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China Stock Battles Destroy Value

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But that may be changing. Well-informed investment professionals have told the TheStreet that the Securities and Exchange Commission is now investigating the process that gets many China-based small caps listed on U.S. stock exchanges -- a process called a reverse merger. The agency's growing interest may in part reflect pressure from Congress: In a letter to the SEC in September, the House Finance Committee asked regulators what they were doing to police the auditing of small-cap Chinese companies.

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In the case of Orient Paper, the shorts have been led by Carson Block, an attorney from California who has lived in China for years. Block has said that he researched the company and toured its facilities in China because his father was considering an investment in Orient Paper. The father, Bill Block, is an investor in Chinese companies, based in California. His company, W.A.B. Capital, says it maintains an office in Shanghai.

The younger Block says he came to believe that Orient Paper's chairman was probably embezzling funds and that its production lines were so hopelessly antiquated the company had to be lying about paper production. Comparing revenue numbers that the company reported in China to those reported to the U.S. Securities and Exchange Commission, Block has suggested that the company's U.S. filings overstated revenues by a factor of 27.

Carson Block published his charges on the Internet and made such a splash he was soon running a small-stock research shop called Muddy Waters, named not for the bluesman, but for an old Chinese proverb: muddy waters make it easy to catch fish. He now offers his services to institutional investors "on an engagement basis."

Orient Paper and its chairman have defended the company and attacked Block with equal vigor. The company has said Block's charges are false. In a press release issued shortly after the initial Block report, Orient Paper suggested that Block had based his research partly on documents filed by another company, He Bei Oriental Paper Co. Ltd. -- which, Orient Paper said in the release, is a "very small paper manufacturer in Baoding [that] has no direct or indirect relationship."

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