Greenberg: Playing ‘Regulatory Arbitrage’ on China Stocks

In the three years I’ve been writing about Chinese reverse mergers there has been one nagging question: Where have the regulators been?

Monday the SEC reared its head by halting the trading in RINO International. But consider this: That’smonths after its stock started trading on the OTC—and that’s only after it was delisted by the Nasdaq for failing to answer the exchange’s questions about allegations by critics.

“The reason these scams have worked is because there’s “regulatory arbitrage’,” says Carson Block, whose Muddy Waters Research is getting quite a name by sounding warnings on some of these companies like RINO and China MediaExpress Holdings .

“That means companies may be breaking the law here, but the businesses they’re lying about are all based in China—so you have to conduct investigations in China,” which is virtually impossible.

The reality, Block says, is that in China many of these companies aren’t considered a scam; the trouble, he says, is that for U.S. stock market consumption their business is inflated to levels greater than it really is.

Furthermore, most are small. Many promoters intentionally push companies with market values below around $100 million—a level that often makes them too small to warrant serious scrutiny by the press or others.

As I’ve previously reported, while many of these companies have miniscule market values, in aggregate their total market value—at their peak of late last year—was around $30 billion.

Block won’t talk about which stocks he’s targeting next, though he makes it clear there is no shortage of names, including Chinese IPOs.

Still, reverse mergers are among the most egregious. “Within deal-making circles in China” with reverse mergers, he says, “they’ll sit around and talk about the percentage of reality a given company is: “Yeah, this one isn’t bad—it’s 70 percent real…yeah, one is 20 percent real.”

My take: That any of them make their way to the market is beyond real: It's simply surreal.

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