Author: Richard Batten LL.B (Hons), Barrister and Solicitor of the Supreme Court of Victoria and Director of Censere Group Co., Ltd

Richard is a Director with the Censere Group and for the past 20 years has been assisting clients in the Asia Pacific Region with Due Diligence investigations in a variety of Mergers and Acquisitions across different industries.  His projects have included clients from China, Japan, India, Korea, Australia and the USA.  

One of the significant trends in the Asia Pacific region over the last few decades has been the emergence in a number of countries of new or tightened laws on privacy of personal data or “Data Privacy”.  This trend has created a particular challenge for forensic practitioners providing integrity due diligence services to clients seeking to mitigate their risk(s) before deciding on significant investments in the region.  Not only does a forensic practitioner need to understand where and how to obtain relevant background information on a target company, and key individuals associated with the target, but is also required to have a sound knowledge of all data privacy laws and guidance in the jurisdictions relevant to particular due diligence projects.

This article examines the current position regarding the Hong Kong Personal Data (Privacy) Ordinance and the Office of the Privacy Commissioner for Personal Data (HK) "Guidance on Use of Personal Data Obtained from the Public Domain" issued in accordance with the requirements of the Ordinance.  The HK Special Administrative Region (SAR) has enacted a strict Ordinance to protect personal data.  It specifically applies to data obtained from the public domain which practitioners previously assumed was able to be used without restriction as such information had already been disclosed to the public.

This assumption has now been legislatively overturned and the ordinance contains significant restrictions on Personal Data use, even where it is either disclosed publicly or available to the public to access relatively easily.  The Guidance specifically states the limitation on wide use of personal data in the public domain:

“It is a misconception that publicly accessible personal data can be further used or disclosed for any purpose whatsoever without regulation.  The protection afforded by the Ordinance does apply to such personal data and there is no general exemption from compliance with the requirements under the Ordinance.”

The key limiting Data Privacy Principle in the Guidance to the Ordinance relevant to due diligence practitioners is extracted below:

“DPP3 specifies that personal data shall not, without the prescribed consent of the data subject, be used for a new purpose. The term, “new purpose” in relation to the use of personal data, means in essence any purpose other than the one for which the personal data was originally collected or a directly related purpose. “Prescribed consent” means consent that is expressly and voluntarily given and has not been withdrawn by the data subject in writing. The term “use” in relation to personal data includes the disclosure and transfer of the data.”

The consequence of this principle means for example that personal data collected by a government registry for its purpose (such as business registration) may not then be used for an unrelated purpose like “integrity due diligence investigations”.  The Guidance specific refers to the potential misuse of personal data by “integrity checking services” and the Commissioner has therefore made it clear that such services may breach the Ordinance.

So what does this mean for organizations wishing to check on the integrity of key persons (officers of a target company) for a proposed merger or acquisition?  In our experience many clients have been reticent to disclose to targets the full extent of the due diligence, particularly regarding integrity investigations, they will undertake before signing off a Heads of Agreement or proceeding with the particular deal.  Should the organization wish to continue with such an approach then they would need to be able to satisfy one of the exemptions to the application of DPP3 specified in the Ordinance.

However the specific exemptions under the Guidance do not cover the undertaking of due diligence investigations, as it relates to the integrity of key individuals.  The key exemptions include:

1. Section 52 for domestic purposes
2. Section 58 for the purpose of prevention or detection of crime remedying of unlawful or serious improper conduct or dishonesty or malpractice
3. Section 59 for health purposes
4. Section 60B for legal proceedings authorized by Hong Kong law or in connection with any legal proceedings in Hong Kong
5. Section 61 for activity of news business in the public interest
6. Section 62 for statistics and research which does not identify the data subjects
7. Section 63B  for due diligence exercises
8. Section 63C for emergency life threatening situations or rescue operations

It should be noted that if an organization relies on one of the specific exemptions above then the onus is on the personal data user (the organization) to prove, if challenged, that the exemption applies and that they were not bound under the Ordinance to follow its' requirements.  In this context an examination of the definition in the Ordinance 63B seems to make it clear integrity checking of individuals is not included, i.e. due diligence exercise is defined only as:

“In relation to a proposed business transaction, means the examination of the subject matter of the transaction to enable a party to decide whether to proceed with the transaction.”

