RISK MANAGEMENT

A Stock Market Guide for the Unscrupulous Chief Financial Officer

So you as CFO have finally completed the initial public offering documents, the investment bankers and sponsors have signed off on them, and the stock has started trading.

Now you, as an unscrupulous CFO, gets ready to please the controlling shareholder (and line your own pocket) by orchestrating what investment bank China International Capital Corp. (CICC) calls Operation Lao Qian Gu, a Chinese phrase the South China Morning Post newspaper translates into English as ‘a cheater’s stock.’

When your company shows signs of being a cheater’s stock or a recruiter comes calling offering a lucrative post in such an enterprise, stay away or just say no

The daily recently reported on how CICC, the mainland’s first joint venture investment bank, is warning Chinese investors about a scheme in Hong Kong that, for now, has not caused a crackdown there.  

The CICC report is meant for educational purposes, but for the unscrupulous CFO, it also provides a roadmap to a scheme that is apparently not illegal in Hong Kong. As the Post tells it, “the 68 ‘cheater suspects’ listed by CICC . . . have done it between two to nine times since 2000” – without incurring regulatory ire.

‘Cheater’s Stock’

So what does the unscrupulous CFO do? First, announce some good news. It can be perfectly legitimate brilliant operating results: higher revenues, better profits, significantly fatter margins. Or it can be speculative: a plan to sell control to a bigger corporation or making a strategic acquisition. Or something that plays into the themes that the market is currently obsessed with, such as moving into fintech or e-commerce.

When the stock price has shot up, ask the controlling shareholder to sell aggressively. Aim to push the price below the company’s book value. “That attracts two types of buyers,” explains the CICC report: those that want to reduce their cost by averaging the total purchases at the much lower price, and those that had not bought, but now see the stock as very cheap.

Continue driving down the price. Have the company issue new shares and dump them at a steep discount to friends and associates disguised as independent parties (which is illegal, so be sure to carefully cover your tracks).

You can then launch a rights issue at a very high ratio, such as a five-for-one rights issue. “Say the price is now 20 HK cents and a 90 per cent discount placement is done,” writes the Post. “You retrieve your stake at 20 cents. That is a gain of more than 90 per cent.”

Typically, most minority shareholders will shun the offering because the stock price had fallen so low. So your controlling shareholder, who is as unscrupulous as you are, can scoop up the offering.

Leveraging the Net

Now comes the second part of the operation. Consolidate the shares at a high ratio – say 20-to-1 – to avoid becoming a penny stock and stay above the delisting threshold. And “a penny stock is no good for a second round of downward manipulation,” says the South China Morning Post.

Because, yes, the scheme can be done over and over. At least one company in CICC’s list has done it nine times. Just be sure to change the company’s name – you can justify it by noting that your business and strategy have changed – so once-burned investors will not get wise to you.

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