The China Fraud | The Acquirer's Multiple®

During his recent interview with Tobias, Maj Soueidan, President and Co-Founder at Geoinvesting discussed The China Fraud. Here’s an excerpt from the interview:

Tobias: Is it just the States? Do you look globally because you’re GeoInvesting?

Maj: Yes. When I launched Geo, the intent was to go– we’ll go everywhere and then we got caught up in China fraud and it was like– once I [unintelligible [00:23:02] that China fraud, you know what? I don’t know if I wanna go emerging market right now.

Tobias: Tell the China fraud story.

Maj: Yeah. The China fraud story is good, man. I was investing in mainly US companies and then I want to say around, I don’t know when it was maybe, but somewhere in that 2000, maybe ’04 or ’05, I started seeing some of these interesting companies trading on the OTC. There were a few that were listed, but like P/Es of 5s and 6s and crazy growth, mostly because it is OTC. So, you started seeing this, you started interviewing management, you could trust the SEC documents that you’re reading in the filings. So, I had the market eventually figured out. I understand there’s a China thing and there’s gonna be a discount to that. I was actually very long in this space. But they weren’t really moving much. In my nano-cap area, they weren’t moving much. I wasn’t really grinding it to know enough early on if there was a lot of fraud going on. But what I ever owned was just sitting there always, the violations continued to stay low.

Then what we had was, we launched Geo, I think, 2007, so basically a wonderful time to launch right before the crash, right?

Tobias: [laughs]

Maj: I was like, “Wow, this is just incredible.” All this great US stuff, all this China stuff, let’s launch Geo to bring this wonderful information to people and we’ll share it, and it’d be great. It was a free site at first, Geo was free. And I really wanted to [unintelligible [00:24:39] good ideas going and everything. They still weren’t moving much. And when 2008 hit and all the US stuff’s getting just crushed. While we’re sitting here in the US, arguing about what to do and not being able to agree on what direction to go, how to cure the economy, politics played a role, China is right there, just pumping, stimulus, giving money out, united front. And these stocks all got found, really fast. People still wanted to invest money. And they found them in these China stocks. 2009 for us was all like a big China move.

Geo was great. We had long. “Hey, we’re here championing China, it’s okay, US will come. In the meantime, invest in China.” We’re running long pieces, looking like idiots, [chuckles] a year and a half later. And then it was like, I just started going to these conferences, and start meeting these people naturally. I’m meeting these CEOs and CFOs of these companies. Something wasn’t right. They wouldn’t speak and they had a translator but you could tell the way they were answering all these questions was almost like, whatever.

Tobias: Bit cagey.

Maj: Cagey, will say yes to whatever you want. And it was getting to that point where I just kept hearing it, never any negative thing from any of the companies. And you started hearing like at one company say, “Yeah, I’m a leader in this industry.” Two doors, “I’m the leader in this industry.” [crosstalk]

Tobias: Same industry.

[laughter]

Maj: Yeah, same industry, he was a leader. But it started getting interesting. And then we start seeing some– Alfred Little, if you remember him, The Ghost. We call him The Ghost, but his name is Alfred Little, actually Jon Carnes is his name.

Tobias: I didn’t know.

Maj: Yeah. And then you had Muddy Waters come out with some stuff. We started– maybe, “Hey, we don’t think we’re wrong yet, okay? But we’re willing to at least prove the short sellers wrong., at least not be blind about it.” So, we decided to go that route and hired a PRC attorney who has actually lived in the US, but started working for us at GEO, just helping us understand the legal framework of things in China, some of the accounting, he was really well versed in financial accounting also, financial analysis. So, it was really a good thing for us.

I took place in a private placement. I was buying some paper from somebody who took place in a private and I just didn’t feel right about the way how that conversation was going. And they were such in a hurry to sell it to me. It was like $1.50 but there was so much growth coming. And that was one of the companies we actually busted later on. It was the last company really busted in China. So, it was cool.

Let’s go to 2010-ish. I think it might have been the summer of 2010. We’re still making money going long China, a lot of it. But more you know, skepticism is coming out. At this point, I had the attorney give me a letter, at least an opinion letter on corporate structure, filings in China. So, a lot of times what we were doing was we were referencing SAIC filings, which are filings in China that are filed at the provincial level. So, a Chinese company has to file– that does business in China, at every place, they do business I guess, at the provincial level, they had to file these filings. And then they aggregate them and then you have a consolidated number you can get. So, you can get these things relatively easily. Those numbers weren’t matching SEC filings, the numbers by drastic amounts.

