Ontario

Commission des

22nd Floor

22e étage

Securities

valeurs mobilières

20 Queen Street West

20, rue queen ouest

Commission

de l’Ontario

Toronto ON M5H 3S8

Toronto ON M5H 3S8

Citation: Sino-Forest Corporation (Re), 2017 ONSEC 27

Date: 2017-07-13

IN THE MATTER OF

SINO-FOREST CORPORATION, ALLEN CHAN, ALBERT IP, ALFRED C.T. HUNG,

GEORGE HO, SIMON YEUNG and DAVID HORSLEY

REASONS AND DECISION

Hearing:

September 2, 3, 4, 5, 8, 10, 11, 12, 16, 17, 18, 19, 22, 24 and 30, 2014

 

October 1, 2, 3, 6, 8, 9, 10, 14, 15, 16, 17, 28, 29, 30 and 31, 2014

 

November 3, 5, 6, 7, 10, 12, 13, 14, 17, 19, 20, 21, 24, 25, 26, 27 and 28, 2014

 

December 1, 3, 4, 5, 9, 10, 11, 12, 15, 16, 17 and 18, 2014

 

January 6, 7, 8, 9 and 12, 2015

 

 

March 16, 17, 18, 20, 23, 25, 26, 27 and 31, 2015

 

April 1, 2, 8, 9, 10, 15, 16, 17, 20, 22, 23, 24, 28, 29 and 30, 2015

 

May 1, 4, 6, 7, 8, 12, 13, 14, 15, 20, 21, 22, 25, 27, 28 and 29, 2015

 

June 3, 4, 5, 9, 10, 11, 12, 17, 18, 19, 22, 23, 24 and 26, 2015

 

September 1, 2, 3, 4, 9, 10, 11, 14, 15, 21, 23, 24, 25, 28, 29 and 30, 2015

 

October 1, 5, 6, 7, 13, 14, 15, 16, 19, 21, 22, 23, 26, 27, 28 and 29, 2015

 

November 2, 4, 6, 9, 11, 12, 13, 16, 18, 19, 20, 23, 25 and 30, 2015

 

December 2, 3, 4, 7, 8, 9, 10, 14 and 16, 2015

 

April 18, 20, 21, 22, 25, 26, 27 and 28, 2016

 

May 2, 4, 5, 6, 9, 11 and 12, 2016

Reasons and

July 13, 2017

 

Decision:

 

 

Panel:

James D. Carnwath, Q.C.

- Commissioner and Chair of the Panel

 

Edward P. Kerwin

- Commissioner

 

Deborah Leckman

- Commissioner

Appearances:

Hugh Craig

- For Staff of the Commission

 

Carlo Rossi

 

 

Malinda Alvaro

 

 

Emily Cole

- For Allen Chan

 

Rohit Kumar

 

 

Caleb Edwards

 

2017 ONSEC 27 (*)

Markus Koehnen

- For Albert Ip, Alfred C.T. Hung, George Ho and

Stephen Wortley

Simon Yeung

Jeffrey Levine

 

Adam Chisholm

 

No one appeared on behalf of Sino-Forest Corporation

2017 ONSEC 27 (*)

TABLE OF CONTENTS

I.

BACKGROUND

1

 

A. Introduction

1

 

B. Sino-Forest

4

 

C. The Muddy Waters Report and the Events that Followed

5

 

D. The Individual Respondents

5

II. EVIDENCE

6

 

A. Witnesses

6

 

B. Challenges for Witnesses in the Hearing

10

 

C. The Independent Committee Investigation

10

 

1.

Scope

11

 

2.

Management

11

 

3.

The Investigation

12

 

 

(a) Data Capture

12

 

 

(b) Forestry Bureaus

12

 

 

(c) Suppliers and AIs

13

 

 

(d) Challenges

13

 

4.

The Final Report

14

III. SINO-FOREST’S TIMBER BUSINESS IN MAINLAND CHINA

14

 

A. Forestry Ownership in Mainland China

14

 

B. Sino-Forest’s Plantation Ownership in Mainland China

17

 

1.

Evidence of Transfer of Forestry Rights

17

 

 

(a) Purchase Transactions

17

 

 

(b) Sales Transactions

18

 

2.

Annual Valuation of Sino-Forest’s Forestry Assets by Pöyry

19

 

C. Forestry Asset Terminology in Sino-Forest’s Disclosure

21

 

1.

Description of Assets

21

 

2.

Description of Revenue Streams

22

 

 

(a) 2003-2006 – Standing Timber: Planted Plantations and Purchased

 

 

 

Plantations

22

 

 

(b) 2007-2009 – Plantation Fibre: Planted Plantations, Purchased

 

 

 

Plantations and Integrated Plantations

22

 

 

(c) 2010 – Plantation Fibre: Standing Timber and Logs

23

 

 

(d) Revenue Reported from the Sale of Logs

23

 

D. Other Issues Relevant to Sino-Forest’s Timber Business

24

 

1.

Fapiao and Tax Implications

24

 

2.

State Administration of Foreign Exchange (SAFE)

25

 

3.

Company Registrations – SAIC Filings

26

IV. SINO-FOREST’S BUSINESS MODELS: THE BVI MODEL AND THE WFOE

 

 

MODEL

26

 

A. The BVI Model

26

 

B. The WFOE Model

29

 

C. Continued Use of the BVI Model and Sino-Forest’s “On-Shoring” Plan

30

V.

ALLEN CHAN’S ROLE AT SINO-FOREST

32

 

A. Testimony of Thomas Maradin

33

i

2017 ONSEC 27 (*)

B. Testimony of William Ardell

34

C. Testimony of James Hyde

35

D. Testimony of David Horsley

36

E. Testimony of Judson Martin

37

F. Testimony of Fred Clifford

37

G. Testimony of Dr. Randall Peerenboom

38

H. Evidence of Ip and Hung

39

I. Conclusion

40

VI. ANALYSIS OF THE STANDING TIMBER FRAUD ALLEGATIONS

41

A. The Standing Timber Fraud Allegations

41

B. Undisclosed Control Allegations

42

1.

Positions of the Parties

42

 

(a)

Staff

42

 

(b) Respondents

43

2. Differences in Translation of Various Terms

44

3. Independent Committee Investigation into Suppliers and AIs

46

4. Sino-Forest’s Relationships with Companies in the BVI Network

47

 

(a)

Did Sino-Forest have Undisclosed Control Over Companies in the BVI

 

 

 

Network?

47

 

 

i. Yuda Wood

47

 

 

ii. Kun’an

55

 

 

iii. Taiyuan

57

 

 

iv. Dongkou

57

 

(b)

Other companies Staff alleges are related to Sino-Forest

59

 

 

i. Juncheng

59

 

 

ii. Shun’xuan

60

 

 

iii. Dacheng

61

 

 

iv. Yuangao

61

 

 

v. Meishan

61

 

(c)

Company Caretaker List

62

 

(d) Huang Ran

63

5.

Guanxi

65

6.

Conclusion: The Real Issue is Control and Value

66

7. The Roles of Chan, Ip, Hung, Ho and Yeung

67

C. Deceitful Documentation Allegations

70

1.

Positions of the Parties

70

 

(a)

Staff

70

 

(b) Respondents

71

2.

BVI Purchase Documentation

72

 

(a)

Purchase Contracts

72

 

(b) Forestry Bureau Confirmations and PRCs

74

 

 

i. Forestry Bureau Confirmations

74

 

 

ii. Comparison of PRCs and Forestry Bureau Confirmations

82

 

 

iii. Legal Opinions

84

 

(c)

Villagers’ Resolutions

87

 

(d) Locating the Standing Timber

88

 

 

i. Maps

89

 

 

ii. Survey Reports

90

 

(e)

Timing and Scope of the Purchase Documentation Process

92

 

 

 

ii

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i. The BVI Model

92

 

 

ii. Q4 2010

93

 

 

iii. Q3 2009

96

 

 

iv. Process Documents

97

 

 

v. Backdating of Purchase Documentation

100

 

(f)

Conclusion on Purchase Documentation

102

3.

BVI Sales Documentation

102

 

(a)

Sales Contracts

102

 

(b) Timing and Scope of the Sales Documentation Process

103

 

 

i. Q4 2010

103

 

 

ii. Sales Documentation Process

104

 

 

iii. Process Documents

106

 

(c)

Misleading the Commission Regarding Revenue Recognition

106

 

(d) Conclusion on Sales Documentation

108

4.

The Set-Off Process

108

5.

Who Knew What When

112

6.

The Roles of Chan, Ip, Hung and Ho

114

7.

Conclusion

118

D. Undisclosed Internal Control Weaknesses or Failures Allegations

121

1.

Positions of the Parties

121

 

(a)

Staff

121

 

(b)

Chan

122

 

(c)

Hung

122

2.Disclosure Requirements under NI 52-109 for Internal Control Weaknesses . 123

3.

Were there Undisclosed Internal Control Weakness?

124

 

(a)

Identification of Weaknesses

124

 

(b)

The Lack of Segregation of Duties

125

 

(c)

The failure to remediate the lack of segregation of duties

127

4.

The Roles of Chan and Hung

130

5.

Conclusion

132

E. Four Examples of Alleged Fraudulent Transactions

133

1.

Dacheng Transactions

133

 

(a)

Positions of the Parties

133

 

 

i. Staff

133

 

 

ii. Respondents

134

 

(b) The BVI Purchase and Sale

134

 

(c)

The WFOE Contracts

136

 

 

i. The Original WFOE Contracts – Dacheng Location A

136

 

 

ii. The Recorded WFOE Contracts – Dacheng Location B

139

 

(d) Pricing and Payments in the Dacheng Transactions

144

 

(e)

Conclusion

145

 

(f)

The Roles of Chan, Ip and Ho in the Dacheng Transactions

145

2.

450 Transactions

146

 

(a)

Introduction

146

 

(b)

Positions of the Parties

146

 

 

i. Staff

146

 

 

ii. Respondents

147

 

(c)

Structuring the 450 Transactions

147

 

(d) Documentation for the 450 Transactions

148

 

 

 

iii

2017 ONSEC 27 (*)

 

 

i. The Purchase Contracts and Supporting Documents

148

 

 

ii. The Sales Contracts

150

 

 

iii. Changes to the Terms of the 450 Transactions in Late 2009 and

 

 

 

Early 2010

151

 

 

iv. The Supplemental Purchase Agreements

154

 

 

v. The Harvesting/Sales Confirmations

155

 

(e)

The Accounts Receivable and Accounts Payable Offsetting

 

 

 

Arrangement

156

 

(f)

Horsley and the Rainy Season Memo

160

 

(g)

Vendor Financing and Nanning Bank Accounts

161

 

(h)

The Roles of Chan, Ip, Ho and Yeung

163

 

(i)

Conclusion

164

3.

Gengma #1 Transactions

165

 

(a)

Introduction

165

 

(b)

Positions of the Parties

166

 

 

i. Staff

166

 

 

ii. Respondents

166

 

(c)

The Evolution of the Purchase Contracts

166

 

 

i. Sino-Forest’s Initial Involvement – Dongkou Contract

166

 

 

ii. Gengma Contract Set 1 – WFOE Contracts

170

 

 

iii. Gengma Contract Set 2 (WFOE Contract) and Supplementary

 

 

 

Contracts

173

 

 

iv. Gengma Contract Set 4 – BVI and WFOE Contracts

174

 

 

v. Assignment Agreement

177

 

 

vi. Conclusion on the Actual Purchase Contracts

178

 

(d) The BVI Sales Contracts

179

 

(e)

Conclusion

181

 

(f)

The Roles of Chan and Ip

181

4.

Gengma #2 Transactions

181

 

(a)

Positions of the Parties

181

 

 

i. Staff

181

 

 

ii. Respondents

182

 

(b) Purchases of the Gengma #2 Plantation

182

 

 

i. Sino-Panel and Yuda Wood Contracts – Gengma #2 Contracts 1A

 

 

 

and 1B

182

 

 

ii. Taiyuan and Gengma Dai Contract – Gengma #2 Contract 2

183

 

 

iii. Yuda Wood and Gengma Dai Contracts – Gengma #2 Contracts 3A

 

 

and 3B

186

 

 

iv. Plantation Rights Certificates for the Gengma #2 Plantation

188

 

 

v. Cash Flows, Payments and Settlements

190

 

(c)

Sales of the Gengma #2 Plantation

191

 

 

i. Standing Timber Sales

191

 

 

ii. Land Sales

192

 

 

iii. Pledge of the Gengma #2 Plantation as Collateral

194

 

(d) Conclusion

195

 

(e)

The Roles of Chan, Ip and Ho

196

F. Conclusion on the Standing Timber Fraud Allegations

197

1.

The Law on Fraud

198

 

(a)

Actus Reus

199

 

 

i. Dishonest Act

199

 

 

 

iv

2017 ONSEC 27 (*)

 

ii. Deprivation

199

 

(b) The Mental Element of Fraud

200

2.

The Standard of Proof

201

3.

Was the Alleged Standing Timber Fraud a Fraud on Investors?

201

(a)The Respondents’ Roles in the Three Elements of the Standing Timber

Fraud

202

i. Undisclosed Control of Purportedly Arm’s Length Companies

202

ii. The Deceitful Documentation Process

204

iii. Undisclosed Internal Control Weaknesses or Failures

206

iv. The Standing Timber Fraud was an Elaborate Scheme to Defraud

 

Investors

206

(b) No Bona Fide Business Purpose

207

(c) The Respondents’ Roles in the Four Frauds

208

(d) Conclusions on the Standing Timber Frauds

211

i. Chan

211

ii. Ip

211

iii. Hung

212

iv. Ho

212

v. Yeung

212

vi. Sino-Forest

212

4.Did Chan, Ip, Hung, Ho or Yeung authorize, permit or acquiesce in Sino -

Forest’s conduct contrary to subsection 126.1(b) of the Securities Act?

....... 213

VII.ANALYSIS OF THE STANDING TIMBER MATERIALLY MISLEADING

 

STATEMENTS ALLEGATIONS

213

A. Materially Misleading Statements

213

1. The Law

214

2.Materially misleading statements allegations are not duplicative of the fraud

allegations

217

3. Who made the statements in the Impugned Disclosure Documents?

217

4.Materially Misleading Statements Regarding Ownership of Assets and

Revenue Recognition

 

218

(a)

Analysis of Materially

Misleading

Statements Regarding Ownership of

 

 

Assets

 

219

(b)

Analysis of Materially

Misleading

Statements Regarding Revenue

 

 

Recognition

 

224

(c)

Did Sino-Forest Make Materially

Misleading Statements relating to

 

 

Ownership of Assets and Revenue Recognition?

226

(d)Did Chan, Ip, Hung or Ho Authorize, Permit or Acquiesce in the Making of Sino-Forest’s Misleading Statements relating to Ownership

 

 

of Assets and Revenue Recognition?

226

5.

Effect of the Four Frauds on the Reported Revenue of Sino-Forest

229

 

(a)

The Misleading Statements

229

 

(b)

Did Sino-Forest Make Materially Misleading Statements with respect to

 

 

the Four Frauds?

230

 

(c)

Did Chan, Ip or Ho Authorize, Permit or Acquiesce in Sino -Forest’s

 

 

 

Making of Materially Misleading Statements with respect to the Four

 

 

 

Frauds?

230

6.

Materially Misleading Statements Regarding Internal Controls

232

 

 

 

v

2017 ONSEC 27 (*)

(a)

The Misleading Statements

232

(b)

Did Sino-Forest Make Materially Misleading

Statements with respect to

 

its disclosure relating to internal controls?

233

(c)Did Chan or Hung Authorize, Permit or Acquiesce in Making Sino -

Forest’s Materially Misleading Statements relating to its disclosure in

 

 

relation to internal controls?

233

B. Is a Due Diligence Defence available to the Respondents?

234

1.

The Law

234

 

(a)

Mistake of Fact and Due Diligence Simpliciter

235

 

(b) The Standard of Care Required

235

2. Analysis of the Defense of Due Diligence as it Relates to the Respondents ...

236

C. Conclusions on the Allegations of Misleading Statements

241

VIII.

ANALYSIS OF THE GREENHEART ALLEGATIONS

242

A. Review of the Greenheart Allegations

242

B. The Greenheart Transactions

242

C. Analysis of the Greenheart Fraud Allegations

245

1. Was Chan the Beneficial Owner of Fortune Universe and Montsford?

245

 

(a)

The establishment and organization of Fortune Universe and

 

 

 

Montsford

245

 

(b) Chan’s involvement in Greenheart Resources

250

 

(c)

Treatment of Spirit Land versus Fortune Universe

252

 

(d)

Flow of cash proceeds pursuant to the First and Second Transactions . 253

 

 

i. First Transaction

253

 

 

ii. Second Transaction

255

(e)Fortune Universe and Montsford’s Holding and Sale of Sino -Forest

Shares

256

i. Fortune Universe

256

ii. Montsford

259

(f) Chan was the beneficial owner of Fortune Universe and Montsford

260

2.Was Chan’s non-disclosure of his interest in the Greenheart Transactions a

dishonest act?

261

3.Were Sino-Forest Investors put at risk as a result of Chan’s non-disclosure

of his beneficial interest in the Greenheart Transactions to the Sino -Forest

Board?

264

4. Did Chan have the requisite mens rea for the offence?

266

(a) Chan had subjective knowledge of the prohibited act

266

(b) Chan had subjective knowledge that the dishonest conduct could

 

result in deprivation to another

266

D. Did Sino-Forest and Chan make materially misleading statements by failing

to

disclose Chan’s interest in the Greenheart Transactions in Sino -Forest’s public

disclosure?

267

1. Were the statements misleading in a material respect?

268

2.Did Sino-Forest breach Ontario securities law pursuant to subsection

122(1)(b) of the Securities Act?

270

3.Did Chan authorize, permit or acquiesce, pursuant to section 122(3) of the

Securities Act, in Sino-Forest’s breach of Ontario securities law?

................. 270

IX. ANALYSIS OF THE ALLEGATIONS OF MISLEADING STAFF

271

A. The Law – Misleading the Commission

271

 

vi

2017 ONSEC 27 (*)

B. Allegations against Chan

272

1.

Submissions of the Parties

272

 

(a) Staff’s Submissions

272

 

(b) Chan’s Submissions

272

2.

Analysis

272

C. Allegations against Ip

273

1.

Submissions of the Parties

273

 

(a) Staff’s Submissions

273

 

(b) Ip’s Submissions

273

2.

Analysis

273

D. Allegations against Hung

274

1.

Submissions of the Parties

274

 

(a) Staff’s Submissions

274

 

(b) Hung’s Submissions

274

2.

Analysis

274

E. Allegations against Ho

275

1.

Submissions of the Parties

275

 

(a) Staff’s Submissions

275

 

(b) Ho’s Submissions

275

2.

Analysis

275

F. Allegations against Yeung

276

1.

Submissions of the Parties

276

 

(a) Staff’s Submissions

276

 

(b) Yeung’s Submissions

276

2.

Analysis

276

X. CONCLUSIONS

277

APPENDIX A – GLOSSARY OF TERMS

I

vii

2017 ONSEC 27 (*)

REASONS AND DECISION

I.BACKGROUND

A.Introduction

[1]These are our reasons and decision on the merits of allegations made by Staff of the Ontario Securities Commission (Staff and the Commission, respectively) concerning the conduct of Sino-Forest Corporation (Sino-Forest) and five

members of its senior management, Allen Chan, Albert Ip, Alfred C.T. Hung, George Ho and Simon Yeung (collectively, the Respondents1 ).

[2]Staff submits the Respondents perpetrated one of the largest corporate frauds in Canadian history.

[3]In its Statement of Allegations, Staff makes four sets of allegations against the Respondents regarding their conduct from June 30, 2006 to January 11, 2012 (the Material Time). First, Staff alleges the Respondents engaged in deceitful and dishonest courses of conduct that ultimately caused the assets and revenue derived from the purchase and sale of standing timber, Sino-Forest’s main business, to be fraudulently overstated, putting the pecuniary interests of investors in securities issued by Sino-Forest at risk contrary to Ontario securities law and contrary to the public interest. Second, Staff alleges the Respondents made materially misleading statements in Sino-Forest’s public disclosure record related to its standing timber business. Third, Staff alleges that Chan committed fraud in relation to Sino-Forest’s purchase of a controlling interest in another forestry company and that by concealing Chan’s substantial interest in this transaction, Sino-Forest and Chan made materially misleading statements in Sino-Forest’s public disclosure. Finally, Staff alleges that each of Chan, Ip, Hung, Ho and Yeung materially misled Staff during the investigation of this matter. In light of these allegations, the Panel must answer the following questions:

a.Did the Respondents engage in dishonest courses of conduct that ultimately caused the assets and revenue derived from the purchas e and sale of standing timber to be fraudulently overstated, contrary to subsection 126.1(b) of the Ontario Securities Act, RSO 1990 c S.5 (the Securities Act) (the Standing Timber Fraud Allegations)?

i.Specifically, did the Respondents engage in what Staff has alleged are the three elements of the Standing Timber Fraud Allegations? Specifically,

A.did the Respondents dishonestly conceal Sino-Forest’s control over its suppliers, authorized intermediaries (AIs) and other nominee companies, leading to the misstatement of the true economic substance of Sino-Forest’s business in its financial statements?

B.did the Respondents falsify evidence of Sino-Forest’s ownership of the vast majority of its timber holdings by engaging in a deceitful documentation process, including the

1Where we refer to the Respondents’ submissions in these Reasons, they do not include the submissions of Sino-Forest, which did not participate in this hearing.

1

2017 ONSEC 27 (*)

fraudulent creation of deceitful purchase and sales contracts, which were then relied on to evidence the purported purchase, ownership and sale of standing timber?

C.did the Respondents deceitfully conceal Sino-Forest’s internal control weaknesses, obscuring the true nature of transactions and preventing detection of the deceitful documentation process (referred to in B. above)?

ii.Did the Respondents engage in significant fraudulent transactions related to Sino-Forest’s purchase and sale of standing timber that had the effect of overstating Sino-Forest’s assets and revenue during the Material Time? Specifically, in these four examples, did they fraudulently engage in:

A.transactions involving a Sino-Forest supplier, Guangxi Dacheng Timber Co., Ltd. (the Dacheng Transactions)?

B.transactions involving the purchase and sale of approximately 450,000 m3 of standing timber (the 450 Transactions)?

C.the purported purchase and sale of a plantation in Gengma County, Yunnan Province (the Gengma #1 Transactions)?

D.the purported purchase and sale of a second plantation in Gengma County, Yunnan Province (the Gengma #2 Transactions)?

iii.Did Chan, Ip, Hung, Ho or Yeung, as officers of Sino -Forest, authorize, permit or acquiesce in conduct of Sino-Forest that was contrary to Ontario securities law, pursuant to subsection 129.2 of the Securities Act?

b.Did the Respondents engage in conduct that resulted in Sino-Forest’s disclosure during the Material Time in respect of its standing timber business being misleading in a material respect, contrary to subsection 122(1)(b) of the Securities Act?

i.

Specifically, was Sino-Forest’s disclosure misleading in a material

 

respect with respect to:

A.Sino-Forest’s ownership of assets and revenue recognition?

B.the effect of the Dacheng Transactions, the 450 Transactions, the Gengma #1 Transactions and the Gengma #2 Transactions on the reported revenue of Sino-Forest?

C.the material weaknesses in Sino-Forest’s internal controls?

ii.Did Chan, Ip, Hung or Ho, as officers of Sino-Forest, authorize, permit or acquiesce in the making of statements by Sino-Forest that were misleading in a material respect, pursuant to subsection 122(3) of the Securities Act?

c.Did Chan fraudulently conceal his interest in a series of transactions through which Sino-Forest purchased a controlling interest in Greenheart Group Limited, a public company listed on the Hong Kong Stock Exchange (HKSE), (the Greenheart Transactions)? As a result,

i.Did Chan engage in deceitful or dishonest conduct in relation to the Greenheart Transactions that was contrary to subsection 126.1(b) of the Securities Act?

2

2017 ONSEC 27 (*)

ii.Did Chan and Sino-Forest engage in conduct that resulted in Sino- Forest’s disclosure that was misleading in a material respect, contrary to subsection 122(1)(b) of the Securities Act?

iii.Did Chan, as Chairman of the Board and Chief Executive Officer (CEO) of Sino-Forest, authorize, permit or acquiesce in Sino-

Forest’s disclosure in respect of the Greenheart Transactions that was misleading in a material respect, pursuant to subsection 122(3) of the Securities Act?

d.Did each of Chan, Ip, Hung, Ho and Yeung make misleading statements in the course of their interviews with Staff during its investigation, contrary to subsection 122(1)(a) of the Securities Act?

[4]Our Reasons are structured as follows. They begin with general background information, as well as discussions of additional background issues that are relevant to our analysis of Staff’s allegations:

I.Background

II.Evidence

III.Sino-Forest’s Timber Business in Mainland China

IV.

Sino-Forest’s Business Models: The BVI Model and the WFOE Model

V.Allen Chan’s Role at Sino-Forest

Following this background is our analysis of the Standing Timber Fraud Allegations, which includes a consideration of the three elements of the alleged fraud, and the four examples of allegedly fraudulent transactions:

VI.

Analysis of the Standing Timber Fraud Allegations

We then consider Staff’s allegations of misleading statements in Sino -Forest’s disclosure relating to three categories of disclosure related to the Standing Timber Fraud Allegations:

VII. Analysis of the Standing Timber Materially Misleading Statements Allegations

Next, we consider Staff’s allegations of fraud and materially misleading statements in connection with the Greenheart Transactions:

VIII. Analysis of the Greenheart Allegations

Finally, we consider whether Chan, Ip, Hung, Ho and Yeung made materially misleading statements to Staff during Staff’s investigation of this matter:

IX.

Analysis of the Allegations of Misleading Staff

To assist the reader, we have also included a glossary of terms, companies and people referred to in these Reasons as an appendix:

APPENDIX A - GLOSSARY

[5]The hearing in this matter has been exceptionally long. The merits hearing started on September 2, 2014. The Panel sat for 188 days over 2014, 2015 and 2016, and the hearing ended on May 12, 2016. Chan, Ip, Hung, Ho and Yeung were represented by counsel throughout the hearing. Sino -Forest indicated it did

3

2017 ONSEC 27 (*)

not intend to participate in this matter and no one appeared on its behalf during the hearing.

B.Sino-Forest

[6]Sino-Forest described itself as a leading commercial forest plantation operator in the People’s Republic of China (China, or Mainland China when referring to the country exclusive of Hong Kong). Sino-Forest’s principal businesses were described as the ownership and management of tree plantations, the sale of standing timber and wood logs, and the complementary manufacturing of downstream engineered-wood products. The majority of Sino-Forest’s business was in standing timber. Allen Chan described Sino-Forest as operating two business models for its plantation operations in Mainland China. In the first model, Sino-Forest would buy standing timber (i.e. forests of trees that were still growing in the ground), hold the standing timber for two to three years and then sell the standing timber without logging it. In the second model described by Chan, Sino-Forest would plant trees on bare land, log the trees once they matured and sell them as logs.

[7]Sino-Forest’s executive office was in Hong Kong, its head office was in Mississauga, Ontario and it maintained additional offices throughout Mainland China. Most Sino-Forest executives, including Chan, Ip, Hung and Ho worked out of the company’s offices in Hong Kong and/or neighbouring Guangzhou, Mainland China. Sino-Forest’s Chief Financial Officer (CFO) was Canadian and worked mainly out of the Mississauga, Ontario office, worked in Hong Kong for about two weeks each quarter and was seldom in Mainland China. Sino-Forest’s operations offices throughout Mainland China were often in remote rural locations. Many members of the Board of Directors were located in Canada and meetings of the Board and the Audit Committee were often conducted by teleconference.

[8]Sino-Forest became a reporting issuer in Ontario in 1995 when it listed its shares on the Toronto Stock Exchange (TSX) through a reverse take-over transaction.

[9]In its 2010 Annual Information Form (AIF) dated March 31, 2011, Sino-Forest described its corporate vision as follows:

Our vision is to sustainably manage a geographically diversified portfolio of fast-growing, high-yielding plantations that profitably produces a steady stream of quality fibre and increases China’s wood supply independence. We aim to become the leading commercial forest plantation operator and the preferred supplier of wood fibre to downstream consumers in the wood panel, furniture, construction, interior decoration and pulp and paper industries in the PRC. We intend to create value by effectively buying, selling and processing fibre, as well as enhancing the growth of our trees using advanced research and development and plantation management practices.

