- A spate of spectacular collapses of Chinese stocks listed on American exchanges has cost U.S. investors billions of dollars. The fiasco has sparked multiple investigations. Accusations are swirling in Washington and Beijing. It all began with an email sent out of the blue a decade ago to a Texas businessman named Timothy Halter.
- The email came from Shanghai native Zhihao "John" Zhang. The former medical student introduced himself and asked: Was Halter interested in helping bring Chinese companies to the U.S. stock market? Zhang proposed using a backdoor method that the Texan had mastered for American firms: buying dormant shell companies listed on U.S. exchanges. Soon, Halter and Zhang brought two Chinese firms to market in America: a manufacturer of power-steering systems and a maker of vitamins, weight-loss supplements and household cleaners.
- The email led to a boom for a niche industry of advisers who specialize in a brand of deals, called the "reverse merger," that use shell companies to give clients easy entry into U.S. capital markets. More than 400 Chinese companies seized the chance.
- Leading the way was Halter, a slim, salt-and-pepper-haired man who played a direct or indirect part in 23 deals; staked his name on at least 20 other deals done by his Shanghai partner, Zhang; and paved the way, through conferences in China, for dozens of other deals. His firm, Halter Financial Group, threw splashy "summits" to promote the industry, including a gathering headlined by former President George W. Bush in 2010. Its website boasts: "Reverse Merger Experts!" But deals birthed by Halter and his imitators are now blowing up.
- Investors have alleged widespread accounting irregularities and other problems at dozens of the Chinese companies that reverse-listed in the U.S., causing share prices to nosedive. Since March, some 30 Chinese firms have seen their auditors resign and at least 25 have been delisted from U.S. exchanges.
- Reuters interviewed nearly 100 industry participants and examined financial records of dozens of Chinese companies to paint the most detailed picture yet of the network of dozens of players involved in the reverse-mergers boom.
- That industry hinges on a handful of leading "shell brokers" such as Halter who purvey paper companies; investment banks who specialize in financing a firm after a reverse merger; and auditors, usually small shops, who are lightly regulated in the U.S.--and not at all in China and Hong Kong.
- The Public Company Accounting Oversight Board, the U.S. auditing watchdog, issued a report in March about potential problems with the audits of Chinese companies formed through reverse mergers. The Securities and Exchange Commission has set up a working group to examine Chinese reverse mergers, and the Federal Bureau of Investigation has opened its own broad investigation, say people familiar with the situation.
- The Chinese reverse-merger boom and bust offer insight into a little-understood corner of American business: the widespread use of shell companies, which can offer their owners a way to minimize regulatory scrutiny. The U.S. in recent years has called for much greater transparency in global business transactions. But on American shores, opaque shell companies are rife.
- A reverse merger hinges on a shell company-a firm without meaningful assets or operations, used as a vehicle for transactions-that's already listed on a stock exchange.A deal typically starts with a so-called shell broker, anyone from a small shop to a larger firm such as Halter's. Brokers acquire shells, often domiciled in a secrecy-friendly state such as Delaware, Utah or Nevada. The broker then sells the U.S. shell to an operating company seeking to trade on a U.S. exchange-a transaction which, unlike an initial public offering, isn't overseen by regulators.
- The acquiring firm thus becomes a publicly-traded company, with access to U.S. investors - but without the time, expense and scrutiny of a traditional initial public offering. Companies are incorporated under state rather than federal law, and so the federal overseer of stock flotations, the Securities and Exchange Commission, doesn't as a matter of course review reverse mergers until after the deal is done.
Wednesday, August 3, 2011
Anyone who has been paying attention to markets the past 6 months has seen the large uptick in blowups by Chinese small caps, almost without exception companies that made it to the U.S. via reverse merger. Reuters has a quite fascinating in depth report on the reverse merger market, specifically focusing on the path many Chinese companies have taken to get backdoor listings (rather than using IPOs). [Jun 23, 2011: List of Chinese Reverse Mergers] Definitely an interesting read for those not familiar with this sort of process, and eye opening in a multitude of ways. Aside from the history of it all, it is quite amazing to see how prevalent shell companies are in this country. Some snippets below:
Reuters: China's Shortcut to America via Reverse Mergers
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