Chinese Firms Using 'Back Door' to US Exchanges

With so much attention on Chinese stocks, something that gets very little attention: U.S.-listed Chinese companies that went public through the back door.

The back door, in this case, is reverse mergers. No IPOs. No road shows. No real regulatory vetting. Just one company from China getting merged into the shell of another created in the US and—presto!—it’s public. And it’s all perfectly legitimate.

By my count, more than 70 of these Chinese reverse mergers trade on the Nasdaq; about two-dozen on the Amex and less than a dozen on the NYSE.

And while most are mini or micro-caps, at least one is valued at more than $1 billion; in total their market value is an estimated $30 billion.

Here’s what investors need to know: Just because they trade on exchanges doesn’t necessarily mean their fundamentals have received some sort of seal of approval.

Just ask Richard Heckmann, chief executive of NYSE-traded Heckmann Corp., a so-called “blank check” company that he formed several years ago to make acquisitions. Heckmann is no stranger to deal-making. As CEO of United States Filter, a rollup sold in 1999 to Vivendi for $5 billion, he did more than 300 deals.

In 2008, when he paid more than $600 million for China Water & Drinks—a bottled water maker—Heckmann thought he knew what he was doing. China Water was a reverse merger via UGODs, a Nevada shell. Heckmann hired two bulge bracket investment banks, a leading law firm and a large accounting firm to dig into the company.

As much as they dug, however, he claims he was bamboozled. Now the two sides are engaged in a legal battle: The founder of China Water, Xu Hong Bin, claims he is owed money by Heckmann; Heckmann Corp., in a counterclaim, insists that it had become the victim of “financial misconduct.”

When I asked Heckmann whether he would be leery of Chinese reverse mergers, he said that he wouldn’t avoid just reverse mergers, but all Chinese companies, because it’s simply too hard to determine the real numbers. One reason: He says he believes, from his experience, a primary goal of Chinese companies is tax avoidance.

Mark Dixon, a founder of, which advises companies on acquisitions, said something similar last August in the New York Times' Dealbook. He wrote that he was hired by a company to help value a Chinese company.

"Every stone I turned over seemed to reveal not a single spider but countless additional stones, each of which need to be investigated," Dixon wrote.

Making matters of transparency more difficult: China has barred the Public Company Accounting Oversight Board(PCAOB) from examining the auditors of most U.S.-listed Chinese companies. The PCAOB was created by the Sarbanes-Oxley Act to oversee auditors of public companies.

But according to a June report by the PCAOB, the auditors of at least 217 U.S.-listed Chinese firms have been able to skirt PCAOB scrutiny. According to the PCAOB, that includes the Chinese affiliates of the big U.S. accounting firms, including Deloitte, Ernst & Young, PriceWaterhouseCoopers and KPMG.

NYSE-listed Chinese companies whose auditors get a pass include:

Thinly traded Synutra International, which started life as Vorsatech Ventures, a Vancouver company.

China Cord Blood, also thinly traded, which originally was Pantheon Acquisiton, an Arizona entity.

American Dairy, originally Utah-based Gaslight.

American Oriental Bioengineering, originally ChampionVentures.

(A full list of companies from China and other countries that ban PCAOB examinations can be found here.)

While the auditors of Chinese companies are hardly alone in skirting PCAOB exams (BP and other large International companies are also on the list) there are considerably more companies in China than other countries.

Why do these companies trade in the U.S. if their books can’t get the proper scrutiny?

A spokesman for the NYSE said all companies that trade on the NYSE must meet listing requirements. I haven’t yet heard back from the Nasdaq.

The SEC did not respond. If I get more, I’ll pass it along.

Update: NASDAQ provided the following statement:

“NASDAQ has high numerical and qualitative listing standards which are applied to all listing candidates, regardless of whether they go public through an IPO, switch from another market, or upgrade from the over-the-counter markets. NASDAQ lists over 140 Chinese companies and approximately 60 of these went public in an initial public offering on The Nasdaq Stock Market. In addition, some Chinese companies now listed on NASDAQ initially went public through a reverse merger with a U.S. company. However, in almost all of these cases, those mergers preceded their listing on NASDAQ and in all cases the merged company was reviewed and required to satisfy our stringent initial listing criteria, as well as the SEC’s reporting requirements, prior to being listed,” said Michael Emen, Senior Vice President and head of NASDAQ’s Listing Qualifications Department.

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