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Shell Game: SEC Backs Legislation to Stop China’s Dangerous Accounting Practices.

Half of Chinese Companies Listed on U.S. Exchanges Pose Potential Risk to Americans.

Photo for: Shell Game: SEC Backs Legislation to Stop China’s Dangerous Accounting Practices.

Key Points

  • SEC is attempting to accelerate the delisting of Chinese companies from U.S. stock exchanges.
  • 217 Chinese companies are listed on U.S. exchanges – but half are incredibly risky.
  • Chinese companies have been criticized for mass accounting fraud in recent years.

The Securities & Exchange Commission has had it with China’s shady accounting practices and they are supporting a new piece of legislation to protect U.S. investors. The gist: all Chinese companies must fall in line with traditional accounting standards or they’ll be delisted – period.

The Accelerating the Holding Foreign Companies Accountable Act (AHCAA) will facilitate a faster delisting process, allowing the SEC to act quickly to protect American investments from the volatile corporate structure known as a Variable Interest Entity (VIE).

So what is a VIE?

In order to get listed on foreign stock exchanges, China will use a VIE to create offshore shell companies used to finance projects without putting the whole enterprise at risk. This shady loophole allows companies to hide certain assets, keeping them off corporate balance sheets.

It also means investors are without voting rights and accounting information must remain in China – a decision the Chinese government claims is to protect “state secrets.” Because of VIEs, no one can easily know the extent to which companies are supported by the CCP.

This lack of transparency makes it difficult for Americans to get a good sense of what they are investing in. And, of the 217 Chinese companies on U.S. exchanges, 125 are VIEs. Delisting the companies could mean $1.5 trillion in losses to the U.S..

But not delisting could also be trouble – like with Luckin Coffee, China’s answer to Starbucks.

In 2020, less than a year after its IPO, Luckin Coffee, imploded due to the discovery of severe accounting fraud. The company was found to be inflating its revenue by almost half of its sales. When this was uncovered, the company’s stock price plummeted over 80% in a day, and much of the value held there belonged to U.S. investors.

Last year, congress passed the Holding Foreign Companies Accountable Act (HCAA), demanding China improve accounting standards and submit to audits or face delisting from U.S. markets within three years – but it wasn’t enough. With the AHCAA, delisting will happen in two years.

VIEs present a legally questionable loophole for China and the United States. The Chinese government reserves the right to ban such practices at any time, but they haven’t taken action. Hopefully, this new legislation, with a push from the SEC, will curtail the use of VIEs.