In late 2010, allegations of securities fraud involving Chinese reverse merger companies began to mount. By December 31 2012, the auditors of at least 67 China-based U.S. public companies had resigned, and 126 China- based public companies had either been delisted from U.S. securities exchanges or had ceased filing reports with the SEC. Stockholders have lost billions in investor funds and the remaining China-based companies listed in the U.S. have had lost market value and investor confidence. Reverse mergers with U.S. public shell companies are the common factor linking most of the securities frauds involving smaller Chinese companies.
According to the Public Company Oversight Accounting Board (“PCOAB”) between January 1, 2007 and March 31, 2010, 159 Chinese companies entered the U.S. securities markets using reverse mergers.
According to the PCOAB’s report these companies generated market capitalization of $12.8 billion. During this same period, three times more Chinese companies were listed on U.S. markets through reverse mergers than through initial public offerings. The report said Chinese companies accounted for a surprising 26% of all U.S. reverse merger deals signed during this period. The PCOAB also notes that 74% of these Chinese reverse merger companies were audited by U.S.-based accounting firms.
Since 2010, Chinese reverse mergers have been the subject of numerous class action suits, SEC enforcement actions and SEC investor bulletins. The SEC actions have targeted the Chinese issuers, their management, outside advisors such as attorneys, auditors and consultants as well as investors and hedge fund managers.
In December of last year, the SEC charged the Chinese affiliates of the big four accounting firms of violating U.S. securities laws because of their refusal to produce audit work papers and other documents subpoenaed in connection with its investigations of Chinese reverse merger auditing firms. The auditors claim they cannot comply with the SEC’s request because to do so would be s violation of Chinese laws that prohibit sharing state secrets. According to the PCOAB, it has been negotiating with China to conduct joint inspections with the China Securities Regulatory Commission of China-based auditors of U.S. listed companies; however, no inspections have been allowed to date.
Realities for Investors in Chinese Reverse Merger Companies
Even when SEC enforcement actions and/or private civil actions are successful, in most instances, assets will be located outside the U.S., making enforcement of judgments and recovey of investor losses difficult. Plaintiffs’ attorneys are seeking recovery of investors’ losses from Chinese companies and their advisors. In 2012, one in four federal securities class action lawsuits involved Chinese reverse mergers with public shell companies. Plaintiffs’ lawyers are even pursuing middlemen in reverse merger transactions–such as Westpark Capital and Rodman & Renshaw–for their roles in enticing Chinese firms into reverse mergers with public shell companies.