The Real U.S. - China Problem
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The Real U.S. - China Problem


As 2012 draws to a close, two imminent issues hang over the world economy. The better known one is the so called fiscal cliff, which could result in simultaneous reductions in government spending and increases in taxes in the United States. The second lesser reported issue is the ongoing clash between the U.S. Securities & Exchange Commission (SEC) and the China Securities Regulatory Commission (CSRC), with the Chinese affiliates of the “Big 4” auditing firms PricewaterhouseCoopers (PwC), Deloitte, Ernst &Young (E&Y) and KPMG trapped in the middle, along with their clients.  While some suggest that Chinese firms should no longer bother trading on tightly regulated U.S. markets, the problem is actually much deeper, with similar cases pending in Hong Kong, and the overall implications painting a picture that investors in Shanghai and Shenzhen should be wary of too.

To briefly summarize events up until now: two years ago “short-seller” research firms, such as Carson Block’s Muddy Waters or Citron Research, started investigating U.S. / Canada -listed Chinese companies for fraud or inaccurate financial statements/reporting.  Teams of investigators travelled across China talking to the companies’ suppliers, customers, current and former staff, as well as examining public records, related filings and presence in relevant markets.  If the investigations suggested issues or problems with the accounts and filings, then these firms would “short” the stock (by borrowing the shares and immediately selling them), and then publish their research for free, profiting as market participants digested the data and then sold down their holdings. 

Investors in the U.S. and Canada lost billions of dollars as several such companies were found to be deceiving investors in one way or another and their share prices collapsed.  Chinese accounting and reporting standards are still sometimes lacking. Although some big name firms which have listed in Hong Kong, New York or London have trusted financial statements, there are numerous difficulties within other companies. In China one joke goes that firms keep three sets of records; one for the tax collectors, one for the investors and the real ones for the managers’ use only.  Rumors of corruption, fraud and deception are frequently confirmed.

As Chinese firms’ reputations became increasingly damaged, short sellers began reporting official harassment as they tried to carry out their research.  What should have been public records were suddenly less available; researchers were prevented from doing their work, and in one case allegedly detained.  Carson Block reported being informed of a “state-backed” attempt to access his Gmail account.  Meanwhile, foreign media organizations, including Bloomberg and then the New York Times, published sensitive in-depth reports detailing the huge wealth that had been amassed by some of the Chinese Communist Party’s leading figures based in part on publically available records, which did not help the air of difficulty surrounding access to information.  

December 29, 2012 at 00:00

Yes they should clean their own house…these Chinese firms are listed in the US…therefore are in the US house. Glad we agree JC.  Extra-territoriality shouldn't apply.  If a foreign firm were to list in Shanghai, they should follow CSRC standards, do you agree? If a foreign firm with state secrets were to list in Shanghai and then refuse to hand over its accounts to the CSRC, should the CSRC make an exception just because the firm is foreign?  This is so obvious it is ridiculous there is even a discussion.  If an individual went abroad and failed to follow the law, should they be let off, or should there be an exception made for them as they are foreign? Obviously not.  Why should a company be any different…
US markets are regulated by US regulators. Anyone listed there must follow the regulations and obey the regulators.  The regulators are mandated and empowered BY LAW to do their job.  If anyone has a complaint, there are channels and means to appeal and discuss. THe law is the law though. 
Chinese markets are regulated by Chinese regulators. Anyone listed there must follow the regulations and obey the regulators. The regulators are mandated and empowered BY LAW to do their job. If anyone has a complaint, there are channels and means to appeal and discuss.  The law is the law though.
Really really simple.

December 28, 2012 at 23:50

So your point…John Chan…is that if one fails at ones job the first time, then one should just give up and not do anything…interesting…
Pointing out that the SEC has the authority to do what they are doing (which is a fact under US law) is not the same as defending them. China should be happy to benefit from better accounting standards which are sorely lacking in China. Just as China benefited from better food safety, electrical safety, airline safety and countless other standards brought in from abroad.  All this defensiveness on some peoples' part is silly. If there is nothing to hide…don't hide it. If there are state secrets in play…then probably better not to list abroad where they will be compromised.  Delist and move home to Shanghai or Shenzhen. It is not anything to get angry about.  Given reports of reporting issues in China then there is bound to be scrutiny…only the guilty have anything to hide, unless there are real state secrets in play. Although Huiyuan Juice was found to be a strategic industry, I can't see how some of the firms being pursued by the SEC are even that close to compromising China's security…how insecure can China be? I can understand big Oil or Chemical or Hi-tech firms being considered sensitive…others though…
So again, if state secrets are such a big thing, move home and list at home. If the amount of advertising space controlled by a media firm on buses in China is a state secret, delist and move home!  Otherwise, follow the laws where you list. Simple, and nothing to get angry or upset about

John Chan
December 25, 2012 at 03:58

Explaining away incompetency for the SEC? Backdoor listings or reverse mergers have existed as long as stock exchanges, their detrimental effect to investors is well known, why hasn’t the ESC yet set up gateways to safeguard the investors?
If the SEC is serious about protecting investors, it should padlock anyone behaves dubiously and unscrupulously. Asking is a slap on the wrist.
The ESC is mandated to vanguard the investors, investigating after the house is burnt down is not van guarding; “better late than never” is the most shameless excuse to gloss over one’s incompetence.

