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Once the largest forestry company on the TSX, now-defunct firm Sino-Forest is being investigated for allegations of misrepresenting its holdings, such as this plantation in southern China.

Adam Dean/The Globe and Mail

The Ontario Securities Commission will lay out its fraud case against collapsed forestry giant Sino-Forest Corp. and some of the company's former key executives on Tuesday, as a hearing begins on the largest corporate fraud allegations to hit Bay Street since the Bre-X gold scandal.

The high-profile proceedings are a key test for the province's financial markets regulator, as it takes on a murky and massively complex case that involves millions of documents and a tangled web of entities in China, where Sino-Forest claimed to control $3-billion worth of timber assets.

"It's an important case. People are looking to the OSC to ensure that investor rights are being protected," said Jonathan Ptak, a Toronto lawyer with Koskie Minsky LLP who acts for Sino-Forest shareholders in a $9-billion class-action lawsuit against the company, some of its former executives, and its Bay Street underwriters and auditors.

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Comparisons have been made to the Bre-X Minerals Ltd. case, which rocked Bay Street in the 1990s after its gold-drilling results in Indonesia were faked. That time, the OSC ended up empty handed, after Bre-X geologist John Felderhof, the only person ever charged, was acquitted in 2007.

And like Bre-X, Sino-Forest became wildly popular with investors with promises of riches based on assets in faraway Asia. The Mississauga-based firm raised some $3-billion from investors in just a few years to become the largest forestry company listed on the Toronto Stock Exchange, with a market capitalization of $6-billion.

But Sino-Forest's shares came crashing down after a previously unknown short-seller, Carson Block, of research firm Muddy Waters LLC, alleged the company was a "Ponzi scheme" in June 2011, charging that the company's timber assets were inflated.

At the time, the company's Hong Kong-based founder, Allen Chan, denied the allegations and pledged to give Bay Street analysts a tour of some of the company's holdings in China to prove his case. But the tour never happened. Even a special committee of the company's board, set up to clear the air, had trouble verifying some of the company's business dealings.

In May of 2012, the OSC alleged the company and some of its former executives were involved in a "complex fraudulent scheme to inflate the assets and revenue of Sino-Forest," made "materially misleading statements" and "falsified the evidence of ownership for the vast majority of its timber holdings by engaging in a deceitful documentation process." The scheme allegedly involved transactions between companies that Sino-Forest secretly controlled.

The allegations have not been proved. The company went into bankruptcy protection in 2012, and its assets were handed over to its debt-holders after no buyers could be found.

An RCMP investigation was also launched into Sino-Forest but no charges have been laid. The Sino-Forest hearing, unlike the Bre-X trial, is not a criminal proceeding, as it takes place before a three-member panel of the Ontario Securities Commission. This means the OSC has a lower burden of proof, but it also means those facing allegations do not face jail time. The regulator has said it could seek up to $84-million in monetary penalties. The former executives could also face lifetime bans from trading or serving as officers or directors of public companies.

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Former chief financial officer David Horsley, the only senior figure facing allegations who was a Canadian citizen, settled with the OSC in July and has agreed to testify at Tuesday's hearing. Unlike the others, Mr. Horsley was never alleged to have committed fraud. But in his settlement, he admitted that his lack of due diligence allowed the company to make "materially misleading disclosures" to investors.

His deal with the OSC bans him from serving as a director or officer of a public company and forces him to pay $700,000 to the regulator and $5.6-million to Sino-Forest investors.

The OSC also alleges that Sino-Forest auditor Ernst & Young LLP failed to properly scrutinize Sino-Forest's books, and will hold a separate hearing starting this fall. The auditor denies the allegations. In 2012, it agreed to pay $117-million, without acknowledging wrongdoing, to settle allegations in the Sino-Forest investor class action – the largest Canadian settlement ever with an auditor in such a case.

The OSC's Sino-Forest hearing is scheduled to continue until the end of June 2015.

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