Text / Liu Qiudi
Published in the 955th issue of China News Weekly on 2020.7.13
In the United States, Ruixing Coffee does not cut ordinary "leeks". In the famous investment circle, Ruixing has become synonymous with "black eye scandal" (beating). Losing well-known U.S. investors include Stephen Mandel’s Lone Capital, Steve Cohen’s 72-point asset management company, and commodities trading giant Louis Dreyfuss, who formed a coffee roasting enterprise with Ruixing Juice company.
Before investing in Ruixing, these "foreign leeks" were also paved by other investors, including the Singapore Government Investment Corporation and the American fund company BlackRock. Underwriters such as Credit Suisse Group (Credit Suisse) and Morgan Stanley, in addition to the lack of due diligence, have also taken additional risks because of lending problems.
Banks such as Credit Suisse, Morgan Stanley and Goldman Sachs provided a $533 million loan to Ruixing in September 2019, backed by stocks. Over the past two months, it has recovered about US$210 million through the sale of stock pledged by former chairman Lu Zhengyao, but the loan gap still exceeds US$324.1 million. The bank plans to liquidate two entities controlled by Lu Zhengyao and his family to pay off outstanding debt.
It can be said that the Lucky Myth is a house of cards built on a series of well-known financial institutions. Several fund managers who invested earlier in Luckin felt that they had no reason to doubt Lucky because it was also supported by other well-known investors such as BlackRock and Singapore Sovereign Wealth Fund. Now it seems that this routine of erroneous rumors will provide a warning for future investors.
Face more magnifying glass
Before being endorsed by international financial institutions, the players of Ruixing Coffee were all "self": the $200 million A round of financing in July 2018 came from the "iron triangle" capital of the same Chinese department as Lu Zhengyao, Li Hui and Joy Capital. Liu Erhai, they also accounted for seats on the board of directors.
In December 2018, the B round of financing, Ruixing also received US$200 million from investors such as CICC, with a valuation of US$2 billion. According to reports, CICC also has Lu Zhengyao's capital. In April 2019, Starbucks’ second largest shareholder, BlackRock Investment Corporation of the United States, invested US$150 million, and Ruixing Coffee’s market value reached US$3 billion.
Qian Zhiya, the founder and former CEO of Ruixing, once boasted that by the end of 2019, Ruixing’s number of stores will exceed 4,500, and it will surpass Starbucks in terms of number of stores and cup volume, becoming China’s largest coffee chain brand. BlackRock's investment symbolizes that the "Raise Fortune Times" has arrived.
In May 2019, Ruixing Coffee was listed on NASDAQ, with a market value of US$4.2 billion. After the market value reached $12 billion in January this year, several Wall Street short-selling investors received a mysterious email in which they accused Ruixing of having evolved from a flawed profit model to a fraud and fraud company, and shared it from Ruixing’s outlets. Of customer receipts and videos, as well as a related long-form report, show that Ruixing overstated sales.
As of January 31st, the short-selling agency's Muddy Water Research published the 89-page breaking news report on Twitter.
In fact, what makes Wall Street fresh is the fact that the 2011 Muddy Water Research once exposed the problem of fake accounts of the Sino-Forest Forestry Company listed in Canada. Some US hedge funds said that they had conducted a detailed review of Ruixing before deciding to invest, but it now appears that due diligence is not in place.
According to domestic media reports, the leader behind the anonymous Ruixing report released by Muddy Water is the Chinese hedge fund Xuehu Capital. Snow Lake was founded in 2009 by Ma Ziming, the chief investment officer born in China and educated in the United States. Ma had worked in the family office of Credit Suisse's investment bank and the Ziv Brothers Hedge Fund. Snow Lake made a good profit by short selling Ruixing stock.
After analyzing all the data, the report concluded that Ruixing had exaggerated sales because channel inspections showed that the sales at its outlets were much lower than the financial report data.
According to the investigation results of Ruixing's internal legal audit, Ruixing started to conduct fake transactions before the IPO in May 2019. Qian Zhiya, the company’s former chief executive officer, and Liu Jian, the former chief operating officer, and some of the employees who reported to them participated in the counterfeit transaction. They first used their personal account registered on their mobile phone number to buy vouchers that can be redeemed for coffee, and then used Many little-known companies buy vouchers in bulk. As a result, net income expanded by 2.2 billion yuan, almost half of revenue in 2019, and costs and expenses were exaggerated by 1.3 billion yuan.