[10]Between February 2003 and October 2010, Sino-Forest raised approximately US $3.0 billion from investors (the Investors) by issuing debt and equity securities. From the start of the Material Time to March 31, 2011, Sino-Forest’s share price

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rose 340% from CA $5.75 to CA $25.30. By March 31, 2011, Sino-Forest’s market capitalization was over CA $6 billion.

[11]On June 1, 2011, trading in Sino-Forest’s shares on the TSX closed at CA $18.21.

C.The Muddy Waters Report and the Events that Followed

[12]On June 2, 2011, Muddy Waters, LLC, headed by an analyst and short-seller with

a short position in Sino-Forest shares, released a report that alleged Sino-Forest was a “near total fraud” and a “Ponzi scheme” (the Muddy Waters Report).2

[13]On the same day, the Board of Directors of Sino-Forest appointed a committee of independent directors to examine and review the serious and wide-ranging allegations made in the Muddy Waters Report and report back to the Board of Directors (the Independent Committee).

[14]Following the release of the Muddy Waters Report, Sino-Forest shares plummeted. On June 2, 2011, trading in Sino-Forest shares on the TSX closed at CA $14.46, and by June 21, 2014, Sino-Forest shares traded at CA $1.99.

[15]The Commission publicly announced on June 8, 2011 that it had commenced an

investigation into Sino-Forest and on August 26, 2011, the Commission issued a temporary order that all trading in Sino-Forest shares cease.3

[16]Sino-Forest failed to file its interim financial results for the third quarter of 2011 and never filed its 2011 audited financial statements. Sino-Forest’s auditors, Ernst & Young LLP (E&Y), resigned on April 4, 2012.

[17]On May 9, 2012, the TSX delisted Sino-Forest’s shares.

[18]On May 22, 2012, Staff issued its Statement of Allegations against the Respondents and David Horsley, Sino-Forest’s former CFO. Horsley settled with the Commission prior to the start of the merits hearing.

[19]On January 30, 2013, Sino-Forest entered into a Plan of Compromise and Reorganization that resulted in Sino-Forest’s former bondholders receiving substantially all of its remaining assets.

D.The Individual Respondents

[20]Allen Chan was a co-founder of Sino-Forest in 1992 and Chairman of the Board and CEO during the Material Time until his resignation on August 28, 2011. Chan remained as Chairman Emeritus of Sino-Forest following his resignation. Staff submits Chan was the architect of the alleged standing timber fraud, assisted by Ip, Hung, Ho and Yeung.

[21]Albert Ip was the Senior Vice-President, Development and Operations North-East

and South-West China for Sino-Forest and reported directly to Chan. Ip was in charge of operations of Sino-Panel (Asia) Inc. (Sino-Panel)4 and its

2The Muddy Waters Report itself was not in evidence. However, the Panel did receive in evidence the reports of the Independent Committee and various Sino-Forest press releases that refer to allegations made in the Muddy Waters Report.

3 The temporary cease trade order, as varied from time to time, remains in place.

4The vast majority of Sino-Forest’s subsidiaries were held through two holding companies,

(i) Sino-Panel, a British Virgin Islands incorporated subsidiary of Sino-Forest, (ii) Sino-Wood Partners, Limited (Sino-Wood), a Hong Kong incorporated subsidiary of Sino-Forest. Ip

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approximately 48 subsidiary companies (the Sino-Panel Group of companies). In this capacity, he supervised over 1,000 employees with operations distributed over nine provinces across Mainland China. Within Sino-Forest’s BVI Model (discussed in more detail throughout these Reasons), Ip was responsible for forest purchases, including standing timber. He worked at Sino-Forest from 1997 until March 30, 2012. Ip studied in Canada and obtained an engineering degree from the University of Ottawa in 1984.

[22]Alfred Hung was Vice-President, Corporate Planning and Banking for Sino-Forest for much of the Material Time. Hung joined Sino-Forest in 1999 and held a number of positions at Sino-Forest during his tenure with the company, including executive assistant to Chan. He continued to report to Chan throughout the Material Time. Hung was responsible for developing financial models for existing and potential new businesses and front-line banking relationship management. Hung oversaw the preparation of cheques for a large number of Sino-Forest subsidiaries within the Sino-Wood group of companies. Within the BVI Model, Hung also oversaw the drafting of purchase and sales contracts and the netting of accounts receivable and accounts payable. He was also a member of Sino- Forest’s Disclosure Committee. Hung worked at Sino-Forest from 1999 until he was put on administrative leave in August 2011. Hung has a Masters of Finance and an MBA, is a Chartered Financial Analyst (CFA), and has a Financial Risk Manager designation.

[23]George Ho was Vice-President Finance for Sino-Forest and was CFO and Vice- President Finance of Sino-Panel. He had ultimate oversight of the accounting personnel in the Sino-Panel subsidiaries and reported directly to Chan and Horsley. Ho worked at Sino-Forest from 2007 until he was put on administrative leave in August 2011. Ho obtained a Bachelor of Commerce in accounting from Simon Fraser University in 1987 and prior to joining Sino-Forest, he worked at business and accounting firms in Canada and Hong Kong, most recently in the Hong Kong branch of BDO McCabe Lo Limited (BDO), Sino-Forest’s auditors at the time.

[24]Simon Yeung was Vice-President, Operations of Sino-Panel beginning in August 2009. Prior to that, he held various roles within Sino-Panel since joining the company in 2002 as Assistant Project Manager. As Vice-President, Operations, Yeung reported to Ip and oversaw operations of the company and its subsidiaries. Yeung described his role as “a first line trouble shooter to deal with operational issues” within the Sino-Panel Group (Affidavit of Simon Yeung, affirmed August 23, 2015). Yeung was put on administrative leave from his duties in August 2011. Yeung obtained a degree in economics in 1982 and a mechanical engineering diploma in 1993.

II.EVIDENCE

A.Witnesses

[25]Twenty two witnesses testified during the hearing.

oversaw the operations of the Sino-Panel Group and another individual, Albert Zhao, was responsible for operations of Sino-Wood and its subsidiaries.

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[26]Staff called the following 12 witnesses:

a.Two Staff witnesses, Anthony Long and Maggie Shao, both Senior Forensic Accountants in the Enforcement Branch of the Commission. Mr. Long testified over 27 days at the outset of the hearing and Ms. Shao testified over 19 days nearer to the end of Staff’s case. Both testified about their work in Staff’s investigation into Sino-Forest.

b.Five former officers or directors of Sino-Forest:

i.David Horsley was the Senior Vice-President and CFO of Sino- Forest from October 2005 and was a respondent to this proceeding. Prior to the start of the merits hearing, the Commission approved a settlement agreement between Mr. Horsley and Staff.

ii.Thomas Maradin initially joined Sino-Forest as a consultant and became Vice-President, Risk Management. Mr. Maradin reported to Mr. Horsley and testified primarily about his role in assisting Sino - Forest to comply with the requirements of National Instrument 52- 109 - Certification of Disclosure in Issuers’ Annual and Interim

Filings (NI 52-109).

iii.James Hyde was a member of the Sino-Forest Board of Directors from 2004 and throughout the Material Time. He was Chair of the Audit Committee and the Corporate Governance Committee and was a member of the Compensation and Nominating Committee. Following the Muddy Waters Report, Mr. Hyde was appointed a member of the Independent Committee.

iv.William Ardell was a member of the Sino-Forest Board of Directors from January 2010 until Sino-Forest was dissolved in 2012. He was a member of the Audit Committee, the Corporate Governance Committee and the Compensation and Nominating Committee, and from June 2010 was Lead Director. He was also appointed Chair of the Independent Committee, following the release of the Muddy Waters Report.

v.W. Judson Martin was a member of the Sino-Forest Board of Directors from 2006 to 2010. Mr. Martin was a member of the Audit Committee, the Compensation and Nominating Committee (of which he was Chair) and the Corporate Governance Committee and was Lead Director from 2007 until 2010. In June 2010, in the course of Sino-Forest’s acquisition of a majority interest in

Greenheart, Mr. Martin became Vice-Chairman and an Executive Director of Sino-Forest, responsible for its acquisition of a majority interest in Greenheart, as well as CEO and Chairman of Greenheart. Following Allen Chan’s resignation on August 26, 2011, Mr. Martin was appointed CEO of Sino-Forest. Mr. Martin testified by videoconference from Hong Kong.

c.Yosanda Chiang was Allen Chan’s Executive Assistant at Sino-Forest, and continued to work for him following his departure as CEO of Sino-Forest. Ms. Chiang testified by videoconference from Hong Kong. She testified in Cantonese with the assistance of an interpreter.

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d.Two members of the E&Y audit team that audited Sino-Forest’s financial statements for 2007 to 2010:

i.Josephine Man is a Chartered Accountant and was a Senior Audit Manager and Audit Planner at E&Y. Prior to joining the Vancouver office of E&Y in 2006, Ms. Man worked in its Hong Kong office from 1996 to 2003. Her native language is Cantonese, she is fluent in English and speaks and understands Mandarin. Ms. Man began working on the Sino-Forest audit in 2007, at which time E&Y was preparing work regarding Sino-Forest’s third quarter financial statements and 2007 audit planning.

ii.Fred Clifford is a Chartered Accountant and managed E&Y’s client acceptance process with Sino-Forest. In 2007, he was the coordinating partner responsible for Sino-Forest in terms of the relationship, the execution and the overall transition into the firm. In 2008 and 2009, Clifford was the independent review partner and in 2010, Clifford became one of the engagement partners for the Sino-Forest audits.

e.Two witnesses from PricewaterhouseCoopers (PwC), which acted as one of the advisors to the Independent Committee:

i.Steven Henderson is a Chartered Professional Accountant with a designation in Investigative Forensic Accounting, as well as a Certified Fraud Examiner. He was involved in creating the work plan for the Independent Committee advisors and led the Canadian PwC team involved in the Independent Committee advisory process.

ii.James Pomeroy is a Chartered Accountant and Certified Fraud Examiner and is a Vice President of PwC in the forensic services group. As part of PwC’s work advising the Independent Committee, Mr. Pomeroy travelled to and worked out of Hong Kong.

[27]Chan did not testify on his own behalf and called two witnesses:

a.Dr. Randall Peerenboom has a Ph.D. in philosophy, with a focus on Chinese philosophy in the classical period and has a J.D. from Columbia University. He was born and educated in the United States, but has lived in Beijing for most of the past 20 years, where he continues to reside with his family. Dr. Peerenboom has legal experience in the United Kingdom and China and has worked as a professor and in academia. Dr. Peerenboom testified as an expert in the field of Chinese law and cultural practices in China within a comparative global and Asia context.

b.Lei Guangyu was a friend of Chan and a Chinese businessman. His companies were involved in the export/import business, real estate, environmental protection and financial investments . He testified predominantly about his involvement with the Greenheart Transactions by videoconference from Shenzhen, China in Mandarin with the assistance of interpreters. Mr. Lei testified in April 2015, but did not complete his cross - examination by Staff. Between April 2015 and the conclusion of the evidence in this hearing in December 2015, efforts to arrange for the completion of Mr. Lei’s testimony were unsuccessful. As a result, we are

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left with testimony from Mr. Lei that is incomplete, as Staff did not have the opportunity to fully test his evidence through cross -examination. The parties were in agreement that Mr. Lei’s evidence should remain part of the record that the Panel can consider in its determination of the merits.

[28]Ip, Hung, Ho and Yeung each testified on their own behalf. With Staff’s consent, they chose to testify by videoconference from outside Ontario. They testified from Hong Kong, and in the case of Ip, from both Hong Kong and the Dominican Republic. Ip, Hung and Yeung testified, wholly or in part, in Cantonese with interpretation assistance. We granted the request of Ho, Hung and Yeung to provide their evidence in chief by written affidavit, on which Staff and counsel for Chan were permitted to cross examine them (Re Sino-Forest Corporation (2015), 38 OSCB 6205).

[29]Ip, Hung, Ho and Yeung called the following four expert witnesses:

a.Michael Murphy works with AlixPartners in Hong Kong as the Managing Director, Asia Pacific Practice. He specializes in consulting engagements on behalf of investors and boards of directors, as well as debtors and creditors involved in operational and financial turnarounds and loan workouts. He has worked in China for over 20 years. Mr. Murphy was qualified and testified as an expert in Chinese business practices and how they relate to business regulations in China, including business practices arising out of the concept of guanxi, foreign exchange regulation, tax regulation, business structures and email usage.

b.Gavin Hao is a Forestry Consultant with the pulp and forestry consulting firm RISI. He lives in Shanghai and his educational and work experience has been in Chinese forestry. Mr. Hao was qualified and testified as an expert in the Chinese forestry industry. He testified in Mandarin with interpretation assistance.

c.

Jinrong Liu is the managing partner of Global Law Office in Beijing, China

 

and is licensed to practice law in China. Mr. Liu was qualified and testified

 

as an expert in Chinese law, regulation and government practices as they

 

relate to:

 

i.

the enforceability of oral contracts in China;

 

ii.

the ability of corporations to lend money;

 

iii.

whether an entity incorporated in the British Virgin Islands (BVI)

 

 

may hold a Plantation Rights Certificate;

 

iv.

the investigatory powers of the Chinese State Administration of

 

 

Foreign Exchange (SAFE);

 

v.

the concept of “retreating from the front line” as a succession

 

 

planning mechanism by Chinese government organizations; and

 

vi.

the meaning of legal terms and, in particular, those that have been

 

 

translated in this proceeding as a right of first refusal as contrasted

 

 

with an option and the term “Project Preparatory Office”.

Mr. Liu testified by videoconference from his offices in Beijing, China in Mandarin through the assistance of an interpreter.

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d.Dr. Robin Hui Huang is a professor in the Faculty of Law at the Chinese University of Hong Kong, with a research focus that includes corporate law and securities regulation. Dr. Huang was qualified and testified as an expert in translation of the term “wai wei gong si” from Chinese characters into English. Dr. Huang testified by videoconference from Hong Kong.

B.Challenges for Witnesses in the Hearing

[30]Some of the challenges in receiving evidence in this case included witnesses testifying by videoconference from different locations, including Hong Kong, Beijing, Shenzhen and the Dominican Republic, in time zones that were as much as a 13 hours difference from the time zone in which the hearing was being held. Witnesses testified entirely or in part in another language with the assistance of an interpreter. Some witnesses’ testimony continued in these circumstances for many days. The Panel is mindful of the difficulties created by these circumstances.

[31]As one might expect, video conferencing is less satisfactory than direct evidence in a hearing room. While the Panel can see an on-screen image of the witness, his or her manner and demeanor are less reliable as a test of credibility. Clarity of the witness’ speech is impaired by the less than perfect sound transmission.

[32]Some witnesses testified in Cantonese or Mandarin with the assistance of an interpreter. Despite some difficulties with interpretation, overall, the Panel finds the quality of the interpretation and the seeing and hearing of the witness’ testimony was sufficient to permit the Panel to understand the witnesses and to make findings, including findings of credibility.

[33]The Panel has kept the challenges of testifying under these conditions uppermost in their minds in assessing witness credibility.

[34]We consider the credibility of any oral evidence in the context of all the evidence before us. We believe it important to highlight the at times difficult circumstances under which witnesses were giving evidence and to note that we have tried at all times to consider the credibility of witness statements in light of such circumstances.

C.The Independent Committee Investigation

[35]A major source of documentary evidence in this case was the Independent Committee investigation and its reports. Both Staff and the Respondents refer to the Independent Committee reports in their submissions. We also heard testimony from two members of the Independent Committee (Messrs. Ardell and Hyde) and two members of PwC, an advisor to the Independent Committee (Messrs. Pomeroy and Henderson).

[36]Following the release of the Muddy Waters Report on June 2, 2011, the Board of

Directors established the Independent Committee. The Independent Committee’s mandate was to independently examine and review the serious and wide-ranging allegations made in the Muddy Waters Report, and report back to and, if appropriate, make recommendations to the Sino-Forest Board. The Independent Committee was initially composed of William Ardell (Chair), James Bowland and James Hyde. At the invitation of the Independent Committee, another independent director of Sino-Forest, Gary West, attended virtually all meetings

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of the Committee and participated in its process. The Independent Committee advisors were: Osler, Hoskin & Harcourt LLP, Canadian counsel who assisted the Independent Committee in developing the appropriate response and identifying and conducting the mandate; PwC, who were engaged as forensic accountants; Mallesons Stephen Jaques, as Hong Kong legal counsel; and Jun He Law Offices (Jun He), as Mainland China legal counsel. Mr. Bowland resigned as director and from the Independent Committee on November 3, 2011.

[37]The Independent Committee released three reports in the course of its investigation. The First Interim Report was released on August 10, 2011. The Second Interim Report of the Independent Committee of the Board of Directors of the Sino-Forest Corporation (the Second IC Report) was released on November 13, 2011. Along with testimony from members of the Independent Committee and its advisors, the Second IC Report and its appendices form the primary basis for our understanding of the Independent Committee’s investigation. A Final Report of the Independent Committee of the Board of Directors of Sino-Forest Corporation was issued on January 31, 2012.

[38]The Independent Committee’s advisors had issued their own Report on Process to Date on November 13, 2011. When Mr. Henderson of PwC was asked why the advisors issued their own, separate report, he testified that the advisors believed it “important to identify in our own report the limitations and qualifications of the investigation, including recommendations, and the IC considered that information and interpreted it accordingly in writing their own report” (Hearing

Transcript, December 5, 2014 at 111:5-9).

1.Scope

[39]The scope of the Independent Committee review was to investigate the ownership structure of the forestry assets on Sino-Forest’s balance sheet, the ownership of trees in Yunnan Province (the geographic focus of the Muddy Waters Report), the existence and value of those trees, Sino-Forest’s revenue recognition process, and the relationship between Sino-Forest and its suppliers and customers in the BVI Model. The scope became broader than the allegations which were initially raised in the Muddy Waters Report. The Independent Committee needed to respond quickly as well to questions raised by the Commission. According to Mr. Pomerory of PwC, the investigation was a massive organization of people and resources, with 100 individuals or more working on a variety of issues, against tight deadlines

[40]The Independent Committee focused its investigation on the years 2006 and following. Its process was limited to the examination and review of three core areas: (i) timber asset verification; (ii) timber asset value; and (iii) revenue recognition. Intertwined with these areas of investigation were issues raised in the Muddy Waters Report regarding related party transactions and relationships.

2.Management

[41]At the outset, management’s role was as a resource to the Independent

Committee and its advisors. Management was also tasked with drafting their own response to the Muddy Waters’ allegations in order to possibly refute any allegations immediately. The Independent Committee dealt principally with Chan, Horsley and Mr. Maradin. As the review progressed, the Independent Committee advisors communicated to the Independent Committee that there was a lack of

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full cooperation and openness from Chan, Ip, Ho and Hung, among others in management, during examinations and failure to provide significant amounts of material information as requested.

[42]Mr. Ardell, the Chair of the Independent Committee, testified feedback from PwC and Mallesons to the Independent Committee indicated that Chan, in some instances, was not forthcoming with respect to full disclosure regarding AI and supplier backgrounds.

[43]He also testified that another example of lack of cooperation was Ho’s initial refusal to comply with a request from the advisors for human resources data. Ho expressed concern regarding employee privacy but he did ultimately hand over the data. However, there were discrepancies between the data provided by Ho when compared with human resources data found on other employees’ laptops.

[44]Mr. Martin testified that, as a result of inconsistencies in certain emails and interviews regarding related parties, Chan was asked to resign as CEO in August

2011. Hung, Ho and Yeung were put on administrative leave in late August. Ip’s duties were limited and under the direction of Mr. Martin, who became CEO.

3.The Investigation

[45]The advisors began with identifying and confirming the cash in Mainland China, Hong Kong and Canada and fact gathering: understanding the business model and what all the Sino-Forest subsidiaries, customers and other corporate entities were; identifying who all the parties were with whom the company dealt; capturing all Sino-Forest’s electronic data, and gathering all the purchase and sale documentation and other timber data.

(a)Data Capture

[46]Electronic data gathering was initially delayed “in view of the potential cultural and other sensitivities of Management,” according to the Independent Committee advisors November 13, 2011 Report on Process to Date, and did not begin until more than nine days after the Muddy Waters Report. Management was not informed of legal hold notices over data until June 12, 2011 and all employees were sent legal hold notices on June 14, 2011. The advisors discovered that the extent of historical electronic data in Sino-Forest’s Guangzhou office was “almost nonexistent” (Report on Process to Date of the Independent Committee advisors at 13). For example, for two senior management individuals, the earliest email retrieval was June 10, 2011, post Muddy Waters Report.

[47]When the advisors were electronically capturing data they discovered that certain Sino-Forest employees were using personal devices and non-corporate email addresses to conduct Sino-Forest business. Further complicating the data collection exercise, certain individuals were changing their emails addresses periodically and using different email addresses outside the corporate email structure.

(b)Forestry Bureaus

[48]One of the steps in the review was visiting the local offices of the Chinese state forestry authority, referred to as Forestry Bureaus, in an attempt to verify Sino-Forest’s rights to standing timber. In order to maintain the independence of the process, the advisors asked management to provide them the contact details

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to directly arrange the Forestry Bureau visits. Management declined to do so, maintained control over the arrangements, and attended all visits.

(c)Suppliers and AIs

[49]Another step in the Independent Committee review was to examine Sino-Forest’s relationship with its AIs and suppliers to determine if such relationships were arm’s length and to obtain independent verification of the cash flows underlying the set-off transactions. Mr. Hyde described the results of the interviews with AIs and suppliers as “mediocre at best”, which will be discussed elsewhere in these Reasons in our analysis of the allegations of undisclosed control of third parties.

(d)Challenges

[50]The Independent Committee advisors encountered significant challenges in gathering the information required to address the Muddy Waters’ allegations and the other matters outlined in the scope of the review. Among the challenges outlined by Mr. Hyde were the following:

Evidence, such as a plantation registration system and documents, were not readily available, and access to Forestry Bureau officials, suppliers and customers was delayed or denied.

While there were national policies regarding the issuance of Plantation Rights Certificates (PRCs) (official government documents confirming title) that were to be rolled down to the territorial (county) level, in practice, the advisors found that many county Forestry Bureaus had not yet started this process – many would not admit this and others simply denied the advisors access.

As well, the Independent Committee advisors found some corporate registry offices refused to conduct searches of corporate registrations.

[51]There were geographic challenges. Yunnan, the centre of many of the allegations, is a remote province and visiting Forestry Bureaus in Yunnan involved many days driving on very rough roads where the advisors were worried that “something was going to happen to them, so dangerous getting in,” as described by Mr. Hyde (Hearing Transcript, November 5, 2014 at 161:19-20).

[52]Culturally, locals were not used to having people arrive and ask for things in a North American fashion. These parties were not compellable so a “little bit of a dating ritual dance” was necessary before discussing business, according to Mr.

Hyde (Hearing Transcript, November 5, 2016 at 162:3-4).

[53]One of the tasks the advisors undertook was to try to establish the standing timber chain of title whereby the advisors were attempting to go back to the very first person who had been granted rights to the land that held the timber. In doing so, the advisors wanted to see if there was a flow of documents that passed title from one to another, which ultimately ended up with Sino-Forest. Hyde testified they found this could not be done – the information was not there.

[54]During the review, the Independent Committee learned the attachments that were referenced in the purchase contracts were not attached. They discovered the PRCs had never been issued. They then tried to look to the resolutions of the original villager owners to support title, which the Independent Committee learned were not attached as well. The Independent Committee was told by

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Chan that these were reviewed but not retained. This is discussed in more detail in our analysis of the deceitful documentation allegations.

[55]On September 29, 2011, without warning or explanation, Sino -Forest requested the advisors vacate the Sino-Forest offices in Hong Kong. On September 30, 2011 all access cards were returned.

4.The Final Report

[56]The Final Report of the Independent Committee was issued on January 31, 2012. There was little additional information beyond what was set forth in the November 2011 Second IC Report. The advisors issued a disclaimer stating:

“This Final Report, while based on the work of such advisors, is the report of the

IC and not the report of the IC Advisors ”.

[57]Further references to the Independent Committee’s reports are found within these Reasons.

III.SINO-FOREST’S TIMBER BUSINESS IN MAINLAND CHINA

[58]Our analysis of the Standing Timber Fraud Allegations set forth below in these Reasons also requires some background on how sales of forestry ownership rights were transacted in Mainland China during the Material Time, and, more specifically, the ways in which Sino-Forest conducted its forestry business.

A.Forestry Ownership in Mainland China

[59]Gavin Hao, an expert in the Chinese forestry industry, testified that regulation of forestry ownership in China is in a process of reform. The most recent period of reform is a continuation of previous reforms that began with China’s general “opening up” after 1978, which initiated the move away from the collective

ownership of forestry land that existed in China during the earlier part of the second half of the 20th century. Following the promulgation of China’s Forestry Act in 1998, the Chinese forestry industry has moved towards implementation of

anew forestry rights regime, which includes the systematic issuance of Plantation Rights Certificates, or PRCs, and confirmation of ownership of forestry rights. PRCs are official Chinese government documents that indicate the owners of each of the four categories of forestry rights and the location of the plantation with reference to its general location, the plantation boundaries at each of the four cardinal directions, the Forestry Bureau compartment and sub-compartment classification numbers and a map.

[60]Under China’s Forestry Act, there are four aspects of forestry ownership in Mainland China. These four rights are separate and can generally be held by different owners. The four types of forestry rights are:

a.Land ownership: This is ownership of the land itself. Only the state or village collectives can hold land ownership rights. These rights cannot be transferred and cannot be owned by individuals. As a result, these rights were never the subject of Sino-Forest’s forestry transactions and are generally not relevant for the purposes of our analysis.

b.Land use rights: This is the right to use the forestry land, such as a lease interest registered on the land. These rights can be held by individuals and used for forestry purposes for a limited time period, and include the

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ability to plant or replant timber on the land. Sino-Forest’s WFOE (wholly foreign-owned enterprises) subsidiaries, as Chinese entities, were able to own land use rights, but its BVI subsidiaries, as foreign entities, were not.

c.Timber ownership: This is the ownership of the trees, or standing timber, growing on the land, which includes the right to use, protect and harvest the timber. We heard expert evidence that these rights would, in most circumstances, go hand-in-hand with land use rights, but could be held by separate parties. Both WFOE and BVI subsidiaries were able to hold timber ownership rights, often referred to throughout these Reasons as standing timber rights.

d.Timber use rights: This is the ownership of the produce, or fruit, of the trees. In the PRCs we have reviewed, this ownership right has always accompanied timber ownership and is not specifically relevant to our consideration of the allegations.

[61]The two rights that are most important for the purposes of these Reasons are therefore (b) land use rights, and (c) timber ownership.

[62]Proof of ownership of forestry rights in Mainland China is generally provided by the issuance of PRCs by Forestry Bureaus. PRCs are official government documents that include the following information:

Excerpts from the “Constitution of The People’s Republic of China” and the “Forest Law of The People’s Republic of China”;

The seal of the Forestry Bureau office that issued the PRC (in the case of Sino-Forest PRCs, usually the county-level Forestry Bureau);

Confirmation to the party requesting the PRC that the ownership or use rights for the forest, timber and forestland have been registered and that the legal rights and interests are protected by law;

A Registration Form of the Situation of Forest, Timber and Forestland for each parcel of land covered by the PRC. These Registration Forms were standardized, with space for the Forestry Bureau to input the following information:

othe owner of each of the four ownership rights; o a description of the general location area;

o geographic boundaries to each of the four cardinal directions;

othe Forestry Bureau compartment and sub-compartment numbers assigned to the parcel of land;

othe colloquial name for the land; o the area in mu;

o the main tree species for the parcel of land; o the forest type (e.g. timber forest);

o the forestland use period (i.e. the duration of the rights); and

oForestry Bureau seal, name of the “responsible person” at the

Forestry Bureau and the date of issuance.

