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Some of the upcoming rule changes will help protect shareholders
By Goh Eng Yeow
20 June 2011
There was once a time when buying any stock linked to China was a sure ticket to healthy gain, given the wealth of opportunities thrown up by the booming economy.
But now investors in the United States, like their jaded Singapore counterparts, are learning to their chagrin that putting their money in China-based counters may not turn out to be a bed of roses after all.
A string of China-based companies listed in the US have been accused of fraud, accounting irregularities and other corporate governance failings in recent months.
There are similarities - at least superficially - between S-chip scandals here and those that have erupted in the US.
The common trend seems to involve high-profile companies that initially produce an impeccable series of quarterly growth numbers and claim a huge cash hoard.
That usually keeps any nosy questions about its business model at bay, but the deception often falls apart when the company’s external auditors take a more in-depth look at the books.
Their path to important venues such as banks to confirm the cash hoards is often blocked as well.
There has been a rash of lawsuits by angry investors in the US alleging that China-based firms had invented sham businesses and inflated revenues.
While they may get their day in court, it is unlikely they will ever see any of their money again. That is because the firms often use empty shell companies in tax havens such as Bermuda or the Cayman Islands to hold their assets.
In the past, some fund managers here have contemplated taking legal action in these jurisdictions to try to seize such firms’ assets.
But the convoluted corporate structures devised by the companies to circumvent China’s strict capital controls turn out to be just as effective in fobbing off a hostile seizure of assets.
Still, the spate of scandals has made some market regulators wise up, and preventive measures are being explored.
The Singapore Exchange (SGX), for example, is believed to be going for the jugular by looking at how to use the Chinese legal system to complement its own regulatory framework, in a bid to make sure such firms toe the line.
In many troubled S-chips, the financial calamities are triggered by bosses taking excessive business risks, rather than outright fraud.
But some fund managers were shocked to learn that many of the corporate checks and balances, which apply to Singaporean and US companies, do not exist in Chinese firms.
Under Chinese law, the company boss is often the ‘legal representative’, which gives him vast authority to execute agreements, transfer assets such as cash and land, and provide guarantees on the firm’s behalf - all without any board oversight.
When problems arise, there is some confusion over whether he can be removed without his consent.
But two China-based lawyers pointed out in a letter to The Business Times recently: ‘Chinese law and regulations provide clear avenues for recourse and enforcement of legal and contractual rights relating to the appointment and removal of legal representatives.’
The SGX wants S-chips to have the framework in place to remove existing legal representatives and appoint new ones if needed. Initial feedback suggests it has been largely successful in its efforts to get S-chips to comply.
As for the problem of getting bank confirmations of cash balances, market watchers believe it will be resolved when electronic confirmations catch on in China.
This will make it easier for auditors to confirm balances at head office rather than at branch level, where most irregularities surface.
Of course, it is difficult to eliminate fraud completely, if top management is implicated too. But sometimes, the mere implementation of simple checks and balances can go a long way in protecting a shareholder’s interests, and this is what market regulators should aim for.