Chinese Fraud is Widespread
posted by The Traveller on Sunday, March 20, 2011

The downfall of China MediaExpress (CCME) has changed the landscape of U.S.-listed Chinese stocks forever. The events of last week, including developments at China Agritech (CAGC), Subaye (SBAY), China Integrated Energy (CBEH) and ShengdaTech (SDTH) prove that Chinese fraud on U.S. exchanges is much more widespread than I originally thought. Numerous trading halts initiated by the exchanges, and more details about the SEC investigation in Chinese reverse mergers, deal-makers and investment banks involved show that U.S. regulators are stepping up to address the issue. Even though we have always advised extreme caution when investing in this space, we have clearly been too optimistic going forward, put too much weight on auditor integrity (incl. Big Four) and third party due diligence (analysts, institutional investors).

China MediaExpress

The battleground for longs versus shorts was China MediaExpress, a high profile self-proclaimed leader in the booming Chinese advertising industry that reported stellar quarterly results throughout 2010. The company was considered among the safest of the RTO/SPAC stocks based on a large number of indicators which supported the credibility of the company and its reported financials. CCME had a Big Four auditor (Deloitte Touche Tohmatsu) since 2009, a large institutional investor (CV Starr) that even increased its position in the stock last fall, consistently bullish analyst reports (Northland called it its Top Pick 2011, Global Hunter repeatedly released detailed research and raised price targets), and supposedly $170 million cash on its balance sheet. The company announced a share buyback program (although never executed) and promised to pay a dividend this spring.

Despite all these bullish signs, short interest in the stock kept rising to staggering levels, even before Muddy Waters and Citron Research released their short reports. The warning signs were always there, both CCME longs and shorts were engaged in a fierce battle over details, but in the end this was a battle between short sellers, who wanted to profit from a collapsing share price, and the reputation of Deloitte, Starr, Global Hunter and other well-known names in the industry, backed by magnificent financial reports. Longs could easily argue that jumping on the Deloitte-Starr-GH bandwagon would be a much safer bet than following the short argument that all those big names got it totally wrong.

Now the battle is over. Deloitte resigned as CCME's auditor. Dorothy Dong, the representative of CV Starr on China MediaExpress's Board of Directors resigned as well, and Global Hunter's senior analyst, Ping Luo, is no longer working for the firm. CCME's stock is halted indefinitely, without an auditor and CFO - Jacky Lam resigned as well - it is unclear when (if ever) we see another 10-K from the company, and the fallout of this scandal sent the average Chinese RTO stock down another 20% last week. Dorothy Dong's resignation letter gives us a good account of what happened with China MediaExpress:
As you know, numerous allegations of a serious nature relating to the conduct of certain members of CCME's management (and that of its subsidiaries) have come to light in the past several weeks. Specifically, by letter dated 3 March 2011, Deloitte Touche Tohmatsu issued a letter to CCME's Audit Committee detailing numerous irregularities it encountered during its audit of CCME, including in particular, irregularities concerning the bank account balances for CCME's PRC subsidiaries.

Subsequently, by letter dated 11 March 2011 to the Audit Committee and the Board of Directors of CCME, Deloitte resigned as auditor of CCME, citing "no tangible process" had been made with respect to the issues raised in its 3 March 2011 letter, and stating that it had "lost confidence in the representations of management (which underpin any audit) ... and reliable financial reporting."
What do we learn from this? CCME's cash balance is most likely massively overstated, and with that the likelihood that we have seen correct financial quarterly reports for 2010 is very low, as most of the cash is supposed to come from operating cash inflows last year ($30 million in Q3/2010 alone). When Deloitte now speaks of numerous problems "of a serious nature", it heavily devalues the quality of its own work over the past 16 months, and especially also the work of Starr and all the analysts we were supposed to rely on. The most plausible scenario is that CCME's founder, majority owner, Chairman and CEO Zheng Cheng, was deliberately defrauding investors with the sole purpose to enrich himself.

