The Microcap Speculator

UPDATED 10/1/2007: The SEC has issued a 10-day trading suspension for China Expert Technology:

The Securities and Exchange Commission announced the temporary suspension, pursuant to Section 12(k) of the Securities Exchange Act of 1934 (the “Exchange Act”), of trading of the securities of China Expert Technology, Inc. (“China Expert”), of Shenzen, People’s Republic of China, at 9:30 a.m. on October 1, 2007, and terminating at 11:59
p.m. on October 12, 2007.

The Commission temporarily suspended trading in the securities of China Expert because of questions that have been raised about the accuracy and adequacy of publicly-disseminated information concerning, among other things, China Expert’s: (1) financial performance and business prospects and (2) current financial condition.
The Commission cautions brokers, dealers, shareholders, and prospective purchasers that they should carefully consider the foregoing information along with all other currently available information and any information subsequently issued by the company.

Further, brokers and dealers should be alert to the fact that, pursuant to Rule 15c2-11 under the Exchange Act, at the termination of the trading suspension, no quotation may be entered unless and until they have strictly complied with all of the provisions of the rule. If any broker or dealer has any questions as to whether or not it has complied with the rule, it should not enter any quotation but immediately contact the staff in the Division of Market Regulation, Office of Interpretation and Guidance, at (202) 551-5760. If any broker or dealer is uncertain as to what is required by Rule 15c2-11, it should refrain from entering quotations relating to China Expert’s securities until such time as it has familiarized itself with the rule and is certain that all of its provisions have been met. If any broker or dealer enters any quotation which is in violation of the rule, the Commission will consider the need for prompt enforcement action.

If any broker, dealer or other person has any information which may relate to this matter, they should contact the New York Regional Office of the Securities and Exchange Commission at 212-336-1100.

UPDATED TAKE: Technically these suspensions are only for ten trading days, but in my experience they generally last much longer and in many cases, shares don’t resume trading. I consider the small speculative position I reentered earlier last week to be a complete loss. This is the third time I have been through this situation, twice on the short side and now this on the long side. Let me tell you, it is much more pleasant to be short going into a suspension.

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China Expert Technology (CXTI.PK) shares rebounded sharply today after the company broke its long silence with this 8-K filing. In it, the company asserts:

1. that it fired BDO on August 17, 2007 (note this is opposite from the internet reports circulating stating that BDO resigned).

2. that there were no “reportable events described under Item 304(a)(1)(v) of Regulation S-K.”

3. that there were “no disagreements with BDO on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of BDO would have caused BDO to make reference to the subject matter of the disagreements in their report on the financial statements for such periods.”

The biggest surprise? BDO actually agreed with all of these statements:

EX-16 2 exh161.htm LETTER FROM BDO MCCABE LO LIMITED

September 20, 2007

Securities and Exchange Commission

100F Street N.E.

Washington DC 20549

USA

Dear Sir/Madam,

We have been furnished with a copy of the response to Item 4.01 of Form 8-K for the event that occurred on August 17, 2007, to be filed by our former client, China Expert Technology Inc. We agree with the statements made in response to that Item insofar as they relate to our Firm.

Yours faithfully,

BDO McCABE LO LIMITED

My take: This is a positive step and given the magnitude of the decline, the bounce may have further to go. However, the long-term path for CXTI is no more clear today than yesterday. It all depends upon whether the company’s business and contracts exist, if they are profitable, and if CXTI can restore investor confidence. At this point I still consider it a long shot, but it is awfully fun to trade.

DISCLOSURE: Long CXTI.PK.

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Only months ago, I thought that China Expert Technology: CXTIE.OB had bright prospects. The Chinese e-government service provider had announced a series of large contracts and appeared poised for a profitable year. After CFO Simon Fu resigned, shares took a huge tumble. Sensing a bargain, I dipped my toe in the water. I was encouraged initially by CEO Huang (Michael) Tao’s press conference, which appeared to be forthcoming. That was then.

Now Tao and the rest of the CXTI gang have ceased communications with the investor community and are delinquent in their SEC filings. They had to promote an insider to the CFO position, perhaps an indication that no qualified outside candidate would accept. Major holder JLF Asset Management has slashed its holdings.

I know from your emails that many of you view this as an asymmetrical bet. Here’s your hypothesis: at current prices, it can only go down $0.68, but any good news or even a cessation of selling could lift shares much more than that. I agree, but here’s the rub: as time goes on it becomes less and less likely that this turns out well.

