Apparently We Don’t Have Enough Fraud at Home; We Import It Too

Clare Baldwin of Reuters ran an interesting article yesterday describing the swagger of two investors attending DealFlow Media’s annual conference, who say they are making a fortune shorting the stocks of fraudulent Chinese companies.  The conference dealt with so-called “reverse mergers” in which a (usually larger) private company is able to become public without going through an IPO by merging with a (usually smaller) public one.  Apparently, according to these investors at least, since the process avoids an IPO, it’s a ripe for fraud.

“It’s not a matter of whether they are fraudulent companies, it’s just a matter of who they are cheating,” 62-year-old Texas-based investor John Bird, who has been very public about his short positions, told a panel at DealFlow Media’s Reverse Merger Conference 2011.

and another:

“The realization I have come to recently is that it’s a giant Ponzi scheme. It’s all going down,” declared Rick Pearson, another investor who holds short positions on some Chinese stocks.

The article continues, pointing out that others at the conference feel like the whole issue is overblown, especially since the Chinese are easy targets:

Some pointed out that highly regarded companies — such as Warren Buffett’s Berkshire Hathaway — were created through reverse mergers.

They also argued that while some U.S.-listed Chinese companies may have had some problems, that is the exception and not the rule, and suggested China is an easy target because of American resentment about its growth as an economic power and its clout as a big owner of U.S. debt.

“I think with China, there’s a total overreaction,” said David Rees, a partner at Vincent & Rees law firm in Salt Lake City, Utah. “It’s an easy target.”

And of course, the motives of those bringing the reports of fraud to the market were called into question:

Most attendees were quick to say that they wanted fraud rooted out, but they became uncomfortable or even angry at the thought that someone could profit even if their allegations ultimately proved false.

“What it comes down to is, is the information truthful and accurate? And, also, do you have an economic motive or an opportunity, assuming it’s false…to profit personally because you’re intentionally putting out this false information?” asked Perrie Weiner, international co-chair of DLA Piper’s Securities Litigation practice.

Whether you are tempted to believe the shorts or the longs, this article reminded us of our general attitude towards the markets: it’s hard to know what is going on with any of these companies unless you are close to the deals.  Let the buyer beware.

Insight: For short sellers of Chinese stocks, it’s time to reap | Reuters

Thumbnail Photo Credit: Carmela Songer

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