With the American economy taking its first steps toward re-opening after months of lockdown, businesses and public officials alike must now confront staggering losses across the market and evaluate how to best focus their recovery efforts. Public pensions, already struggling with staggering unfunded liabilities in many states, have been hit especially hard by this crisis. As we move forward, it is imperative that fund managers take the necessary steps to re-focus their investment decisions, ensuring that pensions aim to maximize returns for the public servants who have paid into them. However, now more than ever, it is also important that public officials take a closer look at how American financial markets operate, how publicly listed companies are held to account, and whether or not investors really know what their money is buying.
Recently, lawmakers from both parties have increased their scrutiny of many Chinese companies listed on U.S. financial exchanges, noting that they have not been subject to the same level of oversight and regulation as companies from the U.S., or, for that matter, anywhere else in the world. Given the sheer size of and potential of many of these companies, Chinese and American investors alike have been understandably enthusiastic about the prospect of major Chinese corporations making inroads into American financial markets – U.S.-listed Chinese companies currently have a market capitalization of over $1 trillion. However, in some cases a lack of transparency has prevented an honest accounting of company prospects, leaving investors in the lurch. The most prominent example of this is Luckin Coffee, once touted as the Chinese Starbucks. When it first launched on NASDAQ last year, it was valued at around $12 billion. However, increased scrutiny after the launch quickly told a different story – namely, that hundreds of millions of dollars in transactions had been fabricated in an effort to boost valuation. Prospects quickly diminished, and NASDAQ eventually suspended trading in Luckin stock. The Chinese government has subsequently launched a fraud investigation into Luckin in cooperation with the SEC.
Luckin serves as a case study illustrating challenges U.S. regulators face in conducting oversight for the audits and financial reporting of Chinese companies listed on American stock exchanges. According to the SEC, Chinese law requires that the records of transactions and events be kept in China and not transferred out of the country. Chinese state security law is often used to narrow American regulators’ ability to supervise the financial reporting of Chinese companies listed in the United States. Beijing also invokes national security to restrict foreign access to Chinese entities’ books and curb American efforts to audit these corporations, allowing these companies to circumvent regulations their American peers on the exchanges cannot.
Investors should be careful investing in these companies as long as this issue goes unaddressed, or they may fall victim to the next Luckin: a huge corporation that attracts investors with creative accounting rather than actual value.