Chinese Protest $5 Billion Losses Tied to U.S Reverse Mergers

Four wrinkled pieces of paper are all that remain of Xiong Renzhi’s Nasdaq-fueled dream of a comfortable retirement in the southern Chinese city of Nanchang.

The certificates gripped in the former electrician’s sinewy hands represent 46,000 shares of Xi’an Xilan Natural Gas Co., which he bought in 2006 for 166,000 yuan ($25,990) by selling his apartment and moving in with his sick mother-in-law. Xiong, 62, said he expected returns many times his outlay when the natural-gas distributor listed on New York’s Nasdaq Stock Market, which it did on June 5, 2009.

Like thousands of Chinese who bet their life savings on companies aiming for U.S. listings -- some of them among firms that later cost U.S. investors billions of dollars -- Xiong and his wife are still waiting for a payout.

“We put all our eggs in this one basket,” said Xiong, who writes articles online to support protests in the financial capital of Shanghai by others who claim they’ve been cheated. “Is the company going to exploit us for nothing?”

Xiong and as many as half a million Chinese who spent an estimated 35 billion yuan ($5.48 billion) on similar investments want authorities to ensure they get their money back. They bought into companies touted by local officials, investors said, only to have their share purchases later deemed illegal by the central government.

Public Protests

Hundreds have vented their anger in four protests since May led by a wheelchair-bound retiree, Lu Yafang. One desperate man last year publicly attempted suicide. All are victims of a failed Chinese experiment with capital markets, said Xiong.

Xiong’s experience shows how little oversight there is in the burgeoning Chinese securities market. Local and foreign investors have been burned by companies that skirted regulations on fundraising while cloaking themselves in government authority. Now that investors have lost money, they’re finding the government is offering them little protection.

“The Chinese government hasn’t bothered to create real financial markets, where you have the infrastructure that rewards good behavior and punishes bad behavior,” said Arthur Kroeber, managing director of Beijing-based GaveKal Dragonomics Research, a financial advisory firm. “In a country where legal institutions are weak, there are lots of opportunities for retail investors to get ripped off.”

Reverse Mergers

At least 16 firms based in Xi’an, the capital of Shaanxi province in China’s northwest, joined more than 400 Chinese businesses that gained stock-market listings in North America by buying public shell companies -- a strategy known as a reverse merger that avoids the scrutiny of an initial public offering.

Investors in U.S.-listed Chinese companies, including former American International Group Chief Executive Officer Maurice “Hank” Greenberg’s C.V. Starr & Co., have lost more than $7 billion this year in plummeting share values as at least two dozen firms revealed accounting flaws or auditor resignations. U.S. securities regulators are investigating.

For many firms that couldn’t meet requirements to list on China’s two domestic exchanges, selling shares to Chinese investors on provincial platforms enabled them to raise funds needed to venture to overseas markets, said Wang Weimin, a former exchange official who helped promote trading in Shaanxi.

Most of Xilan Natural Gas’s 200 to 300 domestic investors have sold their certificates back to the company for 1 yuan a share, according to Xiao Peng, a Xilan executive who handles the issue. That’s about one-fourth what most of them paid. The company hasn’t made a conversion into U.S. shares because of a dispute with an adviser on its public listing, he said.

Capitalist Foray

Xilan raised more than $75 million from U.S. stock sales and attracted buyers including Goldman Sachs Group Inc. The U.S. shares, which trade under the name China Natural Gas Inc. (CHNG), rose to as high as $28.80 in 2007 before the financial crisis. Last year the firm had to revise more than a year of U.S. financial statements related to the disclosure and impact of a bank loan. The shares closed yesterday at $2.44.

A decade ago, Xi’an, an ancient capital of China and the eastern end of the Silk Road trading route, began a foray into capitalism led by local officials seeking to build a high-tech economy. City and provincial governments approved, and in some cases established and funded, five markets to help private companies sell shares, investors said.

Shaanxi officials attended promotional tours in Shanghai. Agents sought investors nationwide through television ads. Some hawked the investments from desks at Xi’an’s representative office in Shanghai, according to accounts by investors, leaving the impression that the shares had official endorsement.

‘Ready to Die’

No fewer than 60 Shaanxi firms sold shares to Chinese investors, according to protest organizer Lu’s count. The inflow of money supported the development of a high-tech district in Xi’an that boasts a five-star Shangri-La hotel, high-rise apartment buildings and a shopping center where Mont Blanc pens and Coach bags are for sale.

About 1,200 kilometers (746 miles) to the southeast, in Shanghai, Lu is trying to get compensation for investors in firms that didn’t keep their promises. A former factory worker, Lu, 55, became an organizer for more than 1,000 investors as she fought for the 100,000 yuan she put into a Shaanxi drugmaker, including money her sister had given her for emergencies.

