Virtual prosperity
In early April this year, the NYSE-listed Duoyuan Global Water Incorporated (DGW) was exposed by Muddy Waters for its potential fraud in financial status, as Muddy Waters caught DGW red handed forging its PRC audit report.
Through investigation it was revealed that DGW engaged in improper undisclosed related party transactions that transferred money to its chairman. Muddy Waters estimated DGW's actual revenue was no greater than 800,000 USD annually, versus the 154.4 million USD it had claimed.
This was not the first Chinese company that was suspected of financial fraud in the US. They share a common characteristic that they were all registered offshore. In order to gain confidence from the stockholders, they usually consider counterfeiting corporate finances and inflating company performance to create an image of virtual prosperity.
Hide and seek
Embezzlement of national assets can also be achieved through offshore companies. In March 2011, the People's Procuratorate of Qingdao prosecuted Song Jun, former deputy general manager of Qingdao Ocean Shipping Company on reasons that he had caused huge losses to the state-owned enterprise.
Around 2006, Song adopted a joint-developing mode with a foreign company in the construction of the second phase of the Qingdao Ocean Plaza, each sharing 50% of the stock. Much to the public's surprise, the foreign company was registered by Song himself in the British Virgin Islands. The People's Procuratorate of Qingdao estimated that Song had embezzled more than 7 million USD from the project.
The original intention of Circular 10 and Circular 75 was to control mergers with related parties and transfers of equity holding. However, many companies still have measures to get around these restrictions. For example, the foreign companies registered before the release date of Circular 10, sometimes called "shell companies," are not under its control. Therefore, buying such companies will dodge the effects of strict limitations.
There are four major ways to dodge the effects of Circular 10 and Circular 75, including changing stockholders' nationality, buying shell companies, using a special purpose trust mode, and protocol control, which enables the continuity of the hide-and-seek game between regulators and companies.
