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Loopholes From Here to China

Stocks in this article: RINO CXTI ONP CGA GFRE BBCZ

"It's extremely difficult to police the small-cap market," said Jacob Frenkel, a former SEC attorney who is now a partner at Shulman Rogers Gandal Pordy & Ecker. "It would take assigning all of the SEC Enforcement division's resources for two years to make a meaningful dent. If you had 800 attorneys suddenly looking at the sector, things would change."

At the heart of the controversy over RTOs is the notion that Chinese companies are "cooking the books" to hold down taxes in China while simultaneously appealing to growth-oriented investors in the U.S. David Gentry, CEO of stock research firm RedChip Companies, says it is not unusual for Chinese companies to have two to three sets of books. "They have one for the banks, one for the State Administration For Industry & Commerce and, if they're public, one for the SEC," says Gentry, whose firm handles investor relations for Chinese reverse merger companies.

Requests for comment from China's State Administration for Industry & Commerce brought no response. A spokesman for the Chinese embassy in Washington said there is no systemic misreporting of business results in China.

"It's not true," said Wang Baodong, on behalf of the embassy. "Like any other country in the world, there may be some loopholes. But the Chinese government has been working hard to improve the tax system by focusing on building a mature market economy."

Baodong said that the People's Republic is encouraging Chinese enterprises to strictly abide by the local laws and regulations in countries where they do business, "to combine the pursuit of benefit with social responsibilities."

The SEC and its counterpart in China, the China Securities Regulatory Commission, signed a memorandum of understanding in April 1994 and then enhanced it in May 2006. The agreement calls for improved cooperation between the agencies, particularly in the area of enforcement, but has so far produced little in the way of concerted action.

Drew Bernstein, chairman of Orient Paper's audit committee and a partner with accounting firm Bernstein & Pinchuk, says the sheer complexity of compliance with two different regulatory systems in two very different languages represents a major challenge, both for small companies based in China and for regulators in the two countries.

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