At a June demonstration in Shanghai, scores of protesters gathered outside a government compound, some holding signs with the single Chinese character for injustice. Lu sat under an umbrella in a drizzle, handing out leaflets that read: “Made our money with toil and ready to die to get it back.”

Two men unfurled a banner before plainclothes police moved in to grab it, sparking a skirmish. Lu responded by playing a pre-recorded speech through a loudspeaker.

Electric Wheelchair

Crippled by a childhood bout of polio, Lu started investing after receiving compensation for being evicted from her home and an early retirement payout from her employer, a state-owned manufacturer of air conditioning systems.

She said she bought shares of Chongyang Biotechnology Co., a Xi’an-based developer of liver drugs, from a stock-promotion company in September 2005 that dangled the prospect of an overseas listing. An agent urged her not to tell her family until she could wow them with her gains, she said. In anticipation, she spent 3,000 yuan on an electric wheelchair.

At the time, Lu said, she had no idea Chongyang Biotechnology’s CEO and his son had been arrested two months earlier for illegal fundraising. The men were sentenced to at least two years, and the manager of the stock-promotion company got 13 years, according to copies of court files provided by victims. Lu said she hasn’t received any compensation.

‘Organized Scheme’

“We weren’t cheated by an individual, it was an organized scheme,” said Lu, who has twice been to Beijing to petition authorities. “If 95 percent of the companies promoted by Shaanxi are bad, isn’t that the government’s responsibility?”

Securities regulators in Beijing, Shaanxi and Shanghai declined to comment or didn’t respond to telephone calls and faxed questions. An official at Shaanxi’s financial office declined to comment when reached by phone.

A committee composed of former Shaanxi officials published a report in 2007 saying that 230,000 investors had bought shares in 160 companies in sales later deemed illegal. The report called the share sales to retirees “fraudulent” and “a huge social risk.”

Pushing Exchanges

“Every city government wants to become a financial center, so you have the continued pushing up of these exchanges,” said Stephen Green, head of Greater China research for Standard Chartered Plc in Hong Kong. “The regulator comes in because they’re often badly managed and people lose money. Then there are social protests.”

Beijing securities lawyer Yang Zhaoquan estimated the number of victims at about 500,000, most of them from low-income groups. Only a small percentage is likely to get compensation for lost investments of as much as 35 billion yuan, Yang said on a webcast last year organized by Securities Times, a government- owned newspaper. He declined to comment for this article.

Xiong and his wife, the Xilan Natural Gas investors, met Lu online after they began communicating with others trying to recoup money invested in Shaanxi company shares. The wife, who asked not to be named for fear of reprisals, gets on the Internet nightly, sometimes posting Xiong’s articles under the name Two Trees.

“I wanted to let off some steam and demand justice be done,” said Xiong, a thin man with a hoarse voice.

Cartoon Pandas

Xiong said he first heard about Xilan after his wife responded to a television ad offering free investment consulting. They had bought stocks listed on China’s main bourses in Shanghai and Shenzhen and were disappointed by the returns, according to Xiong. She said agents convinced her to consider buying so-called internal shares issued by companies that hadn’t yet listed on Chinese exchanges and suggested Xilan.

Xilan had big plans for profiting from China’s skyrocketing energy needs. By December 2005, it supplied gas to about 50,000 homes in the Xi’an area, sold compressed natural gas to fueling stations for use by taxis and buses and expected to open three of its own stations, according to U.S. filings. That month, the company went public in the U.S. in a reverse merger with Coventure International Inc., a financially strapped consulting firm, gaining a listing on the over-the-counter market as China Natural Gas.

China Natural Gas’s website features two cartoon pandas dancing in American flag vests and unfurling a banner that reads “Innovation of Energy Industry.”

20-Hour Trip

Xiong and his wife took an almost 20-hour train trip from Nanchang to Xi’an in January 2006 to check out the company. In freezing weather, Xiong talked to taxi drivers whose vehicles ran on natural gas and who told him of queues at fuel stations.

“I saw good prospects in that industry,” Xiong said.

After buying shares in the company from a freelance agent, the couple went to Xilan’s office. There a woman handling the domestic share program told them that their certificates, stamped with the firm’s official seal, were authentic and could be converted into tradable shares in the U.S. once the company moved to Nasdaq, according to Xiong.

Seats were sold out for the return trip home, and Xiong stood between compartments next to the bathroom. Still, he was feeling happy, he said.

“Finally we seized an opportunity,” Xiong said. “The train was crowded and noisy, but I was relieved.”

