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ICG Risk Blog - [ Physicians, heal thyselves: The Big Four accountancies are setting up as targets for Intellectual Property (IP) theft ]

Physicians, heal thyselves: The Big Four accountancies are setting up as targets for Intellectual Property (IP) theft

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If the Big Four are, as I believe, headed in the direction of becoming a lost cause, what is a corporate SEC-regulated IP-dependent client to do in the age of Sarbanes Oxley? Even when clients are independently building up a credible IP protection program, where do you draw the line on Big Four access to the IP upon which future revenue depends? There may be a remarkable opportunity for second tier accountancies not yet compromised, such as an IP-focused exposure or assessment program (which implies that they will per force have to have their own means of protection in place). With all of that in place, however, they could go in and assess Big Four clients, establish IP-driven carve-outs for business critical valuations and position themselves in a new market space. Even knowing what has been compromised, although painful for boards to face, can staunch an IP hemorrhage as well as evolve into a tool for the allocation of suitably-valued IP protective measures.

RSM McGladrey, Grant Thornton, and BDO Seidman, this is your moment. Where in the market are you?

Previous: Persistent limitations and deficiencies among the 'guardian class' of business advisors charged with protecting their clients' interests in China

And he said unto them, Ye will surely say unto me this proverb, Physician, heal thyself: whatsoever we have heard done in Capernaum, do also here in thy country. Luke 4.23

What was good for a small walled village in ancient Galilee, not to mention for Euripides, Aeschylus, Homer and Ovid, is good for businesses today, especially those who aspire to shepherd businesses for clients.

We predict that the Big Four accountancies, PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young and KPMG are now, and will continue to be, sustained targets for Intellectual Property (IP) harvesting by Chinese aspirants to this coveted market space - and they will be targets not just within the confines of China.

If a reader is taken aback, the questions he or she might ask are, "How can it not be?" "How could the highly profitable, strategic services sector be impervious to what is occurring in the manufacturing and R&D sectors?" By now, a client should be asking, "What happens to all the client data above and beyond the business processes of a Big Four member?" We suspect not.

The realization crystallized as three items crossed our desks, two from the FT's Barney Jopson, China to promote rivals to ‘big four’ and Big four firms plan boost to China staff, and China Business Services flagging the former FT item along with circulating an anti-monopoly draft, Draft Anti-Monopoly Law Approved. Frankly, we should have seen it sooner but coming on the heels of a renewed investigation of Intellectual Property (IP) threats, the implications leapt off the page.

Having previously discussed the difficulties that firms such as management consultancies and accountancies have in preventing IP loss under the best of circumstances, we then dug deeper into their lack of actionable processes for IP protective measures for their clients. I remembered earlier comments by partners at these firms over the near impossibility of rolling out a uniform policy to each office and partner. (The subject was not IP, just the generic process of gaining partner-wide agreement to promulgate a process, design it, approve it and test for compliance across a dispersed network.)

I realized that a historical advantage that many of these decentralized firms in what we may call the "guardian community" becomes a disadvantage in exercising a commitment to a global process rollout and, in fact, leaves them in a far worse condition than their commercial clients who have a more conventional hierarchical structure. Many accountancies, management services firms and multinational professional firms employ a Swiss Verein (or association) model of organization through which independent offices have limited liability in relation to the others. An advantage of the Verein structure is that local offices are "only bound by regulators in their country" and so have great sway over the practices that they elect to employ. Add to that the undeniable profit motive of each office to do 'what sells,' and you have a tenuous ability to roll out a globally effective IP protection plan.

I believe that the Chinese perceive finance and accounting as a strategic asset, at least on par with, say, automotive manufacturing. Just as in automotive, China is "determined also to promote the development of powerful domestic companies in strategic industries, ranging from manufacturing to finance, telling the local champions they should seek to "go global" as soon as they are strong enough."

The Big Four have commenced what amounts to unofficial, uncontrolled joint ventures with the Chinese state. The experience of US and EU automotive OEMs that pursued a far more controlled JV path is well known:

The big four have sought to curry favor with officials by providing consulting and training, and seconding people to bodies such as the finance ministry and the China Securities Regulatory Commission.

Just as in the automotive JVs, these de facto strategic advisory JVs will see virtually everything in the Big Four's inventory voluntarily surrendered without accountability. This is an Intellectual Property nightmare that will only be perceived after the damage is done. Given this state of affairs, I would as a Big Four client have to consider everything transferred to China, or made accessible in China, as compromised.

