‘China Hustle’ Warns Next Big Crisis Born in Reverse-Merger Mud


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Jed Rothstein’s involvement in the project that would become “The China Hustle” began in May 2015 when the filmmaker was introduced to short-selling dynamo Dan David, co-founder of GeoInvesting LLC.

Over appetizers and Bulleit bourbon on the rocks at the TGI Fridays in Manhattan’s Penn Station, David laid out a tale about questionable Chinese companies listing in the U.S. that left Rothstein amazed.

“He started telling me this story that really was kind of blowing my mind about this big financial scandal that started right after the last financial scandal and that nobody knew about,” Rothstein said by phone this week from New York.

Such was the genesis of the documentary that’s set to premiere Friday at the Toronto International Film Festival. “The China Hustle,” backed by 2929 Entertainment — the holding company co-founded by billionaire Mark Cuban — is a sort of historical autopsy. How did a small group of investors uncover widespread fraud when regulators and auditors didn’t?

The tale will be familiar to anyone who lived through the 2008 financial crisis or read accounts of its buildup and explosion in books like Michael Lewis’s “The Big Short: Inside the Doomsday Machine.”

As David points out in the film, after 2008 the U.S. “had a real chance to institute regulations that would have helped us catch up with the global markets,” Rothstein said. “And we missed it.”

Seeds Planted

The seeds for a subsequent crisis were sown in a wave of Chinese reverse-mergers on U.S. exchanges in the decade after 2000, Rothstein says.

David was among the many retail investors who bought shares of these Chinese stocks after the financial crisis ravaged portfolios, seeking quick gains from a rebound. Buying U.S.-listed Chinese companies helped David net a 229 percent return in 2009, he says.

Investors wanted to tap the world’s second-largest economy and the foreign firms were seeking cash. Between 2000 and 2011, about 450 Chinese companies listed on U.S. stock exchanges, according to research from the Singapore Management University. By purchasing shell companies and keeping the listing, they could bypass the rigors of an initial public offering.

Amid the hype in 2010, Muddy Waters Capital, a little known research firm at the time, released a report on Orient Paper Inc. It accused the Hebei province-based papermaker of overstating 2009 revenue by 40 times. Despite denying the claims, the company dropped 40 percent in the four days after the report went out. A later audit cleared Orient Paper of wrongdoing. A spokesman for Orient Paper didn’t have an immediate comment.

Filing Mismatch

David says that incident initially raised his suspicions about U.S.-listed Chinese companies.

He also sensed something was off when, in the span of five minutes at a conference in Miami, two Chinese companies with nearly identical names each claimed to hold the only online education license in the country. Each called the other a fraud. David heard rumblings of issues at other companies he bought into, so he began learning Mandarin and hired a lawyer in China to pull state financial filings for 30 of them. They put the papers side-by-side with documents filed to the Securities Exchange Commission and were shocked.

“None of them matched the SEC filings — nothing matched up,” David said in a phone interview this week. “Nobody knew what these local filings were at the time. But they were public. You paid $100 and could see them.”

Since 2010, when research firms including GeoInvesting began publishing claims of fraud against some of these companies, there was immediate fallout: the SEC deregistered dozens of China-based issuers, sued several others, and some were slapped with class action lawsuits or simply filed for bankruptcy.

Nothing’s Changed

AgFeed Industries Inc., which the SEC alleged had fabricated earnings from 2008 to 2011, went bankrupt in July 2013, followed by the announcement of a $7 million proposed settlement for shareholders of a class-action lawsuit. China MediaExpress Holdings Inc.’s chief executive officer was fined $17.7 million for allegedly misleading investors by overstating the firm’s finances. Both have been delisted.

In 2012 another company, Chinese timber grower Sino-Forest Corp., based in Hong Kong and Canada, filed for bankruptcy protection about a year after Carson Block’s Muddy Waters published a report accusing it of overstating earnings.

Rothstein says despite the regulatory actions, nothing fundamentally has changed.

“The biggest takeaway: Chinese executives could lie to the SEC, could lie to U.S. markets with no consequence,” Rothstein said. “In this Chinese reverse-merger scandal, $50 billion was stolen. Mostly by these Chinese executives but also by their enablers in the U.S. — the lawyers, banks, promoters — all of whom got away scot-free.”

Trump Era

A spokesman for the SEC declined to comment.

At least 100 Chinese-owned firms worth $1 trillion are still using fraudulent financial statements and are still listed in the U.S., David says, declining to name them.

“This wave of Chinese reverse-mergers was just the appetizer,” Rothstein said. “They were smaller, old-line companies that were easier to ferret out. Now, you’re talking about much bigger, much more sophisticated companies that are much harder to unpack, and to examine, audit and to even figure out what the numbers mean.”

Rothstein isn’t hopeful the current administration will deal with the issues his film identifies.

“The general trend that we have now in the U.S. with the current administration is to remove regulations,” Rothstein said. President Donald Trump is “trying to reverse and remove accountability and regulation and the types of rules that would help ensure more transparency.”

— With assistance by Benjamin Robertson, and Dune Lawrence


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