Tuesday, 21 June 2011

Who's Scamming Who

When I was in Beijing I did a bit of freelance editing for anyone who wanted English-language materials "polished", from cultural books about bronze and jade to company profiles. A few I did was for a small outfit for a young girl in her early 20s working for a Chinese man who had spent time in the United States and now set up a company he claimed could help Chinese firms go public in the US.

When I had lunch with the girl who thanked me for helping her out, she had no clue that this tiny office could not be equated to the likes of Goldman Sachs or Lehman Brothers (this was just after Lehman went bankrupt). She was naive and conned by her boss into thinking she too could be an investment banker if she worked for him. She didn't realize how the fallout from Lehman Brothers and the global financial crisis would change the entire economic environment.

And the materials I polished for this company? A series of PowerPoint slides crammed with information about the potential IPO company, from technical details to projections about how much it could earn in the next five to 10 years. None of the information seemed relevant, but there was no point in raising this issue -- had I ever helped a company with its IPO before?

Here was a guy with his own scam on Chinese companies falling over themselves in their keen attempt to get really rich in the US with an IPO, or at least some American investment.

But many of them can't pass through the rigors of getting an IPO through the front door, so many go through the back by buying a listed US shell company and then changing the company name. And once they're "listed" in these reverse mergers, these Chinese companies don't realize they are now accountable to their shareholders and must produce documents and reports to prove the firm's viability and its projects down the road to gain more funding from investors.

Instead more of them are being outed as being bogus or not at all what they claimed to be by short sellers in the US who are having a field day discovering a number of Chinese companies are not being completely truthful. The latest victim is Sino-Forest, whose value plunged more than 80 percent this month after allegations its forestry assets were overstated.

The company is desperately trying to keep its reputation in tact by appointing an independent committee to review the allegations with PriceWaterhouseCoopers assisting. However, the damage is done, and even well-known hedge fund player John Paulson was caught with Sino-Forest shares in the fiasco and his group Paulson & Co has sold its stake in the Chinese company, losing $700 million. It's not too much of a dent into a company whose portfolio is worth $37 billion.

"The realization I have come to recently is that it's a giant Ponzi scheme. It's all going down," says Rick Pearson, a Beijing-based investor who holds short positions on some Chinese stocks.

A New York Stock Exchange listed software company called Longtop Financial Technologies said last month its auditor quit, chief financial officer resigned, and it faced a probe by the US Securities and Exchange Commission amid concerns about alleged accounting irregularities.

Another was a probiotic food products company named China Biotics that said last week it would not file its annual report on time because of "serious issues" raised by its auditors.

These financial irregularities is probably due to the creative accounting that happens in Chinese companies. They always have two sets of books, one to show the taxman and one for their own records and there is a lot of fudging that goes on because the companies are keen to find ways to pay less tax.

And possibly they have brought these strange accounting practices to North America without realizing this is not the culture, particularly in listed companies. Also, it's also possible that these Chinese firms don't understand that having an IPO doesn't just mean lots of money on paper, it makes being much more accountable than before and it can cost at least a million dollars to do that properly every year.

As a result, many Chinese companies are seeing reverse mergers aren't worth it anymore. So far this year there have only been 29 reverse mergers of Chinese firms in the US, compared with 47 in the first half of last year. The deals have also raised much less money. At the end of June last year, Chinese reverse mergers raised over $200 million; so far this year it's only $13 million.

It's giving Chinese companies a bad reputation, but it's a good lesson for them. They need to learn to be accountable. While most of us might think that's a no-brainer, we have to remember the Chinese live in an environment where things are faked or get-rich-quick schemes are a dime a dozen. Hopefully they will come to understand the importance of giving the public a solid product or service, thus raising the bar across the board.

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