Chinese Law Prof Blog

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George Washington University Law School

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Saturday, September 8, 2012

Canadian employee of short seller detained in China on charge of criminal libel

Three unfortunate trends in China have converged on one unfortunate man, Huang Kun. The trends are: (1) fight what you feel is bad information not with good information but with punishing the person who publicized the bad information; (2) when you have a business dispute, get your local police on your side to turn it into a criminal matter; and (3) treat ethnic Chinese, especially former PRC citizens, worse than you do "legitimate" (HT: Todd Akin) foreigners - you know, the ones with the big noses and the pale skin.

Here's the story in the Globe and Mail. Huang apparently helped the web site alfredlittle.com in its research on a Vancouver-based mining company apparently controlled by Chinese nationals; the Globe report says it's listed on the Toronto Stock Exchange, but the alfredlittle.com web site reports on it show it as listed on the NYSE. Recently there has been a lot of news about short sellers badmouthing Chinese companies, and there has been official and unofficial pushback. On the official side, China recently made it much harder for people to get information about companies from the information in the records of local offices of the State Administration of Industry and Commerce. On the unofficial side, there's recently been a loud debate between Kaifu Lee and some Chinese companies on the one side and short-seller Andrew Left on the other.

This move - I don't know why it's being reported only now, since Huang was first detained last December - marks another tactic: intimidation. I don't imagine a lot of people are going to be willing to actually go on the ground and poke their noses into Chinese companies once this news gets out.

Let's step back a bit and think about what's going on here. Here's one question: the objects of these short sellers say the short sellers are making it all up just so they can make a buck, and therefore they are bad guys who deserve to be punished. Maybe some are making stuff up. But maybe some aren't. The question is, is criminal law the best way to distinguish between the two and punish the bad ones?

I think not. There's no reason to think capital markets can't handle this perfectly adequately. If it were easy to make a buck by selling a company short and then publishing bad stuff about it, we could all do it. Why can't we? Because I'm not going to dump my holdings in some company simply because some random person - who, by the way, openly states that he has a short position in the stock - tells me it's a dog. Why would I believe him any more than I believe someone who tells me that some other stock is a sure thing? The market is no doubt full of fools but a lot of money is controlled by people who aren't that naive. They're going to want to know who this person is, what his sources are, and what his track record is. If he has a record of successfully exposing frauds and dogs, well, by golly, what's the matter with him making money from it? Remember that the short seller takes risks himself. If he sells short and then issues a report that turns out to be nonsense, he's going to lose money. If Kaifu Lee really believes that Andrew Left doesn't understand the Chinese internet industry (this is what he has claimed), then why isn't he happily confident that Andrew Left will lose his shirt by selling it short? The market will eventually figure out that Left is not right (sorry!) and in the meantime, Kaifu Lee and his friends could be making a killing by buying its underpriced stock.

The second intesting question is: how will capital markets react to this news? The significance of this news for China-related companies is this: the information about them will be much less accurate in the future. As I suggested above, this action will have its intended effect: scaring the crap out of people who are thinking of investigating fraud in Chinese and China-based companies. We may still see short-seller reports, but they will be based on less solid information and more speculation. Disclosure is already iffy enough; now we can expect it to be even worse. Will markets understand this? Will they care? I sometimes wonder if the vast edifice of disclosure erected in the US under the 1933 and 1934 securities acts and associated SEC regulations is actually valued by investors. My suspicion is that people will keep buying stock in Chinese companies listed overseas, and that fraud will keep getting discovered.

I hasten to add that I have no information, and express no opinion, on the merits of this particular case. For all I know the mining company got a bum rap from alfredlittle.com. But I think the markets can handle downward hyping as well as they can handle upward hyping without heavy-handed criminal sanctions.

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