Capital Markets

Under Secretary of State, Keith Krach explains the need for transparency with foreign investments and activities

Keith Krach: I’d like to talk to you about America’s capital markets, because they’re plagued by a double standard, one that tilts the playing field in the favor of Chinese companies. And in many cases against American companies. Today, U.S. businesses seeking capital on our stock exchanges are subject to strict domestic security laws. They spend millions every year complying with generally accepted accounting principles and reporting their financial activities, according to SEC rules. Meanwhile, through Regulation S, foreign companies do not have to comply with such rigorous standards if their domestic regulators do not require them to. While almost all countries have comparable transparency standards, China stands out as the exception. This sets the perfect environment for financial fraud on a broad scale, particularly when these companies are seeking to make that earnings estimate at the end of the quarter. A prime example is the recent 300 million dollar revenue fraud, in financial reporting of Lukken Coffee. That’s China’s version of Starbucks. When this was discovered, the stock plummeted and American investors lost millions, tens of millions of dollars. This fraud will continue if we don’t act to end it. It will continue because China doesn’t require any form of generally accepted auditing standards. It will continue because many of these Chinese companies are part-owned or state-owned companies of the Chinese Communist Party. And it will continue because the PRC laws are structured to classify company information as state secrets, which severely limits an independent auditor’s ability to discover the truth. Despite these risks, American stock index funds such as MSCI have been including Chinese stocks in their emerging market indexes for quite some time. Now, these index makers know of this lack of independent audits and inconsistent financial principles and attempt to minimize their risk by noting a waiver of liability language which clearly describes this lack of complete accounting. The Federal Thrift Savings Plan, which manages the retirement funds of federal employees and military members, came under intense scrutiny from Congress and on both sides of the aisle. When it moved to invest in these MSCI indexes. 401Ks of all 10 of the largest publicly traded U.S. companies, all 10 of the top federal contractors, and 20 of the largest state pension plans. As well as all six largest mutual fund providers invest in China. At present, this preferential treatment afforded Chinese companies caused an unlevel playing field for capital transactions with an extreme bias against U.S. companies. As a nation, we’re at a crossroads. Time has come to act upon these abuses to protect and defend the quality of U.S. security laws and the reputation of U.S. capital markets. Throughout the world, financial transparency is viewed as a virtue. In the People’s Republic of China, transparency is viewed as a threat to national security, where actions and laws are made to prevent disclosure. We now need to answer as a nation one question and act appropriately, "Can we afford to put American shareholders at risk–to put American companies at a disadvantage and to allow our preeminence as the gold standard for financial markets to be weakened by granting exceptions to America’s security regulations?" That decision is now in our hands.