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Staff are seen at the Sino-Forest and Sino-Panel China headquarters in Guangzhou, Southern China on June 29, 2011.

Adam Dean/The Globe and Mail

Sino-Forest Corp.'s search for answers has become tangled in the complex web woven by the company's own executives.

A months-long investigation by a committee of Sino-Forest Corp. directors has concluded the company has rights to the vast tracts of Chinese forestland it claimed, but also uncovered a raft of evidence of suspicious activity at what was once Canada's biggest publicly-traded forestry company.

The 111-page report includes suggestions that Sino-Forest employees falsified records and created unusually close relationships with suppliers and customer intermediaries that include, in at least one case, sharing access to bank accounts. But it also purports to refute some of the key allegations made by short seller Carson Block and his firm Muddy Waters LLC – accusations that caused the stock price to plunge, wiping out billions of dollars in shareholder wealth, and touched off investigations by the Ontario Securities Commission and the RCMP.

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Mr. Block alleged that Sino-Forest executives had engineered a massive Ponzi scheme, overstated both its revenue and its timber assets on a grand scale in order to raise billions from investors, many of them Canadian.

In response, the company launched an internal probe, which led in August to the resignation of chief executive officer Allen Chan. Three other senior executives were placed on administrative leave.

The new CEO, Canadian businessman Judson Martin, said Tuesday that the interim report proves Mr. Block wrong. "My takeaway on this is that this is not a fraudulent company – full-stop," he said. "Muddy Waters had very strong allegations – fraud, dishonesty, thievery – and I believe this very importantly brings that to a close."

But the report, parts of which were redacted, also illustrated the murkiness and convoluted nature of its dealings in China, and underscored that there may never be definitive answers to some of the questions that still swirl around the company.

For example, the independent committee of the board said it's satisfied the company has the rights to about 800,000 hectares of trees, as it has said.

But the total forestry holdings were confirmed through purchase contracts and other means, rather than "plantation rights certificates" that would establish legal rights.

The committee revealed that the absence of these certificates is a major concern for the OSC. "The OSC expressed grave concerns as to such absence and surmised in its discussions with the [independent committee]that such absence is per se evidence of fraud," the report said.

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Even if the land rights are ultimately verified, the independent committee has made little progress in investigating Sino-Forest's network of brokers, also known as authorized intermediaries (AIs), which sell the company's timber holdings to customers.

The committee met with a number of these brokers over the course of a month, but "the interviewees declined to show any evidence of financial transactions," leaving the committee to admit that is it "unable to compel the AIs and suppliers to co-operate or to produce documents."

Verifying transactions that have been conducted through the authorized intermediaries is crucial to the investigation because these entities are Sino-Forest's selling agents. While the committee believes Sino-Forest owns the rights to its timber, no one has been able to verify the prices at which this timber has been sold, nor has anyone produced an independent valuation of the assets.

The committee acknowledged that such a valuation is necessary, and is in the process of hiring an independent firm to do the work.

The independent committee said a "whistleblower" e-mail discovered by Sino-Forest's Canadian legal firm Bennett Jones alleges a Sino-Forest employee and two agents of the company "engaged in improper activities," including "transactions potentially not in the best interests of Sino-Forest shareholders; personal profit; bribery of government officials; and falsifying company records." The committee's advisers said management's response to the allegations has been "insufficient," according to the report.

In at least two cases, the committee's advisers identified forestry bureau officials who were either "concurrently or subsequently employees of, or consultants to, Sino-Forest." In Hunan province, the committee's advisers learned that a vice-chief of the forestry bureau drew a basic salary from the bureau in addition to a monthly payment of 15,000 yuan ($2,411 Canadian) from Sino-Forest for his work as a "consultant."

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The IC also found that in some cases, forestry bureau confirmations of Sino-Forest's timber holdings were prepared by the company itself using "notional forestry bureau letterhead on which a forestry bureau chop [official seal]was then obtained." There were also indications that "gifts or cash payments are made to forestry bureaus and forestry bureau officials," the report said.

One analyst who follows Sino-Forest and did not want to be identified said that investors would remain skeptical and will not view the committee's interim report as the final word.

"I think the marketplace is going to require more," this person said. "Investors would like to see an independent evaluation of the report."

