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Shanghai's latest stock market rally has been undermined by revelations of irregularities in the use of funds by major shareholders of several listed companies.

Topsun Science and Technology's major shareholder has admitted to misusing 1.5 billion yuan (US$190 million) in company funds, just weeks after Topsun agreed to sell its cold-and-flu medicine business to German group Bayer for 1.264 billion yuan (US$159 million).

Also caught up in allegations of misuse of funds are electronics stores Gome and Kelon Electronic.

"The news has spread quickly because of increasing transparency in the market," said Sun Liang, an analyst from Guotai Jun'an Securities.

Every day from October 31 to November 3, shares in Topsun fell the largest amount allowed by the Shanghai stock market, triggering a trading suspension.

To reimburse investors, Topsun plans to sell 35.58 million shares in a subsidiary company and will raise capital by mortgaging assets including Shanxi Guang Yuyuan Chinese Medicine Co Ltd, Qianjiang Pharmaceutical Co Ltd, and some real estate on Beijing's Financial Street.

"The blind expansion of the company and a focus on Western medicine are the two main reasons for the current capital shortage," said Guo Jiaxue, Topsun chairman. Most privately owned companies in China struggle to compete in the Western pharmaceutical sector because of high costs and a shortage of capital.

Most listed pharmaceutical companies expand through acquisition and consolidation, a model pursued by the Three-Nine Group and Shanghai FOSUN Pharmaceutical (Group) Corporation Limited. "Companies should first strive to have a strong product line before making plans to expand," Sun added.

Another Chinese giant facing allegations is Gome, with its Gome Electrical Appliance Holding Ltd accused of potentially controversial inter-group transactions involving a 300 million yuan (US$38 million) property project.

Government officials are investigating Peng Run Group, a company affiliated to Gome.

Gome's chairman, Huang Guangyu, denies any wrongdoing.

In a third case, nine heads from Kelon Electronic Holdings Company Limited appeared in court yesterday, accused of wrongly declaring registered capital, falsifying financial reports, and embezzlement to the tune of 786 million yuan (US$99 million).

But Sun was confident the scandals would not cause market imbalance or threaten the current rally.
 
"The stock market will not be affected by these incidents because the companies involved do not represent over-weighted stock," he said. "Now and in the future, banks, steel and real estate companies will continue to attract plenty of investment."

(China Daily November 8, 2006)