April 8, 2011

SEC Shuts Down Multiple Chinese Companies Listed on U.S. Stock Exchanges and Investigates their Practices

In 2010 the SEC’s Corporate Finance and Enforcement divisions began a wide-spread investigation into small cap Chinese companies that became public in the United States through a process referred to as “reverse mergers.” The SEC is also investigating the individuals in the U.S. who helped orchestrate these reverse mergers. A reverse merger is also commonly referred to as a reverse takeover or RTO.

In a RTO, a Chinese company is acquired by an American shell company. An American shell company is a company which already has stock trading on a U.S. public exchange, but the company does not operate a business or own assets. The Chinese company merges into the shell. This way, the Chinese company is brought public in the U.S. without the regulatory scrutiny of the Initial Public Offering (IPO) process.

The SEC has found accounting inaccuracies in many of these companies. Companies listed on a U.S. stock exchange are required to maintain and submit audited financials by a firm registered with the Public Company Accounting Oversight board. According to the SEC’s Chief Accountant, hundreds of Chinese companies brought public in the U.S. through the RTO process were using small, largely unknown auditing U.S. firms, who in turn may have been contracting the work back out to local Chinese firms.

The SEC has accused many of the Chinese companies listed on U.S. stock exchanges as engaging in pump and dump scams and other fraudulent practices.

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