Investing in Chinese stocks

Alibaba has certainly been in the financial news these past few weeks. It raised the most money - $25 billion - in its IPO than any other company. On its initial trading day it gained 38%. However, as Pam Martens points out, one should be very leery about investing in this or any Chinese company.

The problems are manifold. These Chinese companies are structured as Variable Interest Equities (VIE) and call the Cayman Islands their financial home. They are really shell companies; investors have a claim on the company's profits but are not owners. Chinese courts and arbitrators have invalidated VIE contracts. Actually, buying Alibaba shares is really buying shares in a Cayman Islands shell company. The prospectus actually states:

“The Alibaba Partnership and related voting agreements will limit your ability to nominate and elect directors."
“The equity holders, directors and executive officers of the variable interest entities, as well as our employees who execute other strategic initiatives may have potential conflicts of interest with our company."
“We cannot assure you that these individuals will always act in the best interests of our company should any conflicts of interest arise, or that any conflicts of interest will always be resolved in our favor.”

Several Chinese-based companies have been charged by the SEC with fraud. Also, the Chinese offices of some major accounting firms have been barred by an SEC Administrative Law Judge from auditing American companies.

Caveat emptor.