CHINA: An Opportunity for Wall St. in China's Surveillance Boom

Li Runsen, the powerful technology director of China's ministry of public security, is best known for leading Project Golden Shield, China's intensive effort to strengthen police control over the Internet.

But last month Mr. Li took an additional title: director for China Security and Surveillance Technology, a fast-growing company that installs and sometimes operates surveillance systems for Chinese police agencies, jails and banks, among other customers. The company has just been approved for a listing on the New York Stock Exchange.

The company's listing and Mr. Li's membership on its board are just the latest signs of ever-closer ties among Wall Street, surveillance companies and the Chinese government's security apparatus.

Wall Street analysts now follow the growth of companies that install surveillance systems providing Chinese police stations with 24-hour video feeds from nearby Internet cafes. Hedge fund money from the United States has paid for the development of not just better video cameras, but face-recognition software and even newer behavior-recognition software designed to spot the beginnings of a street protest and notify police.

Now, the ties between China's surveillance sector and American capital markets are starting to draw Washington's attention.

Rep. Tom Lantos, the California Democrat who is chairman of the House Foreign Affairs Committee, said he was disturbed by a recent report in The New York Times about the development of surveillance systems in China by another company, China Public Security Technology, which, like China Security and Surveillance, incorporated itself in the United States to make it easier to sell shares to Western investors.

Mr. Lantos called American involvement in the Chinese surveillance industry "an absolutely incredible phenomenon of extreme corporate irresponsibility."

He said he planned to broaden an existing investigation into "the cooperation of American companies in the Chinese police state."

Executives of Chinese surveillance companies say they are helping their government reduce street crime, preserve social stability and prevent terrorism. They note that London has a more sophisticated surveillance system, although the Chinese system will soon be far more extensive.

Wall Street executives also defend the industry as necessary to keep the peace at a time of rapid change in China. They point out that New York has begun experimenting with surveillance cameras in Lower Manhattan and other areas of the city, and that corporations make broad use of surveillance cameras in places like convenience stores and automated teller machines.

"Is New York a police state?" said Peter Siris, the managing director of Guerrilla Capital and Hua-Mei 21st Century, two Manhattan hedge funds that were among the earliest investors in China Security and Surveillance.

Mr. Lantos and human rights advocates contend that surveillance in China poses different issues from surveillance in the West because China is a one-party state where government officials can exercise power with few legal restraints.

Mr. Lantos is part of a Democratic Congressional majority that is increasingly eager to confront China at a time of high Chinese trade surpluses and considerable economic insecurity in the United States. He is also a longtime ally of Nancy Pelosi, the speaker of the House and a fellow Californian, who made her reputation in Congress as a critic of China on human rights issues.

A White House spokesman, Tony Fratto said the White House would not comment on specific companies, adding, "It's not appropriate to interfere in the private decisions of Americans to invest in legally incorporated firms."

The New York Stock Exchange said that it had no comment except to confirm that China Security and Surveillance was expected to list on the exchange "later this year, subject to the usual conditions, including approval by the S.E.C."

Because the company already has shares traded in the United States and is not selling any additional shares, Securities and Exchange Commission regulations say approval is automatic once the company fills out a notification form and the New York Stock Exchange confirms it has approved the listing.

Over the last year, American hedge funds have put more than $150 million into Chinese surveillance companies.

The Chinese government trade association for surveillance companies, which also regulates the industry, predicts that the surveillance market here will expand to more than $43.1 billion by 2010, compared with less than $500 million in 2003. Under the Safe Cities program adopted by the government last winter, 660 cities are starting work on high-tech surveillance systems.

Many Western experts, skeptical that China faces a terrorism threat, have suggested that the government may be using it as an excuse for tougher policies toward ethnic minorities in western China, notably Xinjiang Province, and toward Tibet.

Terence Yap, the vice chairman and chief financial officer of China Security and Surveillance Technology, said his company's software made it possible for security cameras to count the number of people in crosswalks and alert the police if a crowd forms at an unusual hour, a possible sign of an unsanctioned protest.Mr. Yap said terrorism concerns did exist. His company has outfitted rail stations and government buildings in Tibet with surveillance systems.

Mr. Yap and Lin Jiang Huai, the chairman and chief executive of China Public Security, said that their companies did not do business with the Chinese military and should not raise concerns in the United States. They also said their businesses used technology developed in China and were therefore not subject to United States export controls.