Ruixing Coffee held a special general meeting of shareholders on July 5 and voted to dismiss the directors' dismissal of Lu Zhengyao (chairman), Li Hui (founder of Dazheng Capital), Liu Erhai (founder of Yuyue Capital) and Shao Xiaoheng. The Wall Street Journal reported that the internal investigation report completed by the special committee of Ruixing's board of directors with the help of Kaiyi International Law Firm showed that Lu Zhengyao knew (or should know) the fraud situation before the incident, including certain incorrect disclosures. Related transactions and did not fully cooperate with the investigation.
After Ruixing, many Chinese companies are facing more inspection with magnifying glass. However, in the US financial market, rumors and news about short selling are commonplace in the military, and do not necessarily mean that something will happen. In the long run, many short sellers have accused companies of accounting misconduct of stocks from rising.
According to data from Breakout Point, a data provider that analyzes short selling trends, between 2017 and 2019, short sellers accused 32 US public companies of accounting violations. In the six months following these allegations, 25 of these companies' stocks rose, and the remaining stocks fell.
Legal audit will be "Xianxue"
By the time Rui Xing was formally forced to delist from NASDAQ on June 29, U.S. time, its limelight was overshadowed by another audit scandal.
Wirecard, once the most touted German payment processing company in Europe, recently exposed $2 billion in fictitious overseas accounts. Founded in 1999 by Wirecard, the stock price reached a record high in September 2018. In the same month, it replaced Commerzbank and entered the list of the top 30 companies in Germany. At that time, the market value exceeded 24 billion euros. When the stock price closed at 3.23 euros on July 3, the company's market value was less than 400 million euros.
The fuse triggered by the truth is that Wirecard postponed the release of its financial results for 2019 because auditors could not count the cash of 1.9 billion euros (about 15.1 billion yuan). The CEO resigned afterwards, but the chief operating officer still did not know where to go.
The auditors of Wirecard and Ruixing are both Ernst & Young and they are now the focus of the media and regulators: Ernst & Young may have been unable to confirm the existence of Wirecard’s self-proclaimed accounts in Philippine banks for three consecutive years.
Although verifying the bank balance is the basic function of "Audit 101", the auditor relied too much on the bank contact information provided by the customer and failed to discover the "unconventional financial arrangement" early. This reminds us of the Enron bankruptcy case in 2001 in the United States, which led to Andersen accounting firms sitting together, and the final dissolution of Andersen.
At present, many investors have condemned Ernst & Young, thinking that Ernst & Young’s audit “is a disaster” and that it should be “examined” by itself.
Wirecard has adopted an unconventional measure in which third-party partners are used to process payments in unauthorized countries. The income from these businesses is stored in a trust account, rather than paid directly to the company. Wirecard explained that the money was used for risk management and stated that it can be saved to provide a refund if needed.
According to the "Wall Street Journal" report, the e-mail showed that Ernst & Young was informed about the handling of funds in 2016 and beyond. Even though some investors have issued detailed complaints about this, EY seems to have chosen to ignore it. A senior manager at Ernst & Young said in a note to Wirecard executives that Ernst & Young is preparing to raise questions about the trustee's account.
Ironically, Ernst & Young was originally a special audit hired by Wirecard in 2008, and its main task was to provide a special audit of allegations that the company's financial statements were defective. Later, Ernst & Young became Wirecard's regular auditor. The Ruixing and Wirecard incidents will inevitably affect investors' confidence in EY's other audit opinions.
Therefore, it is reasonable to believe that in the future, investors will use the method of forensic auditing more frequently and earlier to dissect the invested objects like forensics, especially those that are soaring, compressing the timeline, and the cost of acquiring customers. Companies that are good at using overseas structures.
The difference between legal audits and regular audits is the review of economic crimes, fraud and theft, including reviewing complex accounting systems, sorting out complex financial transaction issues, identifying unusual or suspicious transactions, and testing financial statements for fraud Or misrepresentation, use computer forensics technology to restore damaged accounting records, and test whether the customer’s financial statements have been used and modified without authorization, find hidden assets, and help determine the ownership of assets.
