Small-Cap IPO Volatility – The China Connection

China is one of the largest economic markets in the world, having grown significantly during the past few decades. Numerous companies have significant operations in China, but China is also a volatile market, particularly for small-cap companies. With a highly centralized government, commercial operations are largely subjected to the whims of the ruling party, and there was a significant amount of concern when the PCAOB and the China Securities Regulatory Commission and Ministry of Finance signed an agreement allowing the PCAOB to investigate registered public accounting firms headquartered not only in mainland China but also Hong Kong.

NASDAQ Halts Small-Cap IPOs, Leading to Volatile Market Conditions

In response, NASDAQ halted just about all small-cap IPOs with a connection to China. The response was significant volatility in the IPO market for all companies involved in China, largely mirroring what happened during the 1980s and 1990s. While large upswings create opportunities for business investment, the risk profile can be a lot for businesses to handle.

Even though the decision to halt IPOs on small Chinese companies has come as a surprise to certain investors and companies that seek to go public, there was a significant surge in the share prices of Chinese companies that raise relatively small amounts of money. The market volatility has impacted companies that usually raised approximately 50 million dollars in less during their IPOs.

On the NASDAQ, there were a few companies that saw their share prices rise as much as 2,000 percent shortly after the IPO, only to see those share prices fall back to Earth quickly. Investors who are brave enough to trade penny stocks have lost a significant amount of money in just a few days, forcing the NASDAQ to halt IPOs of small Chinese companies until they figure out what the cause of the aberrant pattern is.

What Is The Cause of the Aberrant Trading Pattern?

According to an executive securities attorney, NASDAQ has informed that certain IPOs will not be allowed to move forward “until they determine what has been the aberrational trading activity in certain Chinese issuers earlier this year.” It is unclear what action NASDAQ is going to take after its probe has been completed. Even though some IPOs might be allowed to continue, there are others that might not be allowed to move forward at all.

Thus far, NASDAQ has not commented on the investigation, but there are several executives who work on the IPOs of small Chinese companies that have indicated that the fleeting stock rallies have been caused by a few overseas investors that have done an exceptional job of concealing their identities. They believe that these overseas investors have snapped up a lot of the shares in the offerings, creating a perception that the companies were in very high demand.

Then, after they saw the share price rise meteorically, they would quickly dump all of the shares to capitalize on their profits. This could be seen as similar to a “pump and dump” scheme. During the past year, Chinese IPOs have returned a total of 426 percent on their first day of trading, compared to just 68 percent on all other types of IPOs .

Can Pump and Dump Schemes Be Prosecuted?

If the SEC can prove that a pump-and-dump scheme is taking place, it can partner with other financial regulators in the United States to announce formal charges and prosecute them accordingly. Thus far, pump and dump schemes involving these companies have not been prosecuted because overseas bankers and investors have been carrying the mountain secret. Furthermore, if these investors are not located in the United States, it could make prosecuting them a bit more difficult. After the investigation conducted by NASDAQ is completed, further action could be taken.

Exchanges Take Small Steps Toward Reopening Business

Much of the turbulence stemmed from market uncertainty, and the NASDAQ regulators had to find answers to questions that investors, members, and company executives were asking. Many of these questions had to do with lock-up agreements, the locations of all participants involved, and the allocation of resources. In the meantime, companies that did not have any operations or major investors in China were allowed to move forward.

The NASDAQ began digging deeper into small-cap companies looking for an IPO. Companies are required to submit information related to pre-pricing indications of interest as well as potential syndicate members. Investment banks are required to provide a list of syndicate members before shares are allocated during an IPO. If NASDAQ sees Asia-based members, they might ask more questions before allowing an IPO to move forward. During the past year, the NASDAQ stock market has largely halted listings of small-cap Chinese companies, delaying approval letters while demanding more information related to the parties involved in various deals. This type of uncertainty has contributed to massive anticipation followed by significant collapses.

Filing an 8-A

During a typical IPO process, a company will be required to file an 8-A, which will register it with a national Securities Exchange, such as the NASDAQ. Then, the NASDAQ will accept the certification, and the SEC will declare the IPO registration effective shortly thereafter.

The 8-A will not be effective until the application is approved by both the NASDAQ and the SEC. Neither the company nor the underwriter wants an IPO registration statement to become effective until after it has been approved to trade on the NASDAQ. Now, some companies have been required to have the SEC declare the IPO registration statement effective before the NASDAQ grants its approval. Some companies might be subject to SEC reporting requirements before being allowed to trade on the exchange, as a result of this shift.

As a result, companies that have relationships with China might be required to fill out this form and register with the SEC before their IPOs have been officially approved. This could result in companies sharing certain information with the public without knowing if they will even need to make a public offering. This shift could have a major impact on companies that fill out Form 8-A and have a relationship with China.

Due Diligence Is More Important Than Ever Before

Even though the NASDAQ has allowed some small-cap Chinese companies to resume their applications, due diligence is more important than ever before. There is an increased amount of scrutiny on companies that have close connections to China, and every investor is likely to be scrutinized by the SEC and NASDAQ Stock Exchange, so you must put your application in the best position possible to be successful. At Colonial Stock Transfer, it would be our pleasure to help you with your IPO. Contact us today to speak to a member of our team.

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