Bloomberg News

China Internet Stocks Fall in New York on U.S. Investigation

September 29, 2011

(Adds analysts’ comment from eighth paragraph.)

Sept. 29 (Bloomberg) -- Chinese Internet stocks tumbled in New York trading after a top U.S. securities regulator said the Department of Justice is reviewing allegations of accounting fraud at firms operating out of the Asian nation.

Sina Corp., owner of the Twitter-like Weibo service in China, fell 9.7 percent and Baidu Inc., operator of China’s most popular online search engine, dropped 9.2 percent after Securities and Exchange Commission Enforcement Director Robert Khuzami made the comments in an interview with Reuters that was published today.

“There are parts of the Justice Department that are actively engaged in this area,” Khuzami told Reuters in comments about allegations of possible fraud that were confirmed by John Nester, a spokesman for the SEC. Laura Sweeney, a Justice Department spokeswoman, declined to comment on whether criminal authorities are involved.

At least four Chinese Internet companies fell sharply today, triggering an SEC short-selling restriction that forces traders who want to bet on a further drop to wait after the stocks fell 10 percent from the prior day’s closing level. Youku.com Inc., China’s biggest online-video site, sank 18 percent, the most this year. Sohu.com Inc. fell 4.7 percent after losing 11 percent earlier in the day.

Sina’s shares slid to an eight-month low of $72.23 at 4 p.m. in New York, after plummeting as much as 16 percent earlier. Baidu’s American depositary receipts declined to $110.29. They earlier lost as much as 12 percent.

Intensified Scrutiny

In the past year, regulators have intensified scrutiny of China-based companies listed on U.S. exchanges amid concern that the firms weren’t complying with accounting standards. The SEC and exchanges have delisted or halted trading in more than a dozen such companies this year, and the agency has sued firms and auditors over bogus disclosures. The SEC only has power to file civil claims for securities law violations, while the Justice Department can file criminal charges.

The SEC’s investigation has focused on so-called reverse mergers, in which closely held firms buy shell companies that allow them to sell shares on exchanges without the scrutiny that would surround an initial public offering. None of the four Internet companies affected by the SEC restriction today were listed through reverse mergers.

VIE Structure

The slump in Internet companies was also caused by investors’ “fear” about their variable-interest entity listing structure, according to Jeff Papp, a Lisle, Illinois-based analyst at Oberweis Asset Management Inc. In a VIE arrangement, a Chinese entity holds the license needed to operate a website, and foreign investors exert control over it through a set of contracts, rather than a direct ownership stake.

“People are extrapolating that because of a non-normal listing structure that automatically means there’s something bad there,” Papp said, adding the four companies imposed with the SEC’s short-sale curb were all listed through the VIE structure.

China’s Commerce Ministry is studying ways to regulate foreign investments through VIE structures, ministry spokesman Shen Danyang said Sept. 20.

Legitimacy

“Investors outside of China can face challenges fully understanding the regulatory landscape -- and the VIE is one of those structures whose legitimacy has not been set in stone yet,” Kevin Pollack, a fund manager at New York-based Paragon Capital LP who invests in U.S.-listed Chinese stocks, wrote in an e-mail.

The big Internet names are especially vulnerable to selloff pressure because of their higher valuations to peers, according to Papp at Oberweis Asset. There is “continued aversion to risk,” he said. “High-beta names are just not in favor in the current environment.”

Sina’s shares are traded at 144 times its trailing earnings, compared with 13 for stocks in the New York Stock Exchange Arca China Index, which dropped 0.5 percent today. The multiple for Baidu is 50.

SEC officials have said they can’t adequately police the firms in part because the Chinese government bars U.S. regulators from inspecting auditors based in that country. Officials from the two countries have met in recent months to discuss the issue.

The SEC this month filed an enforcement action against Deloitte Touche Tohmatsu Ltd.’s China affiliates for failing to produce documents related to an investigation of Longtop Financial Technologies Ltd, which said last month that Deloitte quit because of errors in the company’s financial records. The Deloitte affiliates have said they cooperated with the SEC as much as possible under Chinese law.

--With assistance from Jeff Bliss in Washington. Editors: Gregory Mott, Lawrence Roberts, Marie-France Han

To contact the reporters on this story: Joshua Gallu in Washington at jgallu@bloomberg.net; Belinda Cao in New York at lcao4@bloomberg.net

To contact the editor responsible for this story: Lawrence Roberts at lroberts13@bloomberg.net


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