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Auditors Play Defense on China Stocks

China Fraud Investigation

NEW YORK ( TheStreet) - As the president of an auditing firm closely tied to Chinese companies traded in the U.S., Hamid Kabani faces a steady attack from short sellers hell-bent on proving conspiracy theories all about cooking the books.

Short sellers thrive on bad news, selling stock they have borrowed in hopes they can buy the shares back at a lower price and pocketing the difference. In many cases, they try to drive stocks lower by digging up dirt on the companies. They can be helpful as unofficial watchdogs, but clearly have an ax to grind, and are not infallible.

Kabani says criticism of his company is unfounded and unfair.

"This is a one-sided view that paints everyone relating to China as a villain," Kabani says. "Our problem is that we are in professional services. We don't want to start a mudslinging game with [short sellers] because we won't win."

There certainly is plenty of mud flying in the other direction. The short sellers sling it on web sites, for the most part. They charge that auditors like Kabani are part of a network of investment professionals who get shaky Chinese companies listed on U.S. stock exchanges through tricks with reverse takeovers. The shorts claim that auditors, bankers, and stock promoters then cooperate to float dubious new issues of stock with misleading financial statements, bilking American investors while lining their own pockets -- and those of early investors -- with hundreds of millions in profits.

Prominent on the shorts' list of suspect U.S. auditors are Kabani & Co., Frazer Frost, Goldman Kurland Mohidin, and Sherb & Co., among others. The shorts will sometimes target a reverse takeover company, or RTO, solely on the basis of checking who audited the company's financial statements filed with the Securities and Exchange Commission. None of the auditor firms have faced formal charges of fraud.
The Shanghai Numbers

Sherb & Co. recently came under fire when Kerrisdale Capital, a short-oriented firm, opined on its web site that China Education Alliance (CEU) -- a Sherb client -- was "mostly a hoax." Steve Sherb, managing partner with Sherb & Co., said in answer that his firm takes its responsibilities as auditor of U.S. publicly traded companies "very seriously."

"The allegations against China Education Alliance were by firms or individuals that stated explicitly that they held short positions in the stock," Sherb said.

China Education denied what it called "baseless accusations" and has announced a $10 million share repurchase program.

Goldman Kurland Mohidin partner Ahmed Mohidin, who was formerly employed at Kabani & Co., declined to speak in detail about the Chinese companies his firm audits, but commented broadly that concerns about fraud are overblown.

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