The Evolution of U.S. Listed China Based Frauds

The Evolution of U.S. Listed China Based Frauds

The Best Kept Secret or Not?

By Maj Soueidan
Co-Founder, GeoInvesting

If you have invested in U.S. listed Chinese stocks (ChinaHybrids) you are probably already aware of their rise and fall from grace. If you are thinking about investing in these stocks for the first time, it’s important that you become familiar with the evolution of the space. GeoInvesting has and will continue to play a big role in bringing awareness to the investment risks and opportunities in ChinaHybrids. I bought my first ChinaHybrid in 2004.

I became interested in these stocks because they offered a way to invest in China without having to deal with  the logistical challenges of directly investing in China A share markets.  Furthermore, I could read  SEC regulatory filings in English that were audited by U.S. firms (occasionally big 4 firms). But a big issue still remained: many of the sexiest China names came public through reverse merger transactions and traded on the over the counter markets (OTC).

Reverse mergers are a back door approach to an Initial Public Offering (IPO). A private company essentially buys a non-operating company trading on the OTC for a few hundred thousand dollars or in exchange for stock of the soon-to-be new company. The OTC is well known to house pump and dumps and purely speculative companies that never succeed. This explained why many of these China based stocks traded at ridiculously low valuations, despite reporting meaningful sales and earnings in SEC filings.

From my perspective, this was a perfect example of inefficient markets. With faith that auditors were doing their job, combined with proper research, it appeared I had a great opportunity to buy stocks on the OTC market with low valuations that would later up-list to a major exchange at higher valuations.

The Good Times

GeoInvesting was launched in 2007 to cover U.S. Micro Cap stocks and help bring awareness to ChinaHybrids. Microcap investors seemed like the perfect match. By 2008, over 500 ChinaHybrids were trading in the U.S. The group had sporadic moments of glory, but not usually on a sustained basis.   But then came the Great Recession of 2008, a gift in disguise and perfect storm for ChinaHybrids. China was the first nation to implement policies to combat the global recession. Thus, investors started taking notice of ChinaHybrids that were still growing sales and earnings while the rest of world was suffering. They became the one pocket of hope for many investors.

In 2009 everyone found these stocks and we began writing about them at GeoInvesting. We were “loved” by many investors. China stocks were doubling, tripling and quadrupling one after the other.  I began writing about China companies I met at conferences that I routinely attended, usually hosted by well-known investment banks and research houses like Roth Capital, RedChip securities and now defunct Rodman & Renshaw.

Eventually, my business partner, Dan David, began attending conferences with me.  Management teams would use these conferences to raise billions of dollars of “growth capital” from institutions and everyday investors.

From Chic to Geek: The Bubble Bursts

By the end of 2009, we started the process of building an on the ground China team, partly because cracks started appearing in a few stocks we were following. Stories started sounding too good to be true and the market failed to assign high multiples to seemingly high growth, low risk companies. The market was illogically inefficient.

In 2010, we had our on the ground team in place and in the summer of 2010 we gave them a list of 50 companies to start visiting.  Within two weeks we received a call with a message we were not hoping to hear.

“Sell them all. The China based frauds and deception is much worse than you anticipated. You can’t trust the SEC flings audited by U.S. Big Ten accounting firms,” our investigators told us.

We immediately issued a note to GeoInvesting members regarding ChinaHybrid stocks, stating that this space was basically not investable for the time being.

Shortly thereafter, the bubble began to burst. ChinaHybrids were tanking, getting halted and delisted amid bearish articles calling out the widespread China based frauds and deception.

Investors, even savvy ones, lost billions.

GeoInvesting’s Role In Cleaning Up The China Based Frauds

Initially, we attempted to work with investor relations firms and investment banks to clean the space up. They soon balked on us. We would later learn that the majority of the reverse mergers that these firms were conducting business with were earning them large fees, so we surmised that they just decided to hide behind disclosures and earn fees for as long as they could before the space totally blew up.

We set on a crusade to write hard hitting due diligence pieces, calling out management teams and protecting investors from fraud. Our work outing deceptive Chinese management teams speaks for itself: we are one of the only organizations that got management teams to admit their deceit and subsequently be jailed. Because of our work 12 ChinaHybrids were either halted and/or delisted.

Our Work Is Not Over

While the ChinaHyrbid space is safer than it was in the past, China based fraud and deceit are still prevalent, even in those companies that went public via IPOs. We will continue to do our work in cleaning up the space, while at the same time searching for investable ideas. We have also broadened our portfolio protection activities to out pump and dump scams and other areas where we see potential for deceit.

It’s important for investors not to forgot that we are also very active in the U.S. microcap space and long-investors by blood. We offer investors a unique opportunity to have access to bullish ideas, while offering portfolio protection and having the knowledge and team to continue outing frauds, both in China and in the U.S.

Become a premium member of Geoinvesting.com here or sign up below to learn more about what we do.

About the Author:

Maj Soueidan, President & Co-founder Maj Soueidan is a full-time investor of nearly 30 years. He co-founded GeoInvesting to bring institutional quality investment research to the individual investor and help broaden the awareness of the opportunities that exist in the inefficient micro-cap universe. In addition to educating investors on winning equity strategies, Mr. Soueidan has been on a mission to protect investors from fraud and pump and dump schemes. He introduced the “China fraud” to Geoinvesting and through his research process, identified dozens of U.S. listed China stocks he concluded were frauds, so that the Geoinvesting team could perform exhaustive on-the-ground due diligence research on them, including Puda Coal and Yuhe Intl. Maj works with and manages the GeoInvesting Team on a daily basis to increase its investment opportunity pipeline and heighten GeoInvesting’s awareness in the financial markets to intensify its market influence. He stresses the concept of “information arbitrage” in an era where information overload has actually made it more difficult for investors to locate profitable information. An information arbitrage exists when a disconnect between stock prices and available public information on a company is noticeable, and monetarily worth pursuing.

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