China Reverse Merger Litigation Update

Here’s an update about what’s going on with litigation related to China Reverse Mergers.

First Big Award in China Reverse Merger Litigation

China MediaExpress Holdings Inc., which went public in the U.S. through a reverse merger, was a fraudulent enterprise, a Hong Kong arbitration panel ruled, awarding Starr International Co. as much as $77 million in damages.  CME’s shares have been delisted.

CME’s founding shareholders were ordered by the three-member panel to pay Starr the funds for not honoring an agreement to buy back its stake. CME was among the Chinese companies accused by  Muddy Waters LLC of financial irregularities and its shares plunged 93 percent in five months after Block’s February 2011 report accused the company of manipulating its financial statements.  However, the panel rejected the Chinese company’s claims that its video advertisement display business was destroyed by short sellers.

Zheng Cheng, CME’s founder and chairman, had compared it to a Chinese version of Hollywood.  Nice try, said the Panel.  “Cheng was such an unreliable witness that no credence can be given to this explanation.”

SEC Investigations of China Reverse Mergers

The U.S. Securities and Exchange Commission has deregistered the securities of almost 50 companies and filed fraud cases against more than 40 issuers and executives as part of its investigation into the non-U.S. based firms.

Accounting Class Actions and China Reverse Mergers

Although number of accounting class action filings dropped sharply in 2012, as litigation related to Chinese reverse mergers waned, accounting cases still accounted for more than 90% of all settlement dollars for securities class actions in 2012, according to Cornerstone Research Inc. in an analysis, “Accounting Class Action Filings and Settlements — 2012 Review and Analysis.”

The drop in Chinese reverse merger cases alone accounted for about two-thirds of the decline in new accounting cases, which fell to 45 in 2012 from 78 in 2011.

China Reverse Merger accounting cases are likely to be with us for a while as Accounting cases continue to be less likely to be dismissed and typically take longer to resolve than nonaccounting cases.

In commenting on the Report, Joseph Grundfest, director of the Stanford Law School Securities Class action Clearinghouse in Palo Alto, California said, “The lesson from these data is clear: Courts care about accounting fraud.  These cases are more complicated and expensive to litigate and more likely not to be dismissed. This litigation pattern underscores the importance of the accounting and audit function, and reinforces the need for corporate executives to continue to pay close attention to the numbers.”