The fraud at Sino-Forest Corp. was a "disaster" caused by the "deceitful conduct" of the forestry company's management team in China, an Ontario Securities Commission lawyer alleged Tuesday.
The long-awaited Sino-Forest fraud hearing launched before an OSC panel in a packed hearing room in Toronto, where some people were turned away because there were not enough seats. The case is the largest fraud to be prosecuted by the commission since the Bre-X Minerals Ltd. case, which concluded in 2007.
OSC lawyer Hugh Craig said commission staff will show that five senior executives of Sino-Forest based in China committed fraud and materially misled investors by significantly overstating Sino-Forest's revenues and assets between 2007 and 2010.
"Once a $6-billion company, Sino-Forest was a disaster for investors in Canada and elsewhere," Mr. Craig said in his opening statement.
He said the company's executives misled investors with false financial statements in every quarter from 2007 to 2010.
"Due to lies, no investor could make an informed decision about whether or not to buy or sell Sino-Forest securities," Mr. Craig alleged.
The accused in the case are former chief executive officer Allen Chan and former executives Albert Ip, Alfred Hung, George Ho and Simon Yeung.
None of the five former executives appeared at the hearing Tuesday. All are based in China, and are represented by Canadian lawyers. Sino-Forest itself is also named in the case, but has wound up operations and has opted not to present a defence in the case, Mr. Craig said.
He said the OSC's expected witnesses in the case include three former executives and three former directors from the board of Sino-Forest. The OSC also plans to call three junior employees of the company, including the former executive assistant to Mr. Chan.
Lawyer Markus Koehnen, who is representing four of the Chinese executives named in the OSC case, also told the hearing Tuesday he expects his clients to testify in person at the hearing. Lawyer Emily Cole, who is representing Mr. Chan, did not indicate whether her client will also testify in his own defence.
Sino-Forest claimed to have $5.7-billion of timber assets in China and revenue of $1.9-billion in 2010, but the OSC alleges those valuations were false and inflated.
Mr. Craig said Sino-Forest never disclosed to investors the extent to which it relied on a complex financial structure in which most of its timber assets were bought, sold and held through wholly owned subsidiaries located in the British Virgin Islands. The BVI subsidiaries owned 80 per cent of Sino-Forest's timber holdings and accounted for 94 per cent of standing timber revenue between 2007 and 2010, he said.
Those subsidiaries did many of their transactions "off book" using transactions that were not recorded and were difficult to track or independently audit, Mr. Craig alleged. He said Mr. Hung co-ordinated billions of dollars worth of off-book transactions using information provided by Mr. Ip.
Auditors at Ernst & Young could not independently confirm the cash flows had happened or that the revenue was properly recognized because of the way the BVI entities operated, Mr. Craig alleged. When the company's audit committee raised concerns about the structure with Mr. Chan, "he did not fix the problem – this key weakness remained," he alleged.
Mr. Craig said bondholders who took control of Sino-Forest's remaining assets after the company filed for court protection in 2012 reported in financial statements filed in June, 2014, that the timber holdings of those BVI-based companies were assessed at zero value.
Mr. Craig alleged Sino-Forest officials routinely backdated purchases and sales of timber to the prior quarter, which means they were recorded as having occurred before they ever actually were done.
He said evidence at the hearing will show that sales contracts claimed to include independent land survey reports, but the survey company was partly owned by a Sino-Forest official, and the surveys turned out to be inadequate to identify where the trees were located.
He said the purchase contracts also had attachments purporting to be confirmations of sales from the Chinese forestry bureau, but instead the confirmations were created by Sino-Forest personnel using a standard template. The contracts also said Sino-Forest had authorizations from farmers, but they were not attached to the contracts, Mr. Craig said.
The OSC will also show that Sino-Forest or its executives controlled key aspects of the business of two of the company's biggest suppliers without disclosing those connections, Mr. Craig said.
He said the panel will hear that Mr. Chan's assistant, Yosanda Chiang, had a file on her computer containing a list of allegedly external companies that, in fact, Sino-Forest appeared to control. Each had a "caretaker" named who oversaw the companies.
Mr. Craig also outlined allegations that Mr. Chan was involved in a complex scheme involving a purchase of forestry concessions in South America. Sino-Forest bought the concessions for $120-million from a company controlled by various vendors, including two firms that the OSC alleges were connected to Mr. Chan. Those connections were not disclosed publicly, Mr. Craig said.
Mr. Craig urged the hearing panel, headed by OSC commissioner James Carnwath, not to listen to arguments that business practices are different in China. He said Sino-Forest was based in Canada and operated under Canadian securities laws.
"This is where the culture of accountability must be recognized," he said.