China Agritech

Adding to this scandal is the story that is unfolding around China Agritech (CAGC), another Chinese reverse merger that got heavily attacked by short sellers. The stock was halted by NASDAQ on March 14 before the open, and NASDAQ said trading will remain halted "until China Agritech has fully satisfied NASDAQ's request for additional information." More details came to light after the halt, and all of them point to what I would call highly deceptive behaviour by the company:

On March 13, China Agritech issued a press release, announcing a delayed 10-K filing due to the formation of a special committee in order to "investigate certain allegations made by third parties with respect to the Company and certain related issues." The next day, right before the stock was halted, CAGC announced the dismissal of Ernst & Young Hua Ming (another Big Four) as auditor, based on the management questioning Ernst & Young's independence and "in order to give the public fair and truthful financial results."

The real reasons for both the formation of the special committee and the "dismissal" of Ernst & Young were hidden from investors. In fact it turned out that the "third parties" making allegations included Ernst & Young, and that the auditor threatened to resign if the company wouldn't correct its deceptive press releases. An 8-K form, filed on March 18, tells us a more detailed story of what has really happened at CAGC:
"On March 13, 2011, the Company announced that it formed a special committee of its board in order to investigate certain allegations made by third parties with respect to the Company and certain related issues and that the Company would not be able to meet the its Form 10-K filing deadline. E&Y informed the Company that, in its view, there was a material omission of fact from the Company's press release relating to the formation of the special committee, as the press release did not specifically disclose that the independent investigation was related to issues which were identified during the performance of the Company's year end audit. E&Y further advised the Company's representatives that E&Y may resign as the Company's auditors if a revised press release was not issued. The Company, however, believed that the specific disclosure in the press release about the investigation combined with the disclosure of the indefinite delay in the 10-K filing, was a clear indication to the market that issues had arisen in connection with the annual audit which would have to be addressed.

E&Y informed the Company that the issues identified in performing their audit may, if further investigated, have adverse implications for the financial statements covering the three quarterly reports filed by the Company on Form 10-Q during 2010, and advised the Audit Committee to inform the predecessor auditors of the issues identified, so that they can assess the impact on prior financial reports."
Immediate Conclusion

Last week was a game changer, and right now it is no longer possible to reasonably contain the risks when investing in Chinese small caps, especially reverse mergers and blank-check deals. The number of fraudulent companies in this space is much higher than a common sense approach would even have considered possible - maybe even higher than 50% - and for a retail investor those risks are just too high here. The only stocks we should consider for an investment, at any price, are those with a clean 2010 full-year audit backed by a tier one accounting firm. And even those are not free of fraud-risk.

The shake-out will continue, we will see more Chinese RTO stocks imploding in the next few weeks. And, most importantly, the magnitude of fraud will force U.S. regulators to act swiftly. We have seen as many as five Chinese RTO stocks with an exchange-forced trading halt last week, and this trend will continue. Wall Street can not afford to be seen as a facilitator of systemic Chinese securities fraud, and investors in those stocks are simply not protected.

We will make the necessary adjustments to our China Model Portfolio later today.

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At March 20, 2011 1:13 pm , Anonymous Anonymous said...

yeah. I lost quite much money in CCME and i thought that i am safe because Star-DTT-Ping combo. Oh boy that i was wrong.

- tuoki

At March 20, 2011 1:48 pm , Anonymous Anonymous said...

IMO you should make changes to portfolio after that they have started to trade.

- tuoki

At March 20, 2011 4:29 pm , Anonymous Anonymous said...

I have learned that Chinese businessmen will get away with as much as they can. There is a totally different business and ethical culture in China than the US. I have dumped all of my China small caps and took a position in HSBC (4.8% yield are current price near $50)as a way to play the region. No more Russian roulette playing China small caps for me! When they look too good to be true they almost certainly are.

At March 20, 2011 4:30 pm , Blogger The Traveller said...

Tuoki, they already have started to trade on the new revelations. The CCME/CAGC story unfolded Monday and Tuesday of last week, but the setup of the model portfolio doesn't allow me to make changes before Friday's close.

At March 20, 2011 5:14 pm , Anonymous Anonymous said...

More buy opportunities will show up among the chinese stocks.
The risk in the chinese solar stocks with top 5 auditors isn't higher than any other stock in my opinion.

At March 21, 2011 1:52 am , Anonymous Anonymous said...


