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Buyer Beware: Potential Problems for Retail Investors in Chinese Stocks

December 18, 2018 Blog

Aside from the tensions surrounding the U.S. – China trade war and the recent arrest of a top executive of Huawei Technologies,  investors may have a  far more ominous issue to contend with in investing in Chinese businesses.

U.S. regulators are increasingly worried about getting their hands on the books of publicly traded Chinese companies to review their accounting.

First, let’s think back a decade ago. That’s when many Chinese companies went public on U.S. stock exchanges by merging with American shell companies in a process called “reverse mergers.”

The thrust of the allegations in the stock fraud cases back then was that the Chinese had one set of books for its own regulators and another set of books for the U.S. Securities Exchange Commission. The result was the collapse of many of the China-related companies.

The more things change, the more they stay the same. The SEC is now concerned with its inability to inspect audits of Chinese companies that are traded on U.S. stock exchanges.

This is significant. The two leading companies that fit this bill are Alibaba, the Chinese Amazon, and Baidu, the Chinese version of Google. Both stocks are heavily traded by U.S. retail investors.

“American regulators resurrected a long-simmering fight over their inability to inspect audits of Chinese companies that are traded on U.S. stock exchanges, saying the situation prevents investors from getting information they need,” according to a recent report in the Wall Street Journal.

The SEC earlier this month said 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,” according to the report. “The SEC issued the statement in advance of a major accounting conference where its chairman, Jay Clayton, plans to speak about the problem.”

“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.”

“While the SEC enforces securities laws and can bring enforcement actions against public companies and accountants, the PCAOB focuses its efforts on inspecting the work of public-company auditors,” according to the Journal’s report. “The PCAOB’s work is overseen by the SEC.”

The SEC and PCOAB statement was “intended to remind accountants and American investors of financial reporting risks at companies whose books and records are out of the reach of U.S. regulators,” according to Journal, which cited a “person familiar with the SEC’s thinking” as the source for that bit of information.

The moral of the story? Retail investors in the U.S. should be extremely cautious when purchasing Chinese stocks. A company’s finances could be too opaque and not subject to review by U.S. regulators.

As we have said many times before: Buyer Beware!

Zamansky LLC is a New York law firm which represents investors in court and arbitration cases against securities brokerage firms and issuers.  The firm may represent investors in cases against companies mentioned in this blog.  Zamansky LLC also represents investors in arbitration cases against UBS and other brokerage firms regarding Puerto Rico bonds and UBS closed end bond funds and other investments.

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