Investors dumped the shares of Nasdaq-listed iQiyi late last week after the Chinese company announced that the U.S. Securities and Exchange Commission had initiated an investigation into it for fraud. Why do Chinese companies pillage American investors? Because American rules — more precisely, exceptions to them — essentially invite them to do so. Pictured: Yu Gong, founder and CEO of iQiyi, celebrates his company’s initial public offering in Times Square with Nasdaq CEO Adena Friedman on March 29, 2018 in New York City. (Photo by Spencer Platt/Getty Images)
Investors dumped the shares of Nasdaq-listed iQiyi late last week after the Chinese company announced that the U.S. Securities and Exchange Commission had initiated an investigation into it for fraud.
In April, short-seller Wolfpack Research accused iQiyi of inflating revenue and user numbers by double-digit margins. The “fraud,” as Wolfpack termed it, dated back before iQiyi’s initial public offering in March 2018.
iQiyi, known as the “Netflix of China,” is no fly-by-night operation. It is owned by blue-chip Baidu, “China’s Google.”
The iQiyi scandal follows a series of Chinese frauds, most notably Luckin Coffee, which admitted fabricating sales and was delisted from Nasdaq at the end of June.
Want someone to blame? Of course, you should be angry at dishonest Chinese company execs, but rapacious Wall Street dealmakers and complicit American regulators deserve the tar and feather too.
Why do Chinese companies pillage American investors? Because American rules — more precisely, exceptions to them — essentially invite them to do so.
American officials boast that their laws ensure well-regulated markets, and the U.S. does indeed have strict disclosure rules and tough enforcers.
Unfortunately, Chinese companies have what looks like a free pass to steal. In 2013, the U.S. and Chinese auditing authorities — the U.S.’s Public Company Accounting Oversight Board and China’s Ministry of Finance and Chinese Securities Regulatory Commission — signed the non-binding Memorandum of Understanding on Enforcement Cooperation.
Pursuant to the deal, each side can obtain, in enforcement cases involving publicly listed companies, documents from auditors. Yet the arrangement has not prompted Beijing’s cooperation: it allows the withholding of documents if compliance would violate domestic law. Chinese companies use that provision as a shield, effectively giving them an exemption from U.S. disclosure rules.
As Beijing tells it, the 2013 deal is working well. “The Chinese Securities Regulatory Commission said on Saturday that the Chinese government has not restricted accounting firms from providing audits to overseas regulators,” China Daily, an official newspaper, reported on August 12.
The statement from China’s securities regulator could not be more false. China has not held up its side of the 2013 arrangement, stiffing the Public Company Accounting Oversight Board, created by the 2002 Sarbanes-Oxley Act, at almost every turn.
China prohibits PCAOB, as the American watchdog is known, from inspecting Chinese audits, and therefore it has consistently complained about the lack of cooperation from Beijing.
Americans have squawked about Chinese noncompliance with the 2013 memorandum but have done nothing effective about it.
Unfortunately, China is rapidly moving in the wrong direction. In March, it took a big step backward by amending its securities law to further impede the sharing of audit information with overseas regulators.
The frustrated Trump administration has now shown a pulse. It plans to terminate the 2013 memorandum deal.
Moreover, Treasury Secretary Steven Mnuchin said on August 10 that Chinese and other stocks would be delisted at the end of 2021 if they did not comply with U.S. accounting standards.
The administration’s course of action seems unassailable. As Kyle Bass, the legendary hedge fund manager, told Reuters, “It’s unconscionable that the United States continues to allow Chinese companies raising trillions of dollars from U.S. investors to avoid complying with basic U.S. securities and audit standards.”
He is right, but there are many elements in the United States opposed to enforcing those standards.
The argument of the U.S. financial community is that, because capital can easily flow from one market to the next, the U.S. should not require information about Chinese companies. If the U.S. tightens rules, we are told, those issuers will just list shares elsewhere. “The political instinct to crack down on Chinese companies is understandable,” the Wall Street Journal stated in an editorial on August 10, “but booting them from U.S. exchanges will drive them to Hong Kong or Shanghai where there are fewer investor protections.”
“The issue is not whether this will drive Chinese companies away but whether it will actually be implemented,” Anne Stevenson-Yang of New York-based J Capital Research tells Gatestone. “The U.S. has had the ability to force audits or delist since 2001 and has never used the power.”
“The fact is, the Chinese have no interest in transparency and the U.S. has no interest in pushing listings to London, Frankfurt, and Hong Kong,” she says.
Roger Robinson, former chairman of the U.S.-China Economic and Security Review Commission, told Gatestone that he is also concerned about whether the new rules will be enforced. “Although historic progress is being made vis-à-vis China’s abuse of the U.S. capital markets, there is still a fervent effort underway by Treasury and Wall Street to minimize any disruption to the status quo.”
The concern is that a lot could happen between now and the end of next year, Mnuchin’s deadline, to further delay implementation.
In the meantime, Chinese companies are flocking to the United States. Refinitiv data shows that so far this year, Chinese companies have raised $5.23 billion on American markets, versus $2.46 billion at this time last year.
Many more deals are in the pipeline. As Reuters reports, there is for Chinese companies “the allure of a valuation on the world’s deepest stock market.”
American exchanges are alluring and deep because people want to invest in well-administered markets. U.S. markets are well-administered in part because of strict disclosure rules that are rigorously enforced. Chinese companies come to America because their own markets, including the one in Hong Kong, are polluted and, despite their size, still considered backwaters and cesspools.
Of course, current Wall Street dealmakers want to keep standards low so they can cash in, but just about every other American has an interest in making sure the country’s markets do not descend to cesspool status. Good regulation has always had a cost in the short-term, but it preserves integrity of markets. Integrity, of course, is priceless.
The issue, as Stevenson-Yang notes, is whether American regulators have the “guts” to maintain regulated markets. Chinese companies, many of them with fake books, are betting they do not.
China’s issuers, however, are still coming in droves to America. To steal.
Gordon G. Chang is the author of The Coming Collapse of China, a Gatestone Institute Distinguished Senior Fellow, and member of its Advisory Board.
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