What happened to China's IPO darlings?
Some U.S.-listed Chinese companies these days resemble ducks in a shooting gallery.
Bloggers and financial websites are targeting a growing number of recent Chinese IPOs for bookkeeping errors or outright fraud involving top execs.
On Friday, Sino-Forest's Toronto-listed shares dived 64% after short-seller blogger sitemuddywatersresearch.com accused the forest plantation operator of fraudulently exaggerating its forestry assets. That sparked a new round of selling in a variety of U.S.-listed Chinese firms.
Sino-Forest accused Muddy Waters of defamation on Monday. Muddy Waters, which previously helped expose problems at China MediaExpress and Rino International, which have since delisted after virtually wiping out shareholders, isn't backing down .
The blogger attacks have sparked Securities and Exchange Commission probes. U.S. exchanges have frozen or delisted shares of over a dozen China-based firms since March amid such SEC inquiries.
Many are small caps or microcaps that merge with shell companies here to go public via "back-door" listings. The online sniping often mixes with short-selling, causing these shares to tank on some days despite an absence of official news. This spooks investors and clouds the investment picture.
There are big ripple effects for investors since U.S. IPOs by Chinese firms will keep surging and such online criticism will continue to impact trading.
Blogger and other sites making the charges include SeekingAlpha and Citron Research.
"We know (these bloggers) don't do true, proper forensic investigation when they come out with these reports. There's a lot of stuff (about Chinese companies) that's false, misleading and creating a lot of negative feelings in the marketplace," said Mitchell Nussbaum, the chair of New York law firm Loeb & Loeb's emerging-markets practice, which represents Chinese companies in the U.S. "On the other hand, it appears that some — but far from all of these companies — have gamed auditors to a degree."
Bloggers Defiant
Bloggers are sticking by their guns. "No allegations made on (alfredlittle.com) have ever been disproven by the companies targeted," blogger Alfred Little said in an email interview. "Therefore, what alfredlittle.com provides to investors is a valuable service. And yes, those who have early access to the reports have made a killing shorting the phony stocks," said Little, whose posts appear on SeekingAlpha.
The controversy is stirring calls for more reliable Chinese corporate data. At the end of bilateral talks in Washington in May, U.S. and Chinese officials said they're seeking ways to stiffen oversight of accounting firms "that provide audit services for public companies in both countries."
Bloggers' other recent targets include Deer Consumer Products (NASDAQ:DEER - News) and fertilizer and feed maker Yongye International (NASDAQ:YONG - News).
On May 23, the SEC opened an accounting inquiry of China's Longtop Financial Technologies (NYSE:LFT -News) after a Citron Research report questioned its "unconventional staffing model," stock gifts to employees and friends of the founder and alleged that Longtop had "supersized margins." Deloitte Touche Tohmatsu also quit as auditor after accusing Longtop executives of colluding with its banks to hide its true cash holdings. Longtop shares have been halted since May 16.
"I don't work in concert with (shorts), I am a short-seller. I am a sell-side analyst," said Citron founder Andrew Left, who says all he does is "put out truthful information to the market."
Why do some Chinese firms run afoul of bookkeeping errors after listing in the U.S.? Analysts say there are cases of deliberate wrongdoing. But venture capitalist David Chao, a co-founder of DCM, an IT VC firm active in China, says some players struggle to meet the deadline to comply with Sarbanes-Oxley accounting rules. Chinese firms have one year to comply with U.S. standards after listing. But some find the costs and other demands difficult.
Another issue is that Chinese audit firms that check the books of U.S.-listed Chinese firms and partner with U.S. giants like KPMG aren't subject to inspections by the Public Accounting Oversight Board in the U.S., as required under Sarbanes-Oxley.
The apparent fraud at Longtop, once a highly rated company profiled by IBD, has raised questions about even well-known U.S.-listed firms. Hedge fund king John Paulson's firm owned 14% of Sino-Forest as of April 29. Ex-AIG Chairman Hank Greenberg was invested in China MediaExpress.
As for many smaller Chinese stocks, investors are simply moving to the exits.
Janet Stites, publisher of China Business Knowledge, an online newsletter that tracks Chinese firms trading on the U.S. capital markets, says growing numbers of Chinese firms are eyeing legal action against bloggers.
Some are already in court. Deer Consumer Products filed a New York suit vs. blogger Little, saying he was part of a scheme to depress its stock price.
Sino Clean Energy (NASDAQ:SCEI - News), a producer of coal-water slurry fuel, also said in early May that it's suing Little for blog comments he made about its sales and production figures.
Little fires back via email: "If any of the allegations were false, they should be easy to disprove. Instead, the pattern we have seen is the companies resort to blanket denials and attacks, both physical and legal."
Loeb & Loeb's Nussbaum says it will be harder to cook books going forward given the "heightened awareness" of U.S. audit firms.
Against a backdrop of blogger attacks and rising reporting errors by some Chinese firms, analysts say due diligence is key.
"Investors have to be very careful; every company isn't going to be like Baidu," said DCM's Chao.
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