SEC Increasing Pressure on Chinese Auditors. First Step going after Chinese Companies Listed in the U.S.?

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We have previously on numerous occasions written about the issues with Chinese companies listed in the U.S., and the massive risk faced by U.S. investors. We noted in September Senator Marco Rubio saying;

It’s outrageous that the Chinese government shields China-based companies operating in the United States from complying with American laws. If China-based companies want to list on stock exchanges or access capital markets in the United States, we should make them comply with American laws. If they will not, we should delist China-based companies from American stock exchanges.”

Now it appears SEC are stepping up their oversight.  On Friday they announced that they are going to increase pressure on the Chinese to be allowed to inspect auditors in China that audit Chinese companies listed in the U.S. WSJ writes;

The U.S. Securities and Exchange Commission said Friday that, despite several years of talks with its Chinese counterparts, regulators still face obstacles to getting information needed for accounting investigations and inspections of China-based auditors.   

SEC chairman Jay Clayton noted in a statement;

China’s state security laws are invoked at times to limit U.S. regulators’ ability to oversee the financial reporting of U.S.-listed, China-based companies,” the SEC said in a joint statement with the Public Company Accounting Oversight Board. “The inability to date to achieve this level of regulatory cooperation with Chinese authorities raises a number of investor protection and general oversight issues.”

There are 224 Chinese companies listed the U.S. with a total market capitalization of $1.8trillion were Chinese authorities have blocked inspections of their financial audits. Some of the U.S. listed Chinese companies include Alibaba (BABA US), Baidu (BIDU US) Tencent (TCEHY US), JD.Com (JD US), SINA (SINA US) and Momo (MOMO US). These are some of the biggest companies in the world. Some of them such as Alibaba has faced criticism for example from famous short sellers such as MuddyWaters questioning their accounting;

Entertaining and coherent dissection of how obviously fake $BABA‘s numbers are. Points out Singles Day claimed GMV exceeds ANNUAL rev of Sears/K-mart.

This comes back of more than dozens of Chinese companies being delisted in 2011/2012 due to various forms accounting irregularities. Back in 2012 Public Company Accounting Oversight Board noted in a speech;

“Billions of dollars of market capitalization of such companies have been lost in U.S. securities markets and it is fair to say that all of these smaller China-based companies listed on U.S. securities exchanges have suffered serious losses of both market value and investor confidence as a result of the problems of other companies,” said Lew Ferguson, board member of the Public Company Accounting Oversight Board, the audit industry regulator

It would appear less likely that China would budge on allowing inspections, considering the current geopolitical situation. If that is the case, as a next step SEC could potentially move towards taking steps noting the risk of delisting of Chinese companies the U.S. This would be detrimental for the whole market, especially U.S. shareholders of these companies. As we have mentioned earlier it could be difficult for U.S. shareholders recoup their capital due to the Chinese companies’ VIE structure.    

 

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