1Why Chinese stocks leave US investors vulnerable
By PAUL WISEMAN and MARCY GORDON 21 hours ago
WASHINGTON (AP) — Something about the deal smelled fishy.
China Marine Food Group Ltd., a Chinese company then on the New York Stock
Exchange, spent $27 million in January 2010 to acquire a firm whose main
asset was "algae-based drink know-how." The weird thing: Three months
earlier, the beverage formula had been valued below $8,800.
But when the U.S. Securities and Exchange Commission tried to review the
deal, it got nowhere. The company's Chinese accounting firm refused to
provide documents. And the SEC has been stymied since.
And China Marine? Its share price topped $8 in 2010. It's now around 12
The case represents a cautionary tale for investors eager to invest in
Chinese companies on American exchanges. Chinese companies like Alibaba,
whose initial public offering this year set a record high, operate under lax
standards compared with other stocks on U.S. exchanges. That means higher
risks for investors.
Worries about the risks of Chinese stocks also emerged from a recent
Associated Press investigation of Tianhe Chemicals Group Ltd. When that
Chinese company went public in June, the U.S. investment banking powerhouse
Morgan Stanley helped it raise $654 million from foreign investors. But
Tianhe's stock has lost 39 percent since allegations emerged that it had
exaggerated the value of its business.
"The protections that are often taken for granted are just not there," says
Joseph Carcello, an accounting professor at the University of Tennessee.
More than 100 Chinese companies were suspended or kicked off U.S. exchanges
in 2011 and 2012, most of them for failing to file timely financial reports.
These companies, including China Marine, had exploited a legal loophole so
they could merge with American shell companies. By doing so, they elude much
of the SEC oversight that comes from selling shares on U.S. markets for the
About two dozen of these companies have also been hit with SEC fraud or
accounting charges. Yet the investigations have stalled because the
companies' audit papers are in China — beyond the SEC's reach.
There are currently about 100 Chinese companies trading on the NYSE and the
Nasdaq Stock Market.
China restricts foreign investment in some businesses. To bypass that hurdle
, Alibaba and many other Chinese companies deploy a structure called a "
variable interest entity" or VIE.
It works like this: The company listed on the U.S. exchange isn't the actual
Chinese company. Rather, it's a holding company, typically based in a tax
haven like the Cayman Islands. Foreign investors have no say in the company'
As a result, Chinese managers can restructure a company in ways that
threaten investors. Alibaba CEO Jack Ma, for instance, spun off Alibaba's
payment service into a company he controlled without telling Yahoo, a major
investor in Alibaba.
The VIEs are also legally dubious in China. In 2011, a Chinese panel
rejected a contract between Taiwan-based GigaMedia and a Chinese gambling
business that GigaMedia thought it controlled through a VIE. The manager of
the gambling business had seized documents required to operate in China. And
GigaMedia could do nothing.
In 2012, China's Supreme People's Court threw out contracts a Hong Kong
businesswoman had used to dodge Chinese rules to invest in a Chinese bank.
It cited agreements that "conceal illegal intentions."
Beijing could invoke similar reasoning to one day ban all VIEs, potentially
imposing huge losses on American and other foreign investors, analysts say.
China bars U.S. inspectors from audits done by Chinese accounting firms —
in order, it says, to protect its state secrets. This means most Chinese
stocks on U.S. exchanges don't comply with American law.
"It's a very serious problem," says James Doty, chairman of the Public
Company Oversight Accounting Board.
Experts say Beijing likely fears the documents would confirm suspicions that
Chinese companies are delinquent on loans from state-owned banks or are
involved in corruption. Its stance has hobbled U.S. investigations of stock
Consider the China Marine case. Shares in the snack and beverage firm began
trading on U.S. markets in 2007. U.S. investigators grew suspicious over
China Marine's $27 million purchase of most of a company that was built
around a drink formula it had bought a year earlier for just $8,776.
Had China Marine's accounting firm reviewed the deal? If so, had it
determined the value of the acquisition?
Problem was, the accounting firm wouldn't turn over the papers. And China
Marine's stock price plunged.
Two years ago, the SEC sued the China affiliates of the Big Five accounting
firms, saying U.S. law required them to provide the documents. In January,
an SEC administrative law judge agreed and barred the firms from auditing U.
The accounting oversight board is pursuing a deal with China to obtain the
audits, an effort that Doty has made a high priority. Without a deal, more
Chinese companies could be forced off U.S. markets. And more investors would
Many analysts doubt it will come to that. Chinese companies want access to
American capital. And American investment firms and stock exchanges want the
fees they earn when Chinese stocks list on U.S. exchanges.
In the meantime, the stocks trade on American markets without offering
investors the protections they're supposed to enjoy.
For now, warns Dartmouth University finance professor Anant Sundaram,
Chinese stocks aren't safe: "I would not invest in those stocks. Period."
this is just tip of the iceberg
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