Chinese fraud – something to worry about? Last week, Chinese Communist Party member Lei Zhengfu was forced out of his role as the boss of Chongqing’s Beibei District after a tape showing him having sex with an 18-year old mistress circulated online. The scandal was quite broad and indicates how business is generally done in China. Yes, a bit salacious headline but is there something beyond this story about what is happening in China?

Yesterday the US financial regulator has charged the Chinese units of five accounting firms – including the so-called Big Four – over refusing to hand over auditing data on China-based companies. Now this is a little more serious. The companies are under investigation by the Securities and Exchange Commission for “potential accounting fraud against US investors”. The nine China-based firms are publicly traded in the US. The five firms are the Chinese affiliates of the Big Four – Deloitte Touche, Ernst & Young, KPMG and Pricewaterhouse Coopers – as well as the accounting firm BDO’s China unit. Claims of fraud and questionable auditing standards at several US-listed Chinese companies, for example Sino-Forest Corporation, have dented investor confidence. China’s state law says that Chinese company records can be claimed as state secrets. The firms have cited this in refusing to release their records.

What are they hiding? Remember, the charges are against the accounting firms, so this puts into question almost all Chinese company records, let alone official government released economic statistics. We have often wrote of potential fraud in China – click here and here. I have always believed, if a man has something to hide, there is generally a good reason. I think this case is no different.

However, the China growth story does continue and I am sure that governments in the end will allow the cover up to continue. For us we should be aware of two things that eventually can not be hid. First is the social dis-cohesion and mistrust of the government, that this will cause in the general Chinese population. It for sure will lead to unrest. Secondly, it will definitely put a damper on further Chinese growth, as investors will be wary. This makes my view of global growth in emerging countries, flat relative to recent norms at best, with the obvious fear that if it is worse than we are being told, there is more risk to the downside than the upside.

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Blue Point Trading Market View – December 05, 2012

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