by T. GormanPosted on Posted in SECActions

This is the third segment of a five part series examining issues arising in SEC Enforcement Actions relating to issuers from the PRC whose shares are traded in the U.S.

Corporate governance

A number of PRC based issuers have been named as defendants in SEC enforcement actions. These cases involve a range of issues including financial fraud, manipulation and misuse of assets.

Misrepresentations and financial fraud are the central allegations in SEC v. SinoTechEnergy Ltd., Civil Action No. 2:12-cv-00960 (W.D. Louisiana Filed April 23, 2012). The defendants are the company, a Cayman Island corporation based in the PRC, its chairman and controlling shareholder, Qingzeng Liu, its CEO, Guoqiang Xin, and the former CFO, Boxun Zhang.

The complaint alleges that the defendants mislead investors about the use of the $120 million raised in its IPO. Company filings claimed that it purchased key equipment carried on the balance sheet at $94 million. In fact it made only limited purchases worth less than $17 million. A separate count charges the Chairman with misappropriating over $40 million from the company. The complaint alleges violations of Securities Act Sections 17(a)(2) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) and seeks to impose liability under Section 20(a) as to the individuals. The case is in litigation.

SEC v. Li, Civil Action No. CV-11-1712 (D. Ariz. Filed Aug. 30, 2011) is another action based on financial fraud allegations. The defendants are James Li, Thomas Chow, Wayne Pratt, Christopher Liu and Roger Kao. Mr. Li is a director, president and COO of Syntax-Brillian Corporation, a developer and distributor of H-D LCD TVs. Mr. Chow is a director and chief procurement officer of Syntax-Brillian while Mr. Pratt is the CFO. Messrs. Liu and Kao are executives with Taiwan Kolin, Co. Ltd.

The complaint centers on a financial fraud orchestrated by defendants Li and Chow. According to the SEC, from at least mid-2006 through early 2008 defendants Li and Chow executed a complex scheme to record revenue from the sale of TV sets in China when in fact the sales never occurred. As the scheme progressed, a circular cash flow was developed involving Syntax’s primary manufacturer, Taiwan Kolin and defendants Christopher Liu and Roger Kao. Syntax CFO Wayne Pratt ignored red flags of improper revenue recognition and participated in preparing backdated documentation that were later provided to the outside auditors to support the fictitious sales, according to the Commission’s allegations. The complaint alleges violations of Securities act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5).

Each defendant settled with the Commission with the exception of Mr. Chow. Mr. Li consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(b)(5) and from aiding and abetting violations of the other sections cited in the complaint. He also consented to the entry of an officer and director bar. The court will determine disgorgement and a civil penalty.

Mr. Kao consented to the entry of an injunction based on Exchange Act Sections 10(b), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). He also agreed to pay a civil penalty of $100,000. Mr. Liu consented to an injunction based on Securities Act Section 17(a) and Exchange Act Section 10(b) and 13(a) and to an order imposing an officer and director bar. Mr. Pratt consented to the entry of an injunction based on Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 3(b)(5). He also agreed to pay disgorgement in the amount of $88,000 along with prejudgment interest and a civil penalty of $90,000 and to a five year officer and director bar. In a related administrative proceeding he agreed to the entry of an order suspending him from appearing or practicing before the Commission as an accountant for a period of five years.

SEC v. AutoChina International Ltd., Case No. 1:12-CV-01643 (D. Mass. Filed April 11, 2012) is an action centered on manipulation claims. The complaint names as defendants the China based company, eight individuals and two entities. The individual defendants include Hui Kai Yan, a member of the board of directors.

In order to facilitate obtaining financing using company stock as collateral, the defendants and others are alleged to have engaged in a scheme to increase its trading volume to enhance the appearance of liquidity. Using numerous accounts, many of which were opened on the same day, the defendants and their cohorts engaged in manipulative trading such as wash sales and matched orders. The trading created the appearance of activity, increasing volume from about 18,000 shares per day in the summer of 2010 to over 139,000 shares per day in the late fall of that year. In February 2011 an entity controlled by AutoChina’s Chairman and his spouse obtained about $120 million in financing. The only asset of the entity was AutoChina stock. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 9(a) and 10(b). The case is in litigation.

