China Deals Meet Growing Scrutiny as Suntech Spurs Questions

Chinese Deals Meet Growing Scrutiny as Suntech Sparks Questions
Suntech Power Holdings Co. Ltd. signage is displayed outside of the company's facility in Goodyear, Arizona U.S.. Photographer: Ken James/Bloomberg

Suntech Power Holdings Co.’s admission that it may have failed to verify the existence of German bonds it accepted as loan collateral adds to growing concerns about Chinese business practices that are sparking a wave of lawsuits and regulatory probes.

It’s the third time in a week that internal controls at Chinese companies have been found lacking. The U.S. Securities and Exchange Commission froze assets of traders it accused of insider trading ahead of Cnooc Ltd.’s $15.1 billion deal to acquire Nexen Inc. And fund manager Peter Siris and his Guerrilla Capital Management agreed yesterday to pay more than $1.1 million to settle SEC allegations of “wide-ranging misconduct” related to a Chinese reverse-merger firm.

As Chinese investments in North America and Europe rises and corporate governance standards remain at odds with Western practice, more such allegations and investigations are likely, said Andrew Karolyi, a professor of finance at Cornell University.

“One of the big concerns is that we cannot impose the typical scrutiny that we would like, in terms of the audit function, for a lot of these companies,” said Karolyi, who researches cross-border capital flows and international companies that cross-list their shares on Western exchanges.

Fraud Victim?

Suntech, the world’s largest solar manufacturer, discovered potential irregularities as it sought to sell its stake in Global Solar Fund S.C.A., Sicar, an investment company managed by a former Suntech sales representative, Javier Romero. Suntech accepted 560 million euros ($687 million) of German bonds as collateral when it guaranteed a 554.2 million-euro loan in May 2010 provided by the state-owned lender China Development Bank Corp. for a company that backed Global Solar Fund.

Suntech said yesterday the bonds “may not have existed and Suntech may have been the victim of fraud.”

The incident raises questions about reporting practices at Suntech and other Chinese companies, said Ben Kallo, an analyst at Robert W. Baird & Co. in San Francisco. Some report costs that don’t include depreciation or shipping, for example, or recognize revenue for power-generating assets before they’re sold.

“It’s not always apples to apples,” Kallo said. “It gives you the impression they’re hiding something even if they’re not.”

Freezing Assets

In the Cnooc deal, the SEC obtained a court order July 27 to freeze assets of traders who allegedly reaped more than $13 million by trading illegally ahead of Cnooc’s July 23 announcement that it would buy Canada’s Nexen.

Hong Kong-based Well Advantage Limited, controlled by Zhang Zhi Rong and other unidentified traders, stockpiled shares of Nexen based on confidential information about the deal, the SEC said. The court order froze about $38 million in assets, the agency said.

“This may be the tip of an iceberg suggesting that the government in China has to be more careful about their business and business partners,” Joseph Fan, co-director of the Institute of Economics and Finance at the Chinese University of Hong Kong, said in an interview yesterday.

Other Chinese companies are facing U.S. regulatory scrutiny.

The SEC sharpened its focus on shell companies about two years ago amid complaints that issuers, many from China, were using them to enter U.S. markets through so-called reverse mergers. In a reverse merger, closely held firms buy shells that let them sell shares on exchanges without the scrutiny that would surround a public offering.

Guerrilla Settlement

The agency announced yesterday a settlement with Guerrilla Capital, which had sold unregistered securities and engaged in unregistered broker-dealer activity and illegal insider trading linked to China Yingxia International Inc., a reverse-merger company, according to a complaint filed in Manhattan Federal Court.

The SEC said in May it had halted trading in 379 shell companies, and several reverse-merger companies have seen their share prices plummet amid allegations that their financial statements were inaccurate. The agency has sued companies including Puda Coal Inc., SinoTech Energy Ltd. and Longtop Financial Technologies over claims they engaged in fraud.

Investigations have been hampered by Chinese law, which prohibits auditors from turning over information to U.S. regulators. The legal impasse has prompted several rounds of dialogue between the SEC and Chinese regulators and is also being played out in U.S. court.

SEC Lawsuit

The SEC sued Deloitte Touche Tohmatsu CPA Ltd. for failing to produce documents related to the agency’s investigation of Longtop Financial, a former client of the Shanghai-based audit firm. The company also audited Suntech’s 2011 annual report, which describes its relationship with GSF. Wilfred Lee, a spokesman based in Hong Kong, said the company couldn’t comment on Suntech’s situation today, citing confidentiality agreements with its client.

“Many of these firms came from the state-owned enterprise system, where the people who manage corporate assets are not necessarily business leaders, but government officials,” said Nicholas C. Howson, a professor at the University of Michigan Law School who researches Chinese corporate and security law.

“The people in charge aren’t that used to running up against fiduciary duties or the obligations of directors or officers as fiduciaries, much less the idea of a public prosecutor who will come onto the horizon and say, ‘You’ve let down your shareholders,’” Howson said in an interview yesterday.

Romero Claim

Suntech said it’s filed lawsuits in multiple jurisdictions against Romero, the former sales representative. The company has filed claims “against relevant parties in multiple jurisdictions” to assert control of Romero’s company and its assets, which include solar projects with 145 megawatts of capacity in Italy, the solar company said.

Romero couldn’t be located for comment, and e-mail sent to an address located on the GSF website wasn’t returned yesterday.

“Access to U.S. markets is not a one-way street. It comes with duties and responsibilities,” U.S. Senator Charles Schumer, a Democrat from New York, said in an e-mail yesterday. “If China wants to invest here, it needs to get serious about its standards for corporate governance and about providing reciprocal treatment for U.S. companies looking to do business over there.”

Chinese companies are beginning to improve their governance practices, Cornell’s Karolyi said. In the meantime, the cultural friction has created “an ongoing tension as to what these firms are and what their intentions are,” he said.

Even when the conflicts are from miscommunication, “the intensity is high because the stakes are more elevated than ever before, not only for investors but for the companies themselves.”

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