This is the second of a two-part series on Westpark Capital, accounting firm MaloneBailey and recent allegations of improper accounting at a handful of Chinese companies. Click here for Part 1 of this story.
When MaloneBailey alleged that it had discovered forged bank documents at more than a third of its 25 Chinese clients, it appeared to happen at the last possible second, just as companies were about to file their annual 10-Ks with the SEC. The late-breaking news sent some executives reeling.
That includes China Electric Motor's CFO, "Dexter" Heung Sang Fong, who spoke with
from his home in Northern California. (Like Fong, many CFOs of Chinese reverse-merger companies live in the U.S., thousands of miles away from their employers.) Fong said that China Electric was set to file its 10-K on Thursday, March 31. As late as Tuesday, one of MaloneBailey's audit partners told China Electric's board that "nothing material" had turned up in the audit and that the company could file as planned -- no worries.
By the following morning, however, the auditor's opinion had radically changed, Fong says. MaloneBailey had found "major discrepancies" in the company's books. The discrepancies involved forged bank documents, the auditor told Fong.
"I was shocked," Fong says.
George Qin, the partner in charge of Chinese clients at MaloneBailey, declined to comment on China Electric Motor or Fong's version of events. But, Qin said, "Our work is very hard. It takes a lot of time. The falsified documents, some of them we might have found at the last minute. But I can assure you. As soon as we found those frauds -- because those are massive frauds -- as soon as we found those, we notified the board of directors."
Fong took over as China Electric's finance chief in June 2010 after serving as a director for the previous six months. The CFO post didn't lead to greater transparency for him -- and Fong, who spent a year as finance chief for another Chinese reverse-merger company called
Apollo Solar Energy
, didn't expect it to.
"To be honest, I have no control or access to the company's bank accounts in China," Fong told
. "Ninety percent of Chinese companies don't let their CFOs have access to bank accounts in China."
Every quarter, the company controller at China Electric's headquarters in Shenzhen would send to Fong in California the documents with which he would prepare the period's financial results, according to Fong.
The profit-and-loss figures contained in those documents "always make sense," he says.
He also says: "Every time I go to the factory
in China, everyone is busy, it's full of workers." He said he initially agreed to join China Electric's board partly because
underwrote the company's first public offering of shares, along with WestPark. "I thought, 'Roth must have done enough due diligence,'" Fong says. "If someone did good due diligence, my risk of going on the board should be low."
Fong planned to leave for Shenzhen this week, he said, in an attempt to sort out the crisis, alongside a special committee of the board's independent directors, formed to investigate the potential irregularities highlighted by MaloneBailey. (Fong spoke with
late last week.)
Fong himself has been involved with Chinese reverse-merger companies for nearly a decade. His bio lists a master's degree in accounting from the University of Illinois, and time spent as a CPA at Deloitte, Ernst & Young and KPMG. He was once an RTO promoter, helping Chinese entrepreneurs gain listings in the U.S. One of his clients was Fuqi International, recently delisted by
and kicked to the Pink Sheets after an accounting scandal and amid a long-standing SEC probe. Fong, who took a job at Fuqi not long after it gained its listing here, said he resigned his post in 2008 after growing "uncomfortable" with the company's financial reporting. He says he gave up options to buy some 600,000 Fuqi shares. "Of the entire Fuqi management team, I was the only person with U.S. experience. My family is here; everyone is a U.S. citizen except me." He added, "If the company blows up, I'd be the only person in trouble. That's why I resigned."
WestPark, founded by Richard Rappaport in 1999, serves as a one-stop shop for small Chinese businesses looking to tap American capital markets. The firm says that it and its founders have taken "close to 20" Chinese companies public in the U.S. over the last 20 years. According to its Web site, the firm has offices in Beijing, Shanghai, Hong Kong and Taipei. From those offices, it shops the mainland for suitable companies to bring public in the U.S.
Rappaport is well known in Chinese investment circles for creating his own reverse-merger process, something he calls a WRASP, short for "WestPark Reverse Alternative Senior Exchange Process." The firm has even trademarked the acronym.
The technique is similar to a standard reverse merger, except that it allows for a company to immediately have its equity listed on a major stock exchange, rather than living for some liminal period in the penny-stock purgatory of the OTCBB or the Pink Sheets.
First, WestPark registers a brand-new shell company, as opposed to acquiring one that already exists, according to securities lawyer David Feldman in his seminal text on reverse mergers,
(Bloomberg Press, 2009). A so-called Form 10 shell, or "virgin shell," the vehicle is a form of "blank-check" entity, albeit one without any shareholders or trading history. Usually, when WestPark conducts the merger between the Form 10 shell and the Chinese company, it will also arrange a private placement, selling stock in the still-private company to a small group of investors. After registration statements are filed, and either the Amex or Nasdaq approves the stock's listing, WestPark (sometimes joining with other, larger banks) will underwrite a public offering of shares, according Feldman's text and WestPark's own description of the process. As such, WestPark says, a WRASP has as much regulatory oversight as an IPO.
