China’s new third board - fraud central? | China Accounting Blog | Paul Gillis

China’s new third board - fraud central?

The Wall Street Journal has an excellent article explaining China’s over-the-counter market – the National Equities Exchange and Quotations (NEEQ), also known as the “new third board”.

NEEQ has listed 3,365 companies since 2013. The 3,751 listed companies are mostly microcaps. Listing on the NEEQ is easy. Unlike China’s exchanges, there are no requirements that the companies be profitable or growing. China’s security regulator has little involvement and local CPA firms typically audit the listed companies.

Sound familiar? Yes, it appears to be a Chinese version of the reverse merger technique used by many companies to quickly list in the United States. That technique collapsed in wave of fraud. The problem with many reverse mergers was that the market was that poorly regulated and unscrupulous promoters and advisors took advantage of the lack of regulation to perpetrate frauds on the market. There is a big difference, however. US regulators could not investigate or punish fraudsters located in China. Chinese regulators can. 

It seems likely to me that the NEEQ will repeat the reverse merger fiasco. The US reverse merger wave collapsed when short sellers exposed the frauds. Short sellers are not able to operate in the NEEQ, so they are not going to perform their necessary, often controversial, market regulating role. Investors are left to rely on regulators and auditors, who will need to up their game. I dont think they are ready. 

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