In the author’s view no specific exemption applies to the use of personal data by an organization undertaking integrity due diligence on persons, therefore it is incumbent on the organization to obtain the proper authority under the Ordinance to use personal data it wishes to collect either itself or through its agents.

This can be achieved by ensuring that the consent of each key individual to be integrity checked provides a written consent to the data user who intends to use personal data obtained from the public domain.  In obtaining the written consent of the subject(s) a full explanation should be given on the intention to obtain their personal information from a variety of sources, including the public domain.

Disclaimer:  Before undertaking integrity due diligence investigations requiring the use of personal data in HK every organization should seek the legal advice of internal or external counsel to ensure proper consent is obtained or a particular exemption applies.  The information contained in this article is not provided as legal advice and should not be relied on without seeking independent legal advice.

China is the second largest pharmaceutical market in the world

With China’s expanding personal income and the growing medical needs of its aging population, its pharmaceutical market has become the second largest in the world. IMS Health predicts that global spending on medicines will reach around USD1,300 billion by 2018, a 30% increase over the 2013 level. During 2014-18, the compound annual growth rate (CAGR) on medicines spending will be 4% to 7%. China had a spending level of USD77.2 billion in 2012, which accounted for 8% of global medicines spending. It is forecasted that China’s spending level will reach USD155-185 billion in 2018, which would be the highest among emerging pharmaceutical markets. The key drivers for growth will be healthcare infrastructure improvements, increased access to medicines, and increases in the number of private hospitals.

Sales revenue of manufacturers recorded continuous growth

From 2004 to 2009, China’s pharmaceutical manufacturing industry expanded massively; the number of manufacturers increased by 44.6% to reach 6,807 in 2009. Between 2010 and 2013, the number of manufacturers decreased sharply from 7,038 in 2010 to 5,674 in 2011 and then increased in the two subsequent years to reach 6,525 in 2013. In the meantime, the value of total assets of the pharmaceutical industry increased by 71.6%. Sales revenue and profit received by manufacturers recorded continuous growth from 2011 to 2013 (figure 1), with average annual growth rates of 19.1% and 17.8% respectively. In the first three quarters of  2014, sales revenues amounted to USD264.4 billion and profits to USD25.3 billion.

The pharmaceutical industry is fragmented

The Chinese pharmaceutical industry is very fragmented. The top two pharmaceutical companies together only occupied a small portion of market share, a notable contrast to the US market. Moreover, aggregated revenues for the top 100 pharmaceutical companies only accounted for 27.1% of the industry’s total revenue. In 2013, SMEs experienced rapid growth and 6 more SMEs received USD0.81 - 1.61 billion (RMB50-100 billion) compared with 2012. Another notable observation is that some traditional Chinese medicine manufacturers, such as Guanxi Wuzhou Zhongheng (87%), Chase Sun (70.2%) and Shijiazhuang Yiling (50%), recorded significant year-on-year revenue growth.

Mengniu, Yili and Bright Dairy are Market Leaders

On basis of company sizes, market players in the Chinese dairy market can be categorized into 3 tiers. The 1st tier refers to the national players, namely, Mengniu, Yili, and Bright Dairy. The 2nd tier includes regional players, such as Beijing Sanyuan Dairy, Royal Dairy, and Yantang Dairy. The 3rd tier players focus almost solely on local markets and pose no immediate threat to players in the first two tiers. There are more than 1,500 dairy companies in China, while the number of companies with operational revenues above RMB5 million is more than 400. In 2012 the dairy industry reported sales revenue of RMB246.54 billion, the top 4 dairy companies were all domestic companies and merely accounted for around 39% of market share. Foreign dairy companies, such as Danone, Mead Johnson, and Nestle, made up more than half of the market.

