The SEC Is Investigating Alibaba

The U.S. Securities and Exchange Commission (SEC) is investigating Chinese e-commerce giant Alibaba in relation to its huge sales on China's Singles' Day shopping event and revenue reporting practices.

According to a release from Alibaba, the SEC is investigating its report of operating data from Singles' Day, a day in China to celebrate single people on Nov. 11 (11/11), during which Alibaba generated more than $14 billion in revenue. Alibaba was transparent about the ongoing investigation:

Earlier this year, the [SEC] informed us that it was initiating an investigation into whether there have been any violations of the federal securities laws. The SEC has requested that we voluntarily provide it with documents and information relating to, among other things: our consolidation policies and practices (including our accounting for Cainiao Network as an equity method investee), our policies and practices applicable to related party transactions in general, and our reporting of operating data from Singles' Day.

The statement further stated that the company is voluntarily disclosing the request for information and cooperating with the SEC to provide requested documents.

The existence of litigation, claims, investigations and proceedings may harm our reputation and adversely affect the trading price of our [american Depositary Shares]. The outcome of any claims, investigations and proceedings is inherently uncertain, and, in any event, defending against these claims could be both costly and time consuming, and could significantly divert the efforts and resources of our management and other personnel.

According to Fortune, the investigation focuses on two aspects of Alibaba's business: its use of off-balance sheet affiliate companies to minimize assets and maximize profit margins, and the extent of its Singles' Day success.

Specifically, for the first offense, the SEC is looking into Alibaba's affiliation with Cainiao, a delivery logistics business of which Alibaba controls 47 percent of ownership. However, Alibaba doesn't incorporate Cainiao's revenue, expenses or operating costs. And it's important to note that Cainiao lost approximately $120 million over the last couple of years. By not having to worry about delivery, Alibaba can maximize its profit margins, while, according to Fortune, one of its main rivals—JD.com—hasn't posted a profit, possibly due to its end-to-end delivery system. The SEC is investigating how Alibaba includes companies, like Cainiao, on its balance sheet.

If Alibaba moved Cainiao onto its balance sheet, it would mean Alibaba's income over the last two years would drop by 53 percent of Cainiao's $95 million loss in 2015, along with other losses from the company it doesn't account for.

As for its Singles' Day revenue, the SEC is focusing on how Alibaba reported its data from the sales day. Fortune reported that the company used a metric called gross merchandise volume, which accounts for the gross volume dollar value of products sold on Alibaba's e-commerce platforms. Researchers and analysts claimed that a large chunk of Alibaba's gross merchandise volume is fake, and is the result of small businesses on the platform shipping empty packages to boost rankings.

"The SEC wants to crack down on non-GAAP metrics, and Alibaba might be one that gets targeted," Paul Gillis, an expert on Chinese company accounting at the Guanghua School of Management in Beijing, told Fortune.

As a result of the statement, Alibaba's shares dropped 7 percent last week.