Juggling with live hand grenades and roaring chainsaws
May 20, 2011 29 Comments
When I am traveling in the US, I am often asked by friends whether they should invest in Chinese stocks and, if so, what stocks should they choose. My new answer is going to be: “Do you enjoy juggling live hand grenades and roaring chainsaws?”
I borrow that characterization from Forbes blogger and investment advisor Joshua Brown who is the latest analyst to have a good rant about the con artists and scammers who have listed bogus or garbage companies in the US. In what Brown terms “red collar crime wave,” a total of 159 Chinese companies engineered reverse-merger listings on US exchanges between January 2007 and March 2010. During that same period, another 56 Chinese companies actually listed by going through the front door of the US exchanges through IPOs that were scrutinized and approved by regulators.
These back-door, reverse-merger listings only require Chinese companies to find a shell or failing company that is already listed, and then inject assets into that vehicle (or pretend to). With hedge funds and individual traders constantly hunting for the next hot Chinese stock, the US markets in recent years have been a playground for con artists who concoct these listings and then “pump and dump” the stock along with their hedge fund buddies.
The irony is, these companies could never get away with such scams on the Chinese stock markets. They must travel all the way to the US to engage in these shenanigans. In China, no company gets listed without government approval. TheStreet estimates that US investors have lost some $34 billion through these scams in the past five years.
I remember watching the beginnings of the Chinese stock markets in Shanghai and Shenzhen in my days as the WSJ China bureau chief. I met a guy in 1990 named Millions Yang who controlled all four of the stocks on the then illegal Shanghai market. He told me that he thought that Chinese people were the most compulsive gamblers in the world, and that those instincts would ensure that Chinese stock markets would be very active and have a bright future.
It certainly looks like some of those gamblers have been taking their talents offshore.
Brown’s blog, an excellent in-depth Reuters report and a Barrons article provide an overview of this sorry situation.
Chinese corporate criminals and their US-based enablers are committing Capital Genocide against American investors. We’re not talking about “a few bad apples” or “a handful of exceptions”, we’re talking about a full-blown epidemic. Subterfuge and malicious avarice are simply the tools of the trade when many Chinese companies do business with outsiders.
This undeniable Red Collar Crime Wave is larger in scope and financial consequence than any other international criminal enterprise in the history of the world. We are talking about hundreds of millions of dollars, possibly billions should the Yahoo – Alibaba revelation prove itself to be a harbinger of shocks to come.
At the low end of the spectrum, corrupt representatives of sketchy or even non-existent Chinese companies are conniving their way onto US exchanges via backdoor IPOs, reverse mergers and SPACs. They are slithering through every exchange and regulatory loophole they can find to raise money and establish their fraudulent beachheads here. The penalties for Chinese nationals fudging numbers on a local exchange could range from exile to imprisonment to disappearance. The penalties they face for pulling that stuff here in the US? I don’t know, a letter in the mail? “Don’t ever do it again”?…
Can American investors trade and hold Chinese stocks? I suppose they can…but they can also practice juggling with live hand grenades and roaring chainsaws…just because you can do something, doesn’t mean you should.
Reuters special report:
Many of the questionable Chinese companies gain access to U.S. capital markets through a back door. In what’s known as a reverse merger, a private company buys enough shares of a public firm to essentially become publicly traded. That allows the company to pay a much lower fee to be listed than it would with an initial public offering – not to mention sidestep the more rigorous filing demands of an IPO.
Of the more than 600 companies that obtained entry to U.S. exchanges this way between January 2007 and March 2010, a total of 159 were from the China region, according to the Public Company Accounting Oversight Board (PCAOB). While many are legitimate, some turn out to be outright pump-and-dump schemes and other scams.
A study by financial web publication TheStreet indicated such schemes involving small-cap Chinese firms may have cost investors at least $34 billion over the past five years.
This has taken U.S. exchanges by surprise. NYSE and Nasdaq have delisted several companies and have a veritable “skid row” of more than a dozen firms that have been halted for weeks or months pending requests for information about accounting problems and late regulatory filings. (For an up-to-date list, see: here)
What are regulators doing about it? Although their stocks are traded on U.S. exchanges, the companies are based in China. That makes it unclear whose jurisdiction they fall under — creating a regulatory void that companies can easily exploit.
On top of that, Beijing has barred America’s PCAOB, established under Sarbanes-Oxley, from reviewing China-based accounting firms – even if they are registered auditors with the accounting agency…
In the absence of stricter regulation on companies and auditors, it is left to independent investors like Andrew Left or Carson Block to ferret out suspicious activity.
They, too, are not without controversy. Left, Block and their peers are short-sellers who profit when a stock collapses – and critics point out that they can in theory benefit even if their research proves faulty…
Then there is Beijing, whose policies play a crucial, albeit indirect, role in all this.
Paul Gillis, a professor of accounting who focuses on U.S.-listed Chinese companies at Peking University in Beijing, said China needed to make it easier for its firms to list on Chinese exchanges.
“It makes no sense for Chinese companies to have to go halfway around the world to get capital,” he said, adding that China was in a better place to regulate them than the SEC or the Public Company Accounting Oversight Board…
Barrons commentary on the SEC report:
Since March 2011 alone, she noted, more than 24 China-based companies have disclosed auditor resignations, accounting problems or both – following the auditors’ inability to confirm the amounts of cash or receivables shown on the companies’ balance sheets. The SEC has recently suspended trading in three Chinese businesses that “reverse-merged” into U.S.-traded shell companies, the back-door route to the stock market that Barron’s spotlighted last year (“Beware This Chinese Export,” August 28, 2010). Another eight such reverse-merged companies have had their registrations revoked by the SEC. And Nasdaq has proposed new strict-sounding requirements for reverse-merged listings, after finding fraud in some recent applications. Nasdaq and the NYSE halted trading in almost a dozen stocks.