Wednesday, November 16, 2011

The Sino Forest Independent Committee Report part 1.

Sino Forest - a Chinese forestry company listed in Canada - is the subject of the most spectacular fraud allegation of this cycle of Chinese frauds. The allegation was made by Muddy Waters LLC (MW).

The allegation had three prongs:

(a). The forests largely did not exist
(b). Where they existed the valuations were determined largely by phony transactions with undisclosed related parties (the so-called Authorized Intermediaries or AIs) and
(c). There was no evidence that that many tonnes of wood was harvested in the relevant areas in China - there was for instance nowhere near the necessary number of log trucks.

After the allegations several of the non-executive directors formed an "Independent Committee" (IC) to investigate the claims.

The IC has reported and declared the MW allegations to be false. In particular they declared they have seen documents proving the accounts are (mostly) accurate and they are confident in the authenticity of those documents.

The press originally reported on the IC report as definitive. They have become a little more nuanced since.

Anyway I plan on extracting parts of the supporting documents for the IC report - the most interesting document released so far being the "process memorandum" which outlined the IC's processes.

This part - Paragraph 83 - is concerned with checking the authenticity of the documents purporting to evidence ownership of forests (either land or more often cutting rights or plantation rights certificates).

It is on the basis of the evidence presented here that the IC is confident that the MW allegations are false. I am (proudly) short Sino Forest so I am biased. I am just going to repeat Para 83 verbatim. You can decide.


83. There are a number of factors which have affected the forestry bureau visits and confirmation process:
(i) Management did not provide a comprehensive list of plantation assets which reconciled to its financial statements until June 23, 2011;
(ii) Shortly after the MW allegations, Management, on its own initiative,caused all forestry bureau confirmations to be relocated from their various locations throughout the SF organization to Guangzhou. This resulted in delay in these documents being made available to the IC Advisors.Management explained the forestry bureaus wanted the confirmations returned as they may have exceeded their individual authorities in confirming certain rights. However, the confirmations were not returned to the forestry bureaus and were sighted by the IC Advisors in the offices of Chinese counsel to SF; 
(iii) Forestry bureau officials are not required to meet with any party regarding the confirmations or the process they had undertaken in issuing those confirmations. 
(iv) Prior to August 29, 2011, the process determined by the IC did not allow the IC Advisors to ask any forestry bureau any questions relating to the existing confirmations; 
(v) The IC Advisors have not had visibility into the process regarding the setting up of meetings relating to existing or new confirmations. Judson Martin, in his capacity as CEO, has agreed to provide a letter of representation to the IC with respect to the process undertaken while he has held this position; 
(vi) The IC Advisors were directed by Management to visit Yunnan FB #1. This forestry bureau further directed the IC Advisors to go to one of its subordinate county-level forestry bureaus (Yunnan FB #2); 
(vii) In all four instances where new confirmations were obtained, the forestry bureau or other parties who issued the confirmation did not sign the new form of confirmation as sought by the IC Advisors but instead prepared their own versions whereby ownership is not confirmed and only a contractual arrangement between SF and its Supplier is recognized; 
(viii) The time made available for the meetings with forestry bureau officials has been limited and the IC Advisors have not been permitted to ask certain questions; 
(ix) Due to the limited number of senior SF employees/Management participating in meetings at the forestry bureaus with the IC Advisors, the processes at the various forestry bureaus were conducted consecutively rather than concurrently; 
(x) The process for SF employees to arrange meetings with forestry bureau officials has taken some time; 
(xi) Certain forestry bureaus have deferred or not permitted the IC Advisors’ requests to access the plantation rights registries. Others have advised they have not yet established a searchable registry of plantation rights. The forestry bureaus also indicated they do not issue new PRCs for the transfer of standing timber alone. As such, the IC Advisors have been unable to confirm the existence of the PRCs during the IC Advisors’ visits; 
(xii) In some instances, forestry bureaus would not issue the new confirmations using their letterhead, which is inconsistent with prior practices. 
(xiii) Certain forestry bureaus have given few details as to what due diligence processes they have undertaken before issuing both the existing confirmations and the new confirmations. 
(xiv) At a meeting at Hunan FB #1 on September 2, 2011 to validate the authenticity of the existing confirmations, Management represented a forestry bureau official to be the Forestry Bureau First Vice Chief when in fact this individual was no longer in the position of Vice Chief, and had been paid by SF for several months prior to the visit to act as a consultant for SF. The IC Advisors understand this meeting was recorded by SF employees, but have not been provided with a copy of the tape. 
(xv) The new confirmation obtained at the Hunan FB #2 was not issued by the forestry bureau; rather, it was issued by a “social institution legal person” sponsored by the Hunan FB #2. The relative degree of comfort of this confirmation as compared with the new confirmations from forestry bureaus is not clear. 
(xvi) During the Hunan FB #2 visit held on October 18, 2011 the IC Advisers were informed by the former Chief of the bureau, FB Official #1, that Vice Chief FB Official #2 was assigned by the forestry bureau to work with SF since approximately 2008 to assist SF in conducting its business. The IC Advisers were informed that FB Official #2 continued to receive a basic salary from the forestry bureau while working with SF. They were also advised that this practice occurs with other companies. 
(xvii) The new confirmation obtained at the Yunnan FB #7 was not issued by the forestry bureau; rather, it was issued by a division of the bureau, namely, the Yunnan Forestry Entity #1. The relative degree of comfort of this confirmation as compared with the new confirmations from forestry bureaus is not clear. 
(xviii) The IC instructed the IC Advisors not to make direct contact with forestry bureau officials. The IC explained that Management cited strong concerns that such contact would negatively impact the Company’s relationship with the forestry bureaus.


