China Media Express and a comment on the efficient market hypothesis

China Media Express has announced that it will appeal its suspension from the Nasdaq.

I guess they are going to say that - apart from this amazing 8K they were completely kosher.

[Deloittes] has informed the Company in its resignation letter that it was no longer able to rely on the representations of management and that it had lost confidence in the commitment of the Board and the Audit Committee to good governance and reliable financial reporting. Prior to its resignation, DTT raised the following issues (some of which may be considered to be disagreements) encountered during the audit, including: issues related to the authenticity of bank statements; a loss of confidence in bank confirmation procedures carried out under circumstances which DTT believed to be suspicious; issues concerning the validity of certain advertising agents/ customers and bus operators (including with respect to certain of the Company's top ten customers); concerns over possible undisclosed bank accounts and bank loans; information on file with the State Administration of Industry and Commerce as to certain subsidiaries appearing to be inconsistent with comparable financial information provided to DTT; the verification of the validity of a sampling of tax invoices issued in connection with certain large transactions; the verification of certain subsidiary tax payments with the local office of the State Administration of Taxation; the verification of salary payments made in cash directly to employee bank accounts; the verification of the production process for advertising programs; and the potential double counting of a certain number of buses. As a result, DTT had requested that the bank confirmation process be re-done at the banks' head office and that the issues described above be addressed by an independent forensic investigation. 

You see Deloitte had lost confidence in the management and the board and the audit committee. The board is going to the Nasdaq to protect their listing.  The board is substantially unchanged.

They thought there was problems with the authenticity of bank statements. [Translation: they can't be sure the money was there.]

They lost confidence in bank confirmation procedures carried out under circumstances they thought were suspicious. [Translation: the local bank was in on the scam...]

They thought there was a problem with validity of certain advertising agents/customers and bus operators (including with respect to certain of the Company's top ten customers). [Translation: the customers and bus operators were faked.]

They thought there were concerns over possible undisclosed bank accounts. [Translation: the money raised largely from Starr but also others was transferred to undisclosed bank accounts and is no longer there - presumably stolen.]

They also thought there were undisclosed loans. [Translation: Chinese banks lend money to fictional customers - which will cause awful problems when the Chinese boom ends. This is a bell-ringing observation on China generally.]

Deloitte requested that the bank confirmation process be done again at head office. Management refused. [Translation: head office of the bank was not in on the scam.]

I could go on.

Potemkin Villages and gullible Western investors

This is a company that claimed to advertise on buses.

They showed Western investors buses with media content and adverts. If you asked to be connected to someone from an advertising agency they would take you there. It all looked real. But it was all a Potemkin Village (a good enough one that Delotte signed the previous year accounts).

If you actually went to spy on them unannounced you discovered it was all fiction.

Unfortunately few investors actually stand outside head office or a factory or a bus yard or did any genuine third party check.

That is not what most investors do. [Bronte has a process for doing some third party checks - and even with them we have worked out ways of losing money!]

Instead what most investors do is go on investor relations tours, stay in good hotels, go to nice dinners.

They turn up to a Potemkin village and believe it. Completely believe it. Some people strangely still believe in Potemkin villages even after the scam is exposed.

Gullibility and the efficient market hypothesis

We know - for sure - that there are people who still believe Chinese scams after they have blown up because they have been taken to Potemkin villages and refuse to disbelieve their own eyes. They are truly gullible.

Its a sad statement on the funds management profession that people entrusted with so much money are so easy to deceive. These people are born to lose money. Rich fools. Kids (often money managers under 35) who get recruited because they look good in a suit and can convince people that they are a safe place for a billion dollars in retail money. Or kids who inherit their position.

Critics of the efficient market hypothesis (EMH) have looked at people with better than average results and argued that those results were because they were so smart. I think the EHM critics have got it backward: they should be researching dumb people. The easiest way to argue the EMH is to demonstrate that it is possible to do better than the market because some people are so dumb.

You only need to identify the dummies.

Look at the institutional investors left holding the bag on this stock or on other Chinese shorts and I reckon you have found your candidates.


John