Lumber workers process Yunnan pine at the Gengma Forest Product Corp. Ltd. lumber yard in Gengma, Yunnan Province, China on June 10, 2011. Sino-Panel, a subsidiary of Sino-Forest, purchased forest land from Gengma Forest Product Corp. Ltd. and used the processing factory.Adam Dean
"Muddy waters make it easy to catch fish," allegedly a Chinese proverb, is not a self-evident truth. Muddy Waters Research, which takes this as its motto, is using inflammatory rhetoric in its questionable allegations about Sino-Forest Corp. The waters which Sino-Forest, and other Chinese companies listed on North American stock exchanges, navigate may yet attain greater clarity, which is why the Ontario Securities Commission's announcement last week that it is looking into "matters" to do with Sino-Forest is welcome - as is the company's own engagement of PricewaterhouseCoopers to examine the allegations.
Similarly welcome is the U.S. Securities and Exchange Commission's bulletin last week recommending caution about companies that have gone through "reverse mergers" or "reverse takeovers," a technique by which private companies cause themselves to be taken over by public companies, thus obtaining listings without going to the trouble of initial public offerings. That is how Sino-Forest came to the Alberta Stock Exchange and the Toronto Venture Exchange in 1994 and 1995.
Carson S. Block of Muddy Waters' relentlessly hyperbolic comparisons of Sino-Forest to Bernard Madoff and Ponzi schemes, and his relentless repetition of the word "fraud," undermine his own credibility, even if he eventually turns out to be right.
But Sino-Forest might well have spared itself much grief, if its 2010 financial report had supplied a clear picture of its relationship with its "authorized intermediaries" in China - customers, or distributors in the actual sale of its wood. The status of these intermediaries, only fleetingly mentioned in the financial report (and mostly in the technical context of Chinese tax policy and contingent liabilities), is among Mr. Block's main targets. They evidently are an essential element in Sino-Forest's way of doing business in China, and that may be normal there. A more integrated approach may in the end be desirable. In any case, investors are entitled to a fuller account of how the company actually works.
Any shortage of transparency in the businesses of Canadian-listed companies in China is likely to increasingly spook investors.
Canadians should not retreat from China; instead, they should strive for a better understanding of Chinese businesses - and business practices - and Chinese firms should help by making themselves less muddy and more intelligible.