China’s Chilling Effect for Investor Research

Why an Unflattering Analysis of a Publicly Listed Company Can Land an Investment Researcher in Jail

Shanghai investor Wang Weihua’s final microblog post October 12 was brief and ominous: “The police are coming.”

Three days later, Wang’s family said he’d been taken into custody by police officers who traveled more than 3,600 kilometers to Wang’s Shanghai home from Urumqi, a city in China’s far west.

Police gave the family a document saying Wang was detained on charges of fabricating and disseminating false information about securities and futures trading activity. They gave no additional information.

Authorities in Urumqi, capital of the Xinjiang Uighur Autonomous Region, have yet to release details of the case against Wang. The law says they have until November 11 to decide whether to file formal charges, or have him released.

Wang, forty-two, may have crossed a legal line by writing and publicizing investment analyses about Guanghui Energy Co. Ltd., a Urumqi-based conglomerate whose shares are traded on the Shanghai Stock Exchange.

In blog postings and articles published online over nearly a year starting in October 2012, Wang said Guanghui executives had played accounting tricks, inflated profits in financial reports, and used back-door transactions to manipulate stock prices.

Guanghui officials denied Wang’s accusations. They filed a police report saying their company had been illegally maligned by negative—and fabricated—information.

Wang has stood by his story, however. Through his attorney, Liu Jianghua, he has said that all analyses were based on publicly available material. He has also said he was not financially positioned to gain from any bad publicity about the company.

Guanghui officials have declined to comment. But the investment community is buzzing about the believability of the dirt Wang says he dug up on Guanghui, and the chilling effect that his and similar cases in recent years have had on investment research in the country.

Raising Doubts

Wang had just finished an engineering doctorate degree at Australia’s University of Melbourne and landed a job in academia when police arrived at his home.

In a 2012 post, he said that to attract investors Guanghui executives exaggerated the profit potential of a liquefied natural gas project launched by the company. They also committed financial fraud by making the company appear more profitable than it was, he said, which in turn helped to convince investors to push share prices higher.

Wang also charged that Guanghui’s parent, Xinjiang Guanghui Industry Investment Group, stood to benefit from higher stock prices. In fact, he said, the group used more than seventy percent of its equity in the subsidiary as loan collateral.

Wang raised a variety of doubts about Guanghui’s financials, operations and profitability. And in August, he called investor attention to entrusted loans Guanghui made to two companies that are controlled by its fourth-largest individual shareholder. He said the loans were related-party transactions—a charge the company denied and cited in its report to police as an example of Wang’s maliciousness.

Wang also said the money may have been used to buy Guanghui stock on the secondary market, and reported his findings to the China Securities Regulatory Commission (CSRC), which in turn demanded an explanation from Guanghui.

Wang said his intent was not to short sell Guanghui shares, in part because “the eight percent charge for borrowing securities for short selling is too expensive.”

Rather, Wang said he initially started investigating Guanghui because he believes in the value of investment research. “My personal interest in investment leads me to research companies to seek facts and truth,” he said.

His suspicions concerning Guanghui stemmed from the fact that securities analysts had been overwhelmingly positive about the company as an investment target. Analyst reports had contributed to share price-to-earnings ratios for Guanghui that were on average four times better than those of the company’s peers, he said.

Neither did the campaign against Guanghui have a dark side, Wang said. His attorney said he neither tried to blackmail Guanghui nor collaborated for ill gain with any media outlet. In China, media companies have been known to strong-arm companies to pay a reporter under the table or risk becoming a target of negative publicity.

“All of Wang’s challenges against Guanghui were openly published on his personal blogs, and he never authorized any media outlet to reprint his views,” Liu said.

Investor Fears

Not all in the investment community are buying Wang’s conclusions, but many say they are concerned about how authorities are reacting. Indeed, they say they are watching to see how authorities handle the matter—especially if Wang goes to jail—because it may weigh into future decisions by analysts who have the ability to find fault with and publicize problems at domestic listed companies.

For example, investment researchers who do not want to risk a surprise visit by police from a far-away city may decide to only report sunny skies at firms they study.

So far, the criminal case against Wang has not progressed much. Police have not said what the problem with his writings is. Nor will they say why his writings warranted apprehension by officers trekking across the country.

Fabricating and disseminating false information about securities and futures trading is a crime that carries a maximum five years in prison.

Normally, police need to conduct a preliminary investigation and find reasonable evidence pointing to a crime before taking a person into custody, said Zhang Yuanzhong, a lawyer at the firm Wen Tian in Beijing.

The charges being considered against Wang would only lead to a detention under normal circumstances if “it’s proven that the information is untrue, or that a deduction is obviously flawed, or that the materials on which he based a judgment were completely fabricated,” Zhang said.

If those standards were strictly enforced, the case against Wang may never have been opened, said a lawyer familiar with Wang’s situation, who spoke on condition of anonymity.

Some investors, in comments posted online, said they are angry because Wang’s is not the first case of a public company critic in China being arrested on shaky grounds. They also wonder whether he was targeted due to strong ties between Guanghui’s executives, whose company is a major taxpayer in Urumqi, and the city’s bureaucrats.

Some investors say the stock market’s status as a transparent investment channel has been tarnished by authorities chasing people like Wang simply because they find problems at listed companies.

Indeed, Wang is only the latest investment-research muckraker to find himself on the firing line. Business journalist Chen Yongzhou, of the New Express newspaper in Guangzhou, was detained by police in Changsha, in the central province of Hunan, on October 18 for allegedly damaging the reputation of Zoomlion Heavy Industry Science & Technology Development Co. The latter is manufacturer of construction equipment based in Changsha.

Chen admitted on national television he took money from an unnamed party in exchange for a series of articles bashing Zoomlion for financial fraud. Despite his admission, many in the investment community have continued to question Changsha police for what seemed to be a decision to protect a local business. Chen’s articles mentioned such protection of Zoomlion.

Meanwhile, a recent Wall Street Journal report says authorities in Luoyang, in the central province of Henan, have been illegally holding Canadian stock analyst Huang Kun for more than a year on suspicion of criminally defaming Silvercorp, a Vancouver-based mining company that has mines in China.

The allegations against Huang and other investment analysts are at odds with decisions by the Supreme People’s Court, the nation’s top court, that a precondition for defamation claims in civil cases is an intention to fabricate information, Zhang said. This precondition should be considered “more so in criminal” cases, he said.

Moreover, Zhang said, intention should be at the heart of any defamation charge filed against a person if the case involves a publicly listed company. That is because a listed company “ought to be subject to the public’s supervision and questioning,” he said.

Wang said his analyses of Guanghui’s financial performance were based on the company’s regular statements. The entrusted loan, for example, was reported as a “related-party transaction” in last year’s annual report, he said.

Wang said his related claims, including an analysis questioning the company’s estimates of future oil extraction prospects, were based on publicly accessible data and information from other researchers.

Meanwhile, Wang’s report to the CSRC is still in the pipeline. Without being specific, commission sources said October 18 that they have started looking into the Guanghui matter.