Sino-Forest Corp. and its top executives orchestrated one of the largest frauds in Canadian stock market history through a broad-ranging scheme to falsely inflate the company's assets and revenue, Ontario's securities regulator said in a sweeping set of allegations Tuesday.
The Ontario Securities Commission alleges that Sino-Forest, which traded on the Toronto Stock Exchange and was once valued at more than $6-billion, violated provincial securities laws by overstating its financial performance. The regulator said Sino-Forest moved money in a "circular" manner between various corporate entities in a series of complex related-party transactions. It also said the company falsified evidence of ownership for the vast majority of its timber holdings.
The alleged fraud, which includes the unjust enrichment of the company's co-founder, former chairman and CEO Allen Chan through Sino-Forest's purchase of a company he had an undisclosed interest in, marks the biggest black eye for the Canadian capital markets since the Bre-X scandal in the 1990s.
The scope of the alleged fraud has prompted the OSC to widen its probe beyond the activities of Sino-Forest to scrutinize how the company was able to win billions from Canadian investors.
The OSC has now expanded its investigation to include the so-called "gatekeepers," who oversaw the Chinese company's financial statements as well as the lawyers and underwriters who helped Sino-Forest raise money in Canada. "Our investigation is continuing into this matter, including an examination of the role of gatekeepers," OSC enforcement director Tom Atkinson said in a statement.
Between 2006 and 2011, many of Canada's largest bank and brokerage firms helped Sino-Forest raise more than $3-billion from investors eager to tap in to China's soaring growth through the burgeoning forestry industry.
The company's underwriters, lawyers and its auditor Ernst & Young LLC, were all rewarded with fees, but none of them detected the fraudulent activity the OSC alleges was going on at the time.
At its peak, Sino-Forest claimed to control more than 800,000 hectares of timber assets in China and reported revenues of more than $1.9-billion in 2010.
The OSC, in a 33-page statement of allegations, said many of those claims were a lie.
Sino-Forest and five of its former top executives, Mr. Chan, "engaged in numerous deceitful and dishonest courses of conduct...that ultimately caused the assets and revenue derived from the purchase and sale of standing timber (that constituted the majority of Sino-Forest's business) to be fraudulently overstated," the OSC said.
The watchdog also accused Mr. Chan and the five others of misleading staff during its investigation. Yet it remains uncertain if any of the Chinese-based executives will be held accountable if they are found guilty of breaking securities laws. While the OSC can ban foreigners from acting as a director or officer of an Ontario company it has little recourse to collect any fines if the person refuses to pay.
The RCMP has launched a criminal investigation into possible fraud at Sino-Forest, which is domiciled in Canada but headquartered in Hong Kong.
The OSC charges represent the most detailed and damning evidence yet against a once high-flying company that has been shrouded by suspicion for nearly a year.
In a research report published in June of 2011, a previously little-known short seller named Carson Block and his firm Muddy Waters LLC, accused Sino-Forest of engaging in a "massive Ponzi scheme." The report sent Sino-Forest shares into a tailspin.
A subsequent investigation by The Globe and Mail exposed a number of inconsistencies that raised doubts about the company's public statements. Among other things, The Globe found a string of empty regional offices, and spoke to a key Sino-Forest business partner in Yunnan province, who said the company had purchased far fewer trees than the 200,000 hectares promised under a 2007 agreement. Provincial forestry officials who spoke to The Globe also questioned the size and value of Sino-Forest's timber assets.
Sino-Forest executives and the company denied all of the allegations. The company set up an "independent" special committee of directors led by board member William Ardell to investigate. The committee spent nine months and $50-million but said it was unable to unravel Sino-Forest's business practices and its relationships with its business partners.
In its statement of allegations Tuesday, the OSC said Sino-Forest and its executives used "caretakers" or friends and former employees to control many of the company's business partners. The OSC said Sino-Forest used these arrangements to move funds around in a "circular" fashion that inflated the company's revenue and assets.
The OSC did not accuse Sino-Forest's Toronto-based chief financial officer David Horsley of participating in the fraudulent activity but alleges he did not comply with securities laws and acted contrary to the public interest.
A company spokesman declined to comment Tuesday. The company's legal counsel, Mr. Chan's lawyer, Mr. Horsley as well as Ernst & Young did not respond to requests for comment.
