Underwriter, Two Employees Charged By SEC

The SEC brought another case tied to Chinese reverse mergers. This one differs from many earlier actions which focused on the company and or the executives. This action names as defendants one broker-dealer and two of its employees as defendants. It centers on two public offerings of the shares of Puda Coal, Inc. which, by the time of the offerings, lacked its primary asset — a fact unfortunately not known to those who purchased the shares in the secondary offerings. SEC v. Macquarie Capital USA), Inc., Civil Action No. 15 cv 02304 (S.D.N.Y. Filed March 27, 2015).

Puda Coal, Inc.is the product of a Chinese reverse merger. Its primary asset when it entered into the U.S. markets in 2009 and was listed on the NYSE was Shanxi Coal, a Chinese coal mining company established under the laws of the PRC in 1995. Previously, Puda indirectly owned 90% of Shanxi Coal.

Defendant Macquarie is a Commission registered broker-dealer that is a wholly owned subsidiary of Macquarie Group Limited, a global financial services firm based in Australia. The firm served as lead underwriter and joint bookrunning manager for Puda’s follow-on public stock offerings. Defendants Aaron Black and William Fang are both employees of the broker-dealer. Mr. Black served as a Division Director in the Sydney office while Mr. Fang was an investment banking associate and registered representative in the New York office.

Puda had an off-shore ownership structure that was typical for public companies with operations in the PRC. Its primary business was initially as a supplier of cleaned coking coal used in the manufacture of steel. In 2009 the firm modified its strategy and entered into the coal mining business as a result of certain provincial regulations. In September of that year Puda’s chairman caused its 90% interest in Shanxi Coal to be transferred to himself without the approval or knowledge of the public shareholders or the board of directors. As a result of other transfers he eventually held 99% of Shanxi Coal. Later he entered into a series of transaction through which control of Shanxi Coal was pledged as collateral for a loan to the firm. These transactions were not reflected in the public filings of Puda.

On February 18, 2010 Puda completed the offering and sale of 2.86 million shares, obtaining net proceeds of about $14.5 million. Subsequently, on December 16, 2010 the firm completed the sale of another 9 million shares, obtaining net proceeds of $101.5 million.

Prior to the offerings the Underwriting Committee of the firm directed the Puda transaction team, which included Mr. Black, to engage Kroll Associates Inc., an investigative firm, to prepare a report on Puda and its officers and directors. The firm was aware of the heightened risk of the deal, as reflected in its papers. Kroll identified documents showing that Shanxi was owned by others. Although Mr. Fang read the report and Mr. Black reviewed portions of it, neither pointed out the fact that Kroll had obtained documents showing the mine belonged to others. The firm did not have sufficient systems in place to properly assess the report, according to the complaint.

The offerings went forward using disclosure documents which did not disclose that the largest asset of Puda was no longer owned by the firm. To the contrary, the offering documents continued to list Shanxi as the primary asset of Puda.

In April 2011 an internet report on Puda disclosed some of the asset transfers and transactions involving Mr. Zhao and others. Just before the report became available the share price was at a high of over $16 per share, $4 above the offering price. The day the report surfaced the stock closed at $6 per share. A subsequent investigation by the audit committee uncovered the fraud which was then reported on a Form 8-K. Subsequently, Puda’s auditor resigned, stating that further reliance should not be placed on its prior audit reports. The shares were delisted and now trade in the grey market.

The Commission’s complaint alleges violations of Securities Act Sections 17(a)(2) and (3). The firm has agreed to settle with the Commission by paying a $15 million penalty and covering the cost of setting up a fair fund to compensate investors who suffered losses. The individuals have not settled. See Lit. Rel. No. 23222 (March 27, 2015).

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