Loopholes From Here to China
Among recent RTO-related headlines:
- Orient Paper (ONP) shares tumbled sharply in July, when a short seller's research note alleged fraud and misappropriation of millions. Shares rebounded modestly after the company announced a positive result from an internal review aided by Deloitte & Touche. Drew Bernstein, chairman of Orient Paper's audit committee and a partner with accounting firm Bernstein & Pinchuk, said no evidence of any wrongdoing was found. Still, the stock is down nearly 40% this year.
- China Green Agriculture's (CGA) stock has plunged more than 35% this year, following allegations in June that the fertilizer manufacturer reported one set of sales and net income numbers to the SEC and a different set to the Chinese government. Requests for comment were directed to a press release issued in September, where China Green Chairman and CEO Tao Li said the company would avoid such inconsistencies in the future. China Green shares have recovered very little since Li's statement.
- Chinese specialty chemical products maker Gulf Resources (GFRE) issued a press release on Dec. 8 denouncing an "anonymous report" that called into question the accuracy of its filings to the SEC and raised due diligence concerns. The company continued to fight back with a detailed rebuttal last week. Its stock has held up well. The company declined to elaborate on the press release.
Sources with direct knowledge of the SEC probe have have told TheStreet that the commission has raised specific questions about at least six companies that have yet to disclose inquiries.
To be sure, charges of fraud against Chinese companies are not always borne out. Some seemingly solid companies have been targeted with "research" that has proven flimsy or downright false. Investment bankers experienced in managing RTOs -- and the stock deals that frequently follow -- worry that the entire RTO business has been gravely damaged by a few "bad apples."
Many experienced securities attorneys tend not to buy the "bad apples" argument. They say that the problems with RTOs have illuminated some fundamental weaknesses in the regulatory environments that govern them. They cite the following weaknesses as key:
- China's insularity: The U.S. Public Company Accounting Oversight Board, or PCAOB, says it has sought to review the work of Chinese auditors but has been blocked by the Chinese government. American auditors say that their Chinese counterparts have been slow to learn American standards.
- Laxity in China: Professionals with direct experience of auditing practices and government filings in China say that corruption is a problem -- particularly the understating of revenues to keep taxes down -- and that regulatory standards are shoddy compared to standards in the U.S.
- Manpower limits: U.S. regulators lack the staff necessary to process a heavy volume of RTO deals. They rely mostly on fear of the occasional prosecution as a deterrent, but that doesn't work on entrepreneurs in China, who know that U.S. authorities can't touch them.
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