It's Time the Markets Offload Rogue Foreign Companies
The Senate passes a measure that will delist companies with a history of non-compliance with U.S. regulations.
The notion of launching a Chinese version of Starbucks makes sense: A market with 1.4 billion people, some of whom must like coffee. After all, there’s a Chinese Uber (Didi Chuxing), a Chinese Google (Baidu), and a Chinese Amazon (Alibaba). Enter Luckin Coffee in 2017. It quickly became the largest coffee chain in the People’s Republic, publicly listed on the New York-based NASDAQ with a market capitalization of $12 billion in January 2020. Only its sales were all lies. When it came out that Luckin’s numbers for much of 2019 were fabricated, shares cratered and U.S. investors took massive losses.
How could a Chinese company listed on an American stock exchange have garbage financials? Good question. The story is complex, and it’s not really about Luckin. It’s not even about Communist China, at least not entirely. At heart, this is a story about companies, often state-owned, sometimes under U.S. sanctions, from non-market economies who have effectively unregulated and unfettered access to U.S. capital markets, and the U.S. policymakers who allow it.
It should come as no surprise that in a year in which bank deposits earn interest rates close to zero, interest in the kind of return the stock market can deliver is high. More than half of all Americans are in the market, a slight decline since the Great Recession. And while your average Josephine wouldn’t consider plunking her hard-earned dough on the Shanghai or Moscow exchanges, she doesn’t think twice about Wall Street. That’s probably where her 401(k) is invested if she has one, and since she probably doesn’t like buying individual stocks, she may have some mutual funds or index funds.
Our Josephine, like most others, probably thinks that unlike on the Shanghai or Moscow markets, her precious investments are strictly supervised by the world’s greatest and richest democracy. But there, she’d be wrong. “Gently overseen” might even overstate how the SEC and the Public Company Accounting Oversight Board (PCAOB) regulate foreign companies. Either by its own choice, or because of pressure from the business community, the SEC has historically turned a blind eye to bad behavior by foreign corporations. Which brings us back to Luckin.
This week, the NASDAQ forcibly delisted the luckless Luckin, leaving about 150 other Chinese companies with a capitalization of about $1.5 trillion (not a typo) still enjoying access to U.S. markets. And it’s not just Chinese companies. Russian companies and financial institutions similarly enjoy apparently unfettered access to U.S. markets, including, among others, state-owned Gazprom and Sberbank.
For the uninitiated, Gazprom is Russia’s largest company, and is, with certain subsidiaries and senior officials, under a variety of U.S. sanctions (which limit access to capital and/or technology) mostly related to Russia’s invasion and ongoing occupation of Ukraine. Same for Sberbank, a majority state-owned bank and financial services company. Neither is listed on the NYSE or the NASDAQ, but—notwithstanding U.S. (and European) sanctions—all have access to U.S. capital as so-called over-the-counter (OTC) securities. (OTC securities are even less regulated than listed exchange stocks.) Among their major institutional and mutual fund investors are Vanguard and Pimco (Gazprom), and the Kentucky Teachers Retirement System (Sberbank).
Of course, those are just a few companies under sanctions. Neither they nor unsanctioned corporate compatriots are in danger of SEC action. Because compliance with SEC auditing requirements is, for foreign companies, optional. Despite years of warnings, Chinese and other companies do not cooperate in opening their books to SEC audit. Here’s what the SEC and the PCAOB said in 2018:
China’s state security laws are invoked at times to limit U.S. regulators’ ability to oversee the financial reporting of U.S.-listed, China-based companies. The inability to date to achieve this level of regulatory cooperation with Chinese authorities raises a number of investor protection and general oversight issues.
Back in 2015, the Chinese affiliates of the Big Four accounting firms (KPMG, Deloitte, Ernst & Young, PriceWaterhouseCoopers) settled a 2012 SEC case brought against them for—surprise, surprise—failing to provide documentation supporting the firms’ audits of Chinese companies being investigated by the SEC. But the issue has been simmering ever since Chinese companies began listing on U.S. markets, around the turn of the 21st century. Historically, however, every time the question of compliance with SEC disclosure and auditing “requirements” rears its head—mostly focused on Chinese companies rather than other miscreants because of heavy U.S. exposure—the financial regulators profess deep concern and then do or are allowed to do very little. That might be about to change.
In April, the SEC and PCAOB issued what some called an unprecedented statement, basically warning investors that SEC-registered companies from emerging markets might not be disclosing accurate financial information. Especially, they added, Chinese companies. Caveat, they intoned wisely, emptor. Well, yes. But, as the former head of the SEC and its former international director noted in a Wall Street Journal op-ed, “simply saying ‘buyer beware’ isn’t a credible response.” They counsel more strict policing and enforcement. But for many, that’s not enough.
Yesterday, the Senate passed bipartisan legislation requiring delisting Chinese and other foreign companies after three years of non-compliance with U.S. regulatory requirements. Similar legislation has been introduced in the House. And that’s on top of legislative action encouraging U.S. pension funds (including the massive U.S. government Thrift Savings Plan) to shy away from investments in China itself. Incredibly, notwithstanding Chinese attacks on Hong Kong and the internment of millions of Muslims in concentration camps, China remains one of the most popular countries in which U.S. pension funds invest their money.
In addition, President Donald Trump, his willingness to act against China possibly sharpened by the COVID disaster, recently threatened to delist Chinese companies that don’t adhere to U.S. accounting standards. But he noted that even if the SEC does man up and enforce its own rules, there are financial centers less squeamish about bad actors mucking about. Unless other major exchanges choose to go the same route, Beijing, Moscow, and others will simply shift operations. In the grand battle of money versus morality, or even the prospect of money versus good sense, it should come as no surprise that money often wins.
It’s almost like this calls for American leadership. The U.S. has changed rules governing inbound investment with an eye on China, and other countries have followed. We can do the same with bad actors taking in unsuspecting Josephines around the world. It’s taken far too long to wake up to the fact that Americans are investing in, at best, insolvent foreign companies and at worst, our adversaries’ state-owned concerns. It’s time for the SEC to pull the plug on rogue states, sanctioned actors, and crooked companies.
Photograph by Zhang Peng/LightRocket via Getty Images.