Banking & Finance

Dish the dirt

Short-sellers put Chinese firms’ governance back in the spotlight

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Toxic dispute: chemical firm is biggest target so far for short-sellers

In its vision statement, Hong Kong-listed Tianhe Chemicals says its fundamental goal is to “bind various chemical elements, reconcile the five elements and pay attention to the harmonious co-existence between man and nature”.

The company also emphasises how it adheres to Daoist principles, quoting the moral precept forbidding false speech.

“In all things at Tianhe, we place the highest value on loyalty and truthfulness,” it proclaims.

But the company’s relationship with its shareholders has been anything but harmonious since hacktivist research group Anonymous Analytics (AA) accused it of fraudulently inflating its revenues and profits. In a 67-page report published on September 2, AA said that months of due diligence led it to believe that Tianhe is “one of the largest stock market scams ever conceived”.

One of its many accusations targets Tianhe’s tax data. According to AA, if Tianhe’s financial statements were accurate, then its tax payments would exceed all revenues collected by the tax authorities in the jurisdictions in which it operates.

To sum up its warnings about fraud, AA gave a zero target price for the chemical firm, which has a market value of $8 billion.

Investor reaction was swift – the stock dropped nearly 5% before being suspended from trading at the Hong Kong Stock Exchange (HKEx). Three days later, Tianhe released a short statement refuting AA’s allegations as “false, misleading and highly malicious”.

This week, Tianhe followed up with a further rebuttal, this time running to 25-pages. The chemical firm’s dossier includes a copy of a genuine signature of its chairman Wei Qi, while accusing AA’s report of containing falsified documents with forged signatures in Wei’s name. Tianhe also warned that its “email system has been hacked into” this week and that trading in its shares won’t resume until the HKEx’s concerns are addressed.

True to its name, few details are available on AA’s background. Nevertheless the secretive research group isn’t new to Hong Kong’s investing public. Vegetable grower Chaoda Modern is still suspended from the HKEx three years after AA first accused it of falsifying its financial statements, for instance.

Software firm Qihoo 360 was another target for AA in the past.

Tianhe is the biggest Chinese firm to have been targeted by a short-seller-style study of this type. The fact that it is in the crosshairs at all will surprise some, given it only listed in Hong Kong in June and so ought to have been through an exhaustive due diligence process (it raised $650 million, making it the fifth-largest Hong Kong IPO this year). Prior to AA’s allegations, its stock had climbed 35% from its offering price and was set for inclusion in the Hang Seng Composite LargeCap/MidCap Index, which is tracked by many index funds.

At this point, public investors hold about $950 million of its shares based on Tianhe’s 12.6% of issued capital. A number of pre-IPO investors, some of them attached to the listing’s underwriters, own roughly 15%. This means some investment banking reputations are also on the line. (Only one month earlier, Hong Kong regulators had warned IPO sponsors that they could be criminally liable for false information in prospectuses.)

And Tianhe is not alone in coming under scrutiny. Just one day after AA’s raid, Emerson Analytics published research accusing sausage-casing maker Shenguan of falsifying data. Shenguan has a smaller $1.1 billion market capitalisation, but trading in its shares is also now suspended. In a remarkably similar rebuttal, Shenguan’s management said that the report contained “errors of fact, misleading statements and malicious allegations”.

The controversy has put short-sellers back in the spotlight. Theircritics wonder why the likes of AA and Muddy Waters (which published a damning report on Sino-Forest in 2011, see WiC111) are allowed to trade on share price volatility fuelled by the negative reports they publish.

This should be a matter of concern for all regulators, the Hong Kong Economic Journal notes, given that a negative report published by an anonymous researcher, or even a rumour on blog posts and social media, is sometimes more market-moving then conventional investment bank research.

In one of the latest cases, a netizen posted on a Hong Kong internet forum that UnionPay, China’s equivalent to Visa, might go public in Hong Kong via a reserse takeover of SEEC Media, a Hong Kong-listed firm attached to Caijing magazine.

The information – which the author claimed to have “overheard in the subway” – was enough to send SEEC’s share price soaring almost 40% higher, helped by the previous acknowledgement from UnionPay that it is planning a listing, as well as SEEC’s later disclosure that its controlling shareholder had sold a 16% stake to a third party.

“Collusion between capital markets and social networks is spreading to a deeper and broader level,” the Securities Times reckons, adding that social media is becoming an effective conduit for spreading price-sensitive information and gossip.

That’s why Chinese authorities have been keen to crackdown on the spread of rumours flowing over the internet. Just last week, the China Securities Regulatory Commission banned listed companies and their executives from publishing news via social media networks before making related regulatory disclosures. (About 17% of A-share firms have opened verifed weibo accounts. Many company bosses are also active members of the microblogging platform.)

Conventional media outlets are being targeted too. Last week, police detained eight journalists, including the chief editor of the website of leading financial newspaper 21CN Business Herald. They face prosecution for collaborating with public relations firms to extort money from listed companies in return for positive editorial coverage.

CCTV, the state broadcaster, has been investigated for similar practices (see WiC246).

Of course, regulatory drives in China can sometimes end up looking a little overzealous.

For example, an investor called Wang Weihua was detained in Shanghai last November by police from Xinjiang on charges of fabricating information. Wang wrote blog posts alleging accounting tricks and manipulation of stock prices at a local firm and the company reported him to police. But he is insisting via his lawyer that his analysis was based on publicly available information and that he hasn’t benefited personally from the bad publicity about the company (see WiC214).

Wang’s trial began in Xinjiang last month and Ye Tan, an outspoken financial columnist, describes the legal charges against him as “absurd”. She sees a worrying trend of powerful businessmen using defamation laws to stamp out unfavourable criticism.

“Will critical comments and undercover investigations in future be banned?” Ye wondered on the Financial Times’ Chinese website. “The rise of short-selling-style reports could actually become the beginning of China’s capital market rationality.”

Organisations like Muddy Waters and AA do indeed argue that they are acting in the public interest. Their associates may benefit from short-selling, but that is not sole raison d’etre for trying to uncover fraud. Their success in battering stock prices also speaks volumes about investor faith (or lack thereof) in Chinese company filings and audit reports. “One problem is that people are all too willing to believe the worst of Chinese corporate governance,” IFR concludes.

Whatever happens, one likely outcome from the latest AA attack is an overhaul of Tianhe’s website. Rather unusually it features the William Blake poem Auguries of Innocence, which seems a tad ironic in the current circumstances. (Although management may like the couplet: “The gnat that sings his summer song/ Poison gets from slander’s tongue.”)

AA remains defiant, mind you. In an emailed response to the Wall Street Journal regarding Tianhe’s denials it said: “This further increases our confidence. Management’s half-response comes off as weak and ineffectual. We will respond to Tianhe’s ramblings shortly.”


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