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Why are the China stocks which are listed on overseas exchanges prone to fraud?

• China stocks listed on overseas exchange such as US, Hong Kong and Singapore have a high incidence of fraud. Why are the China stocks which are listed on overseas exchanges prone to fraud? What is the systemic underlying reason for this tendency? This is a follow-up to the question below.

• Answer:

  There are few reasons. The first one is Chinese mentality. Capitalism in China is very young and do not have such strong moral traditions that are widespread in more developed markets. Thus many entrepreneurs make use of western investor's trustfulness for quick profits, because it's much easier for them to become rich with frauds than to establish solid company. Also top managers of Chinese companies know that there is very little chance that SEC will ever punish them for fraud. And local chinese corporate law tends to penalize companies for harm caused to local investors and not to the foreign ones. Another reason is lack of proper due diligence. Nearly every fraudulent chinese company used small US or even asian auditor and even taken alone it should warn investors. I do not remember even a single company that hired a Big-Four auditor. Also most of these companies are quite small therefore it is not very hard to fake an accounting statements and activity at all. Finally I can say that these fake accounting statements looked really well. I remember that a lot of companies (CNOA, GHII, ONP just to mention some) had P/E between 1 and 3 and P/B around 0.3. There were companies that demonstrated extremely strong growth (fake, or course) and were traded with P/E around 5. It was really hard to stay away from them and a lot of investors started to buy these stocks and created a hype that attracts another wave of investors. In other words it became a classic bubble.