American Investors Threatened By China’s Defiance Of Reporting Laws

China’s hazards presented to American capital markets and investors have been at center stage in the last week because of reports of impending disaster for the Chinese firm Evergrande. The now uncertain future of the more than $305 billion in debt carried by Evergrande points up the need for Congress to act to protect domestic investment markets.

Federal law requires all companies that issue securities in the U.S. to submit auditing records to the Public Company Accounting Oversight Board (PCAOB) and the U.S. Securities and Exchange Commission (SEC) to protect investors and ensure that audit reports are accurate. 

China has prevented auditors of Chinese companies from submitting the required reports. The SEC has warned China that its companies will be delisted from U.S. stock exchanges if they comply. However, the SEC has granted Chinese companies a three-year grace period. 

Chinese firms have done exceptionally well thanks to American investors, and as of May, 248 Chinese companies are listed on U.S. exchanges, with a total market capitalization of $2.1 trillion.

China has ordered auditors not to comply with U.S. reporting requirements even though corporate fraud is well-known and longstanding among Chinese companies. 

Luckin Coffee was discovered last year to have falsified large portions of its revenue statements that investors relied upon. The company’s stock price at the time fell to $1.48 per share, down from a high of $51 the year before. 

Soon after that, another Chinese company traded in the U.S., TAL Education Group, disclosed that an employee had fraudulently inflated its revenue figures through a series of forgeries. The company’s share price then fell by 23 percent in a single day.

The accounting scandals exemplify the risks faced by American investors who rely on unaudited financial allegations of some Chinese firms.

Several U.S. administrations have attempted to negotiate with the Chinese government regarding compliance with American law, although China has never acquiesced. Whenever accounting firms in China have been threatened with administrative action in the U.S., they have responded that compliance would cause violations of Chinese law.

In 2020, Congress passed the Holding Foreign Companies Accountable Act (HFCAA), and President Trump signed it. The HFCAA finally requires that records be submitted to PCAOB and the SEC on the penalty of delisting on American exchanges. However, the HFCAA is only triggered after three consecutive years of noncompliance.

A concern is that by 2024, China’s domestic capital market will be developed to the point that companies that have flourished on American exchanges for years will return to China for listing. As things stand, investors in Chinese companies have very little to rely upon in the way of honestly audited accounting.