“We are under attack,” writes Wall Street Journal blogger Josh Brown, an advisor with Fusion Analytics and proprietor of The Reformed Broker website.
While it might sound like the paranoid plot update of the campy Patrick Swayze vehicle "Red Dawn," Brown says a slew of reverse mergers involving Chinese companies listed on American stock exchanges now has the attention of the SEC.
Here’s how it works. A publicly traded American-based company, once a going-concern but now a shell of its former self and trading for pennies, issues a large number of shares to purchase a Chinese company. The Chinese company then becomes the majority shareholder and assumes the public listing of the American parent company.
“It’s a way to skirt the IPO process,” Brown says in an interview with AdvisorOne about his blog post. “With the help of U.S.-base law firms, they engage in revenue exaggeration; they also might says they have four campuses when they really have two, and they might claim a technology edge on an American company. In this way, they’re able to capital formulation.”
He adds they've been able to subvert the more highly scrutinized public offering process that would normally have weeded them out. By "cleaning up" shell companies, which should not be trading or available to begin with, the disease gets a foothold first on the pink sheets and then onto the American Stock Exchange “where the real grifting can begin.”