A Blog by Jonathan Low


Jun 14, 2012

Chinese IPOs Routinely Forced to Buy Illicit Protection to Thwart Negative Coverage

That many of the Chinese companies going public in Shanghai, Shenzhen, Hong Kong and New York are not what they seem is no longer a secret. In the US, the number of companies being de-listed by stock exchanges for accounting irregularities has grown exponentially. And most of them are Chinese.

Chinese officials have so far refused to cooperate with the US Securities and Exchange Commission's investigations of Chinese companies listed in the US or selling shares there. The reasons have to do with reflexive distrust of foreign, especially US government inquiries, the potential loss of face associated with Chinese company misbehavior and China's competitive desire to become a dominant global financial player.

It appears, however, that Chinese investors and entrepreneurs may be suffering more than those in the US. Rings of corrupt accounting, public relations, legal and financial operatives are siphoning off billions in yuan through threats, intimidation and blackmail. According to the following report from the respected Chinese business magazine, Caixin, Chinese laws are being broken. But this system is generating so much revenue for those involved that officials are probably receiving a cut.

The problem for global investors is that investing in Chinese is highly speculative and those who suffer, even if Chinese, have little recourse.

The much more serious problem, for China, is that its accounting and financial reporting is viewed with deep suspicion. The country's reputation as a credible investment has suffered grievous harm and capital flows have chilled. Until the country recognizes that effective governance and a good reputation are more important than making a quick, illicit profit, it will continue to be regarded as an unreliable business center, with all that implies for future growth. JL

Lu Yuan reports in Caixin:
Buying media silence is a common first step toward an initial public offering in China that siphons billions of yuan every year from companies seeking investors in Shanghai and Shenzhen.

The phenomenon has been documented by the China Securities Regulatory Commission (CSRC). It involves public relations and law firms that cut deals with media outlets and IPO-bound companies, and company officials who, for all practical purposes, are victims of extortion.
Executives at a company who fear bad press due to a checkered past, personnel management issues, financial problems or anything that may raise an investor red flag often willingly pay off the media to protect a stock debut.

Dishonesty in China's investment world likewise plays into some company decisions to try building investor trust through news distortion by, for example, paying financial newspapers to publish glowing reports about an IPO plan. Others pay Internet search engines to scrub archives, or hire public relations or law firms to help them work with media outlets to sanitize company history.

Of all the sources interviewed for this report, none agreed to have their personal or company names published by Caixin. Most said they feared retaliation from the media they exposed.

A senior CSRC official said it was wrong for media outlets to abuse their power at the expense of IPO candidates, but that his agency and other authorities have been powerless to stop the practice because extortion victims refuse to talk.

A leading PR firm manager admitted it is an everyday task for his agency to help clients cut deals with media extortionists, even though he would rather arrange road shows for companies preparing for the stock market.

Publish and Perish

CSRC requires any company planning to list to publish all information related to its IPO in one of four, official newspapers – China Securities Journal, Shanghai Securities News, Securities Times or Securities Daily – and the online platform www.cninfo.com.cn run by a Shenzhen Stock Exchange subsidiary called Shenzhen Securities Information Co. Ltd.

However, according to an equities agent who works for a recently listed high-tech company, most IPO candidates buy space for announcements in all four official newspapers, even though the rule says one is enough.

"If you pay only two of them, the other two will write negative reports," he said. "Moreover, the amount paid for the advertisements (in each publication) must be the same, or there will be trouble."

Buying space across the board "also can save some trouble," he said, "because these media companies usually won't write negative reports about a company once they receive payment for an ad."

Threats of attacks on reputation from some other media firms are usually more blatant, he said.

A typical warning goes like this: Unless your company buys an ad, my publication will release sordid details about your company that trashes your fund-raiser.

It is difficult to verify whether these threats could cause real damage, he said. If a company indeed has something to hide, it would have no choice but to pay.

Web portals and search engines play the game, too. The vice president of a company familiar with the Internet schemes said some portals offer to wipe negative reports off a main page for one price, and remove them from an entire website for another.

"There is a price scale depending on whether the information does not appear on the main page, the finance page or with stock market data," he said.

