Why Chinese Investors Fear the Stock Market

Investors watch the electronic board at a stock exchange hall in Huaibei, China.
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The U.S. Securities and Exchange Commission (SEC) is half way across the world from brokerages in Beijing, but small time investor Zhao Qiang is monitoring the American market regulator's moves.

"I do pay attention to the investigations [into Chinese companies]," Zhao said.

He and other Chinese investors are concerned about the ongoing SEC investigations into New York listed Chinese companies. The SEC has been looking for potential fraud and recently announced charges against the China units of the Big Four U.S. accounting firms in the hope of getting access to audit documents.

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The charges have raised tensions in a standoff between American and Chinese regulators. "The Chinese regulatory authorities do themselves a disfavor by not being more cooperative with other international regulators such as the SEC," Jim Zimmerman, Beijing-based attorney with Sheppard Mullin Richter & Hampton said. "Then investors back home here will pick up on that -- as to whether or not that is a concern for their own markets."

What Are Mainland Investors Worried About?

Chinese companies listed in New York and London have been considered the best of the best. For years, a listing on one of the major overseas exchanges was seen by investors in China as an achievement.

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However, the SEC probes into Chinese companies, some of which avoided IPO scrutiny by arranging reverse mergers with already listed firms, is undermining the reputation of Chinese firms for investors such as Florence Xu. Xu lost a large portion of her life savings in the Chinese stock market. "Listing requirements overseas are stricter versus local listing rules," she said. "I'm worried about accounting standards here just like most Chinese."

Those worries reflect a general problem with the stock markets in China - many people don't trust what they are buying. Historically, the markets here have gone through booms and busts but have never gained the stature enjoyed by the overall economy - now the world's second largest.

(Read more: Will 2013 Bring More Pain or Gain for China Stocks?)

The Shanghai Composite has had a dismal year, and is one of the worst performing markets in Asia, after a poor 2011, when it fell 21.7 percent, largely due to retail investors losing confidence in the market.

Sophie Wu invested in stocks but switched to assets she considered safer such as housing and jewelry. "For property and gold, you can see the value rise over the years," she said. "Stock markets are determined by luck."

Compared to New York and London, exchanges in China are relatively new. International investors have limited access. The markets instead are dominated by small time Chinese investors. At trading rooms that feel like gambling dens, they bet on stocks based more on hearsay than by analyzing company profits or prospects.

Many investors have been constrained this year by the worst economic growth since the late 1990s and uncertainty over the nation's leadership change - keeping the Shanghai Composite near a four year low. "I've been investing for around 20 years," Zhao said as investors around him play cards. "Yet the markets are still a mystery to me."

Chinese authorities have promised to improve regulations, which analysts say could include a crackdown on insider trading and forcing weak firms to delist.

Xu would welcome any moves to protect investors and develop China's stock markets as a reliable investment option. "As an investor, we need to look at the long-term earnings," she said. "I don't know which companies may be susceptible [to false accounting] but once I know of it, I would run from it like the plague."

Additional reporting by Juliana Yeh