OSC alleges fraud at Sino-Forest, widens probe beyond company
ANDY HOFFMAN AND JANET McFARLAND
VANCOUVER, TORONTO— From Wednesday's Globe and Mail
Published Tuesday, May. 22, 2012 12:03PM EDT
Last updated Tuesday, May. 22, 2012 7:57PM EDT

Sino-Forest Corp. and its top executives orchestrated one of the largest frauds in Canadian stock market history through a broad-ranging scheme to falsely inflate the company’s assets and revenue, Ontario’s securities regulator said in a sweeping set of allegations Tuesday.

The Ontario Securities Commission alleges that Sino-Forest, which traded on the Toronto Stock Exchange and was once valued at more than $6-billion, violated provincial securities laws by overstating its financial performance. The regulator said Sino-Forest moved money in a “circular” manner between various corporate entities in a series of complex related-party transactions. It also said the company falsified evidence of ownership for the vast majority of its timber holdings.

The alleged fraud, which includes the unjust enrichment of the company’s co-founder, former chairman and CEO Allen Chan through Sino-Forest’s purchase of a company he had an undisclosed interest in, marks the biggest black eye for the Canadian capital markets since the Bre-X scandal in the 1990s.

The scope of the alleged fraud has prompted the OSC to widen its probe beyond the activities of Sino-Forest to scrutinize how the company was able to win billions from Canadian investors.

The OSC has now expanded its investigation to include the so-called “gatekeepers,” who oversaw the Chinese company’s financial statements as well as the lawyers and underwriters who helped Sino-Forest raise money in Canada. “Our investigation is continuing into this matter, including an examination of the role of gatekeepers,” OSC enforcement director Tom Atkinson said in a statement.

Between 2006 and 2011, many of Canada’s largest bank and brokerage firms helped Sino-Forest raise more than $3-billion from investors eager to tap in to China’s soaring growth through the burgeoning forestry industry.

The company’s underwriters, lawyers and its auditor Ernst & Young LLC, were all rewarded with fees, but none of them detected the fraudulent activity the OSC alleges was going on at the time.

At its peak, Sino-Forest claimed to control more than 800,000 hectares of timber assets in China and reported revenues of more than $1.9-billion in 2010.

The OSC, in a 33-page statement of allegations, said many of those claims were a lie.

Sino-Forest and five of its former top executives, Mr. Chan, “engaged in numerous deceitful and dishonest courses of conduct...that ultimately caused the assets and revenue derived from the purchase and sale of standing timber (that constituted the majority of Sino-Forest’s business) to be fraudulently overstated,” the OSC said.

The watchdog also accused Mr. Chan and the five others of misleading staff during its investigation. Yet it remains uncertain if any of the Chinese-based executives will be held accountable if they are found guilty of breaking securities laws. While the OSC can ban foreigners from acting as a director or officer of an Ontario company it has little recourse to collect any fines if the person refuses to pay.

The RCMP has launched a criminal investigation into possible fraud at Sino-Forest, which is domiciled in Canada but headquartered in Hong Kong.

The OSC charges represent the most detailed and damning evidence yet against a once high-flying company that has been shrouded by suspicion for nearly a year.

In a research report published in June of 2011, a previously little-known short seller named Carson Block and his firm Muddy Waters LLC, accused Sino-Forest of engaging in a “massive Ponzi scheme.” The report sent Sino-Forest shares into a tailspin.

A subsequent investigation by The Globe and Mail exposed a number of inconsistencies that raised doubts about the company’s public statements. Among other things, The Globe found a string of empty regional offices, and spoke to a key Sino-Forest business partner in Yunnan province, who said the company had purchased far fewer trees than the 200,000 hectares promised under a 2007 agreement. Provincial forestry officials who spoke to The Globe also questioned the size and value of Sino-Forest’s timber assets.

Sino-Forest executives and the company denied all of the allegations. The company set up an “independent” special committee of directors led by board member William Ardell to investigate. The committee spent nine months and $50-million but said it was unable to unravel Sino-Forest’s business practices and its relationships with its business partners.

In its statement of allegations Tuesday, the OSC said Sino-Forest and its executives used “caretakers” or friends and former employees to control many of the company’s business partners. The OSC said Sino-Forest used these arrangements to move funds around in a “circular” fashion that inflated the company’s revenue and assets.

The OSC did not accuse Sino-Forest’s Toronto-based chief financial officer David Horsley of participating in the fraudulent activity but alleges he did not comply with securities laws and acted contrary to the public interest.

A company spokesman declined to comment Tuesday. The company’s legal counsel, Mr. Chan’s lawyer, Mr. Horsley as well as Ernst & Young did not respond to requests for comment.

Sino-Forest filed for bankruptcy protection from its creditors in March. Its shares have been delisted from the Toronto Stock Exchange.