In the early days of 1994, a little-known Hong Kong entrepreneur named Allen Chan launched what seemed like a promising joint venture in the southeastern city of Zhanjiang in China's Guangdong province.
The unimaginatively named Zhanjiang Leizhou Eucalyptus Resources Development Co. Ltd. was to produce micro-density fibre boards from timber harvested at a nearby plantation controlled by Mr. Chan's fledgling company, Sino-Forest Corp. China's economy was growing fast and its demand for wood was rising just as quickly. This new business was poised to fill that demand.
Partnering on the deal with Sino-Forest, which would soon obtain a stock market listing in Canada, was the Leizhou Forestry Bureau – an arm of the Chinese government.
For Mr. Chan and his co-founder at Sino-Forest, a former Forestry Bureau official in Guangdong named Kai Kit Poon, the Leizhou deal served as a key pillar in the initial stages of building their business. Between 1994 and 1997, Sino-Forest would report $60-million (U.S.) in sales from the venture.
There was just one problem: The Leizhou joint venture never produced a single panel, according to a key executive involved in the project.
More than 17 years later, things are quickly unravelling for Mr. Chan and Mr. Poon.
Sino-Forest is now enmeshed in a devastating scandal, and accused of participating in what could turn out to be one of the largest frauds in Canadian stock market history. Mr. Chan has lost his grip on the company; on Sunday he resigned his executive posts at Sino-Forest (while taking on a new title, "founding chairman emeritus") after the Ontario Securities Commission alleged that he and other executives and directors appear to be engaged in activities that they know, or ought to know, "perpetuate a fraud."
Part of what is so astonishing is that Sino-Forest and its business activities failed to arouse serious suspicions or concerns with most investors until June of this year when a short seller named Carson Block and his firm, Muddy Waters LLC, first levelled accusations of fraud against the company.
For more than a decade and a half, Mr. Chan, a martial arts enthusiast, aficionado of classical Chinese literature and former restaurant employee, along with Mr. Poon, an avid ballroom dancer, had presided over what was, by all appearances, an unparalleled Chinese business success story. By simply buying, managing and selling trees and forestry assets in mainland China, the firm's profit increased from $3-million in 1994 to $395.4-million in 2010.
Mr. Chan and Mr. Poon's business seemed perfectly positioned to cash in on the country's roaring growth and burgeoning appetite for natural resources.
Instead of raising capital on the Hong Kong stock market or even Shanghai or Shenzhen, Mr. Chan and his business associates targeted Canadian investors, whom they said were better acquainted with the forestry sector. Sino-Forest listed on the Alberta exchange through a reverse takeover of a dormant shell company in 1994. In 1995, the company graduated to the Toronto Stock Exchange.
Sino-Forest has since raised more than $3-billion from debt and equity markets, mostly with the help of Canadian lawyers, accountants, analysts and investment bankers, and mostly in the past eight years. Investors bought into the company's promise of a bright future – a promise that seemed to be backed by steadily rising profits. At its peak in March, the company boasted a market value of more than $6-billion (Canadian), making it by far the largest forestry firm on the TSX.
Sino-Forest says it used most of the funds to boost its forestry portfolio in mainland China, which it claims now exceeds 780,000 hectares. Despite healthy profit margins that often topped 50 per cent, Sino-Forest has been almost perpetually cash flow negative as it has spent more money buying trees and other forestry assets than it has generated through sales or by raising capital.
Now, Sino-Forest's shareholders are stuck. Last week, the OSC halted trading in the stock, stating that the company appears to have engaged in "significant" deals with related parties, misrepresented its revenue, and exaggerated the size of its Chinese timber holdings "by providing information … which may have been false or misleading."
The OSC move gave new momentum to the fraud allegations made by Mr. Block and Muddy Waters in June, which, in essence, accused the company of lying about its revenue, its business model, and its claims to control $3.1-billion (U.S.) worth of timber assets.
The Globe and Mail has made repeated requests for interviews with Mr. Chan, and visited both his home and office in Hong Kong, but received no response.
A Globe investigation, based on interviews with people associated with Sino-Forest and an examination of legal and regulatory documents in Hong Kong and mainland China, has uncovered a pattern of questionable deals and disclosures from the company that date back to its earliest days. A probe of some of the company's dealings and financial filings in China indicate that some of Sino-Forest's business claims are overblown, and may support the allegations made by the OSC.
