Chinese Companies Ask Employees To Buy Their Stock, Promise To Cover Losses

Just when we thought there were no surprises left in the world's foremost incubator of "financial engineering" that is China, we got a stark lesson in never underestimating China's market manipulating ingenuity.

According to Caixin, around two dozen Chinese companies recently offered their employees a deal: buy company shares while guaranteeing that any losses would be covered.

While employees think they may be getting an unbeatable deal - who can say no when your employer promises you all the upside and no downside - the reality is that any participants in such scheme are merely locking in their fates with that of their soon to be insolvent employer, who desperately needs to raise the price of their stock to fend off collateral calls on stock-backed loans usually made by founders and other major sharehholders.

As Reuters points out, attracted by guarantees that their principal is "safe", workers have eagerly stepped up to take advantage of the "offer" even as it remains far from clear how these guarantees would work, with employees in some cases being asked to buy shares and hold them for at least 12 months. Details aside, many of the companies that resorted to this drastic stock price manipulation were quickly rewarded and saw their share prices spike.

The entire farcical episode is reminiscent of what happened in 2015 when China's stock bubble grew exponentially, then burst just as dramatically. At the time, there were similar efforts, but then it was the government appealing to major shareholders' patriotism to buy and hold shares in what Beijing said was as a battle against speculators, both domestic and foreign. This time, with the proposal centered entirely on the private sector, the motive is different and is the result of companies using their own stocks as loan collateral, a practice that according to Reuters' estimates has quadrupled in China over the past two years, and which is driven mostly by founders and major shareholders posting large batches of stock as loan collateral in recent months.

Fundamentally a ponzi scheme, this works without a glitch during rising markets but falling prices especially among small and mid-cap companies, have eroded the value of that collateral, raising the specter of forced liquidation - where lenders, often Chinese brokerages, make borrowers sell the pledged shares. Selling the stock adds more pressures on share prices, triggering a downward spiral.

Shenzhen Fenda Technology, a maker of speakers and electronic accessories, was among the first to encourage staff to buy shares one week ago. At the end of March, Xiao Fen, the company's chairman and top shareholder with a 44.5% stake, or 416.4 million shares, had put up 84% of his holding as collateral for a loan, the company said. It did not say what the loan was for. Trading in the company's shares was suspended in late December pending a reorganization, but resumed in mid-April, when the stock price slumped to near their 2015 market crash low.  Last Friday, Xiao promised any employee who bought shares in the company by June 6 and held them for at least a year would be shielded from losses.

What he did not say is that any employee who took advantage of the "generous offer" was effectively providing a bailout lifeline to the chairman. This probably should have been explained to the workers who participated in the offer simply because they saw their co-workers jump right in. "A lot of colleagues I know have bought shares. I have too," said one worker, who gave only his family name, Li. "The company is quite good and the chairman has guaranteed principal, so, of course, we're interested. I know some colleagues even bought shares with borrowed money."

Shenzhen Fenda Technology shares jumped by a tenth after the announcement, but have since edged back down.

Also last Friday, Shenzhen-listed Hunan Kaimeite Gases launched such on offer with a four-day deal. Other companies offered similar deals but for different lengths of time. Kaimeite justified the ludicrous proposal by saying its stock was - what else - "undervalued": “The company is undervalued due to recent volatile trading of the market,” according to Kaimeite Gases’ announcement, filed with the Shenzhen Stock Exchange on Friday. “The buyback plan is to boost investors’ confidence, and it’s based on our bullish view on company’s outlook."

Immediately after the buyback proposal, shares surged: Kaimeite Gases jumped by the legal daily maximum of 10% to 8.86 yuan ($1.30) last Friday. It closed at 8.98 yuan on Tuesday — the day the employee deal ended. As of May 31, the prices of shares of Kaimeite dropped 26.1% since this year’s peak of 10.94 yuan on Jan. 25.

Many others quickly piggybacked on the idea.

