Buying Stock in China’s Publicly Traded Companies: Good Luck With That

I am an international lawyer, not an investment advisor or a stock analyst. So when I tell you that I have never invested in a publicly traded Chinese company and I cannot see myself ever investing in a publicly traded Chinese company, you should completely ignore me and not change your behavior in any respect.

What has spurred this post is a China Accounting Blog post by Paul Gillis, who knows more about China accounting practices than pretty much anybody. Paul’s post cites to and agrees with a blog post, The SEC Has Done an Amazing Job Protecting Chinese Investors – Will China Return the Favor?, bemoaning how the United States Security Exchange Commission (SEC) protects Chinese investors from getting ripped off in EB-5 investor scams, but does almost nothing to protect US investors from getting ripped off by Chinese stocks:

As David points out, the only CEO jailed for defrauding US investors was Dickson Lee of L&L Energy. Lee, however, was a US citizen and was arrested on US soil, so Chinese authorities could not protect him.

Perhaps the most egregious case was Ming Zhao of Puda Coal, who faces a $250 million judgment from the SEC for ripping off U.S. shareholders. Chinese authorities have not helped the SEC to enforce the judgment, and instead elevated Ming Zhao to the Eleventh Standing Committee of the Chinese People’s Consultative Congress. I guess he is viewed as a model comrade.

Now we have ZTE, which was recently accused of circumventing export restrictions by selling products with sensitive American technologies to Iran, despite having agreed to the export restrictions. The US actions likely make it difficult for American companies to serve as suppliers to ZTE. China has screamed foul, saying the US actions would severely affect the normal operations of Chinese companies.

There was also the recent case where Bank of China’s New York branch refused to comply with a US court order to turn over customer information related to a counterfeiting case.

Gillis sees Chinese regulators as “protecting Chinese fraudsters and thereby creating a safe harbor for those who wish to commit fraud against US investors.” Gillis notes how “China has shown no interest in prosecuting Chinese fraudsters for crimes committed in China that are clearly crimes in China, apparently on the basis that victims of the crimes were not Chinese. And US regulators have had little success in getting cooperation from Chinese regulators at bringing the fraudsters to justice in the United States.” This is so true and to a large extent it nicely sums up China’s attitude towards the rest of the world on many fronts.

But if the US started getting tough with China stock fraudsters, Gillis believes we would start seeing results:

The SEC and PCAOB should take a lesson from the Bank of China case. When the pain was great enough, China backed down and produced the documents. The SEC got a partial victory against the Big Four accounting firms in China when it threatened to ban them because China would not allow the production of documents. I believe that if the SEC/PCAOB can make a credible threat that they will kick Chinese companies off US exchanges they can get China to prosecute fraudsters who rip off US shareholders, to help recover funds, and to properly regulate auditors and listed companies.

It is very easy for Chinese companies to engage in stock fraud without repercussions, and our China attorneys see this all the time. If you are buying most Chinese stocks, you are on your own. And that (plus the fact that we rarely see a Chinese company with fewer than three sets of books) is why I have never bought and will never buy Chinese company stocks.

Your thoughts?