Fraud From The Great Wall Hits Wall Street
U.S. investors recently learned a hard lesson about Luckin Coffee, a strong rival to Starbucks in China. The company admitted that much of its 2019 sales had been fabricated. Luckin’s stock, which is listed on the Nasdaq, had peaked at an all-time high of $50 in January. Now, its shares have plummeted and U.S. banks stand to lose more than $100 million in loans.
How did Luckin get away with such phony accounting? Chinese stocks listed on U.S. financial markets are not required to fully disclose their financial information. Essentially, there are two sets of rules in America’s investment markets — one for Chinese firms and one for all other publicly traded companies. This means Chinese companies are continually shielded from the full oversight of U.S. financial regulators — setting up the possibility that investors could unwittingly fund fraudulent entities and bad actors.
The number of companies involved is troubling. The U.S.-China Economic and Security Review Commission (USCC) has identified 156 Chinese companies — including 11 state-owned-enterprises — listed on America’s three largest stock exchanges. And in December 2018, the Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB) warned investors that U.S. regulators face challenges when attempting to conduct oversight of companies whose operations are based in China and Hong Kong.
This has been an issue since at least 2013. At the time, Vice President Joe Biden helped the PCAOB sign an agreement allowing Chinese companies to remain on U.S. stock exchanges even though they weren’t in compliance with financial regulations. It was assumed that subsequent negotiations between Washington and Beijing would settle the details — and make Chinese entities less opaque.
Since signing the 2013 agreement, however, China has consistently failed to provide timely access to the documents that the PCAOB needs to carry out its oversight. And that means scores of Chinese companies have been listed on U.S. stock exchanges for as much as 20 years without adhering to U.S. securities laws.
The USCC has determined that some of these companies are state-owned, which means they could pose a potential national security risk. Realistically, though, each company also poses a risk to investors — since there’s no true accounting of their financials and other key information.
Listing these companies has certainly been good business for Beijing, though. The Chinese companies listed on America’s three largest stock exchanges have a combined market capitalization of $1.2 trillion.
The overall lack of oversight on these stocks conflicts with the requirements of the Sarbanes-Oxley Act. Yet audit firms in China will not release papers to the SEC or the PCAOB. And many of these Chinese companies provide support for the People’s Liberation Army or human rights violations conducted at Uighur concentration camps. Others have violated U.S. sanctions or have been placed on the Department of Commerce’s “entities list.”
The Trump administration is clearly unhappy with the situation, however, and has established a committee to investigate fraudulently listed companies in U.S. stock markets. The committee is charged with making a finding within 60 days. It shouldn’t take long for the administration to determine that many of these Chinese companies should not be listed in U.S. stock markets, since they don’t comply with U.S. securities laws.
The president should instruct the SEC and PCAOB to immediately provide 30 days notice in order to end the agreement signed in 2013. And then, Chinese companies that don’t come into compliance with U.S. securities laws and SEC regulations within six months should be deregistered from U.S. exchanges and stripped from U.S. indexes and associated funds.
As the Trump administration looks to help the nation recover from the economic impacts of the COVID-19 pandemic, it will be important to clean house in America’s financial markets. There’s simply no reason to allow heavily subsidized competitors in China free rein in America’s stock exchanges. It’s time to tell Beijing that the rule of law matters, particularly when U.S. capital is at stake.
Michael Stumo is CEO of the Coalition for a Prosperous America (CPA). Follow him at @michael_stumo
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