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A Registration of Change certificate, which confirmed that, based on the signed contract that transfers forest rights, the plantation ownership had been changed to be under the name of the purchasing party;

A Map of the Boundaries of the Forest, Timber and Forestland to the Four Cardinal Directions, with the parcels of land covered by the PRC identified; and

A Notice which included statements that:

othe PRC “is the legal proof of ownership or use rights for forest, timber and forestland and is valid when sealed by the People’s

Government at county level and above or the Forestry

Administration Department of the State Council”;

othe PRC was to be kept by the proprietor of the forest rights;

o“when there is a legal change to the forest rights, this certificate must be presented on time at the original registration and certificate issuing authority for processing the change in registration”; and

o“this certificate should be presented when the various levels of

People’s government and their forest rights management department or judicial authority are investigating and making enquiries on matters related to the forest rights”.

[63]Mr. Hao explained the process for transfer of forestry rights requires both the seller and purchaser to attend at the local Forestry Bureau to register the change. For a transfer from a village collective, two-thirds of the villagers (or their proxies) are required to attend. This process involves land boundary confirmations by the Forestry Bureau, a two-week public notice period and other registration procedures, all of which generally takes about one month.

[64]Mr. Hao testified the timelines for the implementation of the new forestry rights rules and regulations has varied from province to province and different provinces have achieved varying degrees of progress in the issuance of PRCs. He testified there are several challenges that have delayed forestry reform, which include:

the complexity of confirming land boundaries, which involves participation from forestry authorities, village collectives or farmers and surveyors;

historical disputes over land ownership between villagers in the same villages, family clans in the same village collective or neighbouring village collectives that can make confirming ownership challenging or may cause additional disputes with forestry companies which have acquired the land; and

questions about the proper distribution of land rights to family units, or households – there is ambiguity about how the term “household” should be interpreted and differences of opinion about how rights should be distributed to households where not all births are registered because they were not compliant with China’s one-child policy.

Hao further explained there are substantial variations in the way PRCs are administered. Some are initially issued to the village collective and held by the

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village chief, while others are issued to households or groups of households that jointly own the forestry rights.

[65]In addition to initial PRC registration challenges, Hao testified about the complexities of the forestry rights transfer process in Mainland China. In negotiations to purchase rights to a particular area from villages or households, a forestry company would likely deal with many individuals with ownership interests, in rural areas of Mainland China where education levels are relatively low and villagers often leave to work as migrant workers in other parts of the country for most of the year. The difficulty villagers may have in understanding or being able to read a contract, and the complicating factor of conducting negotiations in the absence of some villagers, means transacting the transfer of forest rights can be complicated and any subsequent challenges to the validity of the contract may be successful.

B.Sino-Forest’s Plantation Ownership in Mainland China

1.Evidence of Transfer of Forestry Rights

(a)Purchase Transactions

[66]One of the issues of contention in this hearing is the adequacy of the evidence of Sino-Forest’s ownership of its forestry assets. Although Sino -Forest obtained PRCs for some of its forestry assets, it was unable to do so for most of its assets, notably those acquired using the BVI Model. As we discuss in greater detail later in these Reasons, Sino-Forest employed two business models in its timber operations. The BVI Model involved the purchase and sale of standing timber by subsidiaries incorporated in the British Virgin Islands. The WFOE Model involved the purchase and sale of timber rights by subsidiaries incorporated in Mainland China. Government restrictions on foreign companies operating in Mainland China resulted in greater constraints on business conducted through the BVI Model.

[67]Sino-Forest noted some of the difficulties in obtaining PRCs in its public disclosure. Its 2010 AIF states that Sino-Forest was required to obtain PRCs in

respect of its land use rights and timber ownership. Sino -Forest disclosed that, for its Planted Plantations,5 it was obligated to apply to Forestry Bureaus at the county level or above, which are responsible for issuing PRCs, but noted the following with respect to its Purchased Plantations:

Plantation Rights Certificates for Our Purchased

Plantations6

For our purchased plantations, we have applied for the corresponding Plantation Rights Certificates with the relevant forestry bureaus. As the relevant locations where

5As explained further below, Sino-Forest used the term “Planted Plantations” in its disclosure to refer to its process of increasing the yield of trees on land that it leased for 30 to 50 years to ensure long-term sustainable harvesting. All Planted Plantations were held in Sino-Forest’s WFOE Model.

6Sino-Forest used the term “Purchased Plantations” in its disclosure to refer to its process of purchasing young trees at attractive prices, capturing the fibre growth during ownership and then selling the standing timber to customers. Purchased Plantations could be owned in both Sino-Forest’s BVI Model and WFOE Model.

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we purchased our purchased plantations have not fully implemented the new form of Plantation Rights Certificate, we are not able to obtain all the corresponding Plantation Rights Certificates for our purchased plantations. Instead, we obtained confirmation of our ownership of our purchased plantations from the relevant forestry bureaus. Based on the relevant purchase contracts and the approvals issued by the relevant forestry bureaus, we legally own our purchased plantations.

[68]As discussed elsewhere in these Reasons, Sino-Forest’s BVI subsidiaries did not obtain PRCs. Ip testified BVIs, as foreign companies, could not own land use rights. Mr. Hao testified that whether foreign-owned enterprises are eligible to obtain PRCs depends on the different implementation measures of the different provinces and it is not clear whether they are eligible to obtain PRCs pursuant to the Forestry Act. BVIs, as foreign companies, could own standing timber rights, but not land use rights. Mr. Hao and others testified PRCs were generally not issued for standing timber ownership alone. We saw evidence of one PRC from Gengma County, Yunnan Province that registered a Sino -Forest WFOE’s ownership of standing timber, but not land use rights for two parcels of land. Mr. Hao testified that although certain Forestry Bureaus refuse to register separate ownership of these rights because they are accustomed to these rights being owned together, he had experience with a company that was able to obtain PRCs for timber ownership alone. We did not hear how many PRCs for standing timber alone were obtained by this company, which did business in Guizhou and Sichuan Provinces.

(b)Sales Transactions

[69]Sino-Forest similarly had to provide proof to its auditors of its revenue from sales transactions. As discussed elsewhere in these Reasons, sales conducted in the BVI Model were not settled by direct payments to Sino-Forest’s subsidiaries, but rather were dealt with through a set-off process, whereby Sino-Forest directed its customers to transfer funds to its suppliers, defined below as the AR/AP Set- Off Process.

[70]Since there was no flow of funds in or out of the bank accounts of the BVI subsidiaries that could be audited, Sino-Forest’s auditors were provided with other documents, including sales confirmations and documents detailing the AR/AP Set-Off Process, which were provided to show that assets had been sold.

[71]For sales of plantations held in the WFOE Model, Sino-Forest customers signed Harvesting/Sales Confirmations. These were documents prepared by Sino- Forest, which indicated that the sale was complete and that harvesting had taken place. Sales in the BVI Model were evidenced by Confirmations of Sales Situation documents. These documents were also prepared by Sino -Forest and confirmed sales had taken place. Both were one-page documents included at the end of some sales contracts. These documents confirmed the volume of timber actually provided to the customer by Sino-Forest pursuant to a specific sales contract, and the total sale price for that contract, based on the volume of timber actually sold. They were addressed to the Sino-Forest subsidiary and chopped by the customer. However, as discussed elsewhere in these Reasons, no actual harvesting took place in the BVI Model.

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[72]In addition, for the BVI Model, Sino-Forest’s auditors were provided with a set of documentation that enabled them to audit the AR/AP Set-Off Process. The standard documentation provided to E&Y as evidence of the settlement of accounts payable and receivable in the BVI Model was the following:

a.A letter from a Sino-Forest subsidiary to a Sino-Forest supplier, asking that the supplier accept a specified amount from a Sino-Forest AI/customer as partial or full payment for a purchase contract. This letter would be dated and chopped with the seal of the Sino-Forest subsidiary.

b.A second letter from the Sino-Forest subsidiary to the AI/customer, asking it to remit part or all of the accounts receivable due to Sino-Forest directly to the Sino-Forest supplier addressed in the first letter. This would also be dated and chopped with the seal of the Sino-Forest subsidiary.

c.A third letter from the AI/customer to the Sino-Forest subsidiary, confirming the customer has remitted the required amount to the Sino- Forest supplier in payment of the accounts receivable. This letter was undated and chopped by the AI/customer.

d.A fourth letter entitled Confirmation of Receipt of Funds Notification from the supplier to whom the first letter was sent. This letter confirmed receipt of the specified amount from the AI/customer, was dated and was chopped by the supplier.

[73]Ms. Man testified these documents indicated the Sino-Forest supplier had received the specified amount from the Sino-Forest AI/customer on the date indicated in the fourth letter, in accordance with the AR/AP Set -Off Process. She confirmed E&Y reviewed 100% of the sets of these four settlement documents for the four years that E&Y was auditor for Sino-Forest, all of which would have had similar content. These were supposedly independent confirmations, but, as will be discussed elsewhere, they were actually orchestrated by Sino -Forest and not independent or audit-worthy.

[74]Ms. Man was not aware of any collection issues in the BVI Model and did not recall that Sino-Forest ever had to write down any BVI accounts receivable prior to the Muddy Waters Report.

2.Annual Valuation of Sino-Forest’s Forestry Assets by Pöyry

[75]Sino-Forest retained the forestry consulting company Pöyry Forest Industry

(Pöyry) each year during the Material Time to prepare a valuation of its timber holdings.

[76]For its valuation of Sino-Forest’s assets, Pöyry used a discounted cash flow approach. It estimated the net present market value of Sino-Forest’s timber assets based on the expected cash flow from the harvesting of existing tree crops. Staff submits that Pöyry’s valuation approach was materially different from Sino-Forest’s business model. Staff cites the following testimony from Ms. Man, formerly of E&Y:

Sino-Forest model is to sell the trees within three to five years. Poyry's model is to look at a cash flow for a typical forestry company which usually the cycle is more

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than 10 years because growing trees usually involve a longer period of time.

So how Poyry did the valuation model, according to a discussion with Poyry, was that they look at the trees that Sino-Forest owned as of every year-end, they put in those data into the model, but ignore the sales cycle of Sino - Forest, but put that as -- into their model assuming that those trees will be sold in 10 years instead of three to five years.

(Hearing Transcript, November 13, 2014 at 34:19-35:5)

When questioned by the Panel if she knew why Pöyry used a 10-year model rather than the three- to five-year model that Sino-Forest actually employed, Ms. Man responded:

We had a lot of discussion with Poyry at that time. They -- my recollection was they mentioned that their model cannot be changed to fit in Sino-Forest's business model and

--or Sino-Forest, the business model of Sino-Forest was really unique, and the other clients that they have is a typical, you know, forestry company that involve a longer period of time in terms of the cycle. So they just can't do it the way that Sino-Forest -- like they can't align the model to Sino-Forest business model, put it this way.

(Hearing Transcript, November 13, 2014 at 36:1-11)

[77]James Hyde, who was the Chair of Sino-Forest’s Audit Committee, described Pöyry’s valuations as “‘what if’ calculations” and “not considered to be a financial number… not a true valuation in any way, sense or form” (Hearing Transcript,

November 3, 2014 at 168 and 169).

[78]Unlike the work of the Independent Committee, or a question we are being asked to address in these Reasons, Pöyry’s work did not include confirmation of ownership of assets. Rather, Pöyry’s assumption was that title to forest assets was as provided in the data from Sino-Forest.

[79]Hung was the contact person for Pöyry at Sino-Forest and was responsible for providing Pöyry with the information it needed, arranging for site visits and reviewing Pöyry’s draft valuations. The annual valuation process began with

Hung, or his subordinate, Kenny Wong (whose title was Executive Project Administration), providing Pöyry with an Excel spreadsheet containing information on Sino-Forest’s purchased and planted plantation holdings. This spreadsheet contained details of Sino-Forest’s total planted and purchased plantation assets by location (province, city and county), with additional information on tree species and year of planting, all of which was derived from the purchase contracts.

[80]For site visits, Pöyry would select a location they wanted to visit (at the county- or city-level). Sino-Forest would provide Pöyry with maps when it arrived for the site visit in Mainland China.

[81]Pöyry sampled a small percentage of Sino-Forest’s plantation assets in the course of conducting its annual valuation. Ms. Man guessed Pöyry would have

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visited around 1% or 2% of the area that covered Sino-Forest’s assets in any year.

[82]Based on Pöyry’s valuation reports for 2007, 2008 and 2009, Pöyry visited no more than 0.5% of Sino-Forest’s timber holdings in each year. Their reports do not distinguish between BVI and WFOE holdings. Pöyry cautioned in the 2007 report that the sample “is not large enough to cover the full range of natural variability across the Yunnan forest resource. However, there is currently no information that allows Pöyry to attribute any greater veracity to existing stand records”. There is no similar reference in the 2008 Report. In the 2009 Report,

Pöyry stated, “in comparison with most other forests, the large Sino -Forest estate is significantly under-sampled for growth and yield estimation purposes”.

[83]To locate plantations to use in its annual valuations, Pöyry relied on maps provided by Sino-Forest. Hung testified Pöyry selected plantations at random and was able to rely on the precise maps that Sino-Forest provided, having satisfied itself about the maps and the presence of standing timber. He noted the 2008 Pöyry valuation report refers to cluster maps of 150 plantation compartments with precise geographic coordinates. In cross-examination, he testified Sino-Forest would have provided Pöyry with the data on location, tree species, area in hectares, planted year and the status as planted or purchased plantations.

[84]As discussed in our analysis of allegations of deceitful documentation, Pöyry’s annual valuations do not assist us.

C.Forestry Asset Terminology in Sino-Forest’s Disclosure

1.Description of Assets

[85]Although the meaning of the terms trees, timber and logs may seem obvious, it is important to note the different terminology used by Sino -Forest in its financial statements to refer to the various forestry assets it owned and sold.

[86]Plantations of trees growing in the ground (i.e. in forests, yet to be harvested) were referred to as standing timber. Sino-Forest transacted most frequently in the purchase and sale of standing timber and this accounted for the vast majority of its revenue during the Material Time.

[87]The word logs, as one would expect, generally referred to trees that had been harvested into logs. However, we heard testimony that assets referred to as

“logs” in Sino-Forest’s disclosure documents could also have been a reference to “standing logs”, which were essentially trees still growing in the ground but sold as if they were logs. There was some discussion during the hearing about the vertical versus horizontal nature of “standing logs” and “logs”, but suffice it to say that a standing log is just a tree. More specifically in respect of Sino -

Forest’s revenue, standing logs referred to unharvested trees that were priced for sale at the expected value of the logs that the trees would yield. In fact, standing timber, logs and standing logs all referred to uncut trees in Sino -

Forest’s nomenclature.

[88]In addition to standing timber, Sino-Forest also owned the land use rights for some plantations. In these cases, Sino-Forests’ assets were comprised of both the timber on the land and the rights to the land itself (i.e. to replant after harvesting). Because of government restrictions that prevented foreign

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companies from owning land use rights, these purchases of land use rights were only made in the WFOE Model.

[89]Sino-Forest disclosed the distribution of its timber holdings amongst its Planted Plantations and Purchased Plantations (discussed in the following section). It did not, however, disclose its holdings in each of the WFOE and BVI Models.

2.Description of Revenue Streams

(a)2003-2006 – Standing Timber: Planted Plantations and Purchased Plantations

[90]Between 2003 and 2006, Sino-Forest reported its revenue from standing timber sales as being derived from sales of “planted plantations” and “purchased plantations”. Purchased Plantations are described as “forestry plantations of third parties” from which Sino-Forest purchased immature trees. In its 2005 Annual Report, Sino-Forest describes them as “where we generate a high gross profit margin from purchasing young trees and cultivating them to maturity, and acquire the rights to lease the land for re-planting”. Planted Plantations are described as “our own”. In 2005, Sino-Forest described them as follows: “where we re-plant and share harvest proceeds with our joint-venture partners”.

[91]In 2006, sales of standing timber accounted for 55% of Sino -Forest’s total revenue. In addition to revenue from standing timber, Sino -Forest also recorded revenue from the following sources in 2006:

imported wood products;

wood chips and logs; and

manufacturing and other operations.

[92]During this period, 2003 to 2006, Sino-Forest disclosed its revenue from its Purchased and Planted Plantations consisted entirely of sales of standing timber. Therefore, immediately prior to the Material Time, Sino-Forest’s AIF disclosure indicated none of its revenue was derived from sales of harvested logs. However, other contradictory disclosure indicates Sino-Forest was engaged in harvesting operations.

(b)2007-2009 – Plantation Fibre: Planted Plantations, Purchased Plantations and Integrated Plantations

[93]In 2007, Sino-Forest introduced the term “plantation fibre” in its financial reporting. Plantation Fibre revenue consisted of revenue derived from Sino-

Forest’s operations in Purchased Plantations, Planted Plantations and “integrated plantations.” Integrated Plantation revenue was derived from Sino-Forest’s new integrated model, which Sino-Forest described in its 2007 Annual Report as follows: “We purchase mostly mature trees, harvest and sell the logs or vertically integrate the fibre with our manufacturing facilities to produce value-added wood products”.

[94]In 2007, Sino-Forest had no revenue from Integrated Plantations, and the term

Plantation Fibre was used somewhat interchangeably with “standing timber”. In

2008 and 2009, Plantation Fibre revenue was reported as derived from all three plantation sources. Sino-Forest specifically disclosed that its Plantation Fibre revenue in 2008 and 2009 was the result of sales of both standing timber and harvested logs.

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(c)2010 – Plantation Fibre: Standing Timber and Logs

[95]In 2010, Sino-Forest reported Plantation Fibre revenue in two differently-named categories, (i) Standing Timber, and (ii) Logs. The Standing Timber revenue was from sources previously described as Purchased and Planted Plantations and Logs revenue was from sources previously described as from Integrated Plantations. Sino-Forest still reported sales of standing timber and harvested logs under Plantation Fibre revenue.

[96]In 2010, Sino-Forest reported revenue from two streams:

1.Wood Fibre Operations o Plantation Fibre

Standing Timber

Logs

oTrading of Wood Logs

2.Manufacturing and other operations

[97]The frequent changes in terminology in Sino-Forest’s revenue disclosure make it challenging to compare its revenue year to year.

(d)Revenue Reported from the Sale of Logs

[98]Josephine Man, formerly of E&Y, testified she understood that as of at least 2008, log sales consisted of standing timber that had actually been cut down and harvested into logs. From an audit perspective, evidence of these log sales was provided by written confirmations, in which the customer would confirm the amount of logs received.

[99]By 2010, Ms. Man’s understanding of log revenue had changed, based on what she had been told by David Horsley. She testified Horsley informed her no harvesting was done for 2010, and instead Sino-Forest agreed with customers in advance of the sale how many logs the plantation would yield, and priced the sales as logs, accordingly. She confirmed for 2010, E&Y understood that none of the harvesting was being done by Sino-Forest, and all the “log” revenue of US $893.3 million for that year was actually the sale of “standing logs” (i.e. uncut trees sold at log price). Ms. Man confirmed the term “standing logs”, however, was never referred to in the 2010 Financial Statements. The entire US $1.4 billion in plantation fibre revenue that was broken down into standing timber revenue and log revenue was, in fact, all revenue from the sale of standing timber assets (i.e., uncut trees).

[100]Although absent from Sino-Forest’s disclosure, the concept of standing logs was known to E&Y when it performed the audit for 2010. A February 26, 2011 internal E&Y memo written in respect of the 2010 audit, notes the following:

2.For sales which involve the harvesting of standing timber (either via third party or AI), ensure that the appropriate harvesting rights/logging quota have been obtained by obtaining such evidence as:

a.Confirmation from the AI/third party that the appropriate harvesting rights have been obtained.

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b.Comparing the amount of logs harvested to the area for reasonableness

Per inquiry of management, EY was advised that the

Company did not have any integrated sales by BVI subsidiaries that involved harvesting in the current year. The type of integrated sales made in the current year represents standing log sales. Standing log sales and its related unit price is made based on the expected yield of wood logs from the standing timber (i.e. fallen yield) whereas sales of standing timber is based on the standing yield of the plantation.

As the BVI Subsidiaries did not have any harvesting activities in the current year, this procedure was not performed.

[emphasis added]

D.Other Issues Relevant to Sino-Forest’s Timber Business

1.Fapiao and Tax Implications

[101]Fapiao are official tax receipts issued by a Tax Bureau in Mainland China for the purchase of goods or services. In exchange for payment to purchase forestry rights, Sino-Forest WFOEs would be issued fapiao. These fapiao could subsequently be used to obtain tax credits upon the sale of the forestry assets.

[102]The Chinese characters for fapiao have been translated to English as “invoice” in various documents in evidence in this hearing, but we have referred to them as fapiao throughout these Reasons.

[103]Fapiao are printed, administered and distributed by the Chinese Tax Bureau. Businesses are required to purchase fapiao from the Tax Bureau according to their business scope, and may provide fapiao to customers in exchange for goods or services. Each local office of the Tax Bureau has a quota for the number of fapiao it may issue, and, in turn, issues a set number of fapiao to each business in its jurisdiction. This quota system can result in a shortage of fapiao for a particular business or area.

[104]Mr. Murphy, an expert in Chinese business practices that include tax regulation, testified that although every fapiao has its own serial number and is not fungible, companies in Mainland China will sometimes borrow fapiao from another company in order to be able to provide them to customers. He testified he had seen this done in situations where a business did not have the fapiao to issue to a customer, but wanted a transaction to move forward. He explained that these businesses run the risk that the Tax Bureau may impose fines or penalties for loaning or borrowing fapiao.

[105]We heard expert evidence that different tax rates could apply to purchases of forestry assets in Mainland China, depending on the substance of the transaction. Land use rights were subject to a 5% Business Tax, whereas standing timber was subject to a 13% value-added tax (VAT). Different types of fapiao would therefore be issued for these transactions, referred to in this

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hearing as general fapiao, or VAT fapiao, respectively. Only businesses qualified as VAT general taxpayers were eligible to issue VAT fapiao. All other taxpayers were only able to issue general fapiao.

[106]Fapiao were also useful in obtaining approval from SAFE (discussed below) for the exchange of foreign currency to renminbi, something Sino-Forest WFOEs were frequently required to do. To obtain approval for an additional exchange of foreign currency, a Chinese company was required to present SAFE with the fapiao resulting from the use of the renminbi from its previous foreign currency exchange.

[107]Sino-Forest’s subsidiaries never obtained fapiao for their standing timber purchases in the BVI Model. If Sino-Forest never obtained fapiao for purchases, it could not provide them to customers. From 2007 to 2010, Sino -Forest’s reported revenue in the BVI Model was US $3.35 billion. We find it beyond belief that no BVI customer ever required a fapiao from Sino-Forest, without which the full sales revenue could be taxable as profit.

2.State Administration of Foreign Exchange (SAFE)

[108]Three expert witnesses provided evidence with respect to SAFE, Dr. Peerenboom, Mr. Murphy and Mr. Liu. Because of strict government controls on foreign exchange, foreign currency cannot be freely brought into Mainland China. Approval must be obtained from SAFE, the regulatory body responsible for overseeing the conversion of foreign currency into renminbi. Although not specific to the forestry industry, SAFE played a notable role in Sino -Forest’s business in Mainland China. Any cash that a WFOE subsidiary brought into Mainland China required SAFE approval.

[109]SAFE places strict restrictions on the use of funds approved for foreign exchange. As part of its regulation of foreign exchange, SAFE inspects and audits the authenticity and legality of the receipt of payments of foreign exchange and punishes violations of foreign exchange regulations. In investigations into the legality of a company’s foreign exchange transactions, SAFE could request information on transactions down the supply chain, and, as a result, companies being investigated, such as Sino-Forest, can have greater insight into the books and records of their suppliers than would be expected of companies operating in North America. SAFE has the investigatory powers to review books and records of Sino-Forest’s suppliers and those of its suppliers’ suppliers if SAFE considers them directly related to Sino-Forest’s transactions under investigation.

[110]Dr. Peerenboom reported the global financial crisis and subsequent low interest rates led to an influx of “hot money” into emerging markets, including China. Mr. Murphy noted that the Chinese government has become increasingly concerned with this influx of “hot money”. Dr. Peerenboom stated this has resulted in closer monitoring of capital flows into Mainland China by SAFE. Mr. Murphy reported that additional restrictions on the settlement of foreign exchange into renminbi were implemented.

[111]Mr. Murphy stated these more stringent regulations restricted companies from converting foreign exchange funds to support activities related to their business scope, and required more substantial supporting documentation for a conversion of foreign funds to renminbi.

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[112]Sino-Forest WFOE subsidiaries were the subjects of a SAFE investigation in 2011. Documents in evidence that track banking and financial information for Sino - Forest suppliers and customers were created by Sino-Forest at the time of the SAFE investigation

[113]The Respondents submit it was because of SAFE’s monitoring and investigation that Sino-Forest obtained detailed information about the books and records of some of its suppliers and customers and why it was monitoring their bank accounts. Staff submits, however, Sino-Forest concocted this explanation for its

“monitoring” of supplier bank accounts when it first came under scrutiny by SAFE and was forced to come up with an explanation for why it was controlling the bank accounts of its largest supplier, Yuda Wood. We consider this in our analysis of the allegations of Sino-Forest’s undisclosed control of purportedly arm’s length companies.

3.Company Registrations – SAIC Filings

[114]The regulatory body that oversees corporate filings is the State Administration for Industry and Commerce (or SAIC). Much of the evidence of the ownership, initial capitalization and officers of companies involved in these allegations has been provided in official SAIC filings.

[115]Registration of a company requires filings with the SAIC and the SAIC requires yearly filings to renew business licenses.

[116]According to Dr. Peerenboom, reliance on SAIC filings can be problematic because Mainland China’s system of corporate filings, independent audits and imposition of taxes is still at an early stage of development. He noted in his expert report that discrepancies between information in SAIC filings and a company’s books and records can be expected. Mr. Hyde, a former Sino -Forest director and Audit Committee Chair, testified the Independent Committee found the financial information disclosed in SAIC filings to be “wholly unreliable” (Hearing Transcript, November 7, 2014 at 183).

IV. SINO-FOREST’S BUSINESS MODELS: THE BVI MODEL AND THE WFOE MODEL

[117]Our analysis of Staff’s allegations requires an explanation of the business models that Sino-Forest used as a means of operating as a foreign-owned forestry company in Mainland China. The company’s operations in China were carried out through its two business models, the BVI Model and the WFOE Model, which we describe below. Sino-Forest conducted the vast majority of its business through the BVI Model during the Material Time.

A.The BVI Model

[118]The BVI Model was Sino-Forest’s solution to challenges it faced operating in the context of Mainland Chinese government restrictions on foreign companies carrying on business in Mainland China. Under the BVI Model, Sino-Forest incorporated subsidiary companies in the British Virgin Islands to facilitate its purchase and sale of standing timber in Mainland China. The BVI Model also involved the use of “authorized intermediaries” (or AIs), purportedly arm’s length companies that acted as sales agents in Mainland China for the Sino - Forest BVI subsidiaries, which could not directly carry on business in Mainland China.

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[119]The BVI subsidiaries could not hold bank accounts in Mainland China and therefore could not settle in cash their purchases and sales. They also could not bring in foreign currency for conversion to renminbi. Similarly, conversion from renminbi to foreign currency was limited. As a result, no cash flowed in or out of the Sino-Forest BVI subsidiaries within Mainland China. Instead, Sino -Forest created an off-book system of netting out its accounts receivable and accounts payable such that Sino-Forest customers were instructed to make payments on behalf of Sino-Forest to its suppliers, rather than to Sino-Forest directly (the AR/AP Set-Off Process).

[120]The AR/AP Set-Off Process created a continuous cycle of funds through the BVI Model: Sino-Forest BVI subsidiaries entered into purchase contracts with its suppliers and sales contracts with its customers, or AIs; payments due on the various purchase contracts were satisfied by directing AIs to make payments directly to suppliers; this in turn satisfied the customers’ payment obligations pursuant to the sales contracts. This process continued quarter after quarter.

[121]All revenue booked by the BVI subsidiaries from the sale of standing timber was used to purchase additional standing timber. Through this process, all the money recorded in the BVI Model remained in Mainland China, and was never held directly by Sino-Forest or any of its subsidiaries. In the BVI Model “[n]o proceeds are directly paid to the Company, either onshore or offshore” (Second IC Report at 51). Settlement of accounts receivable in the AR/AP Set-Off Process necessitated the continuous purchase of additional timber by Sino -Forest. The gap between the cost of timber and revenue from its sale meant Sino -Forest had to enter into additional purchase transactions with parties in Mainland China, funded by the settlement of its accounts receivable in the AR/AP Set -Off Process. As a result, all of Sino-Forest’s reported profit in the BVI Model was trapped in Mainland China.

