(China Hustle protagonist Dan David)
Like a lot of white-collar crime, the fraud depicted in The China Hustle, a new documentary directed by Jed Rothstein and produced by Alex Gibney, is outwardly complex, but the basic act is simple. Rothstein’s film investigates the world of the “reverse-merger,” a type of financial fraud that became big business in the wake of the financial crisis, when investors were looking to Chinese companies to become the next bull market. The trick was to merge a Chinese company with a defunct American one that was already listed, which could then be brought to the market without the usual audits that accompany an IPO (initial public offering).
That’s the outwardly complex part. The simple part was that once the companies were listed, they essentially just invented wildly inflated growth and earnings numbers, and collected money from investors eager to get in on the action. Done correctly, everyone on the inside could get their bonuses before the bottom dropped out, extracting money from anyone still holding the paper when the truth came out. It was often so simple that, as some of the people profiled in The China Hustle discovered, all one had to do to discover it was to compare the numbers in the companies’ Chinese filings, in which they risked jail time and worse for lying, and thus told the truth, to their American filings, in which they could lie without consequence, which they inflated accordingly. It was a multi-billion dollar fraud enabled by the simple failure of two agencies to share numbers (among other things).
It was a simple act — not much different than a pump-and-dump, a Ponzi scheme, a confidence game, you name it — but it took the coordination of a number of different parties to make it work, knowingly or not; American banks to promote the filings, stock promoters to recommend them, regulators to rubber stamp their approvals, and celebrity promoters to give them a sheen of legitimacy. One of the more odd and telling aspects of The China Hustle is its depiction of the “celebrity investor” hustle, where big names in government and the military lend their names to investment banks, giving the investments a sheen of legitimacy despite no one truly expecting a former general or a secretary of state to know anything about Chinese paper companies or coal refineries. Somehow familiar faces short-circuit our brains’ normal logic processes. In the movie’s chosen case, it happened to be ex-NATO commander and former presidential candidate Wesley Clark, who acted as chairman of an investment bank pushing reverse-merger companies, Rodman and Renshaw, most of which turned out to be worthless
Much as in The Big Short, Rothstein sweetens the bitter pill of our financial system being easily gamed and built on lies by focusing on the people trying to expose the truth, the short sellers trying to tank the bad investments, misfits despised by their peers for trying to ruin the party (at one point there’s stock footage of ex-Lehman Brothers scumbag Dick Fuld telling a conference he’d like to rip out short sellers’ hearts and eat them) but who are ultimately doing the right thing. Thus it becomes a hero’s journey built on a tragedy rather than a simple tragedy.
Rothstein also walks a delicate line in The China Hustle. With Donald Trump in the midst of starting a trade war with China, and who spent much of his time on the campaign trail blaming China for all of the US’s economic woes, it would be easy for a documentary that focuses on a fraud with a specifically-Chinese bent to get lumped in with the same kind of easy xenophobia. But as with the Russian collusion investigation, it isn’t really about China or Russia as a specific enemy, they’re both just iterations of a larger problem: global capital. Corporate capital will always exploit regulatory loopholes and play national differences for its advantage because that is its only function: to grow.
Thus The China Hustle raises some more existential questions, like isn’t the entire market essentially a confidence game? And if so can we still harvest some of its benefits without creating a class of losers? With The China Hustle now playing in select theaters and expanding to more this weekend, I got to pick director Jed Rothstein’s brain about it over the phone.
Can you start by just explaining what a reverse merger is?
A reverse merger is when a company, an extant company, merges with the shell of a company that really doesn’t operate anymore, but has somehow the shell, the legal listing and legal entity of the business, has been maintained, and then the extant company takes over the shell and takes over its listing. In The China Hustle story, what would happen is, say, a Chinese coal company would merge with a defunct shell of, say, a mining company from Nevada and take over that publicly traded company’s business body, its business listing on the exchanges, and it was a way to get to U.S. public markets less expensively and more rapidly than the more traditional IPO route.
