China Medical Technologies—Is This Another Chinese Fraud?

Glaucus Research released an explosive report exposing alleged fraudulent transactions on the part of China Medical Technologies

. Compelling evidence suggests that CMED deliberately overpaid—to the tune of $20-23 million—for a company which its own Chairman was a stakeholder. The report rings a bell on preexisting concerns of fraudulent activity on the part of a rising number of Chinese companies that gain public listings in the United States through legal loopholes known as “reverse mergers.” CMED's stock has plummeted on the report, shedding 11 percent in pre-market trading and a further 13 percent after the open at the time of writing. Glaucus Research Group released the damning report as it initiated coverage on CMED with a strong and definitive Sell rating. The report is a result of the Group's collaboration with a team of 13 independent consultants in China and the United States that specialize in law, finance, medicine and accounting practices. The consultants poured over CMED's SAIC filings, transcripts of conference calls, press releases and SEC filings. Glaucus Research concludes that CMED paid $28 million for an acquisition from a seller believed to be secretly related to the CMED chairman and that the acquisition was a gross overpayment. As Glaucus reports, “CMED radically overpaid for the acquisition: a few months before selling the company to CMED, a company controlled by parties related to CMED insiders bought out minority shareholders at prices suggesting that the business was worth $5-$8 million, not the $28 million paid by CMED for the acquisition. In our opinion, CMED's chairman orchestrated an acquisition to embezzle roughly $20-$23million from the public company.” The report continues its disturbing narrative pointing out that CMED engaged in transactions designed to circumspect regulatory enforcement. According to Glaucus, the company moved to sell its primary business to its Chairman at less than 2x trailing EBITDA to avoid the having CMED's permit to sell HIFU products suspended, something the Chinese FDA was in the process of investigating. The report, in addition to wreaking havoc on CMED shares this morning, reinforces serious concerns raised over the past summer on a growing number of Chinese companies listed in U.S. public indices facing accusations of accounting fraud. As it is prohibitively bureaucratic for a company to list in Chinese public exchanges, they have increasingly looked to the American Exchanges, something they achieve through the legal loophole of reverse mergers. According to

, Reverse mergers work when a Chinese company buys a shell company that already lists in U.S. exchanges but is otherwise inactive. The situation is particularly complicated by the murkiness of the regulatory circumstances these companies place themselves. China does not regulate Chinese companies listed in the U.S. At the same time, the United States are not allowed to come into China to regulate auditing firms. Needless to say, the situation has created ripe conditions for ethically unencumbered companies. CMED shares were upgraded to Outperform just last Friday by

Analysts. Today they are trading at $2.79 per share, down nearly 18 percent on their Monday's close.