Do You Know Where Your China Stock CFO Lives?

  • Posted by
  • on June 7th, 2011

UPDATE: The CFO of a US-listed Chinese firm read this post and sent me the following comments. For obvious reasons I am not going to disclose the identity of this person, but the CFO’s company had top-tier venture investors and was taken public by big investment banks.

The CFO is right. The mere fact that a company has an an absentee CFO does not mean that is a fraud. But, we have certainly seen that some of the recent frauds are companies with absentee CFOs. I stand by my suggestion that the SEC require disclosure of the geographic location of the CFO, and that investors ask this question as part of their research.

From the CFO:

Bill, I read your article about where the CFOs live and how that would affect the investment decision. All I can say is it is not that simple. If a Chinese company is based in Beijing, Shanghai and a few other first tier cities, it would be weird (not a warning sign) to find the CFOs living elsewhere but that city. However, if a Chinese company is based in some third tier city, it is hard to find some CFOs that would move his/her family and spend 100% of the time there. In most cases you will find the CFO commute between the company HQ and one of the first tier cities…

…I agree that Chinese companies do need to disclose more to get investor confidence. Look, it is the big environment that is making this mess. The root cause is the government.

END UPDATE

Some investors are learning, usually after all their money has disappeared into the maw of a Chinese stock fraud, that the CFO does not actually live in the same city as corporate headquarters. In fact, he may not even live in China.

Longtop ($LFT) had a sometime absentee CFO. Derek Palaschuk did not live in Xiamen. Of course he spent time there, and telecommunicated from offices in Shanghai and Beijing, but that is no substitute for being in HQ and on top of the company finances. In fact, according to one Longtop investor with a painfully large position in the stock, Palaschuk spent a significant portion of the last year living in Vancouver, Canada. Is Palaschuk just a foreigner hired to front for the Chinese company and sell the stock to other foreigners, kind of a China fraud beard? (See Caution Needed When Investing in Chinese Firms – CNBC for more on this.) Or was he deeply involved in the financial operations of the company, even if somewhat remotely?

Absence may make the heart grow fonder, but it definitely makes faking financial statements easier.

David Horsley, Sino-Forest’s CFO, lives in Canada, even though the company’s operations are in China. Sino-Forest’s stock has cratered, though the allegations of fraud are unproven. Horsley makes a nice living as a long-distance CFO–USD $2.5m in the last year according to Reuters.

Does the SEC require disclosure of the geographic location of the CFO? Do investors ask these questions? How can they get comfortable if the CFO is not a regular presence in HQ?

Our friends over at iChinastock (disclosure: I am an advisor to their parent company Snowball Finance) have created a list of 5 Warning Signs That A Chinese Stock May Be a Fraud:

1. Company went public through an OTCBB Transfer or other ways of back-door listing;

2. Company name starts with “China” [unless they are state-owned they can not register a company in China starting the word "China"];

3. The products are sold in China, but there is minimal Chinese-language information about those products;

4. The business defies common sense;

5. The underwriter, audit firm and accounting firm are second tier and/or have a track record of missing frauds (like Deloitte China).

To this list I would add a sixth warning sign:

6. The CFO does not live in the same city as corporate HQ and is not a regular presence there.

There are lots of good investments out there. Why risk your money on firms with absentee CFOs?

You can follow me @Bill on Stocktwits@Niubi on Twitter and @Billbishop on Sina Weibo.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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