Investor enthusiasm that allowed a record number of Chinese companies to go public abroad in 2010 has evaporated as the accuracy of financial reporting and the quality of due diligence by IPO underwriters has been called into question. That contributed to making the first quarter for global first-time offerings the weakest since the depths of the financial crisis.

Confidence in overseas-listed Chinese stocks had already been undermined by scandals involving companies that went public in the U.S. through so-called reverse mergers. Now, investors are shunning firms based in the world's fastest-growing major economy: Of the 57 IPOs in the U.S. this year, only one came from China, compared with seven in the first quarter of 2011.

Four Hong Kong-listed Chinese firms, including Boshiwa International Holding Ltd., a Shanghai-based Harry Potter apparel licensee, said their auditors resigned this year because of disputes over financial data or other key information. That's four times the number in the same period last year and in the first quarter of 2010. Two other companies reported that their auditors needed more time to verify earnings.

Boshiwa, whose shares fell 66 percent from their September 2010 listing price, was suspended from trading March 15 after accounting firm Deloitte Touche Tohmatsu resigned.

Hong Kong Warnings

The disclosures caused Hong Kong's Financial Reporting Council to announce April 11 that it had identified 13 Chinese companies in need of close monitoring. The agency, which investigates auditing and reporting irregularities of publicly traded companies, declined to name them.

Chinese companies listing on global exchanges in 2010 set a record: 110 IPOs, up from 67 in 2009 and almost twice the number last year. That prompted Hong Kong regulators to warn at least eight times since early 2011 about inadequate due diligence on the part of investment bankers who underwrote the IPOs of companies that applied for listings in 2010.

Overseas IPOs by Chinese firms in 2010 accounted for 16 percent of the $199 billion in global IPO proceeds, excluding mainland China deals, the data show. In the first quarter of this year, foreign Chinese offerings fell to 5.7 percent of the $11 billion raised worldwide.

Equity markets in China's mainland are closed to foreign investors, except as part of investment quotas granted to qualified institutional investors. Chinese domestic stocks also have fared poorly since the beginning of 2010, with the benchmark CSI 300 Index down 27 percent. In December, the index fell to its lowest level since February 2009 on concern that the country's economy was slowing. The index has rebounded 14 percent since then on speculation that the government will further ease monetary policy.

With China's economic growth target revised down by the government to 7.5 percent this year, the lowest goal in eight years, investors may be less willing to tolerate risk.

“Chinese companies in the private sector are bearing the brunt of the country's economic slowdown, leaving investors nervous about their growth prospects,” said Ronald Wan, a Hong Kong-based managing director at China Merchants Securities Co., which oversees about $1.5 billion.

Revenue Declines

More than a quarter of the 56 Chinese firms that raised a combined $32 billion in Hong Kong in 2010, including cellulose producer Sateri Holdings Ltd. and manganese-mining company Citic Dameng Holdings Ltd., have lowered forecasts, saying they expected “significant” or “substantial” declines in revenue.

Sateri has fallen 66 percent since its December 2010 debut, and Citic Dameng has dropped 61 percent since listing in November that year. Both companies, headquartered in Hong Kong, get more than 70 percent of their revenue from China, according to Bloomberg data.

The 56 companies have declined an average of 27 percent from their IPO prices, the data show, while the benchmark Hang Seng Index is down 3 percent from its 2010 average.

“There's a lack of confidence in some of the issuers,” Renato de Guzman, chief executive officer of the Bank of Singapore, the wealth-management unit of Oversea-Chinese Banking Corp. said in an interview on March 30. “That fear creates a lot of undervalued shares.”

Chinese stocks listed in New York have fared worse. The 40 companies that completed IPOs there in 2010 are down on average 39 percent from their offer prices compared with a 22 percent gain for the S&P 500 Index from its 2010 average, the data show. These don't include the two Chinese businesses that went public by reverse merger, in which a closely held firm buys a publicly traded shell company and obtains a listing without the scrutiny of the IPO process.

In Singapore, the third-biggest market for such listings after Hong Kong and New York, eight Chinese companies that went public in 2010 have declined an average of 47 percent from their offer prices, the data show. That compares with a drop of 15 percent for the 23 non-Chinese firms that had IPOs in 2010.

In March, Vipshop Holdings Ltd., the first Chinese company to have an IPO in New York since August, raised 39 percent less than targeted. Shares of the Guangzhou-based online discount store are trading 9.2 percent lower than its offering price. The number of Chinese firms completing IPOs in the U.S. last year fell to 15 from 41 in 2010.

Of the 10 Chinese firms listing outside mainland China this year, the lowest number since the first quarter of 2009, eight were in Hong Kong, one was in New York and one in Malaysia.

A second Chinese firm, China Auto Rental Inc., the nation's largest car-rental company, is scheduled to list in the U.S. next week, seeking to raise as much as $137.5 million in an April 24 IPO on the Nasdaq Stock Market.

