Norm Betts/Bloomberg NewsThe price of Sino-Forest shares, seen on the Toronto exchange in June, plummeted after Muddy Waters Research said the company was a fraud.
7:44 p.m. | Updated
OTTAWA — Canada’s top securities regulator on Friday accused a Chinese forestry company of fraudulently inflating its revenue and exaggerating the extent of its timber holdings.
The regulator suspended trading for 15 days in shares of the company, Sino-Forest, which trades on the Toronto Stock Exchange. But its directive came amid some confusion. The Ontario Securities Commission at first took the very unusual step of ordering five directors and officers of Sino-Forest to resign — only to rescind that demand just hours later.
Wendy Dey, a spokeswoman for the regulator, said that the order against the executives, which included Allen T. Y. Chan, the chairman and chief executive of Sino-Forest, was reversed after the commission determined that it could not force their resignations without holding a hearing.
Chris Nicholls, a professor specializing in securities law at the University of Western Ontario, said that he could not recall the commission previously trying to remove corporate officials without a hearing. “But that’s probably because they can’t do it,” he added. “Clearly there was some mistake.”
Sino-Forest has been the subject of considerable controversy since June, when Muddy Waters Research issued a report by a short-seller, Carson Brock, that called the company a “multibillion-dollar Ponzi scheme” that was “accompanied by substantial theft.”
A reporter for The Globe and Mail of Toronto subsequently spent two weeks visiting various properties ostensibly owned or controlled by Sino-Forest and its subsidiaries. It proved to be a trek that frequently led him to nonexistent addresses and empty offices. Like Muddy Waters, the newspaper also found evidence that Sino-Forest had greatly inflated the size of its forestry assets.
After the accusations, Sino-Forest’s stock price tumbled and the hedge fund manager John Paulson, who had been one of the company’s largest shareholders, dumped his shares. His hedge fund, Paulson Company, which had owned 35 million shares, is estimated to have lost nearly $500 million on Sino-Forest.
Neither Sino-Forest nor its public relations agency would provide comment about the order on Friday.
While Sino-Forest initially rejected the assessment of Muddy Waters and dismissed The Globe and Mail’s article, it did appoint a independent committee of directors to review the accusations. Earlier this month, it said that the review was taking longer than first anticipated because of, among other things, “challenges associated with the sourcing and verification of data in China.”
The securities commission offered no specific details about the reasons for its decision. But in addition to finding that Sino-Forest might have inflated what it owns as well its revenue, its investigators found that the company “appears to have engaged in significant non-arm’s-length transactions.” The commission now has 15 days to hold a hearing if it wants to extend the trading ban or impose the forced resignations.
According to the commission, Sino-Forest has raised about $3 billion through stock and bond issues in Ontario.
The Toronto Stock Exchange has sought to maintain its position as a center for the trading of shares in resource-based companies by actively seeking listings from overseas operations. Even before the concerns about Sino-Forest were raised, there have been questions over how North American investors can accurately assess claims made about the value of mining, energy and timber properties in remote parts of the world that are controlled by overseas corporations.
Many of those overseas companies, including Sino-Forest, now trade in Canada because they have taken over a dormant company with a Canadian stock listing. That allows them to list without first filing a prospectus.
Canadian regulators have begun an investigation into such reverse-merger companies, while the United States Securities and Exchange Commission issued a warning in June about investing in these companies.
Muddy Waters’ accusations fell into two broad categories. It claimed that Sino-Forest was fabricating lumber sales through a complex series of interrelated companies, including at least 20 corporations registered in the British Virgin Islands. At the same time, the research report said that Sino-Forest had greatly inflated the value of its timber lands, again through complicated transactions.
The company’s auditors — Ernst Young Canada — did not detect these practices, Muddy Waters claimed, because of geographical and cultural differences. The firm did not respond to a request for comment.
“When the auditors are based in Canada, and the fraud is in China, the auditors are far less versed in the games fraudsters can play in China,” the report said.
In addition to Mr. Chan, the commission initially demanded the resignations of Albert Ip, senior vice president development and operations for Northeast and Southwest China; Alfred C. T. Hung, vice president for corporate planning and banking; George Ho, vice president of finance; and Simon Yeung, an executive with a Sino-Forest subsidiary.
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