This reminds me of many companies that traded well below their values in 08-09 but that was then the world was ending.

Now we must contend that there is simply no faith to be given in these companies financials

With China supposedly less effected than virtually any country by the recession a strange world are they guilty of the same greed that the US has shown for decades or is this systemic.

Anyone remember ENRON and MCI

Life does continue..

At March 21, 2011 6:10 am , Anonymous Anonymous said...


Fair assessment. It's too bad that CCME had so much going for it and that the ordinary gatekeepers [GH/NL (analysts); C.V. Starr (Smart Money with Board Seat); and Deloitte (shamefully the Big 4 Auditor under whose quarterly and prior year's nose this went on). There's no doubt who won the CCME battleground. My best suggestion to avoid fraud in the China space is to only buy low debt China stocks with a serious dividend paying history and to review manufacturers where you can count and see production hands on. Thanks for the great review of reality in China. We need to protect domestic retail investors from these relentless fiends.

At March 21, 2011 8:48 am , Anonymous Anonymous said...

Rames, if you are right that SEC permits for so long to about 200 chinese frauds (more than 50% as you said) to trade in US markets, then these markets are totally corrupt.

I will sell all my American and Chinese stocks and move to more reliable markets outside US (I don't believe that there is any investor who hold only Chinese stocks ignoring the necessary diversification).

For now, let's see if CCME, RINO, CAGC and the other 2 or 3 stocks like them will be increased to a few hundred.

At March 21, 2011 10:21 am , Blogger The Traveller said...

I believe the SEC and generally U.S. regulators incl. the exchanges have blatantly failed to protect investors in the past, they will have to step up and do something about that now, as the focus will now be on them. A company like DYP - they don't even have an auditor since they fired Deloitte last September - should not be allowed to trade on the NYSE. Other names, let me single out SBAY here, come with such flaming red warning signs that an investigation would have been warranted for a long time already, yet nothing happened.

At March 21, 2011 4:14 pm , Anonymous Anonymous said...


i did not expect such a BAD article from strongly disappointed me. There are so many WRONG and laughable GENERALIZATIONS along with clueless ASSUMPTIONS in your article.Either you turned out to be a shorter or you are living in a cave. Lets start

1) SBAY has not been halted.
Regarding SBAY case, the CFO left. Nothing else. Does this imply fraud ? lol
Why do you reject the reasons for his departure as he has presented them ?
Have you any idea how many CFOs have left from AMERICAN companies since 1980 ?

2) There are more than 300 chinese RTO and SPAC currently traded in the american stock exchanges.

So even if ALL these 4 companies (RINO, CCME, CAGC, SDTH) PROVE to be fraudulent and they are not clean cases like in ONP, UTA , YONG cases etc. then we have a statistical fraud rate of less than 1,5 % ! So firstly this is too low and it is within the statistical error of 10%.
In addition, this extremely low rate does not give YOU any right or basis to generalize a situation.

fyi, the PROVEN (not just allegations released by shorters) AMERICAN frauds and accounting scandals include more than 50 companies! Have a SAMPLE for these PROVEN american frauds below.

Secondly it is so clueless and ARBITRARY your conclusion that 50% of the rto/spac are fraud after RINO, CCME, CAGC cases. You know psychologists say that "generalization of a situation" indicates two things for an individual :

it shows "Extreme Stupidity" and/or "complete inability" for somebody to analyze the situations.

So the "generalization" is the easy way for him to follow.

Thirdly, this is the SAMPLE i told you above. Let me know if you want more. There is PLENTY stuff.

GMCR (Green Mountain)
Brystol Myers Squibb
Chiquita Brands (CQB)
ImClone Systems
Green Mountain Coffee (GMCR)
Peregrine Systems

At March 21, 2011 7:01 pm , Anonymous Anonymous said...

The analysis, score cards, indices, and statistics from your website demonstrate a rational, logical approach to evaluating securities.

The statement that the number of fradulent companies in the Chinese small cap sector "may exceed even 50%" does not meet your usual rigorous standards.

You have said "may" so you are not really stating an estimate. What leads you to say "may exceed 50%" vs. "may exceed 20%" vs. "may exceed 80%"? All of these examples "may" be true. What is your best estimate of the proportion of fraudulent Chinese small caps and how did you derive it?