The complaint in SEC v. Ming Zhao, Case No. 12 CV 1316 (S.D.N.Y. Filed Feb. 22, 2012) is based on allegations concerning the misuse of company assets. The action is against the former Chairman and CEO of the company as well as its current CEO. It focuses on Puda Coal, Inc., a Delaware corporation with a principal office in Taiyucan, Shanxi Province, PRC. Shares were traded on the NYSE from September 2009 through August 2011. Its primary asset was Shaux Coal, a coal mining company that was an indirect subsidiary 90% owned by Puda.

On September 28, 2009, Puda announced that Shanxi Coal was one of the entities selected by the Shanxi provincial government to become a coal mining consolidator. This was an extremely lucrative opportunity for the company. Earlier in September, however, Puda’s CEO, defendant Ming Zhao, transferred all of the company’s interest in Shanxi Coal to himself. Subsequently, a series of steps were taken which culminated with U.S. investors buying shares in a shell company.

First, in July 2010 Mr. Zhao transferred 49% of the coal company to CITIC Trust Co., a Chinese private equity fund. That fund was controlled by CITI Group, the largest state-owned investment firm in the PRC. Mr. Zhao also arranged to have Shanxi Coal pledge 51% of its assets to CITI Trust as collateral for a loan of about $370 million. Second, during the summer of 2010 CITI Trust sold shares to the Chinese public in a trust which held a 49% interest in Shanxi Coal. Third, in 2010 Puda conducted two public offerings in the United States of shares to raise capital for the operations of Shanxi coal, its supposed sole source of revenue. Those shares were sold to U.S. investors. As a result Chinese investors received shares in a trust which owned part of the coal company. U.S. investors received shares in a company which was a shell.

After the Commission’s investigation began, defendant Liping Zhu forged a letter supposedly from CITIC Trust which falsely disclaimed any interest in Shanxi Coal. The letter was produced to the SEC staff by U.S. counsel. After it was disclosed in a filing with the Commission, the letter was exposed as a fraud. Mr. Zhu then admitted the forgery and resigned. Mr. Zhao became CEO. The share price of Puda dropped from $17 to a few cents. The Commission’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 12(b)(2)(B), 13(b)-5 and 14(a). The action is pending.

Next: The FCPA

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by T. GormanPosted on Posted in SECActions

This is the second segment of a five part series examining issues arising in SEC Enforcement Actions relating to issuers from the PRC whose shares are traded in the U.S.

Failure to file periodic reports

One group of cases brought by the SEC involving PRC issuers centers on allegaions that they failed to file the required periodic reports with the Commission. Companies who have registered their securities for trading with the SEC are required to file periodic reports with the SEC under Section 12 of the Exchange Act. Those include annual and quarterly reports. Failure to file those reports can result in the revocation of the company’s registration statement under Exchange Act Section 12(j). In that instance the company’s shares can no longer be traded on a U.S. exchange.

The SEC has revoked the registration statements of over a dozen Chinese issuers. At least 27 other revocation cases pending. In the Matter of Longtop Financial Technologies Ltd., Adm. Proc. File No. 3-14622 (Nov. 10, 2011) is an example of an action brought under Exchange Act Section 12(j) to revoke the registration statement of the company. Longtop is a Cayman Island company based in Shanghai whose ADRs have been traded in New York since its IPO in October 2007. On May 17, 2011 the Exchange halted trading and subsequently delisted the shares of the company. Longtop failed to file its annual report with the Commission for the fiscal year ended March 31, 2011. It also failed to provide investors with annual reports for 2008 – 2010. On December 14, 2011 a order was entered revoking the registration statement of the issuer by default.

