China to Wall Street: The Side-Door Shuffle
By DAVID BARBOZA and AZAM AHMED
Published: July 23, 2011
IT was the hot new thing on Wall Street — one of those exotic investments that seem to promise untold riches for the lucky few.
And, like so many hot new things, it went cold fast.
Such was the fabulous stock-market flameout of a company called Rino International, an untested enterprise that, until recently, would have raised nary an eyebrow in the United States.
But over the last few years, Rino International and scores of other young Chinese companies slipped into the United States stock market through the back door. Rino’s American stockholders later lost hundreds of millions of dollars when accusations surfaced that the company had fudged its books. All told, investors’ losses on these Chinese ventures have stretched into the billions.
How companies like Rino wormed their way into the temples of American capitalism is a story for these financial times. Even amid the wreckage of the 2007-8 financial collapse, an ecosystem of Wall Street enablers — bankers, lawyers, entrepreneurs, auditors — spirited Chinese companies to the United States. With some deft financial maneuvers, these businesses essentially went public while sidestepping the usual rules. Before long, many were trading on the Nasdaq stock market, alongside the likes of Google.
It was all perfectly legal. With bankers’ help, the Chinese companies executed what are known as reverse mergers. They bought American companies that were merely shells and assumed those companies’ stock tickers — sort of the Wall Street equivalent of “Invasion of the Body Snatchers.” The strategy let them avoid reviews with state and federal regulators that are normally required for initial public stock offerings.
At issue now is who should bear responsibility for the bursting of yet another Wall Street bubble. Should it be the Chinese executives and their bankers, who engineered the deals and celebrated these companies? Or should it be the investors, who bought these stocks when, in hindsight, the risks seemed clear enough? The lawsuits are flying.
Next to Bernard L. Madoff and the sins of the subprime era, the supposed shenanigans of a few Chinese companies might seem like small beer. But the developments underscore fundamental questions that came to the fore in the financial crisis: What do the people who create and sell investments owe to those who buy the investments? And where, if anywhere, are the regulators?
Dozens of Chinese companies that, like Rino, entered the United States market via reverse mergers have since been accused of fraud or shoddy accounting. The shares of at least 19 of them have been suspended or delisted by Nasdaq, wiping out billions of dollars in stock market value. Shares of Rino, which were flying high at $35 in 2009, have been removed from the exchange.
Laurence M. Rosen, whose law firm has filed a class-action suit against Rino International, says Rino’s bankers failed investors. Wall Street didn’t do its homework, he says.
“This is egregious,” Mr. Rosen says. “They said they did due diligence but were fooled — but they weren’t doing any solid due diligence.”
Rino has been accused of creating phony business contracts and wildly inflating its sales, among other things. Executives at Rino International, which is based here in Dalian and makes industrial pollution control systems, declined to comment, beyond saying that it is conducting business as usual.
THERE is not much to see outside the headquarters of Rino International here. The company resides in a bland corporate park that is home to a number of other Chinese businesses. A guard stands watch at the gated entrance. Inside, workers load steel beams onto trucks. The bang and hum of factory work rises from workshops.
Dalian, a seaport city in northeastern China with a population of about six million, in recent years has developed into a fast-growing hub of machine manufacturing, petrochemicals, oil refining and electronics. Driving this growth have been companies like Rino, whose name means “green promise” in Chinese.
For international investors, Rino was an alluring equation: “China” plus “environment” equals profit. Like many other Chinese companies, Rino faced obstacles in borrowing money from the state-owned banks that dominate the country’s economic life. It also confronted hurdles in going public on stock markets in Shanghai or Shenzhen, where share prices have gyrated wildly.
And so the entrepreneurs behind Rino — Zou Dejun and his wife, Qiu Jianping — turned to Wall Street.
The matchmaker in this transcontinental deal was an American, Chris Bickel, who earned handsome finder’s fees for bringing Chinese companies to the attention of investment bankers and lawyers back in New York. Working from China with a small New York financial advisory firm, Douglas Financial, Mr. Bickel helped package Rino International for its Wall Street debut.
“We determined at the time that this was a significant market and they had the technology,” Mr. Bickel recalls, adding that any possible improprieties arose later.
As part of the plan, Rino got new handlers in New York: a law firm, an investor relations firm, a new auditor. To complete the package, the company named as its chief financial officer Bruce Richardson, an American businessman who had spent more than a decade in Shanghai. Mr. Richardson declined to comment.
To gain entry to an American stock market without an I.P.O., Rino needed to find an American shell. Enter Glenn A. Little, a Texas entrepreneur who specialized in buying up defunct companies and selling them in reverse mergers.
In 2002, Mr. Little paid about $100,000 to buy Jade Mountain, a failed medical devices company that had once been publicly traded. Jade Mountain, based in Nevada, had no business operations, no debt, no liabilities. What it had was a current stock registration.
