Jul. 07, 2020
Senator Tim Scott, Senate Finance Committee (sent via website https://www.scott.senate.gov/contact/email-me)
Senator Lindsey Graham (sent https://www.lgraham.senate.gov/public/index.cfm/e-mail-senator-graham)
Senator Marco Rubio (sent via website https://www.rubio.senate.gov/public/index.cfm/contact)
Cc: Jay Clayton chairmanoffice@sec.gov
Edward Heys, Managing Partner Deloitte & Touche - eheys@deloitte.com
Dear Senators, Chairman, Mr. Heys,
I write this letter as a United States citizen, a casual investor and a believer in our system. However, I also write this letter from the great misunderstanding or misrepresentation the United States is deploying onto the investor regarding emerging markets and China operations.
The SEC has scheduled a roundtable discussion for this Thursday, June 9th and want to make sure that my thoughts were expressed and you have ample opportunity to summarize your thoughts and influence the appropriate parties to fix this gross negligence. (https://www.sec.gov/page/emerging-markets-roundtable)
I have spent some time recently reading, understanding and educating myself on the various laws, impacts thereof and oversight that the United States provides in these scenarios, and quite frankly I am shocked at the lack of control and oversight we have deployed. Quite frankly, I find it quite alarming that the United States government would allow other countries to play by different rules than what they apply to their own companies.
I believe our government and the appropriate divisions within, have failed to recognize or worse chose to ignore for political gain, the basic rules that should be applied to China and emerging markets.
I often find sometimes governments lose perspective on the bigger picture with all the negotiations and gamesmanship behind the scenes so I decided to write this letter and from the perspective of how different parties might see some of the issues; SEC, a typical investor what a kindergarten might say. I don’t do this to make this a joke or belittle the message. I do it, to clarify how sometimes we lose the end game and how sometimes working a little smarter might get us there.
Issue #1: China doesn’t share with the United States Audited (GAAP) results)
1. SEC Response: “The SEC’s ability to ensure that investors and other market participants have access to high-quality, reliable disclosure and financial reporting, including by providing meaningful, principled oversight and enforcement, is substantially limited in emerging markets including China. In these markets oversight and enforcement is significantly dependent on the actions of local authorities—which, in turn, are constrained by an array of national policy considerations in those countries, including resource constraints and the primacy of local law and practice. As a result, there is substantially greater risk that disclosures will be incomplete or misleading and, in the event of investor harm, substantially less access to recourse, in comparison to U.S. domestic companies. I also note that the ability of U.S. authorities to bring actions against non-U.S. persons, including company directors and officers, in emerging markets is often limited. In my experience, when this individual accountability is lacking, investor risk increases significantly.” Jay Clayton’s letter.
2. A Typical Investor Response: “Are you kidding me? This isn’t happening already? who let this happen?”
3. Kindergarten Response & Solutions: “That’s not fair. Share and share a like.”
Real World Solution: Every document should have the same structure, requirements and procedure for submission. If emerging markets want our investment dollars, they should play by the rules set by that countries governing body. Imagine if you played sports with rules that were different for both teams. It would be chaos. The fundamental principle of investing is truth in the numbers.
Issue 2: The PCAOB doesn’t have full authority over issuances on United States exchanges
1. SEC / PCAOB Response: “Increased SEC and PCAOB Oversight of International Auditing Firms Regarding their Work in China—2019 and 2020. Along with PCAOB Chairman Duhnke and members of the SEC staff, I met with senior representatives of the four largest U.S. audit firms in November 2019 and February 2020 to discuss audit quality across their global networks and certain of the challenges faced in auditing public companies with operations in emerging markets, including China. 5 Most recently, in March 2020, we continued these meetings with two additional audit firms. In these meetings, we have made it clear that with the PCAOB restricted in its inspection efforts in China, we expect U.S. audit firms to bring appropriate increased attention and resources and have the appropriate internal and cross-network quality controls in place. These meetings addressed various issues, including acceptance and retention policies, independent internal and cross-network review processes, training, benchmarking and the anticipated and potential effects of COVID-19.”
2. Typical Investor Response: “Hold on… so your saying the watchdog is watching the watchdog? What happened when we let Boeing control the FAA?
3. Typical Kindergarten Response ” It doesn’t matter what you say you believe - it only matters what you do.” (Robert Fulghum)
Real World Solution: On a U.S. level, this should be easy. On a quarterly basis, every china firm on the U.S exchanges gets reviewed by another firm. Both are held accountable for the results. This should require audited financials.