[122]One consequence of the off-book nature of the AR/AP Set-Off Process was Sino-

Forest’s BVI subsidiaries did not deal directly with the tax liabilities that arose from standing timber sales. Instead, the AIs were responsible for remitting taxes to the Chinese tax authorities. However, Sino-Forest was not provided with any proof these taxes were ever paid by the AIs. To deal with the risk that Chinese tax authorities might seek to recover unpaid taxes from Sino-Forest, the company included an increasing tax liability provision in its Financial Statements. As of December 31, 2010, the amount of this accumulated provision was US $156,941,000.

[123]Internal Sino-Forest process documents for the AR/AP Set-Off Process describe customers’ settlement of their accounts with Sino-Forest as being “payments directly” to suppliers from AIs. However, the Independent Committee investigation revealed the AR/AP Set-Off Process often involved multiple layers of payments, whereby third, fourth, fifth or sixth parties may have been involved in making payments to effect the settlement of Sino-Forest’s accounts receivable and payable. The Independent Committee noted in the Second IC Report at page 53:

some AIs visited stated that they may not in fact make payments themselves as instructed by SF [Sino-Forest] but would instead arrange for other parties (“fourth parties”) to

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make payment on their behalf. Those fourth parties may then instruct “fifth” or “sixth” parties to make payment.

In this situation, the Suppliers receiving payment will sometimes instruct its own “fourth” parties to receive payment on its behalf. …

[124]We heard throughout the hearing that similar set-off mechanisms involving third parties were commonly used to settle accounts in Mainland China, where the planned nature of the Chinese economy created cash flow difficulties. Mr. Murphy, an expert in Chinese business practices, testified liquidity problems in Mainland China often result in workarounds that allow companies to hold on to currency. He testified this can include a set-off process like the one employed by Sino-Forest BVIs. He further testified, although he had seen set-off arrangements involving additional parties, they were not common.

[125]Notwithstanding the various parties involved, and the widespread cash flow difficulties experienced by companies in Mainland China, the payments made through the AR/AP Set-Off Process appeared to be remarkably efficient. Prior to the release of the Muddy Waters Report, Sino-Forest BVI subsidiaries had a perfect or near perfect collection record for their accounts receivable. Of the hundreds of millions of renminbi receivable in the BVI Model, Sino-Forest reportedly never experienced any significant collection issues. This changed dramatically after the Muddy Waters Report was released. Sino-Forest had significant difficulty in collecting accounts receivable. As of March 30, 2012, US $887.4 million was still owed to Sino-Forest for standing timber sales in the BVI Model. Sino-Forest learned that many AIs, which owed money to Sino-Forest pursuant to sales contracts, had deregistered under Chinese law, and essentially ceased to exist.

[126]Sino-Forest publicly disclosed its use of the AR/AP Set-Off Process as involving payments from customers to suppliers. However, what was not clear from Sino- Forest’s disclosure was the reliance on additional third, or more, parties to settle accounts. Documents evidencing the multi-party flow of funds were not maintained by Sino-Forest or provided to its auditors. Mr. Clifford of E&Y testified this “daisy chain of cash” was absolutely inconsistent with his understanding of the AR/AP Set-Off Process at the time he was working for E&Y as auditor of Sino-Forest.

[127]The Independent Committee was unable to confirm the actual movement of money within the AR/AP Set-Off Process:

The IC Advisors have received copies of the Set-off Documents related to all the BVI standing timber purchase transactions between the first fiscal quarter of 2006 and the first fiscal quarter of 2011. However, the IC Advisors have not been provided with any documents showing movement of money to confirm that such set-off arrangements have been carried out. During meetings of the IC Advisors with AIs and Suppliers, representatives from the AIs and Suppliers declined to produce such documents showing movements of money. …

(Second IC Report at 53)

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[128]Staff submits the BVI Model and its off-book settlement of accounts had the advantage of being opaque and malleable and notes that Sino-Forest was totally unable to substantiate its business in response to allegations in the Muddy Waters Report. Staff alleges Sino-Forest used the BVI Model to engage in a massive scheme to overstate its assets and revenue.

B.The WFOE Model

[129]In 2004, government restrictions on foreign ownership were relaxed and Sino- Forest was able to incorporate subsidiaries in Mainland China to conduct its standing timber business directly. Unlike the BVI subsidiaries, these Chinese subsidiaries, referred to as wholly foreign-owned enterprises (WFOEs), were able to hold bank accounts in Mainland China and bring in foreign currency from outside the country for conversion to renminbi (although still subject to strict government regulation). As a result, WFOE subsidiaries did not need to resort to the AR/AP Set-Off Process employed in the BVI Model as a means of purportedly paying suppliers and receiving payment from customers. Instead, WFOEs were able to pay suppliers and receive payment from customers directly. However, as noted elsewhere in these Reasons, some WFOE subsidiaries still employed the AR/AP Set-Off Process, notwithstanding their ability to deal directly with customers and suppliers in renminbi.

[130]Another advantage the WFOE Model had over the BVI Model was the ability to hold additional ownership rights for plantations in Mainland China. As discussed in more detail elsewhere in these Reasons, there are four rights associated with plantation ownership in Mainland China: (i) land ownership; (ii) land use rights;

(iii)timber ownership; and (iv) timber use rights. These rights are separate and need not be held by the same entity. However, there are limitations on the kinds of entities that may own certain rights, and the ways in which Forestry Bureaus provide proof of ownership of these four rights by different entities. Because they could own not only the timber, but also the right to use the land on which the timber was growing, WFOEs had a distinct advantage over BVI subsidiaries. WFOE subsidiaries, which owned the land use rights, would be able to re-plant the land to grow standing timber after harvest.

[131]Proof of forestry rights ownership in Mainland China was generally provided through the issuance of PRCs by local Forestry Bureau offices. Forestry Bureaus would not generally issue PRCs in respect of a company’s timber ownership alone

(i.e. where the company did not also own the land use rights, which BVIs could not do). However, we did see two examples of PRCs issued in situations where the land use and timber rights were separately owned.

[132]WFOE subsidiaries had another advantage over BVIs. Forestry Bureaus would issue PRCs to WFOE subsidiaries, but they were essentially impossible for Sino- Forest’s BVI subsidiaries to obtain. Instead, Sino-Forest’s BVI subsidiaries requested alternative evidence of their forestry rights ownership from Forestry Bureaus in the form of Forestry Bureau Confirmations, which are described in more detail elsewhere in these Reasons relating to allegations regarding deceitful documentation.

[133]Accounting in the BVI Model and the WFOE Model was conducted totally separately. For transactions in the WFOE Model, Sino-Forest used an accounting

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software program, Kingdee. The Kingdee program would not permit the booking of transactions that were backdated to a previous quarter. In addition, in WFOEs, accounting was done at the WFOE subsidiary level. In contrast, in the BVI Model, accounting was booked through Sino-Forest headquarters in Hong Kong, and was done using manual entry spreadsheets, which allowed backdating.

C.Continued Use of the BVI Model and Sino-Forest’s “On-Shoring” Plan

[134]Even after the relaxation of regulations on foreign-owned companies in 2004, Sino-Forest continued to conduct the vast majority of its standing timber business through the BVI Model. In the last four years for which Sino-Forest released audited financial statements, the distribution of Sino -Forest’s standing timber assets and revenue between the BVI Model and the WFOE Model was as follows:

 

 

Standing Timber Asset Holdings

Standing Timber Revenue

 

 

 

 

 

 

 

 

 

 

 

BVI Model

WFOE Model

% in

 

WFOE Model

% in

 

 

BVI

BVI Model (US $)

BVI

 

 

(US $)

(US $)

(US $)

 

 

Model

 

Model

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

1,088,556,000

85,597,000

92.71%

501,345,653,000

20,143,011,000

96.14%

2008

1,479,548,000

173,758,000

89.49%

644,900,557,000

40,503,807,000

94.09%

2009

1,901,983,000

281,506,000

87.11%

882,046,250,000

72,147,699,000

92.44%

2010

2,475,515,000

647,002,000

79.28%7

1,326,032,633,000

75,138,908,000

94.64%

 

 

 

 

 

 

 

 

Total

 

 

 

 

3,354,325,093,000

207,933,425,000

94.16%

 

 

 

 

 

 

 

 

[135]From 2007 to 2010, Sino-Forest’s recorded revenue from the BVI Model almost tripled and the balance sheet value of standing timber holdings in the BVI Model more than doubled. Growth rates in the WFOE Model were also substantial, but the proportion of Sino-Forest’s business being done through WFOEs did not change significantly.

[136]We heard evidence Sino-Forest had plans in 2009 and 2010 to shift from its reliance on the BVI Model to the WFOE Model through an “on-shoring” process.

The on-shoring project was designed to reduce Sino-Forest’s reliance on AIs, free-up the profits “trapped” in Mainland China that could only be used for reinvestment in additional standing timber, and contain the growth of the substantial tax exposure created in the BVI Model. E&Y had little comfort that the AIs were actually paying taxes on behalf of Sino-Forest, and encouraged Sino-Forest to move forward with the on-shoring initiative to cap and crystallize this liability. E&Y had been advising Sino-Forest to maintain the significant tax reserve, and as the company’s profits increased, so too did the reserved amount.

During the Material Time, the reserve increased from US $39,106,000 as of December 31, 2006 to US $156,941,000 as of December 31, 2010.

[137]Sino-Forest’s plan to on-shore assets held through the BVI Model had two elements. First, Sino-Forest would transact its new business through the WFOE Model going forward. As can been seen in the table above at paragraph [134] this did not happen. From 2005 onwards, the proportion of Sino -Forest’s

7This percentage reflects the acquisition of Mandra, a WFOE, in the first quarter of 2010. Excluding Mandra, this percentage for 2010 was 84%.

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revenue recorded for its standing timber business done through the BVI Model remained well over 90%. Second, it would move assets acquired through the BVI Model into the WFOE Model – the on-shoring plan.

[138]In 2008, 2009 and 2010, Sino-Forest was working with E&Y to devise its on- shoring plan. On-shoring the assets held in the BVI Model involved considerations that included determining and dealing with the amount owed to Chinese tax authorities; how and whether the standing timber rights held by a BVI company could be assigned or transferred to a WFOE; whether AIs would be required to intermediate the standing timber transaction; and foreign exchange regulatory implications.

[139]Mr. Hyde, a member of the Sino-Forest Board, testified that the on-shoring project was extremely complex and required consultation with external tax and legal advisors. It was a priority for Sino-Forest and was the subject of significant discussions at meetings of Sino-Forest’s Board of Directors and Audit Committee.

[140]Sino-Forest was only able to complete four on-shoring transactions, in 2009 and 2010, in which assets held in the BVI Model were converted to cash and standing timber held in the WFOE Model. David Horsley testified the on-shoring process for these transactions “took some time” and involved costs for Sino -Forest including VAT and reduced Sino-Forest’s profit margin for the assets involved

(Hearing Transcript, November 26, 2014 at 32).

[141]Sino-Forest management’s efforts in the on-shoring process appear to have been minimal. E&Y was concerned about the slow progress on the on-shoring project. In an internal E&Y email from July 2010, a member of the audit team for Sino- Forest expressed the following concerns that needed to be addressed with management:

-onshoring work needs to be done and client needs to pay for us to help them do it even if they are in denial that they can do it themselves

-the view that Sino can negotiate itself out of the “locked in profits” and “tax exposure issue” is not based on any actual evidence or supportable actions or testable.

[142]Notwithstanding E&Y’s concerns and suggested approaches to this problem, Allen

Chan appeared to believe he could resolve some of the tax issues by personally negotiating a deal with his contacts in the Chinese government. An E&Y Internal Memorandum dated July 23, 2010 notes the difficulties E&Y had in dealing with Sino-Forest on the tax liability issues:

Back in 2007, client said they wanted to fix/cap the BVI tax exposure. We assisted in this exercise but on the client side, there was always a business or technical problem whereby the particular plan was not desirable [it seemed very much that there were just too many challenges and issues such that none of the options we proposed would work]. Since then, they have made very little progress on this matter and the plantation’s book value has gone from approximately $1 billion to $1.9 billion at March 31, 2010. They have last year transacted a few “onshoring” transactions where the BVI

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sold the timber to an AI that onsold the timber to Sino WFOE’s for a small mark-up and thereafter the Sino WFOE’s sold the timber resulting in taxable earnings for Sino WFOE’s (much of taxable earning was offset by losses). However, there were technical challenges associated with the onshoring transactions as well as VAT costs because of the unwillingness of intermediary AI to issue VAT invoices, which has caused them to keep the amounts small. Except for these onshoring transactions, as to their “little progress” it seems they do not have much interest in dealing with challenges [tax or other] to fix or cap the issue. Not sure if the reason is because there may be a cash tax cost (highly likely reason given the VAT and income tax costs) to fix or some other reason.

[143]The same Internal Memorandum notes Allen Chan continued to disagree with

E&Y’s concerns about payment of the outstanding tax liability. It reports Chan expressed the position “he has government connections and can cut a deal”. E&Y expressed concern they had “not yet seen any evidence of his ability to cut a tax deal to clean up the BVI tax issue even after having been willing to sit down and work with him to get to that result” and that management based its position on a “gut feel” they could cut a deal on stated terms.

[144]The witnesses from E&Y confirmed Sino-Forest’s on-shoring project never really got off the ground. Mr. Clifford testified Chan was resistant to E&Y’s solution. Chan rejected the approach suggested by E&Y and Mr. Clifford was unaware of any efforts by Sino-Forest to approach tax authorities. As of the first quarter of 2011, the Sino-Forest Board was continuing to consider alternative means for achieving its goal of on-shoring assets to the WFOE Model.

[145]Staff suggests the explanation for the lack of progress on the on-shoring project is simple – Sino-Forest could not onshore assets that did not exist.

[146]While the on-shoring exercise was complicated, Sino-Forest could have directed new purchases of standing timber (and land use rights) to WFOE subsidiaries beginning in 2004, rather than continuing to use the BVI Model. Senior management made the conscious decision not to, despite the advantages of the WFOE Model.

V.ALLEN CHAN’S ROLE AT SINO-FOREST

[147]Allen Chan was born, educated and resided in Hong Kong. His first language is Cantonese. He obtained an undergraduate degree in sociology. In 1992, Allen Chan co-founded Sino-Forest, together with K.K. Poon, who had worked for 15 years as an engineer with the Guangdong Province Forestry Bureau where he engaged in trading and manufacturing of forestry products, and Leslie Chan, Chan’s former wife. Prior to founding Sino-Forest, Chan worked in project financing and as a management consultant, and had over 12 years of experience structuring joint ventures in China across industries such as hospitality, healthcare, oil and gas, real estate and manufacturing.

[148]Messrs. Ardell, Hyde, Horsley, Ip and Hung testified Chan had extensive relationships with various levels of government including at the local and central

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levels. In 2007, Chan was appointed as Executive Council Member of Renmin University of China (the People’s University of China) for a three-year term. In 2007, Chan was invited to be a member of the Chinese People’s Political Consultative Conference. In 2009 and again in 2012, Chan was awarded by the China National Forestry Industry Association with Forestry Person of the Year Award. In December 2010, Chan was appointed as a Vice President of the China National Forestry Industry Federation. In 2011, he was presented with the Outstanding Achievement Award from China National Forestry Industry Federation.

A.Testimony of Thomas Maradin

[149]Thomas Maradin described Chan as having ultimate decision-making power at Sino-Forest:

A.My -- from my perspective, I looked at it, especially from a Chinese culture, that the person at the top has power, more power in my mind than a North American perspective, so Allen --

Q.As CEO you mean?

A.Yes. Yes.

Q.Continue, please.

A.And power from a standpoint of decision-making,

power from a perspective of people below respecting his position. And so from my standpoint, you know, there's a great deal of respect in that culture to that position and the authority that he has.

(Hearing Transcript, October 29, 2014 at 115:12-24)

[150]Mr. Maradin testified Chan’s decision-making power extended to the selection of members of Sino-Forest’s Disclosure Committee:

Q. And how was it determined who would be on this

Disclosure Committee? Who was the selector of the team?

A. I guess ultimately I sought Allen's approval in terms of the people on the Committee. I certainly gave him the advice as far as the functional areas, but Allen was let's say the approver or acknowledger of committee members.

(Hearing Transcript, October 29, 2014 at 139:19-140:1)

[151]Mr. Maradin confirmed Chan acted as the ultimate and compensating control over Sino-Forest’s contracts. He prepared a report, edited by Horsley, to the Audit Committee dated March 15, 2009, which summarized progress on remediating internal control deficiencies (the March 15 Report). The March 15 Report indicated:

My report highlights the individual process, description of deficiency, applicable business unit, and individual evaluation and remediation points. In a number of cases you

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will note that a deficiency exists (“no evidence”, “no formal written policy”, “no formal pre-approval”) as there is no formal documented evidence although the control does take place in a verbal exchange. In these cases, our remediation will involve documenting the exercise of the control process. Ultimately, notwithstanding the lack of evidence of the control through the process, the ultimate and compensating control is the CEO’s signature on the final transaction be it purchase or sale of standing timber, transfer of funds or payment for goods/services.

[emphasis added]

[152]The March 15 Report is incorrect in one respect. In practice, Chan did not sign purchase contracts. Chan pre-approved all purchases and signed all sales contracts. K.K. Poon signed purchase contracts until the second quarter of 2010, and Ip signed them thereafter.

[153]When questioned about the March 15 Report, Mr. Maradin testified:

a year before this I remember having conversations with

Fred [Clifford of Ernst & Young] about an ultimate control in terms of Allen reviewing and signing off on things, and so this is an accurate statement. And at the time, thinking, okay, Allen is reviewing these documents, receiving his authorization, so it is a compensating control. It doesn't eliminate the deficiency, but it's a strong evidence that somebody independent is signing the contracts.

(Hearing Transcript, October 29, 2014 at 154:4-12)

For further clarity, Mr. Maradin confirmed that the ultimate and compensating control “would be Allen Chan’s signature” (Hearing Transcript, October 30, 2014 at 77:23-24).

B.Testimony of William Ardell

[154]Mr. Ardell described Chan as the visionary and leader behind Sino-Forest:

Mr. Chan was I think at that stage 57 years of age, he was a very key individual in the organization, and certainly, from what I saw or was aware of, there was not a backup plan for a company the size of Sino-Forest.

Q.And when you say he was a key individual in the company, what did you mean by that?

A.He was the visionary, he was the leader to the organization within, to the people within his organization, and as I understood it, he was the key man contact within the forestry industry in China.

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(Hearing Transcript, November 19, 2014 at 136:4-14)

C.Testimony of James Hyde

[155]Mr. Hyde testified Chan attended meetings of the Audit Committee, and it was important to have Chan attend so he could answer questions the Audit Committee had on topics such as operations and company strategy. Chan was able to explain in broader detail some of the analysis that was being presented.

[156]Mr. Hyde viewed Chan as the person in management responsible for oversight of Sino-Forest’s BVI Model (the focus of Staff’s Standing Timber Fraud Allegations, described in more detail elsewhere in these Reasons):

Q. … So, first, if I could just ask, what was your understanding at the time that you were a member of the Audit Committee in terms of which members of management had which respective responsibilities over that structure?

A. In line management I'm not sure who all the various people were. We, quite frankly, looked to Mr. Chan as the overall person. Tends to be a very senior-dominated team, and people look to the senior executive as the person. He was involved and told us he was involved in many of the activities and transactions that were going on.

(Hearing Transcript, November 5, 2014 at 35:4-15)

[157]Mr. Hyde also testified:

Q.And between Mr. Horsley and Mr. Chan, who had more of an involvement in the operations of the company?

A.Mr. Chan definitely in the day-to-day operations of the business.

(Hearing Transcript, November 5, 2014 at 101:16-20)

[158]Mr. Hyde also testified Chan was the compensating control with respect to the identified internal control weakness of a lack of segregation of duties:

we were told there was a compensating control that Mr. Chan reviewed all the settlement agreements and he signed

many of the -- well, I think he signed the purchase agreements and the sale agreements, and that was a compensating control in the whole process .

(Hearing Transcript, November 5, 2014 at 102:18-23)

[159]Mr. Hyde testified although there were others involved, including Ip, Chan was signing the agreements and reviewing Hung’s work with respect to accounts receivable and accounts payable settlements. He testified this was viewed as a compensating control.

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[160]Mr. Hyde confirmed the Audit Committee took steps outside its regular, quarterly meetings to address the fact that the lack of segregation of duties was still an internal control weakness, which had not been resolved since 2007. Both Mr. Martin and Mr. Ardell, in their consecutive roles as Lead Director, approached Chan about this. When questioned why the Lead Director approached Chan about the remediation of this internal control weakness, Mr. Hyde testified:

Mr. Chan, as the chairman and chief executive officer, most senior person, that it was important to set the tone at the top. He was our most senior executive, and it was important to have -- for him to set the tone that this was important that the staff/management address these issues, and it was important to him, and he wanted to see them resolved, that this needed attention.

(Hearing Transcript, November 5, 2014 at 108:8-15)

D.Testimony of David Horsley

[161]David Horsley testified if he wanted answers about Sino -Forest’s vision moving forward, he would turn directly to Allen Chan. He described Chan’s perceived strength as leader of Sino-Forest as follows:

Mr. Chan's, I would say, main strength was his -- his, um, view of the future of where the company would go, where China was going, of how we need to align the business with opportunities that were arising in China. He was the strategic driver of the business, where we would go, what provinces to buy trees. So he was the strategic driver.

(Hearing Transcript, November 21, 2014 at 60:3-10)

[162]Horsley testified Chan’s involvement in the operations of Sino -Forest included approval of details in the budget planning process and negotiations of terms of purchase and sales agreements.

[163]Like others, Horsley confirmed Chan was Sino-Forest’s ultimate and compensating control:

Q.And why did you feel that that was the ultimate in compensating control?

A.It was certainly something that had been discussed

at audit committees, the fact that Allen would -- Allen Chan would be the final signator on those types of documents, and so it was a compensating control. You know, it talks about no evidence, no formal written policy, so if things are being done but aren't being documented, then there's a chance that somebody incurred an expense for something, they didn't get approval before they did it. Ultimately, Allen Chan signing the cheque for payment for goods and services was a compensating control to ensure that it was a legitimate expense of the company.

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(Hearing Transcript, November 25, 2014 at 126:25-127:14)

[164]Horsley revised the March 15 Report prepared by Mr. Maradin to include the statement “the ultimate and compensating control is the CEO’s signature on the final transaction be it purchase or sale of standing timber, transfer of funds or payment for goods/services”. As noted previously, Chan signed only the sales contracts but pre-approved all purchases and sales.

E.Testimony of Judson Martin

[165]Mr. Martin testified his initial impression of Chan’s role within Sino-Forest was that he was a statesman, strategic planner, visionary, driver and entrepreneur.

Martin also testified Chan’s practical contribution to Sino -Forest was his intelligence, experience, and great relationships and connections in China.

[166]Mr. Martin testified Chan’s role with respect to the implementation of disclosure requirements under NI 52-109 was to provide the tone at the top. He further testified Chan was a very strong and respected leader who had very close relationships with the people who reported to him. Mr. Martin testified as a member of the Board, he placed a deep reliance on senior management, including the CEO, and would have a high degree of trust in, and respect for, senior management. Martin further testified without this trust, either he would not be on the board, or the person in the role of CEO would not be CEO.

F.Testimony of Fred Clifford

[167]Mr. Clifford testified that close to the end of the audit cycle, in March 2011, he met with Chan to ask how Chan got comfortable with the fraud risk at Sino- Forest. An internal E&Y memo prepared by Clifford in March 2011 described how Sino-Forest addressed its fraud risk. Chan indicated to Mr. Clifford that, in managing fraud risk, he was seeing all the contracts (both purchase and sale), signing off on all contracts, deciding which entity would acquire the standing timber, signing cheques, and seeing transaction by transaction. The internal E&Y memo notes “Allen [Chan] is very involved in the day to day operatio ns. He reviews cheques and key transactions as they occur. He also has an intimate knowledge of the business and would be able to spot anomalies as they occur”. Mr. Clifford testified Chan had “a great degree of visibility around what the company was doing at any moment in time”, and Chan took “great comfort from the fact that he was seeing these transactions one by one and could spot something that was an anomaly” (Hearing Transcript, November 17, 2014 at

61:1-5).

[168]Mr. Clifford also testified Chan talked about Albert Zhao, who was responsible for operations in the Sino-Wood group of companies and was responsible for BVI standing timber sales, and Albert Ip who was responsible for operations in the Sino-Panel Group and BVI standing timber purchases, and that Chan would play them off against each other:

He also talked about the two Alberts, being Albert Zhao and Albert Ip, running two large, you know, pieces of the business, and he would, I think, for lack of a better word, perhaps play them off against each other and compare and contrast what was happening between those two senior

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executives to see if there was something that, quite frankly, looked odd to him, that stood out as being an anomaly. He thought that, by doing that, he would identify areas where things were happening that could be fraudulent.

(Hearing Transcript, November 17, 2014 at 58:22-59:6)

Mr. Clifford explained further, “He just was very comfortable that by comparing and contrasting those two operations, he could see anomalies and those anomalies he would follow up on.” (Hearing Transcript, November 17, 2014 at 59:11-14).

[169]Mr. Clifford testified Chan was the common denominator in all purchase and sales transactions - he was in the middle. E&Y was well aware of how involved Chan was in the day-to-day operations of Sino-Forest.

[170]Mr. Clifford also testified that Chan represented to E&Y he had extensive relationships at the local and central government levels and in the business community. Chan took great comfort that if something was happening within Sino-Forest of which he was unaware, someone from outside the organization would inform him.

[171]Mr. Clifford also testified Chan was resistant to E&Y’s solution regarding the on - shoring project (moving assets from the BVI Model to the WFOE Model to address problems associated with a substantial and growing tax liability). Mr. Clifford testified one suggestion from E&Y was for Chan to seek a settlement with the tax authorities and crystallize the potential tax liability Sino -Forest was exposed to as a result of transacting through the BVI Model (which, by 2010, was US $156.9 million). However, Chan rejected that approach and Clifford was unaware of any efforts by Sino-Forest to approach tax authorities.

[172]In a separate proceeding, E&Y settled allegations brought by Staff regarding the audits of Sino-Forest without admitting or denying the facts or conclusions of Staff.

G.Testimony of Dr. Randall Peerenboom

[173]Chan called Dr. Randall Peerenboom as an expert witness in Chinese law and cultural and business practices in China within a comparative and global context.

[174]On March 31, 2015, Dr. Peerenboom was asked:

Q.And just talking for a minute about Mr. Chan, I want to ask you about the role of CEO and senior management in a Chinese company. So in your experience, how would you characterize the relationship between the CEO and their senior management in the company with operations in China?

A.Well, in Chinese companies it's definitely the case that the CEO is the boss, the big boss. And so if they're at a negotiation, for example, maybe the senior management would be discussing a lot of the detailed issues, but when it came time to the final decision-making to decide what to do with the basket of issues that's always left over at the end of

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a negotiation, that would be when the CEO or the boss steps in and decides those issues.

In terms of the operational issues, it varies to some extent, depending upon whether the manager is a more hands-on or hands-off manager, but it certainly would be the case that the underlings would only operate within the parameters set by the boss. They would know that they're not authorized to directly violate the parameters set by the boss.

(Hearing Transcript, March 31, 2015 at 151:6-25, 152:1-2)

[175]Dr. Peerenboom also testified on the significance of relationships with government in doing business in China. Dr. Peerenboom testified Chan’s participation with the Chinese National Forestry Industry Federation would be of benefit to Sino-Forest. He explained associations like this are private or semi- private business associations often with close relationships or ties to the government.

H.Evidence of Ip and Hung

[176]Both Ip and Hung testified Chan was closely involved in the review and approval of each purchase and sale of standing timber by Sino-Forest. They reported directly to Chan.

[177]Ip and Hung testified about Chan’s role as “ultimate and compensating control” as described in the March 15 Report. Ip agreed Chan carefully reviewed every purchase and sale of standing timber and any transfer of funds or payments for goods and services brought to him. Hung testified Chan signed every BVI standing timber sales contract and pre-approved every purchase of standing timber in the BVI Model.