‘Primary School’

Xiong said he and his wife were reassured their investment would pay off because Xilan had already listed on the over-the- counter market in the U.S. and its shares were gaining. The month the couple visited Xi’an, China Natural Gas raised more than $10 million in private placements to large investors, including Amaranth Advisors LLC before the hedge fund’s collapse, and its stock jumped 55 percent.

In China, Xilan’s domestic shares were listed on the Xi’an Technology Property Trading Center, one of the province’s five exchanges, according to Xiong and two other Xilan investors.

Such platforms were “like a primary school for capital markets,” according to Wang Weimin, former deputy manager of another exchange, the Shaanxi Technology Property Exchange.

That exchange was founded by the Shaanxi Science and Technology Department in 2001, according to Sun Haiying, who headed the department at the time. Then-governor Cheng Andong approved the platform and authorized 7 million yuan in support, he said. Cheng could not be reached for comment.

Telephone calls to the Shaanxi province information office weren’t returned. Li Yingjun, manager of the Xi’an Technology Property Trading Center, said the share selling had stopped. He declined to comment further.

Shaanxi Exchange

The Shaanxi Technology Property Exchange posted company share prices on an electronic screen near a Buddhist pagoda in central Xi’an and on the exchange’s website. Shares typically were set at about 4 yuan and sold in blocks of 1,000, known as TPs for technology properties, according to Wang. The term was an improvisation to circumvent restrictions on selling securities outside China’s two formal exchanges, he said. Rather than sell shares, the exchange trained brokers to do so.

In August 2003, Shaanxi officials accompanied local executives to Shanghai to meet potential investors from China’s wealthier east coast, Wang said. Among them was Ji Qin’an, who later became chairman and chief executive officer of Xilan. The company wouldn’t make Ji, who owns about 14 percent of China Natural Gas’s shares through direct and indirect stakes, available for comment.

‘Absorbing Money’

“This was a means to an end that some local governments tolerated and supported to grow local economies, absorbing money from more developed areas,” said Song Yixin, a lawyer with Shanghai New Hope Law Firm who represents people claiming they lost money investing in such domestic shares.

The companies promoted on the platforms initially targeted listings on a planned enterprise market in Shenzhen intended to cater to firms that didn’t meet the requirements of China’s main stock exchanges. When the new market was delayed -- it didn’t open until 2009 -- executives turned their attention to the U.S.

Shaanxi officials announced in 2007 that the province would reward companies that raised money on domestic or overseas markets. A firm with an initial listing that brought in as much as 100 million yuan would be eligible for an award of 200,000 yuan, according to a policy issued in June 2007.

Cases like that of Chongyang Biotechnology, the company that protest leader Lu invested in, led to regulatory scrutiny by the central government. In December 2006, China’s State Council, the nation’s cabinet, declared it illegal for companies not listed in China to sell shares to the general public or to more than 200 people.

Crackdown on Fraud

At least four executives and dozens of sales agents were jailed for fraud in a crackdown after firms collapsed or didn’t pay investors back, according to documents from securities regulators reviewed by Bloomberg News.

Xilan and other Nasdaq-listed companies based in Xi’an have suffered few repercussions. Among those accused by domestic investors of reneging on promises include SkyPeople Fruit Juice Inc. (SPU), Sino Clean Energy Inc. (SCEI) and Skystar Bio-Pharmaceutical Co. All listed in reverse mergers and continue to trade.

Sino Clean, a maker of coal-slurry fuel, said it is freeing domestic shareholders from restrictions on trading. SkyPeople, a beverage company, and Skystar, a veterinary drugmaker, didn’t respond to telephone calls and e-mails seeking comment.

Wayne Lee, a spokesman for Nasdaq OMX Group Inc., declined to comment.

‘Law Was Incomplete’

Sun, the former Shaanxi official, said investors and most of the companies were innocent and that the fundamental issue was a lack of a market like the OTC, where the fundraising demands by small private companies could be regulated.

“The law was incomplete, and there was no way to control the middlemen,” said Sun, whose wife lost money on similar investments. “Had the exchange evolved into an OTC market, there would have been no problem today.”

Xiong and his wife first became alarmed in 2007 after Xilan’s website took down a speech by Chairman Ji promising a share conversion, Xiong said. In June 2009, when Xilan celebrated its Nasdaq listing, nobody contacted him. When he called, the company told him he would have to wait to get the U.S. shares, according to Xiong.

Two years and many phone calls later, the company has offered Xiong only 46,000 yuan, 1 yuan for each share, less than one-third of his investment, he said.

Ownership Dispute

Xiao Peng, the Xilan executive, said the company hasn’t allowed a conversion because of an ownership dispute with Benjamin Wey, who advised the firm on its U.S. listing.

