An Ontario Securities Commission hearing panel has found that Sino-Forest Corp. and four individuals, among them former CEO Allen Chan, engaged in “deceitful or dishonest conduct” that constituted fraud, according to a decision released Friday.

The OSC has yet to schedule a hearing to determine sanctions for the violations.

“Sino-Forest, Chan, Ip, Hung and Ho engaged in deceitful or dishonest conduct related to Sino-Forest’s standing timber assets and revenue they knew constituted fraud,” the commission panel found.

At its peak, Sino-Forest had a market value of $6 billion. It claimed to be China’s leading commercial forest plantation and timber supplier. The company was officially based in Canada, with management working from offices just outside Toronto. It would raise about $3 billion from investors by issuing equity and debt securities.

It all came crashing down in June 2011 after San Franciso-based short-seller Muddy Waters LLC accused the company of running a “near total fraud” and “Ponzi scheme.”

The company’s board launched its own inquiry to review Muddy Waters allegations. The internal report would eventually cost about $50 million and be unable to confirm that the company’s supposedly vast holdings of timber existed.

Meanwhile, the OSC, Canada’s largest securities regulator, launched its own investigation. The regulator cease traded Sino-Forest’s shares in August 2011.

The company sought court protection from creditors in March 2012. In May 2012, the OSC issued a statement of allegations against Sino-Forest and Chan, whom OSC staff described as the “architect” of the fraud.

Also named as respondents were executives Albert Ip, Alfred Hung, George Ho, Simon Yeung and the company’s former CFO, David Horsley.

Horsley paid a $700,000 settlement to resolve his own case before the OSC hearing began in September 2014.

In Friday’s decision, the three-member commission panel ultimately concluded that Sino-Forest, Chan, Ip, Hung and Ho engaged in conduct that they knew to be fraud. The fraud case against Yeung was dismissed.

All five individual respondents, including Yeung, were found to have violated Ontario securities law by misleading commission staff during its investigation.

The hearing was technical and complex. Some witnesses testified by video link from Hong Kong, Beijing, Shenzhen and the Dominican Republic. And some witnesses testified in Chinese and the evidence had to be taken through interpreters. “The Panel is mindful of the difficulties created by these circumstances,” the commission said.

Indeed, the panel’s nearly 300-page decision follows a hearing that took 188 days, heard from 22 witnesses, involved 2,000 exhibits, and produced 22,000 pages of transcripts. The hearing opened in September 2014 and finally closed last May.

The panel found that Sino-Forest sold its timber into a network of offshore entities that were purportedly arm’s length customers. In reality, these customers were actually related to Sino-Forest. Hundreds of transactions were used to artificially inflate the company’s assets and revenues.

What’s more, the hearing panel also found that Sino-Forest falsified the records used to document the assets and the sales. “Sino-Forest’s deceitful disclosure put the financial interests of its investors at risk.”

The panel also found that Chan and two other executives, Ip and Hung, provided the company’s external auditors, Ernst & Young LLP, with financial statements that were inaccurate or incomplete. In a separate hearing, the OSC brought a case against E&Y. That matter was resolved in September 2014 when E&Y paid $8 million in a no-contest settlement.

Counsel for Chan argued that his role in Sino-Forest was largely ceremonial, but the OSC panel disagreed, finding that he was “deeply involved” in the company’s operations.

“As the ‘ultimate and compensating control’ over transactions, the approver of all purchase contracts and the signatory on all sales contracts, Chan’s frontline role was much more than ceremonial,” the panel found.

Counsel for the respondents argued that some of the case resulted from the OSC’s misunderstanding over the way business is done in China. Expert witnesses were called to explain how “guanxi” business culture from Mainland China involves intricate cooperation and a close relationship among Chinese companies.

The commission panel took note of the cultural differences, but said they cannot override Ontario securities law and Canadian accounting principles. “For the purposes of our analysis, Ontario securities law is paramount and overrides any explanations for illegal conduct being excusable in the name of guanxi, however it is defined.”

The panel has given counsel for the respondents and OSC staff 30 days to set a date for a sanctions hearing.

dhasselback@nationalpost.com
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