Investors have been unable to trade Sino-Forest shares since August when the OSC halted the stock until at least the new year as the regulator conducts its own investigation. Sino-Forest has also confirmed a report by The Globe and Mail that the RCMP's Integrated Market Enforcement Team has launched a criminal investigation of the company, which once boasted a market value of more than $6-billion.

The independent committee expects to complete its third final report on the company by the end of the year. The company delayed publishing its third-quarter financial results but hopes to do so within 30 days.

With a file from reporter Tara Perkins

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THE COMMITTEE'S REPORT

Sino-Forest's [[entity]]ino-Forest's [[/entity]]RE-T committee of independent directors made public its second interim investigative report, as well as its latest update sent to its legal team. The reports are lengthy, at times providing answers to questions first posed by research firm Muddy Waters LLC, and at times raising even more questions about Sino-Forest's business dealings. The highlights:

Timber assets

Muddy Waters argued that Sino-Forest vastly overstates its timber holdings, so the independent committee set out with an initiative to verify these assets. They quickly realized this is hard to do: Sino-Forest can only hold the right to use the land, as proven by plantation rights certificates – not own the land outright.

The committee had problems obtaining these primary documents. That forced the committee to verify the holdings through new "confirmations," or letters that said Sino-Forest owns the rights, but not the original documents.

This has been a key area of concern for the Ontario Securities Commission. "The OSC expressed grave concerns as to such absence and surmised in its discussions with the independent committee that such absence is per se evidence of fraud," the report said.

Authorized intermediaries

Sino-Forest conducts its sales of standing timber through authorized intermediaries, or brokers who act as middlemen. The company refuses to publicly acknowledge who they are, citing competitive reasons, even though cash flows to and from these brokers are the sure way to verify its revenues.

The committee asked Sino-Forest to provide the Chinese names and identities of these brokers on June 11. A list was compiled a week and a half later, but the committee didn't receive final contact details until Sept. 6.

The committee ultimately met with seven different brokers, but concluded that the meetings served little purpose because the interviewees declined to show any evidence of financial transactions, citing concerns such as scrutiny regarding tax and media exposure.

Without the documentation that verifies cash flows, the committee will find it hard to prove Sino-Forest's revenues are what the company says they are.

Cash

At the very outset of its investigation, the committee asked newly hired independent auditor PricewaterhouseCooper to verify Sino-Forest's cash balance. That process is complete. After verifying a total of 293 accounts controlled by Sino-Forest in Hong Kong and 28 accounts in China, the auditor was "satisfied" that the cash position matched what had been reported.

Suspicious connections and business dealings

There are concerns about the amount of influence Sino-Forest has in China. For instance, after interviewing a person who claimed to be the vice-chief of a forestry bureau, the committee later determined that that person was in fact retired – and was now on Sino-Forest's payroll.

The committee was told by Sino-Forest suppliers that "gifts or cash payments" are sometimes made to forestry bureau officials. Two of the company's suppliers suggested that such "benefits" are offered for the issuance of land holding confirmations.

Valuation

Proving that Sino-Forest holds the rights to the 834,000 hectares of standing timber it says it owns is one thing. Valuing that standing timber is another. The committee hired an independent valuator in August. Yet just a short while later, it determined that it has "material concerns" about the firm's independence and was forced to look for a new firm.

SAIC filings

One of Muddy Waters' major concerns focused on the differences between transaction volumes that Sino-Forest has reported to China's State Administration for Industry and Commerce, or SAIC, and the revenue reported by the company's suppliers. These discrepancies have also been a key focus of the OSC's investigation. After looking into the matter, the committee concluded that SAIC documents are not definitive because the filings are not of the same reliability as in many Western countries.

Tim Kiladze and Andy Hoffman

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About the Authors
Asia-Pacific Reporter

An award-winning journalist, Andy Hoffman is the Asia-Pacific Reporter for Canada's national newspaper, The Globe and Mail. More

Reporter and Streetwise columnist

Tim Kiladze is a business reporter with The Globe and Mail. Before crossing over to journalism, he worked in equity capital markets at National Bank Financial and in fixed-income sales and trading at RBC Dominion Securities. Tim graduated from Columbia University's Graduate School of Journalism and also earned a Bachelor in Commerce in finance from McGill University. More

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