Carlyle's China problem: some questions for David Rubenstein

I have spent considerable time pondering dumb deals done by Carlyle in China. Indeed I wrote a post that suggested that Carlyle's dumb-deals might be the start of the undoing of the China private equity business generally.

But I have spent more time wondering why Carlyle does nothing to patch what will shortly be a sinking ship.

My post (Guanxi vs Analyst) prompted the only public response I have ever induced from Carlyle - when the Carlyle Managing Director David Rubenstein dismissed my concerns in the Financial Times. To quote the FT:

David Rubenstein, co-founder of Carlyle, the US private equity group, has hit back at critics of two troubled Chinese investments, arguing that the amount involved is “insignificant” compared with its $3bn investments in Asia’s biggest economy. 

Mr Rubenstein, one of the world’s best-known private equity deal makers, told the Financial Times that he was “extremely happy with our investments in China, and I wish we had more of them than we have”. 

The controversy over the Chinese companies, which have been accused of fraud and suspended from trading in Hong Kong and New York, is potentially embarrassing for Carlyle as it prepares for a planned initial public offering. 

I was a little off-put when David Rubenstein dismissed my concerns arguing the amounts involved were "insignificant". Mr Rubenstein has never responded to my (repeated) emails and I cannot tell whether he is cocooned from negative outside opinion.

Bluntly, I think David Rubenstein was ill-advised especially regarding China Agritech - but also possibly regarding other investments that Carlyle has made. The amounts of money may be "insignificant" but the loss can be significant in other ways.

This post gives some background to the loss at China Agritech and asks Mr Rubenstein whether he stands by the opinion that the loss was "insignificant" and whether he would be prepared to say so (in light of information presented) in a letter to his clients.

Background to the China Agritech loss

By way of background I wish to extensively quote an article in the British Journal of Criminology titled Beyond Social Capital: Triad Organized Crime in Hong Kong and China. Underlined sections are my emphasis.

The case is about how the leader of Sun Yee On [a major organized crime group], Jimmy Heung, used the social capital he developed in China in the 1990s to commit an organized ‘financial crime’ in Hong Kong (though it was not proven in court). In this case, Jimmy’s company (Win’s Prosperity Group) and a Hong Kong Stock Exchange-listed company (China Prosperity Holdings) joined hands to manipulate the price of the listed company in the stock market. This case evolved through different phases between April and October 1999, as follows.

Phase 1: Accumulation of shares by ringleaders and associates (April to August 1999) 

This case began with the renaming of a listed construction company, OLS Group, as China Prosperity Holdings (CPH) on 29 April 1999. Coincidentally, both the Chinese and English words for ‘Prosperity’ were the same as in Jimmy’s company, Win’s Prosperity Group. Jimmy Heung and a Mr Tang were the only directors of Win’s Prosperity Group. Tang was also the Executive Director of CPH, but Jimmy, as a triad figure, is not allowed to hold directorship of any listed company. It is assumed that both companies were actually under Jimmy’s control. Between April and August 1999, the masterminds of the crime had gradually accumulated the shares of CPH at a very low price, often below HK$1 (US$1 = HK$7.8). After the accumulation, the ringleaders leaked ‘privileged’ sensitive information to their associates about favourable price movement of CPH so that the associates would rush to buy in. In the first week of September 1999, CPH soared 35.39 per cent to close to HK$1.53 on 8 September...

Phase 2: Leaking of news to the mass media (mid-September 1999) 

In Phase 2, a rumour about CPH was leaked out to selected mass media, which drew the attention of ‘smart guys’ to buy the company’s shares ahead of other investors. The rumour was about CPH’s entering into a conditional agreement to acquire a 33 per cent indirect stake in Jimmy’s Win’s Prosperity Group, which was to develop a Century Vision Network (CVN) project that would capture 200,000 subscribers in the first year of operation and 100 million subscribers within ten years in China. There was also a rumour that CPH would enter into a joint venture with a state-owned enterprise in China. The rumour also said CPH would invest about HK$780 million in this project, but we discovered that the company’s unaudited result for the six months ending 30 June 1999 was only a turnover of HK$60.50 million (CPH company announcement on 9 October 1999). As the rumour spread, the ‘smart guys’ who got the ‘privileged’ information bought up the shares speedily and, consequently, the price soared in a short period of time, drawing more share hunters to buy in amid its profitable investments. Overall, between 2 and 24 September 1999, the Hong Kong Hang Seng Index dropped 3 per cent, but the share price of CPH increased by 238 per cent (CPH company announcement on 9 October 1999).

