It was about two years ago that I first met the listings sharks here in China. These sharks don’t swim in the sea, and instead are foreign financial advisors and lawyers, many of them from the US, who peddle listed shell companies to anyone with the cash to buy them and an interest in selling shares on international financial markets. This back-door approach is a great way for Chinese companies to cash in overseas interest in buying into the China boom, without the need for undergoing the financial due diligence needed to do an IPO, however, this can be dangerous for investors.
These guys were not frequenting business events in Shanghai but instead were targetting emerging cities where many companies were making fast money in less-regulated, more opaque environments as they rode the wave of prosperity in China. In places like Changzhou and Zhenjiang these advisors were selling shell companies to anyone with the cash and a reasonably attractive business profile, with few or any questions asked. The advisor makes money selling the shell, the buyer makes money selling shares to overseas investors who assume that listed companies have truthful financial statements that have been checked by independent auditors, and everything should be fine — as long as everyone is truthful and honest.
Now that the sharks have been swimming around for a few years and more companies are getting listed through reverse mergers, this end-run around financial regulations is leading to more company failures and charges of fraud. In one case documented in Bloomberg this week, the Carlyle Group and Glickenhaus & Co, a major US asset management company were duped by a Chinese company which apparently had been faking its books with the complicity of some shady auditors, but was still able to secure a listing on the NASDAQ through a reverse merger. In the Bloomberg report, the company China Agritech Inc. (CAGC), had fired its auditors repeatedly in recent years and was being attacked by short-sellers on the grounds of not having operations in China. According to Bloomberg,
John Hempton, chief investment officer of Bronte Capital, a Sydney-based fund manager who had a short position in China Agritech, wrote in blog posts and e-mails to Glickenhaus that the New York investor had been duped. Glickenhaus was taken to a state-owned fertilizer-bagging plant at an address different from one listed in China Agritech filings, Hempton said in an interview.
“I had a lawyer resident in Shanghai stake out their facilities,” Hempton said in a telephone interview. “There was no evidence of operations.”
The result of this is that the company’s shares tumbled to $6.88 on March 14, when trading was halted for failure to file financial data, from $15.87 on Nov. 8.
According to a statement from Luis Aguilar, a commissioner at the U.S. Securities and Exchange Commission in an April 4 speech, companies that get listings on U.S. markets by reverse mergers aren’t subject to the same scrutiny as those that make initial public offerings. More than 600 such “backdoor registrations” have been done since 2007, including about 150 by firms based in China, and a “growing number” of those companies “are proving to have significant accounting deficiencies,” he said.
China Agritech said it had fired Ernst & Young and begun an investigation. It also said Zheng Wang, a Carlyle executive who sat on the company’s board, had resigned.
Trading in the shares has not resume and China Agritech disclosed on April 18 that it received a letter from Nasdaq saying the exchange intended to delist the company, a decision the fertilizer maker has appealed.
Three lawsuits citing the report and seeking class-action status claimed shareholders had been defrauded, and it is certain that we will see similar cases but the sharks will have swam off somewhere else by then.
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