Financial Fraud Law

SEC Warns Investors About Reverse Mergers

 Many private companies, including some whose operations are located in foreign countries, seek to ac­cess the U.S. capital markets by merging with existing public companies. These transactions are commonly referred to as “reverse mergers” or “reverse takeovers” (“RTOs”). 

Now, the SEC is warning investors to beware.
 
According to the SEC, many companies “either fail or struggle to remain viable following a reverse merger.” Also, as with other kinds of investments, there have been instances of fraud and other abuses involving reverse merger companies. In light of these consid­erations, the SEC recommends, individual investors should take into account their own financial situation, consult their financial adviser, and perform thorough research before mak­ing any investment decisions concerning these types of companies.
 
The SEC adds that another consideration is that some of the foreign companies that access the U.S. markets through the reverse merger process have been using small U.S. au­diting firms, some of which may not have the resourc­es to meet its auditing obligations when all or sub­stantially all of the private company’s operations are in another country. As a result, such auditing firms might not identify circumstances where these companies may not be complying with the relevant accounting stan­dards. The SEC says that this “can result in increased risks for investors.”
 
According to the SEC, in recent months, it has suspended trading in a number of reverse merger entities:
 
(1) Heli Electronics Corp. (HELI);
(2) China Changjiang Mining & New Energy Co (CHJI);
(3) RINO International Corpora­tion (RINO);
(4) Advanced Refractive Technologies, Inc. (ARFR);
(5) HiEnergy Technologies, Inc. (HIET); and
(6) Digital Youth Network Corp. (DYOUF).
 
According to the SEC:
 
• On March 21, 2011, the SEC suspended trading in HELI because questions had arisen regarding the accuracy and completeness of information con­tained in HELI’s public filings concerning, among other things, the company’s cash balances and accounts receivable. HELI also failed to disclose that its independent auditor had resigned due to accounting irregularities.
• On April 1, 2011, the SEC suspended trading in CHJI because questions had arisen regarding the accuracy and completeness of information con­tained in CHJI’s public filings concerning, among other things, the company’s financial statements for 2009 and 2010. CHJI also failed to disclose that it filed its most recent Form 10-Q without the required review of interim financial statements by an independent public accountant and that the company’s independent auditor had resigned, withdrawn its audit opinion issued April 16, 2010 relating to the audit of the company’s consolidated financial statements as of December 21, 2009, and informed the company that the financial state­ ments for quarters ended March 31, June 30, and September 30, 2010 could no longer be relied upon.
• On April 11, 2011, the SEC suspended trading in RINO because questions had arisen regarding the accuracy and completeness of information con­tained in RINO’s public filings since, among other things, the company had failed to disclose that the outside law firm and forensic accountants hired by the company’s audit com­mittee to investigate allega­tions of financial fraud at the company had resigned after reporting the results of their investigation to management and the board, and that the chairman and independent directors have also resigned. In ad­dition, questions had arisen regarding the size of RINO’s operations and number of employees, the existence of certain material customer contracts, and the existence of two separate and materially different sets of corporate books and accounts.
• On May 3, 2011, the SEC suspended trading in ARFR and HIET due to a lack of current and accurate information about the companies because they had not filed certain periodic reports with the SEC.
• On May 12, 2011, the SEC suspended trading in DYOUF due to a lack of current and accurate information about the company because it had not filed certain periodic reports with the SEC.
 
In addition to trading suspensions, the SEC has recently revoked the securities registration of several reverse merger companies. In each instance, the SEC says it revoked the registration because of a failure to make required periodic filings—filings that should contain informa­tion of critical importance to U.S. investors.