Xinhua Finance Media in the United States

Xinhua Finance Media and the Corporate Governance

By Thomas Brom (2007)

Proxy advisor Glass, Lewis & Co. of San Francisco was bought in 2006 by Shanghai-based Xinhua Finance Ltd.—took center stage as a fellow subsidiary of its new corporate parent made a stumbling entrance into the U.S. capital markets.
The acquisition of Glass Lewis itself raised eyebrows because the Chinese government had helped launch Xinhua Finance in 1999, and until recently held a part ownership and two seats on the board. (If the name Xinhua, or “New China,” rings a bell, it’s because the Xinhua News Agency is the largest official news outlet in China.)
In 2005, Xinhua Finance created a subsidiary, Xinhua Finance Media (XFMedia), led by CEO Fredy Bush, an American woman from Utah who had worked in Asian markets for 20 years. Bush planned to provide reliable financial reporting on Chinese companies, and to promote transparency at a time when foreign capital was clamoring to enter China.
At first, the plan appeared to be working. Last year, XFMedia announced a partnership with the Santa Monica—based Milken Institute, and the American Chamber of Commerce in Hong Kong chose Bush for one of its “Women of Influence” awards. In March, XFMedia—organized under Cayman law and listed on the NASDAQ Global Market—raised roughly $300 million in its initial public offering.

In early May, however, there were hints of bad news. XFMedia announced that CFO Shelly Singhal had resigned from his management posts to become head of corporate development. In the same week, two Glass Lewis executives— Lynn E. Turner, research head and a former chief accountant at the SEC, and Jonathan Weil, managing director and research editor—resigned. “I am uncomfortable with and deeply disturbed by the conduct, background, and activities of our new parent company,” Weil wrote in his resignation letter.

Within days, Barron’s reported that the XFMedia IPO prospectus had failed to mention that a Singhal-owned Newport Beach investment firm had been under a cease-and-desist order from the National Association of Securities Dealers (NASD) for allegedly violating SEC rules. The prospectus also failed to mention that Singhal is identified in a suit filed in February 2007 as “the mastermind and orchestrator of the scheme and plot” to defraud stockholders through a “pump and dump” scheme. (National Account Mgmt., Inc. v. Singhal, No. 07CC03088). According to Barron’s, Bush eventually acknowledged to its reporter that Bush “had known about the NASD problems of Singhal’s brokerage firm,” but added that “legal advisers told her that the prospectus didn’t have to make that disclosure.”

A flurry of XFMedia statements quickly followed. “Xinhua Finance Media listed on NASDAQ after complying fully with all disclosure and due diligence processes required in the United States,” Bush asserted. She issued clarifications regarding alleged omissions in the IPO prospectus and, in a letter to shareholders, announced “enhancements” to XFMedia’s corporate-governance practices to include naming a majority of independent directors on the boards of both Xinhua Finance Ltd. and XFMedia.

But by early June, XFMedia’s American Depositary Receipts had fallen to about 40 percent of its $13-a-share offering price. As sure as night follows day, plaintiffs attorneys rushed to file securities class actions, alleging SEC violations through a series of false, misleading, and fraudulent statements in the company’s IPO prospectus. First to file was Bernstein Liebhard & Lifshitz in the Southern District of New York. (Bollag v. Xinhua Fin. Media Ltd., No. 07-CV-3994 (May 22, 2007).) XFMedia stated that the lawsuit is wholly without merit. But a dog pile of suits—seven at last count—by the securities class-action bar quickly accumulated.

Headlines in the business press—”Shattered Glass,” “Broken Glass”—were almost too easy. Even Glass Lewis’s competitors wanted to know how this could have happened to the corporate parent of such a well-respected company. As Gavin Anderson, chairman of GovernanceMetrics International in New York, explains it, “The Chinese authorities want to instill more entrepreneurship, but there’s nowhere near the same amount of disclosure as in the U.S., nor the same style or history.”

Still, the Chinese weren’t solely responsible for preparing the prospectus. “With an IPO in the States, there are all kinds of major players—lawyers, investment bankers, advisors,” says Dan R. Dalton, director of the Institute for Corporate Governance at Indiana University in Bloomington. “Where were they? Glass Lewis had horses in this stable, but some of the horses are apparently blind.”

The irony is that the proxy-voting advisory industry has never been hotter. The reason: “Proxy advice serves as criticism insurance,” says Paul Rose, an assistant professor at Ohio State University’s Moritz College of Law and author of the article “The Corporate Governance Industry,” which analyzes the industry’s role as a voluntary regulator. (J. CORP. L., summer 2007, p. 101).) “Growth is being fed by recent regulations requiring mutual funds to reveal how they vote their street shares, by institutional investments in developing countries, and by exchange rules—scheduled to become effective January 2008—that eliminate broker discretionary voting in director elections,” Rose says. “In all these cases, proxy advisors provide cover, though it’s still not clear if following their advice satisfies a pension fund’s fiduciary duties.”

Should Glass Lewis falter, the most likely beneficiary would be Institutional Shareholder Services (ISS), the proxy advice leader, with approximately 1,700 clients. Appropriately, ISS devoted a section of its 2006 Global Institutional Investor Study to corporate governance in China. It quoted a Chinese mutual fund officer who complained that “a public company’s internal operation is like a black box. We have no idea about it.” The report concluded that Chinese investors look to two places to defend their minority rights—independent boards, and government regulations and enforcement—and find both lacking. More than 90 percent of the investors surveyed desired better disclosure, transparency, and reporting.

Rose, however, is concerned about what he predicts will be a massive shift in power toward proxy advisors. “Corporate governance is a complicated process,” he says. “Of the many variables the firms use to evaluate companies, maybe only a few really matter for all companies. Good governance is often about choosing good people, not just changing structure.”