Phase 3: Company directors’ exercise of share options (17 September 1999) 

As the share price rose sharply, the company directors capitalized their gains by exercising their share options and this practice is absolutely legal. In total, 3 million new shares were allotted to an employee of CPH on 17 September 1999, and 10 million, 3 million and 1 million new shares were allotted to three directors of CPH on 24 September 1999, at an exercise price of HK$0.16 per share, pursuant to an exercise of share options previously granted to them (CPH company announcement on 9 October 1999). Jimmy’s partner, Tang, personally held 10 million new shares. On 24 September 1999, CPH closed at HK$5.05, and was traded between HK$5.0 and HK$6.0 most of the time. That is, the directors could have earned HK$48.9 million, HK$14.67 million and HK$4.89 million, respectively, in this period if they had sold all their shares.

Phase 4: Suspension of trading awaiting company announcement (25 September to 9 October 1999)

In Hong Kong, a company leaking share-price-sensitive information or having unusual trading activities may be requested to suspend its share trading. On 9 October 1999, the Hong Kong Stock Exchange warned that the Exchange was concerned about companies that were leaking information to certain news media instead of making public announcements so as to increase investor enthusiasm for their shares. These companies should release the information necessary to enable investors to appraise them in order to avoid the establishment of a false market. In Hong Kong, if the leaked information is inconsistent with what is announced formally later, the acts may be in breach of the Securities Ordinance. 

CPH was requested by the Stock Exchange to suspend trading on 25 September 1999. On 9 October 1999, CPH was forced to make a public announcement, mentioning a joint venture, through Jimmy’s Win’s Prosperity Group, with China’s Telecommunications Bureau and State Administration of Radio, Film and Television (SARFT). It said the Win’s Prosperity Group had entered into a non-binding agreement to operate the venture with the Telecommunications Bureau, a SARFT subsidiary and other unnamed partners. Under the agreement, Win’s Prosperity Group would hold 33 per cent of the venture, while the Telecommunications Bureau—which controls China Telecom—and the SARFT subsidiary each would have 10 per cent interests. CPH said a final agreement was expected to be reached by the end of October. The following is part of the public announcement:

The CVN Project is in the development stage and may or may not materialise. WPGL [the Win’s Prosperity Group] has entered into two Letters of Intent for the purpose of launching the CVN Project in the People’s Republic of China (PRC). It is unclear if the structure will be changed or not. In addition, WPGL may or may not enter into formal agreements with the PRC telecom partner to arrange for the use of the telephone networks or with the PRC broadcast partner to obtain the approvals for the content to be broadcasted by CVN via the telephone networks in the PRC. As the Letters of Intent entered into are non-binding and commercial negotiations are still being conducted and are not finalised, it is possible that the structure set out in the Letters of Intent could be changed. It is also uncertain whether a formal agreement will finally be reached. If no formal agreement is reached, the CVN Project may not be launched in the PRC. (CPH company announcement on 9 October 1999).

As shown in the announcement, Jimmy’s Win’s Prosperity Group had signed two non-binding agreements with a Chinese telecommunications company. Two points are worthy of mention here. First, it was very difficult and extraordinary for a relatively small Hong Kong company to enter into an agreement with a giant Chinese state-owned enterprise. The Hong Kong businessman, in this case Jimmy, ought to have had outstanding social capital for this joint venture to materialize. Second, very astutely, since these were non-binding agreements, the deal could disappear suddenly without any cause.

Phase 5: Selling of shares by insiders (11–13 October 1999)

When the share price of CPH stood at a high level, the company made a public announcement on the possibility of a profitable venture, which, however, could not be verified immediately. The announcement triggered panic buying by the general public and trading volume soared extraordinarily, but it was time for the ringleaders and associates to sell their accumulated shares. When CPH resumed trading on 11 October 1999 after the announcement, its share price jumped 32.02 per cent to $5.05 from its previous close on 24 September. This provided the syndicate with a timely opportunity to sell their shares. The next day, 12 October 1999, CPH slid 11.38 per cent to $4.475 in heavy trading, suggesting that some investors were actively selling the shares, with insider knowledge that something might happen very soon.

Phase 6: The collapse of the share price (14–20 October 1999)

When the share price of a company is in a panic-buying or selling stage, the government’s watchdog will step in and request the issue to be clarified. The Securities and Futures Commission of Hong Kong challenged the $20 billion valuation of the joint venture as too high, and pointed out that such a venture would not be able to circumvent China’s restrictions on communications investment by foreign companies. The Commission also warned the public through the mass media:

Unequal dissemination of price-sensitive information could lead to insider dealing and the possible formation of a false or misinformed market for these shares . . .. Large changes in prices or turnover may also indicate that there is a false or misinformed market . . . [and the] public may be at risk and suffer loss because they can only trade on the basis of incorrect or incomplete information. (South China Morning Post).

The watchdog contacted the mainland Chinese partner to verify the status of the proposed venture because CPH had refused to provide information about the progress of negotiations. Five days after the company announcement, on 14 October 1999, CPH suddenly announced that the mainland joint venture was aborted, saying that Jimmy’s Win’s Prosperity Group had terminated negotiations with its mainland partner. With the excuse of commercial secrets, CPH declined to disclose the reasons behind the termination, and whether the Commission’s investigation had led to it.  

