The China Hustle Page #3

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but more importantly,

it was the first time

anyone had poked a hole

in the Chinese miracle.

I sent it out into the ether

in late June of 2010.

I stayed up for a little bit

to watch it close,

and going into the close,

it just moved down a little bit.

And so as I went to sleep,

I wondered whether that was

a reaction to the report.

Well, the next day

answered the question

down 25 percent.

And it ended up trading down

as much as 55 percent

from where

we had put out the report.

Even though it's China

and it's a fast-growing economy,

pigs do not fly in China,

and I think that...

There's a proverb in Chinese,

"Muddy waters makes it

easy to catch fish."

(speaking Mandarin)

Yeah, so it means water.

In clear water, there is no fish.

Huh.

That saying,

"Muddy waters makes it easy

to catch fish,"

explains so much

about what goes on

in China.

Opacity creates opportunities

for people to make money.

That's China's view,

muddy waters.

I thought that

that was a very apropos name

for the firm and chose it.

The "Muddy Waters Report"

was the first major claim

against a Chinese company,

and it began to resonate

throughout the industry

nowhere more so

than at Roth Capital,

who'd engineered the deal.

Target price,

less than a dollar.

You have pictures

of dirty factories.

You have pictures

of recycled paper on the ground.

You have people climbing...

pictures.

This is a $150-million company.

It's pretty crazy though.

I had sold

over $22 million of that deal.

I remember

going into Byron's office,

asking, "What's going on here?"

What was "going on"

was that the company

had deployed a classic move

in the reverse-merger playbook:

get a stamp of approval

from a trusted source.

Deloitte and Touche

had come out

with an independent

investigation saying

that the company was

accurately telling

about its financial statements.

In the mortgage crisis,

banks used rating agencies

to disguise

crappy mortgage bonds.

Now Orient Paper was using

an even more

recognizable cover

one of the Big Four

global audit firms.

Every day,

all around the world,

Deloitte professionals are

making an impact that matters...

It turns out that dozens

of Chinese reverse mergers

used the same trick

hiding shady financials

behind audits

from the Big Four.

It was like handing investors

a shiny, thin file

- stamped, "Trust me."

Because when it comes

to living our purpose,

it all starts with integrity.

Whether it's Deloitte

or PwC,

they expect these brands

to have significant value

wherever they are in the world,

but in actuality,

the way these partnerships

are structured

is that each office

is its own entity.

So they were able

to dollarize

renting their name out,

effectively.

All they hoped was that

this company didn't collapse.

Many of these companies

would say, "Well, look.

We're being audited

by Pricewaterhouse."

No, they're not.

They're being audited

by Pricewaterhouse China,

which is like a franchise.

It's not really

Pricewaterhouse.

In the United States,

whenever we've had

a massive fraud--

that we've been short

people always ask me,

"Well, who were the auditors?"

And I always say,

"Who cares?"

It's important to understand,

and most people

don't know this,

that the financial statements

are prepared by management,

not by the auditors.

Auditor's job is to simply

review management's work.

And if management is trying

to hide something

or has co-opted the auditors,

they will hide it.

If hiding it doesn't work,

they opt for plan B.

hire a good lawyer.

Orient Paper brought in

Mitch Nussbaum of Loeb & Loeb

to respond

to Muddy Waters' allegations.

Mitch had helped bring dozens

of Chinese companies to market,

and he knew how to fight back.

You have short sellers who--

who go ahead

and put a short position

on the company

and then throw all sorts

of allegations against them...

Nussbaum's firm

led an investigation.

His unsurprising conclusion

was that Carson's allegations

were false

and that his report

amounted to slander.

How-- do I know what anybody's

telling me is true?

- That's a huge problem.

- It's a huge problem.

All right,

Let's talk about

a case where you did a type

of forensic investigation--

- um hmm.

- Orient Paper.

I wouldn't be prepared

in these circumstances

to discuss or present any more

or additional information

than what we disclosed publicly,

because that wouldn't be,

you know, appropriate.

The Chinese businesses

were a huge profit center

for Loeb & Loeb,

but I imagined

that the company's

often-shoddy paperwork

posed a problem for Nussbaum

and his colleagues.

I wondered how just how much

diligence they had to do

to satisfy regulators.

Forget about the lawyer.

Forget about the banker.

The banker doesn't go

into the books

and records of the company.

The lawyers don't go

into the books

and records of the companies.

We don't go check

to see whether

the shipments were received.

You know, we don't go visit

the customers' homes.

I mean, no law firm does this.

No law firm does this.

This is the part of the story

where I had to do

a double take.

All of the people who

we think of as gatekeepers,

the lawyers,

the bankers, the auditors,

the people making good money

to ensure that

the markets are clean,

weren't doing

anything of the sort.

They simply processed

the necessary paperwork,

took their fees, and moved on.

If the companies were lying,

so what?

The answers

that I was receiving

was insufficient

to thwart my concerns.

And I didn't feel they were

thorough enough

answers to questions.

And that's when

everything significantly

changed for me.

My eyes were open

to this concept

that there was another side

to this company.

I knew what my job was.

I knew what I couldn't do

if I was sitting

in that seat still.

So for me, it was... quit,

go take a break,

and see what happens.

I went on safari.

I'm at a Rodman & Renshaw

conference,

and a firm by the name

of Muddy Waters

puts out a report

on Orient Paper,

and it goes down significantly.

And this is the first time

that we're actually hearing

somebody's publishing a report

and calling it fraud.

We decided that

we were either good

at what we do

or we were lucky,

and if we were lucky,

we were about

to go out of business.

I'm trying to reach

either the general manager

or the property manager...

So we hired our own team.

And our own team went to China

to vet some of these companies

that were accused of fraud.

Let's talk about

China Green Agriculture.

China Green Agriculture

came to our attention

originally in 2009.

And we invested long

into what we thought was

a great fertilizer company.

Their stock was pumping.

Press releases were coming out

about deals they were making

with Nestl and whoever else.

Dan calculated that

in order to fulfil these contracts,

dozens of trucks

would have to be loading

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