Meet the Man Who Exposed a $300 Million Chinese Fraud

By Ned Kelly, July 8, 2023

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Throwback Thursday is when we trawl through the That's archives for a work of dazzling genius written at some point in our past. We then republish it. On a Thursday.

An American in his late 20s, Daniel Smith* was working for a boutique investment bank when he met a hedge fund manager through friends. They developed a rapport, and the manager soon offered Smith a position as his man in China, working as the on-the-ground investment manager for the fund.

It seemed an exciting career move, but Smith soon found himself out of his depth when he came face-to-face with a case of large-scale fraud.

“I don’t really want to say what the company did, as people will be able to check this back; let’s just say they were a NASDAQ-listed company with a market value of USD300 million, and they were doing a public offering of USD30 million.”

Smith’s fund had already invested and Smith had checked them out, calling their top 10 customers, verifying that they were real, that their contracts with the company were real and even finding a third party to corroborate it all. 

“On paper they looked fantastic and everything made sense.”

After months working with the chairman of the company though, Smith said he started to suspect something was fishy. 

“So I flew to the city where they were based. The actual plant was two hours out of the city, and they claimed the majority of production was done at nighttime, when electricity rates were low, so for four nights I slept outside it in a car. The plant was closed every night.” 

On the fourth night two security guards came up to the car and asked he and his driver what they were doing. Smith had a hoodie on and a baseball cap pulled down to hide the fact he was white, but they started banging on the window. His driver got spooked and drove off.

“Sleep deprived and at my wits end, I went back to the city, called the chairman of the company and said, ‘Hey I’m just in town for a surprise visit because I’m starting to worry about whether or not you guys are real.’”

The chairman laughed off his concerns, assured him there was nothing to worry about, asked him where he was staying and offered to pick him up in 20 minutes. 

“Sure enough, he was there in 20 minutes and drove straight out to the factory, so it was two hours and 20 minutes from the time I called to the time I got back to the factory.

"The fact that the local politicians were all involved in the fraud; it quickly scares you when you don’t know where it stops and where it begins."

“They already had it lined up with 20 trucks outside, 60 employees inside working in the factory, all the lights on and everything going. I’m guessing there were a few guys in on it from a high level, and everyone else was cousins, brothers or farmhands that they had roused from their beds.

“So I’m just walking around this place and it is just the most bizarre feeling, because you know all these guys have been told ‘Here’s a few hundred kuai, just put on this lab coat, move this widget around and act normal.’ And you have to go along with this charade for an hour.”

Once the show was over he was dropped back at the hotel. He called his private driver. 

“They had no idea I knew where the factory was because it is a very sketchy area with no road signs, but I still went to a bar first to make sure I wasn’t being tailed.”

Once satisfied he wasn’t being followed, he drove back to the factory. 

“It was completely shut down. The lights were off. It was done.”

He flew back to Shanghai and called his fund manager, who pulled his money out of the company and began telling other people. As the information was disseminated, USD150 million vanished on paper in a matter of weeks. 

“That pretty much broke that fund. They didn’t lose money on it, they got out okay, but their reputation was just shot. It was a very impressive and very elaborate hoax.”

It wasn’t just the hoaxers who made money on the deal though. “There are all these short sellers out there,” explains Smith. “It has become like a cottage industry: finding these sketchy companies, researching them, getting their short position and then releasing a report. 

“That, as well, attracts a very shady individual, because you have this information that is public, but not well disseminated. So it is a very fine line between manipulating the stock.”

Smith stayed in the game, but a second fraud was too much for him. 

“A Chinese company had a domestic shareholder selling their stake in the company. To cut a long story short, in China they were reporting profits and earnings that were less than half what these guys were reporting in the States.

“Basically, I called the Chinese auditor and the American auditor, and the Chinese auditor confirmed they were quoting these low numbers, and the American auditor confirmed they were quoting these high numbers. I collected all this basic evidence and facts and put it out on some financial blogs using a pseudonym.”

Within two hours, and before it had even been picked up by Yahoo News, the pseudonym email address had three emails from lawyers, each one more threatening than the last. 

“Nothing came of it, but the first 24 hours was a very, very tense time. The stock went down 25-30%, and will be in the doldrums forever because they were a sketchy company and never offered a proper explanation.”

When Smith started relating his experiences to friends and acquaintances, he began asking serious questions about his line of work. 

“More and more people I spoke to said it was a silly thing to be in because you never know who is behind these frauds, what kind of people they are, until it’s too late. So that was the last straw for me in terms of international investment in China. I was dying from it. That was a very stressful time.”

It is the first fraud that still lives with Smith. “The weirdest part is I had developed a very tight relationship with the chairman of the company. I had his cell phone number; I could call him 24 hours a day, seven days a week. I’d traveled around the States with him before. I’d done a lot of work with these guys.

“When I look back on it now, I don’t think they were trying to completely 100% be a fraud. I think they realized they could get all this money right now and grow into the numbers they were reporting. That’s the only way I can justify someone being that… horrible; to spend as much time developing the rapport and relationship that we did, and then be on completely conflicting sides.”

He is also overwhelmed by the scale of it all.

“There was clearly one or two ringleaders, but the supporting cast, in order to set up this whole thing, is what really blew my mind. And I’ll never get the proper closure I would have liked.” There were two bankers in New York, of one Smith says, “I always wonder: ‘Was he on the inside, or was he on my side?’

“It very quickly gets into a cloak and dagger thing of who knew and who didn’t. The fact that the local politicians were all involved as well; it quickly just scares you when you don’t know where it stops and where it begins. At that point you walk away. I’m not going to get that much extra peace of mind knowing ‘He was a good guy, he was a bad guy.’

“That was the most rattling part of the whole thing. Losing faith in mankind.”

That statement seems to ring true for Smith across the board. “I was always very cautious about hitching my wagon to one of these sleaze balls bringing Chinese companies to the Western market. None of these guys have created the companies themselves so they’re just trying to get a piece of the action.

“There isn’t really anybody who I would say was noble in this area. There are just a lot of vultures.”

“The whole thing is really scummy. These Chinese companies are not supposed to be listed abroad, so it is not properly regulated. You have all these investment bankers and lawyers telling you what is accepted practice. But there is no law backing it. So that by nature creates a cowboy mentality. 

“Coming in with best intentions, you need someone to guide you through these things. But when you’re on the forefront of something there isn’t necessarily an experienced person and it is very tough to get the guidance you need.”

“There were times when I was at conferences realizing there isn’t really anybody who I would say was noble in this area. There are just a lot of vultures. I spent so much time and effort learning Chinese and paying my dues here. I wanted something more long-term and more sustainable.”

Smith has taken a step back; working as an analyst for a consulting company that advises big funds where to invest. He has no foreseeable plans to return to front-line action. “The whole sector right now in my mind is just disgusting. It’s tainted. And it definitely took years off my life."

* Name has been changed to protect identity

This article first appeared in the January 2012 issue of That's Shanghai. To see more Throwback Thursday posts, click here.

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