"It is a complete misconception to classify these transactions as 'backdoor' reverse mergers," WestPark said in a statement sent to
in response to a list of queries for this story. "Unlike the backdoor listing model," the firm continued, "the WRASP process requires our client companies to undergo full SEC review, subject themselves to diligence by the respective exchange, be declared effective by the SEC and receive an NOL
short for No Objection Letter from FINRA BEFORE any trading in the stock is done."
All four of the now-halted stocks were WRASPs coordinated by WestPark. But don't call that a pattern, says WestPark. One of the firm's spokesmen, Jeff Mustard, told the
, "This is one of those fabulous, circumstantial-evidence cases where all these dots can be artificially connected."
Moreover, Mustard said, reiterating the firm's prepared statement, "WestPark relies on the facts and figures given to them by the auditor.... This is an auditor's story."
WestPark was responsible for the original reverse mergers of the four companies, but the firm later had help in underwriting the public offerings of three of them -- NIVS, China Intelligent Lighting and China Electric Motor -- from a pair of U.S. investment banks with long histories in selling Chinese small-cap stocks.
Rodman & Renshaw
was the co-lead underwriter for stock offerings by NIVS and China Intelligent in 2009 and 2010, respectively.
took the lead role in China Electric Motor's public offering in February 2010, raising $22.5 million.
Roth Capital declined to comment. Rodman & Renshaw didn't respond to a request for comment.
Executives and PR representatives of NIVS, China Century and China Intelligent Lighting didn't respond to requests for comment.
, David Feldman writes that the WRASP process "may indeed provide another innovative, clean, and legitimate alternative to a traditional IPO for a company ready to trade on a major exchange."
That doesn't appear to have been the case for a Hong Kong distributor of watch movements called
Asia Time Corp.
( TYM), one of WestPark's earliest WRASP deals. Asia Time's stock began trading on the Amex in February 2008 after raising funds from the likes of banking giants
. The stock shot as high as $8.50 just weeks after its initial offering, heights it would never regain. Not a year later, the company abruptly went dark. Communication ceased with the SEC and with the Amex, which finally struck Asia Time's stock listing in April 2009. WestPark says the company relied heavily on bank credit to fund its inventory, and was simply forced to go out of business, "a casualty of the global credit and financial crises."
Some of WestPark's other WRASP deals have performed better. Take
Hong Kong HighPower
, a battery maker based in Shenzhen. WestPark arranged for a private placement, selling 2.9 million shares for $1.76 each to a small group of investors. Its stock, after a public offering, started trading on the Amex at $3.25 in June 2008. Though it declined to $1.25 amid the financial crisis, HighPower's shares suddenly exploded in the fall of 2009, shooting nearly to $10 in early 2010 before commencing a long slide from which it has yet to recover. The stock was trading recently at $3.10. The company, as it happens, recently filed a notice with the SEC on March 31, saying it needs more time (not longer than 15 days, it said) to file its 10-K. But its auditor doesn't appear to be MaloneBailey; the company's audit a year ago was conducted by a Hong Kong-based firm called Dominic K.F. Chan & Co.
Rappaport's mission to get the WRASP deal structure up and running as a viable business wasn't easy. He spent two years trying to convince regulators to approve the procedure, according to Feldman in
. (Feldman notes in the book that his law firm helped WestPark set up the Form 10 shells used by the firm in its WRASPs. Reached by
, Feldman declined to comment further on the WRASP process.)
Even while Rappaport was attempting to gain approval for his invention, some of his brokers were engaging in behavior that would later be sanctioned by the Financial Industry Regulatory Authority, or FINRA, which regulates broker dealers.
In May 2010, FINRA imposed a censure on the firm, including a $400,000 penalty, for failing to supervise brokers with histories of disciplinary action. Further, according to FINRA, brokers at a WestPark branch office on Long Island "churned customer accounts and engaged in unauthorized and unsuitable trading in multiple accounts." (WestPark has since shuttered that Long Island office.) According to a FINRA press release, several of the brokers involved in the sanctioned trading came to WestPark from the infamous Long Island boiler room Stratton Oakmont, whose principals pleaded guilty to pump-and-dump stock fraud in 1999, as well as other barred broker dealers. It was WestPark's third FINRA disciplinary action since 2004.
WestPark says it fired the brokers cited by FINRA after less than a year on the job.
Also, the firm pointed out, they weren't involved in any of WestPark's Chinese deals.
-- Written by Scott Eden in New York
This is the second of a two-part series on Westpark Capital, accounting firm MaloneBailey, and recent allegations of improper accounting at a handful of Chinese companies. Click here for Part 1 of this story.
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