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Mainland net stocks fall on U.S. fraud allegations

PUBLISHED : Saturday, 01 October, 2011, 12:00am
UPDATED : Saturday, 01 October, 2011, 12:00am

News that the authorities in the United States are investigating accounting irregularities at Chinese companies listed on US stock exchanges and a generally bearish outlook for the global economy sent mainland internet stocks reeling yesterday.

Youku.com, the mainland's largest online video provider, led the slump, dropping 18.3 per cent to US$16.24, while top Chinese internet search company Baidu lost 9.17 per cent to close at US$110.29. Online game services provider Shanda Interactive fell 9.04 per cent and news portals Sina and Sohu fell 9.7 and 4.7 per cent respectively.

Robert Khuzami, director of enforcement at the Securities and Exchange Commission, this week told Reuters that federal prosecutors were looking into allegations of fraud against Chinese companies listed in American exchanges.

'There are parts of the justice department that are actively engaged in this area,' Khuzami was quoted as saying. 'I think that you will see greater involvement as time goes on.'

The SEC has been investigating accounting fraud in US-listed Chinese companies for more than a year and has suspended trading by many such companies after their auditors quit.

Alex Mou, the chief executive of Zuosa, a website providing software and analysis related to Chinese microblogging site Weibo, said: 'The impact of the news that the US government is investigating is palpable. Only individual Chinese companies listed in the US are falsifying their accounts but they drag everyone into the middle,' Mou said, admitting that the number of 'individual' companies was high.

He said the weak performance of Chinese companies might persist until the global economic trend became clearer. 'The world economy is slowing down and investors believe this is going to affect China, a big exporter.'

Ratings agency Fitch said the increased 'market volatility and uncertainty introduced by 'whistle-blowing' short sellers of Chinese companies is likely to outweigh any positives for investors from improved corporate governance and transparency'.

Groups such as Muddy Waters and, more recently, Anonymous Analytics, have taken aim at Chinese firms in a series of reports alleging malpractice and false accounting.

Zhao Xufeng, a senior analyst at market research firm iResearch, said a key factor affecting internet stocks was Beijing's scrutiny of the variable interest entity (VIE) corporate structure.

Favoured by Chinese Web companies, VIEs operate in a legal haze. To get around Beijing's restrictions on direct foreign investment in 'strategic' sectors, an offshore holding company is set up to control a Chinese business through a contractual agreement rather than share ownership. It is this entity that foreign investors then buy into.

The model has been common in the internet industry but came under the spotlight only this year when online business-to-business giant Alibaba announced the transfer of Alipay, China's most popular online payment service, to a company controlled by Alibaba chairman Jack Ma.

Zhao said the Chinese authorities would not take any drastic measures. 'A large-scale purge will be too difficult. It's just not doable.'

Mou echoed her view that VIEs would not change in the near term. 'China doesn't want to hurt the market,' he said. 'No Chinese investors or Chinese funds will put their money in companies like Sina, Baidu or Soho, and wait years for them to see profits. If VIEs are [made] illicit, the internet companies in China will run out of fuel.'

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