China's Shadow Banking

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In a part of the country that is still underdeveloped, Zeng was mobilizing local resources to build up Jishou. He claimed that he routinely disclosed the extent of his fundraising to officials at the municipal administration and the prefecture government, and was never told to cease. "All the fundraising activities of my company are open to the public," Zeng wrote in the 2009 letter. "The relevant departments and people know it thoroughly. The leaders in the prefecture and the municipal government know it too. The officials acquiesced to it." Many Jishou citizens believe that too. "The local government encouraged us" to lend to the shadow bankers, says retiree Wang Zumin, who used to work in a state hardware company. Still, without official sanction, Zeng was operating in a corner of the economy where the line between illegal and legal is blurred. As Zeng would discover, what China's bureaucrats might tolerate at one point, they can oppose the next — with dire consequences.

Trial by Jail
The beginning of the end for Zeng came when officials in Jishou had a drastic change of heart about shadow banking. Suddenly, in 2008, they decided to rein in Zeng and others engaged in public fundraising. Perhaps the bureaucrats were concerned about how pervasive the practice had become. The first salvo of the crackdown was an edict prohibiting civil servants from participating in shadow-banking schemes run by Zeng and others. The order also caused an immediate stampede of withdrawals from the funds managed by Zeng and other entrepreneurs, seriously destabilizing their finances and forcing them to raise replacement cash from the citizenry even more aggressively. Shortly afterward, one company engaged in public fundraising admitted it couldn't pay back its creditors. That sparked a panic in Jishou in early September. Fearing the loss of their hard-earned savings, an angry mob massed in central Jishou to demand payment, flooding into the train station and blocking rail traffic. Jishou authorities had to call in riot police.

The unrest seemed to have further convinced Jishou's cadres that shadow banking had to be quashed. On Oct. 2, 2008, Zeng was called into a meeting with Jishou officials — and then vanished. "My father was summoned to a meeting, and he never came back," his daughter Zeng Shan recalls. For two months, Zeng's family had no idea what had happened to him. They eventually found out that he had been arrested. Local authorities scooped up Zeng and executives at 21 other businesses allegedly engaged in shadow banking all on the same day, according to state media reports.

In public court documents, prosecutors said Zeng invested only a fraction of the some $560 million he raised from the public and that he owed creditors about $130 million. Nearly $45 million was improperly transferred from the company by Zeng and his family, the prosecutors contended, including about $2.5 million that Zeng hid for himself. By the prosecutors' reckoning, Zeng not only raised funds illegally from the public but also committed fraud by misrepresenting his business. (He was convicted on both counts.) Rather than the promising company he marketed to Jishou's citizens, the prosecutors asserted, Zeng was running a Ponzi scheme, luring unsophisticated local residents into lending him money by promising high rates of return, then passing the incoming cash to other creditors. "His activities have violated China's financial order, caused damage to citizens' property rights and had a serious effect on local social stability," the Supreme People's Court in Beijing explained in its decision approving Zeng's execution. "His crime is very severe."

Peter Wang, Zeng's lawyer, disputes the charges against his client. Wang says Zeng intended to pay back all of his creditors and was unable to do so because he was arrested before his major projects were completed. The lawyer contends that the assets of Zeng's company were worth nearly $400 million, more than sufficient to cover any outstanding claims. The courts, Wang argues, did not have a proper assessment of the value of Zeng's property developments when reaching their verdict. Wang also insists that Zeng was not running a Ponzi scheme, but operating "like a bank," by utilizing some funds to meet his commitments while employing the rest into his investments. Nor did Zeng pocket any of the creditors' funds for himself, Wang says. "I did not transfer or illegally take money," Zeng wrote in one letter from his jail cell. "Except to pay back the investors, all the money I raised was used in the [real estate] projects." Wang also contests Zeng's death sentence. Even if Zeng were found guilty of illegal fundraising, that alone, he says, is not sufficient to warrant capital punishment under Chinese law. According to Wang, there was no fraud in Zeng's case, so, he says, the courts should not have condemned him to death.