(FORTUNE Magazine) – When Li Jinhua assumed his post as head of China's National Auditing Office six years ago, he could say whatever he liked without worrying about how it would play on Wall Street. That was before the giant state-owned companies whose books he examines began hawking billions of dollars' worth of stock on exchanges overseas. These days Li is a major market mover: When he talks, global investors listen.

Consider the furor that followed his Jan. 30 address to an annual meeting of government auditors in Beijing. While recounting the myriad cases of waste, fraud, and outright larceny uncovered by his agency last year, Li let slip that a "routine" inquiry had turned up $652 million in "financial irregularities" at the parent company of China Life Insurance Co. In years past the disclosure might have gone unnoticed. But this year his remarks were broadcast live on state-run television. Within hours they were flashing across financial news wires around the world, setting off a chain of global events with billion-dollar ramifications.

Why would the musings of Beijing's head bean counter amount to any more than a hill of beans in the wider world? Because in December, China Life, the nation's top insurer, floated shares on the exchanges in Hong Kong and New York. The offering raked in $3.4 billion--and became the richest IPO of 2003 (see fortune.com), capping a year in which foreign interest in Chinese issues swelled to an all-time high. Indeed, global investors' hunger for the shares reached such a frenzy that just days before Li's speech the IPO of China Green Holdings, a tiny vegetable exporter, was 1,600 times oversubscribed. The successes of China Life and other large issues were touted as mere appetizers preceding a feast of Chinese offerings. Investment banks including UBS and Morgan Stanley have been frantically lining up scores of IPOs for 2004. All told, Chinese companies hoped to raise $27 billion this year from selling stock overseas. Two supposedly hot offerings on tap: Dongfeng Motor and China Shipping Container.

Now prospects for those and other sales have dimmed. Like rube diners dismayed to learn the exotic dish they found so tasty wasn't chicken after all, many buyers are finding Chinese delicacies hard to stomach. A few weeks after Li's announcement, the U.S. law firm Milberg Weiss slapped China Life with a class-action suit accusing executives of "massive financial fraud." The giant insurer also is the target of an SEC probe. And suspicion has descended upon a host of other Chinese firms preening for foreign investors. "Long term, sure, the opportunities for investing in China are staggering," says Tom Tauli, an IPO expert with Bridgewater Capital in Newport Beach, Calif. "But right now, people have real concerns about the accounting, about the quality of the regulatory framework."

And with good reason. In March shares of Semiconductor Manufacturing International Corp. slid 9% in its first day of trading after statements by its chief financial officer contradicted the company filings with the SEC. Plans for listing China Minsheng Banking Corp., the country's only privately held bank, were delayed after the company admitted faking a shareholder meeting ahead of its 2000 debut on the nation's domestic stock exchange. By mid-May, all but one of the nine China-related firms that floated shares in Hong Kong and New York in 2004 traded below offer price.

True, the bumpier outlook for China's economy is partly to blame for investors' sudden queasiness. In recent weeks China's leaders, spooked by a burst of feverish growth in the first quarter, have hit the brakes, issuing a flurry of administrative edicts to slow bank lending and curb excess investment in roads, bridges, factories, and real estate. But the truth is, global investors soured on China shares in February--well before Wall Street began to fret that the economy there was overheating.

Business in China is still booming. But the recent raft of management and accounting controversies serve as an important lesson for investors: Betting on companies in the world's fastest-growing economy remains a high-risk strategy. For all the talk of restructuring and reform, China's state-run giants are driven by incentives far different from those governing corporations in full-fledged market economies. And authorities in Beijing seem remarkably unfazed by the scandals.

Not to worry, say many in Beijing; the financial shenanigans signal that China's fledgling economy is growing up. The nation's central bank governor Zhou Xiaochuan asserts China's state-owned financial giants need foreign shareholders, not because they lack capital--most could raise money more easily by listing at home--but because carping from outsiders will spur them to reform. "We know that if commercial banks don't go public, there is not enough pressure to force them to change themselves," he told foreign bankers at the April meeting of the Institute for International Finance in Shanghai. But Zhou's argument has a glaring flaw: Beijing has insisted that the government maintain overwhelming dominance as top shareholder of the nation's largest enterprises--even as it prods them to peddle paper overseas. The result is that even deep-pocketed foreign investors lack leverage over the public companies. (And that includes Warren Buffett, who has a stake, recently worth $1.34 billion, in the Hong Kong--listed subsidiary of China's leading oil company.)

Meanwhile, regulators in Hong Kong and the U.S. review the books of only the packaged subsidiaries, not the parent companies. Decisions about how much profit to ascribe to the foreign-listed issues each year are driven as much by political calculus as market performance. "For most big Chinese companies, foreign IPOs are just a waste of time," scoffs Larry H.P. Lang, professor of finance at the Chinese University of Hong Kong. "Managers of China's state-owned companies don't understand foreign stock markets, and they have no reason to care about the foreign shareholders."

That would certainly seem true of China Life. In meetings with analysts and investors in Hong Kong in early May, company officials shrugged off calls for improved disclosure. Even Credit Suisse First Boston, one of four brokerages that underwrote China Life's December IPO, recently cut its rating of the stock.

As for Li, whose comments started all the fuss, he's apparently learning that government openness goes only so far--foreign investors notwithstanding. The transcript of his remarks at the conference was quickly removed from the agency website.