By Pam Martens and Russ Martens: April 1, 2021 ~
We rarely make predictions but we’re going to make one with confidence today. The New York Stock Exchange’s efforts to capture more market share of the IPO business by listing highly questionable Chinese companies and blank-check companies (SPACs) with no prior business history is going to inevitably blow up and cause long-term reputational damage to an institution that is indelibly linked to U.S. markets.
Despite U.S. markets now showing all the earmarks of unbridled corruption fueled by insatiable greed, anti-regulatory Republicans in Congress are still calling U.S. markets “the envy of the world” and demanding a hands-off approach. Rather than actually being “the envy of the world,” the rest of the planet actually remembers that it was inadequately regulated U.S. markets that blew up the global economy in 2008.
RLX Technology, an IPO (Initial Public Offering) that had its debut on the New York Stock Exchange on Friday, January 22 of this year, is Exhibit Number 1 for what we are talking about.
According to a mention in the New York Times on Monday, RLX Technology is one of the stocks that contributed to the implosion of the hedge fund Archegos Capital Management, which has resulted in billions of dollars in losses at global banks – with billions more yet to be announced.
RLX Technology has been in business three years. It sells something that society needs less of, not more of. The company calls itself an “e-vapor company in China” catering to “adult smokers’ needs.”
The prospectus for its IPO is Orwellian in terms of the panoply of risks cited to its future business prospects. And there is also this fun fact in the prospectus:
“We have identified a material weakness in our internal control over financial reporting.”
Exactly what is that material weakness? The prospectus tells us this:
“The material weakness identified relates to lack of sufficient competent financial reporting and accounting personnel with appropriate understanding of U.S. GAAP to design and implement formal period-end financial reporting controls and procedures to address complex U.S. GAAP technical accounting issues, and to prepare and review the consolidated financial statements and related disclosures in accordance with U.S. GAAP and financial reporting requirements set forth by the Securities and Exchange Commission, or the SEC.”
Nonetheless, the New York Stock Exchange listed this company and it began trading on January 22 of this year. The IPO was priced at $12 a share and the stock, notwithstanding all of those risks cited about its future prospects, closed at $29.51 on its first day of trading – an increase of 145.92 percent – which gave the three-year old company a valuation of $46 billion. At that time, its most recent year of reported earnings had come in at $7 million for 2019.
Compare that valuation to the current market cap of Ford Motor Company which has been in business since 1903 and produces something actually useful – as in automobiles used to get to work each day or drive the kids to school. The Chinese vaping company achieved a valuation of $46 billion in one day of trading which is just $2.7 billion shy of the total market cap of Ford Motor Co. which has 118 years of business history.
On its second day of trading, Monday, January 25, RLX Technology traded intraday at a high of 35, making some folks very rich if they sold out at that point. Then along came the sleepy hour of 5:18 in the morning on Monday, March 22. One of the very risks that lawyers for RLX Technology had so carefully mapped out in the 219-page prospectus came to life.
The international wire service, Reuters, reported that “Two of China’s regulators plan to bring the rules governing the sale of e-cigarettes and other new tobacco products in line with those for ordinary cigarettes.”
Prior to that announcement, shares in RLX Technology had been trading between 4 and 5 million shares a day. By the close of trading on Monday, March 22, the stock had traded 107.47 million shares, closed at $10.15 a share, losing 48 percent of its price from the prior Friday’s close. On Wednesday, March 24, another round of selling pressure erupted with 53.4 million shares changing hands. The stock closed at $8.94. As of yesterday’s closing bell, RLX Technology was $10.36.
Exactly how significant a role shares of RLX Technology or equity derivative contracts on it played in the crash of the hedge fund Archegos Capital Management is still unknown.
What is known, however, about most Chinese companies listed on the New York Stock Exchange is that there is very little transparency about the quality of their audits. The RLX prospectus spells out that problem as follows:
“The financial statements included in this prospectus were audited by an auditor based in China, and their audit work currently cannot be inspected by the U.S. Public Company Accounting Oversight Board. If audit work performed in China is not able to be so inspected for three consecutive years, recent U.S. legislation may require that our securities be delisted or prohibited from being traded ‘over-the-counter.’ This could have a material and adverse impact on the value of your investment.”
The Securities and Exchange Commission is completely aware of the risks to American investors in allowing these opaque Chinese companies to continue to list and trade in the U.S.
Since 2010, the Securities and Exchange Commission (SEC) has initiated dozens of fraud cases against China-based firms and dozens of those firms have been delisted from U.S. exchanges – after U.S. investors have been fleeced in most cases.
Many of these frauds involved Chinese companies that went through an IPO using big-name Wall Street firms as underwriters.
In January of 2014, the SEC won a ruling from an administrative law judge, Cameron Elliot, barring the Chinese affiliates of the Big Four accounting firms from leading audits for companies listed on U.S. exchanges for six months as a result of their refusal to turn over their audit work papers on companies under investigation by the SEC. The accounting firms had argued that they had to refuse turning over the documents in order to avoid violating state secrecy laws in China. The accounting firms were Deloitte Touche Tohmatsu CPA Ltd., Ernst & Young Hua Ming LLP, KPMG Huazhen and PricewaterhouseCoopers Zhong Tian CPAs Ltd. One accounting firm, BDO China Dahua Co., Ltd., received only a censure since it had already withdrawn as a registrant in the U.S. market.
The scathing decision delivered by Elliot against the auditors should have given the SEC the power to ensure it got the audit papers it needed in the future to safeguard U.S. markets. Instead, on February 6, 2015, the SEC caved, simply fining the accounting firms $500,000 each and receiving an admission that the auditors did not produce the documents before the proceedings were instituted against them. The SEC continued to allow the auditors to route their requests for audit papers through the Chinese regulator, who remained free to refuse the request.
In 2020, Congress passed the Holding Foreign Companies Accountable Act (HFCA) which was signed into law on December 18, 2020 by President Donald Trump. The law requires that any business that doesn’t allow their audit to be inspected for three years is to be ejected from the New York Stock Exchange or Nasdaq. The HFCA also requires that companies applying for listing in the U.S. disclose if they are under government control.
On March 18, the SEC signaled that it intends to begin implementing the law. It released its first interim final rule on the HFCA for public comment.