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The S.E.C. Alleges Fraud At Chinese Company Two Years After Short Sellers

A gang of stock researchers uncovered fraud at China MediaExpress back in 2011.It took the SEC two more years to formally charge the company.

Posted on June 21, 2013, at 1:40 p.m. ET

If the Securities and Exchange Commission's fraud allegations against China MediaExpress sound familiar, they should — similar charges were leveled by a swarm of short-sellers more than two years ago.

Proving the adage that government agencies move as fast as molasses, the SEC yesterday charged China MediaExpress and its CEO Zheng Cheng with fraud in its financial filings and press releases about the financial condition of the company and its relationship with advertisers.

Back in February 2011, the research firm Muddy Waters, lead by Carson Block, essentially said the same thing. At the time, Muddy Waters released a report, "CCME: Taking the Short Bus to Profits" alleging and detailing inaccuracies and misrepresentations in the accounting and financial condition of China MediaExpress, which sells video ads on intercity and airport buses in China.

Specifically, that report and a follow up one entitled "CCME: Irrefutable Evidence of Fraud" alleged that while China MediaExpress said it had $95.9 million in revenue in 2009 it actually had just $17 million. And while the company reported having 27,200 buses in its network it was telling advertisers it only had 12,565. It also claimed to have a relationship with Apple when, in fact, it didn't. Two other research firms released similar reports casting doubt on China MediaExpress's business.

A month later, Muddy Waters published another report saying that it had "amassed irrefutable evidence that CCME is a substantial fraud" and that "management is engaging in a cover-up replete with further dissemination of fraudulent information."

China MediaExpress was able to list its shares on the Nasdaq in June 2010 thanks to a reverse merger — which is where a larger company takes over a stock listing from a company that no longer operates. Less than a year later, however, the company's Chief Financial Officer and it auditor, a Chinese affiliate of Deloitte & Touche, resigned. It was suspended from the exchange in May 2011 and officially delisted in December 2011. The SEC deregistered the company's shares in March 2012.

The SEC's complaint, filed in Washington, D.C. federal district court Thursday, goes over similar territory as Block and other short-sellers and more. The company "massively overstated its cash balances in filings with the Commission and

press releases issued to the investing public," virtually from the moment it became public, said the SEC. Block's first report described China MediaExpress as a "massive pump and dump scheme whereby it inflates revenue and profits in order to enrich management through earn-outs and stock sales." When Muddy Waters issued its first report, the company's stock was trading at $16.61 and was reportedly trying to sell $50 million worth of shares.

The SEC's filing says "a hedge fund paid $53 million to purchase millions of shares of China Media's preferred and common stock." Earlier this year, Starr International Co, the firm run by former AIG CEO Hank Greenberg, won $77 million from a Hong Kong arbitration panel which said China MediaExpress was fraudulent. Starr had invested more than $53 million in the company.

The SEC's complaint accuses China MediaExpress of saying it had an advertising contract with Pepsi and was distributing Apple products through a shopping platform. In Muddy Waters's first report, it said that the company was "abjectly lying" about having any business relationship with Apple. It also said that "six major buyers of outdoor digital media in China" had never heard of the company. In a letter released February 7, Zheng Chang, the company's chairman and CEO, said that China MediaExpress was subject to a coordinated attack by short-sellers and that it is "strong and doing well" and that its "revenues and cash position have been audited by reputable and well-known auditors who have confirmed both."

The SEC's complaint alleges that Zheng in May 2011, offered a $1.5 million bribe to a senior outside accountant because "he did not want the internal investigation team to review China Media's bank balances going back one or two years because there would be discrepancies between China Media's publicly-reported and

actual cash balances." The complaint also alleges that in November 2010, China MediaExpress claimed it had $170 million of cash on its books when it cash had $10 million.

Or, put another way, for the SEC, when it comes to exposing fraud late is better than never.