Short-Seller Cuts Through China Red Tape

NEW YORK (TheStreet) -- Over the past year and a half, John Bird has been accused of forgery and stock manipulation, spent more than $100,000 on legal costs and hired a cadre of private detectives in Shanghai -- all in the course of exploring the murky world of small-cap Chinese stocks listed on U.S. exchanges.

Bird's wife, Jenny, says all the cloak-and-dagger stuff makes her worry that men with hoods and masks will come for them in the middle of the night. "You've been watching too many Sopranos episodes," her husband replies.

Bird's humor belies his real concern about the dark dealings he is intent on revealing. Those involve a particular category of Chinese small-caps -- the reverse takeover, or RTO, companies.

Seen in the best possible light, RTOs represent a back-door way to get a Chinese company listed on a U.S. stock exchange; the process -- perfectly legal -- bypasses the scrutiny normally applied to an initial public offering or the listing of American depositary receipts, by merging the Chinese company into a shell company that is already publicly traded in the U.S. On the other hand, extreme skeptics see RTOs as a pump-and-dump racket on an intercontinental scale.

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Bird's investigative exploits began innocently enough. A retired entrepreneur and small businessman in Austin, Texas, he started looking into Chinese companies as a kind of retirement diversion, only to become obsessed with a paper trail he regards as evidence of fraud.

He is mostly a short investor in China stocks. In other words, he sells shares that he has borrowed, hoping he can replace them with shares purchased in the future at a lower price. If the price goes down, he makes money. Exposing bad news about companies can accelerate a share decline and make his strategy pay off. That's one of the reasons he has amassed thousands of pages of documents in support of his short positions and has published the ones he considers most revealing on a Web site he set up, www.waldomushman.com.

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Among long investors in Chinese stocks -- those who own shares and profit from increases in the share price -- Bird and his ilk are reviled. Over the past few years, longs and shorts have engaged in a kind of propaganda war over RTOs. Big money is at stake as the two sides battle to sway public opinion and shift stock prices their way. That's where the threats and charges against Bird have come from.

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