Issue 3: SEC is Shifting the Responsibility And Playing The Blame Game
1. SEC Response: “Quality of Financial Information, Requirements and Standards Vary Greatly. Investors and financial professionals should carefully consider the nature and quality of financial information, including financial reporting and audit requirements, when making or recommending investments. Issuers should ensure that relevant financial reporting matters are discussed with their independent auditors and, where applicable, audit committees.”
2. Typical Investor Response: “Say What? Why don’t you get the information, create a standard and enforce compliance? Its not that difficult. “
3. Kindergarten Response: “When we go out into the world, watch out for traffic, hold hands, and stick together.”
Real World Solutions: In todays technology savvy world, compliance should be the easy part. Corporations and individuals are forced to fill out information a very specific way everytime they enter something on the web or computer. Compliance with specific reports, etc. particularly reporting structures that have been around since the beginning of time, eg. Balance Sheets.
An Example To Illustrate Fraud and Abuse – GSX Techedu (Beijing, China) :
Although the list of fraudulent companies is long, I strongly encourage you look at GSX Techedu, Inc a China based education firm trading on the Nasdaq to see some of the challenges a US investor faces when investing in a China based firm. For the naïve, this looks like an online education company that has had wild success since is initial public offering on June 6, 2019. Their website describes their company as the following:
GSX Techedu is a technology-driven education company and a leading online K-12 large-class after-school tutoring service provider in China. GSX Techedu offers K-12 courses covering all primary and secondary grades as well as foreign language, professional and interest courses. GSX Techedu adopts an online live large-class format to deliver its courses, which the Company believes is the most effective and scalable model to disseminate scarce high-quality teaching resources to aspiring students in China. Big data analytics permeates each aspect of the Company’s business and facilitates the application of the latest technology to improve teaching delivery, student learning experience, and operational efficiency.
Governance Issues – Board of Directors
The board of directors is made up of 4 individuals, what is interesting about this board, is every individual is on the Audit Committee, Compensation Committee and Nominating Committee. Segregation of duties seems to be challenged.
1. Larry Xiangdong Chen, Chairman of the Board of Directors and Chief Executive Officer,
2. Xin Fan Independent Director, Audit Committee, Compensation Committee and Nominating Committee
3. Yiming Hu Independent Director Audit Committee, Compensation Committee and Nominating Committee
4. Ming Liao Independent Director Audit Committee, Compensation Committee and Nominating Committee
Evidence of Abuse
5 investigative firms have discovered a series of issues with this corporation without any response from the SEC, FBI or a creditable response from the company. I am sure each of these firms want to see this company fail as I imagine they will profit immensely from their demise. This, however, should not change the fact that it is clear example of the issues the United States faces in dealing with China Operations. I will highlight some of investigative firms work to illustrate not only one fraudulent move but massive amounts of abuse and corresponding stock manipulation.
1. Illegal Marketing Activities using Identity Theft - Fake ID’s and National ID’s are used to create fake students.
2. Illegal VAX Tax Payments – avoiding tax payments through shell corporations.
3. Inflating Revenue through Student Count Inflation – Using their own data and API’s its proven they inflated massively the # of students attending their classes
4. Illegal Cash Movement – Use of third parties to use technology (Bot’s) to inflate student enrollment . Former employees have admitted on record of accepting monies and performing this activity for their benefit.
5. SAIC Filing – it is still unclear if they have filed the necessary documents with the China based SEC (SAIC) as US based individuals do not have access to this data.
6. And on and on.
I strongly suggest you read the following to see the extent this organization has gone to to defraud foreign investors and to learn more of its illicit activities.
1. Muddywaters Research (https://www.muddywatersresearch.com/research/gsx/mw-is-short-gsx/)
2. Grizzly Research (https://grizzlyreports.com/gsx-update-6-2-2020/)
3. Scorpio Capital (http://www.scorpio.vc/pdf/200506/174e818f-7df2-4360-be5d-b8ff0d7fb7e5.pdf)
At a minimum, when credible, well recognized firms have done the work a response from our government should at least alert the investing public of possible fraud after doing their own due diligence. The links illustrate consistent abuse. Not every investor has access to these investigators and their reports. In the case of GSX, their reports are now 4-6 months old without any acknowledgement or receipt.
I guess you can summarize it with a few more kindergarten truisms.
1. Share and share alike.
2. Play Fair.
3. Clean Up Your Own Mess
4. Be aware of wonder. The roots go down and the plant goes up and nobody really knows how or why.
5. Don’t make it harder than it needs to be.
6. And then remember the Dick-and-Jane books and the first word you learned - the biggest word of all - LOOK.”
If you would like to discuss further, please don’t hesitate to reach out to me below.
Respectfully,
Mark Woodward