<HTML><HEAD> <META name=GENERATOR content="MSHTML 8.00.6001.19019"></HEAD> <BODY> <TABLE id=Table26 border=0 cellSpacing=0 cellPadding=0 width="100%" height=31> <TBODY> <TR> <TD vAlign=top align=middle><IMG src="ctsspacer15.gif" width=15 height=10><BR></TD></TR></TBODY></TABLE><!-- end of top section --> <TABLE id=Table7 border=0 cellSpacing=0 cellPadding=0 width=667><!--atimesprint--> <TBODY> <TR> <TD width=1><IMG src="ctsspacer15.gif" width=15></TD> <TD vAlign=top width=513> <TABLE id=Table8 border=0 cellSpacing=0 cellPadding=0 width=513> <TBODY> <TR> <TD vAlign=top width=323><!-- Main Section --> <TABLE id=Table33 border=0 cellSpacing=0 cellPadding=0 width=382> <TBODY> <TR> <TD><FONT size=3><STRONG>The wrong part of China in Manhattan</STRONG></FONT><BR>By Benjamin A Shobert <BR><BR>SHANGHAI - In the midst of an economy seemingly on the verge of another contraction, American investors have found themselves hungry for a new investment trend they can tap into. Commodities have offered one such alternative, but another sector - Chinese companies listing in United States markets - has been receiving rapt attention. <BR><BR>When the likes of Warren Buffett speak publicly about their own Chinese holdings - his now well-known investment in Chinese automaker BYD Co Ltd has been repeatedly run up the flagpole - the casual investor can be forgiven for thinking that his own investments would benefit from some sort of Chinese exposure. <BR><BR>And, for many US investors, the opportunity to invest in Chinese companies through a listing on a US stock exchange is simply<BR>too good an opportunity to pass up. <BR><BR>But 2011 has not been kind to investors who sought out China's US publicly listed companies. Already the disgrace of China Electric Motor, Longtop Financial Technologies, Puda Coal, China MediaExpress, Subaye and a handful of others has drawn attention to the risks American investors face when seeking to add a China position to their portfolio. <BR><BR>Longtop Financial Technologies and China Electric Motor, for instance, faced inquiries by the US Securities and Exchange Commission and Nasdaq over issues ranging from regulatory probes to potential accounting frauds. <BR><BR>Many of these companies have fallen as a consequence of out-and-out fraud, a phenomenon that in fairness cannot - nor should not - be considered unique to Chinese public listings. <BR><BR>However, investors in the US who want to invest in Chinese companies may need to reconsider the simple assumption that a Chinese publicly traded company listed on a North American exchange has crossed a threshold which in and of itself mitigates the risk of major losses. This has already proven to be a simplistic approach, reminding the investing community that there remains no easy means of tapping into the still opaque Chinese economy. <BR><BR>About 200 Chinese companies have listed on either the New York Stock Exchange or on the NASDAQ, but their reason for listing in the US may be an overlooked and much needed cautionary note to strike for American investors consider purchasing their shares. <BR><BR>Paul Gillis, currently the visiting professor of accounting at Peking University, is one of the world's leading experts on China's accounting system and also the author of the China Accounting Blog. In an interview with Asia Times Online, he said he believes that the rationale for these US listings is not a business mandate, but rather, "... mostly because the founder wants the prestige of running a NYSE or NASDAQ-listed company." <BR><BR>And, as Americans should know by now, prestige is a motive that both management and investors can get easily wrapped up in, causing both to overlook more fundamental questions about product, profit, and potential. <BR><BR>For Gillis, the proof that prestige motivates many of these transactions is what tends to happen to the capital once the US listing occurs: "The companies often don't need the capital from an IPO [initial public offering], and the proceeds often just sit in the bank." <BR><BR>For investors, it is worth keeping in mind that China lacks for many things, but liquidity for business expansion is not one of them. Overall, a US listing by a Chinese firm raises the question of why it chooses to jump through the hoops. <BR><BR>Good investors have drilled down to the very specific rationales behind a Chinese firm's reasons for listing in North America, and are confident the motivation is not purely ego. <BR><BR>One well placed-source contacted who declined to be identified due to having close connections with China's state-owned enterprises, reinforced Gillis' conclusion, sharing his experience with a large Chinese company that pursued and won a North American listing which proved largely to be a vanity play on the part of the chief executive officer. <BR><BR>Given the aspirational nature of many Chinese companies who pursue a US listing, it should come as no surprise that the fundamentals to maintaining a viable US listing in accordance with global accounting standards are not properly managed or prioritized once the transaction has closed. <BR><BR>According to Gillis, for Chinese companies that have pursued a US listing for reasons other than economic motives, the resulting offerings can be "risky deals since the CEO may not be all that committed to looking out for the interests