In a March 23, 2014 whitepaper titled: “Cheating in China: Corporate Fraud and the Roles of Financial Markets” authors Minwen Li and Tanakorn Makaew reported on a study on how financial market monitoring affects corporate fraud in China. They came to the conclusion that financial markets play a crucial role in fraud prevention.
Financial markets play a crucial role in fraud prevention.
From the report, “Corporate fraud scandals have plagued emerging markets such as China. In 2012, the China Securities Regulatory Commission (CSRC), the main regulator of security markets in China, received 380 allegations and investigated 316 cases involving financial fraud, false information disclosure, and other violations of the securities laws. Given that there are 2,494 companies listed on Mainland China’s two stock exchanges, such prevalence of fraud threatens to strain capital market activity and overall economic growth.”
Case in point, DEER, a Chinese designer, manufacturer and seller of small home and kitchen electric appliances. Back in Feb 2012, I picked a small position this stock based on the financials provided via Schwab, TD Ameritrade, Yahoo and other publications. According to these reports, DEER has a PE ratio of 3.978, one of the lowest in the Appliance and Tool industry. DEER has a Net Profit Margin of 17.405, making it one of the most profitable in its industry. In March 2012 I bought more on the heels of yesterday’s annual report announcing record results! By August 2013 the lies caught up with DEER and the stock was halted.
This despite that fact that the National People’s Congress (NPC) began to amend the Securities Law and the Company Law in 2003, both of which took effect on Jan 1, 2006. NPC also passed Amendments to The Criminal Law (VI) in 2006 to clarify the responsibilities of listed companies related to breaches of the law, and impose heavier punishments for violations.
Lesson: I don’t know how anyone can trust financials from any company based in China.