Tiger Woman on Wall Stree (16 page)

Those who are single and working on Wall Street and who don’t want to spend the holidays alone have two standard choices: going to glamorous beach parties at St. Barth’s in the Caribbean or skiing in Aspen, Colorado. It had not taken long for word to get out that I was single again, but as I watched my e-mail inbox fill up with invitations to these two predictable destinations, I wasn’t even motivated enough to open the messages and respond.

Rather, I wanted to be close to my family. Strangely enough, I needed to be with my father, to absorb a little of his strength.

I called Peter, my old friend from the education industry, to tell him that I was considering returning to Shanghai for the holidays. “Why don’t we schedule a bunch of meetings for you around the holidays?” was his reply. “That way you can get some research done.” I thought it was a great idea. I hung up and booked a last-minute trip to the place of my birth.

I wanted to see with my own eyes what was lying beneath all that fog and, I hoped, allay my doubts about the corporate governance and integrity of Chinese companies. Exploring a new investment frontier—and being among the people who knew me best—would almost certainly be preferable to facing the holidays as a newly divorced woman in New York City.

Stepping into the lobby of the Four Seasons, not long after I deplaned from my 15-hour flight to China, I was flooded with a sense of familiarity. The decor was just as luxurious as the hotel’s Manhattan branch, with its silken table settings and crystal chandeliers. But the quiet New York sophistication was absent; the vast marble space was a hive of activity. At every table, a transaction was taking place. The crackling energy of the space evoked a sense of excitement and growing prosperity that was lacking on Wall Street.

There could be no doubt that this was China. The raucous hustle and bustle of businesspeople cutting deals was wreathed with the pungent odor of stale cigarette smoke. The coal bosses from the provinces and the flush local financiers yelled out to one another, oblivious to all the refinement around them, their jarring countryside accents drowning out their neighbors’ conversations. An army of waitstaff stood ready to respond to the shouts
of “
fuwuyuan
!” (“waiter!”) from customers across the dining area. This was a new frontier, the Wild East, a place where rags-to-riches stories were unfolding before my eyes.

I was there to meet a friend, Robert, who had moved to Shanghai from New York a few years ago to join the private equity gold rush. I surveyed the room while I waited for him, and then I spotted a familiar face: Nick, a former investment banker and Ivy League graduate, now one of millions of unemployed casualties of the 2008 financial crisis.

“Nick! What are you doing here?” I asked after a quick embrace.

He was on his way to discuss one of the deals that was gestating around me. He briefed me on his latest venture: a boutique advisory shop targeting rural private businesses that needed cash to expand.

Nick’s business model was to hire local analysts to scout out private enterprises far from China’s booming coastal areas. These local hires, who work at one-tenth the salary of a comparable Wall Street position, would find private businesses operating in obscure locations, most of which had limited operating histories, no earnings, and no hard assets for collateral. Nick’s trick was to convince these provincial company managers, many of whom didn’t even need financing, that he could merge their businesses into an already publicly listed shell, therefore bypassing the usual stringent IPO regulations.

This was the model for the now-infamous reverse-merger deal, a loophole that gave companies a back door onto America’s normally well-guarded stock exchanges. An advisory firm like Nick’s would match a company seeking to list with a defunct shell company that still retained its ticker symbol. The first company would merge with the second, effectively going public while bypassing the SEC’s strict auditing and disclosure requirements for IPOs.

Some legitimate companies did go public this way, such as Blockbuster Entertainment and Berkshire Hathaway. But many
of the entities that listed through a reverse merger were evading SEC oversight for a reason. These firms were often too immature or poorly performing to attract investors—otherwise they would have chosen the standard listing route. Reverse mergers helped sneak hundreds of sketchy companies onto U.S. exchanges, including many Chinese firms that would not have passed muster for a traditional IPO. Between January 2007 and April 2010, a total of 159 Chinese companies took this back door onto U.S. securities markets—nearly three times the number of Chinese companies that conducted
traditional IPOs
.

