Sunday, February 12, 2012

A convoluted tale of corporate shenanigans

It's long been known that 'official' Chinese economic statistics are, at best, questionable - at worst, they may be completely untrustworthy. It's beginning to appear as if many Chinese companies are copying their authorities, and releasing highly questionable financial and other data to Western investors. The Wall Street Journal reported last year:

... dozens of companies from China ... have come under fire by investors and regulators for allegedly misleading investors, exposing a loophole that has U.S. regulators concerned.

. . .

Underscoring the SEC's broader concerns, the regulator is examining accounting and disclosure issues regarding Chinese companies that listed in the U.S. through a backdoor process known as a "reverse merger" or "reverse takeover" that requires them to disclose a lot less information to investors than a traditional initial public offering.

"Given the potential risks, investors should be especially careful when considering investing in the stock of reverse-merger companies," Lori Schock, the SEC's director of investor education and advocacy, said in a blunt warning on Thursday.

The Wall Street Journal reported last week that the SEC also is investigating some of the Chinese companies' U.S. auditors, too, and that the inquiry is expected to lead to enforcement cases.

. . .

A survey by the U.S. Public Company Accounting Oversight Board, which monitors auditors, identified 159 Chinese companies from the start of 2007 through March 2010 that listed in the U.S. through reverse takeovers. That is almost three times the number of Chinese companies that launched traditional IPOs in the U.S. over the same period. While most reverse-takeover companies are small, as a group they pack weight: Those covered by the survey had a total market capitalization of $12.8 billion in March 2010.

"While the vast majority of these Chinese companies may be legitimate businesses, a growing number of them are proving to have significant accounting deficiencies or being vessels of outright fraud," said Luis Aguilar, a commissioner of the U.S. Securities and Exchange Commission, in April.

. . .

In all, billions of dollars in market value have vaporized in reverse-takeover companies that have come under criticism from investors, auditors and short sellers.

. . .

The SEC's ability to discipline these companies is limited. Reverse takeovers are legal, and the agency's jurisdiction doesn't extend into China, so it can't subpoena documents and people. With company assets and most senior executives in China, the U.S. has limited scope to enforce any decisions against them.

There's more at the link.

A particularly egregious example of such corporate duplicity has been exposed recently in the case of Focus Media Holding Ltd. of Hong Kong. The Sydney Morning Herald reports today:

The face-off between the Macquarie-advised and Nasdaq-listed Chinese digital advertising company Focus Media Holding Ltd (aka FMCN) and the mud-raking Hong Kong research house Muddy Waters continues.

Four months since Muddy Waters dubbed FMCN the 'Olympus of China' for the alleged 'significant overstatement of the number of screens in its LCD network and its Olympus-style acquisition overpayments', it has issued another update on the company.

In its latest report, Muddy Waters said 30,500 of FMCN's 'verified' 185,174 LCD digital billboards (in response to its original allegations) were 'mere cardboard posters'.

"FMCN has made it unambiguous that 'LCD' means Liquid Crystal - not Light Cardboard - display," said the research firm, which gained notoriety last year by highlighting the financial irregularities in the Toronto-listed Sino Forest.

"FMCN attempted to pull a Jedi mind trick by referring to roughly 30,500 cardboard posters as 'LCD 1.0 picture frame devices'."

Again, more at the link.

As I said, that's a particularly egregious example. It takes a great deal of chutzpah to 'steal' the initials LCD - accepted throughout the world as meaning 'Liquid Crystal Display' - and instead use them to refer to a 'Light Cardboard Display' - i.e. a printed poster! To call that 'misleading' is to be extremely charitable . . . 'deliberately fraudulent' would be a better description. However, that's not the only area where Focus Media Holding Ltd. has been up to some rather disturbing tricks. The Wall Street Daily reported last year:

In case you’re unaware, when one company buys another, it lists the acquisition as an asset at the cost it paid. If the buyer later finds that the asset is overvalued, it can “write-down” those assets, making them worth less and taking the loss.

In Focus Media’s case, it appears to have acquired a number of companies at inflated prices and then wrote-down the assets.

For example, Focus Media paid $24.2 million for a riverboat company, which has large advertising screens on its vessel. It separately bought the boat for $12.4 million (a total of $36.6 million).

However, just three months earlier, a different company had agreed to acquire the same riverboat company for a mere $3.7 million (the deal fell through). In addition, Muddy Waters calculates that the boat’s value was actually closer to $3.9 million, not $12.4 million!

Sure enough, 14 months after the acquisition, Focus Media wrote-down the holdings and declared a $36.9 million loss.

A closer look reveals that Focus Media’s total losses from write-downs like this one totaled $1.1 billion.

. . .

So why the heck would Focus Media want to intentionally rack up losses from acquisitions?

There are at least two possible reasons:

  1. The acquisitions were a smokescreen, used to hide losses from the false number of advertising screens that Focus Media claimed it had.
  2. The acquisitions were used to somehow funnel cash to Focus Media’s insiders. ... And while the allegations haven’t been proven yet, the record shows that Focus Media insiders have cashed out on $1.7 billion in stock since 2005.

More at the link.

Focus Media is, of course, only one of many companies suspected of financial and reporting irregularities by Western regulators. I've used it because it's a convenient example, with much quotable reporting on what it's been doing. Another is Sino-Forest. An Internet search will reveal much more information, if you're interested.

I guess this is just another example of why 'caveat emptor' remains a valid warning throughout the world. Also, we can't really blame Chinese companies alone for employing dodgy financial reporting . . . remember what the banksters got up to prior to and during the 2008/09 financial crisis? The biggest banks and companies in the West have set an example that's being eagerly followed by their Far Eastern counterparts! Note, too, that the Big Five US banks have just agreed to a $25 billion settlement deal to avoid prosecution over their illegal activities in connection with home mortgages. Personally, I think they've gotten off extremely lightly. After all, they issued hundreds of billions of dollars in defective mortgages! I'd have hung them out to dry, including jail time for all those in charge.

Be that as it may, it appears increasingly likely that most companies' financial reporting should be regarded as suspicious in these hard economic times. Too many of them are reporting things in as favorable a light as possible, and if necessary being 'economical with the truth' to get away with it. As broker Ann Barnhardt observed recently:

The futures and options markets are no longer viable. It is my recommendation that ALL customers withdraw from all of the markets as soon as possible so that they have the best chance of protecting themselves and their equity. The system is no longer functioning with integrity and is suicidally risk-laden. The rule of law is non-existent, instead replaced with godless, criminal political cronyism.

Again, more at the link.

Caveat emptor, indeed!



trailbee said...

I'm glad you said something about our mortgage disaster. Our bundles of sub-prime mortgage loans were bought by the Chinese and others because the loans got a AAA rating from S&P, Moody's and Fitch. That's how they were bundled and sold around the world. If the Chinese learned anything from us, this is one lesson I bet they won't forget soon. What goes around comes around, unfortunately.

perlhaqr said...

I'm pro-market, but goddamn the modern economy is stupid and broken.

We desperately need to A.) stop printing more money and B.) stop bailing out people who make up financial instruments out of thin air and heavy bullshit and then end up under a truck full of manure.