New breed of "private equity" scams target China retail investors

SHANGHAI Wed Feb 27, 2013 4:01pm EST

SHANGHAI Feb 28 (Reuters) - Thousands of retail investors in the Chinese city of Tianjin say they were tricked out of more than $500 million by sellers of illegal wealth management products - part of a growing problem stemming from China's rush to develop its private equity sector.

Scam private equity businesses mushroomed in China after a government drive to promote the industry in 2009, leading to a flood of licences for new firms issued without proper regulation.

While private equity is generally the preserve of a small pool of wealthy individuals or institutions, these scams have targeted ordinary small investors, leaving thousands angry and in some cases taking to the streets to protest.

Interviews carried out by Reuters with dozens of victims across five cities paint a picture of fraudulent private equity schemes that is much wider than official accounts or local media reports have previously portrayed.

"It's a huge problem in China," said Long Zan, a sales consultant at China Marketing Association, adding he has seen many salespeople recently selling what they claim to be private equity products, many of which are illegal. "What has been uncovered is just a tip of the iceberg."

At the heart of the issue is the lack of investment options given to retail investors.

China's tight capital controls limit overseas investments, while a ban on property speculation and a sluggish stock market have made many look elsewhere for returns. The huge profits reaped by legitimate private equity operators in China through taking companies public on booming IPO markets in recent years also lured investors to fraudulent schemes.

Latest official data shows 10,000 cases of illegal fundraisings - which also include lending and other financial activities - were uncovered between 2005-10, with combined losses of around 100 billion yuan ($16 billion). While the government has not disclosed detailed data, Reuters calculations based on victims' accounts, indicate losses of at least 100 billion yuan from private equity scams alone.

DEMANDING COMPENSATION

In Tianjin, in the north, more than 14,000 people submitted a petition to the central government demanding compensation for losing a combined 3.4 billion yuan ($544.8 million) from scams in the city. Reuters was shown a copy of the letter in October.

"Frauds of this scale are not a problem of any one company ... the government has inescapable responsibilities," said the letter, sent to the Tianjin government as well as to the State Council, China's cabinet, around July last year. "The current situation is the result of lax government supervision."

The authorities have so far blamed investors for their own greed and misjudgement. An official at the Tianjin government in charge of dealing with illegal fundraising said investors lost money because they were blinded by the promise of stellar returns.

Thousands of private equity fraud victims have taken to the streets in Beijing, Tianjin and Nanjing, demanding government compensation for their losses. In some cases, riot police had to be called in to control the scene.

"I lost everything," said Chen Ende, a former real estate agent who lost nearly 3 million yuan, including some money he borrowed from friends, in a private equity scam. "The government must pay."

CONFIDENCE DENTED

Confidence in Chinese wealth management products has already been dented by problems in the ballooning shadow banking sector. In one example, in December, a product sold through Hua Xia Bank failed to pay its annualised return as promised, sparking protests outside the bank's Shanghai branch.

But while those cases involved legal investment products that went bad, the private equity scams generally involve the selling of products that breach rules intended to restrict participation in the sector - such as a requirement that PE funds should have no more than 200 investors and that the minimum investment should be at least 2 million yuan.

China Marketing Association's Long estimates there are at least 5,000 purported private equity schemes currently operating illegally across China.

The Beijing Private Equity Association, an industry group, was so concerned that it warned in October that illegal fundraisers masquerading as private equity firms had "seriously endangered social and financial stability" as it launched a campaign to educate investors about PE.

"Private equity was red hot a few years ago, but many people don't really understand what PE is, so cheaters took advantage," said spokeswoman Chen Kemang.

The number of private equity firms with official business licences soared from a handful in 2007 to about 4,000 by 2012 after local authorities in Tianjin, Shanghai and Chongqing actively began to attract funds in response to calls from the central government to develop the sector. But lax supervision that accompanied the boom has resulted in fraudulent firms operating with official business permits.

"Why did the government issue licences to those cheaters in the first place?" said retired shop assistant Mou Shanyun, who lost her life savings of 500,000 yuan investing in a coal mine project that turned out to be a scam.

She was first approached by a saleswomen from private equity firm Sheng Hua Group which promised annualised returns of 15 percent in a coal mine investment with guaranteed capital, plus stock options once the mine got listed. Sceptical at first, her doubts were eased once she visited the luxurious premises of the firm's Hangzhou office and saw photographs of its managers with local government officials, and copies of its official business licences.

"I wouldn't have invested if I had not trusted the Communist Party," she said.

A police official in Tianjin said authorities have detained executives of Sheng Hua Group, as well as other private equity firms such as Sheng Shi Fu Bang Equity Investment Co, Huolimu Equity Investment Fund and Tiankai Xinsheng Equity Investment Fund, on suspicion of fraud. Their offices have been shut down while they await trial.

Calls to the firms' listed telephone numbers could not be connected.

($1 = 6.2339 Chinese yuan) (Additional reporting by Stephen Alred in Hong Kong; Editing by Alex Richardson)