China's cold shoulder paves way for more shady U.S. listings

Traders work on the floor of the New York Stock Exchange, June 1, 2011.

SINGAPORE/BEIJING (Reuters) - A spate of accounting scandals involving U.S.-listed Chinese companies has hit New York exchanges as calls for China to punish those responsible go unheeded.

China's reluctance to respond to U.S. regulatory or political pressure, the apparent complicity of some mainland banks and the relative ease of listing in the United States ensure that the accounting shenanigans will continue to thrive.

U.S. investors are experiencing first hand the challenge their Chinese counterparts have faced for years: how to tell a fraud from a gem in a domestic market long plagued by fast and loose accounting practices.

China Electric Motor Inc on Monday joined a growing list of companies, headed by Longtop Financial Technologies, that have revealed potential accounting frauds.

China Electric, whose shares have been suspended from trading since late March, said auditor MaloneBailey had resigned, citing discrepancies in the company's bank records.

Scandals like this have forced U.S. regulators to press their counterparts in China for help in tackling financial crime.

But if they are banking on taking Sino-U.S. regulatory co-operation to the next level, industry experts say they are mistaken.

"There's been no evidence that Chinese regulators are paying much attention to this stuff at all," said Paul Gillis, a visiting professor at Peking University and author of the China Accounting Blog.

Financial fraud is hardly a new phenomenon to the U.S. market, where memories of Enron remain fresh. Even sophisticated finance professionals fell for Bernard Madoff's Ponzi scheme.

And in China securities regulators periodically vow to combat fraud and insider trading in the domestic market, though there have been few high-profile crackdowns in recent years.

The frauds involving U.S.-listed Chinese companies put U.S. regulators in a difficult spot: they can suspend or delist companies' shares and penalise the U.S.-based auditors who signed off on their accounts, but cannot easily punish Chinese executives.

To do so, they need their counterparts in Beijing to play ball and help with investigations. That remains tough given the politics involved.

"It is a political issue and the SEC needs to be sensitive to those considerations if they want to receive the co-operation of the CSRC (China Securities Regulatory Commission) for an investigation," said Alan Seem, a partner at U.S. law firm Shearman & Sterling in Beijing.

An April 27 letter by SEC chairman Mary Schapiro underlined these difficulties, noting that some countries, including China, viewed the regulator's efforts to access witnesses and information on alleged fraud as "a possible violation of sovereignty and/or national interest."

CSRC did not respond to requests for comment by Reuters.

SOURING INVESTOR APPETITE

There are now more than 200 Chinese companies listed on the New York Stock Exchange or Nasdaq, lured across the Pacific by the prestige and relative ease of a U.S. listing.

U.S. investor appetite for tapping into China's huge economic potential is starting to sour as scepticism grows about the veracity of many of these companies' financial records.

What started as a series of scandals at a handful of small Chinese firms that went public via a reverse takeover has moved up a level in recent months, with a number of companies that went public through a full IPO with credible underwriters and auditors being accused of fraud.

Last month Longtop, which listed on the New York Stock Exchange in 2007, disclosed that its auditor Deloitte Touche Tohmatsu CPA had resigned, alleging the company falsified some of its financial records.

Longtop's shares are now suspended pending an SEC investigation, joining another 15 Chinese firms currently subject to a trading halt on the NYSE or Nasdaq.

Deloitte's resignation letter claimed Longtop's bank told the auditor previous financial confirmations they provided were false and omitted details of significant borrowings and incorrectly stated the deposit figures.

Lawyers say such accounting manipulation is relatively common in China, where some companies are still unfamiliar with the reporting standards required by capital markets.

"The employees of many Chinese companies see auditors as a necessary evil that has to be endured for the purpose of getting access to capital markets , " said Tom Fyfe a partner at Barlow Lyde and Gilbert in Hong Kong who specialises in disputes involving fraud and auditor liability.

AUDITOR CHALLENGES

America hopes one way to improve accounting standards and detect potential fraud earlier will be if China allows U.S. audit watchdog, the Public Company Accounting Oversight Board, to inspect auditors working for U.S.-listed companies on the mainland.

PCAOB chairman James Doty told Reuters he was hopeful there may be an agreement later this year.

However, this is unlikely to be enough to trigger a major improvement, some experts say. For a start, it's not necessarily the case that most U.S.-listed Chinese companies have worse auditors than those in the rest of the world -- indeed, many use the local offices of the big four accounting firms.

And auditors are operating in an environment where not all listed companies accept corporate governance norms required for publicly owned enterprises in the west.

"A lot of these companies will, on the face of it, seem to have some kind of check and balance - some independent non-executive directors and an audit committee. But many of these committee and board members tend to get pushed around by the management and either will not or cannot help when the auditors come to them," said Fyfe at Barlow, Lyde and Gilbert.

The quality of disclosure for companies listed in the mainland has improved, said Ding Yuan, a professor of accounting at the China Europe International Business School.

"Having worked in China, Europe, and the US, on a comparable basis I have to say that the quality of financial reporting in China is pretty good," he said.

But companies set on deceiving investors have plenty of tools at hand.

One is that Chinese companies trying to fiddle their books often apparently find it relatively easy to get help from their local bank branch and other key financial intermediaries.

"Many of these scandals have one thing common: the involvement of local bank officials in the forging of bank confirmation," said Gillis, of Peking University.

"China needs to step in and clean up its banking sector, because these types of activities are damaging the reputation of China's banks globally," he added.

(Additional reporting by Melanie Lee in SHANGHAI, Elzio Barreto in HONG KONG, and Benjamin Kang Lim in BEIJING; Editing by Muralikumar Anantharaman)