Many suspect Chinese companies entered the United States by conducting reverse mergers with U.S. listed shell companies. In March 2011, a prominent defender of soon-to-be-halted China MediaExpress (CCME) estimated that over 80% of all China reverse merger companies were frauds. However, an apparent fraud that erupted in May 2011, Longtop Financial, had gone public on the New York Stock Exchange in 2007 with underwriters Deutsche Bank and Goldman Sachs, and at one time boasted a market capitalization of $2.4 billion.
In many cases, China frauds flourished for years under the noses of their auditors, some of which were smaller or regional firms. However, the auditors of CCME, Longtop and other apparent frauds were with the "Big Four" branch office, Deloitte Touche Tohmatsu. Generally, NASDAQ and the other exchanges have become aware of these companies only when their interim filings with the SEC have been delayed or withheld due to their auditors' sometimes belated refusals to sign off on them, as is required by SAS 100. In response, exchanges have imposed lengthy trading halts followed by relegations to the "pink sheets," and immediate, precipitous drops in their market prices. Typically therefore, far more extensive due diligence may be warranted prior to the purchase of any U.S. traded Chinese company's stock than for a decision to buy the stock of a domestic, U.S. traded company.
The means of fraud are many and varied. In both the Longtop and the CCME cases, company income and assets are alleged to have included large amounts of nonexistent cash, as confirmed to company auditors by third party bank branches.  Sino-Forest Corp. (then TRE on the Toronto Stock Exchange), is alleged to have been a 16-year, $4.2 billion "capex" fraud in which a forest products company sold stock regularly, basing its growing valuation on trees that were never harvested because they didn't exist. Other characteristics of China stock frauds may include: delays in filing financial reports; high turnover of CFOs, directors or auditors; unusual or overly complicated corporate structure; research budgets that are low for technology companies; unusual share transactions; revenues, margins or earnings exceeding those of peers; low executive salaries; etc. These frauds began to be exposed in 2009 en masse by the some short sellers. Even as they were being inundated by distressing facts, many Western investors defended the China stocks passionately, potentially giving Chinese company executives, aided by the American counterparties promoting their stocks, additional time to sell out their positions to credulous American investors. By June of 2011, after certain of the China stocks had been exposed as apparent frauds, with no evidence to the contrary presented by the companies themselves, these stocks continued to trade on North American markets at substantial valuations. The stubbornness of some Western speculators (possibly resulting from a combination of "greater fool" theory and magical thinking) appears to have mirrored the outlook of ordinary Chinese investors, who reportedly continued to show little interest in the fundamental values of stocks traded on their domestic exchanges, and a belief that government of the Peoples Republic of China would somehow protect their investments.
The China Stock Frauds in the United States bear striking similarities with the Chinese corporations scandals in Singapore and the series of bankruptcy failures of P-Chips in Hong Kong.
1 Global Comparison of Common Characteristics of China Stock Frauds
2 Partial List of China Stock Frauds in the United States & Canada
3 See also
Global Comparison of Common Characteristics of China Stock Frauds
|Investment Market:||United States||Singapore||Hong Kong||United Kingdom|
|Affected Investable Set:||China Concepts Stock|
|Affected Investable Subset:||N share||S chip||P chip||L share|
|Country of Operations:||China|
|Place of Incorporation:||Cayman Islands, Bermuda, British Virgin Islands, Delaware, Nevada, Florida, Jersey|
|Citizenship of Managers:||Chinese|
|Citizenship of Promoters:||American||Singaporean, Malaysian||Hong Kongers||British|
|Auditors for Chinese subsidiaries:||Local Chinese audit firms|
|Auditors for listed company:||Big Four and Top 10 (45%), Top 100 and Unrated (55%)|
|Bankers for Chinese subsidiaries:||Agricultural Bank of China, Bank of Communications, Xiamen International Bank,|
|Guangdong Development Bank, China Zheshang Bank, Daqing City Commercial Bank,|
|and other banks owned by local governments.|
Partial List of China Stock Frauds in the United States & Canada
|Company Name||HQ Location||Incorporated||Stock Symbol||Year Exposed||Peak Valuation|
|China Energy Savings Technology||none||Nevada||CESV||2006||$616m|
|China Water & Drinks||Palm Desert, CA||Nevada||HEK||2008||$625m|
|Orient Paper||Baoding City, China||Nevada||ONP||2010||$225m|
|China MediaExpress Holdings||Fuzhou, Wanchai, China||Delaware||CCME.PK||2011||$700m|
|Longtop Financial Technologies||Central, Hong Kong||Cayman Islands||LFT||2011||$2,394m|
|Sino-Forest Corp.||Mississauga, Canada||Ontario||TRE.TO||2011||$6,333m|
|L&L Energy, Inc.||Seattle, WA||Delaware||LLEN||2011||$417m|
P Chips Frauds
China Stock Frauds
- ^ Task, Aaron (2011 [last update]). "china stock fraud sec probes reverse merger network: Tech Ticker, Yahoo! Finance". finance.yahoo.com. http://finance.yahoo.com/tech-ticker/china-stock-fraud-sec-probes-reverse-merger-network-yftt_535745.html. Retrieved August 8, 2011.
