Dan Harris in South China Morning Post

Gold mine scams point to trouble ahead, analysts say

Retired Chinese diplomats and non-existent gold mines have been linked to fraudulent investment schemes in what analysts say may be a sign of trouble ahead as tightening liquidity and concerns about the viability of lending products are likely to result in further scams unravelling.

Whenever there is a downturn, there is an increase in scams. That is true of China, as it is true of everywhere,” said Daniel Harris, a lawyer at Harris Bricken and a specialist in investigating mainland scam artists. “I haven’t seen that increase yet and I don’t know why.”

As Warren Buffett said, when the tide goes out, you discover who is swimming naked, and the challenges facing the mainland’s economy and credit markets are likely to expose fake or struggling investments that rely on new capital inflows, rather than asset-generating returns, to fund client coupon payments and withdrawals.

Government data published last year showed the number of reported cases of illegal fundraising on the mainland rose 79 per cent between 2011 and 2012, with more than 16,000 cases solved since 2008. Since 2005, the total annualised value of cases handled exceeded US$3.26 billion.

Illegal fundraising is a catch-all term that can include fraudulent Ponzi schemes and unlicensed investment structures in the shadow banking sector.

In its broadest sense, shadow banking involves online lending, pawn shops, microcredit lending and loans to local government funding vehicles – much of it legitimate business. Mizuho analyst Shen Jianguang estimates it is a 30 trillion yuan (HK$38.3 trillion) business, equivalent to almost a third of credit created on the mainland.

Between 2011 and 2013, 4,170 people were convicted of illegal fundraising, with 1,449 given sentences ranging from five years in prison to the death penalty, according to the court.

New scandals are regularly uncovered by the media.

A 61-year-old woman in Zhejiang province was given a suspended death sentence in November last year for cheating investors out of US$90.5 million, while in a separate case, a 30-year-old man was jailed for life for running a US$4.9 million Ponzi scheme. In December, a Liaoning city official was arrested after US$18 million raised from more than 400 investors on the promise of high returns failed to pay out.

This year, the Guangzhou-based Southern Weekly newspaper profiled a US$43 million scam linking retired diplomats and ambassadors with fictitious mines and the allure of 6 per cent monthly returns.

The term Ponzi scheme was notably applied to the mainland’s entire wealth management trust industry by Xiao Gang, the chairman of the China Securities Regulatory Commission, over concerns underlying assets in many products were failing to generate the expected cash flow, prompting managers to use new money to pay off old clients.

Despite evidence that underlying assets are failing in certain products, investor losses have been kept to a minimum as local governments or state-run institutions front the cash to maintain investor confidence.

“My gut tells me that some big cases will be uncovered” given the slowdown in economic growth, said Sara Hsu, a professor at the State University of New York at New Paltz and an expert on shadow banking.

“There has been a massive inflow of liquidity into infrastructure and property development up until this period, and where there are large liquidity inflows in a bubble environment, there is huge potential for the propagation of financial fraud.

“The trust products that have failed so far have often had rumours of financial fraud associated with them.”