Thank you, Mr. Chairman. I appreciate the opportunity to present my views on the threats to United States interests posed by Chinese state entities in U.S. capital markets.
My name is Montana Quon. I am a Fellow at The Potomac Foundation in McLean, Virginia doing research on economic security issues with Dr. Norman Bailey, former economic adviser to President Ronald Reagan at the National Security Council. For the past twenty years, I have been an investment banker and fund manager in London, Geneva, Moscow, and Hong Kong. I had served as an adviser to the People's Bank of China, Beijing's equivalent of our Federal Reserve. This work has enabled me to be a player-in a small way- in the global banking market, and given me a perspective on what is happening out there with securities and bonds.
For the record, I am an American citizen, born in Hong Kong of Chinese-American parents. I came back to this country when I was twelve, and attended high school in San Francisco and college in New York.
Mr. Chairman, let me begin my testimony with a developing news story. A week before the meltdown of the Hong Kong stock market on October 23 rd , two members of the United States Congress asked for an investigation of Chinese billionaire Li Ka-shing by the U.S. Securities And Exchange Commission (S.E.C.) with respect to his alleged involvement with market manipulation of China-backed shares in New York. The Hong Kong Standard, Oriental Press, the Hong Kong Economic Journal, Next Media, and the World Journal in Taiwan all ran stories-some of them on the front page-on Li's sudden S.E.C. problems.
This prompted a sharp decline in the share prices of the four Li-linked companies on the Hong Kong Stock Exchange. At its lowest point on October 16 Ih , the market capitalization of the four Li-linked companies lost close to U.S.$2.5 billion, with his flagship company Cheung Kong Holdings Ltd., taking the hardest blows, shedding U.S.$ 0.49 per share, and losing 5% of its market value. By comparison, at its lowest point on that day, the Hang Seng Index(the Dow Jones of Hong Kong) lost only 2% of its value.
The Hong Kong market then continued to fall, and soon similar drops followed in the American stock markets as well as those in Japan, South Korea, England, Australia, Germany, Mexico, France, and others. The Washington Post linked all of these drops to the "bad news 99 coming from Asia along with the generally overvalued stocks present for months in the market.
This episode started when I came to Capitol Hill about two months ago to warn lawmakers about the growing involvement of Chinese state-owned enterprises and China-backed investors in the U.S. securities market. I had told lawmakers here that U.S. securities markets will go the way of the Hong Kong Stock Exchange if they fail to stem the waves of Beijing-backed entities who were playing games with the stock market system.
Senator Alfonse D'Amato, Chairman of the Senate Banking Committee, and Rep. Gerald Solomon, Chairman of the House Rules Committee, took the lead by writing to S.E.C. Chairman Arthur Levitt, demanding investigations and enforcement actions. It was their letters reported on the front pages of the Hong Kong newspapers-and on Hong Kong television-that started the sell-off in the shares of companies under the control of Li Ka-shing, the doyen (big boss) of China-backed billionaires in Hong Kong, and a close confidante of Chinese President Jiang Zemin.
Furthermore, with the help of Rep. Solomon, we punctured the "bubbles" on the U.S.$4 billion Initial Public Offering(IPO), Beijing's biggest so far, on the New York Stock Exchange by writing to the S.E.C.'s Arthur Levitt protesting about the listing of China Telecom. This drove the stock price down below its issue price on the first trading day. Previously, I had asked Richard Grasso, Chairman of the New York Stock Exchange, to delay or suspend the listing of China Telecom until the concerns raised by Rep. Solomon has been cleared by the S.E.C. Fund managers duly took note of this in their sell-off of China Telecom on the opening day of trading.
Poor disclosure, lack of transparency, corrupt market practices such as price-ramming, insider trading, and lax accounting standards seem to be the hallmarks of these Chinese state entities. But their shares and bonds are being offered on an increasingly large scale to U.S. mutual funds, pension funds, and other financial institutions. Now the meltdown of the Hong Kong sstock markethas shown the danger of such involvement for this country.
Mr. Chairman, to safeguard the integrity of the free enterprise system in the United States, we must ensure that Beijing plays by the rules of a self-correcting market on a level playing field The United States must encourage China to adopt a market economy, but we cannot allow market manipulation by Beijing and their chosen cronies, in our backyard
The issue here is that Beijing needs big money from the United States to develop its economy.
Recent moves by the Chinese leadership to restructure some 300,000 state-owned enterprises will unleash a tidal wave of Chinese stock and bond offerings seeking gargantuan financing from U.S. capital markets, with U.S. institutional investors as the final destination of a potential flood of Chinese securities and bonds Business Week reported estimates by investment bankers of at least 350 such securities offerings a year for the next ten years. (Business Week, Sept 29, 1997).
Mr. Chairman, despite foreign exchange reserves of some U.S.$130 billion, the losses racked up by China's state-owned enterprises amount to some U.S.$85 billion, on an annual basis. So, it is not hard to imagine that Beijing needs world capital markets to keep its economy growing.
This year alone, China has raised more than U.S.$25 billion in international bond and equity offerings, ranging from a U.S.$278 million deal by Beying Enterprises Holdings Ltd, a grab-bag state company featuring a tourist concession at the Great Wall of China and various McDonald franchises, to a U.S.$4 billion IPO by China Telecom.
Before the IPO in New York, China's Minister of Communications, Wu Jichuan, had promised to ease accounting rules in order to boost the profits of the company, certainly a startling example of state intervention. In the United States, we would call this fraud, as did Congressman Solomon in his now famous letter to Arthur Levitt. The New York Stock Exchange (NYSE) let the company go ahead anyway and raise U.S.$4 billion, in time, I guess, for President Jiang Zemin's visit to Richard Grasso, NYSE Chairman.
