“A Tale of Two Cities” is befalling on Sino Forest. As in the world-famous novel by Charles Dickens, the Chinese company sees its destiny split between two cities. In Toronto, the Ontario Securities Commission launched a probe into Sino Forest’s activities. The company’s share value dropped from C$ 18,21, to C$ 4,92 in the space of a few days and trading was suspended on June 8. Losses by shareholders are equivalent to many millions of dollars. At the HKSE, shares of the Greenheart group were also dragged down dramatically because of fraud allegations by its parent company, i.e. Sino Forest. The Chinese giant owns forests and plantations all over China.
Its list of investors includes the billionaire John Paulson with his powerful hedge fund. Greenheart also owns land plots in New Zealand and the Guayanas. Massive short-selling of its shares ignited their drop in value in both the China and HK markets. A report released by the Hong Kong-based, financial analysis company, Muddy Waters, was the spark. The document was a strong blow to Sino Forest, accused of overstating the value of its assets. Results declared on its “reverse listing” and IPO process over the size and value of its land properties, according to Muddy Waters, do not add up. Reverse listing is a shortcut to access North American stock exchanges. It is sufficient to buy an empty OTC (over the counter) company, to quickly move it to the NYSE or Nasdaq.
In this manner, it is possible to by-pass the China Securities Regulatory Commission (CSRC) and the Security Exchange Commission (SEC) with their severe disciplines imposed on new IPOs. Roughly two thirds of more than 200 Chinese companies, listed at either the NYSE or the Nasdaq, have used reverse listing. Last week, SEC increased its scrutiny and suspended trading of twelve Chinese companies for lack of “current, accurate information”. Prominent US financial companies in addition to Paulson – Carlyle, Fidelity, Tiger, Putnam, Vanguard – have invested in mid-cap Chinese companies listed in New York. They wanted China exposure while sitting in their US offices. The share price of many Chinese mid-cap companies has dropped to such low P/E ratios as compared to HKSE or SSE that the entire system of financial decision-making has become very debatable and uncertain. Symmetrically, Chinese authorities have launched a probe on several small and unknown US merchant banks – not legally registered in China – which supported easy listing in New York to Chinese entrepreneurs through a reverse listing process. Muddy Waters claims it appointed private investigators to detect irregularities, to take photos pictures of land and forestry and interview officials of local governments, while its tracker dogs examined balance sheets and transactions.
Apparently, they discovered that Sino Forest owns only 20,000 hectares of land in the Yunan Province, instead of the 190,000 it officially claims to own. The Chinese company denies any wrongdoing. Carson Block, the man behind Muddy Waters, is a brilliant, 35-year-old, ex corporate lawyer. A strong believer of transparency, some years ago, he started to campaign against obscure information and irregularities. His major weapon is a combination of investigative journalism and analytical competence.
Muddy Waters comes from an old Chinese proverb, which quotes “in order to catch the fish, (in this case, the truth), you must fill the water with mud”. Before his report became public, Mr. Block apparently shorted the same shares he was investigating on, and profited handsomely without anyone objecting. The leading New York financial analysts did not realize that the best way to examine a Chinese company is to use Chinese eyes. CRSC is, in fact, so severe that many Chinese entrepreneurs did not hesitate to seek IPOs’ in New York, where controls are less rigorous. It is almost impossible to determine which system is to be blamed, the Chinese or the American one.
However, the uproar and devastating economic consequences of the Sino Forest/Muddy Waters case should induce us to re-examine corporate laws worldwide so as to understand whether the current state of the art in internet and social networking should oblige us to review the shape and the perimeter of certain criminal and civil liabilities such as those connected to insider trading and market manipulation, for example.
In other words, shouldn’t the unstoppable revolution which is replacing the way we exchange data and information relating to our daily life in business and to our most intimate private life, force us to re-think, on ethical and legal grounds, how to react and redraft our “rules of the game”? Deferring the matter to a later date might be fatal.