The reason I moved back to China a few years ago was so that I could get the best possible information on U.S.-listed China small-cap stocks.

Days like today are when that decision really pays off because I got to buy Orient Paper ( ONP) at an absurdly low price with a high degree of confidence despite (and due to) a recently released short-sellers' report stating that the company is a fraud.

Days like today are also when I realize that the world of investing in China small-caps is a small one -- a very small one.

In January, I toured Orient Paper and produced a video (see below) of the facilities. I liked the company and owned the stock. To my surprise, there were two other Americans present, and to my even greater surprise they happened to be former classmates of mine from the University of Southern California. They are Carson Block and Sean Regan of Muddy Waters Research.

Orient Paper: Factory Tour

As a result of the USC connection, we did quite a bit of catching up on old times. While my purpose was to produce a video of ONP, they were visiting Orient Paper -- according to the company -- to pitch a "paid for" research report that would recommend the stock as a strong buy. I have tried to contact Muddy Waters by cell phone and email Thursday about the allegations but have yet to receive a reply.

During the film tour, my old classmates were kind enough to hold the camera for me a take a few shots of me and of each other. They even asked for copies of the footage. However, their performance was a bit odd during the tour. The word that comes to mind is "perfunctory."

They didn't speak any Chinese to the company (an interpreter was used), and they really didn't ask many questions. At one point, one of them playfully jumped around in a huge pile of scrap paper. No matter how many of these company visits I make, I am always very deliberate in establishing credibility with the company. I try to ask challenging questions that will be focus points for investors (myself included).

Prior to making company visits, I typically spend a few days at a professional language school in Beijing to brush up on industry-specific terminology. I am also very mindful of the risk that in a limited amount of time I will fail to acquire all of the detailed information I need and may need to revisit the company.

After the tour, we all had a long lunch with the company and a two-hour meeting in its corporate offices. Again, I remember being puzzled by the lack of questions from my fellow alumni. When the meeting was over, I clarified my purpose and made it a point to request that the company be available for follow-up.

Block and Regan were basically silent and didn't state their purpose or request any follow-up, which struck me as odd -- not in a bad way, just that it seemed that their visit was wasted and without purpose and that they looked a bit amateurish.

Now their purpose has become apparent. This week, my former classmates produced a massively detailed report identifying ONP as a fraud, with a target share price of less than $1. The stock closed at $5.09 Thursday (one-day chart below) and had been as high as $15 in the past 52 weeks. The report appears to be the first and only report by their newly formed company Muddy Waters Research.

They also disclosed that they were short the stock (and potentially put options) and that they would continue to trade the stock after the report (long or short). I presume their goal is to short it down and then potentially buy it back up.

They also disclosed that the information presented is "as is without warranty of any kind" and that they make "no representation that as to the accuracy, timeliness or completeness of any such information."

In other words, it is my opinion that the purpose of the visit was not to find out information on the company but rather to simply "check the box" and say that they had visited the company to lend credibility to their report.

In one respect, I have to pay very high compliments to my former classmates. Their timing was impeccable. Not only did they choose to launch the report into a tanking stock market, but it also happens that I am not in China at the moment. I am back in the U.S. for the Fourth of July holiday and so am not able to do video tour Round 2 at ONP's facilities. The result of the well-timed report is that ONP has fallen by as much as 50% in two days, from over $8 to as low as $4.11.

I was quickly on the phone to the company, to its IR firm and to other major investors who own the stock. Everyone was equally shocked by the report, and the company vowed to respond immediately. I know a number of investors who have toured ONP, met management, and invested in public and private offerings by the company. The investors have all expressed interest in buying at these levels.

The main focus of the negative report was that ONP had somehow successfully deceived its auditors, BDO, as well as public and private investors, along with Roth Capital, which managed the last offering, and that its actual revenue numbers were a mere fraction of what was being reported to U.S. investors -- i.e., fraudulent.

However, according to the emergency press release put out by the company on June 30, my former classmates were using the wrong data. They were trying to match up the financials of ONP with a Chinese paper company called He Bei Oriental Paper Co. Ltd.. Unfortunately, that is the wrong company, and is in fact a different paper company located in Baoding. The correct name of the operating company is Hebei Baoding Orient Paper Milling Co., Ltd., and according to ONP, the numbers match what has been disclosed in U.S. generally accepted accounting principles. Still, Muddy Waters stated in a release Thursday that "our thesis that ONP is a fraud remains unchanged."

In the new posting, Muddy Waters confirms that the 2009 financial numbers are in fact correct (for example, revenue of $102.3 million) yet stands by other qualitative judgments that ONP is a fraud based on various observations from Block and Regan's due diligence visit.

I am certainly not going to describe this as a deliberate act of deception, however, it seems that a simple phone call to the company to clarify the name of its operating subsidiary would be easy and take only a few minutes. When I call the chairman of ONP, I can reach him on his cell phone day or night and he is always responsive. If I were too lazy to call the company directly, I would probably have referred to the 10-K, which states clearly that "Hebei Baoding Orient Paper Milling Company Limited is the Chinese operating subsidiary" of ONP.

The report also goes on to compare ONP to several public companies such as Shandong Chenming (Ticker:HKG 1812), which has a market cap of over 30 times that of ONP, as well as Nine Dragons Paper (Ticker:2689), which has a market cap of more than 70 times that of ONP. The authors of the report seem shocked that ONP is not operating at the scale of these companies and that ONP seems outdated in comparison.

This is like comparing Home Depot to the corner hardware store. If I wanted to buy into large-cap stocks, I would buy into large-cap stocks, but in my experience I have made more money by buying into small-cap stocks with room for growth rather than in buying the massive global-scale players who have little room for exponential expansion. The individual production lines at these companies likely cost more than the entire market cap of Orient Paper, so showing pictures of these companies for comparison strikes me as a bit silly.

As a result of all of this confusion, I bought quite a few shares of ONP today. Prior to this report, the shares were consistently trading at around $9. Even with the selloff in the overall market I expect a rapid bounce in the share price back to at least $8, with the potential for more upside as ONP reports results. Today, ONP reiterated 2010 guidance of $1.21 per fully diluted share in 2010, which places them at a current multiple of around four times earnings solely due to a single report based on erroneous data. ONP shares closed at $5.09 Thursday, down $1.59, or 23.80%.

For full disclosure, I bought shares of ONP today, and (as always), I never receive any compensation whatsoever from any companies, individuals, investors or any other interested parties for expressing my investment opinions.

Finally, although the authors of the report have claimed that they were filmed without their permission, I would like to thank them once again for helping me film, and I apologize for not sending them the footage directly as they requested. However, as I made them aware, it can be viewed directly (for free) on TheStreet.

At the time of publication, Pearson was long Orient Paper.

Rick Pearson is a Beijing-based private investor focusing on U.S.-listed China small-cap stocks. Until 2005, Pearson was a director at Deutsche Bank, spending nine years in equity capital markets in New York, Hong Kong and London. Previously, he spent time working in venture capital in Beijing. Mr. Pearson graduated magna cum laude with a degree in finance from the University of Southern California and studied Mandarin for six years. He has frequently lived, worked and traveled in China since 1992.

More from Opinion

Red Hat CFO Tells TheStreet: Tech Trends Are Still in Our Favor

Red Hat CFO Tells TheStreet: Tech Trends Are Still in Our Favor

Throwback Thursday: Intel Edition

Throwback Thursday: Intel Edition

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

Wednesday Wrap-Up: GE and Facebook

Wednesday Wrap-Up: GE and Facebook