There have been very few moments of complete bipartisanship over the last 20 years, but there was a bill passed unanimously in the Senate on Wednesday. The subject of that bill was the oversight of Chinese companies that are listed on U.S. stock exchanges. Seeing such agreement from Democrats and Republicans was rather shocking and the timing was just as shocking.
At a time when the COVID-19 crisis has the country divided on almost every topic and the economy hitting record low readings in many categories, I was shocked to see a unanimous vote. President Trump has been extremely critical of China and how they handled the coronavirus that has turned in to a global pandemic. With that as the backdrop, it was extremely surprising to see all Democratic senators vote in favor of the bill.
The bill was co-written by Senators John Kennedy (R) of Louisiana and Chris Van Hollen (D) of Maryland. The gist of the bill requires Chinese companies listed on a U.S. stock exchange to submit to the same audits that other companies are subjected to. The audits are conducted by the Public Company Accounting Oversight Board (PCAOB), an audit watchdog. A secondary part of the bill would require companies to certify that they aren’t under the control of a foreign government.
On the surface the bill seems to make a lot of sense. Why shouldn’t foreign companies be subjected to the same audit standards as domestic companies? My question is, why haven’t they been required to do so for all these years? Regulators have been reluctant to delist Chinese companies from the New York Stock Exchange or the Nasdaq, even as the PCAOB and SEC have attempted to pressure Chinese authorities to open up the books.
The idea behind the audits is pretty simple: protect investors from fraudulent activity. If a company based in Dayton, Ohio has to adhere to these standards, why shouldn’t a company based in Beijing be subjected to the same requirements?
The current relationship between China and the U.S. is on shaky ground due to the health crisis. The trade negotiations that played out throughout 2018 and 2019 are now in doubt as well and that makes the timing of the bill somewhat interesting. It seems like getting China to play on a level playing field is a subject that Democrats and Republicans agree on and that means it may not play a role in the November elections.
While the timing of the bill is interesting due to the coronavirus, there could be another underlying factor behind that timing. A Chinese coffee company and its questionable accounting methods could be playing a part as well. Luckin Coffee (Nasdaq: LK) debuted on the Nasdaq exchange on May 17, 2019. There wasn’t a great deal of fanfare around the IPO and the initial price was $17. From the debut through early November, the stock danced around the $20 price level. That changed in mid-November as the stock took off on a tremendous rally and the price breached $50 in January.
On April 2, 2020, Luckin accused its own COO of fabricating sales figures by $310 million. That’s the huge gap in the chart as the stock plunged 80% in one day. Trading was suspended from April 7 through May 19. Trading was reopened on Wednesday and investors rushed to the exit in order to salvage any value they could before the Nasdaq delists the company. Trading volume jumped to 153 million shares as the price plummeted to $2.40.
The fraud at Luckin could be emblematic of a greater problem. The PCAOB was created in 2002 and it was due in part to some of the fraudulent activity we saw during the dot.com boom in the late ’90s.
San Francisco based equity research firm Muddy Waters Research wrote a research report on Luckin in January and the report warned of the possibility of inflated sales figures. The company also thinks there are a number of other cases of Chinese companies issuing false statements. “This is again a wake-up call for U.S. policymakers, regulators, and investors about the extreme fraud risk China-based companies pose to our markets,” founder Carson Block said in a statement to CNBC.
Hopefully the fraudulent activity isn’t too rampant as it would harm investors. And hopefully the bill is a success and leads to more bipartisan legislation, as long as the legislation makes sense as it does in this case.