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SEC Probes China Stock Fraud Network

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Asia Time (TYM): This watchmaker started trading on the American Stock Exchange at $8.50 a share in February 2008. Without warning, the company stopped filing SEC statements a year later, prompting the Amex to delist its stock. It occasionally trades on the Pink Sheets and last traded Nov. 26 for a penny. Attempts to reach the company were unsuccessful.

China Water & Drinks: This bottled-water company merged into a U.S.-listed shell in 2005. Two years later, it was acquired by a special-purpose acquisition company run by Richard Heckmann, a veteran U.S. investor based in Southern California. Four months after the deal closed, Heckmann charged -- a charge repeated in court papers -- that the Chinese CEO had embezzled millions of dollars and that the company's customer list was mostly fiction. The CEO has denied the charges and countered with a lawsuit claiming Heckmann owes him millions of shares of stock.

In some quarters, China-based stocks are now discussed with near scorn. Famed hedge-fund manager Jim Chanos, who uncovered the accounting fraud at Enron nearly a decade ago, says that accounting irregularities are more the norm than the exception at the Chinese companies researched by his firm, Kynikos Associates.

Chanos has been a vocal critic of China stocks. During an investment conference in New York in October, Chanos argued that investment bankers with strong links to China tend to view U.S. investors as a short-term source of capital, not as long-term partners. Chanos has described Chinese stocks as a "short seller's dream."

The SEC's interest follows a host of damaging accusations by short-sale investors -- those who sell borrowed shares and later profit from a decline in a stock's price. The shorts routinely publish damaging research on the Internet, sometimes causing steep declines in the prices of stocks and occasionally provoking charges of stock manipulation from investors with long positions in those same stocks.

As one Chinese small-cap after another has imploded, the resulting profits have allowed short investors to redouble their efforts. They have been developing databases, scheduling regular trips to China, and hiring experts in forensic accounting.

Their work has been aided by the adroit use of computer technology. Where cultural, language, and legal barriers have prevented U.S. regulatory authorities from knitting together a complete picture of a company's activities, the shorts have succeeded, on occasion, using Internet portals and emails to obtain photocopies of documents filed with Chinese authorities, then comparing those documents with documents filed in the U.S.

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