And so when did you first start pursuing this story and how did you hear about it?
I hadn’t really heard anything about it until one of the producers who knew Dan David and Jon Carnes, a couple of the guys who are profiled in the film, brought the film to Jigsaw here where I have been directing a number of things and, ultimately, it came to me. As I lay out in the film, I met Dan in a TGI Fridays and he laid out that whole sordid tale to me and I’d never really known about this story or this scandal. I was shocked that the story had began in the wake of the last enormous scandal, the 2008 mortgage collapse, and I was also pretty impressed with Dan as an interesting and complex character who was really pursuing this for moral reasons. He had a real sense of injustice having happened and he wanted to pursue justice. And I felt like that was a good basis for telling the story because we don’t really understand stories about things as well as we understand stories about characters. And so I wanted to be able to tell the story through him. And he was pretty reluctant at first, but I eventually convinced him to let me follow him on this quest that he went on, both in talking about some of the events that had already happened, of course, and then his present-day quest to bring this issue to attention in Washington.
Can you explain, with this kind of fraud, where does the money go and who loses?
Well, the money goes, ultimately, to the companies in China who list it on U.S. exchanges, raise investment with the help of bankers and lawyers and stock promoters here, and then the money essentially goes back to China. Who loses is everyone. If the company’s a fraud or a significant misrepresentation, then when the company collapses or becomes de-listed or loses 90% of its value and circles the drain, that money that came from the investing public and from everything from institutional investors to mom-and-pop investors, that money is gone. We all lose it. Most of the money that was lost was lost in a big skim and that’s why I think it was easy to hide. Not a lot of people knew about it because everybody lost a little. Some people, and we show this in the film, invested more directly in these stocks and they lost a lot, for them. But I think we’re all affected in different ways and when pension funds lose money to these things, that money has to be made up somewhere. Pension funds have obligations to be financed on a certain level, and so that comes in raised fees and raised taxes down the road because that money has to come from somewhere to fill it back up when it’s lost. I think it’s like a small tax on everybody, that we don’t know about, and a really big tax on some people.
How much of this is still ongoing? You read some stuff about this and it’ll say the bubble had already burst on reverse mergers. But how much of it’s still happening?
Yeah. I think the initial wave of reverse mergers that we talk about in the film, those companies have either been shorted out of existence or left the markets, going private, or still trade at very much, much lower valuations. I think that wave is generally over, but there are now bigger and more complicated companies that are more and more integrated with China and the global markets and they’re still vulnerable to some of these companies’ books and the mechanisms that allow this fraud to exist, for the most part, still exist, so we’re faced with potential liabilities if there are problems with these companies. And I’m not the financial expert myself, but the guys in the film seem to feel like there are a lot of questions that are going unanswered and they’re concerned that we still have a lot of exposure.
And then you follow Dan as he’s trying to get Congress to take some action. What is the action that they would take? What would that look like?
Well, to demand cooperation between our financial regulators and China’s, to demand access to the audit work papers, which are the documents that the auditors use, in China, to compile their accounting of these companies. If you can’t see those, it’s very hard to pick out fraud, the ability to enforce subpoenas back and forth, and generally sets of changes to the way that we conduct ourselves in the global economy that bring the regulatory framework for the economy up to the speed of the markets themselves. I feel like the markets are operating at 21st century speed and capital can go everywhere, and the regulators trying to keep the rules of the game fair are still stuck in the 20th century. And so Dan probably could articulate more specific, technically specific, rule changes and some of this stuff gets pretty arcane, but I think in layman’s terms, that’s what he would describe.
Was that Soren [Aandahl, a finance lawyer who appears in the film] who found out that he could just find the Chinese filings and find the actual numbers and then other people just didn’t have access to those numbers?
