Fraud Warning - Reverse Takeover, Especially Chinese Companies on U.S. Stock Exchanges

I hope you had a wonderful weekend, it is a very busy time of year. Please read the Thought of the Day at the end. The first paragraph is from Vanguard giving the weekly overview. The topic is about Chinese companies who are publicly traded on U.S. Stock Exchanges using a process called a reverse takeover or reverse merger. Please forward this to people who are traders of stocks.

Vanguard

On the heels of a dismal unemployment report last week, economic indicators showed slight improvement amid recent signs that the uneven recovery is beginning to slow. The U.S. trade deficit unexpectedly narrowed, consumer credit rose more than anticipated, and the Federal Reserve's Beige Book release reported overall economic growth. For the week ended June 10, the S&P 500 Index fell 2.2% to 1,270.98 (for a year-to-date total return—including price change plus dividends—of about 1.9%). The yield of the 10-year U.S. Treasury note was unchanged for the week at 2.99% (for a year-to-date decrease of 31 basis points).

Fraud Warning - Chinese Companies and Reverse Takeovers

The Securities and Exchange Commission, SEC, has issued a statement concerning Chinese Companies that are publicly traded. The primary method being used is called a reverse takeover or reverse merger. First I will explain a reverse takeover followed by more specific information.

In a reverse takeover, shareholders of the private company purchase control of the public shell company and then merge it with the private company. The publicly traded corporation is called a "shell" since all that exists of the original company is its organizational structure. The private company shareholders receive a substantial majority of the shares of the public company and control of its board of directors. The transaction can be accomplished within weeks. If the shell is an SEC-registered company, the private company does not go through an expensive and time-consuming review with state and federal regulators because this process was completed beforehand with the public company. However, a comprehensive disclosure document containing audited financial statements and significant legal disclosures is required by the Securities Exchange Commission for reporting issuers. The disclosure is filed on Form 8-K and is filed immediately upon completion of the reverse merger transaction.

The transaction involves the private and shell company exchanging information on each other, negotiating the merger terms, and signing a share exchange agreement. At the closing, the shell company issues a substantial majority of its shares and board control to the shareholders of the private company. The private company's shareholders pay for the shell company by contributing their shares in the private company to the shell company that they now control. This share exchange and change of control completes the reverse takeover, transforming the formerly privately held company into a publicly held company.

The Wall Street Journal has been providing information on this issue. From January 1, 2007 through May 31, 2011 a total of 1036 stocks were listed on the U.S. Stock Exchanges. Of this group, 603 were through the reverse takeover method and 433 were through the IPO method. Of this group, 159 Chinese companies were listed through a reverse takeover and 56 were listed through the IPO method. This means that Chinese companies are using the easy method 3 times more often.

So why is the fraud occurring in the U.S.? For starters if the fraud was done in China the culprits would probably be executed. Also, a lack of due dilegence occurs during the reverse takeover method. The companies do not have to sound Chinese such as Longtop Financial Technologies, Focus Media, or Air Media.

The bottom line is that an approved method for a company to get listed is the reverse takeover or reverse merger method. You need to research a stock before you buy it and if it was listed using this method, you should be concerned. If it is a Chinese company that used this method, you should avoid it. My opinion is to avoid purchasing the stock of any Chinese company in any U.S. stock exchange. Avoid the hype/media buzz about China and avoid investing in something where the intrinsic value of a company is in question.

Thought for the Day

Today is the oldest you have ever been, yet the youngest you will ever be – so, enjoy this day while it lasts.