The War Over Chinese Stocks

Short sellers are targeting Chinese companies that trade in North America, bringing down share prices and drawing lawsuits

By Dune Lawrence, James Sterngold, Nikolaj Gammeltoft and Zijing Wu

Chinese stocks trading in the U.S. and Canada have become a prime target for short sellers who sniff out suspicious financial statements--and hope to profit from declines in the companies' stock prices. Investors including John Paulson and Hank Greenberg have lost money on Chinese stocks that fell after questions were raised about them.

Carson C. Block, 35, who says he passed his broker's exam when he was 19 and moved to Shanghai after graduating from the University of Southern California in 1998, founded Muddy Waters Research to scrutinize Chinese companies. He made a splash with a Feb. 3 report claiming that China MediaExpress Holdings (CCME), a Hong Kong-based provider of advertising on buses in China, manipulated financial statements. The company denies the allegations. C.V. Starr, run by former AIG (AIG) Chairman Greenberg, owned 8 percent of China MediaExpress shares, which slid 88 percent from Feb. 2 through June 14 and have been delisted from Nasdaq (NDAQ). C.V. Starr did not respond to requests for comment. Sino-Forest, an operator of timber plantations, plunged 71 percent after Muddy Waters called the company a "Ponzi scheme" in a June 2 report and said it was betting against the shares, which trade in Toronto. Hedge fund Paulson & Co. owns about 24.4 million Sino-Forest shares, according to Bloomberg calculations based on information from a June 3 Paulson investor letter and a person familiar with the fund. That means Paulson may have lost about $300 million on Sino-Forest from June 1, the day before the Muddy Waters report was released, to June 14. In the letter, Paulson & Co., which made $15 billion in 2007 betting against subprime mortgages, said it was investigating the charges.

Two other Chinese companies trading in the U.S., Deer Consumer Products (DEER) and Sino Clean Energy (SCEI), filed defamation lawsuits after their shares were battered by fraud allegations on Alfredlittle.com. The website is run by a group of mostly Chinese investors and researchers, according to an individual who identified himself in an e-mail as the managing editor but declined to give his name.

Most of the targets of Muddy Waters and Alfredlittle.com are reverse merger companies. Since 2007 more than 150 closely held Chinese firms entered U.S. markets by buying a publicly traded shell company, avoiding customary scrutiny by regulators and investors. The U.S. Securities and Exchange Commission cautioned investors on June 9 about buying stakes in reverse merger companies, saying they may be prone to "fraud and other abuses." The Bloomberg Chinese Reverse Mergers Index of 78 companies listed in the U.S. has dropped 44 percent in 2011. Concerns about accounting have also affected Chinese companies that listed in the U.S. through initial public offerings. The SEC has revoked the registrations of at least eight China-based companies since December, and more than 24 companies have disclosed auditor resignations or accounting problems to the agency since March, SEC Chairman Mary L. Schapiro wrote in an Apr. 27 letter to Representative Patrick McHenry (R-N.C.)

Muddy Waters's June 2 report said public disclosures by Sino-Forest, based in Hong Kong and Mississauga, Ont., don't match Chinese city records and its production figures may not be accurate. Block says he will keep betting against the shares until they reach "zero."

Allen T.Y. Chan, Sino-Forest's chief executive officer, who has called the allegations "inaccurate and unfounded," said in a June 14 conference call that the controversy will slow the company's pace of timber acquisitions. In a June 6 statement, Sino-Forest said it is "considering its legal remedies" and that it has been "thoroughly scrutinized" by major underwriters and law firms inside and outside China in the course of seven public and private offerings over five years.

Source: http://rss.businessweek.com/~r/bw_rss/asiaindex/~3/2_rZcceUZrs/b4234052635513.htm

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