A Chinese Reverse Merger “Fraud” CEO Speaks

Among the almost countless reasons investors should be wary of investing in taste of the moment or “hot” Chinese stocks, we may now have solid confirmation of a new one: a complete and utter lack of personal responsibility/accountability of/by those running these firms.  This flies in the face of the many critics and short sellers who loudly proclaim the majority of these firms are merely examples of management getting rich while the shareholders get poor.

In an article translated into English, “The president of a delisted high-tech firm in northern China, who prefers to remain anonymous, has shared his views of the whole process of being listed and delisted.  The president claims his company was dragged into the listing process and naively trusted a host of exploitative government officials, bankers, and auditors, only to be torn apart later.”

As far as I can tell, the anonymous executive is none other than Mr. Zou Dejun, CEO of alleged fraud Rino International, at least from similarities mentioned in the article to RINO’s regulatory filings.
Remember, this is the firm whose auditors (questionable firm, Fraser Frost) resigned for lack of reliance in mangement’s representations, and whose stock was de-listed by the NASDAQ in April.

I have not followed RINO’s plight in enough detail to comment on the fraud allegations and/or “proof” offered-up by the likes of Muddy Waters, however, from this executive’s account, there is a far more fundamental concern.  The executive assigns blame for his firm’s misfortunes to literally everyone except himself: auditors, investor relations firms, China and US-based “capital markets” firms, Chinese politicians, his own employees, really everyone EXCEPT himself.

To be sure, a reluctant CEO unprepared and uneducated in matters that come with the title is an unenviable position in which to find one’s self, but there are numerous and extraordinarily simple ways of dealing, for instance, resigning, or better, doing your job and putting your foot down when outsiders try to tell you how to run your firm.  I don’t buy for a second that cultural issues such as pride and honor are acceptable reasons for failure to do so.  This is true in every country – sure to varying degrees – but no CEO anywhere on the planet wants to admit he needs help or can’t handle the task with which he is faced.  Nor do I buy that this executive was so painfully naive and so disconnected from the circles of professional businessmen that he lacked the wherewithal to see what was happening, nay, to see what he was signing-off on.  His sole tangential admission of blame is in saying “if I had to do it all over again, I would have done it differently.”  Great, I’m sure all the shareholders who relied on you to look out for their best interests feel much better now.

This is the job of  CEO, to be able to politely dismiss the interests of others which are not necessarily in the interest of the firm and its stakeholders.  To say to the politician, we absolutely plan on going public, but only when we are ready to show the World how great our firm and our Country are, to say to the lawyers, bankers, and brokers and high-priced auditors thanks, but no thanks.  To allow all of these people to dictate to you – the CEO – what the company is going to do is cowardice.  Man up and do your god damn job.  And if you don’t feel like stepping up, don’t run your mouth and complain about it when the only person you really have to blame is yourself.

The experiences of this executive are hardly unique to China (how many failed executives in the U.S. blame “the markets” or some other outside force for their shortcomings?), however especially in the reverse merger space, I would not be surprised if they are relatively wide-spread and shared by a great many of his peers.  Again, in this executives defense (assuming he is who I believe he is), the risk factors were largely stated in regulatory filings.  I doubt anyone except the lawyers who drafted them actually read that far, though.

As I’ve said dozens if not hundreds of times at this point:

CAVEAT EMPTOR

Those Who Fail to Learn From History, Part 729,842: YOKU

Another Chinese “advertising” company with U.S.-listed shares.  Gee, where have we seen this movie before…

Remember China MediaExpress Holdings?  CCME?  I’ve written at great, great length about the firm and the many, many red flags present in its regulatory filings going back to 2009, but one of the most telling, most glaringly obvious signs of possible trouble was the corporate structure, which I wrote about (among other places) here:

Compare this to YOKU’s, from Page 5 (FIVE!!!!) of their F-1 ADR registration statement:

In both cases, the PRC “operating” companies are controlled entirely by corporate insiders (and their families).  The only recourse the holding-company (and thereby shareholders) has (have) over the operating companies, their assets, and cash flows are spelled-out in “contractual obligations,” spelled-out in very-little detail on pages 5 and 6 of Yoku’s F-1  If corporate insiders and their families loot the bank accounts of the PRC entities, U.S. shareholders will very-likely end up with little, if anything, to show for their “investment.”