In addition to finding that the Leizhou joint venture never got off the ground, more recent transactions point to a steady stream of deals that have raised concern. In one case, Sino-Forest acquired a financially struggling forestry company called Mandra with about 150,000 hectares of trees, citing its ability to produce "sustainable cash flow." The deal boosted Sino-Forest's stated forestry holdings and helped it raise some $800-million from investors in a financing that was announced the same day. Financial statements obtained by The Globe paint a much different picture of Mandra, and show that nine months before it was acquired, it failed to meet a scheduled payment to creditors. The financial statements raise questions about the value of Mandra's assets and Sino-Forest's motivation for the transaction.
In another questionable deal, Sino-Forest paid $7.1-million for a wood products manufacturer that it said had valuable patents. Documents obtained by The Globe, however, suggest the company had few if any useful patents and one of its investors was a Sino-Forest vice-president – making the acquisition an unreported related-party transaction.
These new revelations follow previous findings by The Globe, published in June ( that cast doubt on the size and value of the company's timber assets in Yunnan province. A key business partner there said Sino-Forest had purchased far fewer trees than the 200,000 hectares it claims to control.
Sino-Forest, which has denied all the allegations levelled against it, declined multiple requests for comment on the Leizhou, Mandra and other findings.
'We didn't produce a log'
Mr. Chan and Mr. Poon seem unlikely candidates to have created China's largest forestry company.
Born Chan Tak Yuen in February of 1952, Allen Chan's early business ventures had nothing to do with trees. One business was an outright failure.
He attended what was then called Hong Kong Baptist College and studied sociology. According to at least one document filed with Chinese government offices, Mr. Chan's highest level of education is high school.
In 1980, he took a job working for gambling tycoon Stanley Ho as corporate secretary for the notorious Hong Kong harbour tourist trap called the Jumbo Floating Restaurant. His attempt to purchase a ship building business in 1988 ended in legal action that accused Mr. Chan of misappropriating funds, according to a lawsuit filed in the Supreme Court of Hong Kong.
The controversy arising from those allegations prompted Mr. Chan to withdraw from public view for two years. "It was like a nightmare," he told CEO Magazine in a 2004 interview. "I couldn't read in the first year. I could only sunbathe and listen to music."
But he soon returned to Hong Kong's business scene as a financial columnist for the Hong Kong Economic Journal and an author of business books penned under the name Koon Chung-lin.
An engineer and 15-year veteran of the Guangdong Forestry Bureau, Kai Kit Poon was so impressed with the writings of Koon Chung-lin that in 1992 he asked Mr. Chan to help start the business that would become Sino-Forest.
While the soft-spoken but gregarious Mr. Chan became Sino-Forest's public face, helping to raise billions of dollars from Canadian and international investors, Mr. Poon, now 70, provided relationships or guanxi with government forestry officials, connections that in China are key to doing business.
One of Sino-Forest's first major deals was the 1994 joint venture with the Leizhou Forestry Bureau. The two sides agreed to start an operation that was supposed to produce fibre boards from wood harvested from a Sino-Forest eucalyptus plantation nearby.
In its annual reports, Sino-Forest reported more than $60-million in sales from the operation between 1994 and 1997.
But a former company executive involved in the project told the Globe it never produced a single panel.
According to Qi Shuxiong, who in 1994 retired as director of the Leizhou Forestry Bureau to join Sino-Forest's board of directors, Sino-Forest invested $1-million into the joint venture, but it never got anywhere near the point where it could start generating revenues. Mr. Qi said the joint venture came to an abrupt halt in 1995 when the provincial Guangdong Forestry Bureau pulled rank on the smaller Leizhou office and cancelled the operation in favour of another, bigger project – a pulp mill that would draw trees from the same eucalyptus plantation.
"The ($60-million in sales) information must be incorrect," Mr. Qi, who retired from the Sino-Forest board in 2003, said in an in-person interview conducted in the Chinese city of Guangzhou. "We didn't produce a log. There was no warehouse or factory. … It was only in the planning stage."
Less than a week later, Mr. Qi e-mailed and phoned The Globe and Mail asking to change his account. Despite being one of the seven signatories on the agreement that eventually wound down the joint venture in 1998, he said he had only been a technical adviser, and thus couldn't be sure what had or hadn't been produced by the factory.
Mr. Qi said he had received an angry phone call from Mr. Poon shortly after The Globe had tried to contact the Sino-Forest president for comment on this article.
The Leizhou Forestry Bureau filed a letter in 1999 that attacked Sino-Forest for misusing funds and alleged it had siphoned off some of the $1-million it had originally invested. It now says it has no one on staff who can remember the details of the 17-year-old enterprise or why it failed.
"I don't know how [Sino-Forest] grew so quickly. I wasn't involved any more. I'm a scientist, anyway. ... the CEO [Allen Chan] is in charge of the financing," Mr. Qi said.
