President Obama signed the JOBS Act into law today. Proponents, mostly from Silicon Valley and Wall Street, claim it will enable small companies to do IPOs, enabling job growth. Economists doubt it will create many jobs. Critics, including investor groups and labor unions, argue it will enable fraud.
For investors in Chinese concept stocks, the JOBS Act is a disaster. Three features in the JOBS Act are likely to increase the number of frauds by Chinese companies.
The JOBS Act repeals the requirement for newly listed companies with less than $1 billion in revenue to have an audit of their internal controls by their auditor for the five years after listing. The audits are known as Section 404 audits and were brought in under Sarbanes Oxley to fight Enron type frauds. Chinese companies with a market capitalization over $75 million had to have these audits, and the audits have resulted in some interesting findings. Many Chinese companies have disclosed internal control weaknesses as a result of these audits. Most important, however, is the extensive process of building and documenting internal controls that companies undertake before being audited. These internal controls protect investors, and I fear that they will not be put in place if the audit is not required. The repeal likely leads to serious accounting errors and creates the ability to conduct a fraud.
Recently, the SEC began to require Chinese companies to make public their initial SEC filings rather than allowing the companies to send them to the SEC on a confidential basis. Companies and their advisors like confidential filings since they can keep the public in the dark until they work out all the issues with the SEC. Once that is done they can do a public filing and then quickly go to market before anyone has time to analyze the filing. Domestic companies have not been allowed to do confidential filings. Last year when Groupon filed a non-confidential filing, it became apparent they had some unusual accounting principles and they were required to restate their financial statements before going public. Had Groupon been allowed to do a confidential filing, investors might never have known about the controversy. Under the JOBS Act, all IPOs of companies with less than $1 billion of revenue can do a confidential filing, which increases the chances of a surprise after the IPO.
Finally, the JOBS Act allows a new fundraising idea called crowdsourcing. Crowdsourcing is the raising of funds in smaller amounts through Internet solicitations. Crowdsourcing will become the new Nigerian Email scam. Crowdsourcing was proposed to be completely unregulated, but was tightened significantly in the final version of the law and now funds must be raised on an SEC platform and some financial information must be provided. Expect seminars for fraudsters on this new fund raising idea within weeks in most major cities in China.