Well, I think Soren certainly was one of the guys that found that out early. It’s a big, complicated group of people and they’re not all coordinated, so who was the very first person to discover it, I can’t say. But in the telling of our story, in the group of guys we focus on, that’s one of the people who figured that out. And, of course, it was a method that a number of these guys used to examine the discrepancies between the numbers that [these companies] would report in China, which have to be accurate because you can go to jail or even worse if you lie to authorities there, [and the number they would report in US filings], but there’s really no penalty on the other side for making up numbers to the SEC.
Now does that go both ways? You make a point of talking about, in China, it isn’t illegal to defraud foreign investors. Would it be illegal for Americans to do the same the other way?
I believe it is. There are cases and Dan points out … The short answer is yes, and Dan points out that there are, not in the film, but in some of my discussions with him and some of the press we’ve done, he points out that when people here were found to be defrauding Chinese potential emigres in these visa programs that allowed them to invest in, or still allow them, to try and invest in certain businesses here to get green cards, when there was fraud found out there, our government cracked down on these fraudsters and made sure that the Chinese nationals, or Chinese citizens, who had lost their money were made whole. And I don’t think there is a similar effort on the other side to worry about violations of U.S. law in China.
Is there some hopelessness to trying to get some of this regulated, like when you’re trying to fight for financial transparency and the president still hasn’t released his tax returns even?
I would agree that this president, this administration, is going in the wrong direction in terms of financial regulation. He wants to peel away the regulations that were put in place in the wake of the 2008 frauds to protect consumers. His nominee to the Consumer Financial Protection Bureau requested a zero dollar budget for this year. Zero dollars. And, as you point out, he himself has nothing to do with transparency. We don’t know about his tax returns. We don’t know about the enormous amounts of money coming from foreign governments and foreign lobbyists into his various businesses. Yeah, I think, we’re certainly, in my view, we’re not moving in the right direction on that stuff. By my hope is that we can and we could demand a better system.
I don’t think it’s about one villain or one bad person or even a group of bad people. I think it’s about this system that allows, that encourages, people to take advantage of these loopholes. It encourages a kind of capitalism where people are taking advantage of one another, rather than a capitalist system that’s just based on allocating resources efficiently and encouraging innovation. And I think we can demand a better, fairer system. You’re never going to erase all fraud. You’re never going to erase all corruption. I think it’s part of human nature. But you can put incentives against it and lessen it and make people accountable for it when they do it. And I think, in the international realm, certainly we don’t have that.
It seems like part of the problem is that you don’t have any financial institutions who aren’t benefiting from additional trading, so if you don’t have anyone who’s not a cheerleader somehow, how do you get an honest accounting of what’s happening?
Well, look, even domestically, again, there’s frauds, of course. We all know about Enron and WorldCom and these famous frauds. If you have a company, if you have a factory in Iowa that makes calculators, and you claim that you’re making 10 times as many as you are, you will eventually, in some period of months of filing, be found out and you’ll face jail and you’ll face significant fines. And that’s just not what happened in these cases because the numbers could be made up. Whether the people on the American side knew, or when they knew, is almost irrelevant because it didn’t matter. Nothing could be done on the Chinese side of it. No subpoenas could be enforced. You couldn’t do anything, so there’s no disincentive to make things up. But we do have the ability to do that here and I think if we’re going to have capital flows going everywhere, we have to find some way to broaden that accountability framework.
Right. And then Dan David, he was trying to sell proper vetting [trying to get investors to pay him to vet and verify Chinese companies] and then he couldn’t find a buyer. Was that a case of looking for a market-based solution when maybe it’s more of a regulatory solution?
Yeah. I guess you could say that that is. It’s a way of using that information and research to encourage accountability, and I guess Dan felt that, as he says in the film, that the banks, in general, that he went to were not responsive and that the market itself was responsive. That’s what short selling is. Short sellers are basically putting that same research, as Dan eventually did, putting that research out there.
