Chinese Stocks: Why They’re Under Scrutiny

When you trade micro-cap stocks or small-cap stocks, there is added risk. And when you trade Chinese small-cap stocks, there is even more risk. Just take a look at the media these days and you’ll find some small Chinese company making the news…but for the wrong reasons. Are these companies being unfairly dumped upon or should you totally avoid them?When you trade micro-cap stocks or small-cap stocks, there is added risk. And when you trade Chinese small-cap stocks, there is even more risk.

Just take a look at the media these days and you’ll find some small Chinese company making the news…but for the wrong reasons.

There has been a rise in discussions on the strategy of reverse mergers in the media. The speculation is that numerous small Chinese stocks debuting on the domestic exchanges (via reverse mergers) are currently being investigated for pump and dump schemes and questionable reporting practices on their statements.

Reverse mergers or takeovers occur when a private company that wants to go public finds a shell company that is trading and buys the shell. The private company then transfers its assets into the empty shell and, after some minor reporting, the company becomes public.

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The advantage is that it is much easier to take over a shell company than it is to get listed via the traditional method. The reporting requirements are much less stringent in a reverse merger. This appears to have attracted numerous Chinese companies.

I’m not saying all of these Chinese reverse mergers should be the subject of investigation; but, as this strategy is the easiest method of listing on domestic exchanges, I’m not surprised to hear of wrongdoings in this area.

It appears that there’s a witch hunt on for these small Chinese companies, many of which are likely legit. Yet, we are seeing short sellers, bloggers, and anyone with access to writing on the Web posting negative reports on small Chinese companies.

China MediaExpress Holdings, Inc. (NASDAQ/CCME) saw its share price plummet by over 30% on surfacing news that the company would be the target of an investigation for a pump and dump scheme. The allegation is that the company, via a reverse merger, pumped up the positive news, driving up the stock price, and then dumped the stock for massive profits. Again, it’s only an allegation and is yet to be proven.

China Electric Motor, Inc. (NASDAQ/CELM) hit a wall on Thursday morning after announcing the delay of its 10K, Q4, and 2010 reports.

China Education Alliance, Inc. (NYSE/CEU) announced on Thursday that it would need to delay its earnings conference, but said it was not due to accounting issues. But you have to wonder…

China Century Dragon Media, Inc. (AMEX/CDM) is under investigation and could see delisting from AMEX.

FUQI International, Inc. (formerly NASDAQ/FUQI; now Pink Sheets/FUQI.PK) was delisted. It currently trades on the Pink Sheets.

Other Chinese companies subject to allegations include China Green Agriculture, Inc. (NYSE/CGA), China Agritech, Inc. (NASDAQ/CAGC), AutoChina International Limited (NASDAQ/AUTC), and China Valves Technology, Inc. (NASDAQ/CVVT).

I have covered many of these stocks based on what I believe were factual results and information. You cannot always differentiate the good information from bad. When a sole short seller attacks a company, you have to take a step back and wonder.

Worst yet is that we are seeing stock bloggers rip into companies, driving the stock down. When a sole blogger can drive a share price down, you come to understand the extreme nervousness in the market.

The way I see it is that we have to be careful here. There are some suspicious companies, but I feel that the majority of Chinese companies are legit, including some of those that formed via reverse mergers.

While there are problem companies, many of these Chinese stocks are unfairly being dumped upon. I suggest you take the opportunity to buy on weakness, unless there are numerous allegations against the company, especially from reputable sources. In these cases, AVOID.