Wey, president of corporate advisory firm New York Global Group, said in an e-mail that he hasn’t communicated with China Natural Gas for at least 5 years and has “never been aware of any dispute” with the company.

“The share transfer was done in an ill-formed way in a non-standard market,” Xiao said in a telephone interview.

Xiong said the government should help victims recover the full amount they paid since Xilan’s share sale was illegal. A court in Shanghai ruled last year that one company, Shanghai Perfection Nanometre New Material Co., is responsible along with sales agents for compensating shareholders.

“The issue is like a container that will sooner or later explode,” Xiong said, hitting his palm with a plastic water bottle during an interview in Nanchang in June.

Rat Poison

It already did for 70-year-old Luo Yisheng, a retired grocery store worker who plays the flute. Luo said he walked into the courtyard of a Shanghai government office in March 2010 and emptied five packets of powdered rat poison into his mouth. In his pocket was a suicide note in which he asked for compensation for soured investments in two Xi’an-based companies he had been told would earn him a small fortune on Nasdaq.

“I haven’t got a penny back,” Luo wrote, asking to be cremated with his flutes. “It’s all fake. They’re all scams. How can I face my wife and son? I can do nothing but say goodbye to this world.”

Luo survived after security guards rushed him to a nearby hospital, where his stomach was pumped, he said.

“I can die at home, but nobody would know how suffocated I was,” he said in an interview at his apartment in a suburb of Shanghai in July, his face turning red as he patted the certificates he bought. “Those companies and agents pushed me to suicide.”

Buyback Offer

As for Xilan, its U.S. foray may soon be over. Shares of China Natural Gas have fallen 59 percent in the year since it announced the restatement. Roth Capital Partners and Rodman & Renshaw LLC have suspended coverage. A class-action suit accusing the firm of misleading investors by withholding information is proceeding in federal court in Delaware.

Evidence of Xilan’s dispute with domestic shareholders and a high turnover of chief financial officers pushed Polaris Capital Management LLC, a $4.2 billion investment manager, to sell all of its shares in China Natural Gas this year, according to Bin Xiao, an analyst at Boston-based Polaris.

“Our big concern was on the corporate-governance issues,” said Xiao, who visited the company in April 2010.

On June 30, Ji, Xilan’s chairman, announced a plan to buy out China Natural Gas shareholders for $4.25 a share in a take- private deal backed by Themes Investment Partners, a China- focused private-equity fund. Robert Moses Jr., a Houston-based investor with long experience in the energy business who owns about 3.5 percent of the company’s shares, said at that price he’ll break even or make “a little” on his investment.

Xiong isn’t likely to be so lucky. He and his wife moved into an unfurnished home in a Nanchang suburb last month after her mother died and her brother bought out her share of the apartment. Xiong has put his electrical expertise to work wiring his new abode.

“Ji will have his ‘Escape to Victory’ with money in hand,” said Xiong’s wife, referring to a 1981 Sylvester Stallone movie that was popular in China. “It’s not fair. How could the U.S. too let him get away with this?”

--Wenxin Fan, Dune Lawrence. With assistance from Stephanie Wong in Shanghai and Nikolaj Gammeltoft in New York. Editors: Neil Western, Robert Friedman.

To contact Bloomberg News staff responsible for this story: Fan Wenxin in Shanghai at +86-21-6104-3045 or wfan19@bloomberg.net; Dune Lawrence in New York at +1-212-617-4510 or dlawrence6@bloomberg.net.

To contact the editors responsible for this story: Melissa Pozsgay at mpozsgay@bloomberg.net; Gary Putka at gputka@bloomberg.net.

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Photographer: Qilai Shen/Bloomberg

Hundreds who bet their life savings on Chinese companies aiming for U.S. listings have vented their anger in four protests since May led by a wheelchair-bound retiree, Lu Yafang.

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Photographer: Qilai Shen/Bloomberg

Hundreds who bet their life savings on Chinese companies aiming for U.S. listings have vented their anger in four protests since May led by a wheelchair-bound retiree, Lu Yafang. Close

Hundreds who bet their life savings on Chinese companies aiming for U.S. listings have vented their anger in four... Read More

Photographer: Qilai Shen/Bloomberg

Lu Yafang, an investor who claims that she lost her life savings of 100,000 RMB to investment schemes. Close

Lu Yafang, an investor who claims that she lost her life savings of 100,000 RMB to investment schemes.

Photographer: Qilai Shen/Bloomberg

A woman walks past a China Natural Gas filling station in Xi'an. Close

A woman walks past a China Natural Gas filling station in Xi'an.

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Protesters over investment schemes gather in Shanghai. Close

Protesters over investment schemes gather in Shanghai.

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