FUQI: Fool's Gold

By Eric Jackson

RealMoney Contributor

3/17/2010 12:30 PM EDT

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Fuqi International (FUQI - commentary - Trade Now) announced last night a major restatement of its 2009 numbers and other accounting irregularities, which will delay the filing of its 10-K with the SEC. The stock dropped 35% in early trading today. Some have asked me if this is a buying opportunity. My verdict: I'd steer clear for now. It's just too risky.

I wrote a positive piece about FUQI in early January, saying that the stock was undervalued and that the growing market for jewelry in China would aid the stock. While I'm still convinced about the Chinese jewelry market, my valuation was based on the assumption that the company's numbers were correct. We know now that they weren't.

And this is one of the great risks of investing in smaller, growth-oriented Chinese companies: governance standards are not the same as for smaller American companies. When I talk about governance standards, I mean the composition and conduct of the board of directors, as well as the implementation of proper accounting standards -- and a curbing of related-party transactions.

Related-party transactions seem to have been part of the problem here with Fuqi, as well as with another high-flying Chinese growth stock,Yuhe International (YUII - commentary -Trade Now), which saw its stock take a haircut a week ago.

I sold my Fuqi long position and calls last week. I had been a believer in the stock and expected the company to do well this year. I'll be going to China in a few days for two weeks to meet with several management teams of companies I believe have a chance of seeing their stock prices double this year. Fuqi was one of the companies I had looked forward to meeting.

Several weeks ago, Chinese-speaking employees of my firm, based in Hong Kong and within China, started to reach out to the companies of interest to us. We introduced our firm and expressed our interest in their companies. We disclosed our stock position in them (usually long) and said we wanted to meet with them to better understand their business and potentially increase our position in their company.

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