An article in China’s state-run media blames the accounting fraud discovered in Chinese companies listed on U.S. stock exchanges on a conspiracy by U.S. companies. A critic of the article in the Western financial press said that Chinese nationalism and patriotism are the last refuge for frauds and cheats.
U.S. hedge funds, law firms, and independent research organizations have joined forces to hunt down U.S.-listed Chinese companies in order to gain profits from short selling, according to an article in the China Security Journal (CSJ) that has been widely republished on the Chinese Internet.
Hedge funds are aggressively managed investment portfolios that are generally open to no more than 100 sophisticated investors who are investing at least $250,000 or more. Such funds generally can’t be withdrawn at any given time and are invested for at least one year.
The article claims that the recent rash of accounting scandals by Chinese companies listed on the U.S. stock exchanges was a result of a premeditated and planned conspiracy that originated at the investment research firm Muddy Waters, a company that “specializes in finding Chinese companies it believes are frauds, shorts the firms’ shares, and publicizes the charges on its website,” according to CNBC.
Muddy Waters has shorted five China-based companies prior to publicizing their alleged accounting frauds, causing a combined loss of almost $4.4 billion in market value from the last trading day before publication of his research through June 3, according to Bloomberg.
Short selling is the selling of a stock that is not owned, but borrowed from a third party. A short seller will sell the stock in the hope that he/she will be able to buy the stock back at a lower price and pocket the difference before returning the stock to the original owner. This type of trading is considered high-risk.
Since then, a number of other Chinese companies have been exposed as accounting frauds. Trading on at least 17 Chinese stocks has been halted on NASDAQ since mid-May, and in early June Interactive Brokers banned clients from buying about 160 Chinese securities.
The CSJ article said the incidents show that a system has been formed to systematically frame Chinese companies in order to benefit from short selling their stocks. Muddy Waters’s founder Carson Block “uses his own Chinese speaking ability as an advantage to ‘intercept’ the overseas listing efforts of small- and mid-cap Chinese companies, and sets up traps together with investing firms to gain considerable profits,” the article said.
The article implied that the Chinese companies in discussion were victimized in an unfamiliar market, and said that Muddy Waters and those that have common interests will continue to “pick bones with” even larger Chinese firms.
The article also detailed the affected Chinese companies’ losses, but did not elaborate on these companies’ alleged fraudulent behaviors.
Though posted all over the Chinese Internet, on most sites no reader comments are shown. However, a sharp critique of this article written by the Financial Times commentator Ye Tan seems to have received more attention.
In the June 14 website article, Ye criticized the CSJ report for defending frauds with conspiracy theories and by inspiring nationalistic emotions. She cited the fact that about 40 U.S.-listed Chinese companies either admitted to accounting fraud or were halted for accounting issues since February, suggesting fraud is what will discredit Chinese stocks, not Muddy Waters.
Muddy Waters may have its own issues, Ye said. “But what [it] did is greatly beneficial for building a new order.”
Ye goes on to say that China’s stocks traded on exchanges outside China have been given nationalistic significance. She gives two examples in which appeals to nationalism have been used to justify large Chinese companies’ unethical business practices in dealing with foreign investors.
In one case, Chinese star entrepreneur Shi Yuzhu encouraged Ma Yun, founder of e-commerce giant Alibaba, to be a “patriotic rascal” and force Alibaba’s foreign shareholders, U.S.-based Yahoo! Inc. and Japan-based SoftBank Corp., to sell shares to the Chinese state and companies. In his blog, Shi said this is to protect China’s financial security.
Ye said Shi’s remarks reflected the view of many Chinese business leaders. “Shi Yuzhu also betrayed the most important rules in market economy: integrity and contractual constraints,” Ye said. “If everyone is allowed to break rules under the name of nationalism … future entrepreneurs would become demagogues who cover up their dishonesty and wrong decisions with terms like patriotism and nation.”
In the other case, Chinese company Hilead Biotechnology stole core technology from Cathay Industrial Biotech founded in China by China-born U.S. citizen Liu Xiucai. When reporting on the lawsuit, Chinese media emphasized that Cathay was invested in by an American, according to Ye.
“This is an appalling suggestion that supporting Hilead is patriotic, regardless of right and wrong,” Ye said.
Ye said at the end of the article that frauds and cheaters often use nationalism and patriotism as their last fortress. “When they hide in there, nothing [it] seems can hurt them,” Ye said, “When the [nationalism] flag is used again and again, China’s business credibility is left riddled.”
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