‘They’d Find Fraud, Fraud, Fraud.’
Geo-political aggression is not the only place in which China is making waves. In recent years, several global investors have lost their shirts investing in Chinese companies not due to Covid-19 nor due to the economic slowdown but largely due to fraud. That in turn has spawned a cottage industry in America – experts who are now specialising in trying to catch fraudulent Chinese companies. One such expert is Hindenburg Research:
“Ideanomics, which is headquartered in New York but has much of its operations in China, has touted a big, recently opened sales center for electric vehicles in Qingdao, in China’s Shandong province. But in June, short sellers betting against the company alleged the sales center didn’t actually belong to Ideanomics.
The company had issued a photo of the center, but shortly thereafter short-seller Hindenburg Research unearthed a 2018 Chinese news photo that looked strikingly similar to Ideanomics’ photo. The only difference was that the “MEG” logo of the company’s Mobile Energy Global electric-vehicle operation was on a banner. Hindenburg contended that the company had doctored the photo to make it appear the sales center was its own.”
Fraudulent companies in Emerging Markets are nothing new and obviously fraud is not an issue confined to Emerging Markets alone. What makes China unique is: a) the sheer scale of its economy, now rivalled only by the US; and b) the remarkable creativity of Chinese fraudsters like Luckin Coffee which admitted to $310mn fraud in April; and c) the hardline stance Chinese authorities take against critics of Chinese companies including throwing such people into jail when they visit China. In light of the anti-China sentiment building up in America (and in India), it seems inevitable that there will be regulatory intervention:
“The Securities and Exchange Commission has ramped up its warnings to investors about the risks of investing in Chinese companies. And in May, the U.S. Senate passed a bill aimed at tackling a key part of the problem: China’s refusal to allow U.S. regulators to scrutinize the work of audit firms that vet the finances of many Chinese companies…
Even when the SEC does sue a Chinese company and prevails in court, it’s often hard to enforce its judgment and collect what’s owed. Some Chinese companies and executives have “gone dark” — surrendering their U.S. listing, ignoring their U.S. investors, and retreating into China, where it’s hard for U.S. regulators to find them.
If the SEC can’t reach a settlement, “it’s incredibly difficult” for it to enforce a U.S. court judgment against a Chinese company, said Stephanie Avakian, the SEC’s enforcement co-director…
…Twice in the past 19 months, the commission has warned of the risks of investing in Chinese companies. In April, the SEC said there is “substantially greater risk” of incomplete or misleading disclosures in many emerging markets, including China. U.S. authorities face “significant legal and other obstacles” in obtaining information and “substantial difficulties” in bringing actions against companies.”
The article then goes on to list some of the more outrageous frauds perpetrated by ingenious Chinese companies on hapless American investors:
“Some of the more eyebrow-raising schemes, according to regulators: Universal Travel gave its auditor an address for a purported hotel customer of the company’s that turned out to be a public restroom. AgFeed Industries, an animal-feed and hog-production company, inflated its revenues by claiming sales of hogs that didn’t exist, and later tried to cover up the fraud by claiming the fake hogs had died. The CEO of TV ad-network company China MediaExpress offered a $1.5 million bribe to an outside accountant helping to look into the company’s finances. (The accountant declined.)… The Wall Street Journal reported Luckin had inflated its revenue by selling vouchers for tens of millions of cups of coffee, many of them to companies that had ties to the company’s chairman and controlling shareholder…”
As Marcellus’ clients know, accounting quality in India is not exactly a bed of roses but where India can steal a march on China is by allowing investors – local & foreign – to hold Indian fraudsters accountable for their actions, something that the Chinese authorities seem to be reluctant to do.