[178]Hung testified he never had any signing authority and that even instructions to a bank, including transfers, required the signature of Chan and one of K.K. Poon, Ip, Albert Zhao or Chen Hua (responsible for finance at Sino -Wood). Hung also testified Chan knew he was directing AIs to pay sizeable amounts of renminbi to suppliers without a written purchase contract between the supplier and Sino - Forest.

[179]Ip testified Chan told him the locations of the forest purchases should be kept secret. As a result, purchase contracts were vaguely worded and did not indicate specific plantation locations. Ip testified the descriptions of locations were general in order to keep them a secret from Sino-Forest employees, competitors, and suppliers. Ip also testified Chan would determine which of 28 Sino -Forest subsidiaries was going to purchase the standing timber in the BVI Model.

[180]Ip testified he attended weekly Monday morning senior management meetings led by Chan (Monday Morning Meetings). Ip agreed it was a constant that Chan was always at the Monday Morning Meetings, which also included Xu Ni (Sino-Forest’s Vice-President of Legal Affairs), and sometimes Ho and Alvin Lim (Sino-Forest’s Financial Controller). Monday Morning Meetings were mainly to discuss Sino-Forest’s strategy and development, and to update Chan and t he team on the progress of operations. Hung did not regularly attend these

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meetings but would attend when requested and would be at meetings when quarterly budgets were discussed. The Monday Morning Meetings were held in Hong Kong or Guangzhou throughout the Material Time and were conducted in Cantonese. Horsley and Maradin did not attend. Chan was provided with oral updates that included detailed information about the progress of Sino -Forest’s forestry business in China.

[181]Ip confirmed there was no documentation or written records of the Monday Morning Meetings. Ip testified the purpose was to update on the work done the previous week and discuss Sino-Forest’s development plan and plan for the forthcoming weeks. Ip testified Chan had a macro view of things, was focused on the rate of return, market prices, profits and losses. Ip and others were focused on whether the trees were available and easy to harvest. Ip agreed Chan was the ultimate decision-maker with respect to the entire business of Sino-Forest. Ip testified in the BVI Model Chan would approve a quarterly budget for the purchase of timber, pre-approve the purchases, sign sales contracts and approve every plantation purchase acquisition form.

[182]Ip confirmed Chan would review the profit margin to make a final decision on the sales transaction. Ip testified Chan was the last person to sign each sales contract. Ip confirmed Chan signed the approval for the purchases which preceded the actual purchase contract.

[183]Ip testified he had signing authority under HK $1,000,000 and went to Chan for approval of larger expenditures. Hung stated he never had any signing authority and even instructions to a bank required a signature from Chan and one of four other senior employees, which included Ip.

[184]Hung testified he determined the sales budget by reviewing a spreadsheet of BVI standing timber holdings which he maintained. This spreadsheet included information about the area, volume, location, purchase price and year of planting. Hung testified he would discuss plantations with Chan and Albert Zhao, and Chan would tell Hung what the expected revenue would be.

[185]Hung agreed Chan would know about any changes to purchase contracts because in order to make the purchase, Hung would need to obtain a new purchase requisition form which required Chan’s approval.

[186]Hung also testified the concept of Master Framework Agreement (MFA) came from Chan and Chan explained the concept as locking in a supplier who would either provide standing timber directly or get other suppliers to sell Sino-Forest the standing timber.

[187]Hung confirmed, before a BVI sales contract was sent to a customer for signature, he would forward the contract to Albert Zhao for review and would also obtain an oral approval from Chan on each sales transaction. Hung confirmed Chan was the last person to sign every sales contract.

I.Conclusion

[188]Chan’s written submissions open with four statements:

1.Mr. Chan’s conduct must be assessed by reference to a reasonably competent Chief Executive Officer acting in similar circumstances at the time. His conduct cannot be measured to a standard of perfection.

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[189]We agree Chan’s conduct cannot be measured to a standard of perfection. As will be made clear in these Reasons, Chan’s conduct does not meet the standard of a reasonably competent Chief Executive Officer acting in similar circumstances at the time. Notwithstanding the board of directors, Chan was the driver steering Sino-Forest’s business.

2.As Chief Executive Officer of Sino-Forest, it was not Mr. Chan’s job to be in the business so much as it was to be working on the business: its purpose, its direction, its strategy and its goals.

[190]We disagree. We find Chan was in the business. In addition to deciding its purpose, its direction, its strategy and its goals, he was also deeply involved in the day-to-day operations of Sino-Forest.

3.His conduct must be considered in the unique circumstances of this case. Sino-Forest business operations were located in mainland China which is a significantly different business and cultural environment than Ontario. Because Sino-Forest was engaged in the resource sector, it was particularly difficult, if not impossible, for it to divorce itself from this environment and simply impose North American business standards.

[191]We disagree. No matter what business Sino-Forest was engaged in, it was

Chan’s responsibility to ensure that Sino-Forest complied with Province of Ontario securities legislation as set out in the Ontario Securities Act.

4.Mr. Chan was born, raised and educated in Hong Kong. He had no prior financial, accounting, risk, capital markets/M&A or public company/corporate governance education, skills, or experience. He surrounded himself with North American experts to ensure that the public disclosure complied with Ontario securities law. He reported to a highly qualified board of directors who were experts in North American public company governance requirements. The Sino-Forest Board of Directors had a very experienced Lead Director who acted as the liaison between Mr. Chan and the rest of management and the Board. There is no evidence that the Board was unhappy with Mr. Chan’s performance.

[192]We agree there is no evidence the Board was unhappy with Chan’s performance prior to June 2, 2011. Mr. Ardell, Lead Director and Chair of the Independent Committee, testified his belief in Allen Chan changed as events unfolded following the Muddy Waters Report.

[193]Chan’s role in the alleged frauds is discussed in more detail elsewhere in these

Reasons.

VI. ANALYSIS OF THE STANDING TIMBER FRAUD ALLEGATIONS

A.The Standing Timber Fraud Allegations

[194]In the Standing Timber Fraud Allegations, Staff alleges the Respondents engaged in deceitful and dishonest courses of conduct that resulted in the fraudulent

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overstatement of assets and revenue derived from the purchase and sale of standing timber, putting the pecuniary interests of Investors at risk contrary to Ontario securities law and contrary to the public interest. Staff alleges three elements of the standing timber fraud, each of which Staff alleges cons titute fraud:

a.undisclosed control of companies purportedly at arm’s length to Sino - Forest;

b.a deceitful documentation process; and

c.internal control weaknesses or failures.

Staff cites four examples of alleged fraud: (i) the Dacheng Transactions; (ii) the 450 Transactions; (iii) the Gengma #1 Transactions; and (iv) the Gengma #2 Transactions.

[195]Staff alleges differing involvement by the Respondents in each of the three elements of the standing timber fraud and the four fraud examples. We review the three elements and four alleged fraud examples, in turn, and consider the

Respondents’ individual involvement in each.

[196]Staff asks us to find each of the Respondents breached subsection 126.1(b) of the Securities Act as a result of their involvement in the Standing Timber Fraud Allegations, and that Chan, Ip, Hung, Ho and Yeung, in any case, authorized, permitted or acquiesced in Sino-Forest’s breach of subsection 126.1(b) of the Securities Act.

B.Undisclosed Control Allegations

1.Positions of the Parties

(a)Staff

[197]The first of the three alleged elements of what Staff has termed the Standing Timber Fraud is Sino-Forest’s undisclosed control of purportedly unrelated companies.

[198]Staff alleges Sino-Forest established a network of counterparties (suppliers and AIs, or customers) that were controlled on its behalf by various nominees. If true, this control or influence would call into question whether the transactions with these suppliers and AIs were carried out at arm’s length and therefore recorded at fair value and, more basically, if the transactions actually occurred. The result of this would be that Investors could not rely on the revenue and assets reported on the financial statements because the true economic substance of the underlying transactions recorded with these companies would be misstated and the disclosure would be misleading.

[199]Staff submits Sino-Forest’s control of, or influence over, certain parties was not disclosed to Investors. Staff alleges Sino-Forest established a network of nominee and peripheral companies involved in buying and selling standing timber in the BVI Model.

[200]Staff specifically submits Sino-Forest had undisclosed control over:

Huaihua City Yuda Wood Co., Ltd. (Yuda Wood);

Guangxi Hezhou City Kun’an Forestry Co., Ltd. (Kun’an);

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Guangxi Rongshui Taiyuan Wood Co. (Taiyuan);

Dongkou Shuanglian Wood Co., Ltd. (Dongkou); and

Dao County Juncheng Forestry Development Co., Ltd. (Juncheng).

[201]Staff submits the following were related parties:

Yunnan Shun’xuan Forestry Co., Ltd. (Shun’xuan);

Guangxi Dacheng Timber Co., Ltd. (Dacheng);

Guangxi Hezhou City Yuangao Forestry Development Co., Ltd. (Yuangao); and

Guangxi Rongshui Meishan Wood Products Factory (Meishan).8

[202]Staff refers to these and other companies that were counterparties to transactions carried out using Sino-Forest’s BVI Model as the BVI Network. Some of the companies in the “BVI Network” were suppliers or customers in the WFOE Model. Some of these companies are involved in the four examples of allegedly fraudulent transactions: the Dacheng Transactions, the 450 Transactions, the Gengma #1 Transactions and the Gengma #2 Transactions (discussed below).

[203]In particular, Staff alleges Sino-Forest dishonestly failed to disclose the true nature of its relationship with two key companies in the BVI Network, Yuda Wood and Dongkou.

[204]A central player, whose involvement in many of these companies is interwoven, is Huang Ran, who will be discussed below.

(b)Respondents

[205]The Respondents submit Staff has failed to provide evidence to explain why the concept of control or influence over customers or suppliers matters. They submit the issue with respect to the BVI Network of companies is not control, but value: if Sino-Forest were transacting with parties it controlled, this would raise questions about whether its purchases and sales were recorded at fair market value.

[206]The Respondents submit, while Staff did not introduce any expert valuation evidence, Staff is instead asking the Panel to draw adverse inferences of control and value based on circumstantial evidence that is quite remote from any concept of valuation.

[207]The Respondents submit E&Y, which reviewed every contract in the BVI Model, in its audits never raised any concerns about the volume of purchases from a particular supplier, or its economic dependence on Sino-Forest. In addition, they note the Independent Committee made no conclusions that Sino -Forest controlled Yuda Wood, or any other company that is the subject of these allegations, but noted the Independent Committee was unable to “independently

8These companies and others involved in this matter were Chinese companies that do not have official English company names. Different English translations have been provided for a number of these companies. For instance, the words “timber,” “forestry,” and “wood” have variously been provided as translations for the same Chinese character, and translations variously omit or include location information in the title of a company name such as the city, county or province in which it is located.

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verify” that Sino-Forest’s relationship with Yuda Wood was at arm’s length, without articulating what sort of independent verification was required.

[208]The Respondents contend the record supports the proposition that contracts of purchase and sale were conducted at fair value and that Sino -Forest did not exercise control over Yuda Wood or other suppliers.

[209]The Respondents stress “context is king” and submit the effect of Sino-Forest’s cooperation with its suppliers should be assessed within the context of Chinese business practices, rather than North American practices. Further, the Respondents contest certain literal translations of Chinese idiomatic expressions (notably, wai wei gong si, variously translated as “peripheral”, “cooperative”, “outside” or “external” companies) that Staff is asking the Panel to accept. The Respondents submit those translations provide no insight into the actual meaning of the words or expressions.

[210]Chan further submits there is no evidence he had any knowledge of these companies’ alleged control by, or relation to, Sino-Forest.

2.Differences in Translation of Various Terms

[211]There has been much debate between Staff and the Respondents whether certain Chinese terms have been translated accurately. Many of the documents in evidence in this hearing were originally drafted in Chinese and have been translated into English. The Respondents and Staff have offered various versions of, and expert evidence on, translations of terms. The fact that literal translation versus idiomatic translation from the original Chinese may result in different interpretations adds to the complexity of understanding the evidence in this case.

[212]For example, the Respondents submit the Chinese characters romanized as guanli ren, translated in some documentary evidence as “manager,” do not refer to someone acting as a business manager, within the common North American meaning of the term. Rather, they submit the more appropriate translation would be someone who takes care of something, as an intermediary or problem solver. They submit another Chinese term would have been used to indicate someone holding the kind of management function of an executive within a company.

[213]Another term, translated as “follower”, was also used on company tables that included references to Huang Ran, Li Hua and Gao Fajun (all of whom are involved in companies named in the allegations of undisclosed control). The Respondents submit a contextual interpretation indicates these people were being referred to as intermediaries.

[214]One frequently contested translation was that of the Chinese characters romanized as wai wei gong si. Staff submits the translation of this term as

“peripheral company” provided in evidence is correct. The Respondents refer to the evidence of Dr. Robin Huang who was qualified to provide expert evidence in the four Chinese characters romanized as wai wei gong si. He agreed that the four Chinese characters could be translated as “peripheral companies” but stated that this term did not convey in English the Chinese meaning. Instead, Dr. Huang stated the term referred to an important business partner in a group of corporate entities, one that is arm’s length to other corporate entities in that group. In cross-examination, Dr. Huang agreed with Staff that in order to

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determine the full flavour of the term wai wei gong si, you would need to look at the context in which it is used, and different people might have different views on the meaning of wai wei gong si, depending on the context. The Respondents submit, although “peripheral company” may be a literal translation of the characters, the more appropriate translation, which was provided in at least one instance by a third party translation service, is “outside company”, a reference to companies independent of Sino-Forest, but with which it did business on a regular basis.

[215]The Respondents submit “cooperative companies” refers not to collusion but, as Ho described in his affidavit, to those companies with which Sino-Forest did business and entered into transactions. Ho was referring to a document

(originally in Chinese) entitled “List of Funds that Co -operative Companies Received from Sino and that are not Easy to Explain”. He stated that “not easy to explain” referred to those transactions that are likely to attract closer attention from the Chinese regulatory organization SAFE. Included in this document were transactions between Sino-Forest subsidiaries and the following companies:

Kun’an (which the Panel finds below was related to Sino-Forest),

Taiyuan (which the Panel finds was controlled by Sino-Forest),

Meishan (which the Panel finds was related to Sino-Forest),

Yuangao (which the Panel finds was related to Sino-Forest), and

Yongzhou City Maoxiang Forestry Development Co. Ltd. (which played a prominent role in the alleged fraud relating to the 450 Transactions).

Moreover, there was one entry in this document referring to a transfer of funds between Taiyuan and Kun’an, and another entry between Kun’an and Guangxi Chihui Forestry Co., Ltd. Guangxi Chihui Forestry Co. Ltd. was 80% owned by Huang Ran, who the Panel finds below was Sino-Forest’s nominee in order to control and influence other companies . These three companies were purportedly third party, arm’s length suppliers independent of Sino -Forest, according to the Respondents, but details of transactions between them are found on an internal Sino-Forest document.

[216]Given the extensive connections between these companies and Sino -Forest, as described in greater detail below, we do not accept Ho’s explanation that these are companies with which Sino-Forest simply did business and entered into transactions. Having considered the context in which the term “co-operative” is used, the Panel accepts Staff’s submission that the term “co -operative companies” refers to companies that are either acting as nominees for Sino - Forest or working in collusion with them.

[217]We agree with the Respondents that when dealing with the fundamental issue of control, it is tenuous to rely on translations that may have several different meanings, such as manager, follower or co-operative. We have relied on extensive evidence and testimony on which to base our findings. Rather than interpreting a word in isolation, we adopt the approach that “context is key”. The meaning of a term is best understood by looking at the context in which it is used.

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[218]We had multiple versions of emails in email chains in evidence where the translations of specific words or phrases differed. However, the meaning of the message in the various English versions of the document was consistent. We generally have confidence in the quality of translations, despite the few disputes raised by the parties. There were over 900 exhibits in evidence that were originally in Chinese. These documents varied in length, but many were multiple pages.

[219]In conclusion, the Panel has not interpreted single words in isolation during the hearing, nor in our decision. We have looked at the context and at the numerous examples when each term is used in various emails in order to draw any conclusion as to the appropriate translation in the circumstances.

3.Independent Committee Investigation into Suppliers and AIs

[220]The Independent Committee advisors visited AIs and suppliers in order to confirm transactions, access source documents to link AI recorded payments to suppliers to Sino-Forest recorded revenue, and to confirm actual cash flows from AIs with suppliers to corroborate the set-off process (i.e. Sino-Forest’s system of setting-off accounts payable with accounts receivable, described elsewhere in these Reasons). The advisors wanted to obtain independent third party verification of ownership and transactions. As with the Forestry Bureau visits, these interviews were arranged and attended by management.

[221]Mr. Hyde testified the results of the interviews with AIs and suppliers were described as “mediocre at best” (Hearing Transcript, November 6, 2014 at 77:5). It had been very difficult to obtain interviews; management took more than two months to disclose basic details, did not provide complete names of contacts required for comprehensive analysis, or did not provide Chinese names. Because of cultural differences, it was very difficult to get past the “pleasantries and tea”

(Hearing Transcript, November 6, 2014 at 77). The advisors had difficulty getting a complete list of AIs, suppliers and their contact information from management, specifically Ip. The advisors requested documentation from management, the AIs and the suppliers that would support the transactions that Sino -Forest had reported, which they did not receive.

[222]In the Second IC Report, the Independent Committee stated management also did not disclose all the relationships between Sino-Forest and suppliers and AIs, nor between Sino-Forest employees and suppliers and AIs, nor among the suppliers and AIs. Many suppliers alluded to the use of nominees; as such, the true beneficial ownership of suppliers may not have been disclosed in corporate filings. The advisors selected nine suppliers to interview; four were interviewed. When interviews took place with the principal of Sino-Forest’s largest supplier during the Material Time, Yuda Wood, the advisors were told by management and Sino-Forest’s Canadian counsel not to take any notes or ask any questions as a condition of participation.

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4.Sino-Forest’s Relationships with Companies in the BVI Network

(a)Did Sino-Forest have Undisclosed Control Over Companies in the BVI Network?

i.Yuda Wood

[223]Yuda Wood was the largest supplier to Sino-Forest’s BVIs from 2007 to 2010, with total transaction value of RMB 4,561,599,313 (US $657,789,586), or more than 20% of total BVI transaction value during that period.

Creation of Yuda Wood

[224]Yuda Wood was 100% owned by Hong Kong Sonic Jita (HK Sonic Jita). HK Sonic Jita was incorporated on July 15, 1993 as Combine (Far East) Limited, and changed its name to Sonic Jita Engineering on August 1, 1997. From July 15, 1993 to March 10, 1997, ADS Capital Limited Corp., Kai Kit (K.K.) Poon, and Danny Wu Wai Leung each owned one-third of Combine (Far East) Limited. ADS Capital Limited Corp. was a company owned by Chan, a company owned by

Chan’s mother and another company owned by Chan’s best friend, Alex Chau Chi Piu. Chan was a director of HK Sonic Jita (named at this time Combine (Far East) Limited) and CEO of Sino-Forest during this time. Both Chan and K.K. Poon were co-founders of Sino-Forest in 1992 and directors since 1994. K.K. Poon was also President of Sino-Forest until after the release of the Muddy Waters Report .

[225]From March 10, 1997 to July 28, 1998, Sino-Wood Partners Limited, a Hong Kong subsidiary of Sino-Forest, owned 99.99% of companies eventually renamed HK Sonic Jita. On July 28, 1998, the renamed HK Sonic Jita was sold to Jin Juemin (51%) and Li Haibao (49%). Ownership changed frequently between July 1998 and June 2011. Each of Li Haibao, Huang Ran, Zhan Xiaokun and Chen Jun was a shareholder of HK Sonic Jita during this period and was a Sino-Forest employee during periods that were adjacent to, or overlapped with, the periods they were shareholders of HK Sonic Jita. During the Material Time, Huang Ran was a director and 50% shareholder of HK Sonic Jita prior to August 2011, at which time he became a 100% shareholder.

[226]A 15-page loose document found on the computer of Chan’s Executive Assistant

lists corporate information for over 40 Sino-Forest BVI, Canadian and Hong Kong subsidiary companies, and includes information on HK Sonic Jita9 . Under the names of each of the two listed shareholders of HK Sonic Jita and its predecessors is a note that states, “Held on behalf of the Company w/Declaration of Trust”. All other companies listed in this document were Sino-Forest subsidiaries. Additional lists in the document identify the registered office and which corporate seals or chops each subsidiary has. Similar information is included for HK Sonic Jita. For HK Sonic Jita, the authorized signature, a chop and the minute book are checked off in similar fashion to the directly owned Sino-Forest subsidiaries.

[227]Sino-Forest employees, including Yeung and Ip, were also involved in the business operations of HK Sonic Jita. Examples include retaining a corporate chop and minute book belonging to HK Sonic Jita, handling corporate secretarial matters for the company, and arranging and holding signed cheques from HK

9We note this document was last modified in 2002 when Yosanda Chiang was working at Sino-Forest for Chan’s then-wife.

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Sonic Jita. Ms. Shao, Staff investigator, explained that corporate “chops” are seals used in China. One company may have various chops for different approvals – for instance, a general company chop, a legal representative chop, a finance department chop and a contract chop. The invoice for the corporate secretarial services for HK Sonic Jita was sent to Ip by a Sino-Forest employee who asked “Can I use your cheque to settle this bill?”

[228]Ip, Senior Vice-President of Sino-Forest, was overseeing the changing shareholder structure at HK Sonic Jita. Emails in evidence show that Ip instructed who should be made a shareholder and that he was provided with updates as corporate changes were made.

[229]The Respondents gave explanations why HK Sonic Jita shareholders were also employees of Sino-Forest. These explanations included:

differing names for Beijing and Hong Kong companies, both called Sonic Jita: Yeung and Ip gave evidence that the individuals were employees of Beijing Sonic Jita, a separate company from HK Sonic Jita that did contract work for Sino-Forest;

foreign exchange restrictions: Yeung gave evidence that paying Sonic Jita was slow and cumbersome because of the difficulties caused by China’s foreign exchange regulations and system of fapiao. Since it was much easier and faster to get SAFE approval for regular payments like rent and payroll than for engineering or construction services, the Beijing Sonic Jita employees were put on Sino-Forest’s payroll; and

lack of capital at Sino-Panel: Ip testified that Sino-Panel did not have enough capital to pay Beijing Sonic Jita for work that it was doing on Sino- Forest projects, so Sino-Panel paid the salaries of Beijing Sonic Jita’s employees in order to keep the work going.

[230]These explanations do not help the Panel.

[231]Yeung’s evidence is that in February 2006, Sino-Forest originally planned to create a subsidiary in Hunan Province called Hongjiang City Yuda Wood Company Ltd., but instead named this subsidiary Hunan Jiayu Wood Products Co., Ltd. (Jiayu Wood). Yuda Wood, which was incorporated at the same time, had its registered office in the same city – Hongjiang City – as Jiayu Wood and Sino- Forest’s employees assisted with its incorporation.

[232]An indication of Sino-Forest’s control over Yuda Wood was the participation of Sino-Forest’s employees in Yuda Wood’s purchase of a plastic products factory in Hunan Province in March 2006 (the Ansu Factory). Sino-Forest employees prepared, drafted and signed the Ansu Factory purchase agreement on behalf of Yuda Wood without including Huang Ran, the legal representative of Yuda Wood at that time, on any of the communications. The draft purchase documents were emailed to Ip on March 21, 2006 to review and finalize. Yeung signed the final agreement on March 29, 2006 in the name of Yuda Wood, prior to Yuda Wood’s incorporation. Yeung stated when he signed the agreement, he was confused about whether it was in fact a Sino-Forest subsidiary, or an outside company. Yeung testified his confusion arose because the names of Yuda Wood and the subsidiary that Sino-Forest did, in the end, incorporate (Jiayu Wood) both have two Chinese characters and share one character in common, “yu”.

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[233]Sino-Forest indirectly paid for the Ansu Factory. A third company that Sino- Forest was interested in purchasing at the time, Hongjiang City Hecheng Forestry Development Co. Ltd., used funds Sino-Forest had loaned it to make the initial acquisition payment on behalf of Yuda Wood. Ip testified Chan approved this advance to Hecheng.

[234]The Respondents submit Sino-Forest considered purchasing this factory, but offered the opportunity to Huang Ran when internal approvals were delayed. They submit Sino-Forest personnel told Huang Ran that, subject to Sino-Forest obtaining these approvals, Sino-Forest would purchase the factory from Huang Ran. The Respondents’ position is not supported by the evidence, which demonstrates that Sino-Forest acquired the Ansu Factory in Yuda Wood’s name.

[235]Yeung stated that within a few days of signing the Ansu Factory purchase agreement on March 29, 2006, he became certain that Yuda Wood was not going to be a Sino-Forest company. He signed the agreement on behalf of Yuda Wood after receiving permission from his manager and notifying Ip. Yeung did not remember if Huang Ran knew of the transaction.

[236]It is not disputed that Huang Ran requested Yeung’s help in registering Yuda Wood. Subsequently, a Sino-Forest employee registered Yuda Wood as a corporation, under Yeung’s direction. This same Sino-Forest employee is listed as a contact person with SAFE on an approval form for opening a foreign capital account for Yuda Wood.

[237]Yeung testified that, at the time of Yuda Wood’s incorporation, he was doing a lot of work, was not feeling well psychologically and was working at a location far away from the city. This location was known as the “ghost” or “haunted house”, a location shared by Yuda Wood and Sino-Forest employees. At the time Yeung was living at the “ghost house” between March and July 2006, Yuda Wood and

Sino-Forest shared one phone line and one fax line.

[238]We find Yuda Wood was capitalized by Sino-Forest with US $1.05 million. In an April 2006 email to Ip, Yeung stated in English: “Hunan Yuda registration completed. We could remit max USD 1.05M to its A/C” and attached the following business documents for Yuda Wood: business license, registration information, SAFE document approving the opening of a US dollar account and a bank signature card, with Huang Ran as signatory. Attached to another email sent to Sino-Forest employees in June 2006 was the site office telephone list for a Sino-Forest subsidiary, Guangdong Jiayao Wood Products Development Co., Ltd. Included in the list of contacts for employees are Ip, Yeung, other Sino- Forest employees involved in the incorporation of Yuda Wood and Huang Ran.

[239]The Respondents provide explanations for the involvement of Sino -Forest employees in Yuda Wood’s business, which include Yeung’s lack of English proficiency and confusion about the same character appearing in both names, Jiayu Wood and Yuda Wood. Nevertheless, the Panel finds it difficult to believe Huang Ran, whose base salary with the Sino-Forest subsidiary Heilongjiang Jiamu Panel Co., Ltd. was RMB 5,200 per month at this time, would have over US $1,000,000 with which to capitalize Yuda Wood. We find Sino-Forest capitalized Yuda Wood.

[240]Yeung stated in his affidavit that at the precise moment he sent Ip the email

“Hunan Yuda registration was completed. We could remit max USD 1.05M to its

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A/C”, he must have been confused and either thought Yuda Wood was going to be a Sino-Forest company or he momentarily confused Yuda Wood and Jiayu Wood with each other. However, four days prior to sending this April 22, 2006 email to Ip, he had sent Ip and Hung a similar email stating “Our ‘Hunan Jiayu’ has registered already…Please arrange max USD2.1M for capital audit.” He also attached the business license and bank account scanned pictures for reference. Both this email and the April 22, 2006 email were sent in English; the former was sent to both Hung and Ip while the latter was sent only to Ip. We find Yeung knew he was dealing with two different companies when he sent the emails regarding the capitalization of Jiayu Wood and Yuda Wood.

[241]We find Yeung’s explanation in his affidavit and testimony not credible. First , he stated in his affidavit that approximately three weeks earlier, he became certain Yuda Wood was not going to be a Sino-Forest company so it is difficult to accept his explanation that he was confused. Second, the fact that he sent two emails only four days apart, with very similar wording which he chose to send in English, not Chinese, also makes it difficult to believe he could have been confused, particularly when dealing with such large sums of money. His previous explanation that there is a character in common in Chinese between Yuda and Jiayu does not explain his confusion in two emails sent in English. We find Yuda Wood was capitalized by Sino-Forest.

