JOSH BROWN: We Are Under Attack By Chinese Reverse Mergers

Earlier this week, China’s top general sought to downplay China’s military capabilities and its threat to the U.S. Gen. Chen Bingde said China’s recent efforts to upgrade its military have “aroused unfounded suspicions.”

But make no mistake, the U.S. is “under attack” from China, according to John Brown, VP at Fusion Analytics. The attack is not coming in the form of bombs and bullets — or even poison toothpaste — but via the financial markets.

“Let’s not get distracted here, we should simply focus on the accounting chicanery and falsified filings with which Chinese companies are daily relieving US investors of their capital,” Brown writes at his blog The Reformed Broker. “Working with American law firms and shameless stock promoters, these companies have found a financial engineering solution that lets them steal on our shores.”

Specifically, Brown cites the trend of Chinese companies going public via so-called reverse mergers, whereby a publicly traded American-based shell company, often designed for this very purpose, issues a larger number of shares to purchase a Chinese company. The Chinese company then becomes the majority shareholder and essentially assumes the public listing of its American parent.

“It’s a backdoor IPO,” Brown says. “Let’s be realistic about what this is all about: This is about gaining a foothold on U.S. exchanges, doing a secondary, raising a boatload of money, insiders sell, and then all of a sudden ‘oops’ we may have misstated earnings.”

The past two months have brought a spate of de-listings and trading halts for these companies — at least 24 according to the SEC. Forbes’ Walter Pavlo recently detailed a smattering of them:

  • China Electric Motor — Shareholders lawsuit filed claiming underwriters violated federal securities laws by issuing materially false and misleading information.
  • China Natural Gas — Class action lawsuit alleges directors and officers issued materially false and misleading statements. CFO of company resigned in late 2010.
  • Duoyuan Printing — SEC investigating company for fraud, NYSE delisted April 4, 2011
  • China MediaExpress Holdings, Inc. — Deloitte quit as auditor because “no longer able to rely on the representations of management”. CFO resigned. Stock trading halted March 11

  • China Agritech — Shareholder lawsuit pending. Dismissed its auditor Ernst & Young.
  • China Sky One Medical — Under investigation by SEC.
  • Orient Paper, Inc. — Reauditing previous financials due to licence issues with previous auditor (Davis Accounting Group)

“The common threat is revenue exaggeration,” Brown says. “It’s an absolute joke. To a certain extent we are being invaded; we are under attack.”

This post originally appeared at The Daily Ticker.

Aaron Task is the host of The Daily Ticker. You can follow him on Twitter at @atask or email him at [email protected]