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Naomi Rovnick

Charles Li Xiaojia is on a propaganda offensive. Following an explosion of fraud allegations against Chinese companies listed in the US and Canada, the Hong Kong Exchanges and Clearing chief appears keen to prevent local investors questioning whether our bourse could also be riddled with businesses that may be cooking their books.
On June 2, short-seller Muddy Waters accused Toronto-listed mainland timberland firm Sino-Forest of exaggerating its land holdings in Yunnan province. Sino-Forest has denied the claim.
On May 23, Longtop Financial Technologies, a New York-listed software firm from Xiamen, Fujian, said its auditor and chief financial officer had resigned and it was being investigated by the Securities and Exchange Commission.
Li told Bloomberg last week that such companies would never have made it onto the Hong Kong bourse.
'They wouldn't have seen the light of day here,' Li said. Hong Kong 'has a more prescriptive system' for vetting IPO candidates.
He made similar assertions to Dow Jones earlier this month.
Only last month, Hong Kong-listed timber supplier China Forestry admitted its accounts had been faked, as well as its bank statements, harvesting records and logging permits. China Forestry's IPO was vetted by Li's own staff at HKEx.
Readers may also remember Moulin Global Eyecare, the Hong Kong-listed eyeglass maker that went bust in 2006. Its liquidators discovered, among other evidence of fakery, that a company Moulin had claimed was one of its largest clients shared an address and telephone number with the Goodlife Chinese restaurant in McCook, a small town in Nebraska.
Sino-Forest is the only Canadian-listed mainland company hit by fraud allegations so far. But since February, more than 40 US-listed mainland companies have acknowledged accounting problems or regulatory investigations.
That does not mean the US has a bigger problem with dodgy mainland companies than we do.
What New York has that Hong Kong lacks is incredibly vocal hedge fund short-sellers who have a profit motive to uncover - or claim they have uncovered - fraud.
Carson Block, the American private investor who runs Muddy Waters, posted scathing allegations about Sino-Forest on his website before betting the shares would fall. So far they are down 85 per cent.
Large hedge funds use similar tactics, though they communicate more privately, tipping off US regulators or sending evidence to companies' auditors if they think they have uncovered an accounting scandal. They hope the auditor will resign or the firm will announce a regulatory investigation, resulting in a massive share price drop and instant profits for them.
That wheeze would never work here. I asked five hedge fund managers who regularly attempt to expose fraud at US-listed Chinese companies if they ever tried this in Hong Kong.
All said they did so very rarely, moaning it is almost impossible to profit from exposing dodgy dealings here. One said: 'If I did months of work proving a fraud and sent it to a Hong Kong company's auditor, they would probably ignore me.'
American auditors resign from firms suspected of fraud quickly. US investors regularly band together and sue accountants for negligence in so-called class-action suits. In Hong Kong, shareholder class actions are not allowed.
Short-sellers are not allowed to profit from tipping off Hong Kong's Securities and Futures Commission, either. Our public companies are legally barred from disclosing SFC investigations.
And while speculators may freely gamble that a US-listed company's stock is set to plunge, the trade is remarkably difficult here. In short-selling, traders betting that a share price will fall must borrow the stock they are betting against. Brokers arrange this for a fee.
In Hong Kong, it is hard to find stockholders willing to lend, especially when the company suspected of fraud is a small cap with a low free float. Many public companies are as much as 75 per cent owned by their founders, who are unlikely to offer their stock to people who are publicly attacking their companies. Because lenders are scarce, brokers charge high fees to find them.
Short-selling is a vital feature of a free stock market. As Dr Jacob Frenkel, head of the US Securities and Exchange Commission enforcement practice at the law firm Shulman Rogers, puts it: 'Betting a company is overvalued is as valid as betting its price will go up. It is part of the price discovery process that a free market should enable.'
The main reason US-listed Chinese firms are getting attention is that hedge fund short-sellers have put them in the spotlight. That does not mean Hong Kong-listed companies are not just as bad, just that it's often uneconomical for short-sellers to target them.
 


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