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SEC Probes China Stock Fraud Network

Frequently the prime movers in the process are Chinese, and never leave China. They enlist the help of bankers, auditors and stock promoters in the U.S. with promises of huge profits in the event of success. Often, the promoters -- some Chinese and some American -- are bailing out just as the public gets in.

The SEC is focusing its investigative efforts on the American end of the network. The agency lacks the power to compel compliance with subpoenas in China -- a fact that has not escaped the notice of dealmakers in China.

A distance of 8,000 miles, together with formidable language and cultural barriers, makes it tough for any investor to get to the bottom of a business scenario in China. Even sophisticated investment professionals spending millions on due diligence have been duped. For the moment, the frequent lack of transparency between the two countries is seen as camouflage for stock cheats. But recurring allegations of fraud and new stock blow-ups have raised questions about the reliability of accounting practices at China-based companies generally.

Some well-known blow-ups suggest the character of the broader problem:

China Energy Savings Technology: This company -- the focus of yesterday's SEC action -- billed itself as a manufacturer of "energy savings products." It agreed to sell $50 million in stock through a PIPE (private investment in a public equity) in January 2006 and soon registered to sell 10 million additional shares in a public offering. A month later, the company disclosed that the SEC had opened an "informal" inquiry into its operations. Within weeks, many of the top people in the company resigned -- directors, executives, all the key participants -- and the company went dark in China, SEC records show. In April, 2009, the SEC obtained judgments finding four of the principals liable for fraud, on the basis that they had used a phony shareholder base and phony stock transactions to boost the price of stock that was essentially worthless, pocketing more than $25 million from American investors. The judgments ordered them to disgorge their profits and to pay penalties. The company is defunct.

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