So the short sellers, they can tank a stock with one of these damning reports, and you make the point that it’s dangerous for them personally. Were you worried about making yourself a target, just in making this movie?
Yeah. Certainly, you got to be concerned when you call people out on stuff. They’re going to be upset and, in some places, that can have really violent consequences, thus far, it hasn’t and I hope it won’t. But we saw in the film the story of, I think, for people who are more exposed in the China case are Chinese citizens or even people who are dual citizens, as in the case of Kun [Huang, a Chinese national who worked with one of the short sellers], who’s now also a Canadian. But he was there doing on the ground research and got arrested [and went to jail] for two years. And a lot of these guys, the Chinese-side researchers for the shorts really take on great risk to do what they’re doing.
In a way, it’s encouraging to me because I think some people might come out of this movie and really be down on China, but I’m actually not down on China. I’m encouraged by the large number of people that I came across, Chinese people, who are really working and risking a lot to try and clean things up and to increase transparency, bring China into the global markets in a good way. And I think they face an uphill battle, but there’s a lot of them and it’s a big, complex country that the growth and the potential there is real. The fact that these frauds happen is true, but it doesn’t discount the entirety of the Chinese economy and everything’s that’s going on there. And my hope is that the forces, as Kun said in the movie, that truth will out and the forces of good will prevail.
(Rothstein – pointing – on set)
Can you explain Wesley Clark’s role and what he represents in the film? Why is it such common practice for retired generals to sit on the boards of these random companies that don’t seem to have anything to do with any of their areas of expertise?
I can’t speak about that generally, although I know it’s a thing in the economy, but just in terms of the film, a lot of political celebrities would speak at conferences and events where these stocks and these companies were promoted and where investment in them was promoted and it lends credibility, even if the people are talking about general topics. It’s a way to lend the sheen of credibility and respectability to it. And we were looking at how to tell that story in a compelling a way and I think the question is, well, what reasonable expectation can you place on, say, Colin Powell to vet 275 companies at one of these conferences? That seems like a pretty high bar for him.
But when you’re talking about someone in General Clark’s position, who was the chairman of Rodman & Renshaw, which was one of the few banks really leading this world of raising money for these companies, I think you have a different level of obligation to understand what you’re getting involved with, even if you, yourself, as he said in the film is not executing the deals. You’re still lending your imprimatur to it. And so I felt, even though I like General Clark and I actually have a lot of respect for his service to the country, I felt like it’s an important component of this whole story and it was clearly the most enlightening example of some of the problems that can come with it. He’s in there. Again, personally, I wish it were somebody who I didn’t respect or who was some slimy guy from some department that had a lot of problems and not a war hero, but you deal with the characters that exist in the story.
Does it seem like it was just a case of him seeing his peers making a bunch of money for doing that sort of thing and just wanting to get in on it?
I can only go on what he said to me in the interview and the salient points about it are in there, so I don’t want to speculate as to what his thinking was. But I could say, in general, yeah, look at our society. You have these guys trading stocks and these guys, mid-level workers in tech companies and they’re making seven figures and you have people who are 30 and 40 years giving service to the country and they’re at the highest rank, they’re generals, and what does a general make, 250k? They probably look around and say that a capitalist society is not correctly rewarding merit in our society. It’s skewed. The guys in the public sector are not as well compensated by an order of magnitude, and I could see coming out of that and saying, “Look, it’s time to earn a living for my family.” I don’t think there’s anything wrong with that, but, I guess, I think that it doesn’t remove the obligation to make sure that if you’re putting your name on something, that it’s solid– or certainly more solid than that bank was, which was not very solid.
Sure. But is that part of what makes regulation a challenge, the idea that these political figures are going to do their public service for 30 years, and then they’re expecting these token board positions at these companies, and they’re expecting they get paid out that way? Do you think that becomes a disincentive for them to regulate them more [while they’re in government]?
