NEW YORK (TheStreet) -- As more and more Chinese small-cap companies come under attack as fraudulent, an alleged pump-and-dump scam involving Chinese reverse-merger stocks came to light earlier this week.
According to an
unsealed in U.S. federal court in Detroit -- and a parallel
filed by the
Securities and Exchange Commission
on Tuesday -- a group of promoters, stockbrokers and company executives conspired to ramp up prices in the thinly traded shares of Chinese businesses that had come public in the U.S. via reverse mergers, then dump the stocks for a profit.
Court documents claim that the conspirators made $33 million between 2005 and 2007.
Several of the stocks still trade on the over-the-counter bulletin board, where most Chinese reverse-merger companies begin life as U.S.-listed entities. Those companies include
China Digital Media
, which purports to provide cable-television "operational support services" out of Kowloon, and
, which says it's a drug developer based in the city of Xi'an.
The charges were the result of a three-plus-year FBI investigation, which appeared to begin with a probe into the use of spam to market stocks to potential investors.
Five of the conspirators pleaded guilty
, in June 2009. Several of the accused, including the CEO of one of the companies named, were sentenced to more than four years in prison. In a press release, the FBI said that one of the conspirators, Alan Ralsky, "was at one time the world's most notorious illegal spammer."
The fresh indictment on Tuesday brings wire-fraud charges against Gregg Berger, a broker who worked at two investment firms during the period of the alleged pump-and-dump. Berger is reportedly fighting the charges. His lawyer, Mark Satawa, a partner at the Michigan firm Kirsch & Satawa, wasn't immediately available for comment Thursday. He was quoted by
on Tuesday as saying that his client "fully intends to fight the criminal case, and looks forward to the court system vindicating his role in this scheme."
The SEC's civil complaint, meanwhile, went beyond the Department of Justice's cases. In its civil suit, the SEC is also charging four company insiders -- who were not named in the DoJ's actions -- as complicit in the scheme. They include executives and board members of three companies, including the CEO of China Digital Media.
According to the SEC, two of the executives "played key roles" in the schemes by finding the shell companies into which the Chinese outfits were merged.
"The false spam e-mails lured investors into the market and drove up demand in the stocks by, among other things, touting non-existent IPOs and acquisitions, presenting an unrealistic picture of the companies' business prospects, providing baseless share price projections, or including false disclaimers," the SEC said in a press release announcing the litigation.
The stocks involved in the alleged scam targeted on Tuesday are highly illiquid, and differ by an order of magnitude from the well-capitalized Chinese stocks that are now drawing negative attention from short sellers, the media, and others.
Most of those companies, after merging into U.S. shells, have been uplisted from the Pink Sheets and the bulletin board only after attracting the interest of the types of hedge funds that specialize in investing in Chinese companies. In some cases, the funds aid in the reverse-merger process itself. Their investments provide Chinese issuers with the liquidity necessary to meet the listing requirements of the major exchanges.
Other Chinese companies have come public in the U.S. after merging with another type of shell called a special purpose acquisition vehicle. That was the case with
after a short seller accused the company of reporting fictional profits.
Because so many companies have been accused of fraud in recent months, securities regulators have turned their gaze toward the phenomenon. According to people involved in the probe, the SEC is examining more than a dozen Chinese reverse-merger companies with shares listed on major exchanges. The agency is also interested in the role played by the so-called gatekeepers: the finders, promoters, bankers, auditors and law firms that help bring small Chinese companies to U.S. capital markets.
-- Written by Scott Eden in New York
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