The price of Guangdong Biolight Meditech stock fell by a quarter this year, undercutting the value of the 14.6 million shares that its chairman Yan Jinyuan posted as collateral as of the end of the first quarter. On Monday, Yan made a promise like Fenda's Xiao, and the share price also rose.

With the idea spreading fast, about 100 notices on share buybacks were filed by companies’ major shareholders to A-share markets from June 1 to Tuesday, according to financial data provider Wind Info. By comparison, the number of notices on reducing shares stood at 26 during the same period.

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In a sign that at least someone in China is paying attention, some analysts criticized the practice as a “bailout style” buyback for struggling companies. Xu Yang, chief analyst from HuaAn Securities Co., said it is hard to argue that paying for losses is a smart move for the market over the long term. “Buyback from major shareholders usually provide support on sentiment during market downturns,” Xu said. “But this kind of buyback notice could lead to potential risks of market manipulation.”

Wu Kan, head of equity trading at Shanshan Finance, said that however well intentioned these efforts are, usually by the companies' founders or big shareholders, there is a question mark over their financial ability to make such guarantees. "It could be driven by the genuine belief that the stocks are worth investing in. But it could be a desperate move to prop up share prices to avoid margin calls," he said.

Furthermore, the promise to take any losses "isn't legally binding and largely depends on big shareholders' virtue. And you can't rule out insider trading during the process, which is why regulators are demanding better disclosure,' he added.

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Growing concerns about the lunacy of this latest ponzi scheme to manipulate stocks higher have failed to prevent gullible employees from rushing in. Sun Xishan, a sales worker at Biolight, said he missed the chance to buy stock on the day of the announcement, but would try to get in on the shares later. "I know the company well, it's in pretty good shape and its performance is growing. The chairman promised to cover losses if any, so it's hard not to be interested if one has money," Sun said, cited by Reuters, who is about to lose all the money he puts into this "guaranteed" profit scheme.

The scheme however unveils a deeper threat facing China's smaller publicly-traded companies.  If markets continue to slide, there could be a surge in margin calls on these loans, potentially triggering a vicious cycle of share selling, increasing the risk of broader financial instability. "If stock prices fall, but shareholders don't have enough capital to replenish their collateral, the pledged shares would face forced selling," said Meng Shen, director of Chanson & Co, a Beijing-based boutique investment bank.  "That would develop into a negative spiral; as the more you sell, the lower the stock price, which would then trigger more forced selling."

Of course, China has a broader issue with collateral that could endanger the health of its financial system – as discussed last week, fraudulent or "ghost" collateral, where pledged products either don't exist or are already sold or pledged to multiple lenders.

BofA strategist David Cui warned that a potential "vicious selling circle" could lead to a replay of China's mid-2015 market crash. "As the 2015 experience shows, with high leverage, a vicious selling circle can quickly develop," he said, noting a "moderate" risk of broad-based financial instability. At that point either Beijing will have to step in with another bailout, or scenes such as this one which emerged during the 2015 market rout, will become the norm once again.

Comments

techpriest tmosley Fri, 06/09/2017 - 12:06 Permalink

Obvious attempt to defraud their employees. I'd quit the second I heard something like this.

Let's say that I know a couple of Chinese employees being defrauded by their employers... as long as the boss went to a better school than the employee, they will believe pretty much anything they are told even if you can get them to admit that they are being defrauded. "Yes, they are only paying me with stock in a shell company with no activity, but they went to Harvard!"

The prestige worship is strong. Absurdly strong. Even worse than the MSM worship here, if such a thing is possible.

Too bad really, I want to talk the people involved into leaving, because when you see a con going down you have sympathy for the victim.

In reply to by tmosley

Buck Johnson youarelost Fri, 06/09/2017 - 14:37 Permalink

This is just a way for the employees to bailout or cashout the bigger stock holders of the company and leave the employees holding the bag.  This isn't going to be a repeat of 2015 this is going to be a market implosion of epic proportions.  This is or will end badly this pozi scheme and the govt. is allowing this to happen in China.  When China goes, it will be like a Tsunami across the planet. 

