Bottom line: Alibaba (NYSE:BABA) will avoid being penalized in a new SEC probe, but may be forced to modify some of its aggressive accounting practices in a compromise with the US securities regulator.
I'm beginning to understand why e-commerce giant Alibaba has been aggressively building a team of Washington lobbyists following announcement of its latest clash with a US government agency. This time it's the securities regulator that's tussling with the aggressive Alibaba, with word that the US Securities and Exchange Commission is investigating the company for potential illegal accounting practices. The SEC already is well acquainted with Alibaba following another unrelated probe of the company last year related to piracy in its online marketplaces.
Investors weren't too happy about news of the latest probe, bidding down Alibaba shares by 6.8 percent to a two-month low after the disclosure came out. I have to at least credit Alibaba for taking the initiative to disclose the matter this time. Failure to disclose an earlier clash with China's commerce regulator around the time of its record-breaking 2014 IPO was the source of a separate SEC probe last year, though no wrongdoing in that case was ever announced (previous post).
This time Alibaba disclosed it's being probed by the SEC for possible violations of federal laws in some of its accounting practices (English article; Chinese article). The SEC is looking specifically at Alibaba's consolidation practices, its related transaction accounting and the way it accounts for its Single's Day mega-online shopping event each year on November 11.
In Alibaba's case, the consolidation and related transactions accounting issues are quite significant since the company has gone on a massive buying spree worth billions of dollars over the last three years. That spree has taken Alibaba into many unfamiliar areas outside its core e-commerce business, and it's likely the SEC wants to know more about how and if the company includes the results of those other businesses in its financial reports.
The Single's Day promotion also is significant because it has become a major event both in terms of sales and publicity. Last year alone, the one-day event attracted a whopping 90 billion yuan ($13.7 billion) in sales on Alibaba's e-commerce platforms, and the company has built a huge culture of promotion around the date. While the event is hugely popular, reports often say that Alibaba uses strong-arm tactics that pressure third-party merchants on its platforms to report fake or exaggerated sales on the date. For example, some orders may have actually been placed earlier or were made and then quickly cancelled.
Land of Inflated Results
This kind of manipulation is actually quite common in China when calculating things like sales, transaction volumes and user numbers, and aggressive accounting also is quite common. That kind of practice sparked a series of accounting scandals at several smaller overseas-listed private Chinese firms five years ago, leading to a prolonged confidence crisis in the stocks.
In its disclosure, Alibaba said only that it was informed of the SEC probe and is cooperating, and added that investors shouldn't jump to any conclusions. Indeed, it doesn't appear that Alibaba was ever found guilty of wrongdoing in the probe last year, when the SEC investigated whether the company failed to disclose its clash with the State Administration for Industry and Commerce (SAIC) before its IPO.
Alibaba is an aggressive company, and it has been aggressively building a team of seasoned American publicists and Washington lobbyists to protect its image and defend itself in this kind of conflict with government departments. Those efforts helped Alibaba to avoid being named as a "notorious" market for piracy in an annual list published by Washington last December. I expect that lobbying machine is now back in action, and will ultimately help Alibaba to mediate this latest clash with the SEC.