Friday, June 3, 2011

Investors pit blame on 'bad apples'

Article China Daily US version

The shares of many Chinese companies listed on stock exchanges in the United States have plunged recently after a number of accounting mismanagement and fraud scandals.

But investment firms in the US claim the majority of these companies have been unduly punished from negative media reports and a few bad-apple Chinese companies, such as Longtop.

Kevin Pollack, managing director at New York-based Paragon Capital LP (which invests in US-listed Chinese stocks), said these scandals have affected unrelated Chinese companies whose valuations have come down dramatically.

It is unfortunate that many Chinese companies have taken a hit from "unsubstantiated short seller attacks", Pollack said. He said he will continue to invest in Chinese companies.

"I expect Chinese companies to take more proactive action to prevent short seller attacks and to build greater trust among investors," Pollack said. He cited Deer Consumer Products Inc's lawsuit against bloggers who slandered the company as an example of a Chinese company that needs to defend itself.

"These lawsuits can reduce the credibility of the allegations made and deter future attacks," he said.

As the accusations against Longtop reach a fever pitch, the securities lending business has become more and more skeptical of other Chinese companies. Many Chinese companies' stocks have slowed to a crawl. US shares of China Agritech Inc have stood still for the past two months.

Investors also claim there have been inaccurate media stories recently about Chinese companies.

Van Carter, special counsel at Kelley Drye & Warren LLP's New York office, said he believes reporters have misinterpreted two reports issued by the staff of Public Company Accounting Oversight Board (PCAOB) - the Staff Audit Practice Alert No. 6 on July 12, 2010, and the Activity Summary and Audit Implications for Reverse Mergers Involving Companies from the China Region on March 14.

"These are very technical materials and some reporters don't understand the details behind the regulations and rules. There's nothing in the report that says Chinese companies were not being honest or did anything wrong," Carter said.

He said the reports were aimed at a small number of US-based accounting firms which were taking shortcuts in their audit work for Chinese reverse mergers.

When contacted by China Daily, Joseph St. Denis, director of the office of research and analysis at PCAOB, said the Staff Audit Practice Alert No. 6 report was based on their observations that "some companies may not be conducting those audits in accordance with PCAOB standards".

It is not legally wrong for an audit firm to outsource its work to a third party, but the primary auditors of companies that have become public through reverse mergers have the sole responsibility to make sure the work meets PCAOB requirements. But when some US-based audit firms rely on the work of an audit firm in China, the PCAOB will not be able to review the work firsthand because it is blocked from conducting inspections in China, St. Denis said.

According to an e-mailed statement from PCAOB Chairman James Doty, the board is holding talks with China this year to allow inspections of PCAOB-registered audit firms in China.

Denis said the agreement would certainly be helpful for US-based auditors who are the primary auditors of Chinese reverse merger companies.

"On the other hand, if all the audit work is done by a US-based auditing firm, and if they are able to get all the paperwork out of China to review and validate it it would be generally less of an issue for us," St. Denis said.

The US Securities and Exchange Commission (SEC) has revoked the registrations of eight China-based companies since December last year, according to an April 27 letter written by SEC Chairman Mary Schapiro.

In response to China Daily's inquiry, Kara Brockmeyer, assistant director of Division Enforcement at the SEC, said: "Generally, the SEC revokes a company's registration statements when the company has become significantly delingquent in filing its quarterly and annual reports, which means that investors have no current information about the company's financial condition."

Bloomberg has reported that the SEC launched an investigation into Chinese companies' use of reverse mergers last year. But Brockmeyer said the issue is not specifically about Chinese companies, but foreign companies that become US issuers via reverse mergers. Right now, a majority of those companies happen to be based in China, she said.

She confirmed that a number of these companies have had their trading halted by a US stock exchange or have had their trading suspended by the SEC due to "significant accounting issues".

Edward Normandin, partner at Pryor Cashman LLP, said any Chinese company which wants an IPO or a reverse merger in the US should engage a qualified, experienced firm that knows China.

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