The fact is that most of these Chinese securities and bonds listed through Hong Kong capital markets for resale to U.S. institutional investors are subject to market manipulation by privileged insiders closely tied to the Chinese leadership. State corruption at the highest level throws into doubt the reality of Beijing's much ballyhooed conversion to a market economy. Are the forces of the market really at work in China's so-called market economy? Or is it the result o market manipulation by the ruling Communist elite?
Mr. Chairman, the question we must ask is this: by letting Beijing access our capital markets, are we helping China's economic reform, or are we financing the regime's corruption-and capital flight? Mr. Chairman, the same question can be asked about Russia.
The recent troubles in the Hong Kong stock market, with its heavy concentration of Beijing-backed companies, have shown the perils of such entanglement for the U.S. exchanges. As this concerns the security of U.S. capital markets and the integrity of our free enterprise system, we must put this issue on the agenda of the nation and make it a bilateral concern in U.S.-China relations.
The American people should now be deeply concerned with the growing involvement of Chinese state corporations in U.S. capital markets. Beijing is seeking massive financing from the United States for its state-owned enterprises through securities and bond offerings, often taking the shortcut by circumventing S.E.C. rules.
A Chinese sponsor of one securities offering linked to Li Ka-shing has been named by New York Federal Judge Charles Sifton as engaged in 66 systematic fraud". Lao Yuanyi, managing director of First Shanghai Capital Ltd., instigated a Ponzi scheme in foreign exchange futures defrauding the life-savings of hundreds of elderly pensioners in Brooklyn, New York. The details of this case can be found in Order No. CV-93-0088-CPS, U.S. District Court, Eastern District of New York, August 9, 1993. Mr. Chairman, I hope your colleague from New York on the Senate Banking Committee can bring this to the attention of Robert Morganthau, the New York District Attorney, for criminal prosecution, as the U.S. Government is only going for civil fraud in this case, no doubt due to the Administration's sensibilities over relations with Beijing.
But this goes on and on, Mr. Chairman. The Insider Dealing Tribunal in Hong Kong had found Li Ka-shing to be culpable of "insider trading" in 1987. But this material fact was not disclosed in the new stock offering by China Telecom on the New York Stock Exchange, even though companies controlled by Li Ka-shing are listed as principals in the transaction. Imagine if this is a case involving Michael Milken, what the public outrage would be!
Nor is this material fact disclosed to the S.E.C. by Mr. Li's flagship company, Hutchison Whampoa, in its U.S.$2 billion bond placement with U.S. institutional investors two months ago. This is in direct contravention to Rule 10b(5), Section 12(2), and Section 17(a) of the federal Securities Act, which mandate full and complete disclosure of all material facts.
Mr. Chairman, even if Congress agrees that, in a global economy, U.S. pension funds and financial institutions should finance Chinese state owned enterprises, the United States must ensure that Beijing and their cronies play by the rules of an open, transparent market-the level playing field so crucial to democracy in this country.
American fund managers who have suffered heavy losses in the past week must now be wondering whether companies with such lax standards as China Telecom, China Southern Airlines, and Bejiing Enterprises should have been allowed to offer their securities to U.S. investors, and whether these Chinese state entities have complied with all the relevant U.S. regulations and laws in their share offerings.
Market manipulation by Beijing-backed investors may have contributed to the meltdown of the Hong Kong stock market and indirectly to the mini-crash on Wall Street last week. Their flagrant disregard for the integrity of the free market now has new victims-the small investors on Main Street.
Beijing's reform of state-owned enterprises is becoming a Trojan horse for the mob rule of a one-party state, to be subsidized by capitalization from U.S. savers and retirees.
Mr. Chairman, I believe the intent of your legislation is not to inhibit the free flow of capital in our increasingly globalized economy, but to ensure that this flow takes place on a level playing field. That is why the legislation should focus first on enforcing existing laws, the federal Securities Act of 1933 and 1934, such as the full disclosure requirements mentioned earlier in the testimony.
Many of these Chinese-and Russian-securities and bonds are unable to meet the rather strict registration requirements of our S.E.C. That is why they are being sold to U.S. institutional investors through the exemptions under existing securities laws.
There are two main exemptions from S.E.C. registration requirements currently in use by these problematic issuers. The first exemption is Regulation S, which allows these unregistered securities and bonds to be sold to American investors in offshore transactions. The second exemption is Rule 144(A), which enables these same securities and bonds to be sold in private placements with financial institutions in the United States, again without having to be vetted by the S.E.C.
Mr. Chairman, it would be relatively simple to force these undesirable corporate entities to submit to the vetting process of the S.E.C. Current federal case laws already provide an easy remedy and a legal precedent. The case of Stokes v. Lokken on the 8th Circuit Court in 1981 has already established that those claiming exemption from S.E.C. registration have the burden of showing its application.
Therefore, Mr. Chairman, you and your colleagues on the Senate Banking Committee should remind Arthur Levitt that all he has to do to keep out the undesirables is to require all those claiming exemption from S.E.C. registration to prove that they really qualify. I have written an Open Letter On Chinese Shares to the S.E.C. on September 2nd , with detailed analysis and recommendations on some of the concerns raised. Mr. Chairman, I hope your legislation, the U.S. Market Security Act of 1997, can provide the institutional framework for the S.E.C. to focus on a solution to these problematic practices, which are beginning to change the rules of the game in our free market system here.
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