After the announcement, the share price of CPH plunged 31.84 per cent on the first trading day, 26.22 per cent on the second day and another 12.88 per cent on the third day. The company’s share price surged to HK$5.05 after the announcement of the joint venture but collapsed 61.18 per cent to HK$1.96 after the termination of the negotiations, very close to its price before the early September rally (see Figure 2). To let the public forget its past devious dealings, not surprisingly, CPH changed its name to Prosper eVision Limited a few months later, on 5 June 2000. No one was prosecuted in the end. Moreover, the present study has not identified any evidence of money laundering involving the triad or Chinese stakeholders. Nonetheless, as money laundering is not uncommon in mainland China (Song 2002; Zhang and Chin 2008), the price fluctuation would provide a valuable and timely opportunity for money launderers to clean their illicit income through legitimate transactions in the stock market.

What is described here is appears to me to be a conventional (though very large) pump-and-dump scheme. 

*The scheme was (it is asserted) controlled by Jimmy Heung (who the author describes as the leader of the Sun Yee On Triad). For reference Jimmy Heung's Wikipedia page also asserts he is the leader of the Triad. 

*The front-man for the scheme is (it is asserted) a Mr Tang (of whom little details are given). 

*The scheme (it is asserted) involved Chinese State Owned Enterprises who entered into and then did not consummate non-binding agreements which were marketable on the Hong Kong Stock Exchange.   

*That the (asserted) malfeasant company in the end changed its name to Prosper eVision to help the public forget the dirty-dealings. 

My obsession here is with the mysterious Mr Tang. The article does not tell you who he is. However cursory exploration of the SEC database will tell you that this Mr Tang is the same Mr Tang who later appeared as the Chief Financial Officer of China Agritech.

This SEC filing announced his appointment as the CFO of China Agritech and gives a brief CV:

On October 22, 2008, Mr. Yau-Sing Tang was appointed as the Chief Financial Officer of the Company. Mr. Tang, age 46, was most recently chief financial officer of Carpenter Tan Holdings Ltd., a retail chain in Mainland China which is applying to be listed on the Hong Kong Stock Exchange. Prior to that, he was the founder and managing director of GC Alliance Limited, a CPA firm in Hong Kong. From April 2003 to December 2005, he was executive director and chief financial officer of China Cable and Communication, Inc., which was listed on the OTC Bulletin Board. Mr. Tang received his Bachelor of Social Sciences (Honors) degree from the University of Hong Kong. He is a fellow of the Association of Chartered Certified Accountants in the U.K. and the Hong Kong Institute of Certified Public Accountants. He is also a member of the Institute of Chartered Accountants in England and Wales and the Taxation Institute of Hong Kong.

This release reveals that he was previously the CFO of China Cable and Communication. Following the trail you can find this filing which gives his CV at that company.

Yau-Sing Tang joined the Board of Directors in February 2003, and assumed the post of Chief Financial Officer and Chairman of the Board of Directors shortly thereafter. Mr. Tang served as Chairman of the Board until October 2003, when he assumed the position of President of the Company. Since January 2002, Mr. Tang has served as Chief Executive Officer and Executive Director of CCCL.  

Since November 2000, Mr. Tang has served as Managing Director of GC Alliance Limited, a Certified Public Accountants firm in Hong Kong. Prior to that, Mr. Tang served as Deputy Chairman and Chief Executive Officer of Prosper eVision Limited (Stock Number 979), a company listed on The Stock Exchange of Hong Kong Limited and CCCL. Mr. Tang has over 17 years of experience in accounting, finance, corporate finance and management, especially management of listed companies in Hong Kong, Australia and companies listed on NASDAQ. He is a fellow member of both the Hong Kong Society of Accountants and the Association of Chartered Certified Accountants and holds a Bachelor Degree in Social Sciences (major in Management Studies) from the University of Hong Kong. He is also the Chief Executive Officer and Executive Director of CCCL.

Note that this Mr Tang was the Chief Executive of Prosper eVision - the previously mentioned pump-and-dump.

Carlyle's China Agritech problem summarized

T. Wing Lo, a criminologist writing in the (peer reviewed) British Journal of Criminology asserts that Mr Tang fronted a major stock fraud for the leadership of the Sun Yee On Triad.

He was later the Chief Financial Officer of China Agritech - a company listed on the New York Stock Exchange.

This was a company Carlyle invested in and lost money.

Mr David Rubenstein dismisses that as "insignificant".

Perhaps he would like to finish this letter:

Dear Limited Partners

We have lost some of your money in a company led financially by someone who the British Journal of Criminology asserts fronts for the Sun Yee On Triad.  

I believe this loss is "insignificant" because ...

My view

Carlyle has major problems in their investment process and competence in China. This should be dealt with by head office (and head office is being ill-advised if they believe the problems are "insignificant").




John