Mr. Little himself was so enamored with Rino that rather than take payment in cash, he asked for shares in Rino. The bankers’ pitch seemed irresistible, he recalls, all the more because several big institutions, including Bank of America, were investing in Rino, too.
“They gave me a book and it had the two most exciting words you could hear: ‘China’ and ‘pollution,’” Mr. Little says. “They had audited financials, big-name lawyers and Bank of America.”
In October 2007, soon after Rino acquired Jade Mountain, Bank of America and about a dozen other investors, including Alder Capital, a hedge fund, bought Rino shares in what is known as a private placement. That sale raised $25 million. Before long, Rino stock was trading on the over-the-counter market for about $4.50 a share.
Over the next several years, Rino reported ever-higher quarterly profits. It expanded its business and its product line. Word spread on Wall Street: Rino was a company to watch.
David N. Feldman, a New York lawyer and the author of “Reverse Mergers and Other Alternatives to Traditional I.P.O.’s,” says that such reverse mergers reflected a confluence of two powerful forces. One the one hand, Chinese companies were desperate to raise capital. On the other, American investors were desperate to tap into China’s fast-growing economy. “A lot of this is about access to capital,” Mr. Feldman says.
ALAN GREENSPAN and Diana Ross were headliners at a September 2009 investment conference held by an investment bank that is little known outside financial circles: Rodman & Renshaw.
Founded in 2002, Rodman has carved a niche for itself as the Goldman Sachs of private placements — sales of new stocks or bonds that circumvent the public markets. The hurdles for these private sales are lower than for public offerings, the theory being that the buyers — large, supposedly sophisticated investors — can do their own homework.
Like many investors, Rodman smelled opportunity in China, and in 2009, when Rino wanted to raise more money in the United States, the bank gave the Chinese company a prominent place at its gala. The presentation served as Rino’s splashy debut before thousands of investors.
A few months later, Rodman helped Rino raise $100 million in a deal that valued the Chinese company at nearly $1 billion. From there, however, Rino’s stock price began to decline. In November 2010, it fell off a cliff.
That month, Muddy Waters Research, a firm that has grabbed Wall Street attention by digging up dirt on Chinese companies, released a scathing report on Rino. It said Rino had vastly overstated its revenue, fabricated contracts and diverted tens of millions of dollars to its own executives.
Rino later owned up to some of the findings and cautioned that its financial statements from 2008, 2009 and early 2010 “should no longer be relied upon.” Eventually, the S.E.C. suspended trading in its stock.
Representatives of Rodman & Renshaw, which itself went public by assuming the ticker of a defunct company, declined to comment.
WHEN it comes to China, the question on many investors’ minds is how fast its economy can keep growing. Beijing has been trying to head off a new surge in inflation.
Back in the United States, there has been an explosion of class-action lawsuits, many of which are aimed at auditors and investment banks that brought Chinese companies to American markets. Everyone is pointing fingers at everyone else: lawyers are blaming the bankers, and the bankers are blaming the auditors, and the auditors are blaming executives in China.
Fanning the flames is an army of private investigators, bloggers and Wall Street short-sellers that hope to profit from the stock-market implosions, like Muddy Waters. In the aftermath of the China meltdown, reverse mergers have slowed sharply, and the Securities and Exchange Commission has warned investors of risks associated with such deals. S.E.C. officials met Chinese regulators two weeks ago in Beijing to discuss auditing rules for such companies.
Chinese regulators are worried. “I hate these scandals; everybody hates them,” Liu Qingsong, deputy director of the research center of the China Securities Regulatory Commission, said this month at a conference in Singapore, as reported by Reuters. “The scandals are very damaging to the reputation of all Chinese companies in the U.S.” Yet, for many, China seems irresistible, with money to be made and, invariably, lost. Since 1990, the benchmark stock index on the Shanghai exchange has soared 27-fold, despite a crash in 2008 and a lot of ups and downs in between.
One question that won’t go away is whether investors can really trust the numbers in China. Even investors like John A. Paulson, the hedge fund manager who made a killing on the subprime collapse, have lost big in China.
Michael Licosati, a founder of Alder Capital, bought shares in Rino. Today, convinced that fraud is rampant in China, he is betting against such stocks.
“You cannot compare the capitalist system in the U.S. with the capitalist system in China,” he says. Bank of America, another early Rino investor, declined to comment.
In Dalian, Ms. Qiu, Rino’s chairwoman and the wife of its C.E.O., says only that it is business as usual at the company. “What I can tell you is that our company is doing well and the operation has been very normal,” she says.
Inside the gated compound, workers in tarred jerseys and goggles weld and drive screws. Back in New York, Rino’s shares are frozen at 40 cents.