The US government is now considering de-listing China based firms for lack of regulatory oversight. These firms range in size from Alibaba to Luckin Coffee.
Clearly President Trump and China’s Xi are locked in what amounts to a high stakes card game. And no one is acknowledging that Trump has a “Trump card” yet to be played.
This Trump card pertains to a remarkable pyramid scheme, orchestrated by the Chinese government, that is fleecing US investors in tax exempt accounts, including 401K’s, IRA’s, public pensions, foundations and endowments.
The good news is that the scheme can be stopped in its tracks by invoking the ERISA 404C prudent fiduciary rule and disallowing tax exempt status to any entity that invests directly in China domiciled companies that refuse regulatory oversight.
ERISA is the law that created IRA’s and 401K’s and its key provision is the 404C prudent fiduciary rule. A rule that strikes fear in employers. They simply don’t want the liability if something goes wrong in their plan. For this reason, employers hire outside independent 401K advisors.
It is somewhat ironic that the Supreme Court just heard a case regarding Intel’s retirement plan, deciding when “constructive knowledge” regarding a mix of hedge funds in the plan was adequately received by plan participants.
The case was triggered by my blog post encouraging Intel to fix its plan and reported in both the Oregonian and later in the NY Times. Sadly, it was also picked up by plaintiff shopping attorneys in what amounted to a nuisance suit.
Intel has a great plan and fully disclosed fees. It did not however provide the more detailed, publicly available, department of labor 5500 report to all employees.
So while Intel provides broad based disclosure, they may still be left with a liability for losses incurred in these hedge funds during the narrow time window in which the case was filed.
Meanwhile, a pyramid scheme brazenly violating the 404C rule has sent more than $1 trillion to China, in the last two years alone, in what could be considered a US economy disabling financial virus. England, France, Germany and other nations are seeing a similar impact.
As Bloomberg recently reported, 95 percent of China based companies’ audit reports are shielded from US and European regulators. Only after uncontrollable collapses such as Luckin coffee, what was to be the Starbucks of China, are such failings revealed. After Luckin declined more than 90 percent it looks to be conveniently deciding to go “private,” leaving US based investors with permanent losses.
How China’s Pyramid Scheme Works
During the last decade there has been explosive growth in index based investments. So much growth that the primary firm preparing and licensing the indexes, MSCI, is now publicly traded.
MSCI’s stock is worth $28 billion and has doubled since Jan 2018 after adding China domiciled companies to its various indexes. Remarkably, annual revenues are only $1.6 billion. Put another way, it is highly leveraged for a simple business whose primary source of revenue is licensing indexes.
The four largest shareholders of MSCI are Vanguard, Blackrock, Fidelity and State Street. These same firms are also the largest providers of index based investment funds.
MSCI Stock Up 100% After Adding China to its Indexes
How China is Manipulating the MSCI and Other Leading Indexes to Move Capital to China Domiciled Companies
Back in 2007, I was stunned that Petro China’s market valuation briefly exceeded $1 trillion. The reason it passed $1 trillion was that the company withheld a large block of the shares from the market. Essentially restricting the supply at a time with high demand, thereby spiking the share price.
Back then, Chinese firms were not in the international indexes. Indexes that are based upon the total stock market value of each company.
This same financial sleight of hand is now being aggressively used by most Chinese firms, making the lack of regulatory oversight even more critical. For example, how many shares are going to executives, government officials, etc? How much of the sales are really not sales, but instead barter transactions, etc? Simply put, regulators reviewing accounting policies matters.
Let’s take a look at two mature leading Chinese companies, Alibaba, which has 33 percent of its shares not traded and Tencent, which has 40 percent.
By inflating its share price, these companies can garner a larger share of the index. Indexes that are based upon the market capitalization or the total stock market value of each firm.
This is why mainland domiciled Chinese firms now account for more than 50 percent of the $80 billion Vanguard Emerging Markets Fund, a fund based upon the MSCI emerging markets index.
So close your eyes and imagine who might be the top two holdings in the Vanguard Emerging Markets Fund? Perhaps a young scrappy Vietnamese Company, something in the Phillippines?
Here they are, the Google and Amazon of China. Alibaba and Tencent.
This $80 billion Vanguard Emerging Markets Fund or an equivalent fund is prevelant in most all 401K plans. Target date retirement fund choices use not only this MSCI emerging markets index but also various other MSCI global indexes, creating the same impact.
In the case of this Vanguard fund, $40 billion, more than half the fund, has been transferred to China. And this is but one fund.
This is before considering the dramatic shift to China-based investments in tax deferred public pension plans via leading private equity partnerships firms including Blackstone, KKR and TPG.
So while the government is quibbling over whether or not Chinese firms should be able to list on US exchanges, the US pension system is being looted via the back door. China doesn’t care if firms are listed in the US, what they want is to dominate the indexes. This looting amounts to more than $1 trillion over the last 2 years.
Recommendation:
Memo to the President… Pull your “Trump Card” out of your pocket and place it on the table. This is a requirement that no tax deferred accounts can be invested in China domiciled companies due to lack of regulatory oversight necessary to fulfill the ERISA 404C prudent fiduciary standard.
Those employers who chose not to divest will essentially be on the hook for investor losses. And if they deem that not possible, have a chat with Intel, which again has a great plan.
Quibbling over agricultural quotes, general fairness, etc. is an absolute waste of time.
China has a new value system that only recognizes power and money. This strategy will leverage both and help the US economy develop, including agriculture, and bring China along toward being a better global partner.
