Chinese Reverse Merger Companies

These have been in the news recently,  but what the heck is a Chinese reverse merger company?

 

To answer that, let's start off with what a reverse merger is.  Investopedia defines a "reverse merger" as "a type of merger used by private companies to become publically traded without resorting to an initial public offering.  Initially, the private company buys enough shares to control a publicly traded company.  The private company's shareholder then uses their shares in the private company to exchange for shares in the public company.  At this point, the private company has effectively become a publicly traded one."

 

So, yes.  In a reverse merger, the private company buys a public company, hollows it out, and wears it around like a suit  The strategy makes the private company the emerald cockroach wasp of the business world.  A Chinese reverse merger company, then, is just a Chinese company that has gone public in the US markets by hollowing out a US company - typically something Over-The-Counter or that has one of the smaller exchanges as a home exchange[1] - and then wearing it around.

 

Now, why are people concerned about this?  BusinessWeek had a pretty good article on the subject back in March, but here's the reasons in a nutshell:  this reverse merger process circumvents the SEC requirements for taking a company public in the United States.  Instead of meeting minimum shareholder and asset requirements, and filing all of the appropriate regulatory forms, they just need to get the merger approved.  As a result, they manage to combine all of the risks of a penny stock and a speculative private placement.

 

But wait!  There's more!  In addition, most of these companies operate as shell companies.  There might be a US address, but the entire company is still in China, significantly restricting the ability of the SEC to compel them to conform to US securities laws and regulations, or to enforce fines and arbitration against them.

 

As a result, since December, the SEC has been investigating a number of these firms for stock fraud, and the indications are that this will expand into a widespread investigation of pretty much every Chinese reverse merger.

 

[1]  Although some companies, such as China BAK Battery, have managed to get onto the American Stock Exchange and the NASDAQ.