China Security and Surveillance has been aggressively raising money in the United States, including $110 million in convertible loans so far this year from the Citadel Group, a big hedge fund in Chicago. In the last 18 months, the company has used the money to acquire or make a deal to buy 10 of the 50 largest surveillance companies in China.

James Mulvenon, the director of the Center for Intelligence Research and Analysis, which does classified analyses of foreign military and intelligence programs for the Pentagon and other government agencies, said that Beijing clearly wanted the company to consolidate the industry.

"They're really sort of the Ministry of Public Security's national champion," Mr. Mulvenon said of China Security and Surveillance. "In terms of the gear and building the surveillance society, they are the ones."

After the company announced sharply higher sales and profit on Aug. 13, a succession of American hedge fund managers and investment bank analysts took turns on a conference call questioning and congratulating Mr. Yap.

Traded on the over-the-counter bulletin board market while waiting for the beginning of trading on the New York Stock Exchange, the company has raised almost all of its money through the Citadel loans and private placements of stock with 17 institutional investors in the United States, including the Pinnacle Fund and Pinnacle China Fund in Plano, Tex., and JLF, a hedge fund based in Del Mar, Calif.

The Pinnacle funds' investments have risen six-fold in 17 months. The funds, which raise all their money in the United States, are also the main investors in China Public Security Technology, with a stake that has nearly tripled in value since February.

Barry Kitt, the founder and general partner of the funds, declined to comment. Citadel and JLF officials also declined to comment.

Each time China Security and Surveillance makes an acquisition, it holds an elaborate banquet, with dancers. The majority of the 500 or more people invited are municipal and provincial security officials, as well as executives of rival companies that may become acquisition targets.

"When they come, they hear central government officials endorsing us, they hear bankers endorsing us or supporting us, it gives us credibility," Mr. Yap said. "It's a lot of drinking, it's like a wedding banquet."

Lehman Brothers bankers and various Ministry of Public Security officials have spoken at such events, which have been held all over the country. One was at the Great Hall of the People in Beijing, where Mr. Li himself - of Project Golden Shield - addressed the crowd.

China Security and Surveillance has headquarters in Shenzhen, a high-tech manufacturing center in southeastern China, but two years ago it purchased a "shell" Delaware company with no operations but a listing on the American over-the-counter bulletin board market. It turned the Delaware company into its corporate parent.

China Public Security, also with headquarters in Shenzhen, incorporated in Florida in the same way to obtain a listing on the over-the-counter bulletin board.

China Security and Surveillance is involved in some of the most controversial areas of public security. Mr. Yap said on the conference call with Wall Street analysts and hedge fund managers in August that one of the company's growth areas involved surveillance systems for Internet cafes; the government is trying to clamp down on users of the cafes in order to discourage pornography and prostitution.

Critics say the surveillance is aimed at catching democracy advocates, Falun Gong adherents and others the Communist Party regards as threatening, noting that rules for nightclubs are less rigorous, and do not require live feeds to police stations.

Mr. Yap said investment firms from Europe, the United States and Asia were so enthused about the surveillance market in China that he typically led a full-day tour each week to some of the company's factories and installations.

At an aging Shenzhen police station, where the scuffed and peeling yellow walls look as though they have not been painted since the Cultural Revolution, a $100,000 bank of new video screens behind the duty officer's desk shows scenes from nearby streets. In another neighborhood, the company has installed a $1 million system.

Many of the surveillance cameras are still assembled at a modest factory. But the company has used $20 million of the cash it raised in the United States to acquire a large industrial park with six just-completed factory buildings and six dormitories.

In Shenzhen, white poles resembling street lights now line the roads every block or two, ready to be fitted with cameras. In a nondescript building linked to nearby street cameras, a desktop computer displayed streaming video images from outside and drew a green square around each face to check it against a "blacklist." Since China lacks national or even regional digitized databases of troublemakers' photos, Mr. Yap said municipal or neighborhood officials compile their own blacklists.

To show off his systems, Mr. Yap strode across a nearby plaza flanked by apartment towers and a low-rise shopping area, pointing out tiny unobtrusive domes and tubes attached to various poles. "See, there's a camera on the lamp pole, and another one over there and another one here," he said. "Big Brother is watching you."

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