"[He] got me invested in some kinda fruit company."
You may recall Tom Hanks saying this in the movie Forrest Gump after he made a fortune investing in Apple Inc stocks without having an inkling of what the company did.
In real life, consumers and investors are not so lucky. Business fraud rose to a whole new level last week when news surfaced of about five fake Apple Stores operating in Kunming. Similar outlets were also said to have opened in Chengdu and Xian. Apple Inc operates only four stores in China – two each in Beijing and Shanghai.
Online photos and video footage at first glance show the fake stores to be almost perfect copies of the real thing – down to Apple’s trademark blue T-shirts worn by staff, who in fact were themselves convinced they were working for the California-based Apple Inc. But a closer look would have raised suspicion. Cheap materials and signs of poor workmanship with the fixtures and fittings were a dead giveaway.
The words "Apple Store" appeared in Chinese and English on the signboard beside the famous Apple logo. But authentic Apple stores only display the iconic logo. One shop even had the word "store" misspelled as "Stoer."
If you have bought anything at these stores, you may be kicking yourself right now for not taking a closer look.
But "Apple Store" is one case where consumers are taken in if they are not careful in China. In the investment world, you can be equally victimized. You would expect stocks you bought to be thoroughly scrutinized by the analysts and bankers following the company. Sadly, this is not always the case – as clearly illustrated by two other recent events.
Next magazine reported a few weeks back that a pig farm in Anhui province owned by chairman Zhu Yicai of the Hong Kong Stock Exchange-tradeYurun Food Group – a leading mainland food products firm – had no pigs at all.
Even before the Next article, Yurun was already a victim of market rumors that short seller Muddy Waters was about to print a report on the firm.
Investors panicked and the stock dropped over 20 percent in a matter of days. You can’t blame investors for overreacting.
When Muddy Waters actually published a report in early June on the Toronto-listed Sino-Forest Corporation, a leading commercial forest plantation operator in China, the stock nosedived more than 80 percent at one point.
The report alleged that the Toronto- listed company’s forest holdings were far more modest than claimed and that it had falsified its investments. Investors, torn between riding out the storm or dumping the stock to cut losses, were left to bleed.
They also wanted to know why these issues were not picked up earlier by analysts and due-diligence teams. I once met representatives from a top global financial institution and was appalled by the simplicity of their due diligence process – they merely bought some off-the-shelf research previously done on the same subjects. It was a one-size-fits-all solution with no specific intelligence gathering, no site visits and no inquiries at all.
Others offered excuses for not employing full-scale or any due diligence, such as they know their counterparts well enough from personal interaction and industry knowledge.
You may also notice financial institutions are increasingly offering new due diligence positions but a closer look reveals most of these are junior posts to conduct desktop research. The problem is, much of the so-called due diligence doesn’t include adequate on-site investigation and inquiries. Otherwise, how can you explain – if the allegations are indeed true – the missing pigs and trees?
Having said that, proper due diligence shouldn’t be just a bean- counting exercise, such as confirming assets like pigs and trees. It should also involve a thorough look into various areas like financial, legal, environmental issues and – the one usually overlooked – reputation.
Reputation due diligence, put simply, is a fact-check exercise to ensure folks on the opposite side of the table are not keeping from you embarrassing secrets and other negative issues about the company. The last thing a prudent institutional investor wants is to appear on the front page of the newspapers for the wrong reasons and be perceived as not doing its homework, or worse, as a collaborator of fraudsters.
In addition to desktop research, reputation due diligence includes an intelligence gathering process usually known as discreet source inquiries – chiefly to search for potential red flags and also collect and confirm certain information discreetly from well-placed and sometimes obscure sources related to the case.
Both Yurun and Sino-Forest have sought to refute and challenge the negative coverage to resuscitate stock prices. Investors on their part should always question whether investment decisions were based on proper and thorough due diligence done by professionals, and didn’t just involve desktop research.
Perhaps Forrest Gump should have asked: "What exactly is this fruit company I’m investing in?"
Vanson Soo runs an independent business intelligence practice specialized in the Greater China region. E-mail: email@example.com This appeared originally in The Standard of Hong Kong.