Another China based company which went public through a reverse merger and had its registration statement revoked under Exchange Act Section 12(j) also spawned five other Commission enforcement actions. China Yingxia International, Inc. was a Florida corporation headquartered in Harbin, China. The company entered the U.S. capital markets through a reverse merger in May 2006. Its shares were quoted on OTC Link which was formerly the “pink sheets.”

From 2006 through 2009 the company purported to be in the health food business. On February 2, 2012 the Commission instituted an administrative proceeding against the company alleging violations of Section 12(j) since it had failed to file any periodic reports since late 2008. In an order dated March 7, 2012 each class of China Yingxia’s registered securities was revoked. In the Matter of China Yingxia International, Inc., Adm. Proc. File No. 34-66304 (February 2, 2012).

Related actions

One of the actions related to China Yingxia named as defendants Peter Siris, and his companies, Guerrilla Capital Management, LLC and Hua Mei 21st Century, LLC. Mr. Siris and his entities served as advisers to China Yingxia as well as several other China based entities. SEC v. Siris, Civil Action No. 12-cv-5810 (S.D.N.Y. Filed July 30, 2012).

Mr. Siris is the author of several books on investing and manages two New York based funds which invest in U.S. listed Chinese companies. Guerrilla Capital is a management company and Hua Century is a sub-advisor to it. Mr. Siris invested $1.5 million in China Yingxia through the funds he manages. He was one of three consultants to the firm and, along with Hua Mei, helped raise money for it. In the reverse merger through which the company went public Hua Mei received both cash and shares in return for performing due diligence. Portions of the shares came directly or indirectly through a person controlled by the issuer, in a transaction structured to evade the registration provisions of the securities laws, according to the court documents. The shares were sold yielding $24,600 in illicit proceeds. The next year Mr. Siris acted as an unregistered broker in raising over $2 million for an $8.7 million PIPE transaction conducted by China Yingxia. In connection with that deal he was paid $107,500 in transaction based compensation.

As a consultant for the firm Mr. Siris reviewed filings made with the SEC, press releases and was involved in hiring decision. In February 2009, after learning of difficulties at the company from its CEO, including the fact that she had engaged in illegal fundraising in China and that the company had shut down, he sold a substantial number of company shares prior to the public disclose of these events. The next month, after reviewing a draft press release disclosing the matters he increased his selling activity. Overall Mr. Siris sold 1,143,600 shares of China Yingxia yielding profits of $172,000 while in possession of material non-public information. After a press release was issued on March 6, 2009 the share price plummeted and the directors and CFO resigned, effectively ending the operations of the company.

The complaint also alleges that Mr. Siris made misrepresentation to investors in his funds concerning China Yingxia and traded on inside information regarding ten other Chinese issuers. He is also alleged to have directed short sales on the shares of two other Chinese issuers in violation of restrictions prohibiting such sales prior to his funds’ participation in firm commitment public offerings for the companies. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b), 15(a) and Advisers Act Sections 206(4). Each defendant settled, consenting to the entry of permanent injunctions based on the sections cited in the complaint. In addition, the three defendants have agreed to pay disgorgement in the amount of $592,942.39 along with prejudgment interest. Mr. Siris will also pay a civil penalty of $464,011.93.

A related action was brought against Ren Hu, Alan Sheinwald and Alliance Advisors, LLC. SEC v. Sheinwald, Civil Action No. 12-CV-5810 (S.D.N.Y. Filed July 30, 2012). Mr. Hu became the CFO of China Yingxia in 2008 despite having expressed skepticism about the company. He was also the CFO of several other Chinese reverse merger company. He signed certifications required by the Sarbanes-Oxley Act of 2002 regarding the controls of the company. Mr. Hu claimed to have participated in the design of the disclosure and internal controls of China Yingxia when in fact it had virtually none. Mr. Sheinwald and his investor relations firm, Alliance Advisors, acted as unregistered securities brokers for China Yingxia in 20 07. The complaint alleges violations of Exchange Act Sections 10(b), 13(b)(2)(B) and 15(a). The case is in litigation.

