Cash and VIEs | China Accounting Blog | Paul Gillis

Cash and VIEs

TechRice has found a list of Chinese internet companies and their sizable cash positions. Because each of these companies uses the VIE structure, these companies are at the confluence of the two big Chinese accounting stories of 2011 - auditing cash in China and variable interest entities.

Rankings (USD):

1). NetEase (NASDAQ: NTES), 1.7 billion

2). Baidu (NASDAQ: BIDU), 1.6 billion

3). Alibaba (HKEX: 1688), 1.5 billion

4). Tencent (HKEX: 0700), 1.25 billion

5). Renren (NASDQ: RENN), 1.23 billion

6). Giant Interactive (NYSE: GA), 966 million

7). Sina (NASDAQ: SINA), 826 million

8). Sohu (NASDAQ: SOHU), 811 million

9). Youku (NYSE: YOKU), 631 million

10). cTrip (NASDAQ: CTRP), 611 million

11). Focus Media (NASDAQ: FMCN), 591 million

12). Shanda Gaming (NASDAQ: GAME), 589 million

13). cYou (NASDAQ: CYOU), 414 million

14). Perfect World (NADAQ: PWRD) 336 million

15). Qihoo 360 (NYSE: QIHU), 309 million

16). 51Jobs (NYSE: JOBS), 286 million

17). SouFun (NYSE: SFUN), 264 million

18). DangDang (NYSE: DANG), 257 million

19). the9.com – 9City (NASDAQ: NCTY), 210 million

20). Phoenix New Media (NYSE: FENG), 180 million

21). Shanda Interactive (NASDAQ: SNDA), 136 million

22). KongZhong (NASDAQ: KONG), 134 million

23). Taomee (NYSE: TAOM), 119 million

24). Ku6 (NASDAQ: KUTV), 111 million

25). BitAuto (NYSE: BITA) 100 million

26). JiaYuan (NASDAQ: DATE), 91 million

27). Tudou (NASDAQ: TUDO), 59 million

The VIE angle is important here, because this much cash might provide the wrong incentive to a fraudster. While I have not looked at the corporate filings of all of these companies, I have seen few instances where the filings indicate whether any of this cash is in the VIE. In most cases, there is little reason for the cash to be in the VIE, since the VIE is usually only used to hold the internet content provider license. If the cash has been transferred into the VIE for any reason, it significantly alters the math that aligns the VIE owner with the public shareholders. Too much cash in the VIE creates an incentive for the VIE owner to find a way to take the VIE.  

The SEC should be pushing U.S. listed Chinese companies to disclose the assets that are held by VIEs. This would help shareholders assess the risk associated with holding assets in VIE form instead of in companies that the public company actually owns. Getting cash out of VIEs is difficult, with both tax and foreign exchange issues that need to be dealt with. 

Most Chinese frauds have involved missing cash, often covered up through fake bank confirmations done with the help of corrupt bank officials. Auditors have been upping their game in this area, and these balances indicate how critical it is that cash auditing procedures are updated to reflect the higher risk environment of China. It is not good enough to just send out a bank confirmation at the end of the year. That process is too easily corrupted. Auditors need to get creative in seeking audit support for cash balances. I have heard some good stories from auditors on new things they are doing this year. I don't want to tip off the fraudsters by detailing them, but they mostly entail introducing unpredictability  to the process by doing audit steps at unusual times, including such things as confirming in person at several times during the year. Auditors are creatures of habit. Frauds are hard to pull off, and when the auditors start acting spontaneously they make life miserable for the fraudsters, who likely trip up.

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