Foreign researchers wreak havoc by illegally short selling Chinese stocks

2011-12-01

An increasing number of Chinese stocks have been shorted by foreign research firms, shaking the foundation of Chinese stock markets and causing the shares of several major companies to plunge. Researcher Muddy Waters has continued to hold short positions on advertising firm Focus Media, while investors sold stocks in Sina, a long-established internet portal, as rumors spread that it is Muddy Waters’ next target.

Muddy Waters reiterated in a report released on Nov. 29 its suspicions that Focus Media had overestimated the scale of its LCD network and that the company had engaged in insider trading and inflated acquisition deals. Focus Media vice president Ji Hairong said there is nothing new in the report and that the company is collecting evidence against Muddy Waters.

Shanghai-based Muddy Waters has held short positions on several Chinese firms, such as Douyuan Global Water and Yurun Foods, and focuses particularly on those listed in the US.

Ding Lei, founder and CTO of web portal Netease, said these companies share several characteristics. They all see large fluctuations in stock prices, have unique business models very different from American companies, and have a history of mergers and slip-ups that make them targets for short-sellers.

Focus Media fits all of these qualifications. The company has merged and divided several times, and its LCD advertisement business model is relatively unfamiliar to US investors.

President Benjamin Wey of New York Global Group — a private equity fund that focuses on Asia — told the 21st Century Business Herald that a change in regulation at the US Securities and Exchange Commission, passed two years ago, allows financial firms to sell stocks directly to investors interested in shorted stocks, opening up huge opportunities for short-sellers. Wey said Chinese enterprises have little understanding of US capital markets, while US investors know even less about private business in China. Therefore, stocks are easily influenced by the research specialists, media and hedge funds, even those that are rather small and lesser-known.

Sina’s stock price fell 14% last week to its lowest point in one year over concerns that the internet giant would be the next target of Muddy Waters. Sina CEO Cao Guowei was formerly the chairman of Focus Media and a senior auditor at PricewaterhouseCoopers. Investors have been very interested in his insights on Focus Media’s expensive acquisitions, said Eric Jackson, a Wall Street Journal columnist.

Jackson also suggested that Sina has been involved in suspicious stock trading involving Mecox Lane, a Chinese online shopping website focusing on apparel and accessories — Mecox Lane’s stock has fallen 75% since Sina bought the firm from Sequoia Capital. Jackson said the deal highlighted a close relationship between Mecox Lane, Sina and Sequoia Capital.

Chinese financial news website cnYes warned that these research institutions are short-sellers that work in their own interests and seek profits from the European debts crisis and high-risk investments. The media have also suggested that these short-sellers are shifting their focus from exposing fraud among small firms to larger, more reputable major companies such as Qihoo and New Oriental, once superstars in the Chinese stock market.

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