- ^ Wachtel, Katya (2011 [last update]). "The SEC Is Conducting A Wide Investigation Of Possible Chinese Stock Fraud". businessinsider.com. http://www.businessinsider.com/sec-probes-china-stock-fraud-network-reverse-merger-nyse-2010-12. Retrieved August 8, 2011.
- ^ Aguilar, Luis (2011 [last update]). "Facilitating Real Capital Formation (Commissioner Luis A. Aguilar; April 4, 2011)". sec.gov. http://www.sec.gov/news/speech/2011/spch040411laa.htm#P86_44685:. Retrieved August 8, 2011.
- ^ Pearson, Rick (2011 [last update]). "China Stock Fraud News Already Priced In - TheStreet". thestreet.com. http://www.thestreet.com/story/10953738/1/china-stock-fraud-news-already-priced-in.html. Retrieved August 8, 2011.
- ^ a b c Eden, Scott (2011 [last update]). "SEC Probes China Stock Fraud Network - TheStreet". thestreet.com. http://www.thestreet.com/story/10952277/sec-probes-china-stock-fraud-network.html. Retrieved August 8, 2011.
- ^ "Asensio.com: Report". asensio.com. 2011 [last update]. http://www.asensio.com/Reports/ReportView.aspx?ReportId=1094&CompanyId=170&CompanyName=Report. Retrieved August 8, 2011.
- ^ a b c Norris, Floyd (May 26, 2011). "The Audacity of Chinese Frauds - High and Low Finance - NYTimes.com". The New York Times (New York: NYTC). ISSN 0362-4331. http://www.nytimes.com/2011/05/27/business/27norris.html?pagewanted=1&_r=2&ref=business. Retrieved August 8, 2011.
- ^ See 2010 SEC Order imposing sanctions against Moore, Stevens, Wurth, Frazer & Torbet LLP, and K. Dean Yamagata, CPA
- ^ Gammeltoft, Nikolaj; Lawrence, Dune (2011 [last update]). "China MediaExpress CFO Quits, Auditor Calls for Inquiry of Bus Advertiser - Bloomberg". bloomberg.com. http://www.bloomberg.com/news/2011-03-14/china-mediaexpress-cfo-resigns-auditor-calls-for-investigation.html. Retrieved August 8, 2011.
- ^ IAB Editorial (2011 [last update]). "Deloitte quits as Longtop auditor". vrl-financial-news.com. http://www.vrl-financial-news.com/accounting/intl-accounting-bulletin/issues/iab-2011/iab-489-490/deloitte-quits-as-longtop-audi.aspx. Retrieved August 8, 2011.
- ^ E.g.,
according to Norris, infra, Deloitte had approved the Longtop filings
for six years prior to withholding its approval to the required March
31, 2011 filing.
- ^ "Trade Halts - Current". nasdaqtrader.com. 2011 [last update]. http://www.nasdaqtrader.com/Trader.aspx?id=Tradehalts. Retrieved August 8, 2011.
- ^ Xuan (2011 [last update]). "How to Detect Potential Chinese Stock Frauds - Seeking Alpha". seekingalpha.com. http://seekingalpha.com/article/281286-how-to-detect-potential-chinese-stock-frauds. Retrieved August 8, 2011.