December 22, 2012 at 10:14

Woooo. JC, don't get too excited. There are short sellers in China too (Chinese ones), even if there are ridiculous regulatory restrictions making it harder to short than long (a mistake common in many markets).  Also you are again slightly wrong, we don't call it going short just when you sell something. In financial vocab, going short is specifically borrowing an asset and selling, inverting the risk structure of going long.  Not all trades require a long side and a short side (i.e. pre-IPO buying in the primary market = everyone is long). Many markets exist (and have done in history) with short selling totally banned.  Someone holding an asset or security might sell even if they think the price will rise for other reasons (cash flow etc), or there may be relatively better long positions they would prefer in other securities.
You are correct that there shouldn't be a moral angle, although many would argue that banning short selling makes markets more likely to enter bubble territory, bubbles inevitably suck in people who don't understand the situation and they can lose a lot of their wealth.  If short sellers are harrassed or demonised (as has happened in China and from a group of Chinese tech CEOs in the press) then this is taking a moral position against them.  
Short sellers provide a valuable service in keeping bubbles in check, and providing an extra level of "oversight" to protect against fraud and deception. In the EU now, there are moves against them, but the opiate of stability in the "short" term is always deceptive. Short sellers (by which i mean those who borrow an asset and then sell it) take on unlimited risk (sales price to infinity) and can often lose.  If Chinese firms believe they are being unfairly targetted, they simply need to improve their transparency and filing standards, then the short sellers will be unable to create doubt.

December 22, 2012 at 10:03

John Chan….a few corrections as usual:
1 – Backdoor listings or reverse mergers means that many of the companies listed did not come under SEC scrutiny. The SEC may have missed the problems them, but it is investigating now. So to answer your question, this IS the SEC due dillgence. better late than never. Whether they dropped the ball or not before, the point is they have the authority to do what they are doing now.
2 – Yes they will ask the US investment banks. They are doing so. The difference is that the banks are not prevented from cooperation by an overlapping law. It may be partly the banks fault, or it may be that the underwriters or deal makers were misled by their clients. It doesn't really matter.  If i hire someone to list me, it is my job to make sure (legally) that I won't be put in such a position.  Otherwise there will be consequences…which is what the SEC is doing now…

John Chan
December 22, 2012 at 04:20

Hedge funds are there to make money, that’s their reason of existence. They just like the American’s imperialism “it is in the business of making profits, not in the business of charity.” Carson Block’s Muddy Water is a hedge fund.
Insider trade is a fraud and a convictable crime, it acquires stocks first then spreading news to pump up the stock for profit taking, it is also called “pump and dump;” Muddy Water is a borderline “pump and dump” operation, they short instead of long. Muddy Water short the stock first then pump bad news to depress the stock price for profit taking, but they legitimize their pumping (market manipulation) action on the moral high ground, the faired minded traders call them hypocrites.
This article simply shows how unscrupulous the West is, they can gloss over a dubious operation as white knight for the western investors (greedy lot looking for money without working for it) and slander China for the Chinese companies doing what the West does in financial market.
The revolving door practice has totally discredit SEC and other law enforcement agencies van guarding ordinary investors’ interests. Those agencies refuse to take up their responsibilities they are mandated to protect the people despite the loud calls within their own nations.
SEC’s Chinese counterpart simply refuses to let Chinese companies be the scapegoat for the SEC’s own crimes. USA better cleans its own house before pointing finger in any direction.

December 22, 2012 at 03:09

The greed in cases like this really begins from the firm that takes money from investors by misleading the investors about the firms profitability.  Whether the company gets exposed by a short selling tactic or not, the investors who believed the frms misrepresented financial data have already lost their money – simply because the firm has lied about its value and its returns are never going to eventuate.

