Can Alibaba overcome the 'China syndrome' with its US IPO?
Accounting challenges create problems and opportunities for American investors wanting to buy into China growth story via Alibaba IPO
The ghosts of Enron and Arthur Andersen are rising from their graves to greet Alibaba and PwC.
Let's assume that there exists a price for the e-commerce giant's initial public offering where you can compromise on corporate governance and reliable accounts in order to buy into another China growth story.
But that would still only make sense if investors could depend on Alibaba's audited financial statements at the time of listing and in the future.
Unfortunately, the history of recent Chinese listings in the United States is a horror show of fraudulent accounting. Alibaba's partners' campaign for complete control of the board of directors is so uncompromising that they might as well eliminate the annual general meeting of shareholders.
An IPO usually requires a clean or unqualified audit, which represents what auditors call a "fair and true" view of the company's accounts.
The mainland affiliates of the Big Four global accounting firms have been charged and suspended by a US judge for refusing to cooperate with US Securities and Exchanges Commission subpoenas.
China's Ministry of Finance wants to bar international accounting firms from sending staff to audit mainland companies. So investors will be completely at the mercy of mainland auditors for the credibility of their audited financial statements of Alibaba.
Since the collapse of Arthur Andersen, international audit firms have restructured themselves to avoid being entirely wiped out by an affiliate's mistakes.
The only way PwC can protect itself from repeating the Andersen fiasco is through stringent disclaimers with the audited financial statements in the prospectus. But disclaimers that protect the firm from any and all responsibility for the accuracy of the audit will render the auditor's report useless.
Besides its fees, PwC needs to calculate the risks to its global brand of this unusual arrangement. It is struggling at present with the auditing shortfalls of NQ Mobile, a Chinese client listed on the New York Stock Exchange.
The company has postponed the filing of its audited annual report twice. Carson Block of Muddy Waters, the famous short-seller of US-listed Chinese stocks, has described NQ Mobile as "unequivocally a fraud".
To avoid embarrassing itself, PwC needs to avoid taking on as audit clients Chinese companies that do not meet Western accounting standards.
Alibaba's desire for a listing on an exchange that would accept a dual-class shareholding structure may backfire on the firm.
US vigilante investor advocates will take vigorous action , including mounting class-action suits, against any company they believe to be abusing minority shareholders.
Unlike in Hong Kong, this is a blood sport in the US. Alibaba's New York listing and high profile mean that would-be plaintiffs wouldn't have to chase chairman Jack Ma Yun in a Chinese court to hurt his brand.
Being the biggest technology listing in history with a complicated business only sets Alibaba up as a prime target for litigants and short-sellers.
So what standard of corporate governance can we expect at Alibaba?
According to the latest filings, the firm's board of directors appear to be a cooperative lot. They are unlikely to question or oppose Ma's proposals.
Tung Chee-hwa may have been Hong Kong's first chief executive, but compared with directors of other major internet or social media companies, he doesn't have any discernible experience in technology.
Jerry Yang's track record as chief executive of Yahoo was mediocre. Yang was criticised for disregarding the interests of shareholders by not accepting Microsoft's takeover offer in 2008. This is a board that appears incapable of self-criticism or self-correction.
US-listed Chinese companies represent an unfair and asymmetrical trade for foreign investors, because no Chinese national has been meaningfully prosecuted for defrauding US investors or breaking the regulations of US capital markets. This has encouraged some Chinese to lie and inflate numbers because there is no fear of legal recourse.
As a result, US-listed Chinese companies tend to trade at a substantial discount to their Western peers.
Peter Guy is a financial writer and former international banker