That’s certainly possible, yeah. And, of course, there’s the whole problem of the revolving door [between businesses and the institutions that regulate them]. Again, I can’t get inside people’s heads, but we all know about the revolving door in politics. This is not having anything to do with this story in this movie, but congresspeople move in and out of public service and the lobbying world and, of course, make many multiples more lobbying. We all know that this is a problem. We all know that it provides perverse incentives not to do the right thing in the public interest, and I could imagine that the ability to get these speaking engagements and board seats would have a similar effect. But in General Clark’s case, remember, he is not a politician. He wasn’t making laws and he wasn’t overseeing regulations. He was really a public servant working in the military and doing, again, extraordinary things that are very commendable and worthy of respect. I don’t want to connect his motives to something that maybe is a broader problem in society, but isn’t relevant to him.
Sure. Well, it seems like there’s a credibility laundering thing going on. Like when Theranos (Elizabeth Holmes’ blood-testing startup, which had current defense secretary James Mattis, as well as former Secretaries of State George Schultz and Henry Kissinger and Navy Admiral Gary Roughhead on its board, among others) happened.
Right. They have all these people on the board, right?
Yeah. It’s all ex-generals and political people and it seems like there’s this practice of taking public servants and political figures and using [their celebrity] to launder stock fraud or whatever you want to call it.
I think obviously there are cases of fraud and those are the worst, but there’s also, I think, a problem where you get into something and it seems like a good thing and then it turns less good over time, but you don’t get out of it. And I’m very hesitant to … One of the characters in the film says this, “You want to blame all this on one guy? It’s crazy. You can’t blame it on one guy. It’s all of us. It’s the system.” It’s like in The Big Short. Yes, the banks sold these complicated products that were hugely problematic and certainly, at a certain point, knew it and kept doing it and made all this money on it. But you also have people going to get mortgages and stating that they make five or 10 times as much money as they actually make and that have no business buying these expensive houses and taking these expensive loans, but are doing it. It’s like we’re all kind of culpable if we set up a system where the rules don’t encourage us to be at least sort of fair and basically honest.
In terms of individuals that could maybe be punished in this story, what about these guys like [lawyer Mitchell] Nussbaum and Crocker Coulson, where it seemed like they were actively involved in smearing and defaming people who were just auditing? Is there any potential for consequences there?
Here’s a really interesting thing about this story. The activity on the American side of it was legal. People were acting in accordance, maybe you find some isolated cases where they weren’t and I’m sure you could, but in general and in the story that we tell, the American side of it, the guys raising the money, the guys processing the legal papers, the auditors, the promoters, were operating within the law. Their work was legal, at least as far as I discovered in what I did. The guys on the Chinese side, the executives who were lying about what their businesses were doing or, in some cases, were selling the same assets to different people multiple times or taking shareholder money and putting it in private accounts and bankrupting their companies and all those things, which are clearly fraudulent and illegal, were unpunishable because of the structures that we were talking about earlier. And so that gap in-between is what allowed all this money to be lost.
But on the American side, I would say that’s where we look to… let’s come up with a different system of rules of the game that discourages the types of things that went on in this scandal. But I don’t know that you could go to one of these folks and make claims about their wrongdoing because they’re just saying, well … It’s like Mitch said in the film, no law firm is going to go and run down … if a client makes an assertion, you assume that it’s true until you have some reason to not believe it’s true.
But it seemed like they defamed the authors of reports in the aftermath. I think they were trying to go after them to a degree that, I don’t know, maybe rose to a level of illegality?
Again, the shorts can fight that out with them, but those guys are in a pretty rough and tumble, back and forth and I think most of the shorts that I met, they know that when they’re making these claims about these companies, they’re going to get into it with them. And they do and they have lawsuits and they have public battles and whether one side is doing something illegal or not, my guess is no, but maybe you could find cases where they did, but I didn’t.
All right. Well, thank you for talking to me.
Yeah, my pleasure.