As you have done in the past, you should provide your readership with facts rather than speculations, particularly on such a controversial subject.

At March 21, 2011 7:26 pm , Anonymous TJB said...

Why fight the tape? Sell first, ask questions later. CEO leaving, CFO leaving, Auditor leaving or Seeking Alpha/Muddy Waters/Analyst/Media claiming fraud just sell the stock. Game over and move on.

I own three China reverse merges: CKGT, CSGJ & CNAM

I am getting absolutely killed but believe these are safe from any fraud claims.

Love your aritcles and website, thanks!

At March 21, 2011 9:40 pm , Blogger The Traveller said...

Anonymous 4:14PM

I encourage you to take a deeper look into some of the issues. Subaye (SBAY) changed their business model every few quarters (movies, video advertising, cloud computing, etc.), and this "reinventing themselves" goes along with dubious acquisitions, like giving away more than half of the whole company for buying out a 30% minority shareholder in one of its own subsidiaries.

Other companies do equity raises when they supposedly have tens of millions in cash on their balance sheet, when they are profitable and yet they feel the need to raise money at ridiculously low valuation (less than 5x earnings).

There are no buyout offers in this space, hardly any mergers or acquisition attempts, even at those crazy depressed prices. Don't tell me that nobody wants to buy some of those high growth and highly profitable businesses for 5x earnings. Also no merger attempts within this space. None of the announced management buyout attempts got anywhere so far.

Then we have many names in this space with blatant corporate governance deficiencies, others are not communicating, others have registered auditors that do no longer exist, buybacks announced but never executed, CFO's and other executives are resigning with record frequency. Have a look at CNOA for example:

You need to set the bar much higher from here on, and the companies will have to do the same or they will never again achieve reasonable multiples. About 60% of all China small caps I have applied our safety/risk model on (total ~40 names) FAILED the test. That doesn't mean at all that they are all frauds, but it shows that they have significant problems as public companies.

You can trade anything, it doesn't matter if there are problems with the company for a trade to work. But for value investors it should be the first duty to look into corporate governance and credibility issues. Don't forget that CCME is a stock that passed on most metrics that can be applied for a "value stock". Metrics beyond just cash flow and P/E ratio - the company has a tier one auditor, an experienced CFO, a large institutional investor, a strong, leading position in its core market etc. - CCME did not pass in ownership (single almighty majority owner) and growth/margins (way above the industry average), but those margins could be reasonably explained by longs. Yet it turns out that there have been "numerous irregularities" encountered.

Starr sued CCME, Deloitte, Chairman Zheng Cheng and Jacky Lam on Friday for "systemic violations of the securities laws and its fraudulent inducement of hundreds of millions of dollars of investments."

We really need to be careful here, the CCME issue is much bigger than RINO and everything else before. This could easily be a game-changer that forces U.S. regulators to step in, and to investigate the whole RTO process much more thorough than what has already been announced. Investors are currently NOT PROTECTED, it is unlikely that U.S. investors that lost money with CCME will be able to get any of it back from China (from Zheng Cheng).

So be careful and look beyond income and revenue numbers. I know of significant problems with many more companies in the China small caps space, most of them will come to light at some point. There is plenty of money to be made on the long side, no doubt about that, but you have to evaluate a risk profile before you jump in - it doesn't help you knowing that there are American frauds as well

At March 22, 2011 8:16 am , Anonymous Anonymous said...

Dear Rames,

I see that you also, like the most authors who referred to Chinese fraulent stocks, did not clearly seperate the RTO/SPAC Chinese stocks from the IPO Chinese stocks.

My opinions is that ALL RTO/SPAC stocks are more riskier than IPOs, no matter if they are Chinese or American.

Also, there is no indication or evidence that the Chinese IPO stocks are more fraulent than the American ones.

Therefore, I consider as a fallacious deduction and as a misleading generalisation a statement which accuse indiscriminately ALL China small caps as very riskier and with a very high percentage of them to be fraud.

