Only China can tackle its own dodgy accounting
By Martin Hutchinson
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
WASHINGTON — Serious reporting shenanigans have hammered several U.S.-listed Chinese companies — most recently Longtop Financial Technologies. However, American investors and regulators have little redress across the Pacific. They should practice healthy skepticism until China opens and polices its own markets.
Examples of the problem abound. The September 2010 resignation of Duoyuan Printing’s auditor, Deloitte Touche Tohmatsu, was followed by silence, and the company was recently delisted by the New York Stock Exchange for failing to file any reports since May 2010. The same firm just resigned as Longtop’s auditor, citing “falsity” in the company’s financial records and management interference, among other things.
There have been several reports of the overstatement of income through creation of fictitious invoices, and some of businesses that bore no relation to the extensive operations described in annual reports and Securities and Exchange Commission filings. Currently the NYSE and Nasdaq have suspended trading in 14 Chinese companies and, according to an April 27 SEC letter, 24 China-based companies had in the preceding year reported auditor resignations, accounting problems or both.
Part of the trouble has been the use of reverse mergers, where Chinese companies buy listed shell companies and thereby avoid some of the scrutiny from investors that applies to standard initial public offerings. But misdeeds appear in companies that went through regular IPOs as well.
Enthusiastic short-sellers have published reports detailing extensive alleged failings of particular companies. In some cases, these reports have relied on misreadings of SEC reports or misunderstandings of the companies’ business models. But enough have proved accurate to devastate share prices in the sector as a whole.
The problem is partly one of enforcement. Dodgy U.S. filings may cause companies to be de-listed, or allow Chinese management to buy out U.S. shareholders at knock-down prices. But malfeasance in relation to U.S. rules rarely leads to harsh penalties from the Chinese authorities. The incentives therefore exist for bad behavior.
In the long run, China needs to open its markets fully to foreign investors, establish globally accepted accounting standards and enforce them rigorously. Meanwhile, buyers should beware — and legitimate Chinese companies will find American capital harder to get.