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TheStreet Open House

China Reverse Mergers Continue Wild Ride

(Article on the ongoing issues related to Chinese reverse takeovers updated with latest news.)

NEW YORK ( TheStreet) -- Fraud scandals have waylaid many Chinese small-cap stocks this year, centering on those that came public through the controversial reverse-merger method. Securities regulators are investigating, and Congress has taken an interest as well. Throughout 2011, TheStreet will track major market-moving events among Chinese small-cap stocks. Click onward to view the year's biggest headlines in this sector so far this year. (Articles are reflective of the news at the time they were published.)

June 21: China Fraud Plot Thickens With Fake SEC Suit

Carson Block

A controversial short-seller who has made a career out of accusing Chinese companies of fraud was the victim of a hoax.

According to a document that rippled across the Internet on Tuesday, June 21, the Securities and Exchange Commission filed a civil suit against Carson Block, the short-seller who composes critical reports on Chinese companies under the name Muddy Waters, alleging stock manipulation.

The document, however, was a fake. SEC spokesman John Nester confirmed as much. "We've issued no such release," he said. He declined to comment further.

Phony SEC press releases and other documents are nothing new, especially in the Internet age. The commission has in the past pursued enforcement actions against individuals who have created and released them.

A vibrant social-media network dedicated to Chinese stocks has developed over the last few years. The fake SEC complaint was posted and reposted by dozens of Twitter users. It also found its way to several market-focused blogs and Web sites.

The complaint was a fairly obvious fabrication. Marred by grammatical errors, it carried the litigation release number "21053." The true SEC document referred to by that number is the announcement of a permanent injunction against a person named Victor Ragucci in April 2010.

Block, who, by his own admission, takes short positions in the stocks he publicly accuses, has certainly made enemies. His scathing research reports have predated the implosions of Rino International and China MedieExpress. A third report, on Duoyuan Global (DGW), came days before the New York Stock Exchange halted trading in the stock.

A fourth, which accused the Toronto-listed Sino-Forest of brazen fraud, has sparked concern among investors that accounting problems exist at Chinese companies beyond the small-cap names that entered the public markets through obscure avenues, such as reverse mergers. The Sino-Forest controversy, which has drawn in even world-class investors such as hedge-fund manager John Paulson, has has helped cause the China stock-fraud phenomenon to make the front pages of the world's major newspapers, along with the high-profile troubles of Longtop Financial (LFT), an NYSE-listed stock that went public through an IPO. (Paulson has reportedly unloaded his position in Sino-Forest.)

Block got his start almost exactly a year ago, when he put out a report on Orient Paper (ONP) that sparked a long-short battle that played out on these very Web pages.

Orient Paper has denied Block's allegations and has avoided the utter disasters that have afflicted his other targets; its stock recently traded at $3.19. (Block stands by his research on the paper company.)

The SEC hoax drew such immediate interest from followers of China stocks because it seemed as though U.S. securities regulators had turned their attentions away from the companies accused of fraud -- and toward their accusers.

Since last year, the SEC has been conducting an investigation into Chinese small-cap stocks, based in part on claims made by short-sellers, who place bets that make money when share prices decline.

The fake complaint against Block attempted to use familiar SEC legal lingo to paint a picture of short-seller fraud and stock manipulation -- one in which short-sellers concoct evidence of fraud against companies out of thin air and then sell those reports to hedge funds ahead of making the allegations public on the Internet.

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