On July 14, 2017 the Ontario Securities Commission (“OSC”) published its 278-page decision respecting Sino-Forest. The panel found that the respondents, former CEO Allan Chan and three other executives of Sino-Forest Corporation – Alfred Hung, George Ho and Albert Ip breached Ontario securities laws. Allen Chan was a co-founder of Sino-Forest and Chairman of the Board and CEO of Sino-Forest. The OSC found that Chan, together with three other executives, committed fraud. The panel found that Simon Yeung misled OSC staff during the investigation but the other allegations against him were dismissed.
The decision comes six years after short seller Muddy Waters first raised issues about Sino–Forest. Sino-Forest was a commercial forest plantation operator in the People’s Republic of China. Its principal businesses were described as the ownership and management of tree plantations, the sale of standing timber and wood logs, and the complementary manufacturing of downstream engineered-wood products. The majority of Sino-Forest’s business was in standing timber. Following the release of the Muddy Waters Report, Sino-Forest shares plummeted. The OSC issued a cease trade order in August 2011 and on May 9, 2012, the TSX delisted Sino-Forest’s shares.
Between February 2003 and October 2010, Sino-Forest raised approximately US $3.0 billion from investors by issuing debt and equity securities. By March 31, 2011, Sino-Forest’s market capitalization was over C$6 billion. On June 2, 2011, Muddy Waters, LLC, a short-seller with a short position in Sino-Forest shares, released a report that alleged Sino-Forest was a “near total fraud” and a “Ponzi scheme”. The panel agreed and found that Sino-Forest and four of the five executives engaged in deceitful and dishonest conduct related to Sino-Forest’s standing timber assets and revenue that constituted fraud, contrary to subsection 126.1(b) of the Securities Act.
The panel held that public disclosure regarding Sino-Forest’s ownership of assets and revenue recognition was misleading, untrue or did not state facts that were necessary to make the statements not misleading contrary to subsection 122(1)(b) of the Securities Act. The panel also found that four of the five executives misled the Commission during its investigation, contrary to subsection 122(1)(a) of the Securities Act.
Sino-Forest’s deceitful disclosure included the following: (a) concealing key facts, (b) overstatement of assets and revenue, (c) creating documents to deceive CFO and auditors, (d) backdating of contracts post-quarter-end; (e) providing insufficient proof of ownership of assets, and (f) failing to identify the specific assets being acquired, such that the standing timber could be independently verified. According to the panel, the deceitful disclosure put the financial interests of its investors at risk.
The OSC panel found that to establish the requisite intent of a corporation to commit fraud, it is sufficient to show its directing mind(s) knew or reasonably ought to have known the acts of the corporation perpetrated a fraud. Chan was the directing mind of Sino-Forest. The Panel found that Chan never disclosed any interests and conflicts of interest in several transactions with a non-arm’s length company to the Board of Directors of Sino-Forest, or the investors before, during or after the transactions and that the investors’ interests were put at risk by Chan’s failure to disclose his interests and conflicts of interest.
According to the panel, investors need to be able to rely on the accuracy and truthfulness of the public disclosure documents of issuers so they can reliably base their investment decisions on this disclosure. In the absence of this required and truthful disclosure, Sino-Forest investors were unable to make informed investment decisions. As a result, their pecuniary interests were put at risk. The panel found therefore that Sino-Forest engaged in deceitful and dishonest conduct related to its standing timber assets and revenue that constituted fraud, contrary to subsection 126.1(b) of the Securities Act.
The OSC panel found that Chan’s conduct did not meet the standard of a reasonably competent Chief Executive Officer acting in similar circumstances at the time. Chan was deeply involved in the day-to-day operations of Sino-Forest. It was Chan’s responsibility to ensure that Sino-Forest complied with Ontario securities law.
The panel rejected expert testimony that the illegal conduct was not fraud but rather in accordance with the Chinese customary practice of “guanxi”, which was described as “drawing on connections in order to secure favours and reciprocal obligations, is based on intricate and pervasive relational networks”. They found that the evidence was something more than a cultural difference and stated that: “For the purpose of our analysis, Ontario securities law is paramount and overrides any explanation for illegal conduct being excusable in the name of “guanxi” however defined.”
At the time of writing, a hearing to determine appropriate sanctions for the respondents is yet to be scheduled.
The reasons of the OSC panel can be found at http://www.osc.gov.on.ca/documents/en/Proceedings-RAD/rad_20170713_sino-forest.pdf on the website of the Ontario Securities Commission.
For more information, please call Barbara Hendrickson at BAX Securities Law (416) 601 -1004.
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