China Automotive Systems, Inc.: The Case for Reverse Mergers
Armstrong, Vaughn S., Gardner, Norman D., Journal of the International Academy for Case Studies
This case concerns a" reverse merger" by which a Chinese corporation obtains publicly traded status in the United States. The objective is to familiarize students with this alternative to an initial public offering, the more widely known method by which a company can become publicly traded, and to sharpen their analytical and research capabilities as they access the SEC website and EDGAR database as well as websites that provide other financial information for the answers to specific questions.
This case is appropriate for use in an advanced corporate finance class, an entrepreneurship or new business formation class, or an international finance class. Some aspects of the case may also be of interest to a business law or securities class. The case has a difficulty level of four, and should take from one to two hours of class discussion. Students will require three to four hours of preparation time.
The "reverse merger" is an alternative to the initial public offering (IPO) method of "going public." This back-door SEC registration technique is relatively common in practice, but is entirely ignored in finance textbooks as well as the academic literature.
The case considers China Automotive Systems, Inc., formed when Visions-In-Glass, Inc., a US non-operating, public "shell " company, acquires Great Genesis Holdings Limited, a closely held Hong Kong company that indirectly owns joint venture interests in mainland China. After the merger, Great Genesis stockholders own most of the stock of Visions-In-Glass, Inc., thus controlling the corporation and Visions-In-Glass retains its publicly trading status. The privately traded Hong Kong company becomes a publicly traded U.S. company.
In addition to focusing on the process of the reverse merger and the financial returns to various investor groups, this case examines how recent SEC actions may affect future reverse mergers. These actions include the suspension of trading in 26 shell companies for delinquent reporting, and the promulgation of regulations adding reporting requirements for shell companies or reverse mergers. These actions may reduce the advantages of a reverse merger in the future. Students gather information and render an opinion as to whether the China Automotive reverse merger presents evidence of a fraudulent "pump and dump" scheme, as well as whether reverse mergers remain advisable in the future. A further unique aspect of this case involves restrictions on investment and/or currency exchange that a foreign country may impose on its residents. The case demonstrates how transactions may avoid or circumvent such restrictions. Finally, the case illustrates the layering of funding common in a start-up business, and how firms use exemptions from SEC registration (for private placements and the Reg S exemption) in connection with funding.
CHINA AUTOMOTIVE SYSTEMS, INC. - THE CASE FOR REVERSE MERGERS
Visions-In-Glass, Inc. was incorporated in Delaware in June 1999 for the purpose of designing, manufacturing and marketing art stained glass with themes that memorialize the holocaust. The company had only minimal funding, $1000 from its founder and $2300 from seven other shareholders. Eight months later, the company raised an additional $6300 from 48 non-U.S. investors. Table 1 details the company's stock issues.
None of the shares issued were registered with the SEC. The initial issue relied on the section 4(2) exemption and the later shares were issued under Regulation S. To obtain publicly traded status, the company registered its common stock with the SEC in August 2001. The company wanted the stock to be listed for public trading on the over-the-counter Electronic Bulletin Board. In August 2002, Yarek Bartosz acquired the founder's 5 million shares for $ 1 00,000 and became the company's sole officer and director. At that time, the company had no assets and had never had any substantial operations. …