The Wolf of Wall Street's Chinese Cubs

Over-the-counter markets like NEEQ are fertile hunting ground for stock manipulators.

The wolf of Wall Street's cubs may find a new hunting ground in China.

The rapid growth of the nation's over-the-counter National Equities Exchange and Quotations market should remind investors of Jordan Belfort, the former stockbroker immortalized in the 2013 Martin Scorsese movie. The difference is what China's regulators are doing, which is to say not enough.

Growing Teeth

The CSRC imposed a record number of fines last year but still is a long way behind the SEC

Sources: SEC, CSRC

The China Securities Regulatory Commission is asking brokers to limit access to the nascent market to qualified investors, Bloomberg News reported Wednesday. Founded in 2012, Beijing's NEEQ was home to some 5,000 companies with a total capitalization of about $385 billion at the end of last year, and according to consultancy Zero2IPO , those figures are poised to double.

Yet qualified investors are the reason why NEEQ has grown so fast. A complicated approval system for initial public offerings in China has limited the number of companies that sell their shares to the public via traditional venues. There are at least 700 companies currently in the queue to list in Shanghai and Shenzhen. Meanwhile, regulatory enforcement doesn't seem to be keeping pace.

Authorities have been promoting smaller over-the-counter markets in the hope of allowing easier funding for small- and medium-sized enterprises -- the ones that generate the most jobs. Aside from NEEQ, there are a number of regional venues in China where only local companies can sell stock. (OTC markets differ from regular stock exchanges in that they can pick and choose their participants, whereas stock exchanges are open to any investor.)

Like the OTC Markets Group in the U.S., previously known as the Pink Sheets, NEEQ and other OTC exchanges' inherent lack of liquidity make them ripe for manipulation strategies, such as pump and dump schemes or private investment in public equity. While not so popular yet, these venues could make companies easy targets for penny-stock manipulators. The CSRC has already slapped a few wrists to show they don't want market rigging. But enforcement activities have fallen well shy of North America, even as some mainland companies, such as Zhejiang Longsheng Auto Parts and Beijing Baofeng Technology, record wild share-price swings.

Driving Things Higher

Stock in car seat components maker Zhejiang Longsheng Auto soared between a private share placement in March and June 2, after which it embarked on a long descent

The Securities and Exchange Commission last year carried out 807 enforcement actions and obtained $4.2 billion in penalties. Although there's no publicly available breakdown on how many of those were related to penny stocks, the agency identified the securities of dormant or thinly traded companies as most vulnerable. The CSRC by contrast undertook 345 investigations, a 68 percent increase from 2014, and got 5.4 billion yuan ($835 million) in penalties, more than 1.5 times what it did the 10 years prior. A solid improvement, but there's still a lot of work to be done.

The CSRC needs to step up its enforcement game, especially if it plans on allowing OTC markets to grow at such a fast clip. Authorities are already starting to face protests from placard-waving disgruntled investors, as the Wall Street Journal reported this week. If Beijing doesn't tighten the free rein it's giving NEEQ, wolves will soon be at the door.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Christopher Langner in Singapore at

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    Katrina Nicholas at

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