It was the photographs that clinched it for Chris Carey.
Researching stocks in 2010, Carey noticed the same Caucasian man sticking out amid groups of mostly Chinese executives in the traditional snapshots taken at ceremonies celebrating a company going public on Nasdaq or other stock exchanges. Tall, red-haired and resembling a humourless David Letterman, the man was a spectral presence in the photos. “When I looked at the SEC filings for those companies, he was nowhere to be found,” says Carey, “and so then I began to dig further into how these companies came to go public.”
Carey scrutinizes the margins of the markets for sharesleuth.com, which is majority-owned by the American billionaire Mark Cuban. Carey had been looking into Chinese reverse takeovers, specifically a firm called Telestone Technologies Corp., a wireless equipment manufacturer based in Beijing and listed on Nasdaq. The mysterious redhead, Carey learned, was a Canadian by the name of S. Paul Kelley. He’s a venture capitalist from Oakville, Ontario. It turned out Kelley had helped bring not just Telestone but a raft of other Chinese companies onto the North American capital markets via reverse takeovers.
Kelley’s work provides a window on the how-to of Chinese RTOs. It’s a modus operandi that involves a network of mostly Wall Street bankers, lawyers, entrepreneurs and auditors who have brought hundreds of Chinese companies to North American investors since 2004, introducing some $50-billion worth of stock (all currency in U.S. dollars unless otherwise noted). The soundness of these companies was thrown into question after a number of them blew up spectacularly, most notably Sino-Forest Corp., which was accused in 2011 of making false claims about forests it owned in China. Once the largest publicly traded timber company listed on the TSX, Sino-Forest had entered the markets through the back door of a reverse takeover in 1994. “I’m of the view that the vast majority of Chinese companies listed on North American markets are committing fraud to some extent,” says Carson Block, founder of Muddy Waters Research, the short-selling firm that triggered the Sino-Forest scandal. “These reverse takeovers deserve immense scrutiny,” says Louis Gagnon, a finance professor at Queen’s University. “It’s just a fact that many of these are not viable companies. It’s a great cause of concern in the marketplace.”
The story of Chinese RTOs engineered from Canada is, in no small part, the story of S. Paul Kelley.
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Unlike the conventional route of bringing a company to market through an initial public offering, reverse takeovers allow firms simply to purchase a shell company that’s already listed on the markets and, via a share swap, merge with the corpse—it’s the corporate version of Invasion of the Body Snatchers. By doing so, the RTO engineers sidestep some of the due diligence that regulators and underwriters require for IPOs.
In the case of Chinese companies, it’s often assumed in North America that a reverse takeover is conducted by the company itself. “We are victims of our arrogance,” Block says, “because we think, ‘Of course Chinese companies want to list here.’ But during the past decade, there has been so much liquidity in China that if you really had a good business, you didn’t need to get financing in North America. All the money you wanted was easily available in China.”
So if Chinese companies don’t need our capital, why have so many alighted on North America’s markets? As it turns out, it’s not just Chinese businesspeople masterminding these mergers—it’s Canadians and Americans who see them as a sure-fire way to get rich. People such as Kelley, who is the son of Stafford Kelley, a controversial mining promoter.
Stafford’s career took a hit after he became embroiled in a scandal involving Hucamp Mines Ltd., an Ontario junior mining company that began trading on the CDNX exchange in 2000. Stafford, who briefly consulted for the firm, traded its shares for more than a year. After trading in Hucamp shares was shut down by the Ontario Securities Commission in 2002, Stafford was discovered to have engaged in trades between various accounts to generate a false picture of market activity. In 2008, he consented to an OSC order that banned him from trading in the markets for five years and fined him $10,000 (Canadian).