Sometimes a Cave is Just a Cave

Reuters profiles China’s “Underground Grand Canyon,” a cave and tourist attraction in a remote part of Shandong Province which exemplifies the controversial measures Chinese companies sometimes take to achieve the recognition that accompanies an overseas listing:

The owners of the Underground Grand Canyon attraction eventually used a dizzying array of holding companies to ultimately list in the United States through a reverse merger that accomplished the feat in 2010.

That practice has come under scrutiny over the past year, as short-sellers including Muddy Waters have targeted some firms listed in the United States and Canada, publishing research reports accusing them of fraud that caused their stock prices to plummet, from which the short-sellers profited.

Some companies that listed through reverse mergers, including Chinese clean-tech firm Rino International, were eventually delisted following investigations prompted by short-sellers’ accusations of accounting flaws.

The New Yorker’s Evan Osnos writes that even though the company hasn’t been accused of any accounting irregularities or fraud, the story of the Underground Grand Canyon and others which have similarly sought reverse-mergers has fueled recent concern over investing in China:

The prospect of wrongdoing isn’t really the point, anyway. This is probably not the Madoff of caves, and the listed entity, BTHC XV Inc., isn’t even trading yet, as far as I can tell. This is far more interesting as a milestone of a rarer kind, as I’ve mentioned before, as in the moment that a Chinese entrepreneur sought to purchase a significant chunk of Iceland not long ago. It is the kind of moment when those of us keeping an eye on China’s rise pause with a hand against the wall to recover our bearings.

Reverse mergers—by which a Chinese company gets listed through the back door, using the carcass of another firm—have proved to be one of the occasionally toxic byproducts of overzealous ambitions to bring China into global markets faster than its companies should have. This is one of the realizations behind the surge of concern lately about Chinese investments, in which various analysts have been offering versions of what Sean Williams, at the Motley Fool, titled, “I Was Wrong About China.” (Among other lessons, he writes, “The second mistake I made was assuming that corporate governance in China was comparable to what we’re used to in the United States.”)

Sino-Forest, the name most associated with and responsible for the recent cloud of suspicions that has engulfed foreign-listed Chinese companies, began to fight back last month against accusations of fraud in an August research report published by Muddy Waters which caused the Toronto-listed stock to plummet and prompted regulatory and criminal investigations into the company. See also coverage, via CDT Money, of new allegations by Muddy Waters against advertising company Focus Media.