Asia is helping to haul the global economy out of its malaise as US and European economies continue to underperform. As a result of its sustained strong performance, the region continues to attract substantial investment, although the associated risks remain high. Last year, the largest number of firms affected by fraud were in Asia, with Japan listed as a major offender. Closer examination of these cases reveals that minimal due diligence had been conducted at the outset of the transactions, with underlying problems exposed only much later.
The expression “the devil is in the detail” should serve to remind firms how important it is to thoroughly examine potential business partners to identify risks not visible or obvious from financial and legal reviews. Due diligence can help avoid often costly (and potentially embarrassing) pitfalls; in contrast, failure to conduct these checks—especially in Asia—may leave a potential skeleton in the cupboard.
Here are two recent cases illustrating the importance of undertaking due diligence as part of the evaluation process. The first instance shows the myriad problems that can arise when adequate checks are not conducted prior to engagement, while the second shows how a thorough investigation in the early stages can present opportunities for deals to be structured to mitigate risks identified.
Post-transaction red flags
In 2010, we received an urgent query from a somewhat distressed client regarding potentially fraudulent activity at a branch office. The client had received an anonymous letter indicating possible issues associated with its investment portfolio in Japan, with suggestions that the provenance and profitability of its investments may have been distorted by local employees. The alleged issues included many of the red flags financiers dread: potential connections between investments and funding of affiliated firms in the portfolio; possible kickbacks received by a local representative; and general mismanagement and neglect of investments.
FTI-International Risk was engaged to investigate, with the aim of providing leverage for discussions with errant employees and evidence for any subsequent legal proceedings.
Our investigations involved examining substantial amounts of data retrieved from a computer forensics exercise, and conducting discreet inquiries with several entities related to the local firm. A picture emerged of a duplicitous faction within the firm that had established a number of Special Purpose Companies (SPCs) without the knowledge of our client’s management. These SPCs, many in the client’s name but with private funding, had been used as the vehicles for several investments that previously had been discarded by the risk department. During the economic bubble, they had been raking in a substantial profit, although in recent months had been significantly less lucrative.
By piecing together the complex network of funding and transactions conducted by these SPCs, we were able to compile sufficient information to support our client in implementing major personnel and structural changes at its local branch, as well as litigation against the parties concerned.
Pre-transaction risks
In a more precautionary move last year, a long-standing client engaged FTI-International Risk to examine the background and reputation of a real estate firm in Japan. This prudent client was well aware of the many risks in this challenging industry, and was keen to identify any issues with the potential to affect a proposed investment before making a commitment.
We conducted a comprehensive due diligence investigation by means of investigative on-line research and wide ranging inquiries using various knowledgeable sources. The target firm emerged as an extremely unstable and unsavoury enterprise. The first area of concern was that several of its property acquisitions had been channelled through shell companies, suggesting a non-transparent financial structure that is common in an industry known for accounting fraud and tax evasion. Subsequent inquiries found instances of bid rigging, involving corrupt local officials, in order to secure these deals. A third issue related to the heavy handed eviction of tenants resident in some buildings—so-called land sharking—with a few high profile aggressive disputes having led to some arrests. The thugs hired were reported to have organised crime connections, a relationship confirmed through checks of official watch lists. This, in turn, revealed associations with money-laundering activities and a possible North Korean affiliation.
The colourful report resulting from our investigation was naturally quite alarming for our client—especially the verified link to organised criminal activity—and it was able to save itself from considerable financial and reputational risk.
