It appears to be dawning on officials at the U.S. Securities and Exchange Commission (SEC) that cooperative, cross-border financial investigations are completely foreign to China.

Washington’s regulators have been trying since late 2010 to gather information that could help them probe fraud allegations involving so-called Chinese concept stocks listed on American exchanges.

U.S. investors were burned after buying concept stocks, which hundreds of Chinese companies have floated in recent years through reverse-mergers that legally sidestepped SEC disclosure rules.

Short-sellers, whistle-blowers, skeptical shareholders and others have claimed, especially since last year, that concept-stock companies cheated investors by, for example, faking financial reports.

In many cases, SEC launched the investigations after share values plummeted. But investigators often hit impenetrable rock in China while digging for concept-stock company financial data because their Chinese counterparts refused to cooperate.

“The SEC is having a hard time using the tools that it typically uses to investigate or prosecute frauds,” said William McGovern, a former SEC attorney now working in the Hong Kong office of New York-based law firm Kobre & Kim.

Under China Securities Regulatory Commission (CSRC) rules, domestic auditors and financial consultants are prohibited from sending audit reports on Chinese companies listed overseas to anyone outside China, said Guo Bingna, a lawyer at the Los Angeles-headquartered firm O’Melveny & Myers LLP.

Moreover, Guo said, the Chinese government has blocked access to audits under the nation’s vaguely worded State Secrets Law.

Chinese companies listed on U.S. exchanges have been sued in U.S. courts by the SEC every year since 2004. Since 2011 alone, six concept-stock companies and their auditors have been sued.

Eric Jackson, founder of Hong Kong- and Shenzhen-based Ironfire Capital LLC, said most American investors these days assume any Chinese company that lists domestically through a reverse merger is a fraud. They’re also skeptical about SEC’s ability to prevent cheating.

A group called the International Organization of Securities Commissions (IOSCO), whose members include SEC and CSRC, coordinates cross-border securities regulation by arranging memorandums of understanding between participating countries.

So far, though, the IOSCO system has done little to help U.S. regulators garner CSRC support for investigations into Chinese firms. A source close to SEC said CSRC officials have claimed their mutual agreement does not obligate them to share audit reports.

Qiu Yonghong, legal affairs director at the Shenzhen Stock Exchange, said signers of a bilateral IOSCO agreement will, as far as legally possible, do their best to provide securities and derivatives transaction records, account holder names, and records from affiliated businesses.

Judging by these obligations, it seems that CSRC officials are going as far as they legally can, and their denials of SEC access to audit reports is reasonable.

CSRC officials interviewed for this report said the Chinese government’s right to protect national sovereignty affects their agency’s attitude toward cooperating with American securities regulators.

The officials, who asked not to be named, said Chinese regulators have no interest in probing U.S. companies at home because Americans are not allowed to list on Chinese stock markets. So, they reason, CSRC need not let U.S. regulators look into Chinese firms based in China.

The SEC source, however, criticized these comments as short-sighted, arguing that CSRC should share data with the Americans because the Chinese may want to conduct their own cross-border investigations on U.S. soil in the future.

And some CSRC officials lean toward the SEC view. One official, for example, said he backs more open cooperation between Chinese and American regulators. It would be a mistake, he argued, for China to shut its door to foreigners.

Another reason why Chinese regulators are reluctant to cooperate is because they themselves often lack access to company financial information, particularly when a concept-stock issuer is legally based on a distant island.

Paul Gillis, a professor at the Peking University Guanghua School of Management, said many Chinese concept-stock companies are incorporated in the Cayman Islands, which means their records are generally beyond the reach of Chinese regulators.

Another drawback for CSRC is that its securities oversight agency is understaffed compared with its U.S. counterpart. Only about 200 of the agency’s 1,200 investigators are specifically assigned to securities investigation. At SEC, though, about one-third of the agency’s 3,700-plus staffers focus on investigations.

From a legal standpoint, too, CSRC lacks the authority needed to force companies to turn over information, nor can it take legal action against any that refuse to cooperate with investigators.

McGovern said it’s “routine” for SEC’s counterparts in Hong Kong and most Asian countries to cooperate with the commission’s cross-border investigations.

Cooperation usually runs both ways. Securities regulators around the world submitted 492 requests for SEC help last year, according to the agency’s records, while the Americans filed 772 similar requests with other countries.

Swiss authorities sometimes resist requests for information, the SEC source said, but exchanges go smoothly everywhere else outside China.

“They get this roadblock from China,” McGovern said. “They don’t understand it.”

Jiang Yang, assistant to CSRC Chairman Guo Shuqing, said the Chinese regulator has in recent years complied with 72 of 105 requests for cooperation from 18 countries. Over the same period, he said, China received 10 positive responses out of 11 requests for help from other countries.

Without data from mainland authorities on concept-stock companies, McGovern said, U.S. authorities with SEC, the New York Stock Exchange and Nasdaq are usually powerless to pursue legal action. About all they can do is suspend trading or delist a stock after a company refuses to provide information.

The former SEC official thinks the roadblocks to bilateral information exchanges could be lifted if Sino-American relations were improved at the diplomatic level.

On the other hand, the SEC source said, CSRC’s refusal to cooperate may be rooted in Chinese government disinterest in domestic firms that list overseas. Most of these companies go public abroad rather than submit to the kind of CSRC supervision required for initial public offerings in China, he said.

He thinks a foreign investor backlash targeting concept stocks may have a desired effect in Beijing’s eyes as it may bring domestic companies crawling back to mainland stock markets.

McGovern agreed. The Chinese government’s equation also calculates future growth for financial centers in Shanghai and Hong Kong, he said. CSRC officials could be thinking “it’s better to keep that capital-raising close to home,” he said.

Recent friction between securities watchdogs in China and the United States dates to last year’s fallout over an investigation into Longtop Financial Technologies, a Chinese company that traded in New York before its stock was delisted in August.

The company was accused of accounting fraud, but SEC’s investigation has been stymied by a roadblock put up by the China division of global auditor Deloitte. The auditor has refused to cooperate with SEC’s May 2011 request for Longtop documents.

Then in May this year, Deloitte China refused a separate SEC request for an audit report for another concept-stock company under investigation.

Deloitte China says its hands are tied. Audit reports cannot be released to any foreign regulator, the company explained in a statement, without Chinese government approval. And Beijing has refused to help.

In each case, though, SEC has refused to ease the pressure on Deloitte China. A source close to SEC said the agency eventually hopes to win cooperation from Chinese authorities.

Meanwhile, the non-profit U.S. Public Company Accounting Oversight Board is looking into companies and auditors connected to Chinese concept stocks. Board Chairman James Doty said his staffers hope to visit Chinese inspectors on the job and eventually work with them in joint inspections based on U.S. and Chinese standards.

Doty said board members have started talks with CSRC and Ministry of Finance officials. So far, the Chinese side has agreed to let U.S. personnel observe accounting firm oversight procedures, although no timetable has been announced.

But friction between U.S. and Chinese regulators has overshadowed the board’s progress. For example, neither SEC nor CSRC officials budged when they met in May in Beijing at an annual IOSCO conference.

SEC officials at the meeting said the agency is not looking to assert itself globally and CRSC officials argued China has the sovereign right not to cooperate with U.S. investigators.

For more on this story go to:

www.marketwatch.com/story/sec-probes-hit-a-wall-in-uncooperative-china-2012-06-11?pagenumber=2