mkyeg said...

Personally, I like para. 141 where the IC advisors are kicked out of the Sino Forest offices.

Daniel Chisholm said...

Good thing you presented para 83 verbatim and didn't highlight the red flags, it would have ended up a bloody mess.

Para 83 does make for remarkably humourous reading, of the deciphering-tangential-BS sort.

My advice isn't even worth what you paid for it, but I don't think you should cover your short yet John.... ;-)

Anonymous said...

So every sentence is saying that the IC couldnt do this, couldnt confirm that, couldnt meet this person, didnt find that and yet the IC is confident that the forest exists? Hooray for Chinese Corporate Governance!


Kyletestkyle said...

from the Bloomberg article (which also quotes a certain messr Hempton):

"The Ontario Securities Commission’s preliminary review of the Sino-Forest report “has firmly suggested that our investigation, which is ongoing, should continue,” Tom Atkinson, the commission’s director of enforcement, said yesterday in an e-mailed statement."

Frozen in the North said...

For those interested from this morning's Globe and Mail

Anonymous said...

Someone needs to call Simon Murray out on his BS. His comments to the press are outrageous given his stature in the business community.

Anonymous said...

I would love a job at Bronte just so I could listen to John run around saying 'check out these new bozos I found!' every week...

Travel_the_World said...

The new CEO Judson Martin seems to be using his real estate and TV background in spinning the report, when you read the interim report it does not look anything like the executive summary; while Chinese business is a Wild East capitalism when they list in the West there are certain expectations of them and they are clearly miles away from that. It would also be interesting to know why James Bowland quit the IC and the SF board just days before the report.

Anonymous said...

also see para 61. verbatim:

61. On June 9, 2011, E&Y informed the IC Advisors that a central searchable online
database was publicly accessible that would enable the IC Advisors to validate
timber holding certificates held by SF. The IC Advisors acted on the information
provided by E&Y and attempted to access the purported registry; however, when
the site was checked, it appeared to be a private site (as its domain name did not
end with “”) which had been shut down temporarily. When subsequently
checked (on September 28, 2011) and the site was active, the IC Advisors
observed that the site data was incomplete with very limited coverage on one
county in Guangdong Province and did not include forestry bureaus at which SF
PRC’s were registered.

Christie said...

it is Bronte that spins and spins...along with Carson and the Globe and Mail wanna be social activists.

Anonymous said...

Is it even legal to own forests in China? You can only lease the land from the government and get a "land use certificate" if you were a property developer. I am surprised that SinoForest can "own" the forests. If they don't, then how do they value them? At cost - which means the amount they paid out? Paid out to whom??

Papafox said...

The report is a masterpiece of lawyer-speak with lots of irony presented as blank facts.

Para 54 is a classic. At least one office only had emails going back to 10/Jun (MW report was 2/Jun), with no previous backup available. The investigators were initially denied access on 13/Jun and they were only able to begin investigations on the 15/Jun.

Hamlet got it right "Thus conscience does make cowards of us all"

Anonymous said...

The lawyer in me loves the claim for legal professional privilege at the bottom of each page. I suspect they have put this there in some pathetic attempt to be able to deny liability for whatever lies are in the document on the basis that it is privileged and accordingly you shouldn't have seen nor relied on it... ironic given it is on the web site being relied upon to bolster their bona fides.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.