The underwriters who assisted Ruixing in listing were also under great pressure, including questions about whether their research department was truly independent of the investment banking business department. After the Muddy Water Research published a report on Ruixing, Credit Suisse said in a research report on February 4: "We have not found conclusive evidence in the short seller report to prove that Ruixing's business is fraudulent, and We believe that some of these allegations are unfounded and even have major flaws." Morgan Stanley also maintained its original rating in a Luckin report released that month. After Ruixing exposed its false accounts in early April, analysts at the two banks suspended the rating of Ruixing's stock.
This means that outside financial experts “based on management information and financial data reviewed by the company’s auditors” are far from enough to tap inside. Ruixing's prospectus for the sale of shares in January 2020 included the interim financial statements reviewed by Ernst & Young and the "consolation letter" of the accountant, stating that the figures in the financial statements were not in any way problematic. These misjudgments raise questions about how deep the due diligence of regular auditors and financing underwriters should be.
In the "post-Ruixing era", even the endorsement of professional investors and well-known financial institutions, can not pack votes for the integrity of a company. The due diligence requirements of professional investors, auditors and banks assisting financing will be deeper and wider.
The Bloomberg News columnist believes that investors of Ruixing Coffee are overly addicted to the "Suixing Beverages" confusion, and they are motivated by China’s Internet economy, including the use of mobile applications to lure China’s 1.4 billion population dividend. The model is addictively addictive. These investors hungry for high returns are eagerly pursuing China's dual growth story-consumption and technology.
The author believes that US investors should be aware that other Chinese companies, in order to pursue the US financial market with a large amount of capital flow, also have enough incentives to exaggerate the prospectus data with mythical growth and consumer demand. The only antidote for investors is to completely eliminate this addiction.
"Accountability Law for Foreign Companies"
On May 20, the US Senate unanimously passed the "Accountability Law for Foreign Companies", requiring financial audits of listed companies in the United States to be transparent and not to be held or controlled by foreign governments, triggering the possibility of Chinese companies being "collectively delisted" under the trade war. "Worries.
Companies that raise funds publicly in the United States must be audited by accounting companies certified by the US Securities and Exchange Commission, and these audits will also be supervised by the Accounting Supervision Committee of Listed Companies. The Accounting Supervision Committee of Listed Companies has been established in 2002 in accordance with the requirements of the Sarbanes-Oxley Act and is supervised by the United States Securities and Exchange Commission. Its task is to supervise the accounting firms that sign the audited books of listed companies.
For a long time, based on national security considerations, China has prohibited the transfer of auditors’ audit records. Therefore, although Chinese companies are listed in the United States, they have not fully complied with U.S. securities laws. Although the bill is not yet available in the House of Representatives, the financial industry has a strong public opinion to support the passage of the decree due to the successive fraudulent accounts exposed by Luckin and Wirecard. Once the Act is passed, if a branch of an audit company employed by a listed company is located in a foreign jurisdiction and the listed company’s accounting oversight committee cannot review the branch and its records, the listed company must submit documents to the US Securities and Exchange Commission to prove It is not owned or controlled by a foreign government.
Even if the listed company can prove that it is not controlled or held by a foreign government, if the listed company’s accounting supervision committee cannot review the listed company’s accounting firm and related audit records for three consecutive years, the company’s securities will not be able to be traded in the United States.
From the perspective of the text, this bill attempts to weld two different concepts: one is the issue of company auditing, and the other is the issue of foreign government control. There is actually no necessary causal relationship between the two. So this bill also carries some ideological baggage.
If excellent Chinese companies are forced to withdraw from the market, it will cause huge losses to American and international investors. Therefore, I believe that even if the law is passed, Chinese companies that operate routinely and do not involve national security should still be able to find an effective way to comply with US regulatory requirements.
At present, the US Securities and Exchange Commission's investigation of Ruixing has not ended, and the shareholder's lawsuit is still hot. Because the behavior and evidence of making fake accounts occur in China, the US regulator should rely heavily on Chinese regulators. Survey results.
The US Securities and Exchange Commission and the China Securities Regulatory Commission have stated that they will assist each other in their investigations. This is a rational and mutually beneficial direction. Chinese companies should refuse to be "swissed" or "conceptualized". Only if more outstanding Chinese companies succeed and credibility in the international capital market will investors be allowed to distinguish individual "bad apples" from other "good apples."
(The author is a doctor of law from Columbia University, a master of arts from Yale University, and was a partner of Wall Street Law Firm)
"China News Weekly" No. 25, 2020
Statement: The publication of the "China News Weekly" manuscript is subject to written authorization