Sino-Forest Corp. (TRE) Chairman William Ardell says he found no sign of major fraud while overseeing an
eight-month probe of the company. He also says a full account of
the Chinese timber producer’s activities and business ties may
never be known.
“There has been no material evidence provided that would
indicate that there has been a major fraud,” Ardell said in an
interview. “I can’t give you a 100 percent guarantee as to
everything.”
Ardell led an independent committee of company directors
charged with investigating allegations made by research company
Muddy Waters LLC that Sino-Forest exaggerated its timber assets
and operated a Ponzi scheme. The committee, which said in a
report last month it may not be able to disprove some of the
allegations, hasn’t conclusively demonstrated that “there is
timber there, and there is value there,” Ardell said in the
interview.
Once the largest Chinese forestry company by market value,
Sino-Forest has lost shareholders about C$3.3 billion ($3.3
billion) since Muddy Waters published its report on June 2.
Ardell and his colleagues are trying to pull the company out of
a death spiral after its shares were suspended amid
investigations by Canadian regulators and police, and Chief
Executive Officer and founder Allen Chan stepped down.
The plight of Hong Kong- and Mississauga, Ontario-based
Sino-Forest and its shareholders also has thrown a spotlight on
contrasting Chinese and North American business practices.
Ardell, 68, who spoke at his lawyer’s office in Toronto on Feb.
4 and in three separate phone interviews, says his challenge now
is to convince investors, regulators and auditors that the
company’s lack of transparency doesn’t diminish its underlying
value.
‘Life Imploded’
“I have a belief in the business,” Ardell said. “I have
a belief in Allen Chan.”
The first inkling Ardell had that his belief might be put
to the test came the day Muddy Waters issued its report.
“‘Have you heard?’” Ardell recalls his wife, Sherry,
asking him by phone just after he’d finished 18 holes at Lambton
Golf & Country Club in Toronto. “‘Sino-Forest is a fraud.’”
“Life imploded at that point,” Ardell said.
Sino-Forest shares slumped as much as 25 percent before
being suspended on the Toronto Stock Exchange. They tumbled 64
percent the following day after trading resumed. Ardell, a
Canadian who lives in Oakville, just outside Toronto, says he’s
spent four months in Hong Kong since then dealing with the
fallout.
‘Unjustifiable Black Hole’
Ardell started his career in accountancy and rose to become
CEO of Southam Inc., once Canada’s largest newspaper publisher,
which was acquired in 1996 by Hollinger International Inc., the
media company whose chairman and CEO at the time was Conrad Black.
He joined Sino-Forest as a director in 2010 and was
appointed chairman in August to replace Chan, who resigned after
the Ontario Securities Commission halted the stock pending an
investigation.
Sino-Forest’s structure makes documenting its assets and
revenues difficult, according to Ardell. About 80 percent of its
timber assets measured by value are held by subsidiaries based
in the British Virgin Islands. Those units use suppliers and
what the company calls “authorized intermediaries” in China to
buy and sell timber and plantation harvesting rights.
The so-called BVI model and its use of intermediaries is
“an unjustifiable black hole” that’s been used to fabricate
sales, avoid taxes and overstate the company’s timber holdings,
Muddy Waters said in its report.
Cash Flow
Ardell says the structure was put in place in the late
1990s to deal with rules barring foreign companies from leasing
timberland and repatriating forestry profits.
With its profits marooned in China, Sino-Forest reinvested
the money in more timberland while using some proceeds from
sales of bonds and shares to cover operating costs, according to
Ardell.
While it was the only way to organize the company, it meant
“you can’t see the cash move,” he said. Ardell also says that
helps explain why Sino-Forest doesn’t have positive free cash
flow or pay a dividend, both factors cited by Muddy Waters as
evidence the company is a Ponzi scheme.
Since 2004, the company has been able to structure its
Chinese units as so-called Wholly Foreign Owned Enterprises,
which allows them to lease timberland and repatriate money,
Ardell says. While Sino-Forest plans eventually to switch to
this model entirely instead of the BVI structure, the timing
isn’t certain, he says.
No Maps
One of the few ways Sino-Forest can prove its ownership of
standing timber is through purchase contracts negotiated with
Chinese villages, communes and other leaseholders, Ardell says.
Because they don’t infer title to land, the contracts aren’t
registered with local government forestry bureaus, he says.
“There just isn’t a central registry for sales and
purchases of standing timber, and there wouldn’t be in North
America either,” Ardell said.
What’s more, Sino-Forest doesn’t retain complete maps of
some of its timber holdings because “there is a sensitivity in
the Chinese government about maps being held by foreign-
controlled companies,” Ardell said.
The independent committee, aided by PricewaterhouseCoopers
LLP, spent $50 million on its investigation and reviewed more
than 1.5 million documents, according to Ardell. It was hindered
by a lack of cooperation from many of the suppliers and
intermediaries involved in the BVI transactions, Ardell says.
Cash Holdings
“All of a sudden a lot doors closed very quickly”
following the Muddy Waters report, he said.
A lack of documentation relating to corporate relationships
was due partly to a lack of adequate internal controls and also
to Chinese business practices, he says.
“The Chinese generally aren’t as meticulous at record-
keeping as in the West because so much of the business is based
on personal relationships,” said John Evans, a retired senior
partner at Osler Hoskin & Harcourt LLP in Toronto who has known
Ardell for more than 20 years. “A lack of documentation is very
common in China.”
The committee said in its final report published Jan. 31
that it wasn’t able to confirm the existence of all the
company’s timber and cash holdings in China, or the full scope
of Sino-Forest’s relationships with its suppliers.
Bondholder Accord
“You can’t spend that much time, money and witness
managements’ interference with your investigation and reasonably
conclude that the fraud charges had no merit,” Carson Block, a
short seller and Muddy Waters founder, said Feb. 4 in a
telephone interview.
Ardell says management hasn’t interfered in the
investigation.
After missing an interest payment on its 2016 convertible
bonds in December, Sino-Forest reached an accord last month with
a group of bondholders, in return ceding them a degree of
control over its affairs. A restructuring committee is working
to write a new plan for the company and deliver its report to
bondholders by March 31.
Ardell says he’s sticking with the company and continues to
assist the Ontario Securities Commission and Royal Canadian
Mounted Police investigations. Sino-Forest has commissioned two
consulting companies to independently evaluate its holdings,
which according to its website cover about 894,200 hectares
(3,452 square miles) in China, an area about three times the
size of Rhode Island.
“If I can demonstrate ownership, existence and value, the
rest of it all goes away,” Ardell said. “That’s basically what
the business is: Ownership and value.”
To contact the reporters on this story:
Christopher Donville in Vancouver at
cjdonville@bloomberg.net;
Steven Frank in Toronto at
sfrank9@bloomberg.net
To contact the editor responsible for this story:
Simon Casey at
scasey4@bloomberg.net
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