Postings | China Accounting Blog | Paul Gillis


Lead auditors

China Life today announced that it has changed its auditor for the US Form 20-F from Ernst & Young to Ernst & Young Hua Ming. Ernst and Young Hua Ming is the mainland China affiliate of Ernst & Young.

Ernst & Young Hong Kong resigned due to “requirements for project manage-ment”.  Those requirements are likely proposed PCAOB standards that make it clear that the lead auditor must sign the audit report. I am certain that the China Life audit was actually done by the mainland affiliate. The Hong Kong office signed off on the audit because that had become standard practice of the Big Four, even though I believe that the practice violated US and international auditing standards.  

I previously pointed out that KPMG was doing this on many of its overseas listed companies and that the practice was misleading to investors. 

Auditing standards require that the audit be signed by the principal auditor. AS 1205.02 requires the auditor to decide whether his own participation is sufficient to enable him to serve as the principal auditor and to report as such on the financial statements. The PCAOB proposed new rules on April 12, 2016 that make it clear that reports must be signed by the principal (proposed to be called lead) auditor. 

ZTO’s unusual VIE

This is a guest post by Fredrik Öqvist , one of my former students who remains active in this field. Mr. Oqvist can be reached at

VIE structures still appear to be very common among the new Chinese IPOs in the US. They’ve been around for a good while now so investors should be fairly well informed about what they are and how they operate. At this point in time the general set-up has been largely standardized, although not always in ways that I like, but I found an interesting quirk in one of the recent structures.

ZTO (IPO pending) is a company that sits on the delivery side of China’s rising ecommerce tide. As such it sees ideally placed to see strong growth on the back of expressed government support for increased consumption among the general populace. It recently filed to list in the US, and due to regulations in the delivery industry it set up a VIE structure to be able to list the company.

For those that do not know a VIE structure is basically a set of contracts drafted to mimic ownership and allow a listed entity to consolidate the financials of the contractually controlled VIE. In order to meet the requirements for consolidation the listed entity should be able to control the VIE, and also bear the majority of the risks and rewards from the company’s operations.

Attacking shorts

Hong Kong’s Market Misconduct Tribunal has punished Andrew Left of Citron for market manipulation in connection with his short report on China Evergrande.  Left had alleged that the company was insolvent and had engaged in fraud. 

The Tribunal banned Left from trading on the Hong Kong Stock Exchange for five years and ordered him to turn over the HK$ 1.6 million he made by shorting the stock. He was also given a cease and desist order that warns he could face criminal charges if he does it again. 

Short sellers play an important role in financial markets. I liken them to the hyenas of the markets, preying on the sick and weak, while improving the overall health of the herd. They are also the buyers of last resort, providing liquidity to investors in troubled stocks as they cover positions.  

The action against Left follows the eviction of an analyst with a sell recommendation from a company briefing. 

I have long argued that many short sellers use the “kitchen sink” approach to their research – throwing many unsupported allegations at companies in hopes that something sticks. Often we have seen short seller attacks that fail to prove accurate, yet other problems arise during the investigation that bring down the company. Some attacks fail to be proven, often leading to depressed stock prices.  Long investors are particularly frustrated in these situations, since the short sellers usually profit from unproved allegations, yet long investors often pay a long term price. 

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