of the public shareholders". <BR><BR>In such an environment, the pressure from management to access the prestigious American capital markets can result in corners getting cut by Chinese accounting firms. While this may not come as a surprise, the extent to which Chinese banks have enabled these corners to be cut remains troubling. <BR><BR>The role of Chinese banks has become clear to outsiders have examined Chinese companies that have been caught in fraudulent accounting practices. "There have been a number of scandals with one thing in common - the bank providing false confirmations of bank balances to the auditors," Gillis commented. <BR><BR>Even when the accounting firm knows the right questions to ask - which is not always a safe assumption given China's dynamic and highly elastic business practices - they may still encounter banking statements that have been doctored to reflect what the Chinese management team knows is necessary for an American listing to proceed, or for a particular box on the audit to get checked. <BR><BR>Gillis is quick to point out that these sorts of practices may be the result of "local branch managers", but acknowledges that this type of illegality "undermines the credibility of China's financial system" and that "banks really need to crack down on this illegal practice". <BR><BR>For outsiders already critical of China's banking sector, problems like these draw into sharper focus concerns over the extent to which non-performing loans and off-balance sheet debts may have been overlooked, simply as a function of China's extraordinary growth. <BR><BR>But being listed in the US requires both an acknowledgement of the higher degree of transparency demanded and equally a willingness to be held to higher standards of accountability than Chinese firms are used to. <BR><BR>If these aspiring Chinese companies have such fundamental problems with the integrity of their business practices, many are left to wonder whether more pervasive problems exist within the country's less forward-positioned businesses in general, and in the banking system more specifically. <BR><BR>It does not seem a stretch to ask whether issues uncovered at some US-listed Chinese companies are symptomatic of a deeper problem plaguing China's economy: has much of what China built recently been the result of aspiration instead of a rational deployment of capital to where it is most needed by Chinese business and society? <BR><BR>For those remaining Chinese firms still viable and publicly listed in US markets, Gillis believes the price of adjusting their accounting practices may simply be too high for them to continue. ''Many Chinese companies are regretting the decision to list in the US,'' he said. ''They have discovered that it is complicated and expensive to run a US listed company and they have not seen many benefits. With the values so low for many companies, they ought to be looking at taking the company private.'' <BR><BR>It is worth noting the crossing streams of Chinese companies pursuing US listings and US companies who are racing to China - in particular those in the clean-tech space - as a means of accessing capital more easily. <BR><BR>Largely speaking, Chinese companies seeking to sell shares in New York desire either the legitimacy of what being listed in America brings, or a signal to Washington that they acknowledges they must become truly multinational in order to participate at the next level of the national economy. <BR><BR>Interestingly, many American companies in high-risk, high-reward fields like green energy have sought out China's capital markets after having exhausted domestic options. For these companies, they know they can get cheaper capital with fewer strings attached in China, while accessing a highly incentivized and subsidy-rich Chinese market which enables their technologies to come to scale much more quickly than if they limited their capital seeking to North America. <BR><BR>Unfortunately for US-China relations, the accounting fraud disclosures come at a particularly bad time. Within the US, accusations of accounting fraud by Chinese companies listed on the NYSE are another reminder of China's willingness to cut corners, which some suggest the country's businesses have an aptitude for, and an inclination towards, doing. <BR><BR>These problems add to past frustrations over poor quality products and further build the wrong sort of national brand for China. <BR><BR>Gillis is right that, "China is a high-risk environment for investors". As such, Americans should exercise extreme caution in decisions to invest in Chinese companies listed in the US. <BR><BR>Hopefully Americans will be able to keep in mind their own history of fraud, avarice and greed and remind themselves that there are many ways to benefit from the China story. It is a country still learning how to work within the confines of the established economic order and as a result is likely to make many immature and reckless errors - just as the United States did when it was coming of age. <BR><BR><I><B>Benjamin A Shobert</B> is the managing director of Teleos Inc (www.teleos-inc.com), a consulting firm dedicated to helping Asian businesses bring innovative technologies into the North American market. </I></TD></TR></TBODY></TABLE></TD></TR></TBODY></TABLE></TD></TR></TBODY></TABLE></BODY></HTML>