Chinese reverse-merger firms delisted in U.S. may go private, lawyers say

By Guest Contributor
August 5, 2011

By Patricia Lee

SINGAPORE, Aug. 5 (Thomson Reuters Accelus) - Chinese reverse merger companies recently suspended or delisted from U.S. stock exchanges for various breaches may find it more viable to go private than to re-list in the U.S. or elsewhere,  lawyers said. The protracted investigations by U.S. regulators and the potential costs involved in settling the lawsuits mean that, for some companies, selling their entities would be a better strategy.

When the benefits of listing are outweighed by the time and expense, some companies might choose not to re-gain listing in the U.S. or in other jurisdictions, Barry Genkin, partner at Blank Rome and chair of the firm’s Asia capital market practice told Thomson Reuters.  ”In other situations, from a strategic prospective, it may make sense for the company to be sold,” he added.

In the last few years, many mainland Chinese companies with funding needs have made a beeline for the U.S. capital market following unsuccessful attempts to secure bank borrowings in China. Mainland Chinese banks and China’s domestic capital market have traditionally been skewed in favour of state-owned enterprises rather than privately owned companies.

At a recent conference held in Singapore, Liu Qingsong, senior research fellow at the China Securities Regulatory Commission, attributed this phenomenon to the “imbalances between direct financing and indirect financing” in China’s bank market, as well as “imbalances in China’s securities market structure”.

A COSTLY AFFAIR

When listing via reverse merger in the U.S. proved to be a less expensive and time-consuming route compared with the traditional initial public offering process, which entails extensive disclosure and massive compliance costs, listing in the U.S. became appealing and practical at the same time. But the recent U.S. Securities and Exchange Commission’s probe into some Chinese reverse merger companies for listing breaches and alleged fraud, and the ensuing lawsuits, may turn out to be a much more costly affair than these companies had initially envisaged.

Siu Woon-Wah, partner at Pillsbury Winthrop Shaw Pittman, based in Shanghai, thinks it is too early to tell the fate of Chinese reverse merger companies whose shares have been suspended from trading or which have been delisted, many of which are under investigation.

“Investigation usually takes time. If a company is found to have done nothing wrong, the company can get back on track by filing the all the necessary SEC reports and be listed on an exchange or be quoted on the U.S. Over-the-Counter Bulletin Board again.  If a company is found to have committed wrongdoings, the company and its directors and officers may have civil and even criminal liabilities. The most unfortunate case would be when a company did not commit any wrongdoing but suffered so much reputational or financial damage from the allegations that it could not recover,” she said.

Siu said typically Chinese companies that became public in the U.S. via the reverse takeover process have their shares quoted on the Financial Industry Regulatory Authority-regulated OTCBB, which requires them to be 1934 Act reporting companies. That requirement for OTCBB companies entails various filings with the SEC as well as compliance costs, although compliance costs for OTCBB companies are lower compared to those costs for exchange-listed companies.

Siu said being a 1934 Act reporting company is important to any company interested in raising capital because most investors would expect some level of transparency on the part of the companies in which they invest, through their public disclosure.

In the recent saga surrounding Chinese reverse merger companies, a number of them, according to Siu, have ceased to qualify for quotation on OTCBB because they had failed to comply with their 1934 Act reporting obligations. As a result, they became “pink sheet companies” — companies whose shares are quoted in the unregulated OTC market but which do not require reporting.

Still, Siu believes many companies that went public via reverse merger ultimately aim for a listing on a main board of U.S. stock exchanges. “Why would a company spend the time and effort to become public in the U.S. market? It is not cheap to go public in the U.S. even if a company does so via a reverse merger. And many of these Chinese companies want to have access to capital in a liquid and deep market in the first place to finance their operations,” she said.

TO LIST OR NOT TO LIST

Lawyers said Chinese reverse mergers could apply for re-listing on U.S. exchanges if they resolved the issues raised by the U.S. regulators. Genkin said: “To the extent these companies are able to cure the issues raised by the SEC, and assuming they can once again meet the listing standards, they should be able to re-apply for re-listing. Where companies choose not to or cannot meet the listing standards, they may consider listing on other exchanges where they are able to meet the listing criteria.”

Siu, however, warned that re-listing elsewhere is not the panacea for Chinese reverse merger companies facing regulators’ probe and lawsuits as some might think. She said those companies should deal with their current issues or they could face potential challenges in their re-listing efforts. She pointed to the Hong Kong and China markets, whose stock exchanges and regulators require issuers to disclose their history.

“For instance, if an issuer applying for a listing in Hong Kong were a Chinese reverse merger company that had been delisted or investigated, the Hong Stock Exchange and the Securities and Futures Commission would want the issuer to disclose the history of the reverse merger, why the issuer was investigated by U.S. regulators, the outcome of the investigation and why the issuer went dark in the U.S. market,” she said.

NATIONAL POLICY, OR MOTIVATION

The recent episode involving Chinese reverse merger companies in the U.S. has shed light on the predicament of China’s privately owned companies in securing financing in their home market and the potential quagmire should they be caught in lawsuits. The problem, however, is a less straightforward one, according to experts. It involves not only China’s national policy but also the motivations behind some of these Chinese companies’ decisions to tap the U.S. capital market.

Simon Gleave, KPMG’s partner in charge of financial services in China, told a recent conference that some Chinese companies listed overseas had management with a very short-term approach. “One of the problems in China itself has been that in newly listed companies, CEOs don’t stay very long. They make money and then disappear into America or wherever they want to live,” he said.

Some industry experts said the saga should serve as a starting point for Chinese regulators to re-evaluate the lending policies that they have laid down for domestic banks.

Siu said: “At the moment, it is still not easy for small and medium sized Chinese private enterprises to borrow from mainland Chinese banks. Often they are able to secure only short-term bank borrowings. Chinese banks’ lending practice is often aligned with or influenced by national policy. The state-owned enterprises have no problem in securing loans from Chinese banks. If Chinese banks can be more open to providing financing to Chinese private enterprises, it may reduce the need for these enterprises to access overseas capital markets.”

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete (http://accelus.thomsonreuters.com/solut ions/regulatory-intelligence/compliance- complete/) provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges.)

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