Challenges Facing Chinese Reverse Merger Companies: SEC Tightens Listing Standards and Its Implications



As the latest official stance, on November 9, 2011 the SEC approved new rules to toughen the standards that companies going public through a reverse merger must meet to become listed on the three major U.S. listing markets NYSE, Nasdaq, and NYSE Amex. The rules was adopted against the backdrop that the SEC and U.S. exchanges in recent months had suspended or halted trading in more than 35 companies based overseas accused of a lack of current and accurate disclosure about the firms and their finances, many of which were structured through reverse mergers. In June 2011, the SEC issued an investor bulletin warning investors about reverse merger companies.

The adoption of new rules was due to the pressure of marketplace. Since summer 2010, the trustworthiness of foreign reverse merger companies, most of which are Chinese firms that substantially operates in China, have been questioned by some independent research firms such Muddy Waters and Citron Research. Though the targeted companies are questioning the validity of the information source of these analyst reports, the plausible arguments and concerns raised by these reports have effectively created public distrust on the reverse merger structure and caused a wide stock price plummet of China-based listing companies for months.

The new rules prohibit a reverse merger company from applying to list until the company has completed a one-year trading in the U.S. over-the-counter market or another regulated U.S. or foreign exchange following the reverse merger and all the required disclosure are current and accurate in addition to the maintenance of minimum share price for at least 30 of the 60 trading days immediately prior to the listing application and the exchange’s decision to list.

Many Chinese stock analysts argue that the scrutiny should be on the specific companies rather than the reverser merger structure as that could hurt or put on hold normal capital formation for some small foreign companies. Many believe that SEC’s new rules have officially closed the window for a period of maybe one year or two for new Chinese companies in pipeline to enter the U.S. capital market and created a dilemma for current listing companies on market.

Challenged by the tightened SEC rules and marketplace distrust, the essential pressure that Chinese listing companies including those with well-performed finances are facing is to fight back investors trust and confidence through transparent, effective, full-access, proactive communications with investors and take tougher measures to strengthen corporate governance and financial management.

Investors still welcome listing companies with well-performed financial fundamentals. For instance, Qihoo 360 Technology Co., Ltd. (QIHU.NYSE) listed in March 2011 was targeted by Citron Research this November has seen a plummet of stock price during the month. However, the company Q3 financials filed on November 17 was above analyst estimates with quarterly net income rose to $11 million from $3.8 million in 2010 and revenue rose to $47.5 million from $15.5 million a year ago. The trading prices immediately rebounded that day.

For the other direction, some listing companies are considering privatization. On November 22, 2011 Chinese interactive-media company Shanda Interactive Entertainment Ltd.  (SNDA.Nasdaq) announced the agreement to go private and pay stakeholders $41.35 an American depositary share, which values about $2.3 billion. The company in October received the offer from its Chairman and Chief Executive Tianqiao Chen that valued the company at $41.35 a share, a premium of $9.18, or 29%, over its Oct. 14 price. The privatization pursued by the companies like SNDA is commonly regarded as a calculated and temporary retreat from marketplace and the prelude to a return with a brand new public offering after the completion of reorganization and business improvement.

So, it is time to turn right or left. Stay or go? Chinese listing companies at the crossroad have to make decision now.

Jade Ye

Account Executive

China Direct Industries, Inc. (NASDAQ: CDII)

431 Fairway Drive Suite 200

Deerfield Beach, FL 33441 

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