Thanks for hosting,

Leon Alberti

At March 22, 2011 9:03 am , Anonymous Anonymous said...


i see you change it now and you understand your clueless assumptions and your ridiculous GENERALIZATIONS expose you a lot and give fuel for your legal prosecution....I advice you to be cautious with this issue.

The change of business, the secondary offerings, the lack of mergers do NOT imply fraud. How do you come to this absurd conclusion really ?


Have you any idea what is going on with the american companies the last months ?
Numerous CFOs and CEOs and directors have resigned too !!!!
These american companies must be fraud according to you !!!

Your clueless implications "i know significant problems are coming" are also ridiculous. As i said, they fuel a legal action against you who spreads MISLEADING info.
If you really know sth , WRITE it DOWN NOW and SUPPORT it WITH FACTS.

What is your relation with Alfred Little, Muddy waters, Citron and Andrew Left who have been convicted for FRAUD according to FACTS below?

How do you take as BIBLE whatever these bloggers with the notorious professional claim ?
To give you an idea, read the FACTS below.
So how do you believe an almost imprisoned person ?
Again, you are either affiliated with these bloggers or you are completely naive.

At March 26, 2011 12:29 pm , Blogger The Traveller said...

Look guys, I am just being realistic here. Chinese fraud is much more widespread than I thought, especially - but not exclusively - with RTO/SPAC deals. Clearly, I have been too optimistic in the past, but I simply can't ignore the facts that are on the table now. Running a public blog comes with a certain responsibility, and that includes to clearly point out the risks that China small cap investors are facing right now.

Look at the drama that was unfolding this Friday with NIV, CIL and CDM. NIV's auditor "found accounting fraud and irregularities in forging accounting records and bank statements." Additionally with two other public companies, which might easily be CIL and CDM as both stocks have been halted by NYSE as well and share MaloneBailey as auditor. All three stocks were regular IPO's, led by Westpark Capital.

You should not "believe" anyone else than yourself, incl. myself, company management, Alfred Little, Muddy Waters or any sell-side firm that provides research. Assess all the available information and then come to your own conclusion. Look at the filings from a different angle than you did before, evaluate the facts open-mindedly. Then come to your personal conclusion.

The key here is to protect your capital until you have evaluated the risks. Ideally you are very smart and hardworking, so you can identify several Chinese names that are unfairly beaten down with the group. When the dust settles, and if the company can successfully distinguish itself from its fraudulent peers, then you will make good money. That is what we are trying to do here.

At March 28, 2011 12:39 am , Anonymous Anonymous said...

The Traveller

It can't be easy dealing with the feedback but it seems you are making it harder on yourself with your "no opinions changed until Fridays"stance. If something happens on a Mon-Thursday that changes your mind about a stock you shouldn't have to wait till Friday to boot it.

Do you ever hear about any of these blatant fraudsters being punished in their homeland of China? OR do they feel they are safe as long as they can't be arrested outside the USA?

At March 29, 2011 7:55 pm , Blogger The Traveller said...

The portfolio is set up as a long-term investing portfolio, and to make it as transparent as possible the Friday rule is in place. Most (if not all) model portfolios use intraday trading which is intended to boost performance to increase their (usually paid) subscription numbers.

And about the Chinese "fraudsters"... most of those companies have VIE structures in place where investors in the U.S.-listed stock do not own the operating Chinese company. Those are just contractual arrangements that allow its results to be consolidated into the U.S.-listed holding. The risk for those thieves would be exponentially higher if the stock were domestically listed. In some cases their action might not even be punishable under Chinese law, but if that goes on I wouldn't be surprised if some unconventional form of "punishment" would be enforced by defrauded investors. It's about time that China and the U.S. sit down together and sort this problem once and for all.

At April 04, 2011 4:20 pm , Anonymous Anonymous said...

I knew when CCME was being recommended by everybody and his dog it was already too late to get in profitably. Of course it turned out worse than that. The CPAs not being able to get cash balances right is strange. Cash is the easiest thing there is to audit, as the banks issue monthly statements you can reconcile to.

Sometimes there is no fire behind the smoke. DEER is now being attacked by a blogger and their management is taking him to court. I like that. We need some third party to sort this kind of claims.

At November 25, 2013 3:31 am , Blogger China Fraud Hunter said...

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