Sino-Forest’s Control over Yuda Wood’s Bank Accounts

[242]Sino-Forest controlled two bank accounts in Yuda Wood’s name, which were opened in Guangzhou, and monitored other Yuda Wood bank accounts. Online transfers out of the Guangzhou bank accounts required approval from Sino- Forest employees. During the Material Time, Sino-Forest paid over RMB 347 million into Yuda Wood’s Guangzhou accounts, 67% of the total cash Sino -Forest paid directly to Yuda Wood during this period.

[243]Huang Ran stated in his 2011 interview during the Independent Committee investigation that Ho controlled one of Yuda Wood’s bank accounts.

[244]Between November 2008 and October 2010, Yuda Wood made six payments to Gengma Dai and Wa Tribe Autonomous County Forestry Co., Ltd. (Gengma Dai), another supplier, totaling RMB 30.3 million from these Guangzhou accounts. Ip and Ho approved these payments and Sino -Forest employees were directly involved in coordinating these payments. While the question of whether or not these are bona fide transactions between two suppliers will be dealt with in our analysis of the Gengma #1 Transactions below, the fact remains that Sino-Forest would not be involved whatsoever in these Guangzhou accounts of Yuda Wood or payments by Yuda Wood if Yuda Wood was indeed independent of Sino-Forest.

[245]The Respondents maintain Sino-Forest was only monitoring Yuda Wood’s bank account to have leverage over Yuda Wood to support Sino -Forest in case, as Ho stated in his affidavit, “a supplier failed to deliver on our expectation to resolve problems”. If this happened, “Sino-Panel could exercise leverage by limiting the supplier’s ability to make further payments from the bank account we monitored”.

[246]The first attempt to explain the monitoring of accounts as a way to exert influence over suppliers was an email sent in connection with SAFE’s

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investigation of Sino-Forest subsidiaries in 2011, giving weight to Staff’s contention that this explanation was simply devised for SAFE’s benefit. Ho explained suppliers resolved problems that might arise after a purchase had been completed and provided examples of problems such as farmers asking for more money and farmers not allowing operations teams to enter the forests. In his affidavit, Mr. Ho states “I suggested we get some leverage over suppliers by monitoring supplier bank accounts”. He discussed this concept with Chan, who agreed. Ho did not recall if this concept was his idea alone or if it arose in discussions with Chan. In addition to Sino-Forest’s monitoring of Yuda Wood’s bank accounts, in Ho’s cross-examination, we heard one Taiyuan bank account and another bank account of a different company were already monitored by Ip prior to Ho’s arrival at Sino-Forest, although “there was not much money that went through these bank accounts”. Huang Ran was also involved with both these companies and the Panel finds Sino-Forest controlled Taiyuan (as discussed below). Ho arranged for another bank account of a separate company to be monitored, however Sino-Forest never did any business with this company in the end.

[247]Ultimately, only the two Guangzhou Yuda Wood bank accounts were truly “monitored” although the Panel finds the role played by Sino-Forest was more than simply monitoring but actually controlling the cash flows out of these accounts. Sino-Forest held a USB key that was required for transfers out of these accounts. Ho had the password for this USB key; Huang Ran and other Yuda Wood employees did not.

[248]Ho’s testimony is inconsistent: unlike what he said in his affidavit, he was not the prime mover behind the concept of monitoring supplier bank accounts – this was going on before he joined Sino-Forest. Other than the accounts previously referred to, we saw no evidence of Sino-Forest’s control of bank accounts of other suppliers, despite the fact that Sino-Forest transacted with at least 18 suppliers in the BVI Model. It is difficult to believe only Yuda Wood permitted this monitoring to occur, as the Respondents submit.

[249]Therefore, we find it more likely than not that the monitoring explanation was concocted for the SAFE investigation in 2011. Moreover, Ho’s explanation that

Sino-Forest could exert leverage over Huang Ran to resolve problems is inconsistent. Huang Ran only dealt with aggregators, not farmers, so he could not help resolve these types of problems. As well, Sino -Forest rarely logged timber but simply resold forests, so they likely would not encounter many operational problems and thus would not need this type of leverage. In one example where the Respondents submit Yuda Wood was positioned in a transaction to act as an intermediary, Sino-Forest engaged directly with the supplier in dispute resolution, as discussed in our analysis of the Gengma #1 Transactions below.

[250]The Respondents provide great detail in their submissions and called extensive expert evidence regarding “guanxi”, the business culture in Mainland China and the culture of close cooperation among Chinese companies. Guanxi is discussed more extensively in paragraphs [347] to [350]; briefly however, it relates to trust, communication and loyalty in all aspects of Chinese life. The requirement to monitor a supplier’s bank accounts and the necessity to have leverage to enforce expectations appear to the Panel to be inconsistent with the concept of

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guanxi, a concept the Respondents rely on to explain Sino-Forest’s relationships with Yuda Wood and other companies.

[251]The issue of guanxi is not relevant as we have found this monitoring/leverage explanation was only concocted for the SAFE investigation in 2011. The control over Yuda Wood’s bank accounts was just one aspect of Sino-Forest’s control over Yuda Wood. Furthermore, Sino-Forest would be a very significant and highly valued customer of Yuda Wood. Yuda Wood transacted RMB 4.56 billion with Sino-Forest between 2007 and 2010, and Sino-Forest represented at least 40% of Yuda Wood’s business. The mere threat that Sino-Forest would stop doing business with Yuda Wood would have been enough to ensure Yuda Wood would follow through on Sino-Forest’s expectations. As such, the Respondents’ explanation for monitoring, which we find was actually control over, Yuda Wood’s bank account, is not accepted.

Sino-Forest’s Ongoing Control of Yuda Wood

[252]Sino-Forest had access to Yuda Wood’s business records, including its tax obligations and accounting records with the cost basis of assets sold to Sino - Forest. If Yuda Wood was independent, it does not make sense that it would disclose what it paid for timber to Sino-Forest as this is a competitive advantage Yuda Wood would not want to lose.

[253]On April 13, 2011, a Sino-Forest employee emailed Huang Ran telling him how much income tax Yuda Wood owed for the first quarter of 2011, and that she could not get these funds ready in time. In this email, she instructs Huang Ran to find other ways to make payment. Huang Ran then emailed Ip asking for help. Ip forwarded this email chain to Ho and copied Chan. In his email to Ho on April 15, 2011, Ip tells Ho Huang Ran’s account has no money to make the transfer and that “you’d better help Yuda resolve this issue externally”.

[254]This email is instructive in two ways: first, if Yuda Wood was independent, the Sino-Forest employee would not be telling Huang Ran what his company owes in taxes or arranging payment options. Second, Chan is copied on this email, when he had not been on the email chain before, which indicates Ip is escalating this issue to Chan because it is important. This raises the likelihood Chan read these emails and is therefore aware of Sino-Forest’s control over Yuda Wood.

[255]On May 10, 2011, a Sino-Forest employee emailed Ho regarding “Yuda-Bohu Adjustment of Forest Purchase Cost”. Four emails in the subsequent chain discuss various ways in which to increase the cost by up to RMB 60 million. The final email on May 15, 2011 is from Ip to Ho, among others, and copied to Chan. Ip forwards an email from another Sino-Forest employee and asks Ho if he has any solutions to what the employee has described as the “great concerns” about reversing current account records that Bohu has. Three issues are outlined in the email from the employee: first, “[t]he purchase of the forest by Sino Guangxi Company from Bohu is not true” as the PRCs had not been transferred to Bohu; second, “[t]he sale of the forest by Sino Hunan to Bohu is not true”, and third, “Sino transferred the foreign exchange funds through Yuda and Bohu back to Sino”. The email goes on to state: “it can only be adding to the evidence of continuing falsification on purpose”.

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[256]Bohu” refers to Sino-Forest’s second largest supplier between 2007 and 2010 after Yuda Wood, Zhanjiang Bohu Wood Co., Ltd., which had RMB 3,069,924,356 in sales to Sino-Forest in that period.

[257]The May 15, 2011 email clearly indicates Sino-Forest has control over Yuda Wood since it was able to adjust the cost at which Yuda Wood recorded its purchases and because Sino-Forest could control funds through Yuda Wood. As before, the fact that Chan is copied on this email, when he had not been on t he email chain before, indicates Ip is escalating this issue to Chan because of the gravity of these issues, particularly with respect to the “continuing falsification” of transactions. This raises the likelihood Chan read these emails and is therefore aware of Sino-Forest’s control over Yuda Wood.

[258]This Yuda Wood-Bohu arrangement is also discussed in the 31-page email chain regarding the SAFE investigation, on which Chan is copied on every email in the chain.

[259]Sino-Forest had control over the use of Yuda W ood’s corporate chops, which Yeung held from April to August 2006. He directed his subordinates to use the chops to open a bank account in Yuda Wood’s name in April of that year. A 2010 email to Yeung indicates Ho’s approval was needed to apply Yuda Wood’s chops to a proof of receipt of funds document. This email is followed by another from Yeung to Huang Ran telling him to take back the chops. While the chops were with Huang Ran at this time, according to the Respondents, Yeung was under the impression they were still at Sino-Forest four years later. Employees of Yuda Wood and Sino-Forest who were included in the email also were under the impression Ho’s approval was needed and that the company seals were still with

Sino-Forest.

[260]In June 2006, in email correspondence among Yeung, Ip and others, it is recommended Yuda Wood apply for a loan for Sino-Forest’s benefit for reasons that include “its operating authority is 100% under our control”.

[261]Mr. Henderson testified that during the Independent Committee investigation Chan was shown this email and attachment. Mr. Henderson testified Chan’s response to the Independent Committee advisors was: “He [Chan] said it was all in the beginning” (Hearing Transcript, December 5, 2014 at 126:10-11). The Independent Committee advisors’ notes of Chan’s response in his interview were read to Mr. Henderson in cross-examination: “… Tight supervision to make sure they [Yuda Wood] would perform as we asked them to perform… That was in the beginning, to make sure that they don’t do something which would be – I don’t want them to cause trouble in the local community and reflect badly on us” (Hearing Transcript, December 5, 2014 at 180:4-5 and 9-12). Chan’s explanation appears to address why Sino-Forest had control over Yuda Wood’s two Guangzhou bank accounts – for leverage – as explained by Ip elsewhere in these Reasons. Chan’s explanation regarding an email in 2006 does not address the fact that control of Yuda’s two Guangzhou bank accounts continued until 2011, well past “the beginning”. Further, it does not in any way explain Sino-

Forest’s ability to use Yuda Wood to apply for a loan, or explain the phrase

“100% under our control”.

[262]When Ip was shown this email and its attachment during his interview by Staff during the investigation in this matter, he replied: “I don’t know what 100

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percent control means. In what extent? In what aspect?” (Hearing Transcript, December 5, 2014 at 143:14-15).

[263]Mr. Pomeroy testified that when Yeung was shown this email and attachment during his interview in 2011, Yeung stated: “Those are what the words say, but that’s not what it means.” Mr. Pomeroy testified Yeung “dismissed it out of hand, and indicated that, ‘Although the words say that we, Sino -Forest, controlled Yuda 100 percent, or it’s within 100 percent of our control, that’s not what it meant.’”

(Hearing Transcript, December 9, 2014 at 119:23-24 and 120:3-6) Yeung did not elaborate further.

[264]Later, Yeung explained in his affidavit, dated August 23, 2015, he used the phrase “100% under our control” because he had retained Yuda Wood’s chops and could control the proceeds from Yuda Wood’s loan. The Panel rejects Yeung’s explanation and Ip’s professed lack of understanding and interprets the phrase “100% under our control” literally: Yuda Wood was 100% under Sino-Forest’s control.

[265]The difference between the purchase transactions with Yuda Wood recorded by Sino-Forest and the revenue recorded by Yuda Wood in its SAIC corporate filings is dramatic: cumulatively between 2007 and 2010, this difference is in excess of RMB 4.36 billion. Sino-Forest BVIs recorded purchases from Yuda Wood of RMB 4.56 billion, while Yuda Wood reported revenue from Sino-Forest of approximately RMB 197 million in its SAIC filings. This difference represents 96% of the total transaction volume that Sino-Forest claimed to have done with Yuda Wood over the same period. We heard evidence that revenue is under-reported in Mainland China in order to avoid and/or minimize taxes paid; however, this difference is significant and supports Staff’s allegation that transactions with

Yuda Wood were fictitious and therefore there was no real revenue to report to SAIC.

[266]Sino-Forest and Yuda Wood shared telephone numbers throughout the Material

Time and, in particular, in 2007 when they shared land lines in the same “ghost house”.

[267]Further evidence of Yuda Wood’s lack of independence is the fact that Yuda Wood’s Accounting Manager was not able to respond to audit confirmation letters without Sino-Forest’s assistance. The purpose of these Audit Confirmation Letters was to provide independent confirmation from Sino-Forest’s suppliers and customers to E&Y of the details of their transactions with Sino -Forest. On February 16 2009, the Accounting Manager at Yuda Wood emailed a Sino-Forest employee asking for more information for the “due to and due from amounts” as the transactions were ”not in the books of Yuda”. There are two main conclusions that we draw from Yuda Wood’s questions to Sino-Forest about what the details ought to be: first, the Audit Confirmation Letter provided by Yuda Wood is not independent, thus negating its value to E&Y for audit purposes; and second, it supports Staff’s allegation that Yuda Wood was controlled by Sino -Forest.

[268]The Respondents submit the Independent Committee was satisfied Huang Ran was not an employee of Sino-Forest and that Yuda Wood was not a subsidiary. We agree Huang Ran was not employed by Sino-Forest in 2011 and that Yuda Wood was not a subsidiary of Sino-Forest. However, the Independent Committee never got comfortable with the idea that Yuda Wood was not a related party to

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Sino-Forest, and this is one of the reasons that the third quarter 2011 results were never released. The question of Yuda Wood’s independence was still an unresolved issue at the time E&Y resigned as auditor in April 2012.

[269]Based on the foregoing, we find Yuda Wood was controlled by Sino -Forest. The evidence that underlies our conclusion includes:

the myriad former and current employees of Sino-Forest who were owners of Yuda Wood through HK Sonic Jita at various periods. They were clearly nominees, only holding shares on behalf of Sino-Forest. Their position as nominees is further supported by the fact that the ownership was simply transferred among them and not sold for any consideration;

the involvement of Ip, Yeung, Ho and other Sino-Forest employees in key aspects of Yuda Wood’s business: acquiring the Ansu Factory, possession of corporate books, records and chops, and knowledge of Yuda Wood’s tax obligations;

the fact that Sino-Forest capitalized Yuda Wood;

the control of Yuda Wood’s Guangzhou bank accounts by Sino-Forest;

the documents evidencing a proposal that Sino-Forest use Yuda Wood to apply for a loan for Sino-Forest’s benefit because Sino-Forest had 100% control of Yuda Wood; and

Yuda Wood's lack of knowledge of the details of transactions that had purportedly already occurred between Yuda Wood and Sino-Forest upon receiving the E&Y Audit Confirmation Letter.

[270]For these reasons, the Panel finds Sino-Forest controlled its supplier, Yuda Wood. For reasons more clearly set out below, the Panel finds Sino -Forest used Huang Ran as its nominee.

ii.Kun’an

[271]Kun’an was a supplier to Sino-Forest in 2009. It was registered on January 20, 2009 with RMB 500,000 in initial capital and two shareholders, Yu Degang (who owned 60% and was also the Legal Representative of Kun’an) and Tian Jianguo (who owned 40%). Yang Jun was responsible for finance at Kun’an. Both Yu

Degang and Tian Jianguo were former Sino-Forest employees: Yu Degang between May 2007 and October 2008, and Tian Jianguo between March 2005 and October 2008. Yang Jun was a former employee of Sino-Forest and also worked for Huang Ran, whom the Panel finds below acted as nominee on behalf of Sino-Forest. Kun’an had the same address as Sino-Panel (Hezhou) Co., Ltd., a Sino-Forest WFOE subsidiary. Chan was involved in determining Kun’an’s name.

[272]In 2009, Sino-Forest BVIs purchased standing timber totalling RMB 1,807,078,984 (US $264,486,380) from Kun’an. It was Sino-Forest’s largest supplier in the BVI Model in 2009, accounting for over 29% of total BVI purchases. One transaction was recorded by Sino-Forest 11 days before Kun’an was even registered. Yet, in Kun’an’s SAIC filings at April 20, 2010, Kun’an reported no income from sales, no profits or losses and no taxes paid since its establishment.

[273]An email on September 29, 2009 shows that Sino-Forest exerted significant influence over how Kun’an was run: Yeung told Huang Ran by email, copied to Ip

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and another Sino-Forest employee, that Kun’an needed a fixed office location. He told Huang Ran that Kun’an was to be built up so that “it looks like a company with substance”. Huang Ran was also instructed: to collect all contracts signed between Kun’an and Sino-Forest or between Kun’an and Yuangao (another supplier of standing timber) and keep them on file; that documents such as accounts receivable should be issued in the name of Kun’an; and that he should get back Kun’an’s seals (i.e. company chops), licenses and certificates.

[274]In this same email, Yeung told Huang Ran that Ip had instructed Kun’an should have two bank accounts and that two seals for each account should be kept, one of each with Yang Jun (who was responsible for Kun’an’s finances) and the others with a supposed competitor of Kun’an’s and Sino-Forest’s.

[275]Yeung ends the email by telling Huang Ran to “build up Kun’an as if it is a new company”, yet by this time, Sino-Forest had recorded 12 contracts with Kun’an worth RMB 1,226,683,784 (US $179,549,163).

[276]In a reply email from a Sino-Forest employee to Huang Ran, copied to Yeung, the Sino-Forest employee writes that Kun’an is to “cooperate with our side tacitly” and that he “can recommend a candidate who … can fully understand and carry out our intentions”.

[277]An attachment to an email dated April 20, 2011 copied to Ip and Ho shows that a subsidiary of Sino-Forest transferred RMB 4,000,000 to Kun’an to pay the registered capital of RMB 2,000,000 for each of Guangxi Chihui Forestry Development Co., Ltd and Shun’xuan (both purportedly independent of Sino- Forest).

[278]Huang Ran’s Kun’an business card shows his title is General Manager. He is listed on Sino-Forest internal documents as “manager” and “follower” for Kun’an. Huang Ran is listed as follower for: Taiyuan, Kun’an, Meishan and Juncheng, among others. These translations are disputed by the Respondents. They submit that the original Chinese term should not be translated as “manager”, but as someone who takes care of problems. Similarly they submit that “follower” is more properly translated as someone who follows up on these matters. Whatever the translation, it is clear that Huang Ran is acting with respect to Kun’an on behalf of Sino-Forest. The instructions Huang Ran receives from Yeung make it clear that Yeung is directing Kun’an’s business and that Huang Ran is responsible for its business matters on behalf of Sino -Forest.

[279]Further connecting Huang Ran and Kun’an to Sino-Forest, he provided Kun’an’s bank account balance information to Ip.

[280]The Respondents submit Sino-Forest used Huang Ran as an intermediary with

Kun’an to express Sino-Forest’s dissatisfaction with Kun’an’s performance. They submit Kun’an sent Sino-Forest a demand letter for an overdue payment, behaviour they submit is inconsistent with Kun’an being controlled by Sino- Forest.

[281]Staff submits the purpose of the demand letter to Sino-Forest was to facilitate Sino-Forest obtaining SAFE’s approval to access foreign exchange funds.

[282]Based on the detailed email from Yeung described above, the interwoven connections between Kun’an and former Sino-Forest employees including Huang Ran, and the inconsistencies in Kun’an’s SAIC filings, the Panel finds Sino -Forest

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exercised significant influence over Kun’an and that Kun’an was a related party to Sino-Forest.

iii.Taiyuan

[283]Taiyuan was a supplier to Sino-Forest in the WFOE Model. At the request of Sino- Forest, Taiyuan was registered on June 20, 2005 by two Sino -Forest employees, Shen Siguo and Chen Jinxing, each of whom owned 50%. They each contributed RMB 250,000 of registered capital, which was loaned to them by Sino -Forest. There is no evidence these loans were repaid. Ip agreed that Sino-Forest was using Shen Siguo and Chen Jinxing as nominees.

[284]The Respondents submit Sino-Forest was interested in moving into the Rongshui area of Guangxi Province, where Taiyuan was located, and where Sino-Forest was considering the acquisition of a state-owned factory. Ip testified Sino-Forest wished to purchase the factory while hiding Sino-Forest’s identity. He further testified the plan was for Sino-Forest to acquire Taiyuan from Shen Siguo and Chen Jinxing, but Taiyuan was an asset not recorded on Sino-Forest’s financial statements. Sino-Forest did not ultimately acquire the factory.

[285]In February 2006 Huang Ran became a 50% shareholder of Taiyuan by acquiring

Shen Siguo’s shares for no consideration and also became its Legal

Representative. In November 2006, Huang Ran acquired the remaining 50% from Chen Jinxing, also for no consideration. Ip testified Huang Ran repaid Sino - Forest with particle board but there was no evidence to corroborate his testimony. Ip did not know when this repayment was made and also indicated it was “repaid through offset and recovered” (Hearing Transcript, May 27, 2015 at

57:12-14). No further details were provided.

[286]From June 1, 2006 until at least November 2006, Huang Ran was both a shareholder of Taiyuan and on Sino-Forest’s payroll. Huang Ran continued to report to Ip on the operations and financial condition of Taiyuan. In an attachment to an email dated March 3, 2011 regarding Audit Confirmation

Letters, copied to Ip and Ho, Huang Ran is listed as “Follower” with respect to

Taiyuan.

[287]On December 1, 2006, Gao Fajun was appointed Taiyuan’s Supervisor under Chinese company law. Gao Fajun was an employee of Sino -Forest from February 2006 until March 2010. He was also a shareholder in other Sino -Forest suppliers and customers: Guangxi Pingle Haosen Forestry Development Co., Ltd. (involved in the 450 Transactions), Guangxi Chihui Forestry Development Co., Ltd. and Meishan.

[288]Ho testified that Ip had been monitoring Taiyuan’s bank account prior to 2007.

[289]We find Sino-Forest capitalized Taiyuan with RMB 500,000. There is no evidence Huang Ran or his predecessor shareholders repaid Sino-Forest for this capitalization of Taiyuan, other than Ip’s testimony. Sino -Forest employees owned and operated Taiyuan. Ip monitored Taiyuan’s bank account.

[290]The Panel finds Sino-Forest controlled Taiyuan.

iv.Dongkou

[291]Dongkou was a Sino-Forest customer in the BVI Model and was established in Hunan Province on March 30, 2005. In October 2005, Sino-Forest became

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interested in acquiring Dongkou’s wood processing factory and standing timber business and investigated the company. Sino-Forest bought the factory assets on November 18, 2006. Ip testified that Sino-Forest continued to be interested in the remaining plantation assets of Dongkou. Liu Zhiwei, later a Sino-Forest employee, became a 47.5% shareholder at an unspecified date and continued to hold shares in Dongkou until December 31, 2008. Du Aiguo, later a Sino-Forest employee, became a 52.5% shareholder of Dongkou on November 16, 2006, two days before Sino-Forest acquired Donkgou’s factory, and remained so until sometime after April 1, 2009. While Sino-Forest explored purchasing the shares of Dongkou, it ultimately acquired only the factory facilities.

[292]Du Aiguo was a Sino-Forest employee from December 8, 2006 until July 1, 2008 and Liu Zhiwei was a Sino-Forest employee from March 19, 2007 until at least December 2010. Thus, both individuals were employees of Sino -Forest at the same time they were co-owners of a Sino-Forest customer. Ip did not dispute the overlap in time, explaining that this arrangement was part of the negotiations with Liu Zhiwei and Du Aiguo.

[293]In 2008, Dongkou was Sino-Forest’s largest customer, accounting for sales of

RMB 867,708,084 (approximately US $125 million). No cash was received with respect to any of these sales; rather, the AR/AP Set-Off process was used to settle the receivables.

[294]A 2007 Project Funding Schedule for Sino-Panel lists three contracts between

Dongkou and three third party suppliers: Guangxi Hezhou City Shengdong Forestry Development Co., Ltd., Gengma Dai1 0 and Yongshun Shunfa Agriculture and Forestry Information Consulting Co., Ltd. Also included on this schedule is the Yunnan Master Framework Agreement between Sino-Panel and Gengma Dai. Sino-Forest therefore appears to be tracking Dongkou’s transactions as it would one of its subsidiaries.

[295]On January 12, 2007, a Sino-Forest employee emailed Ip attaching a contract between Dongkou as buyer and Gengma Dai as seller. In the email, the employee asks Ip if the contract should be “sent to Mr. Xie of Gengma”. No employees from Dongkou are copied on this email.

[296]On February 3, 2007, a Sino-Forest employee emailed the final contract version to Ip, stating: “Attached please find the latest final version of the contract that we plan to sign …” [emphasis added]. It is clear the terms and conditions of the contract were negotiated between Sino-Forest employees and Gengma Dai. Ip was asked to advise if he had any comments for further amendments. The employee emailing Ip wanted to “stress and highlight” that payment must be made by a certain deadline, otherwise “they will not sell to us” [emphasis added].

[297]Another contract, between Dongkou and Guangxi Hezhou City Shendong Forestry Development Co., Ltd. was emailed by Ip to a Sino-Forest employee on January 13, 2007.

1 0 The Project Funding Schedule identifies the seller as “Yunnan Gengma County Forestry Co., Ltd.”, which Ip testified was another name for Gengma Dai. Although Gengma Dai is identified as “Gengma Dai and Wa Tribes Autonomous County Forestry Co., Ltd., Yunnan”

elsewhere in the Project Funding Schedule, the evidence is clear that the Dongkou contract was with Gengma Dai.

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[298]None of these contracts were signed or chopped.

[299]The Respondents submit Sino-Forest was preparing contracts in the name of Dongkou because, at that time, Sino-Forest was still considering purchasing the shares of Dongkou for its timber management business, in addition to the factory asset. By March or April 2007, Sino-Forest had decided not to proceed with this acquisition.

[300]We reject the Respondents’ argument that Sino-Forest was preparing Dongkou contracts because Sino-Forest was considering a share purchase. For example, the email to Ip on February 3, 2007, discussed in detail in paragraph [296], refers to an attachment entitled “Final Contract Version”. In this contract for approximately 80,410 mu at a price of RMB 1,000 per mu, Dongkou agrees to pay RMB 25 million to Gengma Dai by February 15, 2007 and to participate in a survey by March 1, 2007. Following the Respondents’ explanation, Sino -Forest would have had to acquire Dongkou between February 3 and February 15, 2007, the date when RMB 25 million was due. This timeframe seems unlikely. Therefore, the Respondents ask us to believe Sino-Forest was committing an unrelated third party to a substantial liability; otherwise Sino -Forest would be assuming this liability in 12 days, even though at this stage, Sino -Forest was simply “considering” the share acquisition. There were no concrete plans to acquire the shares. We reject the Respondents’ submission.

[301]In addition, the phone number listed for Dongkou in a contract with Gengma Dai is the same as a cell phone number of a Sino-Forest employee.

[302]Dongkou was Sino-Forest’s largest customer in the BVI Model in 2008 with sales of RMB 867,708,084 or US $125,028,109. All six sales contracts were signed by Chan on behalf of Sino-Forest and by Du Aiguo on behalf of Dongkou. Three of these contracts were signed by Du Aiguo on behalf of Dongkou at the same time that he was an employee of Sino-Forest.

[303]Based on the cumulative weight of the evidence, we reject the Respondents’ explanation and find that Sino-Forest controlled Dongkou.

(b)Other companies Staff alleges are related to Sino-Forest

[304]Staff submits Juncheng, Shun’xuan, Dacheng, Yuangao and Meishan are also related and worked in collusion with, or were influenced by, Sino -Forest and played a role in the Standing Timber Fraud Allegations.

i.Juncheng

[305]Juncheng was a Sino-Forest supplier in the BVI Model and was established May 27, 2010; He Yongning owned 80% and contributed RMB 800,000 in registered capital. He was 23 years old at this time. During the third and fourth quarters of 2010, soon after Juncheng was capitalized, Juncheng supplied Sino -Forest BVI subsidiaries with RMB 1.825 billion in standing timber. Ip suggested there was a backer behind He Yongning, the identity of whom Ip did not know and about whom he could not recall any details at the time of the hearing.

[306]In total, Sino-Forest transacted RMB 3.56 billion of purchases from Juncheng in the second half of 2010 and the first quarter of 2011.

