Another Chinese “advertising” company with U.S.-listed shares. Gee, where have we seen this movie before…
Remember China MediaExpress Holdings? CCME? I’ve written at great, great length about the firm and the many, many red flags present in its regulatory filings going back to 2009, but one of the most telling, most glaringly obvious signs of possible trouble was the corporate structure, which I wrote about (among other places) here:
Compare this to YOKU’s, from Page 5 (FIVE!!!!) of their F-1 ADR registration statement:
In both cases, the PRC “operating” companies are controlled entirely by corporate insiders (and their families). The only recourse the holding-company (and thereby shareholders) has (have) over the operating companies, their assets, and cash flows are spelled-out in “contractual obligations,” spelled-out in very-little detail on pages 5 and 6 of Yoku’s F-1 If corporate insiders and their families loot the bank accounts of the PRC entities, U.S. shareholders will very-likely end up with little, if anything, to show for their “investment.”
The filing does go into a bit more detail on these “contractual arrangments” and the risks thereof, specifically, on pages 30/31 (emphasis mine):
Our consolidated affiliated entities and their respective shareholders may fail to take certain actions required for our business or follow our instructions despite their contractual obligations to do so. If they fail to perform their obligations under their respective agreements with us, we may have to rely on legal remedies under PRC law, including seeking specific performance or injunctive relief, which may not be effective.
Under the equity pledge agreements among 1Verge Internet and the respective shareholders of 1Verge Information and Jiaheyi, these shareholders pledged all of their equity interests in 1Verge Information and Jiaheyi to 1Verge Internet. Our PRC counsel, TransAsia Lawyers, has advised us that these pledges were duly created and effective given that such pledges have already been duly registered with the relevant local branch of the SAIC in accordance with the PRC Property Rights Law. As a result, if any of 1Verge Information, Jiaheyi or any of their respective shareholders breaches its obligations under the contractual arrangements, we may be able to successfully enforce the pledges.
All of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in certain other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements, which may make it difficult to exert effective control over our consolidated affiliated entities, and our ability to conduct our business may be adversely affected. See “—Risks Relating to Doing Business in China—Uncertainties with respect to the PRC legal system could adversely affect us.”
While this is largely boiler-plate language, you should ignore it at your peril. You should notice that the 2nd bolded section (and the preceding text) suggests that if the PRC opco shareholders (corporate insider & family) decide to renege on their “contractual obligations,” the holdco (by way of an intermediate opco, still in PRC) can seize controlling interest in the operating subsidiaries.** The purpose of this is to disincentivize the operating company shareholders from acting against the best interests of the end-shareholders in the holdco (read: you), but riddle me this: If the managers/owners of the opco loot its bank accounts, what do they care if they lose their ownership interest in whatever’s left of it? I’m not an expert in Chinese corporate law****, but considering how easy its been over the years for white collar criminals to perpetuate their frauds here in the U.S, how hard do you think it’d be to do in China, with all the horrific control and audit issues they have?
Surely there is a non-zero chance that YOKU is a legit (or at least more-legit) company relative to CCME; I don’t know it well enough yet to say yea or nay with any certainty, but the fact remains: if you insist on investing in co’s with obvious red flags, be prepared to lose your entire investment.
**This is an oversimplification of what would actually happen in practice.
**** In response to the 2nd comment below, I should clarify: I’m not particularly well-versed in legal proceedings involving corporate fraud/malfeasance in China, especially if/when the ultimate “victims” are outside PRC. I’d appreciate any comments from those who are, as alwasy!