A few random thoughts to consider:

1. History rhymes. Yes, I realize that approximately two years ago, CXTI plunged to well under $1, only to recover and eventually move to fresh highs. But there are critical differences. That drop only lasted a few days and did not have nearly the volume of this one. Moreover, the prior drop in my view was caused by the overhang of a toxic convertible offering. This one is a different animal, propelled by fears that the entire company could be a hoax.
2. JLF, JLF, JLF. Many readers believe that this was prompted by a margin call at major holder JLF Asset Management. After a little research, this theory appears to be wishful thinking. Last week, JLF had around 4.5M shares. At $2, that is less than a $10M position for a fund with holdings last reported at $674M. Other theories posit that JLF learned inside information from former CFO Simon Fu, who has since taken a position with HollySys (to be acquired by another JLF holding, Chardan North China Acquisition Corp. ). I have my doubts. Selling on inside information would obviously expose JLF to enormous legal liability. At the same time, I don’t think that JLF would allow Fu to take the helm at HollySys if it believed that he operated a hoax on them. JLF now owns exactly 5% of outstanding CXTI shares, after selling over 2.6M shares on 9/10/07.
3. The Contracts. Blogger Cabeza Howe, who is fluent in Mandarin and appears to be very balanced in his views, was unable to confirm the existence of any of five contracts he investigated. Note that most of these contracts are attached to SEC filings. Is it possible that they were made up out of whole cloth?
4. BDO McCabe Lo. CXTI’s auditor that signed off on the last 10-K was the asian arm of respected BDO Seidman. The 3rd Standard for Field Work under Generally Accepted Auditing Standards (GAAS) requires auditors to confirm the reliability of financials with “sufficient competent evidential matter” to be obtained through “inspection, observation, inquiries and confirmation.” It seems to this layman that BDO would have had to confirm at least some of the contracts and operations, but I have no idea whether or not this occurred.
5. The Website. http://tech.chinaexpertnet.com. Its a joke, which would be a problem in any case but is worse here because CXTI is supposed to be a technology services company. Also, IR company Hayden Communications resigned due to its inability to communicate with the company.

All of these facts point to two possible scenarios: (1) the company and contracts really exist but the company has decided to cease communications with investors, perhaps to conceal fraud raised when Fu resigned, or (2) the whole thing was a hoax. The only certainties are that CXTI will not go lower than zero, and that it will soon be trading on the pink sheets. A bounce is likely here, but a return to its prior trading range is not.

DISCLOSURE: Long CXTIE.OB (a small but regrettable position).

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Its official — China Expert Technology has blown its extended deadline to file its quarterly report with the SEC, so the ticker has changed to: CXTIE.OB. On August 17, I wrote that if the company blew the deadline, “we could see $2.50 again.” I still think that is in play, and it could even go lower if the situation drags on.

Investors need to weigh two possibilities. On the one hand, the filing could be delayed only by the transition in the CFO post. That’s the benign scenario, but it still does raise concerns about management credibility. After all, Tao told us in the conference call that financials would be filed on time, and then in an SEC filing stated that the company expected to have the filing completed within the 5-day extension. The other possibility is that the filing is held up by accounting problems, which would also explain Simon Fu’s departure.

Bottom line: China Expert’s failure to file is disappointing, regardless of the reason. I expect that this will take a while to sort out, and until it does, shares will continue to fall. That said, I do still have a small long position that I will trade around.

DISCLOSURE: Long CXTI.OB CXTIE.OB.

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China Expert Technology: CXTI.OB filed an 8-K today announcing that it has elevated the controller of a major subsidiary to the CFO post recently vacated by Simon Fu:

On August 15, 2007, the Registrant appointed Qiyou Li (Jeff), age 38, as Chief Financial Officer. His appointment as Chief Financial Officer was appointed by the board of directors, and is pursuant to a written employment agreement containing basic terms of employment.
* * * *
Biographical Information. Qiyou Li (Jeff) was appointed as CFO of the Registrant on August 15, 2007. From September 2005, to the present, Mr.Li has been the financial controller of Expert Network (Shenzhen) Co. Ltd., the Registrant’s wholly owned subsidiary, and was responsible for all financial, accounting and internal auditing. From October 1999 through September 2005, Mr. Li was the financial manager of ZhongQi Power Technology Company, where he was responsible for the establishing and maintaining the budget for the headquarters and for seven subsidiaries. Mr. Li holds a Bachelor degree from University of Jiangxi Finance and Economics.

If the company reports within the 5-day period allotted under its automatic extension, and if there are no surprises, I expect that shares will appreciate considerably. If not, we could see $2.50 again.

DISCLOSURE: Long CXTI.OB.

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