Even as the latest doubts over accounting at a Chinese company sent investors fleeing from its shares, investors who specialise in ferreting out dodgy businesses say that a crackdown by Beijing is making their work more difficult and in some cases dangerous.
Shares of New Oriental Education & Technology Group Inc. lost more than half their value in two days, after the company said the U.S. Securities and Exchange Commission told New Oriental it was investigating the company’s corporate structure and a short-seller released a report critical of the education provider, which trades on the New York Stock Exchange. The stock gained back some ground Thursday after New Oriental issued a statement disputing the short-seller’s report.
The SEC didn’t return calls seeking comment Thursday.
New Oriental Education is the latest of dozens of Chinese companies that have come under fire by regulators and short-sellers in the past two years. Over the past several months, it has become harder to investigate these companies as corporate information has become harder to get and researchers have been harassed, say investors who seek to do due diligence on Chinese companies.
The Chinese government’s moves are part of a “broad-based clampdown of non-government-authorised information that involves the economy or investment,” says Steven Dickinson, a Seattle-based attorney at law firm Harris & Moure and co-author of the China Law Blog, aimed at multinationals doing business in the country.
What started as seemingly localised harassment of investigators and researchers by corporate security people and local authorities now also involves national government measures to crimp the availability of access to information about Chinese companies.
“Eight or nine months ago it was already getting dangerous to research a company,” said Dan David, a vice president at GeoInvesting LLC, an investment fund. “Back then you could still go back and talk to people you’d interviewed and get more information. Now it’s too dangerous to go back for a second turn.”
Mr. David said that in the second half of last year one of his fund’s investigators was knocked down and had his ID taken by security people at a company he was investigating. Mr. David said the man was standing across the road from the company’s factory counting trucks as they entered and left.
On April 20, China’s police started a campaign across 20 provinces against companies that conduct private investigations, according to an article in the People’s Daily, the Communist Party’s official publication, a week after the campaign began. That campaign was aimed at preventing investigators from getting personal information on individuals, the article said. In practice, the rules affected investigations of corporations because they often involve background checks into the political connections and other business interests of company executives.
As of April 28, more than 1,900 people had been detained in connection with the campaign, according to the front page story in the People’s Daily. People in the industry say more detentions followed.
The campaign came after it became almost impossible to access corporate records at the State Administration of Industry and Commerce, according to lawyers, investors and research companies. Such documents were typically the starting point for investors conducting due diligence on a company they were considering investing in. The State Administration of Industry and Commerce declined to say last month whether it had moved to limit what it once made public, but the Beijing-branch of the agency said some lawyers in the past had abused the availability of data by selling it.
Jon Carnes, who runs Eos Global Holdings, an investment fund, said three of his researchers, including a Canadian national, were detained in December during the course of an investigation, and still are greatly restricted in their movement. Mr. Carnes himself left China in October after living here for more than five years, saying it had become too dangerous.
Muddy Waters Research Inc., a well-known short-selling research firm, weighed in on New Oriental the day after the news of the SEC investigation, alleging that the company doesn’t actually own its network of schools, in part based on what it described as a conversation between the New Oriental and a potential franchisee.
New Oriental said in a statement Thursday that it allows third parties to offer a couple of niche programs in its name, but those programs are immaterial to its business and have never been included in its count of schools. “The Muddy Waters report is wrong,” New Oriental’s statement said.
The company’s shares closed Wednesday at $9.50 on the NYSE, down 57% in two days. Thursday afternoon, following the New Oriental statement, the stock was up 16% at $11.05.
Muddy Waters founder Carson Block said that in the course of his investigation into New Oriental one of his employees had been visited by officials from the Ministry of State Security. The Ministry of State Security couldn’t be reached for comment.
“The message that investigative firms are hearing [from state security] is that we do not want any more work done researching companies, especially public companies,” Mr. Block said.
On Tuesday, New Oriental said the SEC was investigating whether profit earned by its mainland-China-based “variable interest entity” can legitimately be included in the listed company’s financial statements. Such entities, known as VIEs, use a series of contractual agreements to enable an offshore holding company owned by foreign investors to effectively run a business inside China. However, foreign investors don’t have direct control over the assets in the VIE.
The controversy centres on whether the company has absolute control over these entities or if there is a risk that someone else can claim ownership, potentially wiping out some or all of the value of the company. In a conference call Tuesday, New Oriental President Louis Hsieh said he didn’t know what triggered the investigation.Dinny McMahon
The Wall Street Journal
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