Thursday, January 24, 2013

Paper: "Shell Games: Are Chinese Reverse Merger Firms Inherently Toxic?"

In a paper called "Shell Games: Are Chinese Reverse Merger Firms Inherently Toxic?", three accounting professors looked at Chinese reverse merger firms to see whether they are inherently riskier or more problematic than a control group of U.S. firms.

While they say that they "find little evidence that Chinese RMs are systematically riskier, or more problematic", I'm not entirely convinced by that result. My real interest, however, is Appendix A, "Chinese reverse mergers identified as fraudulent by the media, short sellers or the SEC since 2010" with the date of reverse merger, date of trading halt, date added to pink sheet, and date of delisting.

These are something of a concern when betting against Chinese securities - although less so since the spate of halts in 2011, and more so with companies that are frauds (as opposed to simple business failures/insolvencies). I'm not familiar with any cases where there was a halt right in conjunction with a bond maturity... they seem to be more common when a potentially fraudulent company is just lingering without providing financial information and with no catalysts (like a BK filing) for the situation to be resolved.

The Shell Games paper is from Nov 2012. In the appendix listing of frauds, they list 32 companies. Of these, 27 were halted at one point and 5 were not. Of the halts, only three were in 2012 and the rest were in 2010 or, mostly, 2011. These halts varied from one day to a week or two, to many that lasted for three months, with the longest being six months (Keyuan Petrochemicals).

Interestingly, only four of the 32 were listed on the NYSE (which is where Suntech is listed). One of those traded without interruption, two began trading again within a week, and one within a month.

I think the trading halts are very foolish - how do they help? - and the halts in 2011 because certain exchanges were caught having listed tons of these bogus Chinese companies and panicked. It's interesting that the NYSE, which had fewer, dealt with the problems without interrupting the market so much.

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