Reverse Mergers

Chinese enterprises that completed foreign IPOs in the early 2000s have done better. The 91 companies that sold shares overseas from 2001 through 2004 and are still trading have gained on average 289 percent from their offer prices, according to data compiled by Bloomberg. That compares with the MSCI World Index's 32 percent gain from its average in those four years.

The 61 Chinese firms that listed overseas in 2011 are down 6 percent on average from their offer prices, the data show. The MSCI World Index is up 2 percent from its 2011 average.

The disclosures of financial irregularities or auditor resignations last year by Chinese businesses that went public in the U.S. through reverse mergers resulted in “significant negative sentiment” toward companies based in China, Paragon Capital's Pollack said.

The U.S. Securities and Exchange Commission cautioned investors in June about buying stakes in such firms, saying they may be prone to “fraud and other abuses.” The Bloomberg Chinese Reverse Mergers Index, which tracks 82 companies, has lost 62 percent since the beginning of 2010.

Sino-Forest Corp. lost C$3.3 billion ($3.3 billion) of its market value after Carson Block, founder of research firm Muddy Waters LLC, accused the company of overstating its timber holdings last June. The Toronto Stock Exchange will delist Sino-Forest shares in May, the firm said in an April 5 statement.

Also recently delisted was Longtop Financial Technologies Ltd., a Hong Kong-based maker of financial software whose lead underwriters for its 2007 IPO were Goldman Sachs Group Inc. and Deutsche Bank AG. The SEC in December revoked Longtop's registration, saying the company was in default for failing to respond to an agency order. D&T Shanghai resigned as Longtop's auditor after discovering improprieties, according to the SEC.

Underwriters Liable

Hong Kong's Securities and Futures Commission may make banks arranging IPOs liable for statements in their clients' prospectuses to prevent fraud by locally listed Chinese companies, Martin Wheatley, head of the agency at the time, said last year. The commission has inspected 17 listing sponsors since late 2009 and found deficiencies in some of their work, according to a report published by the regulator in March 2011.

“The gatekeepers have to be vigilant and that includes all the actors that surround an IPO,” Ashley Alder, Wheatley's successor, said at a press conference in September.

The Hong Kong Monetary Authority, which regulated five financial institutions that sponsor initial share sales before supervision was transferred to the SFC, also has urged bankers to increase due-diligence standards and improve their internal supervision of the IPO process.

The city's central bank conducted onsite examinations between the fourth quarter of 2010 and the second quarter of 2011 and found cases where guidance on how to deal with “suspicious scenarios” was deficient and where senior investment bankers didn't review their employees' due diligence, according to a Nov. 25 report.

Singapore's stock exchange went to court to enforce its listing rules for the first time after a Chinese company ignored a deadline to appoint a special auditor. The exchange sued China Sky Chemical Fibre Co. and four of its Chinese directors on Jan. 6 to compel the Quanzhou City-based company to have a special auditor investigate “interested party transactions,” a failed land acquisition and certain costs. The Monetary Authority of Singapore is seeking a court order to freeze the assets of former China Sky Chemical CEO Huang Zhong Xuan, according to papers filed March 28 with the city's High Court.

In Hong Kong, Deloitte resigned as Boshiwa's auditor after the company failed to provide information it requested, according to a March 15 filing to Hong Kong's stock exchange.

Daqing Dairy

Deloitte also resigned as auditor for Daqing Dairy Holdings Ltd., according to a March 30 filing. The Heilongjiang, China-based milk producer, which raised $200 million from an October 2010 Hong Kong IPO, said it had a disagreement with the auditor about the accuracy of its financial statements. Daqing Dairy has fallen 62 percent from its offer price.

Wilfred Lee, a Hong Kong-based spokesman for Deloitte, said he couldn't comment on the cases because of client confidentiality.

In February, Crowe Horwath LLP resigned as auditor for Mayer Holdings Ltd. after the Hong Kong-based producer of steel pipes failed to provide information related to a court case, according to a filing with the exchange. China Forestry Holdings Co., based in Chaoyang, China, and suspended from trading since last year because of accounting irregularities, said Jan. 6 that its auditor, KPMG LLC, had resigned citing valuation concerns.

Other Hong Kong-listed Chinese companies, including Shenzhen-based Shirble Department Stores Ltd. and Ausnutria Dairy Corp. of Changsha, have delayed releasing full-year 2011 earnings because auditors need more time to complete work, according to filings by the firms.

Spokesmen for Ausnutria, Boshiwa, China Forestry and Shirble declined to comment beyond the exchange filings. Bunny Lee, a Hong Kong-based investor relations officer for Daqing Dairy, said the company is trying to complete its 2011 earnings report. Mayer officials didn't immediately respond to a phone call and an e-mail seeking comment.

Doing due diligence is beyond the capabilities of many investors who remain positive about China's future growth, said Paragon Capital's Pollack.

“We're still very bullish on the China story as a whole, but I think all investors are exercising a lot of caution,” he said. “There are certain red flags an investor needs to look for, and there are certain positive indicators too.”

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