Reverse Merger Attorneys
Posted by Securities Attorney Laura Anthony | May 1, 2011 Tags: , , , , , , , , , ,

Many of the Chinese companies that go public in the United States do so via a Reverse Merger. The reverse merger methodology versus the traditional Initial Public Offering (IPO) is the preferred method used by the Chinese and their US-based legal and auditing advisors. Many of these Chinese companies believe, erroneously, that by utilizing the reverse merger process, they can avoid the in-depth disclosure requirements and scrutiny associated with an IPO. However, legally this is not the case.

The failure of Chinese company legal, accounting and market makers to understand the fundamental elements required of Foreign Corporations trading stock on US markets has led to numerous shareholder class action lawsuits, trading suspensions and enforcement actions against publicly traded Chinese companies.

Auditors and Market Makers Fall Short on Due Diligence

Many of the problems resulting from Chinese reverse mergers are due to the failure of corporate counsel, auditors and market makers to thoroughly complete due diligence on the company’s officers, directors, operations and financial statements. Under ordinary circumstances, when preparing SEC filings, legal and accounting professionals can rely on the representations of their clients. However, when the subject Company has opted NOT to list their securities on their country of origin exchange, additional measures must be taken to ensure transparency.

Verify, Then Verify Again

It is always advisable to “kick the tires” of the subject company (visit their facilities, confirm that copies of all agreements have been provided, etc.) but in the case of Chinese entities, it is doubly important (actually it is essential). When providing “going public” services to an operating Chinese business, one that is going public or already trades on the US markets, the key is to verify, verify, verify.

Moreso than in any other scenario, auditors, attorneys and market makers must act as gate keepers so as to keep their Chinese clients compliant with US securities laws. Obviously, due diligence can only go so far, no matter how thorough the evaluation process. In the end, ultimately, auditors, attorneys an market makers are in the unenviable position of relying, to one extent or another, on the documents and attestations provided to them by the officers of the subject company. Forged, fraudulent and outright fictitious corporate documents are becoming all too commonplace.

Further complicating the problems stemming from Chinese companies going public in the United States are the increasing number of subsequent capital raises comprised of domestic, US investors. Once trading on the OTCQB or NASDAQ, the now public entity has a myriad of financing options, to the chagrin of the unsuspecting investment public.
Some regard the Chinese stock market as essentially unregulated, therefore creating an attitude among some officers and directors that US Exchanges are just as forgiving in respect to compliance and overall transparency.

Other issues may stem from the language barrier. Some may even be a result of differences in cultural business practices. In any event, the Securities Act of 1933, as amended, requires that all sales of stock be via either a registration statement or legal exemption to registration. All registration statements require in-depth disclosure in accordance with the legal parameters set forth in Regulation S-K and accounting parameters set forth in Regulation S-X. US regulators and class action counsel have clearly set forth that these standards are not being met.

Failure of Corporate Governance

Also, the lack of corporate governance oversight has intensified the problem. In addition, there are significant accounting differences. Since China does not follow Generally Accepted Accounting Principles (GAAP), confusing, and sometimes irreconcilable, financial statements are provided to domestic, PCAOB, auditing firms.

Hence, with a relatively lax regulatory stock market environment in China (as compared to stringent regulatory oversight in the United States), fundamentally different accounting and auditing procedures, and divergent societal and political structures the Chinese reverse merger debacle should not come as a surprise to anyone.

Civil Suits Against Chinese Companies Mount

Years of poor due diligence practices by US accounting, auditing and law firms has resulted in numerous shareholder class action lawsuits being filed against Chinese companies that have completed a reverse merger or RTO (Reverse Takeover) in the United States.

Because of the highly publicized problems of Chinese reverse merger fraud, some individuals incorrectly assert that the reverse merger process itself is somehow a dubious device used to gain access to domestic exchanges. Nothing could be further from the truth. Since the majority of companies going public in the US are completed via a reverse merger, it stands to reason that that the majority of Chinese companies going public domestically will use the same process.

Chinese Stock Fraud is not Limited to Reverse Mergers

Class action law firms and the investment public are now discovering that Chinese stock fraud is not limited to reverse mergers. Chinese companies that have gone public via S-1 Registration Statements, full blown IPO’s, and alternative methods such as WestPark Capital’s unique WRASP ™ (Public Offering and a Share Exchange hybrid) program have collapsed under close scrutiny as well. Certain reverse mergers or RTO’s were simply the first to fall.

In conclusion the fact of the matter is that the reverse merger process is a legitimate cost-effective and completely legal method of going public and has been used by such companies as: Yahoo, Turner Broadcasting Systems, Occidental Petroleum, Berkshire Hathaway, Texas Instruments and Blockbuster Entertainment to name a few.

The Author

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

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