On October 21, the China Securities Regulatory Commission (“CSRC”) opened an investigation into six Chinese companies for alleged fraud relating to initial public offerings (“IPOs”).  The six companies under investigation are (1) Longbao Ginseng & Antler Co. (“Longbao”), a biotechnology and pharmaceutical company; (2) Guangdong Guangzhou Daily Media Co., an advertising firm; (3) Ingenious Ene-Carbon New Materials Co., a graphite supplier; (4) Infotomic Co., a property developer; (5) P2P Financial Information Service Co., a real estate developer; and (6) Shenzhen Ecobeauty Co., a natural gas equipment manufacturer.  One of the six companies, Longbao, is currently preparing an IPO, while the remaining five have already gone public.

These six cases mark the start of a relatively new campaign by the CSRC intended to detect and punish IPO fraud.  The commission announced that it will be investigating all parties involved in the IPOs, including the lawyers, underwriters, and auditors.  It also announced that penalties could include delisting the companies’ stocks, issuing financial penalties, and even imposing criminal charges and fines.

The alleged fraudulent acts for the six companies under investigation include false representations made in IPO prospectuses and inflation of company revenue and net income, designed to induce market speculation and artificially boost company stock prices following an IPO.  While foreign investors are barred from being shareholders in domestic Chinese companies, IPO fraud is an enormous area of concern affecting Chinese investors, who stand to lose millions, with China only recently starting to seriously crack down on this type of market fraud.

This past June, China for the first time expelled a company for committing IPO fraud from one of its several stock markets, the Shenzhen Stock exchange, after an investigation revealed that Dandong Xintai Electric fabricated financial data in its IPO application.  The underwriter of the IPO was also ordered to pay 550 million yuan ($82.2 million) to compensate investors and an additional penalty of 57.3 million yuan ($8.5 million).

The deputy chairman of the CSRC, Jiang Yang, noted back in June that the CSRC would strictly enforce its delisting procedures on companies that fail to meet the highest corporate disclosure standards.  Yang noted that “what we should focus on at present is a solid capital market foundation composed of listed companies … the market shouldn’t allow sensational hype”; and the “bottom line [is] in preventing systematic risks.”

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