinformation,andthatisillegalandextremelyriskytoallpartiesinvolved.

ItmayseemthatusingonlypublicallyavailableinformationsourceswouldlimittheeffectivenessofRepDDandtheresultsyoumightfind.Idisagree.Thisiswherefindingthepuzzlepiecesandthenputtingthemtogethercomesin.RepDDpractitionersfilterthroughhugeamountsofinformation,andconnectthedotstoidentifythingslikecriminalorcivillitigation,misuseofgovernmentsubsidies,outsidebusinessinterests,andanyotherreputational“redflags”.

InthatwayRepDDuncoversratherinterestinginformationdespitewhatmaybeperceivedasobstaclesorlimitations.

Frombothapracticalandlegalperspective,keepinmindthatinChina,informationnotavailabletodaymaybeavailabletomorrow,ormoreoftenvice-versa.

WhoshouldconductRepDD?

Whythetopicofwhoshoulddothework?SothatyourRepDDriskmanagementtooliseffective,andnotanexpensivewasteoftime.

MoreandmoreforeigncompaniesarerequestingRepDDfromserviceproviders,becausetheworkisnoteasy.Companieswantthemostvaluableinformation,quickly.IfyoudoconsiderengagingaRepDDserviceprovider,whatshouldyoulookfor?

• SpecialistsinChinaRepDDoratleastaRepDDfirmwithadesignatedChinaRepDDteam.RepDDisdifferentinChina.

• WithintheChinaRepDDteam,thereshouldbeexperiencedpractitionerswhounderstandtheenvironmentinChinaandwhocanintegratenativeunderstandingoftheculture(notjustlanguage).It’snotaboutthelanguagebutaboutlookingattheinformationinfrontofyouandanalyzingwhatitreallymeanswithregardstoaparticularcase.

• UnderstandhowtheRepDDserviceproviderconductsresearchintermsofusingpublicallyavailableinformationsources.Takingphotosorobtainingcorporateinformationfromathirdpartyareinsomecasesnotpublicallyavailableinformationsources.

Disclaimer: The informationsetout in thisdocument is foreducationalpurposesonlyanddoesnotconstitutelegaladvice.Lohtsmanacceptsno liability–whether in contract, tort (includingnegligence),orotherwise– toanypersonorentitywithrespectoftheinformation.



Thankyou!IammorethanhappytodiscussanyquestionsonRepDDoritemsrelatingtoyourparticularChinagoals.Feelfreetocontactmeatmydetailsbelow.

LauraisFounderofLohtsmanwheresheassistsclientswithBusinessPartnerReputationalDueDiligenceandChinaMarketPre-EntryStrategy.

AForensicAccountantbytraining,Laura’sbackgroundisinfraudinvestigation,havingspecializedinreputationalduediligenceonChinesebusinesspartners.ShehasoverseenhundredsofcasesfromFCPAcompliancetoinvestigatingundisclosedChinesebusinessinterests,havingidentifiedimportant"redflags"whichotherwisewouldhavegoneunnoticed.

LaurawasbornandraisedinNashville,Tennessee,USA.Shespent10yearsinFranceandover5yearsinChinabeforemovingtoIsraelinAugust2016.ShehasaMastersdegreeinForensicAccountingfromFloridaAtlanticUniversityandisaCertifiedFraudExaminer.

LauraOtterpohl,CFE|FounderLohtsman|ChinaDueDiligenceEmail:[email protected]+972-50-649-5990TelUS+1-615-208-5791TelHK+852-8191-5932

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