So, of course, the management teams of these Chinese companies, the investment bankers, reputable bankers, it’s all because of gap, US gap accounting versus IFRS accounting versus China, it’s all different. It’s nebulous. How do you prove it? Most of us are actually going, “Yeah, that sounds right.” It’s in the FCC docs, auditors signed off on it, lawyers signed off on it. You got a reputable investment banker. That’s what I’m gonna believe. We’re not gonna believe these bloggers writing about it. But that went as far as, our PRC guys are like, “No, everybody else is wrong. These things do matter sometimes. And here’s when they matter.”

So, that’s how we started getting– we started trying to say, “Okay, here’s when fraud does matter. But here these things do matter.” Understanding corporate structure, VIE structures, when the filings matter, when these numbers are accurate, representations of the company, and we wrote about that, And there were still people who didn’t believe us, so okay. And then I had greatest college kid called me one time and he says, “You know, I love what Geo is doing.” This is the summer of 2010. “I’m bull on China like you guys are. I understand you’re still a little pessimist in some areas but send me to China. And let’s look at these companies.” I already had a smaller China team starting to percolate there with our PRC lawyer guy, so let’s do it.

We thought 50 companies, say, “Go do this.” And within like, five days, “They’re all frauds, get rid of them all.” He looked like a tier 20. The following few days, I went through every one of our company– we had a lot of coverage in these companies. I wrote a note, suspending all coverage on these companies that [unintelligible [00:30:41], we’re a little worried. And for every company, we went through and wrote down our concerns now with each one, it was a really laborious process. And then we said, “Okay, you know what? It can’t all be frauds.” Empty factories, cagey related party relationships, feudal between brothers, it was all this weird stuff, man. You couldn’t script it better.

So, I said like, “Let’s still do the right thing. We’re still long, guys. We’re not short sellers yet. Let’s at least not work with investor relations firms. Let’s work with investment banks. Let’s help you find the fraud. We’ll let you know what companies are fraudulent so you can drop them. We do the right thing.”

Well, when you realize that 80% of these are fraud [unintelligible [00:31:42] whole income stream, they all say yes. And then when it comes really down to it, we finally got one or two firms to say, “Yeah, you know, what, show us we’re frauds and we’ll do that.”

Tobias: But it turns into a risk for them at some stage, right? They gotta be nervous about the fact that they’ve been associated with this fraud. You wouldn’t welcome that kind of insight from somebody else.

Maj: Yeah, we hope so. But then you got behind disclosures. Never trust a fucking [unintelligible [00:32:11]

Tobias: But once you become aware of it, now you’re really on notice, now you know.

Maj: The tough decision, the SEC [unintelligible [00:32:26]. You have GeoInvesting telling you as a fraud, with all the evidence. Then, you have the CEOs showing you their evidence, like filings in China and stuff. The regulators are also in a tough situation where they can get sued. Then, I think the NASDAQ’s been sued. But I don’t think that’s why they didn’t. It’s all about fees, but there is still a fine line there.

What’s sad is that it’s just happening. We’re not 10 years removed from this whole thing, when this fraud began, and regulators still haven’t really taken that information. All the tools that we used, Muddy Waters, Citron, Geo.

Tobias: What about Kerrisdale? Did you see them in there?

Maj: Kerrisdale is great, man. Yeah, I could see them. He was one of the pioneers for this whole thing. Using the information that we all used to put together a template that the regulators say, “Here, every company that wants to come here in the US and list from China for example, here’s a checklist that auditors, lawyers have to have to follow, investment banks, before you bring the public here. For Christ sake, make sure they have their licenses to operate. The simple things. Make sure you actually have cross checked an SAIC filing with an SEC filing.” And they still aren’t doing it. Just two weeks ago or three weeks ago, I think they’re gonna pass– Congress is trying to get through some law passed now to basically and might just look at, in my opinion, to delist– if you have any ownership in your company that’s bought or controlled or ownership by a state-owned enterprise or a government entity in China, you can’t be listed here or if you don’t allow your auditors to be inspected, you’d be delisted.

