DD Support Board and Research Team

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Bill Alpert's follow-up on Chinese RTO's

Mergers That Don't Enrich Shareholders
Reverse Mergers of Chinese companies continue to sag

We were on to something when we warned investors against the hundreds of Chinese businesses that had their shares listed on U.S. exchanges through the back-door technique of reverse-takeovers ("Beware This Chinese Export," Aug. 30, 2010).

The stocks have been poor performers. Two weeks ago the Wall Street Journal reported a wide-ranging investigation by the Securities & Exchange Commission, which is looking into the supply chain of stock promoters, bankers and accountants who have brought public some $50 billion worth of such stocks by merging China ventures into publicly traded American shell corporations. Congress members have vowed to hold hearings. On Dec. 20, the SEC fined a California audit firm featured in our story -- Moore Stephens Wurth Frazer & Torbet -- which agreed to a bar from auditing additional public-company clients in China, Hong Kong and Taiwan.

But that modest action by the SEC may be the only regulatory effort that investors can expect for quite a while. People with first-hand knowledge of the SEC's inquiry say that its investigators are worried about the expense of probing overseas businesses, especially because the agency can't subpoena evidence from China.

Investors don't need evidence of securities violations to conclude that reverse-merged China shares are lousy stocks. Our August story showed that the median performance of this type of stock was about 75% worse than the Halter USX China Index, an index of U.S.-listed Chinese companies. Since August, the shares have continued to underperform. Most of the 350-odd group that we studied are now penny stocks. Considering just the 127 of those stocks whose share prices were above a buck back in August, the group's mean return over four months has been flat. The median stock in the group lost 1.7%. By comparison, the Halter Index has gained about 12% since August. The Nasdaq and the Russell 2000 have gained about 25%.

The riskiness of reverse-merged shares has as much to do with the American side of the reverse-merger business as it does with the Chinese. Consider some stocks assembled by Belmont Partners, a Washington, Va.-based investment-banking outfit. The firm says it has supplied publicly traded shell companies for more than 160 reverse-merger transactions, with a total market capitalization in excess of $2 billion. Dozens of those reverse mergers involved Chinese enterprises like China Green Agriculture (CGA) and Sino Gas Holdings (SGAS), both of which sold off sharply in 2010. Belmont Partners' founder Joseph Meuse created the Reverse Merger Association of America in 2008; the same year his firm held a conference featuring Alan Greenspan as keynote speaker.

"The leading shell provider in the U.S. !" bragged Belmont in a classified ad on a Chinese Website. "Cut out the middle man, low price guaranteed!" China reverse mergers assembled by Belmont Partners include Qingdao Footwear (QING), Buddha Steel (AGVO) and Longhai Steel (ACTN). Meuse played multiple roles in these transactions -- so many, in fact, that the SEC finance division asked Longhai Steel to revise its May 2010 proxy statement to explain potential conflicts between Meuse's role as an investor in the Chinese steel-wire business and his role as chief executive of the U.S. shell company with which Longhai negotiated a merger. Meuse, who says he recently has switched the focus of Belmont Partners, recused himself from the merger vote.

Belmont Partners' point man in Shanghai starting in 2006 was William H. Luckman, grandson of one-time Chicago Bears star quarterback Sid Luckman. As director of business development, Bill Luckman helped put together more than 40 reverse mergers. His resume before Belmont, however, might leave some investors uneasy.

A decade ago, SEC filings show that Luckman was the sole officer and director in stock offerings promoted by Stephen Durland and Donald F. Mintmire. In September, Durland agreed to a permanent bar from serving at a public company, in settlement of SEC allegations that he secretly sold millions of dollars of stock through nominees at Pegasus Wireless (Barron's, "Slow Hand, Fast Hand," Sept. 4, 2006). In 2005, Mintmire was convicted on federal charges of conspiracy and obstruction of an investigation into what prosecutors called "box jobs" -- stock promotions where Mintmire secretly controlled the shares of U.S. companies like Amenity Zone, which falsely listed as shareholders people his son had recruited in a bar. Luckman was not charged with any wrongdoing and could not be reached in China by Barron's. Meuse says he terminated Luckman in mid-2010.

Helping Meuse finance and arrange the shell-company transactions for Qingdao, Buddha and Longhai and many others was a Syracuse, N.Y.-based car dealer named Joseph C. Passalaqua. One of their deals was for a Passalaqua company which operates ATM machines in Syracuse strip clubs. Neither Qindao nor Buddha shares have traded lately. From an early 2010 high of $30 (split-adjusted), Longhai shares now go for $15 and the company is trying to raise $15 million in a units offering underwritten by Ladenburg Thalmann & Co.

Calling Barron's from Tibet, Meuse said he moved to China in March 2010 and retired from supplying reverse-merger shells to concentrate on private-equity investing. "I wanted to get out of the situation where you can't really control what you've got," he said of his reverse-merger deals.

http://online.barrons.com/article/SB50001424052970203822504576048012938012584.html?mod=BOL_hpp_mag