Since 2007, more than 600 privately held foreign businesses have merged with U.S. listed shell companies to gain access to NASDAQ or the New York Stock Exchange. Using this form of “backdoor registration”, they are able to avoid the accounting scrutiny of a direct listing. However, researchers have revealed many of these firms to be a scam:
When Glickenhaus, 29, joined his family’s New York asset- management company in October, he wanted to bring its stock picking into the era of global warming. That led to a $4 million investment in China Agritech Inc., a Beijing-based firm listed on the Nasdaq Stock Exchange and 22 percent owned by Carlyle Group. It was, Glickenhaus said, a way to profit from the need to feed China in an environmentally responsible way.
Or so it seemed. The same week in November that Glickenhaus & Co. bought most of its 326,130 shares, China Agritech replaced its auditor. Three months later, investors who had bet against the stock attacked the firm as a scam with no real operations. Shares tumbled to $6.88 on March 14, when trading was halted for failure to file financial data, from $15.87 on Nov. 8.
The practice has caught the attention of the Securities and Exchange Commission:
The SEC set up a task force to look for fraud in overseas companies traded on U.S. exchanges, with particular interest in Chinese reverse mergers, and began a probe last year asking auditors for information on the firms. China Green Agriculture Inc. (CGA) in Xi’an and Rino International Corp. (RINO), a Dalian-based maker of water-treatment equipment, said they have received inquiries from the agency...
On Feb. 3, a report titled “China Agritech: A Scam” was published on the website of Lucas McGee Research. The 16-page paper, whose authors were identified only as holders of short positions, or bets against the company, said China Agritech “has no valuable technology, intellectual property, customer relationships or capital assets.”
Site visits to company facilities “found each one empty, idle and without production equipment,” with the exception of one plant in Beijing, the report said. Financial data supplied to Chinese regulators and obtained by “legal agents” who weren’t identified, showed that China Agritech had 2009 revenue of $7.6 million. While the company said it had almost $46 million of cash on its books and unaudited 2010 revenue of $119 million, the report concluded that revenue last year couldn’t have exceeded $7.5 million.
A number of Chinese reverse mergers have been exposed:
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 license issues with previous auditor (Davis Accounting Group)
As NASDAQ seeks tougher rules to curb reverse mergers, an army of short sellers has been unleashed against the existing worthless companies.