Something about the deal smelled fishy.
China Marine Food Group Ltd., a Chinese company then on the New York Stock Exchange, spent $27 million in January 2010 to acquire a firm whose main asset was “algae-based drink know-how.” The weird thing: Three months earlier, the beverage formula had been valued below $8,800.
But when the U.S. Securities and Exchange Commission tried to review the deal, it got nowhere. The company’s Chinese accounting firm refused to provide documents. And the SEC has been stymied since.
And China Marine? Its share price topped $8 in 2010. It’s now around 12 cents.
The case represents a cautionary tale for investors eager to invest in Chinese companies on American exchanges. Chinese companies like Alibaba, whose initial public offering this year set a record high, operate under lax standards compared with other stocks on U.S. exchanges. That means higher risks for investors.
Worries about the risks of Chinese stocks also emerged from a recent Associated Press investigation of Tianhe Chemicals Group Ltd. When that Chinese company went public in June, the U.S. investment banking powerhouse Morgan Stanley helped it raise $654 million from foreign investors. But Tianhe’s stock has lost 39 percent since allegations emerged that it had exaggerated the value of its business.
“The protections that are often taken for granted are just not there,” says Joseph Carcello, an accounting professor at the University of Tennessee.
More than 100 Chinese companies were suspended or kicked off U.S. exchanges in 2011 and 2012, most of them for failing to file timely financial reports. These companies, including China Marine, had exploited a legal loophole so they could merge with American shell companies. By doing so, they elude much of the SEC oversight that comes from selling shares on U.S. markets for the first time.
About two dozen of these companies have also been hit with SEC fraud or accounting charges. Yet the investigations have stalled because the companies’ audit papers are in China — beyond the SEC’s reach.
There are currently about 100 Chinese companies trading on the NYSE and the Nasdaq Stock Market.
China restricts foreign investment in some businesses. To bypass that hurdle, Alibaba and many other Chinese companies deploy a structure called a “variable interest entity” or VIE.
It works like this: The company listed on the U.S. exchange isn’t the actual Chinese company. Rather, it’s a holding company, typically based in a tax haven like the Cayman Islands. Foreign investors have no say in the company’s management.
As a result, Chinese managers can restructure a company in ways that threaten investors. Alibaba CEO Jack Ma, for instance, spun off Alibaba’s payment service into a company he controlled without telling Yahoo, a major investor in Alibaba.