It didn’t take companies like Nick’s long to exhaust the low-hanging fruit. As the China gold rush continued, banks began hunting down companies—IPO ready or not, with real earnings or not—to conduct reverse mergers. A few boutique investment banks in New York and California handled many of the reverse-merger deals. They sent employees to China’s hinterlands to seek out new candidates, packaged them with promotional materials, and sent them down the assembly line to investors. Bankers weren’t picky—there was too little meat and many mouths to feed. Likewise, many investors didn’t know or care about the real quality of China-based companies.

They should have been more concerned. Some of these banks courted their Chinese clients by promising to use a light touch when doing due diligence. Investment banks are charged with verifying a company’s financials before an IPO. But some American bankers sold Chinese executives by pledging not to contact their banks to check their cash positions—in other words, giving them a green light for fraud.

Reverse-merger production lines boomed, and Nick, ever the stellar salesman, became quite popular in China’s business arena. Maybe even a little
too
popular—in less than six months after our encounter in Shanghai, both he and some of his clients would become targets of an ongoing investigation by the SEC.

By the end of 2010, fraud and serious accounting issues were being uncovered everywhere at Chinese firms, with the help of a group of independent research firms that began digging up dirt on fraudulent Chinese companies for their hedge fund clients.

Chief among these research firms was Muddy Waters, an outfit led by a former lawyer named Carson Block. Block drew the name of his company from an old Chinese proverb: “Muddy waters make it easy to catch fish.” According to Block, the opacity of China’s business environment had made it a breeding ground for committing fraud, cutting corners, and gaming the system. Block and his counterparts plunged into these murky waters and started catching fish.

His methods were simple and effective: Block would identify a target and dig in. His researchers spent months tracking down and interviewing insiders and delving into corporate structures. They would even travel to remote locations in China to videotape empty factories or count acres of farmland. Block’s reports did not just tell their reader about fraud; they demonstrated it step-by-step with pictures, data, and insider information.

By September 2012, exposés by Muddy Waters and other firms had forced the auditors of 67 Chinese companies to resign. And 126 Chinese companies had either been delisted or had “gone dark,” meaning they were
no longer filing with the SEC
.

Those results shouldn’t have been that surprising. Many of these reverse-merger companies were low-end manufacturers or commodity companies in China’s hinterlands. The management at these companies left a lot to be desired; many had built their businesses off local connections, as opposed to management or finance skills. It’s unlikely that many knew enough English to say “Nasdaq” instead of “Na-si-da-ke,” the Chinese transliteration—let alone understood and respected the mechanisms of first-world capital markets and their legal requirements.

Nick hurried off to his next meeting as I continued to scan the lobby for my friend Robert, who appeared a few minutes later, apologizing profusely for his tardiness.

“You must be really busy with all those listings,” I said, as we sat down in a more discreet corner of the lobby, screened by a clump of potted bamboo.

“We had to push them out of the pipe because their four- to five-year shelf life was up,” he explained. “Some of these guys are too hickish to go public. Their businesses don’t make money, and they’re burning cash. Banks won’t lend to them because they’re not connected with the Communist Party. So we have to push them out while the market is still hot.”

Two Johnnie Walker and green teas later, he grew even more candid, confiding that one of the local sportswear merchandisers his firm invested in was in fact struggling. Sales objectives were met by channel stuffing—forcing products into retail channels so that the company could book the revenue, even though there was no customer demand for the products. The stores ended up stockpiling the goods or getting rid of them at a steep discount, sometimes by sending them back to the company or by unloading them on a gray market. In any case, the retailers rarely returned to the company for more orders, as the company’s subsequent quarterly earnings demonstrated.

I couldn’t help but think back to the IPO lunch scene at the St. Regis in New York. Nick wouldn’t have been in business if it hadn’t been for the insatiable demand for Chinese stocks. The demand came from such eager yet ill-informed American investors like Brian and those attending GET’s IPO lunch. It started to make sense to me—a lot of sense.

