Are China’s Real Estate Stocks the Next Great Fraud?

During the past two years there have been several cases of outrageous fraud involving Chinese companies listed on foreign stock exchanges, and yet another one was uncovered this week in which a Chinese coal mining company had clearly documented the theft of its primary assets by the company’s own officers.

These stories are exciting to read, and the uncovering of these frauds has created a profitable industry for Carson Block’s Muddy Waters, Citron Research and a host of other short sellers who specialise in ferreting out naughty Chinese companies listed on foreign exchanges.

But the big question is, given the amount of money made by listed Chinese real estate companies, and the hunger of overseas share markets for China’s real estate stocks, why have none of the famous fraud cases to date involved a Chinese property firm?

How Puda Coal Fooled the New York Stock Exchange

I will let the New York Times tell you about the latest case of fraud related to a US-listed Chinese company, this time the culprit being the formerly NYSE traded Puda Coal.

The latest charges of fraud in a Chinese company traded in the United States were filed this week by the Securities and Exchange Commission against two former executives of a Chinese coal company who the commission says stole and sold the company’s assets before they raised more than $100 million from public investors in the United States.

Puda, which went public in the US through a merger with a shell company in 2005, did not disclose these vital tidbits when, in February 2010, it raised $12.8 million selling stock to American investors, in an offering underwritten by Brean Murray, Carret & Company of New York and Newbridge Securities of Fort Lauderdale, Fla.

In December 2010 , a $100 million share sale was underwritten by Macquarie Capital, a Canadian firm, and Brean Murray. Investors in that offering paid $12 a share for stock that now trades for about 25 cents.

Prior to this case, the shorts have uncovered no shortage of bogus Chinese firms listed on US and other foreign exchanges. The following is just a sample of the companies that have been accused by the shorts to date:

From Citron Research:

China Technology Devel. Corp., Syntax Brilliant, China VoIP Digital, Xinhua Financial Media, China Finance Online,Terra Nostra, American Superconductor, New Oriental Education, Origin Agritech,  SinoCoking Coal & Coke, China-Biotics, China New Borun, China Valves Technology,  China MediaExpress Holdings, Deer Consumer Products, Longtop Financial,  Sky-Mobi Ltd, and Harbin Electric.

From Muddy Waters:

Focus Media, Spreadtrum Communications, Sino-Forest Corporation, China MediaExpress, RINO International Corp, and Orient Paper.

Lots of media and technology firms, mixed in with a few manufacturers. But no accusations of fraud against real estate people.

Are people who work in real estate inherently more honest than people working in other sectors? Maybe,  if the other sectors you are talking about are restricted to used cars.

Is it harder to defraud people in real estate than in other sectors? In the latest case against Puda Coal, it is pretty evident that the company clearly filed all the legal documentation in China making plain that it had transferred the company’s assets to the ownership of its directors before it listed on the NYSE, so it would seem that hiding your fraud is not the issue.

The US is the New Home for China’s Fraudsters

The most plausible explanation of why there haven’t been any cases of fraud against China’s listed real estate companies may just be that the companies have been lucky enough to not need to list overseas.

While the requirements for listing on China’s, and even on Hong Kong’s stock exchanges (at least for Chinese companies) are more stringent than for foreign exchanges which allow back-door listings through shell companies, for real estate firms getting onto these Asian exchanges is easier than it is for startups.

So real estate companies of reasonable scale can raise cash here in Asia — but only after having reasonably clean books.

For China’s tech firms and other industry sectors, these Asian capital sources are often closed to them, so they have gotten more creative in seeking funding sources.

In fact, they have gotten so creative in flogging their shares, that they now seem able to do so even after transferring company assets to their own executives.

Does this mean that China’s real estate sector is immune to fraud?

Not from what I can see.