Substitute electronics, sensors, chip design, automotive and aircraft production for pharmaceuticals and accounting, then consider the following:

  • The big four "are proceeding with ambitious expansion plans in China" boosting "their staff in China by more than 20 pct this year" in the face of "official discomfort over the fact that China’s biggest companies depend on the services of foreign accountants to raise capital
  • The Chinese state is encouraging the rise of ‘national champions’ in accounting "to reduce the country’s reliance on the big four international firms that monopolise the auditing of Chinese companies listed overseas"
  • Domestic Chinese accounting firms "resent the kudos and influence" of the Big Four and service what amounts to financial table scraps of the listed Hong Kong firms
  • The Ministry of Finance has begun to "call for consolidation among China’s 5,600-odd accounting firms"
  • The Ministry of Finance has called for several national champions "able to prepare and certify accounts for such large flotations" as the IPO of Bank of China (BOC), which incidentally is now audited by PricewaterhouseCoopers

In Persistent limitations and deficiencies, I noted that "firms driven offshore in [a] "flight condition" are generally destabilized, plunged into a "catch-up mode" at any cost" and tend to be irrationally hopeful about, or at least inattentive, to their exposure to IP collection efforts. "They usually quickly become an easily harvestable asset." The "frantic China hirings" by the Big Four and the go-go atmosphere, problems with corruption notwithstanding, create just such an opened condition where the only focus is market position and profit. In such an environment, active collection efforts will not be noticed.

We depart from Jopson over comments that simply do not stand given Chinese practice and performance to date in other industries:

But the chances of a credible big-four rival emerging from present-day China look remote, as the country lacks experience of international disclosure requirements, accounting rules and audit procedures… the government would not give domestic firms "special privileges or preferential treatment" and stressed it was up to companies to decide which auditors they hired. Lack of direct government support could make it more difficult for local accounting firms to compete internationally.

Christopher Cassidy's Chinese Law: Smoke and Mirrors and Dan Harris' Chinese Law: Smoke And Mirrors And Who Really Wields The Influence. are far closer to reality on the ground. Reading them is recommended. Cassidy also noted that the "vice director of the Institute of Intellectual Property Law at China University of Politics and Law [could only point] to the pragmatism of Party leaders as the driving force behind what he hopes will be an effective system for IPR protection." That is not my definition of a transparent, legal framework for IP protection.

If the Big Four are, as I believe, headed in the direction of becoming a lost cause, what is a corporate SEC-regulated IP-dependent client to do in the age of Sarbanes Oxley? Even when clients are independently building up a credible IP protection program, where do you draw the line on Big Four access to the IP upon which future revenue depends? There may be a remarkable opportunity for second tier accountancies not yet compromised, such as an IP-focused exposure or assessment program (which implies that they will per force have to have their own means of protection in place). With all of that in place, however, they could go in and assess Big Four clients, establish IP-driven carve-outs for business critical valuations and position themselves in a new market space. (Even knowing what has been compromised, although painful, can staunch an IP hemorrhage as well as evolve into a tool for the allocation of suitably-valued IP protective measures.)

RSM McGladrey, Grant Thornton, and BDO Seidman, this is your moment. Where in the market are you?

Chinese Law: Smoke And Mirrors And Who Really Wields The Influence.
Posted by Dan Harris
China Law Blog
June 13, 2006 at 04:03 PM

China set for investment revolution
Sundeep Tucker, London
The Australian - FT Business
June 13, 2006

Chinese Law: Smoke and Mirrors
by Christopher Cassidy at 8:10 PM
Asia Business Law
June 09, 2006

The Nexus of IPR and Culture in China
posted by Christopher Cassidy at 3:07 PM
Asia Business Law
June 09, 2006

China to promote rivals to ‘big four’
By Barney Jopson in Beijing
Financial Times
Published: June 8 2006 01:25 | Last updated: June 8 2006 01:25

Draft Anti-Monopoly Law Approved
China Business Services
June 8, 2006

China approves draft anti-monopoly law
By ELAINE KURTENBACH
AP
June 7, 2006 · Last updated 10:52 p.m. PT

China's bank corruption doesn't faze investors
The multi-million-dollar scandals are a footnote in the floats
Tom Mitchell and Justine Lau
The Australian-FT Business
June 05, 2006

Accounting firms plan to boost China staff by over 20 pct - report
AFX News Limited/Forbes
06.04.2006, 08:34 PM

Big four firms plan boost to China staff
By Barney Jopson in Shanghai
Financial Times
Published: June 4 2006 22:04 | Last updated: June 5 2006 05:19
Mirrored as
Big four accountants in frantic China hirings at The Australian - FT Business, June 06, 2006
Mirrored at China Daily/Foreign Media on China

Biggest law firm in China seeks help
By Clare Cheung
Bloomberg News/IHT
MAY 31, 2006

Around Asia's Markets: Bad loans dim ardor for China banks
By Michele Batchelor
Bloomberg News
APRIL 25, 2006

China, and the Story of the Malicious Foreign Takeovers
China Business Services
March 15, 2006

Gordon Housworth



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