M&A: Dangerous reversing manoeuvres
Authorities in the US and China must clamp down on reverse merger fraud.
Market participants in the US and China are awaiting the results of an SEC probe into the practice of Chinese companies listing via shell companies in the US, in what are known as reverse mergers or reverse takeovers. Launched earlier this year, the investigation comes as a result of an increasing number of incidents in which investors in these deals have lost money following the discovery of irregularities in the numbers at the listed firms.
In a typical example, a Chinese company will hire accounting and legal firms at home and in the US to help it create a shell company, which is then listed on an exchange – typically in the US the OTCBB (over-the-counter bulletin board). Shares in the shell company then trade at values relating to the performance of the underlying company in China – the shell itself has no business itself, hence the name.
The structure invites problems because the diligence and disclosure requirements are much less rigorous than would be the case for an exchange listing. In a typical example highlighted by online magazine TheStreet, in December 2010 the SEC reached an agreement with US audit firm Moore Stephens Wurth Frazer & Torbet in which the firm agreed to a $129,000 fine and a temporary ban on accepting new China audit clients.