U.S.-listed Chinese stocks were rattled in late May when the Senate passed a bill that would crack down on Chinese stocks, forcing them to prove they are not controlled by foreign governments and increasing their financial transparency. While investors of stocks such as Alibaba Group Holding Ltd - ADR (NYSE: BABA) and JD.Com Inc (NASDAQ: JD) are looking to prepare for the potential impact of the new legislation, experts don’t yet seem to have a clear picture of how the situation will play out.
On May 21, the Senate passed the Holding Foreign Companies Accountable Act, which would require foreign companies listed on the Nasdaq or NYSE to certify that “they are not owned or controlled by a foreign government.”
The bill would also require each of these foreign companies to have their auditors inspected by the Public Company Accounting Oversight Board for at least three consecutive years. Chinese stocks that failed to comply with the new requirements could be delisted from major U.S. exchanges and even potentially be banned from trading on the OTC markets.
Why It’s Important
The major U.S. exchanges have strict financial transparency requirements when it comes to accounting and financial filings. Yet a handful of recent fraud revelations related to Chinese companies such as Luckin Coffee Inc - ADR (NASDAQ: LK) and TAL Education Group (NYSE: TAL) suggest the U.S. Securities and Exchange Commission hasn’t been able to adequately enforce the regulations.
Given the close involvement the Communist Party of China has in many large Chinese companies, it may be difficult for some of these U.S.-listed companies to meet the new requirements.
Typically, when stocks are delisted from the Nasdaq and NYSE exchanges, they trade on the OTC market, which has less rigorous financial disclosure requirements. Some large Chinese companies such as TENCENT HOLDING/ADR (OTC: TCEHY) already trade on the OTC market.
The bill passed in the Senate would reportedly even ban delisted stocks from trading on the OTC markets.
Another factor that muddies the waters is the fact that companies like Alibaba and Baidu Inc (NASDAQ: BIDU) utilize a corporate structure called a variable interest entity, or VIE. For example, U.S. investors don’t directly own shares of Alibaba, but rather a VIE that is headquartered in the Cayman Islands and is contractually linked to Alibaba’s business.
Benzinga reached out to several online brokers to get some clarity on what shareholders of these Chinese stocks should expect if their stocks are eventually delisted.
A spokesperson from Interactive Brokers Group, Inc. (NASDAQ: IBKR) said it’s “just too early in the process to really know what will happen.”
A spokesperson for TD Ameritrade Holding Corp. (NASDAQ: AMTD) similarly said they are “not going to be able to weigh in” on what investors can expect if their stocks are delisted.
The price action in major Chinese stocks since May 21 suggests U.S. investors may see the legislation more as political posturing ahead of the U.S. election in November than an actual threat to these companies.
Shares of JD.com are up 4.1% since May 21, while TAL Education shares are up 11.6% in that stretch.
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One Theme Is Popping Up Among These Chinese Companies: Fraud
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