Activist short seller Dan David is the reluctant star of “The China Hustle”

This article was first appeared on Valuewalk.com

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Dan David is an activist short seller and hedge fund manager who operates from the small town of Skippack, PA. That’s a world away from Hollywood, not to mention China.

But David is the star of “The China Hustle,” a film produced by Oscar winner Alex Gibney (Enron: The Smartest Guys in the Room) and backed by billionaire Mark Cuban. The documentary uncovers a post-financial-crisis scam where Chinese companies -- with the help of U.S. investment bankers --  steal hundreds of millions from U.S. investors.  And nobody seems to care.

The documentary premiered Sept. 8 at the Toronto International Film Festival. Magnolia Pictures is co-owned by Todd Wagner and Cuban, who also owns Landmark Theatres. 

“The China Hustle” follows David and others as they expose empty U.S.-listed shell companies posing as fast-growing Chinese growth corporations, and make millions shorting the fraudulent stocks. Critical response to film has been positive. Variety called The China Hustle “wildly entertaining” and compared it to “The Big Short“, a big box office success that also depicted the excesses of greed in the investing world.

But when ValueWatch caught up with Dan David in a phone conversation a few weeks back, the activist short seller did not seem to be living the life of a movie star. 

“On Monday I got a cease and desist letter,” he says. “On Tuesday, I got a complaint served for a lawsuit...On Wednesday, there's a short squeeze on a fraudulent stock I’m short. Because a fraudulent company can say anything they want at press release. They’re already caught so they might as well squeeze the stock and get out while they can...On Thursday, my broker reaches out to me and says, ‘We're calling in your short position because it's hard to borrow now and bigger funds want it.’ I mean the list goes on and on and on about how difficult this [short selling business] can be.”

Whatever the challenges of being a professional shortseller, Dan David is very good at it. David operates his own hedge Fund, FG Alpha Management, and along with his partner Maj Soueidan, has run the research firm GeoInvesting since 2007.  The duo’s first short report was China Redstone Group on January 19, 2011, and it began a run of very prescient short calls.

Much of David’s and GeoInvesting’s success -- and the focus of The China Hustle -- revolves around one phenomena: Fraudulent China RTO’s.

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But Dan David never intended to be a short-seller.

David had worked as a corporate executive for 14 years, the last several in St. Louis, when in 2006 he was given a choice: Take a promotion and move to Milwaukee or receive year’s pay as severance. He took the year’s pay.

He returned to his hometown of Skippack, PA and went into business with Soueidan, whom he had first met in 2001 when David joined his flag football team. Soueidan, a former Vanguard employee, had taken a $40K stake and turned himself into a millionaire before he was 30 by investing in small and micro-cap stocks. Soueidan ran a friends-and-family oriented hedge fund.

Soon the hedge fund’s success with “information-arbitrage” investing -- learning information about a company that other’s don’t have and profiting from that intelligence -- led to requests for research, and the two started GeoInvesting in 2007. 

“These were under-loved, under covered companies,” David says. “They often didn’t have analysts. And at the time you would go to Yahoo and Reuters and the estimates were wrong. All the information about them was wrong.

“We were up 50% in 2006, 49% in 2007, and flat going into September 2008.”

But then came the financial meltdown and the duo’s hedge-fund was down 78% in November. The majority of investors in their fund where friends and family. The two were devastated.

After some soul-searching in December-January, David and Soueidan agreed that after years of success with their information-arbitrage strategy, what happened in the fall of 2008 was an anomaly.

“We decided we were going to get all the money back and work for free until we do,” David says. “It almost cost us everything. But it meant a lot to us. And we were going to stick to the same strategy because it had worked over the long period and the split of a cycle was just that.”

So, as 2008 came to an end, David and Soueidan -- like so many investors around the world -- were dead set on recouping losses incurred during the financial crisis.

And as the two sifted through the wreckage of thousands of bombed-out stocks, one group of equities came up as especially attractive -- Chinese RTOs. These are Chinese mainland companies that gain listing on U.S. Exchanges by way of “reverse takeovers.”  

In a reverse takeover (RTO) a company buys the corporate shell of a defunct U.S. company still trading on the penny stock exchange, and then promotes the newly merged company’s growth potential.

“The short-sellers are wrong. They're understating the problem. It’s fraud out in the open.”

Foreigners are prohibited from investing directly in China’s markets, but aided by U.S. investment bankers, many Chinese corporations used RTOs as a way to gain access to U.S. securities markets, but avoid the regulatory scrutiny normally applied to an initial public offering.

U.S. investment banks would spread word of the “new” public company’s exciting prospects and drum up fresh capital through secondary offerings of stock. By 2010, firms like Roth Capital Partners and Rodman & Renshaw were banking big profits in RTOs.

