FPI / August 21, 2020
Commentary by Jason Orestes
Luckin Coffee, a Chinese company listed in the U.S. was once worth nearly $13 billion before it was unearthed that half of its sales, some $300 million, was fraudulent. The stock plummeted well over 90 percent and decimated U.S. investors.
This isn’t an isolated incident.
Chinese companies have been perpetuating dishonest and deceitful behavior for some time by way of cooking books, reverse-merger scams, and opaque accounting. It’s driven the Trump administration to finally enforce equal accounting standards for all foreign participants who enlist on our exchanges, a rule the Securities Exchange Commission is expected to adopt next year.
And it looks like we may have another substantial Chinese fraud on our hands, as the SEC is now opening an investigation into the “Netflix of China”, also known as iQiyi (IQ).
In its quarterly earnings release, IQ said, “The SEC‘s Division of Enforcement is seeking the production of certain financial and operating records dating from January 1, 2018, as well as documents related to certain acquisitions and investments that were identified in a report issued by short-seller firm Wolfpack Research in April 2020.”
Wolfpack Research, in a scathing report appropriately titled “iQiyi: The Netflix of China? Good Luckin” makes explosive accusations that claim IQ inflated its revenue by 27-44 percent and overstated its users by 42-60 percent. They said IQ gets away with this by inflating the prices it pays for expenses, content, and other assets to burn this fictitious cash and deceive its auditors and shareholders.
Wolfpack asserts this has been going on for some time and that IQ has been committing fraud “well before its IPO in 2018, and has continued to do so ever since.” IQ is Nasdaq listed and claims to have 100 million paying users and $1 billion in revenue.
IQ has of course come out strongly asserting that Wolfpack Research’s allegations are without merit, issuing a press release, “IQ has been made aware of and reviewed the short seller report published by Wolfpack Research on April 7, 2020. IQ believes that the report contains numerous errors, unsubstantiated statements and misleading conclusions and interpretations regarding information relating to IQ.
IQ emphasizes that it has always been and will remain committed to maintaining high standards of corporate governance and internal control, as well as transparent and timely disclosure in compliance with the applicable rules and regulations of the Securities and Exchange Commission and the Nasdaq Global Select Market.”
The stock fell more than 14 percent on the news.
Interestingly, IQ has also recently stated it has retained a team of advisers to conduct an expansive internal review of Wolfpack Research’s claims. It hasn’t advised of any timeline associated with the review and stated it can’t predict its outcomes or potential consequences.
This thematic type of behavior by Chinese firms is precisely why the US State Department has asked that American colleges divest their holdings of Chinese equities from their over $600 billion in endowments. The Trump administration has also discouraged their purchases by pensions as it warns of a potential “wholesale delisting” of Chinese firms.
“The boards of your institution’s endowment funds have a moral obligation, and perhaps even a fiduciary duty, to ensure that your institution has clean investments and clean endowment funds,” Keith Krach, undersecretary for economic growth, energy and the environment, wrote. “I also ask that you strongly consider publicly disclosing to your campus communities immediately all People’s Republic of China companies that your endowment funds are invested in, especially the PRC companies in emerging markets index funds.”
The investments made in these pensions impact real, every day Americans relying on them to exist. Luckin Coffee was a very popular stock that crushed retail investors. This fraud isn’t hurting just Wall Street or hedge funds, it’s robbing blue collar citizens who trust the integrity of U.S. capital markets.
This kind of business behavior is intolerable, and the real shame is how long the US has allowed it to go on unaddressed. Thankfully, it looks like the U.S. and SEC are finally standing up for their own standards and beginning to demand the same transparency from foreign companies that we provide them.
Jason Orestes (@market_noises) is a former Wall Street financial analyst who focuses on contemporary political developments affecting economics, markets, and culture. His commentary can be found on Washington Examiner, TheStreet, MSN Money, RealClearMarkets, and RealClearPolitics.
FPI, Free Press International