INTERNET: High-Profile Alibaba Draws SEC Scrutiny

Bottom line: An SEC probe is likely to find that Alibaba misled investors by failing to disclose a government report about widespread piracy on its Taobao site, which will weigh on its shares for the rest of the year as it moves to fix the problem.

Alibaba under scrutiny by the SEC

E-commerce giant Alibaba (NYSE: BABA) is quickly learning that the publicity it craves can be a double-edged sword, with word the company is being investigated for failing to disclose important negative information in the run-up to its blockbuster IPO last year. I’ve never been a big fan of Alibaba’s tendency to hyperbole, even though I do think it’s a fairly well-run company and quite savvy in its core e-commerce area. My general view is that companies should let their performance be their loudest spokesman, and let investors decide the rest.

Alibaba founder Jack Ma is the antithesis of that approach, and loves to hype his company at every opportunity he can. His cheerleading skills helped Alibaba secure a valuation well above what many expected, allowing it to raise a record $25 billion in its New York IPO last fall. Now it seems that the US securities regulator is looking into whether Alibaba failed to disclose key information that could have significantly cooled investor enthusiasm for the company’s IPO shares.

Alibaba is quite careful in its official statement on the matter, saying only that the US Securities and Exchange Commission (SEC) has asked for “background facts and other information” related to its relationship with the State Administration For Industry And Commerce (SAIC), one of China’s main business regulators. (company announcement; English article) Alibaba adds that it had no obligation under disclosure rules to inform investors about the request, and is taking the action to avoid false rumors and speculation. It further adds that the SEC’s request shouldn’t be construed as implying any wrongdoing.

The SEC doesn’t comment on its investigations either, but the request is clearly a reference to the recent high-profile spat involving an SAIC report criticizing Alibaba for rampant piracy on one of its main e-commerce sites. That report was made public last month, and said that nearly two-thirds of the goods sold by third-party merchants on Alibaba’s Taobao.com marketplace were fakes, according to the SAIC’s own survey.

The disclosure took much of the wind out of Alibaba’s inflated stock, and its shares are now down about 14 percent from when the report’s findings were first made public. But what’s drawing everyone’s attention now is the fact that the SAIC actually showed Alibaba the report last summer, but delayed making it public to avoid affecting the company’s IPO. Perhaps the SAIC had good intentions in delaying the report’s release, but many are now saying that Alibaba had its own responsibility to disclose the information as a major risk factor before the IPO.

At least a half dozen law firms that specialize in shareholder lawsuits immediately sensed an opportunity after the report was made public, and launched their own investigations into whether Alibaba failed to disclose important information before the IPO. There’s certainly a strong argument that the answer is “yes”, and now the SEC is following with its own inquiry into the matter. Alibaba will try to convince the SEC that it did nothing wrong, but it does seem inevitable that the SEC will ultimately find that the company misled investors and probably impose a large fine on Alibaba.

Such a fine, combined with damages Alibaba will face from a flood of lawsuits, could easily reach $1 billion or more. That amount is certainly high, but quite affordable for a company like Alibaba that had $12 billion in cash at the end of last year. The bigger issue will be damage to the company’s reputation, and a likely business slowdown that results when it moves to rectify the piracy problem. Such overhangs will weigh on its stock for much of this year, and I reaffirm my previous assertion that its shares will continue to sag and re-approach the $68 level of their offering price.

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