US Officials: China Refuses to Help Stop Investment Scams


Experts tell ABC News the frauds were fueled by a burst of interest among U.S. investors in putting money behind the Chinese industrial boom.

Companies were able to exaggerate and in some cases fabricate their earnings reports, hiding behind an opaque Chinese financial system that made it difficult for auditing firms to verify the numbers. Many of the companies were located in rural parts of China where it could be difficult to verify that factories were actually producing the goods they had been describing to investors on glossy brochures and in presentations at lavish conferences.

"In 2009, everybody wanted to be in on it," said Dan David, vice president of GeoInvesting, LLC, a firm that monitored the Asian investment craze. "Then we started to see reports from people on these companies that said that there were accounting errors and material misrepresentations. And then it started to grow from there that there was outright fraud."

David told ABC News that collectively, the epidemic of China-based frauds has grown into one of the most costly crime sprees in history.

"Billions. Tens of billions -- in just pure, outright [fraud]," he said. "They raised money here, took it, kept the money."

Among the most notable cases was one involving Puda Coal, a rural Chinese coal company that is alleged to have sold off its coal mine without ever telling investors.

Another company accused of fraud is China Integrated Energy, a large Chinese energy firm, one of whose biodiesel plants was supposed to be producing fuel at maximum capacity of 100,000 tons a year. Jon Carnes, a so-called short seller, whose investment strategy involves profiting when the value of a company goes down, began to question the company's production reports in 2010 and decided to send investigators with a camera to see what really was occurring where the plant was located, in the remote city of Tongchuan. The resulting time-lapse video appears to show an almost dormant plant, where only six tanker trucks stopped to fill up over the course of four months.

"During that period, I found that they produced, essentially, nothing," Carnes said.

Carnes's report sparked a frenzied response in the U.S., as investors began to question the profit statements from the company.

The company responded by conducting an internal investigation. "While some issues remain as to production at the Company's Tongchuan biodiesel facility, and while the investigation revealed the need to strengthen internal controls and take similar measures, the primary substance of all other allegations has been proven groundless," the company's report said. In the aftermath of Carnes's report, the company's auditor resigned and NASDAQ moved to remove its listing from the exchange.

As fraud cases involving China-based firms began to mount over the past three years, the SEC began issuing warning letters to investors about the risks involved. And the two major U.S. stock exchanges began taking steps to address what had clearly emerged as a problem.

For several years, NASDAQ, NYSE and the exchange it owns that was known as the AMEX had all been allowing Chinese companies to be listed through a process called a "reverse merger" that was quicker than the more traditional approach of an initial public offering. The firms would merge with dormant companies that had already attained an SEC registration, speeding up the path to getting listed on a stock exchange.

Officials with the New York Stock Exchange noted that the vetting of Chinese firms was the responsibility of multiple parties. "It's easy to focus in on the exchanges, but there's a food chain involved here," an NYSE official told ABC News. "When a company lists, it involves law firms and bankers and regulators. Then you have the accounting firms, who are really critical to this process. When we list a company you need those audited and verified financials. That's what we all depend on."

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