Robert Khuzami, Director, SEC Enforcement (Photo credit: Wikipedia)
A second shoe has dropped in the SEC’s ostensible effort to crack down on the “red collar” crime wave. The term refers to stock scams emanating from China that, by TheStreet.com’s estimate, already by last year had cost U.S. investors at least $34 billion. As I pointed out on Tuesday, this scandal puts the United States and China on an epic collision course.
The news this morning is that allegations of accounting fictions at Deutsche Bank are now a hot-button issue at the SEC. Deutsche Bank’s troubles may seem a long way from China but the two scandals are linked by an important common factor: Robert Khuzami, the SEC’s director of enforcement. He happens to have been Deutsche Bank’s general counsel at the time of that bank’s alleged cover-up. Now he is – at least when the cameras are rolling – leading the charge to clean up the Chinese accounting profession.
An analysis of the Deutsche Bank flap, and Khuzami’s involvement in it, has been published in today's Financial Times – just three days after Khuzami, very belatedly, announced plans to get tough on the China stock scams. This raises an interesting question: is Khuzami sincere in his effort to tackle crooked Chinese accounting? Or was his tough-sounding statement last Monday merely intended to front-run an FT story that he knew was in the works?
Even before today’s news, skeptics had wondered whether he has the intestinal fortitude to stand up to Beijing. The long-established pattern in U.S. relations with East Asia after all does not bode well. Whether we are talking about Japan, Korea, Taiwan, or China, the story of the last fifty years has been the same: American officials sound tough in going after controversial East Asian financial and economic practices but nothing of value to the American national interest ever seems to result. The truth is that East Asian officials are not only famously intransigent in the face of American pressures but famously creative in cooking up compromises that, while they sound convincing to the American press, are eviscerated by fine print that neither the American not East Asian sides is interested in disclosing. The East Asian bet is that Americans are superficial, short-term thinkers with a mindset that rarely extends beyond the next quarter and certainly not beyond the next election cycle. Thus the strategy – pioneered by Japan and now faithfully copied by China – is to procrastinate and in the ultimate stitch together a piece of make-believe that will buy off the Americans until U.S. public opinion moves on to something else.
The basic issue here is that Beijing considers the auditing of Chinese businesses – even the least of them – a matter of “national security.” Thus Chinese auditors, including those working for the Big Four international accounting firms, are comprehensively banned from sharing their work papers with foreign regulators. Meanwhile the SEC insists on the right to vet the auditing worldwide of any corporation listed on an American exchange.
As the U.S.-born, China-based accounting expert Patrick Chovanec points out, the U.S. and China are headed for an “accounting Armageddon.” If the SEC presses the issue, the result could be the delisting of countless Chinese stocks from American exchanges. Another prominent China-based observer, Michael Pettis, goes even further, raising question marks about the listing of any American corporation that derives a significant share of its profits from China. He cites in particular Yum Brands, which owns KFC and derives 44 percent of its revenue and 50 percent of its gross profits from China. Other American corporations with large exposure to China -- and with similar Gordian-knot style accounting issues -- include Starbucks, Coca-Cola, and McDonald’s.
I am conducting my own analysis of the China stock scandal -- a scandal I think of as "Sweet-and-Sour-Gate." American investors are treated to Chinese stocks with apparently delicious financial profiles. Then everything suddenly goes sour. I want to build a file of victims' experiences, so if you have been caught by the scams, I would like to hear from you. I will be writing again in due course, and it goes without saying that the identity of my sources will be treated in the strictest confidence. Please email me at efingleton@gmail.com.