I began to suspect, as I met with more and more people in Shanghai, that the entire financial food chain was laced with fraudulence. U.S. investors were sitting behind Bloomberg terminals
daydreaming of striking gold but were either too lazy, too blind, or too hopeful to dig up the dirt and examine its contents. They would buy almost any stock from China, making the bankers seem like geniuses for financing the IPO.

But the real malfeasance involved the supply side—the sometimes fraudulent, sometimes immature companies that private equity partners and investment bankers churned out as IPOs. It began with the delirious demand for all stocks Chinese, which drove enterprising bankers into China’s less traveled regions in search of IPO candidates. There they found companies that were in need of capital but that also had unsophisticated management teams, limited operating histories, no earnings, and no government backing—and therefore no way to list domestically or in the United States. These companies were willing to pay the bankers’ commission because having a New York listing gave them bragging rights in China. Several reverse-merger companies confided in me that after the fees to bankers, lawyers, and stock marketers, little of the IPO proceeds were left to grow their businesses.

Private equity had a similarly suspicious role in setting up fledgling private companies for IPOs. Bankers were pursuing companies, suitable or unsuitable, to cut them a check that would allow them to get listed in the United States.

When a hot investment theme begins to feed on investor greed, ignorance, and laziness—and is further inflated by unscrupulous, opportunistic investment banks—ugly things tend to happen. The Red Party was clearly a gold mine of shorting opportunities.

Beyond that, it prompted more questions. If Chinese stocks were mostly hyped-up myths, was the larger Chinese economy also not what it seemed?

Escaping New York for Shanghai this holiday season had turned out to be another rabbit hole of due diligence, and I couldn’t resist jumping in. I had to learn more, the rank cigarette smell and coarse manners of these Chinese businesspeople notwithstanding.
I figured there was one way I could begin to find out. I called my sister and asked her to pick me up. I needed to talk to her and my dad. I needed an inside perspective—the truth about the reality of modern China.

A
S
I
WALKED OUT OF THE
F
OUR
S
EASONS, MY SISTER
, J
ASMINE
, pulled up in her brand new Mercedes—her second car. Jasmine, a marketing manager at the Shanghai office of a New Zealand dairy company, lives a typical Shanghai upper-middle-class lifestyle. She and her husband, a purchasing manager at an American multinational machinery company, take home healthy paychecks; they bought an apartment several years ago without taking out a mortgage.

Like most of her friends, Jasmine loves to drive to work, even though it means an hour’s commute each way instead of the 20 minutes it would take by subway. Rather than fight through the crowds that swarm the trains and buses at rush hour, Jasmine prefers the luxury of sitting in the car, texting on her iPhone, and eating a tuna sandwich from Starbucks for breakfast. Because of the glut of cars that has recently appeared in China’s big cities, it’s often faster to walk than drive during rush hour. For locals, however, the novelty of such luxury more than offsets the inconvenience.

Sliding into Jasmine’s front seat, I noticed a yellow tassel dangling from her rearview mirror with a Buddhist pendant promising lifelong protection. “When did you start to believe in Buddhism?” I asked.

“After having consumed enough, one desires some spiritual fulfillment,” she said. “In China, there isn’t much to believe in.”

Sitting under the dangling tassel in a new Mercedes, I couldn’t help but smirk at the hypocrisy. “Don’t Buddhists believe in minimalism?” I restrained my tone so as to not offend, but she didn’t seem to care.

“We buy fish from the wet market and release them in the river every Saturday,” she said. “Buddhism has become really popular among the upper middle class.”

The traffic in downtown Shanghai was total gridlock. We sat among shiny Buicks and BMWs at an intersection with Nanjing West Road, an ultracommercialized section of the city. Nanjing Road has long been a heavily populated, neon-lit shopping street, even when I was little. But only in the past few years have the world’s most high-end luxury retailers taken over the boulevard’s shops, turning this thoroughfare into an outlet for Shanghai’s new spending power and the city’s growing taste for ostentation.