US investors are told to be cautious when investing in Chinese companies following revelations of accounting irregularities by some of those businesses. [Photo / Provided to China Daily]

 

Just a couple of months ago the debate was still open as to whether there was a bubble in US-listed Chinese Internet stocks. Today, it's hard to deny that the bubble is there - unless it has already burst.

In recent weeks, investor fever for the typical Chinese growth story has quickly turned into doubt and panic, with many starting to shun the sector that used to provide such high rewards.

The Nasdaq China Index, which tracks major Chinese stocks trading in the US high-tech stock market, has dropped nearly 20 percent in fewer than 40 days, from $243.45 on May 2 to $196.83 on June 10. Moreover, the price of Chinese stocks, including Sino-Forest Corp and Yongye International Inc, has plunged more than 50 percent.

"You never know you are in a bubble until it's over," said Duncan Clark, president of the Beijing-based research firm BDA China. "It's part of human psychology. And it takes an event to shake people back into a sense of reality."

And for many fevered investors, the event that has shaken them back to reality is a series of alleged financial scandals involving Chinese companies.

Since March, more than two dozen China-based companies have disclosed information regarding auditor resignations or accounting problems. Last month, the hedge fund manager, Jim Chanos, president of Kynikos Associates and one of the most prominent short sellers of Chinese stocks, said that it was getting hard to find shares to short.

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Over the following weeks, a number of US independent investment companies, including Muddy Waters Research, issued negative reports on some Chinese companies, claiming they had been "aggressively committing fraud".

The market panic even forced Interactive Brokers Group to ban clients from borrowing on margin to buy approximately 160 different Chinese companies. "While the vast majority of these Chinese companies may be legitimate businesses, a growing number of them are proving to have significant accounting deficiencies or are vessels of outright fraud," said Luis Aguilar, a commissioner at the US Securities and Exchange Commission (SEC), in April.

In the same month, SEC Chairman Mary Schapiro said in a letter sent to the House Committee on Oversight and Government Reform that "the SEC has moved aggressively to protect investors from the risks that may be posed by certain foreign-based companies listed on US exchanges".

Schapiro noted that while the majority of foreign-based issuers are engaged in legitimate business operations, others may be taking advantage of the remoteness of their operations to engage in fraud.