Don't Trust Anyone

Investment banks, auditors, advisors and ratings agencies all fail to see fraud coming with China Forestry

When it comes to offering a façade of respectability by charging a high price for doing nothing, western investment banks and so-called professional advisers have few peers.

With regulators themselves blinded by the big-name dazzle – and perhaps hoping for some future mega salary with one of them – ordinary investors who are supposed to be protected by regulators and professional advisers take the hit from frauds. The frauds are possible simply because the so-called professionals pass the buck of carrying out due diligence. Yet the likes of S&P, Moody's, UBS, Standard Chartered and auditors KPMG hide behind the small print in unreadable prospectuses.

Take the case of China Forestry, a scam given respectability by all the above-named firms, which collected huge fees for failing to do their job. But don't expect the firms to suffer either at the hands of the supposed regulators. Batteries of expensive lawyers will protect them from any civil actions for damages that might be brought by the duped investors. Even big-name investors like Carlyle, a big loser in this case, appear reluctant to challenge the competence of professional advisers.

China Forestry has recently acknowledged that much that the public was told about it by its former management was a pack of lies. These should long ago have been uncovered long before its initial public offering but such is the greed of all so-called professionals involved that they had their eyes fixed firmly on their fat fees than on the facts of China Forestry. As of mid-2010 the company was claiming net assets of HK$9 billion and profits for the previous six months of HK$426 million. So whatever the truth, this is deception on a grand scale.

The company did actually buy some forests with money obtained from private placements with the likes of Carlyle in the years prior to its IPO. It was then able to issue a three-year profit record, needed for the IPO, simply by revaluing its forests. The so called "fair value" was provided by a mainland valuer, Greater China Appraisal. However, this company did not actually verify anything itself but relied on an opinion from a mainland law firm, Commerce and Finance Law Office. Likewise a New Zealand forest company engaged to report on the quality of the forests actually carried out only a cursory physical inspection and appraisal but relied on information provided by the company itself!

Despite such flimsy proof of the quality of the assets and despite the company's obvious reliance on asset valuations, not production, to generate profits UBS, Cazenove (owned by J.P. Morgan) and Standard Chartered pushed ahead with the IPO, which was duly given approval by the Hong Kong regulator. Listed at HK$2 in late 2009, its share price initially did not do much but after lots of bullish media and brokerage coverage went to HK$3.50. The price collapsed in April 2010 when it had to admit a fall in the value of its forests but UBS spurred renewed bullishness by focusing on its acquisition of another 120,000 hectares and the share price rose further on announcement of a deal to supply logs to a state enterprise. The price climbed back briefly over HK$4 and traded around HK$3.50 until shortly before its suspension in January this year.

Moodys and S&P joined the party late last year by assigning quite respectable credit ratings (Ba3 and B+ respectively), which enabled China Forestry to raise US$300 million of debt, which was sold though UBS and Standard Chartered. The party continued until a huge share sale by the then chief executive, using Standard Chartered. This triggered an inquiry by the Securities and Futures Commission, suspension of the shares and a Moody's "review for possible downgrade." The chief executive has been removed and arrested in China and the proceeds of his share sale have been frozen.

And now the auditor, big name firm KPMG, has admitted that many of the papers and accounting staff have gone missing so it is unable to verify anything. A new board admits that basic data such as management accounts, bank statements and logging information may have been falsified.

This is not just a story about China Forestry, or even just about the buck-passing among highly paid financial firms and professional advisers. It is a story about the difficulty of verifying information in China and the folly of relying on mainland professional firms to do a competent and honest job under the temptations and pressures they often face. It is bad enough that big name, Hong Kong-based international firms were hoodwinked for so long. It shows up the folly of the territory agreeing in future to accept mainland audits for Hong Kong listings. This decision is typical of the "any business at any price" attitude of Hong Kong's stock exchange (whose chairman and half the board are government appointees) and the ambition of its new chief executive, a mainlander with a US investment bank background. Hong Kong's reputation for high standards is being sacrificed on the altar of the greed and short term thinking of market players.

The deep involvement of Standard Chartered may also be partly linked to its attempt to curry political favors by its appointment of Katherine Tsang, the sister of Hong Kong chief executive Donald Tsang to chair its Greater China operations. She has had a stellar rise at the bank after a modest career as a human resources manager for the Hong Kong government.