Finding the Upside in Chinese Reverse Mergers – Are We Throwing the Baby Out With the Bathwater?

Investors have become rightfully spooked at some Chinese companies listed on US exchanges through reverse mergers, as these acquire a reputation akin to electronic investment-seeking correspondence from Nigeria. Our real-time Benzinga Pro news feed keeps our subscribers on top of disruptive and potentially fraudulent activities. For the sake of balance, we often ask the question: Does all of this negative coverage throw the baby out with the bathwater? There is no doubt that the structure of reverse mergers is an inherent cause for concern. Reverse mergers are transactions through which a foreign-based privately-held company acquires a publicly-listed but inactive US shell, which essentially enables the foreign company to be listed publicly under its acquisition's guise. Where reverse mergers differ from traditional IPOs - whether in the US or in China - are in the level of disclosure and compliance costs. As Chinese private companies pursue these reverse mergers, they secure funding which they are unable to get in a domestic capital market that has been traditionally skewed towards state-owned enterprises, says Patricia Lee of Thomson Reuters Accelus. They also enter a regulatory grey area where accountability gets lost somewhere between the home and guest nation. This way, US authorities have less leeway on overseeing operations based largely or entirely in China, and Chinese counterparts may not have the relevant standards—or large enough stake—to enforce their jurisdiction on compliance via US requirements. This creates a short-term bonanza for ethically unencumbered companies to hide potential red flags from investors, such as inflated acquisitions or insider trading. Eventually, US regulatory bodies catch on and take appropriate action, which may or may not result in restitution to harmed investors. The discovery of such legitimate frauds can go beyond the protection of public interest. It also entices market speculators to create new opportunities for short sales for similar companies that may not share in the fraudulent practices. Today's crowd-blogging on the topic raises a serious question: who regulates these media outlets to make sure the agenda does not go beyond communicating the facts? Benzinga reported on China's Deer Consumer Products DEER recovery in today's trading after yesterday's severe sell off. DEER has legal proceedings going against outlets with alleged recent histories of falsifying facts to advance short interests held. The company affirmed its sound business health by reiterating the state of its financial health. The jury is still out on all allegations involved. While all these developments should keep investors and companies alike on their toes and on their best behavior, we have to be ever mindful of the facts. The truth is that today, with just a computer and Internet connection, anyone has the potential to become jury, judge and executioner. : :