[307]In cross-examination, Ip testified he knew little about the company despite its substantial transaction volume with Sino-Forest. He said the 20% shareholder

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had previously been employed with Sino-Forest and had good forestry connections and knowledge.

[308]Yang Jun, who was also connected to Yuda Wood, Kun’an and Yuangao, worked for Huang Ran and was a former Sino-Forest employee, was also involved with Juncheng. On March 3, 2011, Yang Jun emailed a Sino-Forest employee, and asked her to confirm seven letters of enquiry from E&Y regarding settlements of offsets between Sino-Forest BVI subsidiaries and Juncheng. In the English translation of this email, Juncheng is described as a “peripheral company”. The Sino-Forest employee then forwards this email to Hung five minutes later, stating she will print out the letters and send them to E&Y.

[309]Two conclusions can be drawn from this email. First, Sino-Forest had discretion over correspondence between E&Y and Juncheng. Second, because E&Y depends on this supposed independent confirmation in its audit process, the fact that the confirmation is not independent calls into question the veracity of the financial statements based upon this audit process. In this context, we reject the Respondents’ submission that the correct translation of the term “peripheral company” is “outside company”.

[310]Both Ip and Ho are copied on a March 2011 internal Sino-Forest email regarding Audit Confirmation Letters from E&Y sent to Sino-Forest suppliers and AIs. Attached to the email is a chart that tracks the delivery status of the Audit

Confirmation Letters to each listed “Related Entity”. Huang Ran and Yang Jun are listed in this report as “followers” for Juncheng. Huang Ran is also listed on this document as a “follower” for Taiyuan, Kun’an and Meishan. The Respondents submit that a contextual interpretation of the term indicates the entities are being referred to as “intermediaries”. Whatever the English translation, in this context, it can only be negative. We reject the Respondents’ submission. This email and attachment refer to Sino-Forest’s involvement in supposedly independently-derived Audit Confirmation Letters required by E&Y. Sino-Forest should not be involved in this confirmation process between E&Y and Sino- Forest’s suppliers and customers, nor should Huang Ran who we find acted as Sino-Forest’s nominee in companies Sino-Forest secretly controlled or over which it had significant influence.

[311]Huang Ran also provided Juncheng’s bank account information, including cash balances, to Ip in March 2011.

[312]Based on these facts, the Panel finds Sino-Forest exerted significant influence over Juncheng and that it was a related party.

ii.Shun’xuan

[313]Shun’xuan was a supplier to Sino-Forest WFOEs with transactions worth RMB 39 million between December 10, 2010, its date of registration, and March 2011.

[314]Ip and Ho are copied on the April 20, 2011 email (previously referred to in our analysis of Kun’an) between Sino-Forest employees with a subject line of “Details of the disposal of the funds received from Sino-forest by the Cooperating

Unit(s)”, and that contains the instruction “… the term “periphery” should not appear in emails or documents/forms”. Shun’xuan is included in the attached charts of payments between Sino-Forest subsidiaries and “cooperating units” or peripheral companies.

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[315]The attachment indicates a subsidiary of Sino-Forest transferred RMB 2,000,000 to Kun’an that ultimately was used to pay Shun’xuan’s registered capital. Yu Degang is a 30% shareholder in Shun’xuan and a former employee of Sino - Forest, who worked there from May 1, 2007 to October 31, 2008. Wu Ruiming owns 70% of Shun’xuan and was a Sino-Forest employee from September 24, 2007 until August 6, 2010.

[316]An email sent May 9, 2011 to Ip and Ho, among others, shows that Sino-Forest was considering using Shun’xuan to falsify transactions during the SAFE investigation but could not, as Shun’xuan had not yet been incorporated in 2008.

[317]The Panel finds Shun’xuan is a related party for the following reasons: Kun’an was used by Sino-Forest to provide the funds to capitalize Shun’xuan and we earlier concluded that Kun’an is a related party to Sino-Forest, and Yu Degang is a shareholder of both Kun’an and Shun’xuan.

iii.Dacheng

[318]Dacheng, a supplier to Sino-Forest in the WFOE Model, was part of a group of companies in what was called the “Bohu Group”, all owned by Li Hua.

[319]There is limited evidence of a control-like relationship between Sino-Forest and Dacheng: a senior employee of Sino-Forest borrowed RMB 800,000 from Li Hua; Dacheng was included in a Sino-Forest email that described it as a “cooperative company”; and Li Hua may have a personal relationship with Huang Ran. The evidence is insufficient to find that Dacheng was related to Sino-Forest.

iv.Yuangao

[320]Yuangao was a supplier to Sino-Forest WFOEs in October 2009 in the 450 Transactions (addressed later in these Reasons). Its total transaction value with Sino-Forest was RMB 182,522,798 (US $26,711,073).

[321]Huang Ran was a 39% shareholder of Yuangao.

[322]On July 16, 2010, Ho was sent an email titled “FW: The Yuangao Company’s jointly managed account information”, which refers to Ip having arranged Yuangao’s bank account. The Sino-Forest employee asks if internal approval procedures are needed to use the account and asks if Ho and Ip can confirm.

[323]A March 4, 2011 email from Huang Ran to Ip outlining the “situation of funds for the periphery companies is as follows” lists Yuangao, among other “periphery companies”. Whether “periphery companies” or “outside companies” is the correct translation is not most critical in this email. What is important is the context of this email. It lists various suppliers’ and customers’ (some of which may be competitors to Sino-Forest) bank account information, including cash balances. Other companies listed in this email include Kun’an, Taiyuan, Juncheng and Meishan, which the Panel finds were controlled by or related to Sino-Forest. Yuangao figured prominently in the 450 Transactions, which the Panel finds were fraudulent (described in our Reasons below). Yuangao was instrumental in facilitating the circular flow of funds, which we find later in these reasons was controlled by Sino-Forest, not Yuangao.

[324]Based on this evidence, the Panel finds Yuangao is related to Sino -Forest.

v.Meishan

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[325]Meishan was a customer in the WFOE Model that was brought to Sino -Forest’s attention by Huang Ran in May 2007. Huang Ran provided a brief report to Sino - Forest on the acquisition potential of the Meishan factory. The report appears to have been prepared by Taiyuan and ends with the line “Awaiting the leaders’ instruction on whether it is suitable!”

[326]Gao Fajun, while a Sino-Forest employee, did the due diligence on the potential acquisition of Meishan on behalf of Sino-Forest, after which he bought the factory himself in October 2007, while remaining an employee of Sino -Forest.

[327]The March 2011 email from Huang Ran to Ip that provides bank account information for suppliers and customers lists Meishan among the “periphery companies”. As noted above in our analysis of Yuangao, what is important in this email is that the bank account details for Meishan and other purportedly independent companies were provided to Sino-Forest.

[328]The Panel finds Meishan is related to Sino-Forest.

(c)Company Caretaker List

[329]One document obtained during Staff’s investigation whose significance was contested was the Company Caretaker List.

[330]The Company Caretaker List was a five-page Chinese-language spreadsheet that contained references to companies that are involved in the allegations against Sino-Forest. It was found on the computer of Chan’s assistant, Yosanda Chiang. The metadata indicated it was last modified on January 20, 2011 on Ms.

Chiang’s computer. It does not indicate the date the spreadsheet was actually created. It is titled “nominee managers/information of managed companies” and lists more than 120 companies. The Respondents dispute how some words have been translated.

[331]The following are among the 120 companies listed:

Bohu,

Dacheng,

Meishan,

Taiyuan,

Kun’an,

Guangxi Chihui Forestry Co., Ltd.,

Gaoyao City Xinqi Forestry Development Co., Ltd. and Guangxi Pingle Haosen Forestry Development Co., Ltd. (referred to in our analysis of the 450 Transactions),

Jiangxi Province Senchangtai Forestry Co. Ltd. (referred to in our analysis of the Gengma #1 Transactions),

Yongzhou City Maoxiang Forestry Development Co. Ltd. (referred to in our analysis of the allegations about deceitful documentation and the 450 Transactions), and

Renshi (China) Real Estate Development Ltd. (referred to in our analysis of the Greenheart allegations).

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[332]The document lists the following individuals, among others: Huang Ran, Pauline Chan (Chan’s sister), Marco Lam (a Sino-Forest employee), John Zeng (involved in the Greenheart Transactions, Sino-Forest’s external counsel, and represented

Chan during his interview by Staff in connection with this matter), Lok Ho Ting (involved in the Greenheart Transactions), Li Hua (legal representative of Bohu), Lei Guangyu (involved in the Greenheart Transactions), and George Ho.

[333]It is not clear who created this document. Ms. Chiang testified John Zeng asked her to print out a copy from a USB drive that he gave her while he was waiting to meet with Chan. She testified that she printed out one copy and gave it to Mr. Zeng.

[334]Chan submits there is no evidence that Mr. Zeng discussed this List with Chan during their meeting that day, or on any other day. Chan further submits there is no evidence that Chan saw this List during the Material Time.

[335]It is clear Chan was aware of the Company Caretaker List. Mr. Martin tes tified he saw the List after Sino-Forest filed for CCAA, “was quite upset by it”, since it implied these companies were related parties to Sino-Forest, and spoke to Chan about it (Hearing Transcript, December 3, 2014 at 103:15). Chan explained to Mr. Martin that the List was translated incorrectly or “misunderstood” and was “his way of managing on a knowledge basis all of the companies that are…significant companies doing business with Sino -Forest” (Hearing Transcript,

December 3, 2014 at 104:16-18). Clearly there is evidence that Chan was quite knowledgeable about the List during the Material Time.

[336]It is reasonable to infer Mr. Zeng discussed this List with Chan, at the meeting on the day he asked Ms. Chiang to print it out. Why else would he need the List, the contents of which related entirely to Sino-Forest, at the very same time he was meeting with Chan? If he didn’t need it immediately, Mr. Zeng could have had his own assistant print it out at a later time. Mr. Zeng’s actions imply some urgency to have the spreadsheet printed out in time for his meeting with Chan.

[337]We reject Chan’s submission. There is evidence Chan was well aware of the

Company Caretaker List and Mr. Zeng discussed it with him.

[338]Ip, Ho, Hung and Yeung submit they did not see this List before this proceeding commenced and have no knowledge about its origins. The Respondents challenge the translation of “manager” within the title in the traditional English meaning. Rather, they say it refers to someone who “follows up on matters”, is an intermediary or liaison officer. They submit that to rely on a List that is inadequately translated is a far too tenuous basis on which to conclude Sino- Forest controlled its suppliers.

[339]The Company Caretaker List includes companies that we find above, for other reasons, were controlled by or related to Sino-Forest. The Panel further finds this List makes it more likely than not Chan was aware Sino -Forest had control, or significant influence, over these companies.

(d)Huang Ran

[340]Huang Ran figures prominently in Sino-Forest’s operations. Huang Ran is listed in the Company Caretaker List as either Registered Shareholder, Legal Representative, Nominee Manager, Follower or Manager for companies including:

Yuda Wood (supplier)

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Gaoyao City Xinqi Forestry Development Co., Ltd. (customer)

Meishan (customer)

Taiyuan (supplier)

Guangxi Pingle Haosen Forestry Development Co. Ltd. (customer and supplier)

Kun’an (supplier)

Guangxi Chihui Forestry Co. Ltd. (supplier)

Jiangxi Province Senchangtai Forestry Co. Ltd. (supplier)

Yongzhou City Maoxiang Forestry Development Co. Ltd. (supplier)

Yuangao (supplier)

Dacheng (supplier)

[341]These companies are located in the four bordering provinces of Hunan, Jiangxi, Guangxi and Guangdong. As has been noted previously, the Respondents take issue with the translations of the words used in these documents to describe

Huang Ran’s role. Putting the issue of specific translations aside, these documents show that Huang Ran was involved with many suppliers and customers purported to be operating at arm’s length to Sino -Forest. The fact of his prolific involvement with companies purportedly operating independently is more important to us than the title ascribed to his role with each company.

[342]The evidence shows Huang Ran participated in internal Sino-Forest meetings and was on the Sino-Forest payroll during some of the same periods he was involved with suppliers and a customer.

[343]The Respondents submit that because of obstacles, including tensions between residents of Mainland China and Hong Kong, and difficulties in conducting business between Hong Kong and Mainland China, including those related to the language differences of Mandarin and Cantonese speakers, Huang Ran was used as an intermediary to bridge the gap in guanxi, language and culture. If true, this would mean Huang Ran’s influence spanned the four provinces in which these companies did business. Sino-Forest had control over the bank accounts of Yuda Wood, a company owned 50% by Huang Ran (through his 50% ownership of HK Sonic Jita). The Respondents submit the reason Sino-Forest controlled these bank accounts was to maintain leverage over this supplier in cases of disagreement. This does not accord with Sino-Forest’s reliance on Huang Ran, based on guanxi, to act on its behalf with other suppliers and AIs to bridge the gap in language and culture.

[344]We did not hear direct testimony from Huang Ran and must draw inferences based on the evidence presented, including numerous emails.

[345]When interviewed in September 2011 by the advisors to the Independent Committee, Huang Ran declined to disclose the names of the supporters behind Yuda Wood, whether himself or others. Huang Ran was also recorded as majority owner in three other Sino-Forest suppliers: Guagnxi Chihui Forestry Co. Ltd., Jiangxi Senchangtai Forestry Co. Ltd. and Taiyuan. Huang Ran also stated he dealt only with aggregators, not farmers. Ho however, testified Huang Ran would act as an intermediary or facilitator with farmers. This inconsistency further undermines the Respondents’ explanation of Huang Ran’s role.

[346]We find Yuda Wood, Taiyuan and Kun’an were controlled by, or related to, Sino - Forest through Huang Ran as its nominee. Huang Ran facilitated the control or

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significant influence Sino-Forest had over supposedly independent third party suppliers and customers.

5.Guanxi

[347]The Respondents provided extensive expert evidence on the concept of guanxi in a cultural and business context. Mr. Martin testified that guanxi relates to a level of cooperation that is essential to business and personal relationships in China.

Guanxi is the concept of drawing on connections in order to secure favours and reciprocal obligations, is based on intricate and pervasive relational networks,

and can be distinguished from the Western concept of networking (Yadong Luo, Guanxi and Business, 2d ed (Singapore: World Scientific Publishing Co. Ptd. Ltd., 2007) at 2). Dr. Peerenboom described guanxi as being a reference to ethical relationships based on communication, trust and loyalty built over time. It refers to relationships between people, primarily, not companies and is a form of human capital. Dr. Peerenboom, who provided expert evidence on Chinese law, culture and business, likens guanxi to concentric circles, with the sense of obligation higher the closer one is situated in the circles to the centre. While guanxi is not meant to facilitate illegal business transactions, he testified that it could lead to someone doing something illegal on behalf of someone else.

[348]The Respondents submit the prevalence of guanxi explains the close cooperation with suppliers and customers and is not evidence of control or influence. They submit that, in the rural locations in which Sino-Forest purchased plantations, the fact that one had a contract for standing timber did not necessarily guarantee access to the trees. Therefore, Sino-Forest relied heavily on its suppliers. This of course does not address the “close cooperation” Sino -Forest exhibited with some of its customers, including Meishan and Dongkou.

[349]While the submission regarding access to trees is disconcerting because it calls into question the enforceability of contract law, the close relationship that Sino - Forest had with many of its suppliers and customers goes far beyond guanxi. The evidence shows Sino-Forest had control over bank accounts, was negotiating contracts between supposed independent third parties, had access to confidential competitive information and tax information, was considering using Yuda Wood to apply for a loan for Sino-Forest, and can be traced to having capitalized various companies. An email from a Sino-Forest employee stating a company was “100% under our control” is evidence of a relationship that went far beyond guanxi. Dr. Peerenboom, when asked in cross-examination if he would expect a supplier to share its financial records with its customers, he replied:

You know, this is a very unusual type of information for -- to be asked for in this context, and so they would, yes, be reluctant to provide that type of information….To share the

details of your purchase and sales agreements and all and so forth, yes. It's not generally the normal course of business.

(Hearing Transcript, April 8, 2015 at 103:25-104:9)

[350]The Panel is cognizant of cultural differences that companies encounter globally; however, Sino-Forest was listed on the TSX, was an Ontario reporting issuer, raised US $3 billion of capital from Investors, and was required to issue financial statements prepared in accordance with Canadian generally accepted accounting

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principles. For the purposes of our analysis, Ontario securities law is paramount and overrides any explanations for illegal conduct being excusable in the name of guanxi, however it is defined.

6.Conclusion: The Real Issue is Control and Value

[351]Staff alleges Sino-Forest established a network of counterparties that were controlled on its behalf by various nominees. If true, this control or influence would call into question whether the transactions with these suppliers and AIs were carried out at arm’s length and therefore recorded at fair value and, more basically, if the transactions actually occurred. The result of this would be that Investors could not rely on the revenue and assets reported on Sino-Forest’s financial statements. The true economic substance of the underlying transactions recorded with these companies would be misstated and the disclosure would be misleading.

[352]The question of control is directly related to value, existence and ownership. In the BVI Model, because there were no cash records or bank statements to verify transactions, significant weight was placed by E&Y during their audit process on the Audit Confirmation Letters. The auditors relied on these for independent verification of Sino-Forest’s business – with independence being a key fundamental test.

[353]After the Muddy Waters Report, when Fred Clifford of E&Y learned that the payments made in the AR/AP Set-Off Process were not directly between the supplier and the AI but instead may have involved three, four, five or more intermediaries, he referred to this as a “daisy chain of cash” and testified the risk of fraud and the risk of the existence of the transactions would be dramatically increased (Hearing Transcript, November 17, 2014 at 84). When asked to explain the risk he was speaking of, Mr. Clifford stated: “Well, I think it goes to the fraud risk. It goes to the risk to the existence of these transactions, the completeness of these transactions. I think it’s pretty broad-based” (Hearing

Transcript, November 17, 2014 at 140:20-24). With this “daisy chain of cash”, there was no way for E&Y to confirm the transactions actually took place.

[354]Further, if suppliers and customers were related to Sino -Forest, then the Audit

Confirmation Letters were, according to Mr. Clifford, “not really audit worthy evidence” (Hearing Transcript – November 17, 2014 at 130). Mr. Clifford testified the Audit Confirmation Letters were documents E&Y would produce and retain custody of, would separately forward to suppliers and customers and would retain to get assurance about the nature and validity of these transactions. Mr. Clifford called these letters key and foundational to the audit process. The auditors sent these letters directly to suppliers and customers and believed they were receiving the letters directly back as well. However, the evidence shows Sino-Forest was inserted into this process to provide the information to supply to E&Y. The objective of these Audit Confirmation Letters was to support the legal ownership of the assets by Sino-Forest. The Audit Confirmation Letters did not provide any independent verification of ownership or revenue in the BVI Model. The fact that these suppliers and customers were controlled or related parties, and not independent of Sino-Forest, was extremely significant in the context of ownership and the revenue reported by Sino-Forest from sales of standing timber.

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[355]E&Y received direct confirmation in management representation letters from Sino-Forest senior management, including Chan, that suppliers and AIs were not related parties. Clifford described these as the “foundation to the audit process”

(Hearing Transcript – November 17, 2014 at 34). They were critical and without them, the auditor would not release its audit opinion. In these management representation letters, management confirmed the information provided was complete, there were no related parties that were not disclosed and the offsets were genuine and complete. The auditor required management to represent: (1) the transactions are real; (2) they happened; and (3) they were between third parties without any mutual interest among them. Each year this management letter was signed by Sino-Forest senior management and specifically by Chan. After the Muddy Waters Report, Sino-Forest management, including Chan, were asked to provide an updated management representation letter. They did not.

[356]The Respondents submit the real issue is not control but value, and criticize Staff for not providing expert accounting evidence as to why the concept of control over suppliers or customers actually matters. To the Panel, the “why” is self- evident, and was explained very comprehensively by Mr. Clifford.

[357]The Panel finds the lack of independence of purportedly arm’s length customers and suppliers has been well established. This directly calls into question the true economic substance of transactions between Sino-Forest and these companies, and therefore the value of assets and revenues recorded. The financial statements that the individual Respondents certified or sub-certified as true and on which investors are entitled to rely, did not present fairly the financial position of Sino-Forest and the results of its operations. Sino-Forest’s deceitful disclosure put the financial interests of its investors at risk.

7.The Roles of Chan, Ip, Hung, Ho and Yeung

[358]We find Chan knew of, and was involved in, Sino-Forest’s undisclosed control of Yuda Wood.

Between 1993 and 1997, Chan, Chan’s mother and his best friend owned the company that had a one-third interest in HK Sonic Jita, Yuda Wood’s parent company. During this time, Chan was a director of HK Sonic Jita’s predecessor company and CEO of Sino-Forest.

A loose document on his executive assistant’s computer that listed corporate information for Sino-Forest’s BVI, Canadian and Hong Kong subsidiaries included HK Sonic Jita.

Chan was also involved in the monitoring of Yuda Wood’s accounts. Ho’s evidence was that he discussed getting leverage over suppliers by monitoring their bank accounts with Chan, and could not recall whether this was his idea or whether it came up in discussions with Chan.

Chan was copied on two emails regarding an increase in tax owed by Yuda

Wood and adjusting Yuda Wood’s cost base on a purchase from another supplier, which evidence Sino-Forest’s control of Yuda Wood.

Chan was also copied on every email in the 31-page email chain regarding the SAFE investigation. Emails in this chain indicate Sino -Forest’s control over Yuda Wood.

When shown the document that states Yuda Wood was “100% under our control” during the Independent Committee investigation, Chan’s response indicates he was aware Sino-Forest controlled Yuda Wood.

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Chan approved the advance of Sino-Forest funds for payment for the Ansu Factory purchased in the name of Yuda Wood.

[359]Chan was involved in selecting the corporate name for Kun’an, another Sino - Forest supplier in the BVI Model, which we find was related to Sino -Forest.

[360]Chan was well aware of the contents of the Company Caretaker List, which we find makes it more likely than not Chan was aware Sino-Forest had control, or significant influence, over the companies it listed.

[361]We find Ip was involved in, and therefore knew of, Sino-Forest’s control of Yuda Wood:

He was involved in the business operations of Yuda Wood’s parent company, HK Sonic Jita.

Ip oversaw the changing shareholder structure of HK Sonic Jita and was provided with updates as corporate changes were made.

Ip was kept informed about the capitalization of Yuda Wood by Sino - Forest.

Ip was sent draft documents for Yuda Wood’s purchase of the Ansu

Factory.

Along with Ho, Ip approved six payments to Gengma Dai from the Yuda Wood bank accounts controlled by Sino-Forest that totaled RMB 30.3 million.

Ip was sent the document that states Yuda Wood is “100% under our control”.

Ip directed Ho to resolve Yuda Wood’s income tax issues.

Ip was involved in adjusting Yuda Wood’s cost base on a purchase from another supplier.

[362]We find Ip was aware of Sino-Forest’s non-arm’s length relationship with Kun’an:

He was copied on emails from Yeung, which indicate the significant influence Sino-Forest exerted over Kun’an.

He instructed that Kun’an should have two bank accounts and two seals.

Along with Ho, he was copied on an email that shows a Sino -Forest subsidiary transferring RMB 4 million to Kun’an to pay the registered capital for two other purportedly arm’s length companies.

[363]We find Ip was also involved in Sino-Forest’s control over Taiyuan:

Huang Ran reported to Ip on the operations and financial condition of Taiyuan.

Ip had been monitoring Taiyuan’s bank account since before 2007.

He agreed that Sino-Forest was using its employees as nominee directors for Taiyuan.

[364]We find Ip was also involved in Sino-Forest’s control or significant influence over other companies. Ip was sent multiple drafts of contracts between Dongkou and Gengma Dai for his review and comment, and was asked to arrange payment to Gengma Dai. Ip was sent a May 2011 email that shows Sino -Forest was considering using the purportedly independent company Shun’xuan to falsify transactions during the SAFE investigation but could not as Shun’xuan had not been incorporated at the time of the 2008 transactions. He arranged Yuangao’s bank account. Huang Ran provided him with bank account balance information

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for suppliers and customers of Sino-Forest including Kun’an, Juncheng, Yuangao and Meishan, which we find were related to, Sino-Forest.

[365]Ip was copied on an internal Sino-Forest email regarding E&Y Audit Confirmation Letters, in which Huang Ran and Yang Jun are listed as “followers” for supposedly independent companies listed as “related entity”. We concluded that

Sino-Forest should have been far removed from this confirmation process between E&Y and Sino-Forest’s suppliers and customers.

[366]We find Hung was less involved in Sino-Forest’s undisclosed control of purportedly independent companies. He was involved in and knew of Sino-

Forest’s involvement with the supposedly independent Audit Confirmation Letter process. He was forwarded an email from an employee of Juncheng to a Sino- Forest employee in which Juncheng is described as a peripheral company and the Sino-Forest employee is asked to confirm seven letters of enquiry from E&Y regarding settlements of receivables. In her forwarding email, the Sino-Forest employee informs Hung that she will print out the letters and send them to E&Y.

[367]We find Ho was involved in Sino-Forest’s control of Yuda Wood. Huang Ran stated in an interview during the Independent Committee investigation that Ho controlled one of Yuda Wood’s bank accounts. Along with Ip, Ho approved payments from Yuda Wood to Gengma Dai totaling RMB 30.3 million from accounts controlled by Sino-Forest. Ho’s approval was also required to apply Yuda Wood’s corporate chops to a proof of receipt of funds document.

[368]Ho was copied on an email that indicated a Sino-Forest subsidiary paid RMB 4 million to Kun’an to pay for the registered capital of two other companies that were purportedly independent of Sino-Forest. He was also asked to confirm whether internal approval procedures were needed to use an account belonging to Yuangao, a purportedly independent company, which we found was related to Sino-Forest.

[369]Ho was copied on an internal Sino-Forest email regarding E&Y Audit Confirmation

Letters, in which Huang Ran and Yang Jun are listed as “followers” for supposedly independent companies listed under the heading “related entity”.

We concluded that Sino-Forest should have been far removed from this confirmation process between E&Y and Sino-Forest’s suppliers and customers. Ho was also sent the May 2011 email that shows Sino -Forest was considering using Shun’xuan to falsify transactions during the SAFE investigation.

[370] We find Yeung was very involved in Sino-Forest’s control over Yuda Wood:

He held Yuda Wood’s corporate chops on behalf of Sino-Forest from April to August 2006 and directed his subordinates to use them to open a bank account in Yuda Wood’s name.

Yeung signed the Ansu Factory purchase agreement in the name of Yuda Wood, prior to Yuda Wood’s incorporation.

It is not disputed that Huang Ran requested Yeung’s help in registering Yuda Wood, and subsequently a Sino-Forest employee registered Yuda

Wood as a corporation, under Yeung’s direction.

Finally, Yeung sent out the document regarding Yuda Wood that states

“its operating authority is 100% under our control”.

[371]We find Yeung was also involved in Sino-Forest’s non-arm’s length relationship with Kun’an. He informed Huang Ran that Kun’an needed a fixed office location

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and that it was to be built up so that “it looks like a company with substance”. Yeung also told Huang Ran to “build up Kun’an as if it is a new company”. By the time of these emails from Yeung, Sino-Forest had recorded 12 contracts with Kun’an worth RMB 1,226,683,784 (US $179,549,163).

C.Deceitful Documentation Allegations

1.Positions of the Parties

(a)Staff

[372]The second element of the Standing Timber Fraud Allegations by Staff is a deceitful documentation process. Staff alleges Sino-Forest falsified evidence of ownership of the vast majority of its standing timber assets by engaging in a deceitful documentation process. The alleged Deceitful Documentation Process employed in the BVI Model involved the creation of deceitful purchase and sales contracts and their key attachments. Staff submits this resulted in Sino-Forest consistently misstating its revenue throughout the Material Time. Staff alleges the Deceitful Documentation Process put the pecuniary interests of investors at risk and constitutes fraud. Staff submits Sino -Forest, Chan, Ip and Hung were directly involved in the fraudulent deceitful documentation and that Ho authorized, permitted and acquiesced in Sino-Forest’s actions in breach of Ontario securities law regarding the fraudulent Deceitful Documentation Process. Staff does not allege Yeung had a role in the Deceitful Documentation Process.

[373]Staff alleges the documentation processes for both Sino -Forest’s purchases and sales were dishonest.