How the short sellers are providing a service that is of benefit to the wider investment community is obvious: When the fraudulent company attempts further capital raisings the investment community will not be fooled again, because the short sellers have exposed the company's lies. Of course those that were initially fooled have lost their money, but unfortunately, they always had. However the short sellers have now saved others from making the same mistake and investment funds will now be directed to (hopefully) companies that are profitable and away from cheats such as Enron. The money to be made by short sellers provides incentive for further investigation.
Consider a world without cheating companies,  short sellers like those described in the article could not possibly exist.
You may call the short sellers greedy, but at least it is providing a service by diverting money from those who truly do not deserve it, those companies that take money from investors and through mismanagement and corruption waste it completely, where those funds could have been creating something of value to the world, rather than paying the wages of cheats. Clearly the management of those corrupt companies are the ones of true dispacable and greedy nature.
Unfortunately companies like this exist everywhere, China, the US and the rest of the world. Wherever financial information is repressed to save the corrupt companies, the distrust generated costs the whole market, good and bad alike, because investors cannot distinguish between them. So lets hope the short sellers continue to find new ways to expose cheats, so that companies that deserve funding are able to find it at a fair price!

December 22, 2012 at 01:15

Haha. Yes. Push a bit harder! Go on and say what the article is hinting at!

December 22, 2012 at 01:03

Fraud is fraud wherever it happens.  We should all move away from nationalities and call a spade, a spade.  When it comes to money, some firms and some people will cheat regardless of thier nationalities.

December 22, 2012 at 01:00

It's a simple case of telling investors to beware.  In the US, all have seen the big-time fraud of Enron, WorldCom, etc. where banks and auditors colluded because of their vested interests.  Citibank was selling bonds for Enron and WorldCom, knowing full well of what was happening.  As long as nobody blows the whistle, fraudulent firms will carry on and many will go for the ride and profit from it.   What can happen in the US can happen in China.  Investors all over the world suffer the same dangers, fraud.  Whether it is the Chinese government or the American government, private investors should be careful.  Do not believe everything you read, whether it is the prospectus, auditor's reports or even the news.  

John Chan
December 21, 2012 at 13:20

Please spare us your ignorance in following counts.
1. All Chinese companies listed on the US stock exchanges have to be approved by the SEC before their stocks can be traded on the US stock exchanges. If there are problems with those companies, you should ask the SEC where its due diligence is.
2. The Chinese companies were unable to do the listing themselves, all their listings were done by the US investment banks on the Wall St., accounting consultants and legal firms with lucrative fees. If there are problems with those Chinese companies, you should ask the US firms how come?
3. You should not take this article at face value and bashing China blindly, this article is a classic work of the graduate of Dick Cheney School of Imperialism, mixing fabrication with some facts and produce a piece convincingly true of propaganda to increase its effectiveness of China bashing.

John Chan
December 21, 2012 at 12:39

@Leonard R,
It seems you are a complete financial illiterate; a trade only can take place with two sides, one side for long and one side for short. If the market goes down the short side wins and the long side loses, and vise versa; it is as natural as breathing air. Greed gets people into trade regardless one is on the long side or the short side, there is totally void of morality. The winning side no need and does not take pity on the losing side, sometimes the winning side brags on the blood of the victims on the moral high ground. This is the face of capitalist’s trading world, it is pure and simple.
50% of people long and 50% of people short, your praise of the short-sellers is totally misguided, wrong-headed, bias and illogical, no wonder you are a member of anti-China clique like all the anti-China bloggers on this site, they are misguided, wrong-headed, bigotry, illogical and sometimes racist.
If the anti-China clique gets into market, they will be slaughtered by the elite of the western capitalist world in no time.

December 21, 2012 at 01:29

The daughter is stupid and so is the mother :p
We the people of the world(not us) are fake and the brands, records, relations, documents and all sundry, if they’re fake can flourish well, if not, then its market is in paradise

December 19, 2012 at 15:31

The urgency due fiscal deficit leads to many extortions by US and netting in billion $$$ from foreign institutions. 
No such luck! China is telling the US SEC to mind it's language.

December 19, 2012 at 06:38

Well, I am not surprised at all by the ongoing clash between Chinese companies and SEC in the U.S. What do you expect? The Chinese companies can manufacture fake products of all world class name brands, such as Gucci, Armani, Louis Vuitton, Rolex, etc. So they can easily fabricate their financial records to get listed on the New York or Hong Kong Stock Exchanges. Chinese companies should be banned en mass from listing on New York and Hong Kong and all other Stock Exchanges. They are simply not reliable and they are in their to deceive.

John LaChance
December 19, 2012 at 02:37

Is it me, or did this article raise the spectre of a great story nearly to the limits of a possible climax then end much too soon for a satisfying resolution?  Nasty, unsatisfying sex. 

Ed Webster
December 19, 2012 at 01:18

Very interesting. Is there any news on China High Precision? Is there a case currently underway between them and the HK Commission?

Leonard R.
December 18, 2012 at 14:04

I never thought I would admire short-sellers for their integrity and courage. But Mr. Parker's article made it happen. Hooray for short-sellers!  
I don't see this as a problem. I see it as an opportunity. Now US investors are more aware of the dangers of doing business with China. That's a good thing. 

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