The shifting stories and details lost in time – as well as the company's apparent effort to control what is said by whom – highlight the difficulties faced by those looking to find the truth about Sino-Forest. The company's independent committee recently said its investigation, initially scheduled to wrap up by September, may take until the end of the year because the job of gathering the data is so complex.
The mystery of Mandra
Even though the Leizhou joint venture failed to produce a single board, Sino-Forest kept growing. From 1994 until 2010, the company reported profit increases in every year but one.
In addition to raising their social status in China, Sino-Forest's rising share price helped line the pockets of its co-founders. According to Bloomberg, since 2006 alone, Mr. Chan has sold $3-million (Canadian) worth of Sino-Forest shares and Mr. Poon has unloaded more than $30.1-million worth of company stock.
As Sino-Forest's profits and assets continued to increase, Canadian and international investors clamoured to get in on a series of stock and debt offerings in the belief that the company was a proxy for China's surging economic growth. Mr. Chan and his partner Mr. Poon didn't disappoint. They used proceeds from these sales to snap up more trees and sign deals with suppliers to buy more timber. Sino-Forest soon dwarfed its competitors, and was, by far, the largest owner of forestry assets in mainland China.
There are questions, however, about the quality and validity of some of the assets Sino-Forest was buying. For example, the company completed in February, 2010, a deal to buy Mandra Forestry Holdings Ltd. At the time, Mr. Chan hailed the acquisition in glowing terms. But considering Mandra's shaky financial position, it's unclear what the benefit of the acquisition was other than to inflate Sino-Forest's timber reserves and enable it to raise more money from investors.
Sino-Forest said Mandra would add more than 150,000 hectares of trees to its holdings, an increase of more than 30 per cent. Mr. Chan raved about the location of the trees, in eastern China, not far from economically vibrant Shanghai. "Mandra's plantations will be sustainably harvest[ed], while generating substantial cash flow," he said.
In the long run, perhaps Mandra's assets would do exactly that. But an examination of financial documents filed with the State Administration for Industry and Commerce (SAIC) offices in China point to a struggling company – one whose supposedly bright prospects contrasted sharply with its unsuccessful past.
Mr. Chan and his executives certainly knew the asset they were buying. Mandra Forestry was launched in 2005 as a timber firm with big ambitions to acquire 270,000 hectares of plantations in Anhui province, according to a report by forestry consultants Jaakko Poyry Consultants. Sino-Forest had provided some money to get Mandra going and was a 15 per cent shareholder of Mandra from the start.
The two companies had also signed a so-called "master sales" agreement in 2005 that would see Sino-Forest buy all cut logs harvested from Mandra's plantations for five years as well as manage the company's forests in Anhui.
But it's not clear whether Sino-Forest ever purchased any logs from Mandra. What is clear is that Mandra's business never flourished.
Of three Mandra subsidiaries investigated by The Globe, only one appeared to have conducted any significant business at all by 2009, the year before Mandra was purchased by Sino-Forest. It lost about $600,000 that year, according to filings made with the Chinese government.
Another Mandra subsidiary appears to have essentially ceased operations in 2006, having informed Chinese authorities that its "plan to purchase forest land could not be carried out," due in part to "improper management." The third subsidiary was deregistered in 2008.
By May, 2009, Mandra was so strapped for cash that it missed an interest payment due on $195-million (U.S.) worth of its senior bonds. In July, Sino-Forest announced that Mandra had terminated its sales and management agreement with the company.
Bay Street wasn't fazed. Sino-Forest analyst Richard Kelertas of Dundee Securities told Reuters that despite the loss of the Mandra sales agreement, "there is no impact whatsoever on Sino-Forest."
Several months later, Sino-Forest came along with a substantial offer: It would pay up to $9-million in stock for Mandra and would exchange $187-million of its own debt for Mandra's bonds. (Not surprisingly, Mandra's bondholders agreed to the deal, en masse.)
The deal added close to $200-million in debt to Sino-Forest's balance sheet, a rich price to pay for a faltering enterprise. At the time, however, the stock market was pricing Sino-Forest shares in part based on the company's vast holdings of forest and the Mandra acquisition simply gave Sino-Forest more timber, regardless of its actual worth.
That, in turn, helped Sino-Forest raise more money. The Mandra deal was announced in conjunction with a massive debt and equity sale by Sino-Forest that saw the company issue $460-million in convertible notes and $367-million in new stock.
