2011 saw surge in securities class actions against Chinese companies

Companies are taking steps to protect themselves from litigation arising from the past decade's reverse-mergers

A trend that was all the rage on Wall Street a few years ago has, since the start of 2011, caused much handwringing, paper filing and gavel banging.

In the late 2000s up to last year, reverse-mergers were a popular, perfectly legal way for foreign companies, especially in China, to wedge their feet in the doors of U.S. stock exchanges. The reverse-merger, in which a foreign company purchases essentially the shell of a defunct American company that is still listed on U.S. exchanges, was an easy way for the foreign buyer to enter the market without having to deal with the battery of reviews from state and federal regulators that come with the traditional initial public offering (IPO) route.

Affronting Analysts

In many of these cases, the story behind the alleged fraud began with what Weiner terms “so-called analysts” who are “not your Goldmans of the world” but essentially are “a step above bloggers.” These analysts took Chinese companies’ filings from the State Administration for Industry & Commerce (SAIC), a Chinese registration and licensing authority, and compared them to the U.S.-based SEC filings, often finding discrepancies dealing with reports on the company’s performance, its asset values and the assets themselves.

Taking Precautions

For U.S. companies looking to deal with China-based companies, due diligence, as usual, is a must. But the risk isn’t as bad as the press has made it out to be during the past few years. Chinese companies that are attached to major law firms and accounting firms typically have minimal risk because the diligence already has been done. The only times when there may be risk is when a company that went public through a reverse-merger did not use reputable auditors and lawyers. In those cases, attached U.S. companies must do their own diligence.

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