Sino-Forest filed for bankruptcy protection from its creditors in March. Its shares have been delisted from the Toronto Stock Exchange.
HIGHLIGHTS OF THE OSC'S ALLEGATIONS AGAINST SINO-FOREST CORP.
Greenheart Group Ltd.
Sino-Forest concluded a deal in 2010 to purchase a controlling interest in Greenheart, a public company listed on the Hong Kong Stock Exchange, for a total of $120-million. The OSC alleges Sino-Forest never disclosed that one of the biggest beneficiaries of that deal was co-founder and then-chairman and CEO Allen Chan. According to OSC allegations, Mr. Chan secretly controlled two holding companies that had an interest in Greenheart, and he allegedly received $22-million in cash and shares from the Greenheart purchase. The OSC alleged that the Sino-Forest shares he received as part of the payment appreciated in value and were later sold for $35-million. To keep the transaction secret, Mr. Chan allegedly sold the shares using a brokerage account opened by his assistant on his instructions.
The OSC alleges Sino-Forest falsified the evidence of ownership for the vast majority of its timber holdings using false documentation, which included the "fraudulent creation of deceitful purchase contracts and sales contracts." The OSC alleges Sino-Forest's management in China secretly created a network of "nominee" or "peripheral" companies without disclosing Sino-Forest's connections to the companies. The companies were controlled by various employees, friends and contacts referred to by the OSC as "caretakers." The forestry firm allegedly did a significant amount of its sales and purchases with these companies without disclosing the links. Some of the biggest deals involved Yuda Wood, a company purported to be Sino-Forest's largest supplier from 2007 to 2010. It was paid $650-million for its timber, but Sino-Forest never disclosed that it secretly controlled Yuda Wood, nor that Yuda Wood was registered and capitalized by members of Sino-Forest's Hong Kong management team.
The OSC dubbed one example of the timber fraud the "Dacheng fraud," alleging Sino-Forest purchased the Dacheng timber plantations in 2008 from a company called Guangxi Dacheng Timber Co. Sino-Forest allegedly recorded the timber assets twice on the records of two different subsidiaries, overstating assets by $30-million in 2008 as a result. In 2009, Sino-Forest "purported" that one of the subsidiaries sold the plantation assets for $48-million. The funds from the falsified sale caused revenue to be overstated by $48-million in 2009, the OSC alleged.
450,000 cubic metres
Sino-Forest bought and sold 450,000 cubic metres of standing timber in late 2009, using companies connected to management, the OSC alleged. In one e-mail, vice-president Simon Yeung allegedly described the purchase and sale of the timber as "a pure accounting arrangement." Three subsidiaries of Sino-Forest were purported to buy the timber for $26-million in October, 2009, and the company alleged it sold the timber shortly afterward to three customers for $33-million or a profit of $7-million. The OSC alleged that the seller and the buyers were "caretaker" companies controlled on behalf of Sino-Forest. By 2010, none of the sale proceeds had been collected, so Sino-Forest devised two offsetting accounting arrangements to make "payments" and recover "payables." The circular transfer of money was done through fake supplier and customer bank accounts set up by Sino-Forest, the OSC alleged.
A Sino-Forest subsidiary purchased land use rights and standing timber in 2007 from Gengma Forestry for $14-million. But the OSC alleges the transaction was never recorded. Instead, Sino-Forest purported the purchase of the same assets from related company Yuda Wood for $68-million in 2007, which was recorded on the books. The OSC said the false recording led to an overstatement of Sino-Forest's timber holdings in 2007, 2008 and 2009. In 2010, the same standing timber was purportedly sold for $231-million. But the same holdings were offered as collateral for a bank loan in 2011, so the sale of the assets could not have taken place in 2010, the OSC alleged.
Sino-Forest recorded acquiring standing timber in Yunnan province from Yuda Wood in 2007 for $21.5-million. The OSC alleged that Yuda Wood did not actually own the timber assets until September, 2008, so could not have sold them in 2007. Sino-Forest later disclosed it sold the timber rights for $49-million in a series of transactions in March, 2008, and November, 2009. The commission said Sino-Forest could not have owned or sold the assets before September, 2008, and overstated its revenue by disclosing the sale in March that year.