- ^ Deloitte Touche Tohmatsu CPA Ltd. (2011 [last update]). "exv99w2". sec.gov. http://www.sec.gov/Archives/edgar/data/1412494/000095012311052882/d82501exv99w2.htm. Retrieved August 8, 2011.
- ^ a b 40-page,
downloadable Muddy Waters Report on Sino-Forest Corp. (June 2, 2011)
(describing Sino-Forest as the "granddaddy of China RTO frauds," having
grown through "deft navigation" from a little noticed "pump and dump"
fraud company on the Toronto Stock Exchange to being perceived as "an
institution – a seasoned stock with 'quality management' that
consistently grew earnings over more than a decade").
- ^ See, also, "Reaction to TRE Q1 Earnings Call" (Muddy Waters, June 13, 2011).
- ^ Soueidan, Maj (2011 [last update]). "27 Red Flags for Chinese RTO Stock Investors to Look For - Seeking Alpha". seekingalpha.com. http://seekingalpha.com/article/242575-27-red-flags-for-chinese-rto-stock-investors-to-look-for. Retrieved August 8, 2011.
- ^ Eden, Scott (2011 [last update]). "China-Biotics: Latest RTO Trading Halt - TheStreet". thestreet.com. http://www.thestreet.com/story/11155971/1/china-biotics-latest-rto-trading-halt.html. Retrieved August 8, 2011.
- ^ See,
e.g., "Muddy Waters, LLC believes that China MediaExpress Holdings,
Inc. is engaging in a massive “pump and dump” scheme.... (February 3,
- ^ See also, CCME: Irrefutable Evidence of Fraud (March 2, 2011).
- ^ R. Vlastelica, & D. Bases, "US China Shortsellers," (The Daily News, 20110511).
- ^ [author missing] (2011 [last update]). "Is China Media Express Legitimate? - Seeking Alpha". seekingalpha.com. http://seekingalpha.com/article/250894-is-china-media-express-legitimate. Retrieved August 8, 2011.
- ^ As of June 15,
2011, CAGC.PK, ONP and CCME.PK traded at a combined valuation of $166m;
TRE.TO, more recently exposed, traded with a valuation of $710m.
- ^ Soo, Ai Peng; Tan, Clement (2011 [last update]). "Chinese investors shrug off U.S. accounting scandal fallout | Reuters". reuters.com. http://www.reuters.com/article/2011/06/13/china-fraud-reaction-idUSL3E7HD0KS20110613?feedType=RSS&feedName=marketsNews&rpc=43. Retrieved August 8, 2011.
- ^ See
SEC complaint, filed in the ED of New York on Dec. 4, 2006, detailing a
reverse merger-enabled pump and dump scheme that netted the fraudsters
"in excess of $25,000,000."
- ^ See
"Heckmann Corporation to Acquire China Water and Drinks Inc. for
Approximately $625 Million," Bloomberg.com (20080520) This event appears
to have been the operative reverse merger.
- ^ See
"HEK 1st Quarter 2009 Financial Results," (20090508 Press Release)
reporting a $184m goodwill impairment charge necessitated by actual
water sales of only $7.9m. HEK appears to have remained viable, however
because, as it was a private acquisition, HEK reduced the cost of the
acquisition below its original estimate through due diligence, leaving
the new shell with cash to acquire water properties in other countries.
See, generally, the '08-'09 period press releases at
- ^ See, generally the list of Muddy Waters' research reports, including its first, for ONP dated June 28, 2010.
- ^ "Asensio.com: Report". asensio.com. 2011 [last update]. http://www.asensio.com/Reports/ReportView.aspx?ReportId=1094&CompanyId=170&CompanyName=Report. Retrieved 8 August 2011.
- ^ L&L
Energy: "Questions Surface After Closer Look at Company's Filings,"
Glaucus Research, Seeking Alpha 20110802 (describing US and Chinese
securities filing disclosing that corporate funds may have been used to
acquire a coal coking factory that is currently held in a sole
proprietorship under the sole ownership of LLEN’s CEO and chairman)
* Posted on Wikipedia as http://en.wikipedia.org/wiki/China_Stock_Frauds