Short Sellers Target Chinese Companies Listed in U.S. Using Reverse Mergers

For the average Joe, the main warning is: check your small cap funds that they aren't trading any of this stuff.

Texas Short Seller Fights China Fraud in $20 Billion U.S. Shares

Sky One and the other companies have moved onto U.S. exchanges through a process called a reverse merger, in which a closely held company buys a publicly traded shell company -- and retains the U.S. listing as its own instead of extinguishing it, as usually happens in takeovers. Bird says that many reverse merger companies are deceptive, at best, about their numbers.

The SAIC is the Chinese government agency responsible for market supervision, regulation, and enforcement. According to a SAIC filing, Sky One’s operating unit, Harbin Tian Di Ren, had 2008 sales of 6.93 million yuan, roughly $1 million at 2008 exchange rates. Yet to the SEC, Sky One reported 2008 sales of $91.8 million, with Tian Di Ren accounting for at least 65 percent, or $59.7 million.

The company’s shares are available to retail investors through such funds as the Oppenheimer Main Street Small Cap Fund and the Powershares Golden Dragon Halter USX China Portfolio, and are scooped up by small cap index funds.

Roth Capital Partners, an investment bank in Newport Beach, California, that has been one of the most active in helping Chinese reverse merger companies raise money, recently tried to define the size of the market. It came up with a list of 94 companies with a market capitalization between $50 million and $1 billion that trade an average of at least 50,000 shares daily, with a total stock market value of more than $20 billion.