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Plantations owned by Sino-Forest are seen in Tang Kong Village, near Gaoyao, Southern China, in 2011.Adam Dean/The Globe and Mail

Former key executives of Sino-Forest Corp. alleged by the Ontario Securities Commission to have engaged in fraud or the violation of securities laws could face as much $84-million in potential penalties, the watchdog has told the company.

According to court documents, the OSC told Sino-Forest recently that it had not yet decided whether to pursue monetary penalties against the former officers and directors that it named in allegations it released earlier this year.

But if it did, the market regulator warned, it could seek up a total of up to $84-million, with between $7-million and $72-million in penalties that "could relate to fraud."

The OSC's allegations against the failed forestry company have not been proven, and a hearing on the case before a tribunal is still a long way off. If the OSC were to prove successful, the penalties would be among the largest it had ever imposed. However, in the past the OSC has only been able to collect a small fraction of its monetary penalties, blaming difficulties in tracing assets. Directors and officers of companies typically have insurance policies that can cover legal costs and in some cases damage awards – but such policies usually do not cover fraud.

The possible penalties were included in a recent report from Sino-Forest's court-appointed monitor, FTI Consulting Canada Ltd., which is overseeing Sino-Forest as it restructures under court protection from its creditors. This week, a judge approved a plan to transfer what remains of Sino-Forest's business assets to a new company, owned by its debtholders, after an external buyer could not be found.

The OSC said it would not seek monetary penalties against the company itself "in light of the substantial losses that stakeholders would potentially suffer," the monitor's report reads.

In May, the OSC issued allegations against the company, Sino-Forest's former chairman and chief executive officer, Allan Chan, as well as four other former executives. The regulator accused them of a "complex fraudulent scheme to inflate the assets and revenue of Sino-Forest" and of making "materially misleading statements in Sino-Forest's public disclosure record related to its primary business."

The OSC also issued allegations against former chief financial officer David Horsley, alleging that he "did not comply with Ontario securities law and acted contrary to the public interest." The OSC has not alleged Mr. Horsley engaged in fraud.

Lawyers for Mr. Chan and Mr. Horsley declined to comment on Wednesday. The OSC also declined to comment.

Last week, the OSC alleged Sino-Forest's former auditor, Ernst & Young LLP, failed to properly scrutinize Sino-Forest's books. The allegations were released as it emerged that Ernst & Young had agreed to a tentative $117-million settlement with investors suing it and Sino-Forest in a potential class action.


The Sino-Forest story

Before the fall

Sino-Forest Corp., with its headquarters in Mississauga, Ont., and its business of buying and selling timber rights in China, was once Canada's largest publicly traded forestry company, with a market capitalization of more than $6-billion. From 2003 to 2010, it raised about $3-billion from investors, who saw the company's stock price on the Toronto Stock Exchange surge by 340 per cent by 2011. The company said it controlled more than 800,000 hectares of forest in China worth more than $3-billion.

Muddy Waters

In June of 2011, Carson Block – a previously little known short-seller behind an investment firm called Muddy Waters LLC – alleged that the company was a "Ponzi scheme," causing Sino-Forest's shares to crash and prompting investigations by the RCMP and the Ontario Securities Commission. The company and its executives denied the allegations. An independent committee of the company's board of directors launched a $50-million, nine-month investigation, but the probe was unable to unravel the company's complex network of business relationships. The shares have since been delisted from the TSX.

The legal mess

Sino-Forest became entangled in overlapping court proceedings. Investors filed numerous potential class action lawsuits in Canada and the United States. The potential Ontario class actions, demanding $9.18-billion from Sino-Forest, key executives and its auditors and Bay Street underwriters, were consolidated into one case led by lawyers from Siskinds LLP and Koskie Minsky LLP. In March of this year, Sino-Forest sought court protection from its creditors. And in May, the OSC alleged that the company and some of its executives had engaged in fraud. The allegations must go to a hearing before a tribunal, and have not been proven.

What's left

This week, the Ontario judge overseeing Sino-Forest's restructuring approved a plan to transfer the company's assets to a new company, owned by the holders of $1.8-billion of Sino-Forest debt. The deal is subject to conditions and is not expected to close until at least January. The move comes after an attempt to sell the assets failed. According to court filings, Sino-Forest's court-appointed monitor has not been able to track down several Chinese companies said to owe Sino-Forest subsidiaries millions of dollars. The monitor said in July that three Chinese entities that owed more than $500-million were no longer in business. And of the 800,000 hectares of Chinese forest Sino-Forest says it controls, an independent company successfully verified just 8 per cent before work was halted.

Jeff Gray