SEC Probes China Stock Fraud Network

NEW YORK (TheStreet) -- The Securities and Exchange Commission is investigating allegations that U.S. firms and individuals have joined with partners in China to steal billions of dollars from American investors through stock fraud, according to people familiar with the probe.

Individuals with direct knowledge of the investigation say that the SEC is focusing on stock promoters, investment bankers, auditors and law firms that have been active in recruiting Chinese companies to U.S. stock exchanges and raising capital for those companies by selling new shares.

On Monday, the SEC made an example of an auditing firm that it said had failed to protect U.S. investors from overstatement of revenue by a Chinese firm. The commission said it had reached a settlement with the firm -- Moore Stephens Wurth Frazer & Torbet -- and with Kelly Dean Yamagata, a partner. As part of the settlement, the firm will be temporarily barred from accepting new auditing assignments in China and will pay $129,500.

The case relates to audits the firm did for China Energy Savings Technology, a China-based company that has been the focus of a series of SEC fraud complaints since 2006.

John Heine, a spokesman in the SEC's public affairs office, would neither confirm nor deny a new investigation, citing agency policy against commenting on active investigations. But the questions that SEC investigators are asking hint at their direction. Those questions suggest a suspicion that stock manipulators have devised a kind of template for stock fraud -- one that exploits fundamental weaknesses in the regulatory apparatus of the two countries -- and now use the template to cheat investors in deal after deal.

Word of an SEC probe surfaced during the course of a three-month analysis by TheStreet, which included interviews with scores of investment professionals focused on China stocks, together with reviews of SEC documents, company statements and market data. Some of the same sources later provided information to the SEC.

Of special concern to the commission is a class of company brought public in the U.S. through a back-door process known as a reverse merger, sources directly involved in the investigation have told TheStreet.