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Exploring the State of Relations between U.S. Regulators and China
Between January 1, 2007, and March 31, 2010, U.S. capital market participants invested large sums into small Chinese companies through a process known as a "reverse merger." According to a PCAOB research report on this topic, a reverse merger is-
Broadly used to describe any acquisition of a private operating company by a public shell company that typically results in the owners and management of the private operating company having actual or effective voting and operating control of the combined company. Through a reverse merger transaction, although the public shell company is the surviving entity, the private operating company's shareholders control the surviving entity or hold shares that are publicly traded. In a reverse merger transaction, the entity whose equity interests are acquired (the legal acquiree) is the acquirer for accounting purposes. Through such a transaction, the private company, in effect, becomes a SEC reporting company with registered securities without filing a registration statement under the Securities Act of 1933 or the Exchange Act of 1934. ("Activity Summary and Audit Implications for Reverse Mergers Involving Companies from the China Region: January 1,2007 through March 1, 2010," PCAOB Research Note 2011-PI, Mar. 14,2011)
By September 2012, however, 79% (126 of 159) of these companies either had delisted from U.S. stock exchanges or had "gone dark," meaning that they no longer filed current reports with the SEC (PCAOB Research Note 2011-PI). Numerous lawsuits have been brought in U.S. courts by shareholders who feared the worst and attempted to recover lost funds.
As a result of these investor losses, sorely needed capital for similar small enterprises in China has virtually disappeared over the past several years-not only from U.S. investors, but also from worldwide sources (Paul Gillis, "Remarks at the China Best Ideas Conference," China Accounting Blog, Oct. 14, 2013). Some experts on frie Chinese markets have noted that these small Chinese firms were in over their heads in trying to comply with the U.S. regulatory system (Gillis October 2013), whereas some investors (short-sellers, such as Muddy Waters and Citron) alleged financial improprieties and fraud (Floyd Norris, "The Audacity of Chinese Frauds," New York Times, May 26, 2011).
The attention generated by these and previous investor losses...