Chinese companies face hard sell on Wall Street
Reverse merger gravy train dries up for companies seeking to list in New York after fraud allegations lead US authorities to tighten rules
For smaller Chinese companies looking for quick access to US capital, the reverse merger was the method of choice.
An ecosystem of advisers and promoters helped Chinese companies unable or unwilling to list at home to buy into American-listed shell companies that were then promoted to US retail investors. But the strictures of American reporting rules meant many of the reverse mergers quickly got on the wrong side of US regulators.
Successive allegations of fraud led to tighter rules in 2011, marking the beginning the end of the boom. The arrest last month of one of the prime movers behind the reverse mergers for Chinese firms, mainland-born Benjamin Wey, signalled the endgame.
"Benjamin Wey was legendary in the field … But the market is over and now they are just searching for the guilty," said Paul Gillis, an accounting expert and professor at Peking University's Guanghua School of Management.
He said the reverse merger was used primarily as a way to get around the processes involved in initial public offerings.
"So a company could come to market very quickly without audited financial statements and without the due diligence that lawyers and investment bankers would do in advance of an IPO."
Chinese companies completed 268 reverse mergers between January 2008 and May 2015, according to PrivateRaise, a provider of reverse merger and small-cap data in the US. There were only nine reverse mergers last year, compared with 81 at the height of the boom in 2010, PrivateRaise data showed.
A lack of clarity over many of the companies, concerns about Chinese auditing practises, and critical analyst and media reports led US regulators to tighten reverse merger rules for foreign firms in November 2011.
Among the rule changes, overseas firms had to actively trade in the small-cap over-the-counter market for at least a year before advancing to one of the larger listing boards.
That way, US regulators reasoned, investors and regulators could see how a firm's track record held up.
More than 100 Chinese reverse merger firms had been attacked by short sellers, said Gillis, referring to traders who take positions that pay out when a firm's share price tumbles.
From their peak until July 2011, the 122 Chinese reverse-merger stocks tracked in a Reuters' study cumulatively lost US$18 billion in market value.
"It's harder to do reverse mergers. With all the negative press investors are very wary," said Jessica Lee, a US based investment analyst.
One company tracked by Lee was Shanxi-based Puda Coal. The firm raised about US$100 million in 2010 through a reverse merger but lasted just two years before US regulators charged Puda executives with fraud. The firm was delisted.
In another case, animal feed producer AgFeed also raised about US$100 million from investors only to later pay US regulators US$18 million to settle allegations it reported false revenues. The firm was delisted from Nasdaq in 2012.
Wey and his New York Global Group, whose clients included AgFeed, have been accused by US regulators of market manipulation.
"We allege that when Wey and NYGG were supposed to be helping Chinese companies go public in the US, they were secretly obtaining control of blocks of their clients' shares so they could manipulate the markets and derive illegal profits," the Securities and Exchange Commission said in an announcement last month.
David Siegel, a lawyer for Wey, told the South China Morning Post the charges had no merit and that Wey "looks forward to clearing his name".
As one international venue for capital market fundraisings began to close for smaller Chinese companies, another opened at home. Since its launch in 2012, China's over-the-counter style National Equities Exchange and Quotations board had attracted several thousand small companies to list, before Chinese markets crashed this summer.
More US-listed Chinese companies are expected to follow, as the reverse merger fades into history.
"I blame everybody who was involved in these things. The promoters, the professionals brought with them, the investors who were stupid enough to buy into these things, and the companies that thought there was free money available," Gillis said.