A Chinese Reverse Merger “Fraud” CEO Speaks

13 Jul

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

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6 Responses to “A Chinese Reverse Merger “Fraud” CEO Speaks”

  1. Sean July 13, 2011 at 3:54 pm #

    You’re underestimating the pressure from the local governments.

    Check out: http://newcer.chinaeconomicreview.com/en/content/end-line

    Key graf:

    “Taking an honest assessment, many Chinese companies should never gone public in the US to begin with. China has a business environment where tax evasion, bribery and obfuscation are often, but not always, the necessary evils of being competitive. Being listed in the US brings a set of responsibilities including timely financial reporting, investor communications, Sarbanes-Oxley and Foreign Corrupt Practices Act compliance, which many Chinese management teams are completely unprepared for.”

    Those “necessary evils” are often encouraged by the local politicians, to varying degrees.

    • The Analyst July 13, 2011 at 4:03 pm #

      Thanks for the link, much appreciated.

      While I certainly sympathize with someone who all of the sudden finds himself in the CEO role and with it the poking and prodding from greedy politicians, lawyers, bankers, and stock promoters, I find it far more difficult to have any sympathy whatsoever for those who knew with some certainty what they were getting themselves into, i.e. founders of the company.

      If again this is the RINO CEO, I believe he was the founder of the firm, and his bio in the various regulatory filings must be significantly BS if his claims that he spent most of his career in very low positions (I think this is at least somewhat possible), as his resume includes some VP+ mentions.

      It’d be like one of the guys at these Silicon Valley startups complaining that too many VC’s thew money at his company and valued it at too high a price, and then the market finally realizing it and pricing the company accordingly, and the CEO finger pointing and complaining that its everyone’s fault bus his own. Come on, to an extent you have to be pretty freaking naive to not at least have some idea that these things are coming, or that things you might not expect may come.

      • Sean July 13, 2011 at 9:55 pm #

        You’re right about that fundamental point, but I think still missing how difficult it could be to extract oneself from that. It would be more similar to a VC encouraging sketchy accounting tricks a year after they’ve invested. Or a better analogy: the mafia coming to call a few months after providing a loan that was crucial to your growth.

        The local governments usually try to find an industry to favor for their town. If they favor your company, you initially get, say, floor space and tax incentives. Once you start growing and adding headcount you encounter the usual growing pains — made all the worse by the difficulty of getting loans. The government comes back again and encourages illegal behavior. Allowing revenues without tax receipts, different accounting reporting standards, etc. This all allows you a bit more cashflow to keep going. Nothing unusual at all about this, I’d guess (out of my ass) that a majority of major employers in each town are getting some deal like this. Eventually some officials (who are out to your factory regularly, and begin acting like they own the place, since they can break you now) come and start pressuring you to go public. You no longer really own the company yourself — your ‘stakeholders’ in the government are exerting pressure and it would be ugly and maybe disastrous to refuse them.

        Ideally the entrepreneur would refuse all the government meddling from the beginning. But that would require one confident owner who would be willing to do that when the larger competitors already have similar deals with their own local governments.

        • The Analyst July 13, 2011 at 10:04 pm #

          That’s a really great comment, and I fear you’re probably right, so thank you very much!

          Funny how I don’t hear too much about this sort of risk in the china critics reports/posts.
          http://www.stonestreetadvisors.com

Trackbacks/Pingbacks

  1. Morning News: July 14, 2011 | Crossing Wall Street - July 14, 2011

    […] Stone Street: A Chinese Reverse Merger “Fraud” CEO Speaks […]

  2. The Best Laid Plans of Mice & Men: YOKU Summary Thesis Update « Stone Street Advisors - July 28, 2011

    […] slow, I fear management is going to truly feel the pressure of politicians to keep the growth high (a bunch of the frauds have been driven in some part by these pressures, or so the CEO’s claim).  Whether Victor Koo will jump ship (like he did from Sohu) or stand strong in the face of […]

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