China’s Coronavirus-Era Accounting Scandals May Not Be the Last

(Bloomberg) --

If you're like me—bewildered by this uncertain time and seeking a road map of what's to come—you're most likely tracking China's response to the deadly virus that ripped across its shores before spreading to the rest of the world. Its experience can offer indications as to when infections may subside or schools might reopen. Investors would be smart to heed the financial warnings piling up in China, too.

Recent weeks have ushered in a spectacular crumbling of some of the most hyped U.S.-listed Chinese tech and consumer companies, kicked off by Starbucks challenger Luckin Coffee Inc.

The buzzy, venture-backed coffee chain, which listed shares on Nasdaq less than 18 months after its founding, told investors it had fabricated much of its 2019 sales. The admission came earlier this month, after the company originally denied the fraud allegations.

Then just last week, an internal audit revealed sales at online tutoring upstart TAL Education Group had been artificially inflated by an employee who had forged contracts. And IQiyi Inc., the Chinese video-streaming company majority owned by Baidu Inc., was accused in a short-seller report of overstating revenue and subscriber numbers. IQiyi denies the claims, but shares in all three companies have plummeted.

On top of that, China's securities regulator on Monday barred two smaller tech upstarts on its new Nasdaq-style tech board, the Star Market, from selling additional stock or bonds for a year as punishment for failing to provide adequate disclosures.

The raft of financial chicanery mostly appears to have predated the economic fallout from the coronavirus. Short-sellers had previously flagged some of the issues, and investors and lawmakers have long questioned the credibility of financial data in China. Still, the current economic crisis is important context. Downturns have long been catalysts for bringing previously hidden accounting scandals to light.

When the good times are rolling, it's far easier for tech darlings and other fast-growing startups to hide problems—big and small—under the guise of monster growth. That gets harder when money is tight. It’s not a coincidence that Enron imploded after the dot-com bust and Bernie Madoff’s fraud came to light during the Great Recession.

If there’s a lesson here for U.S. companies it’s that as the economy seizes up and funding grows tight, the virus could be the stock market and venture capital's best disinfectant for fraud. It will be harder for high-flying companies to cover up numbers that look too good to be true. And much like the disease outbreak before it, the financial scandals may not stay confined to China for long. 

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