The filing does go into a bit more detail on these “contractual arrangments” and the risks thereof, specifically, on pages 30/31 (emphasis mine):

A Wolf In Sheep’s Clothing

Much has been written about Goldman and the Timberwolf deals since the now infamous “shitty deal” showdown between Senator Levin and GS officials last fall. In reading the majority/minority report issued last week in its entirety, there’s a few things that really stuck out to me.

On The Upcoming Glencore IPO: Is The Juice Worth The Squeeze?

Glencore is the most powerful, connected commodities trading firm on the planet.  Since many valuable commodities are located in politically unstable parts of the world, earning, and more importantly retaining that honor necessitates that Glencore engage in some possibly questionable business practices, some (many?) of which might just happen to violate one or more international laws or sanctions.  Running such operations as a private, closely-held firm based in a quiet corner of Switzerland is hard enough, but doing so as a soon-to-be publicly-traded company in both London and Hong Kong may provide near impossible given the much higher visibility and scrutiny that comes with a public listing.

Muddy Waters’ Founder Carson Block On Investing In Chinese Reverse Mergers: CNBC Interview

Herb Greenberg got the chance to sit down with Carson Block, Founder of research firm Muddy Waters today to talk about investing in Chinese stocks, especially RTO (reverse-merger) situations.

http://plus.cnbc.com/rssvideosearch/action/player/id/3000016286/code/cnbcplayershare

I think he brought up a term seldom heard in the financial media – Potemkin Factory – and went on to explain some very basic tenants of due diligence apparently ignored by many investors Who Should Know Better.

China MediaExpress Holdings: Excuse My Continued Lack of Shock

When you – in this case, CV Starr and affiliated funds – buy a large chunk of a Chinese Reverse Merger company, like, oh, I dunno, China MediaExpress Holdings, and you get a board seat, perhaps you should insist your “man on the ground” is on the Audit, not Compensation committee.  And perhaps you should do a little more independent due diligence, instead of meeting management and reviewing documents they supply.    Just sayin…

Otherwise, don’t be surprised when your Auditor and CFO resign, and your board member steps down citing “in particular, irregularities in the bank account balances of CCME’s PRC subsidiaries.“

Caveat Emptor, Part 7,931

For the past few months, Long Island, NY-based David Lerner Associates has been advertising on CNBC with some pretty aggressive claims and customer testimonials.  Were I not of the cynical, skeptical variety, I could see myself being quite intrigued by the commercials, which portray customers heaping nothing short of the highest praise for the investment performance and service they’ve received from Lerner.  Now, EVERY broker/dealer gets fined and subject to arbitration for Regulatory violations, customer complaints, etc, that’s just the nature of the business, but that’s another conversation for another time.  Let’s use DLA as an example for how retail investors can and should protect themselves:

ETF Mania, or: A Study of Herd Behavior, By @macrotradr

Nestled on page B11, in this weekend’s Wall Street Journal was an article, “Social” Funds Embrace Emerging Markets. One of the fads that’s irked me for some time is Socially Responsible Investing. Surely, that must go against the whole capitalist ethos, no?

What does Socially Responsible Investing even mean? And I don’t mean the wikipedia definition. I mean, you’ve got 30 secs to explain it to me……….. go!

Uh huh, thats what I figured.  Sounds good though, right?  All you need is a prospectus plastered with an image of giggling children frollicking in a field of daisies, under a sun filled sky et voila!

This whole ETF and theme-based fund frenzy is really starting to get out of control.

A Public Service Announcement: Think Owning a Boat is Too Costly?

…Then compare it to other activities the cost of which we’ll grossly over-inflate to convince you to buy a boat – the cost of which we’ll grossly understate – that’s 99% likely to lose you ridiculous amounts of money!  Granted, having a boat (especially a sweet yacht) is likely to get even the most pathetic guys some attention from the ladies, but a Ferrari is likely cheaper, holds its value better, and costs less to maintain/use.

