Chinese Small Caps Get Even More Hilarious

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The disaster that has become U.S.-listed Chinese small-cap stocks continues to amaze. According to the Nasdaq website, 12 stocks halted since the beginning of April remain halted today. Eleven of them are Chinese.

The list includes familiar names for those following the mess, including Longtop Financial (NYSE: LFT  ) and Duoyuan Global (NYSE: DGW  ) , as well as lesser-known names like China Ritar Power (Nasdaq: CRTP  ) and Jiangbo Pharmaceuticals (Nasdaq: JGBO  ) . China-Biotics (Nasdaq: CHBT  ) and Yuhe International (Nasdaq: YUII  ) joined them over the past week.

I'd like to focus for a moment on Yuhe, because the story behind its halt is so, well ... Let's just say that while many colorful words could apply, few are fit to print on a family-friendly website.

As I was perusing new SEC filings today, I ran across a just-released letter to Yuhe from its auditor, Child, Van Wagoner & Bradshaw. It read:

Based on management's misrepresentation and failure to disclose material facts surrounding certain acquisition transactions and off balance sheet related party transactions, our auditor's report on the financial statements of Yuhe International, Inc. ... for the year ended December 31, 2010 ... should no longer be relied upon and must no longer be associated with the financial statements.

Ouch, right? But wait, it gets better! On June 17 (the date of the auditor's letter), the company held a conference call with shareholders to clear up a bit of a misunderstanding. Paraphrasing here, the company said that in 2009, it had agreed to buy 13 breeder farms to expand its chicken business. The CEO ended up in a disagreement with the seller, and the transaction didn't go through. He didn't tell the CFO or board of directors. Instead, he went out and negotiated to acquire 13 different breeder farms.

All good, right? Not even close. But if the situation itself isn't funny enough, here's the company's chief accounting officer's explanation of why the CEO did what he did:

Since we had a contract signed with Dajiang and the contract was disclosed, we worried that the cancellation of the contract and refunded cash would provoke negative reactions from the capital market, so that we decided to reside the money in a private Company under Yuhe Group.

That sounds an awful lot like something we'd hear from Dennis the Menace:

Since my parents had paid a lot of money for the lamp in the living room, I was worried that they would be angry when they found out that I broke it by throwing the football in the house. So I decided to sweep the pieces under the rug and see if I could find another lamp that looked similar.

Way to set a high bar for professionalism, guys.

Even if we suspend both disbelief and all of the concerns about possible outright fraud (which Yuhe could have trouble shaking), it's very clear that many of these companies don't seem ready to trade publicly, period, let alone on a foreign market in another country with different rules, different cultural and business norms, and a different language.

I remain tempted to think investment opportunities must lurk somewhere in this mess. But with each passing day, and each bizarre story like Yuhe's, I'm further convinced that with plenty of unencumbered cheese sprinkled all over the world's public markets, there's little reason to stick my hand into these industrial-strength rat traps.

Fool contributor Matt Koppenheffer does not have a financial interest in any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

Read/Post Comments (10) | Recommend This Article (22)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 24, 2011, at 12:18 PM, Gonzhouse wrote:

    The real worry: there does not seem to be a bottom to the Chinese small cap mess.

  • Report this Comment On June 24, 2011, at 1:31 PM, jekoslosky wrote:

    I agree. I'd like to profit from China's growth, but investing in Chinese small caps seems too risky to me right now.

    My take here:

    And here:

  • Report this Comment On June 24, 2011, at 1:49 PM, jhsellars wrote:

    You left out the part where they published the sale documents from the failed deal to prove that the allegations were false and then defended that act by saying that although the deal fell through...........the documents were the real ones from the failed deal. It's a mess.

  • Report this Comment On June 24, 2011, at 1:51 PM, TMFKopp wrote:


    Again, assuming we're not talking fraud here, it really seems that they just don't even know up from down right now. All I can do is shake my head...


  • Report this Comment On June 24, 2011, at 1:56 PM, soycapital wrote:

    Thank God I got out of YUII about six weeks ago. I did not really think they were dishonest but they were getting beat up pretty bad and with all the other going on I figured better just get out. Thank you!

  • Report this Comment On June 24, 2011, at 2:01 PM, Straightener wrote:

    CRTP has voluntarily gone to the pink sheets as of 6/23 along with a 70% haircut.

  • Report this Comment On June 24, 2011, at 3:29 PM, Ventureshadow wrote:

    This is not as ridiculous as what China-Biotics did with its AUDITOR. To misrepresent the amount of cash they had in the bank they directed him to a fake website. The auditor saw that it was fake and he resigned. How do fraudulent clowns like this get certified and listed on a stock exchange?

    The amount of contempt these people have for us is boundless.

  • Report this Comment On June 26, 2011, at 8:42 PM, MDexpat wrote:

    I have lived and worked in China for over three years now. I own no Chinese company stock nor will I ever buy Chinese company stocks. Why? Because the scenario described in this article is the corporate norm in China. In truth, there is no such thing as a "public company" in China. The concept of a Chinese public company is intrinsically an oxymoron.

  • Report this Comment On June 27, 2011, at 7:57 AM, rlmenzies wrote:

    I bought DGW and YUII and now will NEVER buy any more Chinese stocks. Assuming a growing number of investors have my experience doesn't this mean China will lose a lot of potential investment because no one believes their financial numbers? Isn't the Chinese Government concerned that the rest of the world has such a negative view of Chinese securities?

  • Report this Comment On June 29, 2011, at 1:05 PM, seymourfroggs wrote:

    And now ace hedge fund manager John Poulson loses >$100M on SINO-FORESTS. Another scam.

    He made billions betting on the failure of banks, at the right moment, 4 years ago.

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