Analysts hastened to say that there was nothing inherently suspicious in a reverse merger, but Gillis said such operations “avoid much of the scrutiny that takes place in a normal IPO. That makes them the preferred route for fraudsters.”
Once here, these companies attract retail investors who screen for stocks with high growth rates and low prices, and often run into companies such as this, seemingly diamonds in the rough overlooked by others.
“You see these Chinese companies that have these great numbers, they never miss a quarter of earnings. They are always right on. Their expenses are low. Their growth is tremendous, regardless of the economy. So you go, ‘Hmm, this doesn’t make sense’,” said Mr. Left.
James Chanos, founder of the New York-based hedge fund Kynikos Associates LP, says the Chinese scams follow a classic pattern.
“The modus operandi by these stock promoters is to find what the hot area for retail investors is, so 15 years ago it would have been the dot-coms, a bunch of years ago oil and gas and now it is China. You sell the big story,” he said.
Dave Gentry, president and chief executive officer of investor relations at research firm RedChip Companies, points out that 70 per cent of China’s double-digit economic growth is created by companies with less than 2,000 employees.
While some companies may be overstating their results to entice American investors, Gentry says in their homebase, Chinese firms more frequently under-report revenues to tax authorities - a problem he said was “systemic.”
“It comes down to the character of the CEO and the management team in these companies and there is fraud. We cannot be in denial about this,” he said in a telephone interview while meeting clients in China.
Investor relations firms play a big role in helping companies navigate through the listing process, either through a reverse merger or an IPO.
Crocker Coulson is the president of CCG Investor Relations and Strategic Communications, a company which handles investor relations for some 35 companies, many of them Chinese.
One Chinese client, Puda Coal Inc. , which provides coking coal for steel production, saw its stock plunge and halt on the NYSE Amex stock exchange less than a month ago after another investor, Alfred Little, took aim at the company.
His April 8 report alleges the chairman of the company “transferred the ownership of PUDA’s sole Chinese operating entity, Shanxi Puda Coal Group Co., Ltd (”Shanxi Coal”), to himself in 2009 without shareholder approval according to official government filings.”
Asked how he felt about companies he works for that have had their shares halted, Mr. Coulson paused, shifted his feet uncomfortably, and said: “I’m going to say no comment.”
As for his client Puda, on April 11 the company said it would investigate the allegations. The chairman, Ming Zhao, agreed to cooperate in the investigation. That’s not stopping law firms from sharpening their pencils as a handful have filed for class action status on behalf of investors.
By April 29, with the investigation still underway, the company issued a press release saying the board received a preliminary non-binding proposal from Zhao to buy 100 per cent of the company’s outstanding shares in a “going private transaction at up to $12 a share.” Puda’s shares were trading near $13 a week before Little’s report but plunged to $6 on April 8. The stock was halted before trading started on April 11. In December 2010 the shares hit a closing high of $16.47.
Another company fighting allegations from Little is Deer Consumer Products . It has accused Little of being a “fictitious character,” and said in a press release there is evidence of illegal short-selling on the part of hedge funds distributing false information through web sites, including the popular Seeking Alpha, where Little has published articles.
At the Shenzen headquarters of Deer, located in a six-story building in an industrial part of town, officials would not answer questions.