The SEC Is Conducting A Wide Investigation Of Possible Chinese Stock Fraud

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Fraud has plagued several Chinese IPOs in recent years.

  • China Energy Savings Technology, Fuwei Films, and China Water and Drinks, after they listed here, were found to have engaged in fraud.
  • Fuqi International received a delisting notice from the Nasdaq, and manufacturer Rino was delisted after it admitted claims about certain contracts were fake.
  • China Life Insurance was plagued by $652 million in “financial irregularities” months after it floated
  • Plans for listing China’s only privately held bank were delayed after the firm admitted faking a shareholder meeting; and the IPO of retail giant ITAT stalled due to doctored sales figures and shoddy accounting.

So it’s no surprise the SEC is allegedly investigating accusations that American firms and individuals, with co-conspirators in China, have defrauded American investors out of billions of dollars via specific method of taking a company public: the reverse merger.

The SEC won’t confirm or deny the probe, but according to The Street, there’s a suspicion that:

[S]tock manipulators have devised a kind of template for stock fraud — one that exploits fundamental weaknesses in the regulatory apparatus of the two countries — and now use the template to cheat investors in deal after deal.

Of special concern to the commission is a class of company brought public in the U.S. through a back-door process known as a reverse merger.

In a reverse merger (or reverse IPO), a private company purchases a public ‘shell’ company and the two entities merge. The publicly traded company is known as a “shell” because all that remains is that firm’s organizational structure.

The shell company issues the majority of its shares and gives board control to its new owner, and the reverse takeover is complete. Circumventing all the usual complexities of taking a firm public, now the privately held company is a publicly held company.

The NYSE’s takeover of Archipelago Holdings was a reverse merger.

And it’s this process by which U.S and Chinese firms are taking advantage of investors, the SEC allegedly believes.

A firm that represents 50 Chinese companies said, “the attention given to the bad seeds is overblown and… ‘people have seized on that to go out and attack high-quality companies that have done nothing wrong — on thin evidence.'” The same individual also acknowledged there has been “financial chicanery by some reverse merger companies.”

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