Back in June, The Frost Report wrote about the sorry state of Chinese companies listed on North American exchanges. Namely, that many such companies are rife with fraud (The Sick Man of Asia). This week, both Canadian and American securities regulators began exacting their revenge.
The best way to understand this story is from the perspective of a Chinese con-artist/short-term entrepreneur, whom the new rules are designed to thwart. And so, both the initial problem and the solutions are presented here in letter form:
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Dear North American Securities Regulators,
A few years ago, I had it made. Through reverse mergers (buying out American companies listed on stock exchanges), I had a quick and easy way to become rich - fast!
Merely by listing on a North American exchange, putting together an impressive website, and manufacturing some nice accounting numbers, it was easy to get investors excited. Most of them thought that because my company was listed on a North American exchange, it must be legitimate - the idiots! Ha ha. It was easy money.
Then the problems started.
Savvy North American investors started questioning things - like my receipts and accounts that don't match, the ridiculously spectacular sales numbers, and the head office that doesn't exist (I didn't think anyone would go to Central China to check)! And, I certainly didn't think anyone would check my resume to see that I actually did graduate from business school. In China, buying a degree is no big deal: everyone does it - it only costs a few bucks for a degree from Harvard.
So now, it's all going to hell.
This week in the US, the Securities and Exchange Commission (SEC) announced stricter requirements for foreign companies that become listed on American stock exchanges through reverse mergers (buying out listed American companies). Under the new rules, foreign companies like mine will be traded on the “over-the-counter” (highly risky, restricted) market for a full year before being allowed to trade on a larger exchange. How am I supposed to make my fortune? I need to have investors trust me immediately. I need to take my cash and buy an overpriced house in Vancouver or Sydney right away, before I get arrested. One year is too long.
Then I heard that in Canada, the Ontario Securities Commission (OSC) accused Zungui Haixi Corp and two of its executives of failing to cooperate with their special investigation. The company’s auditor, Ernst & Young LLP, suspended audit of the company’s financial statements just because of a few “inconsistencies” in bank documents, assets and invoices. How dare they!
Now, the OSC is saying it will be unveiling “a number of cases” in the coming months. My friends are all worried that this is the end of the easy life.
So, I am asking you - the employees of the securities exchanges - to please back off. If you do, there is a nice fat red envelope full of cash waiting for you in locker number 6 at the local train station.
Sincerely,
"Entrepreneur"
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Certainly, the vast majority of Chinese companies are legitimate business enterprises.
However, small-cap Chinese companies must be investigated fiercely before being bought as investments - fantastic sales numbers and low debt levels don’t mean much if the numbers are simply fabricated. For the majority of investors, your best bet is to simply stay away.
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