Reverse Mergers: Americans Caught in Chinese Investment Scams

The China Hustle

Directed by Ted Rodstein (2018)

Film Review

This documentary exposes a recent scam which some 400 small Chinese companies used so-called “reverse mergers” to list their companies on the New York Stock Exchange (NYSE) – a move enabling them to attract American investors.

At preset, the Chinese government bans direct foreign investment in China’s businesses. However between 2006 and 2012, two enterprising US investment banks (Roth and Rodman and Renshaw) enlisted small Chinese companies to enter into “reverse mergers.” Locating legally registered US companies that had ceased operations, the two banks recruited Chinese companies to legally “merge” with the defunct companies. This, in turn, enabled the Chinese companies to register on Wall Street and sell shares to US investors.

A pattern emerged, in which Roth and Redman and Renshaw obtained high accreditation ratings from their auditor (Deloitte) and aggressively promoted the stocks. Then they sold their holdings just before they collapsed – reaping hundreds of millions in profits.

Becoming suspicious, Dan David, co-founder of the due diligence firm Geoinvesting, became suspicious and went to China to visit some of these companies. In every case, he found they were exponentially overstating the size and volume of their operations, as well as the revenue they generated.

He first took his findings to the investment bankers at Roth and Redman and Renshaw, then to the SEC (which is theoretically responsible for preventing this type of fraud) and finally to Senator Pat Toomey. The latter was part of the Senate committee investigating n the potential risk China posed to the US economy.

When it became obvious there was no other way to end the fraud being perpetrated on US investors, David began collapsing the share price the companies he investigated by short selling* their stocks.

In this way he ended 40 reverse merger scams by shutting down the companies.

Before the massive fraud came to public attention, public pensions funds lost more than $14 billion in reverse merger scams, with private investors losing $20-50 billion. Rodman and Renshaw was eventually forced into bankruptcy.


* Short selling involves the sale of an asset that the seller has borrowed in order to profit from a subsequent fall in that asset’s price. It commonly has the indirect effect of driving the share price down.

 

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