Even low-ranking search engine editors can find ways to share in the spoils, another company equities agent said. For a few thousand yuan, an editor may agree to clear an expression or word from a search function.

An online ad sales agent said kickbacks may be paid to PR firms that help websites blackmail companies. Other PR firms offer to help companies fight media extortionists, while certain law firms actually make most of their money through pre-IPO extortion plots.

A general manager at a public relations agency familiar with the schemes said about 70 percent of all enterprises with plans to list on the Shenzhen exchange's ChiNext growth board are targeted.

And the CSRC knows it. "Every ChiNext-listed enterprise has spent an average 6 million yuan on this," a CSRC official said.

"It's an open secret," a public relations source said. "Some people may have broken laws. But no one is investigating."

Cold Sweat

Business executives who've survived an IPO in China say they agonized for months during the CSRC application review period and in the run-up to the release of a prospectus before a stock debut. They were well aware that the media vultures could attack at any time.

"I was nervous every day," said a manufacturing company executive. "Calls from the media started the day CSRC started reviewing our application. Some wanted to arrange interviews. Others tried to extort us and threatened to publish negative reports."

One equities agent said he dealt with a reporter from a leading Beijing newspaper who demanded his company spend at least 100,000 yuan on ads to protect its reputation. After a close look at the reporter's threat, though, the company refused to pay.

"We found the information" in the reporter's hands "was only an analysis of risks mentioned in the prospectus," he said.

In another case, a manager for a company that recently listed on ChiNext described signing a 4 million yuan deal through a public relations firm in exchange for ads in several influential securities newspapers.

"All advertising contracts were signed between the media and the PR agency," the manager said. "We neither saw the contracts nor supervised their execution."

The manager said the agency "promised to spend the money on several media outlets out of a pool of 20. They decided which ones to choose and when to place the ads, arguing they knew the media industry better."

Another manager said his company bought 200,000 yuan worth of protection through a PR agency. Half the money went to the media outlet's editorial offices, he said, and half went to the advertising department.

Some publications in China work to protect newsroom integrity by separating editorial and ad departments. But extortionists can find ways around a wall by, for example, arranging for each side to receive its own payoff.

"I have no clue whether the money was indeed given to the media's editorial department or how it was distributed," the manager said. "There is no proof or receipt. The PR agency told us this is how things work in the business."

The names of several mainstream media outlets appeared on the company's written agreement with the PR agency, which the manager showed Caixin.

"There were 10 media companies with high impact," he said. "Each company receives 200,000 yuan, which adds up to 2 million yuan. Ten media companies with less influence each received 100,000 yuan.

"Three million yuan was gone in a blink of eye, and that was just the first round."

But sometimes even steep payoffs are not enough to protect a company's image. IPO applicants have been known to play one outlet's extortion game and later fall victim to another.

"I have a client that was reported on by a competitor" who handed a negative report to a media outlet, said the director of investment banking at a major brokerage. "Media coverage followed, and the company had to spend more than 10 million yuan to settle things."

Outright lying was cited among the reasons why CSRC rejects IPO requests. Last year the commission turned down 16 percent of all applications, , financial data analyst Wind Information Co. reported.

CSRC typically has hundreds of applications waiting on its desk at any one time. Some 515 companies were waiting for regulatory approval to go public as of January, CSRC said, including 220 ChiNext candidates and 295 combined for the main boards in Shenzhen and Shanghai.

Companies that get a thumbs down usually have trouble proving sustained profits or fail information disclosure tests, said a CSRC source. Moreover, said a manager at one company, public attention influenced by media coverage can affect how members of a CSRC committee rule on an IPO application.

Under a whistleblower rule, any negative report filed with CSRC during an IPO application review can, if deemed credible, trigger a special regulatory investigation. Sometimes this clause gives an IPO hopeful's competitor a way to plot an extortion scheme with or without a an attack on reputation.

Whistleblowers have been known to emerge from among a company's competitors, disgruntled former employees or former advisors, such as investment banks that used to work for the IPO applicant.

A particularly vindictive whistleblower can send damaging accusations to a financial newspaper reporter and CSRC officials at the same time, prompting widespread media attention that scares off potential investors and destroys an IPO.


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