In reply to by youarelost

Consuelo Fri, 06/09/2017 - 11:53 Permalink

  These Chinese planes must be made pretty darn well I tell ya - they've been 'crashing' since 2008, and the little fuckers still fly...!!! Thank Gawd & Gaia I'm fully parked in $Treasuries.../s    

cheech_wizard Fri, 06/09/2017 - 11:57 Permalink

From the keeper of lists website:1. The check is in the mail.2. I'll respect you in the morning.3. I'm from your government, and I am here to help you.4. It's only a cold sore.5. You get this one, I'll pay next time.6. My wife doesn't understand me.7. Trust me, I'll take care of everything.8. Of course I love you.9. I am getting a divorce.10. Drinking? Why, no, Officer.11. I never inhaled.12. It's not the money, it's the principle of the thing.13. I never watch television except for PBS.14. ...but we can still be good friends.15. She means nothing to me.16. Dont worry, I can go another 20 miles when the gauge is on "empty."17. I gave at the office.18. Don't worry, he's never bitten anyone.19. I'll call you later.20. We'll release the upgrade by the end of the year.21. Read my lips: no new taxes22. I've never done anything like this before23. Now, I'm going to tell you the truth24. It's supposed to make that noise.25. I *love* your new _____!26. ...then take a left. You can't miss it.27. Yes, I did.28. Don't worry, it's OK -- I'm sterile.29. I won't come in your mouth.30. You can keep your doctor.New list addition:31. Buy our company stock, we will cover your losses.

OccamsCrazor Fri, 06/09/2017 - 12:08 Permalink

Chinese companies are corrupt as all fuck.  They dont give a shit about their employees, and won't ever pay back any losses.  They just want their stock falliciously propped by any means, even if it involves bankrupting employee's lives and futures.   I deal with Chinese companies and they all suck dick. They lie and deceive, and say they give you warranty, but never do, for the shit ass crap products they make.  Build your own stuff and buy US.  

rf80412 OccamsCrazor Fri, 06/09/2017 - 12:26 Permalink

They just want their stock falliciously propped by any means, even if it involves bankrupting employee's lives and futures. 

Western companies do the same thing.  Every action they take is about pumping their stock price, no matter the cost in body and soul to their employees and even no matter the cost to the long-term health of the company.

In reply to by OccamsCrazor

gregga777 Fri, 06/09/2017 - 12:08 Permalink

"At the end of March, Xiao Fen, the company's chairman and top shareholder with a 44.5% stake, or 416.4 million shares, had put up 84% of his holding as collateral for a loan, the company said. It did not say what the loan was for." It's probably for real estate in Toronto he hopes to use as a place to stash his loot.   

Kayman gregga777 Fri, 06/09/2017 - 13:11 Permalink

Canada is corrupt. Houses the Clinton Giustra anonymous foreign bribe fund. And loves enriching their top elitists via dirty money from China.Oh, and a government study says only 5% of real estate sales in Vancouver and Toronto are to foreigners.(See- "I promise not to come in you mouth" for clarification.)

In reply to by gregga777

therover Fri, 06/09/2017 - 12:16 Permalink

Lets make a bet within 3-6 months (if not already) the terms and conditions of employment are a mandatory payroll deduction into the stock plan. 

Dragon HAwk Fri, 06/09/2017 - 12:29 Permalink

Blatant red Flag,  i remember when  cough cough ( TYCO ) pulled that trick when they took over our company..  I swear the guy who gave the welcoming adress was the same one to go to Prison..

Last of the Mi… Fri, 06/09/2017 - 12:43 Permalink

Not a big deal. I remember working for a large box store here in town a few years ago. It was obvious they were going down, we couldn't get merchandise from the warehouse because vendors had cut them off. Just before the whole thing went under management was going around encouraging employees to buy stock with their retirement funds and had a form to sign to do it. Gamble 25 years of retirement away with one form. Some actually did it "to save the company". There is a sucker born every minute.