COMMENTARY: Spotlight is again on Chinese stocks for the wrong reasons
Asia News Network
By Risen Jayaseelan in Petaling Jaya/The Star | ANN – Wed, Jun 29, 2011
Petaling Jaya (The Star/ANN) - The spotlight is again on China stocks for the wrong reasons.
It's stemming from Sino-Forest, a Chinese timber company listed in Canada.
Its shares have plummeted amidst reports that it had overstated the value of its assets, raising again concerns about accounting scandals involving Chinese companies listed abroad.
Well known hedge fund Paulson & Co has been in the thick of the story, taking a lot of heat for its investment in Sino-Forest.
News reports have suggested that the fund could have lost up to US$500mil in Sino-Forest.
And now some regulators are scurrying about trying to ensure the other Chinese stocks listed on their exchanges don't suffer from accounting shenanigans.
In the US, the trading in the shares of at least 21 small cap Chinese stocks has been halted over the last one year with the Securities and Exchange Commission (SEC) investigating these companies, their auditors and sponsors.
In Korea, the stock exchange is now considering some rule changes to improve investor protection and to ensure the reliability of the financial statements of foreign companies.
In Malaysia, existing safeguards exist but investors still have their work cut out for them.
For example, the reporting accountant for any Chinese company listed here has to be a Malaysian firm.
Also, any foreign company listing here has to have at least two Malaysian independent directors.
And the firm that audits the books of the Chinese company has to be operating globally and have the same set of professional standards in its firms in China as in other countries.
It is universally accepted, though, that the auditing process is not designed to detect fraud. And this is where sponsors come in.
Regulators in most markets place a lot of responsibility on sponsors of foreign listings, more so if the companies come from China. Simply put, sponsors are supposed to carry out their own due diligence on companies that they are bringing to market.
Sponsors and other advisors can be taken to task if they are proven not to have done a good enough due diligence. They can also be liable for a criminal offence if any serious misrepresentations about the listed company has been made to the investing public.
For the seven Chinese listed companies in Malaysia and the others that are enroute to a listing here, investors needn't unnecessarily fret.
But what they need to do though is to ensure that the sponsors have done their job properly.
It should be noted that it is difficult to pin down exactly what is expected in the due diligence of sponsors, especially of China companies.
Recent developments should give us some clue as to what to watch out for. A March 2011 report by Hong Kong's Securities and Futures Commission highlighted deficiencies in the work done by some sponsors, including the following:
- Failing to conduct interviews with major customers of the applicant so as to verify the genuineness of the sales figures.
- Unduly relying on a piece of legal advice which was prepared based upon certain facts which did not reflect the full and actual business operation of the listing applicant.
- Deploying inadequate manpower and resources to undertake the level and nature of sponsor work.
Then there's Paulson's experience.
The fund has since disclosed that it had conducted considerable due diligence on Sino-Forest, including reviewing public filings, participating in conference calls and talking with management and analysts covering the company.
A Paulson employee is also said to have visited the company in China and spent time with customers, even meeting a Chinese government hospital dealing with forestry matters.
And yet it seems to have missed the alleged overvaluation of the company's assets.
So those investing in China stocks should pay attention to the sponsor of the company. Is it a credible sponsor? And has it done a thorough enough due diligence?
Sufficient attention should also be paid to the disclosures in the prospectus and questions raised (especially at the time of the draft prospectus disclosure state) as to whether there is any likelihood that this information may not be all it seems.
