Going dark | China Accounting Blog | Paul Gillis

Going dark

China Medical Technologies Inc (NASDAQ:CMED) missed a December interest payment on its $125 million, 6.25% convertible senior notes. NASDAQ has halted trading. The default seems unusual, given the company reported $206.5 million of cash on its September 30th balance sheet. Of course, this could be another case of missing cash that has been covered up through fake bank confirmations. Kerrisdale Capital has posited that the company may be preparing to go dark. Kerrisdale defines going dark as management simply disappearing into the sunset. These companies stop filing reports with the SEC and stop communicating with shareholders. While NASDAQ and the NYSE are quick to delist any company that stops filings, it often takes a while for the SEC to catch up with them. Recently the SEC put 21 Chinese companies on administrative notice that they are in danger of having their shares deregistered after failing to file periodic reports in a timely fashion.  Going dark might just work for these companies. The SEC appears to be unable to do anything more than deregister the companies since Chinese authorities are not going to allow them to enforce U.S. laws in China. While the number of class action lawsuits against U.S. listed Chinese companies exploded to 33 in 2011, it remains to be seen if shareholders will be successful in collecting anything. Collection is even more remote in cases where the assets are held in variable interest entities. CMED does not use the VIE structure. 

Many of the Chinese frauds have been disclosed when the auditors began to upgrade cash confirmation processes last year. If CMED decides to go dark, auditor PwC will likely not get a chance to double check the cash confirmation. Tighter audit procedures might be encouraging companies to go dark rather than face the likelihood their acts will be revealed. 

There are three notable trends right now in China concept stocks. First, the IPO market has been dead in the water for six months, since Tudou listed last August. There are many companies in the pipeline, but the market appears to be shut down tight. The other trends, privatizing and going dark, relate to companies exiting the U.S. markets after facing regulatory hostility and disappointing valuations. Over twenty companies have announced plans to privatize and delist. Most long term shareholders of these companies will incur a significant loss on these transactions, but they will likely fare far better than shareholders of companies that go dark.

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