See also In the Matter of Peter Dong Zhou, Adm. Proc. File No. 3-14964 (July 30, 2012)(settled administrative proceeding against a registered representative who helped China Yingxia engage in the unregistered distribution and sale of restricted securities, assisted with the retention of its CFO and insider traded when he learned the company was collapsing; the action settled with a consent to a cease and desist order based on violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b), the imposition of a bar from the securities business and from participating in a penny stock offering with a right to reapply after three years and an agreement to pay disgorgement of $20,900, prejudgment interest and a penalty of $50,000); In the Matter of Stephen Mazuchowski, Adm. Proc. File No. 3-14965 (July 30, 2012)(settled proceeding based on allegations that the Respondent acted as an unregistered broker for China Yingxia; the action settled with a consent to a cease and desist order based on Exchange Act Section 15(a), a bar from the securities business and from participating in a penny stock offering with a right to reapply after two years and an agreement to pay disgorgement of $126,800, prejudgment interest and a penalty of $25,000); In the Matter of James Fuld, Jr., Adm. Proc. File No. 3-14966 (July 30, 2012)(settled proceeding based on the alleged sale of securities of China Yingxia; based on the Respondent’s cooperation the case was resolved with the payment of disgorgement of $178,594.85 along with prejudgment interest).

Issues with auditors

The accessibility of work papers prepared by PRC based auditors registered with the PCAOB for Chinese issuers whose shares are traded in the U.S. markets is a critical issue. The Sarbanes Oxley Act of 2002 or SOX requires the independent audit firm for any issuer who has a class of securities registered with the SEC be registered with the Board. SOX Section 106(b) provides that any audit firm that registers with the PCAOB consents to produce its work papers on request by the SEC or the Board.

Despite the mandate of SOX, U.S. regulatory officials have not been able to access the accounting work papers related to PRC based issuers whose shares are traded in the U.S. capital markets. This is the critical issue on which the Commission’s action captioned In the Matter of Deloitte Touche Tohmatsu Certified Public Accountants Ltd., Adm. Proc. File No. 3-14872 (May 9, 2012) is based.

That proceeding names as a Respondent PRC based Deloitte Touche Tohmatsu Certified Public Accountants or D&T Shanghai. The action is based on Rule 102(e)(1)(iii) of the SEC’s Rules of Practice which permits the Commission to revoke the right to appear and practice before it as an accountant if that professional engages in a willful violations of the federal securities laws.

The Order for Proceedings or OIP alleges violations of SOX Section 106(b). According to the Order, since April 2010 the SEC staff has made extensive efforts to obtain the work papers related to “Client A.” The firm has declined, through its international parent, to produce the requested work papers based on its understanding that PRC law precludes production. The Order alleges that the failure to produce the requested work papers constitutes a violation of SOX Section 106(b). A hearing will be convened.

The same audit firm became the subject of a second Commission action which relates to Longtop Financial Technologies, Ltd. SEC v. Deloitte Touche Tohmatsu CPA, Ltd., File No. 1:11-MC-00512 (D.D.C. Filed Sept. 8, 2011). This is a subpoena enforcement action. The court papers allege that the audit firm is registered with the PCAOB and served as the outside auditors for Longtop. In a letter dated May 23, 2011 the firm resigned from the engagement after discovering numerous improprieties during a year end audit.

Subsequently, the SEC issued an investigative subpoena for documents to the audit firm. To date no documents have been produced. Initially, the Commission moved forward with the action, requesting that the court order the documents produced. In a July 18, 2012 filing however, the SEC asked that the Court stay the proceeding for six months. The request was made because of “ongoing negotiations with a foreign regulator that could impact the appropriate resolution of this case. If the Court grants this stay, the SEC would file a status report with the Court no later than January 18, 2013 to advise the Court of the general status of these negotiations and, if appropriate, to request that the briefing schedule be reset.”

The PCAOB has also engaged in discussions with their counterparts in the PRC. To date those discussions have not resulted in any agreement to give U.S. regulators access to audit work papers as required by SOX.

Next: Corporate governance

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