As a person who keeps almost half his net worth in China stocks, I've been obliged to follow the new going private method closely, as it's been applied to ZSTN and CMED(Q).
Today, my research turned to CMEDQ's shareholders' derivative suits and to my great surprise I learned that it's being sued by shareholders for allegedly falsifying its cash numbers from 2006 to the present (to see the suit for yourself go to "Scribd" site, document # 105716411).
Add that to the fact that I know the reason ZSTN was de-registered was because it failed a Cash Verification, and add both of those to Longtop and CCME, two older Chinese frauds I've previously researched, both of which also had fraudulent cash numbers (among other sins, in CCME's case), and I reach a total of 5 out of the 5 Chinese frauds that I've closely studied had fraudulent cash numbers. (I can provide cites for each, but it's hard to do without being able to post LINKS; at any rate, I'm not lying).
What I'd primarily like to know is whether my experience is just a statistical fluke (I seem to be surrounded by them lately), or is this actually a pattern worth investigating?
1. First, c'mon, Chinese nationals, show a little imagination in your fraud. There's lots of ways to steal from a company, so why always the same M.O.?
2. Second, has anyone studied any other Chinese frauds and if so, was their problem also fraudulent cash numbers?
3. Finally, why does the cash line on the balance sheet always seem to be the problem in Chinese frauds? Is this part of those corporate cultural differences that I've had so much trouble getting my head around?
I had a potential breakthrough today in answering the "why is it always the cash number?" question, but it could use some peer review.
I'm thinking it might be due to the nakedness of Chinese fraud. What I mean is, since fraud in China stocks is usually someone outright stealing the company's cash, the balance sheet cash number is forced to "grow" for the following reason: the company always needs X dollars, just to run its day to day affairs, so that number's always got to be in the cash line, and it's real cash.
AND, the stolen cash also has to be included in the balance sheet's cash line, otherwise the theft would be discovered.
SO, the two together, real cash and stolen cash, must be reported as real cash. Therefore, the more that gets stolen, the more the cash number on the balance sheet has to grow, until, in not so very long, the cash number starts to look "too big" when compared to the company's industry peers (of similar size, until I figure out a ratio I can use).
Is that theory sound?
Chinese understand cash. They really have a problem with the accrual thing.
There is some cultural issues going on. Cleverness and obtaining something of value with less effort than your neighbor are respected individual characteristics. Westerners would use words like deceitful, dishonest, and cheating to describe these activities. The average Chinese desires the respect for these characteristics so much they will take a minor amount without consideration of the huge amount they are forgoing by being patient. Before being critical of this condition, consider the power elite in China can remember a time when the way Beijing fixed budget deficits is by systematically starving parts of the population, in the millions, to death. I am not sure how I would make decision, if in my mind I could consider that possibility.
In a weird way, a Chinese fraud not cash concentric would be a good thing. It would signal a maturing of the Chinese’s understanding of modern finance. They could collective make better decisions.
For someone whose half of their portfolio is in China from someone whose half of their earned income is in China, here are my rules for doing business in China. Always know where the quickest exit from a room is and sit with your back to a corner closest to the exit, then have fun.
My response to your post, by paragraph:
Para 1: Yeah, that's no fun.
Para 2: When Professor Gillis first laid out his China specific investment risks acronym for me, FIVE: Fraud, Inspection rights, Vie's and Esoteric corporate culture, I thought the last one sounded like fluff (was it added just because "FIV" isn't a word?). Little did I then know that the cultural differences would turn out be the most difficult aspect to understand by far.
Para 3: It might also make them better at fraud, a terrifying thought.
Para 4: Solid, solid, solid advice.
A couple of points need to be made. First, putting half your assets in Chinese stocks is too much. I have 25% of my portfolio in Chinese stocks and that may be too high. Second, the Chinese stocks that turned out to have problems or be outright frauds were not on the NYSE, did not have dividends and were not engaged in buybacks. So they have nothing in common with Xin other than the fact that they are Chinese. Would you avoid American stocks because of Enron??
If I were a less active investor, I'd reduce my 50% China stocks rule; I'd probably even consider your 25% rule as a possibility, so we're essentially in agreement on that.
I'd need to see research before I'd be willing to believe your theory that NYSE listed China stocks are any safer than Nasdaq listed China stocks. After all, the SEC rules governing both are identical.
We discussed dividends as a fraud indicator the other day; someone I respect, but I forget who now, mentioned that DEER paid dividends before it was unmasked, but I haven't verified that myself. But no matter how you slice it, there's no magic rule of "Any Dividend = No Fraud At All". If people start believing there is, the one thing we can count on is that every fraud in China will declare and pay a dividend. Remember, these companies still have millions of real dollars coming in and going out every month.
On Share Repurchase, my experience is that having it seems to make a company MORE likely to be a fraud. Of the 5 frauds I've studied in depth, 3 of them (60%) did Share Repurchases within a year or two before they were unmasked (CCME, ZSTN, CMEDQ).
In fact, Share Re-Purchase looks like it might be the usual first step in the new going private transaction, a transaction that would be a perfect fit for XIN, even more perfect than it's been for CMEDQ and ZSTN, the first two companies.
Sure, but even if stealing cash is the easiest way to stuff your pockets, wouldn't you at least make some basic moves to hide it?
Last night, Shel posted a LINK to an inventive Chinese national who invented a fake bank in Delaware, then "bought" it and stuffed his pockets with the $70 million, or whatever. Why don't more folks do something like that?
That way, the cash/equivalents number -- the top line on your balance sheet and the item that gets the single most scrutiny -- wouldn't be off. It also wouldn't start looking "too big" at any point.