Well, the reality is that auditor thing was always here. It’s been here for 10 years. Okay, so that’s not new. And then what they said in the ruling was, I think, more like, you have to attest that you don’t have any ownership interests from– [unintelligible [00:34:48] fucking why. Furthermore, it’s about like a three-year process to get these things delisted potentially. So, there’s so many more things you could put in there. Make sure [unintelligible [00:34:57], make sure they have their licenses, make sure– you’ve gone through this whole of the red flag list, make sure it has accountability by investment banks if you do bring this stuff here. All of these not gonna be any kind of incentive, it’s gonna keep it going.

Tobias: It’s hard if you’re– I admire the fact that you’re able to switch from long to short, those companies. I had a little bit of experience with them as a lawyer. We had some companies that wanted to set up operations in China, and we went and helped them do that. And it’s a very different process to the one that I was used to in the States and in Australia where it’s a lot looser, the structuring is a lot looser. There are some weird intellectual property rules where after, I think, five years that the entity owns all of the intellectual property of the parent company, which you don’t want that as a– there’s some very odd things in it.

And it was all documented and it was a much looser structure than I was used to. And so, when I became a full-time investor, when I found them as an investor, you’re conditioned as a long guy, to look at things that everybody else has sold this thing off. You still think it’s cheap and it can work and so you’re trying to look through and see like “what is it that everybody else is seeing that I’m missing?” With the China stuff, it was hard. Maybe, it’s just the fact that these are Chinese companies like they’re just off the run. Nobody really– it’s a weird structure. Maybe, that is the thing that is depressing them.

But then, so I made some mistakes through that long stuff that got blown up. But they were big funds in Los Angeles. I won’t name the name of the fund, but I think they put in $100 million into Sino-Forest like two weeks before it blown on. And they went as far as to send an analyst to China to look at the forest. And they said there’s the forest. They just didn’t own the forest. What can you do?

Maj: Right. We actually wrote an exposé on a cemetery company, same thing. Here’s our cemetery. Well, it wasn’t your cemetery.

[laughter]

Maj: [unintelligible [00:37:04] who do you believe? Do you believe Geo or do you believe the auditors from the regulator’s point of view? It had to get to the point where you eventually had to do so much work to get it done. And it was worth it then because these were 100% frauds. So from a business point of view– so we eventually ended up having to short these stock so because no one was paying us to do due diligence. We weren’t gonna get funded by anyone. So you know, what, if we’re gonna do this– is we want to clean the space up still, we wanted to clean up, we’ll start shorting and so we started shorting these stocks.

Tobias: Let’s talk about Geo little bit. What is Geo now?

Maj: When we first launched, the real single-line mantra was to bring institutional-type quality research to the everyday investor, bullish kind of ideas. And then moving forward, as we went through the whole China phase, now it became– we wanted to do that still but also have portfolio protection. Letting our members know when we come across fraudulent companies. Well, not even fraudulent but maybe some red flags before you invest and it’s more of a learning process. We teach our membership base how to look for great companies, but also how to identify risks, how to know when certain risks are worth investing in, and maybe some aren’t. And through that process– and we’re putting out constant research all the time with that, every day.

Our research becomes like a learning process when we do it. Then, it turned into a situation where we were short sell. We were known for being short, because nano-cap, micro-cap, that’s not sexy. And you were doing a great job there, everybody forgot that we really were. There was that period of this, between like ’10 and ’14, we’re these short sellers guys. The last few years, I’ve been trying to rebrand a little bit. That made us better investors. It was something we had to go through. A, because we were long in these stocks, we thought we had to go short or at least tell you that we were wrong in that and help you understand the risk. Along our path, we started exposing pump and dump stocks. Based on all [unintelligible [00:39:17], we exposed 12 US-China frauds and 22 pump and dump stocks along the way. So, I think that we’re in a position that’s “Hey, we’ve done it all. We finally won, but we’re not blind longs.”

So, what Geo is today is more of, “Hey, we’re still 100% all about going long, being bulls, but also understanding when you identify risk, we should let people know about it.” And more of a risk portfolio protection pieces, we’re not always out there putting out short pieces all the time anymore like we used to.

You can find out more about Tobias’ podcast here – The Acquirers Podcast. You can also listen to the podcast on your favorite podcast platforms here:

Apple Podcasts