The Government Drives Industry Consolidation

After the melamine incident in 2008, the Chinese government has been endeavouring to restructure the domestic dairy industry. The country is planning to create a few national dairy heavyweights that control the production of milk powder, infant formula, and raw milk, as well as a greater proportion of dairy-product processing. The “Proposal to accelerate the consolidation of milk formula industry”, jointly released by the MIIT, NDRC, MOF, and CFDA in June of 2014, proposed the establishment of 10 milk formula groups with respective annual revenue of over RMB2 billion and raising industry concentration of the top 10 domestic brands to 65% by end of 2015. Moreover, the proposal also aims to create 3 to 5 large infant milk formula groups that each have an annual revenue of more than RMB5 million, and to further increase market concentration of the top 10 domestic brands to 80% by 2018. The new policy is an extension of the “Double lifting” policy proposed in 2013.

In May of 2014, the China Food and Drug Administration released the results of a six-month review of the infant-formula industry, issuing production permits to just 82 of the 133 companies that submitted applications. The Ministry of Industry and Information Technology announced its intention to shrink the sector to 50 manufacturers by 2018. 

The raw-milk production sector is also undergoing continuous consolidation. The number of farms with a dairy herd of more than 1,000 cows increased from 5.5% in 2008 to 18% in 2013. In the meantime, the number of farms with one to four cows fell from 32.4% in 2008 to 20% in 2013.

As the dairy industry continues to consolidate, the number of deals in the industry is accelerating. In 2013, there were about 10 M&A deals, with a total value of USD3.2 billion. In first half of 2014, the industry had 15 deals, totalling more than USD2 billion. Some major recent transactions are listed in table 1.

 Why people commit fraud

Financial stress is widely recognized as one of the key reasond why people commit fraud. Some people commit fraud for other, pathological, reasons, but these are small in number and not typically the kind of fraudsters we deal with daily.

However emplyees and suppliers who have had a long and trusted relationship with you may feel added pressures when there are dark clouds on the horizon. Presently with the price of oil, coal and other minerals at recent record low, many Resouces and Energy Sector employers are looking to reduce costs to help mitigate any potential losses. Orders are down, inventories are being reduced, payment cycles are increasing; there is generally a greater level of uncertainty right now.

Your staff and suppliers may feel their position with you is threatened and start to worry about their short to medium term future. At the same time your staff and suppliers are seeking their cost of living and business costs increasing, with little they can do about it.

It is at exactly these times of economic uncertainty that your staff and suppliers will start to feel increased stress about how they will meet their own financial obligations. For many it is a lifestyle issue, for others it really is a matter of survival. Committing fraud is often seen as the only way.

Stressors 

Your staff will worry about how to pay their rent, mortgage, car lease, school fees, medical bills, a wedding perhaps and even how they will take that much longed for overseas holiday. Your suppliers will worry about how to pay their own staff, rent, creditors as well as their personal expenses which will not be reducted at all. These stresses can cause otherwise logical, and dishonest decisions.

Rationalization

In this environment it is much easier for people to "rationalize" their actions should they feel the need to commit fraud. Those under financial stress may consider that their need is greater than yours. They may start out "borrowing" some money with the faint intention of "repaying" it at a later time. They may be so desperate to maintain their current lifestyle that this is their only rationalization. They may feel they are entitled to this money given how long they have worked for you and how important they see themselves in the success of the organisation. You know who all these people are in your organization already.

Controls

In times of financial stress companies often reduce headcount, primarily as a cost saving mesure. However this also increases the workload and responsibility of those who remain. This has the unintended consequence of removing some formal and informal internal control and surveillance capacity. Put simply, less people doing more work have no time to worry about what anyone else is doing.

Countermeasures

The good news is that there is much you can do to mitigate the potential for fraud. Below is a short list of possible countermeasures that you can implement.

・Fraud awareness / training allows staff be aware of what to look for

・Whistleblowing system give staff and suppliers a change to report concerns

・Fraud risk reviews identify potential "hot-spots"

・Forensic Analytic reviews identify anomalous transactions or payments

・ Supplier/Vendor audits identify potential conflicts of interest

Advice

Censere has many years of experience advising clients across the Asia Pacific region on such matters. our subject matter experts are located across Asia, including in Indonesia, Singapore, Thailand, Hong Kong and China. we will be pleased to come and discuss your specific or potential issues with you, without obligation.