Chinese companies with dual-listed stocks were seeing their prices plunge in Hong Kong trading here on Friday after the U.S. Securities and Exchange Commission began identifying companies that are afoul of new accounting rules.
While the SEC has identified only five companies so far, the spillover effect is sending south the shares of companies such as Alibaba Group Holding (BABA) and HK9988. They are cursed by connection, not direct implication, after the SEC's action.
The securities watchdog has published a list of five U.S.-listed Chinese companies that are noncompliant with their accounting. This means they violate the Holding Foreign Companies Accountable Act and ultimately could be delisted. They have until March 29 to submit evidence disputing their inclusion on the list.
The highest-profile name on the list is Yum China Holdings (YUMC) and HK:9987. Yum China shares were down 8.0% in mid-afternoon trading in Hong Kong; they had fallen as much as 12.4% after their 10.9% fall on Wall Street the day before. Yum China was spun out of Yum Brands (YUM) and runs fast-food restaurants in China under brands such as Pizza Hut, KFC and Taco Bell.
The other four companies include three biotechs: cancer drug developer BeiGene (BGNE) and HK6160; cancer and autoimmune drug specialist Zai Lab (ZLAB) and HK:9688; cancer and immunology drug maker HutchMed (HCM) and HK:0013; and semiconductor cleaning equipment maker ACM Research (ACMR) . ACM Research is the only company among the five that is not listed in Hong Kong.
These five companies are only the start. The SEC said it will be adding to the list. These companies have been targeted only because they happened to file their 2021 annual reports first, according to the brokerage China Renaissance.
The issue threatens to affect all Chinese companies with U.S. listings, explaining why other such companies are falling in Hong Kong even though they're not on the list.
E-commerce operator JD.com (JD) and HK:9618 is the worst performer on the Hang Seng Index, down 12.3% in early afternoon Asian trading as it followed through on a 15.8% fall on Wall Street the day before.
Rival Alibaba Group Holding was off 5.8% in Hong Kong after dropping 7.9% in New York.
The two companies dominate e-commerce in China as the local equivalents of Amazon.com (AMZN) and then some, but have suffered in the face of regulatory pressure from U.S. and Chinese authorities.
Grocery delivery app operator Meituan (MPNGF) and HK:3690 is another notable name falling in Hong Kong. It's down 6.6%. JD.com, Alibaba and Meituan are the worst performers on the benchmark Hang Seng Index, in that order. Meituan is notable because its primary listing is in Hong Kong, with only an over-the-counter ADR available in the United States.
The four dual-listed companies on the list fell hard at the open. BeiGene shares plunged 10.9% in first moves and are down 6.3% in the Hong Kong afternoon after a 5.9% fall in New York; Zai Lab dropped as much as 16.5% but was now showing a 6.2% decline at this writing after falling 9.0% in New York; HutchMed remains down 12.2% but was off as much as 16.1% at its lows in Hong Kong, more than double the 6.5% fall on Wall Street; and ACM, with no Hong Kong listing, is simply posting its 22.1% descent in U.S. trading.
Congress passed the Holding Foreign Companies Accountable Act into law in December 2020. It requires any non-U.S. company listed in the United States to file accounts that can be audited by the SEC's accounting arm, the Public Company Accounting Oversight Board.
The SEC said the five companies hired accounting firms in a jurisdiction where the oversight board cannot inspect or investigate company filings. China has prevented overseas entities from auditing the work of Chinese accounting firms, even the local wings of the Big Four, saying it is necessary to prevent any sharing of state secrets.
Another point of contention is that the U.S. law requires companies to declare whether they are owned by a foreign government. This is a highly complex situation in China, where the Chinese Communist Party, provincial governments and cities all have a variety of corporate holdings and all ultimately answer to the Communist hierarchy and President Xi Jinping. Some private companies have written into their charters that the Communist Party cell within the company can override the directions of management and the company board.
The China Securities Regulatory Commission (CSRC), the equivalent of the SEC, is the entity charged by Chinese law with coordinating with overseas entities on any sharing of local auditing. But the SEC wants direct access to the books. So the SEC and the CSRC have established rules that are impossible for U.S.-listed Chinese companies to follow. They can only keep one regulator happy at a time.
The Holding Foreign Companies Accountable Act applies to all international listings in the United States but is widely seen as directed at Chinese companies after a string of accounting scandals.
The case of Luckin Coffee brought the issue to a head. The would-be Starbucks (SBUX) rival listed on Nasdaq under the ticker "LK" to much fanfare in May 2019. I told investors at the time that they "should not buy into the company's growth story" and should sell the shares if they owned them. The numbers simply didn't work out that it could add seven stores per day with any guarantee they were in the right location and well-run. It wanted to be bigger than Starbucks, which had been expanding in China for more than 20 years, in just over two years. It didn't make sense.
Luckin's plans unraveled in less than a year, as I explained in a follow-up column. By April 2020, the company was forced to admit that several employees, including the chief operating officer, had been fabricating sales numbers. The shares cratered. Luckless Luckin pulled the Nasdaq listing but is still available over-the-counter.
Outright fraud would be hard to detect even if the SEC could inspect the books. But it is entirely reasonable for the U.S. stock watchdog to say that U.S.-listed stocks must file accounts to the same standard as any other company listed on U.S. markets.
Companies can be delisted from U.S. markets under the new law if they do not provide auditable accounts for three consecutive years, so the SEC citation is only the first step. Chinese companies have time to respond, but as I've indicated, it may be impossible, legally, for them to do so.
Essentially, the securities regulators in China and the United States need to sit down and hash this one out. Failing to do so would require the delisting, basically, of all Chinese companies from the United States. There's some sentiment in Congress that companies from a Communist country, with many state-owned enterprises, should not be freely raising capital in the heart of capitalism, on Wall Street. But U.S. investors would be poorer if they cannot access the "China story" and stocks such as Alibaba.
