In February 2012 a raft of financial scandals at Chinese companies listed in the US saw the FBI being called to examine reverse mergers. This article originally appeared on the web site CleanBiz.Asia.
Problems are about to get worse for Chinese firms. Those companies which listed on the US exchanges through reverse mergers are under scrutiny. The Federal Bureau of Investigation has begun an investigation into the New York Global Group, which is known for taking Chinese companies public in the United States using reverse mergers.
On Wednesday its offices were searched by the FBI, increasing the focus on the increasingly controversial practice. There has been no statement from the company or its president, Benjamin Wei. The US Securities and Exchange Commission (SEC) has already been investigating a number of allegations of accounting fraud and delisted Bodisen Biotech in 2007.
There is growing speculation on Wall Street that action against Chinese reverse merger firms is accelerating and widening its investigation to include advisors, consultants and accounting firms. It is understood that China’s regulatory authorities are also taking a closer look at companies that have acted as a part of due diligence, including accountants.
Why use a reverse merge?
The reverse merger technique is cheaper than a conventional IPO in the US. More importantly, it also means avoiding the stricter reporting rules of an IPO. Chinese companies do so by purchasing a defunct American-listed company, a shell, merging with it and then adopting its ticker symbol.
The problem has been that there have been increasing worries about the value of the financial figures reported by the companies and US investors have lost billions on them over the past year.
According to a study by the Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research in Boston, more than a quarter of all federal securities class-action lawsuits filed in the first half of 2011 were from investors in these China-based companies. There were 24 lawsuits filed compared with seven suits filed in all of 2010.
In September Glancy Binkow & Goldberg LLP announced it was taking a class action suit on the American Depositary Shares of SinoTech Energy Limited.