Announcing plans to acquire more forest assets in conjunction with debt or equity offerings was a common tactic for Sino-Forest. In June, 2009, Sino announced a stock sale that ended up raising $380-million at the same time it announced plans for a new forest purchase agreement in Jiangxi province. Similarly, in March of 2007, Sino-Forest raised $200-million from a private placement stock sale that was announced in conjunction with a deal to buy forestry assets in Yunnan province.
A deal with a vice-president
Around the same time that it was pursuing Mandra, Sino-Forest unveiled another acquisition that appears to have enriched a company insider, according to documents obtained by The Globe.
When Mr. Chan announced the purchase of a company called Homix Ltd. in January, 2010, for $7.1-million, he stressed its research and development capabilities, asserting it had "developed a number of new technologies with patent rights."
He also stressed environmental benefits. China, he explained, is too inefficient in its use of wood. By using the technology of Homix, a wood manufacturer with operations in Guangdong and Jiangsu provinces, Sino-Forest could begin producing "quality lumber" from six-year-old eucalyptus trees instead of 30-year-old trees of other species. "We believe that this will help preserve natural forests as well as improve the demand for and pricing of our planted eucalyptus trees," he said.
Like Mandra, Homix was anything but a huge money-spinner. A review of Sino-Forest's SAIC financial statements shows that its two subsidiaries posted a combined loss of about $1-million in 2009. But those documents also show something else. Sino-Forest's senior vice-president of administration and finance, Chen Hua – also known as Hua Chen – was a major shareholder in a Homix unit by the name of Jiangsu Dayang Wood Co. Ltd.
The finding is significant because Sino-Forest has never disclosed that Homix was a related party and has strongly denied engaging in any undisclosed related-party transactions. In a June interview with The Globe, Sino-Forest chief financial officer David Horsley insisted that any non-arm's-length transactions would have been disclosed in Sino-Forest's financial statements. The OSC's recent allegations, however, allege that Sino-Forest subsidiaries appear to have engaged in "significant non-arm's-length transactions."
The documents obtained by The Globe show Ms. Chen was one of the first shareholders of Jiangsu Dayang in 2003 and increased her stake in July, 2004, when she was also named chairwoman of the board and legal representative.
She sold her shares soon after, SAIC records show, but then bought back into the company in January, 2008, investing three million yuan (about $465,000 Canadian) for a 30 per cent stake. The SAIC files show that Ms. Chen remained a shareholder of the company until Sino-Forest closed the deal to buy Homix in June, 2010.
Sino-Forest refused to comment on Ms. Chen's apparent interest in Homix.
Jiangsu Dayang, incidentally, holds just two patents in China, both registered in August, 2008. One is for a "wood dyeing method and equipment" and the other is for "wood dyeing equipment." A check of State Intellectual Property records show that Homix's other subsidiary had not registered any patents in China.
Despite the gravity of the allegations facing him and the company he co-founded, Mr. Chan has shown no signs of withdrawing from public view to sunbathe and listen to music as he did when his business ventures collapsed in the late 1980s. At least not yet.
When the Muddy Waters report was first published in June, he called the accusations "unfounded," posted a video on the company's website addressing the allegations and promised a summertime tour of Sino-Forest's operations in China to Bay Street analysts.
But soon after, the analyst tour was cancelled, and then Mr. Chan, who according to a document filed with regulators in China is a member of the Chinese Communist Party, went quiet.
On the last Friday in July, a reporter visited Sino-Forest's executive offices on the 38th floor of the Sun Hung Kai Centre in Hong Kong's Wanchai district and was told that Mr. Chan was "unavailable."
Less than an hour later, the Sino-Forest chairman and CEO exited the elevator in the building's lobby and strode quickly through the marbled foyer.
Half a world away in Toronto, a special committee of Sino-Forest directors was beginning to zero in on the man who helped start it all. At the same time, a group of Canadian investors who had watched helplessly as billions of dollars of shareholder value was wiped out was preparing to launch a class-action lawsuit seeking more than $7-billion from Mr. Chan and his associates. In less than a month, Canada's top regulator would publicly accuse him of fraud.
But on that hazy Friday in Hong Kong, Mr. Chan seemed unconcerned. Dressed casually in navy slacks, a dark blue polo shirt and a multipocketed red vest, he stepped outside into the moist afternoon heat.
Waiting for him was an air-conditioned chauffeured black minivan. The vehicle, a 2009 Toyota, is registered to a company called Sino-Panel Gaoyao. It is one of more than 100 entities in the complex web of Sino-Forest subsidiaries that Mr. Chan helped engineer over the past two decades.
Mr. Chan climbed in the back seat, said something to the driver, and the automobile quickly sped away.