Latest Chinese Fraud May Cost Maverick Capital Nearly $200 Million

For the most part Chinese micro fraudcaps, as most Chinese companies trading in the US are now affectionately known to most, have so far been small companies, with market caps topping at around $250 million. They have also been a veritable gold mine of P&L as short after short has generated massive returns, to the point where our proprietary ZH short basket has just hit a record low and has returned over 38%. Most have been happy as the SEC has continued to largely ignore the topic of Chinese reverse-merger (and other) IPOs on US exchanges, meaning free money would likely continue as many, many more such frauds would continue to be exposed by share sleuths armed with lots of time. All this is about to change, courtesy of the biggest Chinese (alleged) fraud to date: $1 billion market cap (said market cap will be a fraction of this number once LFC is unfrozen for trading), whose largest investors are not some mom and pop retail investors, but Fidelity, as well as investment "legends" Maverick and Tiger Global (and JPMorgan in 4th). And with Maverick standing to lose as much as up to $200 million, one can be sure the SEC is suddenly going to promptly move to pop the Chinese fraud bubble, after over 6 months of warnings by the likes of Zero Hedge, thereby finally removing the "market efficiency" function that speculative shorters (who are apparently the only ones who actually do their homework) truly provide in this case, as well as in all others.

Bloomberg recaps the Longtop story:

Longtop Financial Technologies Ltd. (LFT), a Hong Kong-based maker of financial software, said auditor Deloitte Touche Tohmatsu Ltd. resigned and a U.S. regulator started a probe of the company’s financial reports.

Longtop, whose 2007 U.S. initial public offering was underwritten by Goldman Sachs Group Inc. (GS) and Deutsche Bank AG (DBK), said Deloitte and Chief Financial Officer Derek Palaschuk resigned because of “falsity of the company’s financial records in relation to cash at bank and loan balances (and possibly in sales revenue)” among other issues, according to a press release today. The U.S. Securities and Exchange Commission informed Longtop that it is investigating matters related to Deloitte’s claims, the company said.

The probe of Longtop, which has been suspended in New York trading since May 17 as it delayed filing its annual report, represents an expansion of regulatory scrutiny beyond smaller Chinese companies listed in the U.S. by reverse mergers. The SEC launched an investigation last year into the use of reverse takeovers, in which a closely held firm acquires one that’s publicly traded, enabling it to sell shares without the regulatory and investor examination of an IPO.

“We learned that there’s no such thing as pedigree anymore in the Chinese market,” said Andrew Left, Los Angeles-based founder and owner of Citron Research, who wrote reports questioning Longtop’s financials. “This company had Goldman at their IPO, Deloitte as their auditor, and major firms as their investors. You couldn’t ask for a better structure.”

Oddly, it took Deloitte a few years to figure out what was blatantly obvious to several focused "speculators":

Deloitte said in its resignation letter from May 22 that it found falsehoods in the company’s financial statements and experienced “deliberate interference by certain members of Longtop management” in the audit process, including “unlawful detention” of audit files, according to the statement from Longtop.

Deloitte said its previous audit reports cannot be trusted because the auditor can’t rely on management’s representations and “declined to be associated with any of the company’s financial communications in 2010 and 2011,” according to the statement.

The company defended itself valiantly: The CFO "said on a call with analysts April 28 that Citron had compared Longtop’s profit margins with firms that aren’t “direct competitors” and that the company would defend itself against “these absolutely baseless allegations.” Longtop also said on the call that it would double a share buyback."

The CFO resigned on May 19.

Alas, that will not help the likes of Maverick and Tiger, which are now holding shares that have been halted for almost a week, and which will probably reopen (in a few months if ever), with a .PK suffix.

Ironically, Maverick was adding all the way in:

Something tells us the same cautious VWAP algo used to accumulate over the past 2 years will be promptly jettisoned in favor of a market Sell order when and if the shares finally reopen.

In the meantime, the performence of the Zero Hedge proprietary China short basket is doing just as expected.


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