This is what industry lobbying (like the NAR or NRF or any of the others) gets you:

Of course, the tool on that website only allows you to consider those activities versus buying a boat up to $100,000, even though they assume owning a second home costs $27,000/year, because that’s almost comparable (or nowhere freaking close!).

People, the lesson of this is: When people try to sell you things, they’re trying to get paid, and more often than not, they’ll say some pretty inaccurate things to get that cash money.  Do not take their word for it.  DO.NOT. (Unless you want to get taken advantage of, then by all means, go buy a boat/house/car/etc without running the numbers.)

On The SEC’s ABACUS Case Against Goldman Sachs

Back in Sophomore (maybe Junior) year Finance class, we learn some very basic approaches to investment analysis. Before we ever touch upon analytical methods, we learn high-level stuff, for example, first and foremost you should analyze a potential investment on its merits; extraneous information is, at best, of secondary, tertiary, or just no concern. If I’m considering buying the ABACUS synthetic CDO deal at the heart of the SEC’s case against Goldman, my primary focus is to analyze the RMBS transactions in the reference portfolio selected by ACA (NOT Paulson – ACA could have throw out EVERY/ANY security Paulson suggested if they thought it was a crap bond), the structure of the deal. Once I’ve done the granular analysis of EVERY bond in the reference portfolio – as close to loan-level as possible, especially with the 20+ person diligence team that IKB reportedly employed – and decided everything looked good, then and only then would I get into other considerations. Have we covered all our bases? Are we missing anything? What are other smart people doing with this/similar transactions?

I firmly believe this story pretty cut & dry: IKB/ACA/ABN did their diligence (well, let’s give them the benefit of the doubt they did, at least) and determined they wanted to buy the deal. They had the blessing of the Ratings Agencies (which, with the wisdom of hindsight – key word – we know was not a very bright idea), they had other “smart” people reinforcing their view (long live confirmation bias!), and the financial industry, as a whole, was generally still long housing.

Anyone who claims that the buyers (longs) would have backed-out if they knew some no-name Hedge Fund manager with ZERO mortgage investing experience suggested part of the reference portfolio is material is full of it. The buyers were arrogant, over-confident in their experience and ability to analyze complex structured finance transactions. Hell, if they WERE made explicitly aware of Paulson’s “involvement” they probably would have enjoyed a good, hearty laugh at his expense and quite possibly even bought MORE of the deal when they knew they were up against such a rube, a novice, a guy in WAY over his head.

One person on the other side of this debate says that in order for me to make such a claim I must be either clairvoyant or have worked on IKB’s deal team in 2007. While I think that’s a bit of a non-sequitur, I’ll allow it, and then accuse the SEC of the same apparent psychic abilities. How on Earth do they presume to prove what IKB WOULD have done? How could anyone prove what they WOULD have done in the past? Sure, I WOULD have prepared differently for the GMAT’s if I knew I was going to run out of time on the math section, but I didn’t KNOW that would be the outcome, since I knew the material very well. Similarly, IKB “KNEW” structured finance RMBS investing, they just didn’t know or expect the outcome we know so well with the benefit of hindsight.

That’s it. Everything else is irrelevant. IKB knew the material that was going to be on the test (the composition of the reference portfolio and all other relevant deal information), they had the ability (experienced deal team) to prepare for the test (analyze the deal), they just came to what turned out to be the wrong conclusion, and didn’t do as well as they expected.

Ultimately, whether Paulson’s involvement will be decided in court, and what I have to say is, unfortunately, just words on a page.  I agree there is the possibility that when all of the information is made available (emails, etc), there may have been an intent to deceive, or scienter,but that’s for the courts/lawyers/etc to decide.

Update: Since I published this in haste (my bad), I should have rephrased the bolded text three paragraphs up, to ask “How does the SEC believe they can use the ‘reasonable person’ test in this situation?”  That is, this is a market, which by definition necessarily includes two parties both of whom believe themselves to be reasonable with different, nay, opposing views.   Thanks to @_phlox for the legal edit.