Allen Chan has resigned as chairman and CEO of Sino-Forest as the fallout from fraud allegations made in early June by short-selling specialist Carson Block of Muddy Waters Research continues to escalate.
The Toronto-listed company made the announcement yesterday, after the Ontario Securities Commission (OSC) on Friday ordered all trading in Sino-Forest stock to be suspended for at least 15 days and called for the resignation of Chan and four other company officials, though the Canadian regulator quickly retracted its call for the five officials to step down. While it didn’t offer any explanation for the retraction, various media have reported over the weekend that the regulator first needs to complete a hearing to force a resignation. Such a hearing is expected within 15 days.
The OSC is conducting its own investigation into the activities and businesses of Sino-Forest and its management, and said in the temporary order that “Sino-Forest and certain of its officers and directors appear to have misrepresented some of its revenue and/or exaggerated some of its timber holdings by providing information to the public in documents ... which may have been false or misleading in a material respect”.
It added that Sino-Forest and certain of its officers and directors, including Chan, “appear to be engaging or participating in acts, practices or a course of conduct related to its securities which it and/or they know or reasonably ought to know perpetuate a fraud”.
These latest allegations, which give further credit to Muddy Waters’ initial claims of serious misconduct at the company, come after Sino-Forest said earlier this month that its internal investigation into the allegations would not be completed by mid-September as it had earlier planned, but will take until the end of the year. The delay prompted Standard & Poor’s to cut its credit rating on the company for the second time in two months last week.
It is also bound to cast a further shadow over Chinese companies that are listed, or are trying to list, in North America as investors worry that Sino-Forest is not an isolated incident. Block of Muddy Waters has pointed to questionable accounting issues at several Chinese companies.
Sino-Forest, which has denied all allegations, said yesterday that Chan’s resignation was voluntary, and added that he had “expressed his willingness to step aside” prior to the OSC’s issuance of a cease-trade order. It further acknowledged that the allegations made by the regulator, “while unproven, are of a serious nature”.
The company, which operates commercial forest plantations in China, has been cooperating with the OSC by responding to numerous and extensive information requests and by providing regular periodic briefings, it said. At the same time, the company’s own independent committee continues its work. “The company’s business is complex, the scope of the review is significant and there are enormous amounts of data that have been marshalled and are under review. In these circumstances, the [committee] has not yet reached any conclusions.”
However, it did note that it has placed three unnamed employees on administrative leave, during which they have been relieved of their responsibilities, but remain available to assist the company if required. These actions were undertaken after “certain information was uncovered during the course of the independent committee’s review and subsequent to the release of the company’s second-quarter financial results”.
Block, who is the founder of Muddy Waters, told Reuters over the weekend that he welcomed the trading halt as it would protect investors. “It seems the OSC has some information investors do not that it believes is material to investment decisions,” Block said. “We’re encouraged that it looks like the wheels of justice are turning.”
Some may argue that the halt is coming too late, however, as the company has already lost about 75% of its market value since Block’s initial report in early June — although it has recovered from the lows of C$1.99 and before the suspension on Friday traded a C$4.81. US hedge fund manager John Paulson is one of those who have given up on Sino-Forest in the interim. He sold his entire stake in the company in late June, taking a loss of almost $500 million.
On the other hand, New Zealand-born billionaire Richard Chandler made use of the tumbling share price to buy Sino-Forest shares. After gradually adding to his stake in the market, he now owns 18% of the company, according to a disclosure earlier this month. It will be interesting to see whether the OSC’s allegations will sway his support for the company.
S&P said last week that its downgrade of Sino-Forest’s long-term rating to B from B+ reflects its view that the company’s operations will be negatively affected for a longer period than previously expected because the investigation into the alleged fraud irregularities has been extended by several months. Also, the company’s financial strength will likely weaken further as its profit margin “remains at a materially reduced level”. In the second quarter, the profit margin fell to 23% from an average of about 35% over the past four years.
The ratings agency added that while the allegations are left unresolved, investors’ confidence in the company is likely to be further reduced, customer relationships may be damaged, and employee retention levels could fall. The delay also diverts the management’s focus from operating the business.
“We are likely to lower the ratings on Sino-Forest by multiple notches if any of the fraud allegations prove to be true or the company’s liquidity deteriorates sharply,” S&P credit analyst Frank Lu said in a August 23 note.
Sino-Forest said the board has appointed William Ardell, lead director and chairman of the independent committee, as chairman and Judson Martin, executive director and vice-chairman, as CEO. Chan has been named founding chairman emeritus and will be fully available to assist Martin with operational matters and with the independent committee review as requested.
The three overriding priorities of the company, it said, are to complete the work of the independent committee, to cooperate with the OSC and to preserve shareholder value. It added that it doesn’t believe that the trading halt will trigger a default of its outstanding guaranteed bonds or convertible bonds, but said it will continue to review the terms of all of its debt and other contractual arrangements.
According to the OSC, Sino-Forest has sold approximately C$2.99 billion ($3.05 billion) of equity and debt since the beginning of 2004, including four share offerings that have raised a combined C$1.05 billion.