Between 2000 and 2011, there were 448 Chinese RTOs, according to research from the Singapore Management University.

By the middle of 2009, David and Soueidan had 80% of their portfolio long Chinese companies trading on U.S. exchanges.  And as global equities recovered from the meltdown, David and Soueidan absolutely killed it with the long China picks. By the end of 2009, they were up 229%. In one year, they got it all back, and then some.

But around the middle of 2010, the analyst team started hearing that some U.S. short sellers like Carson Block of Muddy Waters Research were disparaging the companies that David and Soueidan had sold at big profits (only because their price targets were reached). So they hired a U.S.-based China attorney who put together a team and set about investigating the China RTOs. David and Soueidan were intent on proving the short sellers wrong. 

As David tells it, the attorney came back from China and said:  “‘The short-sellers are wrong. They're understating the problem. It’s fraud out in the open.’” The attorney’s team discovered that when ROC and Rodman came out and did an investor tour, the China companies hired temporary workers and got the factory running, and when the investors left, it all shut down.

Initially the two weren’t sure what to do. “Look, we don't want to be short-sellers,” David says. “That's not who we are. We’re investors for the long side. But we decided we had to go to Rodman and ROC. We had to go to the U.S. exchanges and tell them what's going on. Maybe we can sell them our research...How naive we were.”

David and Soueidan reported the fraud they discovered to the U.S. investment banks sponsoring the RTO’s. “We were told to get the ___ out of there or we’d get sued.”

“So we went to the U.S. exchanges. They didn't know what to think. They didn't know who we were. And quite frankly, the exchanges make a lot of money on these companies, too.”

The two decided to publish their research, reasoning investors could see that GeoInvesting wasn’t a short seller, but was simply doing exceptional research. They assumed investors would pay for great short ideas.

The first fraudulent RTO they published a report on was China Redstone Group (NASDAQ: CGPI) a company that fraudulently claimed, among other things,  to operate a large cemetery in China. David and Soueidan bought five cemetery plots to prove that this company didn't own the cemetery. They went on to lay out the company’s fraud in detail. The stock tanked.

 Source: S&P Capital IQ

Source: S&P Capital IQ


They published more research, exposing fraud and crashing stocks. But people didn’t buy their short research. Accordingto David, they’d hear: “‘We don’t care if you say you’re not a short seller. You are one and we're not going to pay you anything.’” GeoInvesting spent $50,000 on RTO short research, exposed rampant fraud, and hardly made back a dime.

Finally they had enough. “On the next one we did, we said, ‘Screw it. We’re taking a short position. It’s our right to do it. Maybe it’s not our true mindset but, it’s our right. It’s public information and we’re going to do it.’”  They shorted Puda Coal (OTC: PUDA) and the stock crashed -- falling from $13 at the time of GeoInvesting’s exposé, to basically zero six months later. The SEC eventually ended up getting a $250 million dollar default judgment against the CEO (which it’s been unable to collect).

And from early 2011 till now, David says he and Soueidan have caused more companies to be delisted than all the other short sellers combined.

David and Soueidan were doing work that regulators should be doing -- exposing fraud that was costing American citizen’s millions of dollars. But they were pocketing millions for themselves in the process.

As David says: “So we're crashing these companies and we're making money, I still felt like this was the wrong thing for our country. I started to lobby Congress on behalf of investor rights and the fact that these China CEOs who have admitted stealing money from us don't go to jail, don’t pay a fine because the SEC can’t collect it.

 Source: S&P Capital IQ

Source: S&P Capital IQ

"We view ourselves as true activist shorts and we're also trying to change the landscape. And some of the things that my senators and congressmen have said to me are like, ‘Wait a minute. Don't you make money off of these?’ And my response is ‘Yes. I’ve made millions. But every dollar I make comes at the expense of an American constituent of yours and that bothers me. Why doesn't it bother you?’”

And according to David,  nothing much has changed: “China gets smarter, we get dumber. That’s just how it works. You know the PCAOB [a non-profit that regulates auditors of publicly-traded companies] still can’t have full access to audits of RTOs listed on U.S. exchanges. That’s ridiculous, you know, some seven year later.

“A foreign country is just taking money from Mrs. Smith and Flynn in the U.S. and giving it to Mr. Jones in China...It’s not going to change.”

And until it does, activist short sellers like David will continue profiting from the fraud.

As Dan David says near the beginning of “The China Hustle”:  "There are no good guys in this story, including me.”

Magnolia Pictures is eyeing a late-March 2018 release for “The China Hustle”.

Mark Gaffney