June 24, 2011 / 12:46 PM / 6 years ago

Analysis: Sino saga shows flaws in Canada's regulatory regime

TORONTO (Reuters) - Canadian regulators are under fire for their disappearing act as shares of Chinese forestry company Sino-Forest melted down, raising new questions about a regulatory regime that’s long been criticized for lacking teeth.

<p>The company logo of Sino-Forest is displayed at the entrance of its office in Hong Kong June 8, 2011. REUTERS/Xavier Ng</p>

Sino-Forest, which three weeks ago had a market capitalization of about C$4.7 billion, is now worth just C$700 million, after accusations of fraud leveled by Hong Kong-based short-seller Carson Block and his one-man firm Muddy Waters sent its shares and bonds into a downward spiral.

Regulators said they had launched an investigation, but then stayed silent, doing nothing to quell the speculation, halt the stock or drill down into the problems.

There were similar complaints of inaction during the huge Bre-X stock fraud of the 1990s, while shareholder activists noted bitterly that press baron Conrad Black was successfully prosecuted in the United States and not in Canada.

“We have a system in Canada that is 80 years behind the times,” said Al Rosen, a forensic accountant with Rosen & Associates, who said Canada’s current reporting standards serve the interests of auditors more than investors.

He said Ontario regulators, responsible for Mississauga, Ontario-based Sino-Forest under Canada’s patchwork of provincial regulators, have let investors down, and Canada would be better served by a single securities regulator, with separate prosecution and regulation arms.

“If you don’t have these people with proper supervision and leadership and guts and courage you’ve got nothing,” he said.

The Ontario Securities Commission, the biggest of Canada’s provincial regulators, did not return repeated phone calls seeking comment.

“The OSC’s policy all the time is to not comment, which is a convenient policy, right?” said Rosen. “So when the OSC say, we’re giving it the same treatment we’ve given everything else, you can read anything you want into that. I read into it that they’re doing nothing again.”

Joseph Groia, a securities lawyer and former director of enforcement at the OSC, also believes regulators were slow to respond in the Sino-Forest saga.

“As best I can tell, they’ve done nothing. My view is that the horse is out of the barn and there is probably no point in them doing anything now,” he said.


Block, in his fifth successful assault against the stock of a North American-listed Chinese company, said Sino-Forest had fraudulently overstated its assets in a gigantic Ponzi scheme.

Sino-Forest denies the charges.

But while some experts said the OSC should have halted Sino-Forest shares pending probes into the allegations, others said the market should decide the company’s fate.

“With 20/20 hindsight you can always say regulators should have done more. But that doesn’t mean that at the time there were any warning signs, or red flags that suggested they should have done more,” said Cristie Ford a University of British Columbia professor and an expert on securities regulation.

Ford is less sure that U.S. regulators would have been more proactive in their response than their Canadian counterparts and said the Canadian framework is more “compliance-oriented.”

“It’s about trying to catch things before they require enforcement action rather than hitting the company with the big stick after they’ve done the bad thing,” she said.

“The Americans are very much outliers when it comes to how much enforcement and how much strong action they take in these kinds of situations, relative to everybody, not just Canada.”

Sino-Forest’s collapse has prompted parallels with Canada’s 1997 Bre-X mining scandal, when rock samples were salted with gold to create the impression of a massive gold strike.

That scandal led to a whole new regulatory framework to govern how miners outline mineral resources, and some said Sino-Forest’s woes could prompt new rules on other matters, regardless of whether the accusations turn out to be true.

“It is very likely that once the matter of Sino is fully determined one way or the other, the regulators will take a more proactive role in closing any gaps that might have occurred,” said Darryl Levitt, a lawyer with Macleod Dixon.


But for now, investors burned by the scandal are left to wonder who is actually in charge.

“There are quite a few regulatory bodies in Canada and it would appear that the buck is being passed,” said Levitt.

Federal government officials defer to provincial regulators, while officials at IIROC, which oversees trading activity, and the Toronto Stock Exchange operator TMX Group point to the OSC as the organization that handles cases like this.

“I think they’ve been lax right across the board,” said Rosen, author of the book “Swindlers,” which says Canadian regulators who should watch corporations and protect investors are all too often missing in action, or asleep at the wheel.

“It’s like having signs on the highway that say it’s 50 km/h. But there’s never any police, there’s never any radar, there’s never any helicopters. How many people are going to treat it seriously?”


The Sino-Forest case and accounting scandals at other North American-listed Chinese companies have also shone a spotlight on the murky world of reverse takeovers, that let small private entities go public via listed shell companies with far less scrutiny than through an initial public offering.

“For certain types of transactions, even if they are done via RTO‘s, regulators may ask for a prospectus, as opposed to an information circular and thus up the nature of disclosure required,” said a lawyer who asked not to be named due to a conflict of interest.

Even as class action lawsuits pile up against Sino-Forest, its directors, its management and its auditors, some say analysts and short-sellers like Muddy Waters should also be held accountable for their actions.

“There are eight research analysts covering this company, all of whom had a buy or an outperform rating on this stock. It’s their job to kick the tires in a way that regulators never do,” said UBC’s Ford.

“If you’re going to lay this at the foot of the regulators for not having put a cease trade on this company it seems a little bit misplaced. What about all those research analysts? Why weren’t they doing the job they were meant to be doing?”

Any case against analysts who touted the stock, or others that have slammed the company is unlikely to proceed until the allegations are proven, or quashed by an independent probe.

Groia said regulators should watch short-sellers like Muddy Waters too.

“This ought to be a lesson that the regulators learn from, so that they put more liability on the Muddy Waters of this world,” he said. “They are not doing this because they are altruists; they are doing it because they are capitalists.”

Additional reporting by Louise Egan and Randall Palmer; Editing by Janet Guttsman

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