[374]Staff alleges BVI purchase contracts and their three attachments were fundamentally flawed in the following ways:

a.since the BVI subsidiaries could not obtain PRCs (Forestry Rights Certificates) from the Chinese Forestry Bureau, Sino-Forest relied on Forestry Bureau Confirmations as evidence of ownership of standing timber allegedly purchased by the BVI subsidiaries;

b.Sino-Forest employed a deceitful quarterly documentation process whereby Sino-Forest drafted and executed the BVI purchase contracts and created the Forestry Bureau Confirmations in the quarter after the dates on which the purchases allegedly occurred and were included in Sino -

Forest’s public financial disclosure;

c.although the purchase contracts referred to attached letters of authorization and resolutions of the villagers (Villagers’ Resolutions)

(sometimes translated as “farmers authorizations”), these documents were not attached, and there is no evidence that ownership of the standing timber was ever properly transferred to Sino-Forest or its suppliers; and

d.the attached reports on a survey conducted for the plantation being purchased (the Survey Reports) were prepared by one survey company, and drafts of the Survey Reports were, in some cases, located on the computer of a Sino-Forest employee and were deceitfully dated to the quarter prior to their creation.

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[375]Staff submits this flawed purchase documentation does not constitute proof of ownership and does not identify the precise location of the standing timber being purchased such that its existence could be readily verified and independently valued.

[376]With respect to the sales contracts, Staff alleges they were similarly created and executed in the quarter after the date on which Sino-Forest purportedly entered into the sales contracts. This resulted in Sino-Forest recognizing revenue in the BVI Model in the quarter prior to the creation of the sales contracts and publicly disclosing its revenue from standing timber for that quarter in a manner that was materially misleading and deceitful.

[377]Staff alleges Sino-Forest misled the Commission regarding its revenue recognition process during the Material Time in its correspondence to Staff.

(b)Respondents

[378]Chan denies Sino-Forest’s purchase and sales documentation process was deceitful or fraudulent.

[379]Ip, Hung and Ho admit Sino-Forest employed a quarterly process of drafting and executing purchase contracts and Forestry Bureau Confirmations in the quarter after the purchases occurred, but they submit there was nothing deceitful about the timing of documents within the BVI business. They submit the purchase and sales documentation was based on oral contracts entered into on the stated date of the contract and the Respondents believed there were valid business efficiency reasons for preparing contracts and their supporting documents towards the end of a quarter or early the following quarter.

[380]Hung and Ip submit they were forthcoming about the fact the written contracts were prepared at the end of the quarter or early in the following quarter. They submit Sino-Forest’s Legal Department, Mr. Horsley, Mr. Maradin and the Audit Committee were all aware of Sino-Forest’s practice with respect to contract preparation and Chan’s role in signing and approving the final contracts. Ip, Hung and Ho submit, given the Audit Committee, the CEO, the CFO and the Vice-President, Risk Management knew the practice of batching and post -dating contracts, it is unfair to expect more junior members of management of Sino - Forest, such as Ip, Hung and Ho, to be wary of this practice.

[381]The Respondents submit the BVI AR/AP Set-Off Process was employed by many companies in Mainland China and was well-known within Sino-Forest, including to the Board of Directors, and to E&Y. Moreover, Pöyry, an independent forestry valuator, conducted annual site visits to Sino-Forest’s timber assets and never raised any questions about the legitimacy of the BVI business. Hung and Ip maintain they would therefore be justified in thinking the BVI Model, which was in use when they both joined Sino-Forest, constituted a bona fide business.

[382]In addition, Chan submits, as CEO, he relied on K.K. Poon and the Operations Department for their forestry education, skills and expertise and, in particular, to interface with the Chinese domestic companies and people necessary to conduct the day-to-day standing timber business.

[383]Chan submits Mr. Poon established Sino-Forest’s forestry business and had the technical knowledge about the species of trees, growing considerations, forest management, resource conservation and harvesting. He submits Mr. Poon was

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responsible for managing all Sino-Forest’s operations, including the standing timber business, for the ten years before Ip became involved, recruited management for Sino-Panel’s Operations Department and established Sino- Forest’s business relationships in the Chinese forestry industry.

[384]Chan submits he similarly relied on Albert Ip and Albert Zhao, who took over Mr.

Poon’s responsibilities for BVI standing timber purchases and sales. Chan submits Mr. Zhao was responsible for negotiating sales with the AIs and, additionally, liaising with local governments, and Ip was responsible for the general supervision and management of the Sino-Panel Group.

[385]Chan submits his role in Sino-Forest’s standing timber business was to set the strategy, including which provinces to expand into, establish a budget, approve purchases, and sign contracts for standing timber. He submits his “frontline” role in the field as CEO was largely ceremonial, and his reliance on others was reasonable as there were no red flags that should have alerted him to potential issues in Sino-Forest’s BVI business.

2.BVI Purchase Documentation

[386]Staff alleges the BVI purchase contracts and their three attachments were fundamentally flawed.

[387]Mr. Horsley, Mr. Clifford and the Independent Committee all believed the purchase contracts and the Forestry Bureau Confirmations were the primary evidence of Sino-Forest’s ownership of the BVI standing timber holdings. We first consider the purchase contracts.

(a)Purchase Contracts

[388]Sino-Forest’s purchase contracts in the BVI Model followed the same standard template. They were prepared by Sino-Forest personnel and signed and/or chopped by K.K. Poon or Ip, and the supplier. When translated into English, they were generally four pages in length.

[389]Purchase contracts contained a “Subject of Acquisition” clause which provided little detail about the asset being purchased. For example, a BVI purchase contract from October 2010 provides the following limited amount of detail about the asset that is the subject of the transaction:

Tree Species: Yunnan pine, broad-leaved trees.

Location: Lijiang City

Area: 102,449.90 mu (6,829.99 hectares)

Timber Stock: 810,792.17 m3

Proprietorship: Collective proprietor

Plantation area measurements are generally expressed in “mu”, a Chinese measurement of land. 15 mu is roughly equivalent to one hectare. Harvested timber is generally priced by volume and measured in cubic meters. The stock volume in a purchase contract for standing timber would be an estimate of the yield upon harvesting.

[390]BVI purchase contracts also included provisions for obtaining harvesting permits and logging the timber, and the right of first refusal on the transfer of forestland after harvest. They also specified that the rights being transferred were standing timber rights.

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[391]Sino-Forest entered into MFAs (Master Framework Agreements) for provinces in which it purchased standing timber. MFAs were designed to lock in a supplier who would either provide standing timber directly, or get other suppliers to sell standing timber, to Sino-Forest. These MFAs were not referenced in Sino-Forest’s purchase contracts, which were with various third party suppliers and not limited to suppliers with whom Sino-Forest entered into MFAs.

[392]Each Sino-Forest standing timber purchase contract recited it included the following three attachments:

a.Survey Report;

b.Villagers’ Resolutions; and

c.Forestry Rights Certificate (i.e., PRC) or other proof of ownership to verify the ownership of such timber.

[393]Each purchase contract referred to Villagers’ Resolutions and PRCs as attachments. Ip, Xu Ni (Sino-Forest’s Vice-President of Legal Affairs) and Kenny Wong (a Sino-Panel employee who reported to Hung) stated they never saw a

Villagers’ Resolution attached to any BVI standing timber purchase contracts.

The Second IC Report states none of the BVI contracts had either a PRC or a Villagers’ Resolution attached. Following the release of the Muddy Waters Report, the Independent Committee asked Sino-Forest management to obtain these attachments and the Independent Committee advisors asked the suppliers to obtain the same documentation. Nothing was produced.

[394]In Staff’s review of the BVI purchase contracts during the investigation into this matter, Staff was unable to find any attachment (b) or (c), above. Ms. Shao testified that these were never provided by Sino-Forest, although requested by Staff. Ms. Man confirmed that she never saw a Villagers’ Resolution attached to a

BVI purchase contract and never saw a PRC for a BVI standing timber purchase

[395]The Respondents submit Sino-Forest’s Legal Department developed the purchase contract template and Forestry Bureau Confirmation template. Xu Ni had no forestry experience or legal training in forestry. She stated the templates were drafted with the help of outside legal counsel and including the PRCs and

Villagers’ Resolutions as attachments was on the advice of ext ernal counsel. She stated, however, that she had never seen these attachments for purchases in the BVI Model. She agreed if attachments were missing, there would be problems “to understand the ownership of title, if the timberland exists, and where those trees are”. Ms. Xu Ni stated she raised these issues about attachments to purchase contracts with Chan and the Operations Department.

[396]Prior to Q2 2010, K.K. Poon signed every BVI purchase contract on behalf of Sino-Forest. Subsequently, they were signed by Ip. Each quarter, the purchase contracts were prepared by Kenny Wong along with the Forestry Bureau Confirmations, which we discuss next. Kenny Wong prepared all the BVI purchase contracts by merging a template contract with an Excel spreadsheet of purchase information emailed to him by Hung.

[397]Mr. Clifford explained the process he followed in E&Y’s review of the purchase contracts for the audits of Sino-Forest from 2007 to 2010. He testified the critical components of standing timber purchase and sales contracts, which were

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in Chinese, were explained to him by an E&Y Chartered Accountant on the audit team who was fluent in that language. Mr. Clifford testified he was not aware two of the attachments contemplated in the purchase contracts were not in fact attached, and did not recall whether he was aware that these attachments were required. After reviewing the Second IC Report, Mr. Clifford was “disappointed in the fact that, you know, evidence that was supposed to be there was not attached to those contracts” (Hearing Transcript, November 17, 2014 at 94:21- 23).

(b)Forestry Bureau Confirmations and PRCs

i.Forestry Bureau Confirmations

[398]We first consider one of the three documents meant to be attached to purchase contracts, Forestry Rights Certificates (i.e., PRCs) or other proof of ownership.

[399]Official government PRCs were never issued as proof of ownership for Sino -

Forest’s purchases in the BVI Model. Ip and Xu Ni stated PRCs could not be obtained for standing timber ownership alone. Hyde and Ip further testified that BVIs, as foreign companies, could not own land use rights . As discussed elsewhere in these Reasons, eligibility of foreign companies to obtain PRCs in different provinces and counties varied during the Material Time, as did Forestry Bureau practices with respect to the registration of separate ownership of standing timber and land use rights. We heard evidence changes to the legal regime were contemplated that would permit the registration of standing timber alone; this practice had not been implemented by the Forestry Bureaus in the regions where Sino-Forest operated. When the Independent Committee advisors visited Forestry Bureaus, a number of Forestry Bureaus expressly indicated foreign offshore companies (such as BVIs) were not entitled to obtain PRCs. We find it more likely than not PRCs could not and would not be issued to Sino- Forest BVIs during the Material Time because (i) they traded in only standing timber, and (ii) they were foreign offshore companies.

[400]In circumstances where Sino-Forest subsidiaries (BVI and WFOE) could not obtain PRCs as proof of their asset ownership, Sino -Forest sought alternative evidence of ownership in the form of Forestry Bureau Confirmations. For every BVI purchase and for those WFOE purchases that did not involve land use rights, Sino-Forest instead requested Forestry Bureau Confirmations. Forestry Bureau Confirmations were documents prepared by Sino-Forest on the basis of a template, issued on the letterhead of the applicable local Forestry Bureau and addressed to the supplier selling timber assets to Sino-Forest. During the Material Time, the content of the Forestry Bureau Confirmation followed the same general format, an example of which is provided in a Confirmation issued by the Hezhou City Forestry Bureau to one of Sino-Forest’s suppliers, Dacheng, in 2008. It reads:

To: Guangxi Dacheng Wood Co., Ltd.

CC: Sino-Panel (Hezhou) Co., Ltd.

We have received the "Timber Acquisition Contract" ("Contract") (see the attached detailed list of contracts) submitted to our office by your company. After examination,

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we agree to your company's transfer of the relevant eucalyptus, pinewood, and mixed-wood to Sino-Panel (Hezhou) Co., Ltd. according to the terms specified in the Contract.

With regard to your application for processing the change of timber ownership, we are temporarily not able to process the registration of the change in the relevant timber ownership to the transferee, Sino-Panel (Hezhou) Co, Ltd. since our city has not implemented in full the works of forest rights registration, licensing, and the reissue of the new version of the forest rights certificate. Our office agrees that we shall arrange to process the above for Sino-Panel (Hezhou) Co., Ltd. and issue "The People's Republic of China Forest Rights Certificate" according to the uniform timetable of the city government.

At the same time, our office confirms that, upon the maturity of the eucalyptus, pinewood and mixed-wood under the provisions of the Contract, Sino-Panel (Hezhou) Co., Ltd. shall have the rights to harvest, transport and sell the aforementioned mature timber according to the law. We also agree that the aforementioned mature timber shall be listed in the harvesting quota of that year and ensure the harvesting quota allocation to Sino-Panel (Hezhou) Co., Ltd. However, prior to harvesting and transportation, applications for the corresponding harvesting and transportation permits must be made to our office according to the law.

This serves as our certification.

The Forestry Bureau Confirmation was sealed with the chop of the issuing Forestry Bureau. Listed on a second page was the name of the seller, purchaser, area in hectares, stock volume in cubic metres and the date the contract was signed, which was also the same date as on the Confirmation. Forestry Bureau Confirmations issued during the Material Time consistently stated, in effect, the local Forestry Bureau had not yet fully implemented changes to the forestry registration regime but would issue PRCs at some future time. The message did not change during this five-year period.

[401]Ip testified Forestry Bureau Confirmations were sought at the request of Sino -

Forest’s Legal Department. He explained industry practice was not to issue PRCs unless the transfer of land use rights was involved and it was uncommon to request some other form of proof of ownership from Forestry Bureaus. Rather,

Forestry Bureaus obliged the request from the “Canadian side” and agreed to issue Forestry Bureau Confirmations as evidence of standing timber ownership. Ip explained the requirement for Forestry Bureau Confirmations as being a unique requirement for Sino-Forest, as a Canadian company operating in Mainland China:

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It is a cultural difference between the East and the West. In China, in the forestry industry, it was very straightforward. You buy, you sell. And the PRC is only issued where land is involved.

For Sino-Forest, the legal department requested for the confirmation letter because of the Canadian side request to

in order to evidence ownership, the confirmation letter had to be issued, and therefore the suppliers had to arrange with the forestry bureau to issue this confirmation letter.

And, in fact, sometimes I would be laughed at. They would say, jokingly, “You want to buy these vegetables growing in the fields? Would you request the farmer to issue an ownership right before you will buy these vegetables from the fields?” They would say that.

(Hearing Transcript, September 16, 2015 at 16:2-17)

[402]Signed Forestry Bureau Confirmations were supplied to, and relied on by, Sino-

Forest’s auditors. Josephine Man of E&Y testified that, based on discussions with

Sino-Forest management and legal opinions from Sino-Forest’s counsel, E&Y understood Forestry Bureau Confirmations to be documents the Forestry Bureau would issue under normal circumstances and were evidence BVI subsidiaries were the legal owners of the plantation assets from the date of the purchase contract. She understood Forestry Bureau Confirmations were obtained in circumstances where Sino-Forest was not able to obtain the new form of PRC as a result of Forestry Bureau backlog in implementing forestry reform at the local level. This was consistent with statements in the Forestry Bureau Confirmation letters. From discussions with Mr. Horsley, she further understood Sino-Forest had applied for PRCs for all its plantation purchases, but because Sino -Forest held timber assets for relatively short periods, the Forestry Bureau did not have enough time to process its requests for PRCs. As we discuss further below, Sino- Forest did not apply for PRCs in the BVI Model. Although E&Y reviewed PRCs for some WFOE purchases, Ms. Man never saw a PRC for a BVI standing timber purchase and was never told they were not available to BVIs for standing timber purchases.

[403]Mr. Clifford testified he understood Forestry Bureau Confirmations to be official government documents that were only issued after the purchaser and vendor delivered the purchase agreement to the Forestry Bureau, along with supporting documentation that could, in fact, be the PRC. He understood the Forestry Bureau would complete its due diligence with respect to that transaction and would then issue the Forestry Bureau Confirmation, which was satisfactory evidence of title.

[404]Josephine Man testified she understood the Forestry Bureau Confirmations were prepared and issued by the Forestry Bureau. Ms. Man further testified the terms “Forest Rights Certificate” (i.e., PRC) and Forestry Bureau Confirmation were used interchangeably by the E&Y audit team in documents that referenced checking to ensure Sino-Forest had legal title and ownership. We find these two documents were not equivalent.

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[405]The Respondents submit the Forestry Bureau Confirmation together with the purchase contract are sufficient proof of the transfer of ownership of forestry rights. Sino-Forest obtained legal opinions from external counsel, including one for the benefit of E&Y in 2008, which stated if PRCs could not be processed because of Forestry Bureau backlog, Forestry Bureau Confirmations were valid proof that Sino-Forest BVI subsidiaries owned the standing timber they acquired through purchase contracts. In an interview with Staff during its investigation into this matter, Xu Ni agreed that without the PRC, there was a significant risk that Sino-Forest did not own the assets it claimed to own. The issue of BVIs not being able to obtain PRCs came to Xu Ni’s attention in 2003, the year she joined

Sino-Forest. Nonetheless, the BVI purchase contracts continued to reference PRCs.

[406]During the hearing, we learned the Forestry Bureau Confirmation was originally created by Sino-Forest and was presented to the Forestry Bureau by the supplier to affix its official chop to the document. The Independent Committee advisors initially understood the Forestry Bureau Confirmations were independently obtained by suppliers from the Forestry Bureaus. However, they learned these Forestry Bureau Confirmations were actually prepared by Sino -Forest, and, in at least some cases, on the official letterhead of the local Forestry Bureau. Generally, the supplier had the local Forestry Bureau transfer the Confirmation, prepared by Sino-Forest, onto Forestry Bureau letterhead and chop it. Hung oversaw the preparation of Forestry Bureau Confirmations. They were prepared by Kenny Wong, along with the purchase contract documentation, after the quarter in which Sino-Forest recorded the purchase. Although the Confirmations had the same date as the purchase contract to which they related, Hung explained this was at the request of the Sino-Forest Legal Department and was not the date on which the Forestry Bureau actually chopped the document.

[407]In contrast to the process for issuance of PRCs, according to Ip, the Forestry Bureau did not require the presence of the seller and purchaser for the issuance of Forestry Bureau Confirmations. Rather, Ip explained it was the supplier’s responsibility to have the Confirmations issued, and Sino -Forest personnel would only visit the Forestry Bureau to deal with issues about harvesting quotas and inquiries about whether there were forests available for purchase in the jurisdiction. Sino-Forest would ask the supplier to request the Forestry Bureau issue the Confirmation.

[408]The Forestry Bureau Confirmations were standard in format and stated the Forestry Bureau had reviewed the purchase contract, approved the contract arrangement and confirmed that BVIs were entitled to harvest, transport and sell timber. The term regarding harvesting contradicts evidence we heard from Mr. Liu that an owner of standing timber requires a PRC, or the assistance of a PRC holder, to obtain a harvesting permit.

[409]The sample Forestry Bureau Confirmation at paragraph [400], above, states the

Forestry Bureau is “temporarily not able to process the registration”. This is misleading, as it implies the Forestry Bureau would be able to issue a PRC to a BVI at some point in the future. This is untrue – a PRC would not be issued to a BVI.

[410]The Forestry Bureau Confirmation also states the Forestry Bureau agrees to issue PRCs to BVIs and to register the timber ownership “according to the

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uniform timetable of the city government”. This term – that the Forestry Bureau will issue a PRC to the BVI – is false and calls into question the authenticity of the document itself, as Forestry Bureaus would have been aware that foreign companies, such as BVIs, could not obtain PRCs. No evidence was presented that there was a “uniform timetable” to issue PRCs to BVIs.

[411]Mr. Henderson testified the primary objective from the onset of the Independent Committee investigation was to reconfirm the original Forestry Bureau Confirmations, as they were the primary piece of information supporting title to Sino-Forest’s standing timber. In their November 13, 2011 Report on Process to Date (a schedule to the Second IC Report), the Independent Committee advisors state:

Senior Management expressed strong concerns about approaching the forestry bureaus to reconfirm existing confirmations obtained by the Company. Reasons for these concerns included:

(i)such confirmations were not standard forestry bureau documents, contained statements that could embarrass the forestry bureau officials (see (iii) and

(iv)below), and were issued as a favour to the Company;

(ii)SF had been asked to keep the existence of such documents confidential, so if any party other than SF was to seek reconfirmation of them, the forestry bureaus would likely deny having issued them;

(iii)the forestry bureaus may have exceeded their authority in issuing such confirmations, especially as they related to harvesting and transportation rights, and therefore the officials could risk sanctions if they reconfirmed the earlier documents;

(iv)references contained in the existing confirmations may contradict the position of the Chinese Central Government and thus cause embarrassment to officials, since many of the forestry reforms may not have been implemented; and

(v)the relationships developed by SF with the forestry bureaus would be jeopardized by this process.

[412]The Report on Process to Date set forth 18 factors which affected these visits and the confirmation process, including:

management did not provide a comprehensive list of plantation assets reconciled to its financial statements until June 23, 2011;

shortly after the Muddy Waters Report, management caused all Forestry Bureau Confirmations to be relocated from their various locations in the Sino-Forest organization to Guangzhou, which resulted in a delay in these documents being available to the Independent Committee advisors. Management explained the Forestry Bureaus wanted them returned as they may have exceeded their authorities in

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confirming some rights. The confirmations were not returned to Forestry Bureaus, but were sighted by Independent Committee advisors in the offices of Sino-Forest’s Chinese counsel;

Forestry Bureau officials were not required to meet with the advisors;

prior to August 29, 2011, the Advisors were not allowed to ask any questions relating to existing Forestry Bureau Confirmations. The new Forestry Bureau Confirmations that were issued simply confirmed that Sino-Forest had a contract to purchase standing timber;

the time made available for meetings with Forestry Bureaus was limited and the Independent Committee advisors were not permitted to ask certain questions;

certain Forestry Bureaus either deferred or denied advisors access to their plantation rights registries;

in some instances, the new Forestry Bureau Confirmations would not be issued on Forestry Bureau letterhead, which was inconsistent with prior practices and in one instance, the new Confirmation was not issued by the Forestry Bureau but by the “social institution legal person”; and

at one Forestry Bureau meeting, management represented an individual to be Forestry Bureau First Vice Chief, when in fact this person was no longer in that position and had been paid by Sino - Forest for several months prior to the visit to act as a consultant. In another visit, the Independent Committee advisors learned that the former Vice Chief of the Forestry Bureau was assigned since 2008 to work with Sino-Forest to assist it in conducting its business. This Vice Chief continued to receive a salary from the Forestry Bureau while working with Sino-Forest.

[413]The Independent Committee was unable to obtain insight into the Forestry

Bureaus’ process for issuing Confirmations. The internal authorization process is unclear, as the Confirmations were chopped by the Forestry Bureaus but the name of the authorizing Forestry Bureau official did not appear on the document.

[414]The due diligence process is also unclear, especially given the apparently short turnaround time in which the Forestry Bureau Confirmations were issued. Evidence of 17 Forestry Bureau Confirmations prepared by Sino-Forest in Q4 2010 illustrates this point. These Forestry Bureau Confirmations were sent out, chopped and returned all within 34 days.

[415]However, the evidence suggests the process for confirming or transferring ownership was both cumbersome and complex. As of January 12, 2011, Sino- Forest had prepared unsigned, unchopped draft purchase contracts and Forestry Bureau Confirmations. For the 17 BVI standing timber acquisitions in Q4 2010, Sino-Forest would presumably have adhered to the following purchase process timeline:

draft purchase contracts would have been sent to five different suppliers in Mainland China to be signed (and/or chopped);

these contracts would then be sent back to Sino-Forest for Ip to sign;1 1

1 1 There is some discrepancy about where BVI purchase and sales contracts were physically signed. Management representation letters provided to E&Y and Sino-Forest process descriptions indicate that they were signed in Mainland China. However, Horsley testified it

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the signed contracts and draft Forestry Bureau Confirmations would then be sent to the five suppliers who sold standing timber to Sino-Forest BVIs in Q4 2010 for distribution to 13 different county Forestry Bureaus spread across five provinces;

after a due diligence process, which according to the Second IC Report and confirmed by Ip, would include Forestry Bureau officials reviewing contracts and upstream PRCs, an on-site investigation and confirmation of ownership with villagers, the Confirmations would have been chopped by the Forestry Bureaus;

the 13 Forestry Bureaus would return the contracts and chopped Confirmations to the five suppliers; and

finally, by February 14, 2011, the five suppliers would return the contracts and chopped Confirmations for the 17 purchases to Sino- Forest.

According to Sino-Forest’s documentation for Q4 2010, this process occurred within 34 days.

[416]The Forestry Bureaus were located in 13 different counties, in remote locations, described by Chan’s counsel as “far-flung provinces of China” (Hearing

Transcript, April 27, 2016 at 70:16-17). Mr. Hao testified, in order to confirm ownership and issue a PRC, the Forestry Bureaus would have to confirm the boundaries of the plantation, that there were no disputes and, where the land use rights were held by a village collective, that two-thirds of the villagers consented to the transfer. However, Mr. Hao could not opine on whether the

Forestry Bureaus’ due diligence for Confirmations was equivalent to the process that occurred when issuing PRCs. When the Independent Committee advisors sought to have new Forestry Bureau Confirmations issued following the release of the allegations in the Muddy Waters Report, they were told by a Forestry Bureau Vice-Chief that it would take approximately four weeks to issue a new Confirmation because due diligence needed to be conducted. Ip agreed the due diligence process described in the Second IC Report was consistent with his understanding of the work done by Forestry Bureaus prior to chopping a Confirmation.

[417]However, the Independent Committee advisors established Forestry Bureaus did not keep track of standing timber-only changes in ownership. Hyde explained they asked several Forestry Bureaus how they were able to issue new Confirmations if they did not maintain records or monitor transfers of standing timber. The Forestry Bureaus stated they had done work, but the Independent Committee advisors were not able to ascertain the nature of this work. The Panel did not hear an explanation as to how the Forestry Bureaus could therefore confirm the supplier had the legal right to transfer ownership of the standing timber to Sino-Forest. We find the geographic distances, the many steps to get the contracts signed and the Forestry Bureau Confirmations issued, make it more likely than not the process for confirming ownership simply did not happen.

was important the contracts be signed in Hong Kong, and not Mainland China, so there would be no risk of creating a permanent establishment in Mainland China relating to the BVI business.

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[418]Examples of the dubious reliability of Forestry Bureau Confirmations are found in the Gengma #1 Transactions and the Gengma #2 Transactions, analyzed elsewhere in these Reasons. In the Gengma #1 Transactions, a Forestry Bureau Confirmation purports to confirm the transfer of standing timber from Yuda Wood to a Sino-Forest BVI subsidiary, Suri-Wood Inc. (Suri-Wood). Yuda Wood never registered its ownership, and a WFOE subsidiary of Sino -Forest already held a PRC issued for the same plantation. In the Gengma #2 Transactions, a Forestry Bureau Confirmation purports to confirm a transfer of standing timber from Yuda Wood to Suri-Wood despite the fact that Yuda Wood was never the registered owner. Moreover, in both the Gengma #1 and Gengma #2 Transactions, the contracts indicate that Sino-Panel (Yunnan) is the purchaser, not Suri-Wood.

[419]E&Y, in its annual due diligence audit process, never visited a Forestry Bureau. An internal E&Y memorandum dated July 26, 2010 refers to a rumour from a business contact of a retired E&Y partner who raised concerns about the authenticity of sales and purchase transactions with authorized intermediaries. As a result, E&Y had contemplated visiting the Forestry Bureaus during the 2010 audit as part of the increased rigour of audit procedures around Sino -Forest’s business with the authorized intermediaries. However, Horsley informed E&Y that Sino-Forest management, and Chan specifically, was not supportive of E&Y visiting the Forestry Bureaus. Clifford testified E&Y determined in the end it was unnecessary for them to visit Forestry Bureaus.

[420]Initially, the Independent Committee had been under the (mistaken) impression that the Forestry Bureau Confirmations had been independently obtained by the suppliers. Mr. Henderson testified the Independent Committee advisors initially did not think there would be any problem in obtaining reconfirmation as they had no reason to believe there was any issue in doing so. In the end, the Independent Committee did not reconfirm existing Forestry Bureau Confirmations, as they concluded this would be disruptive to Sino -Forest’s existing Forestry Bureau relations. Instead, a new form of Confirmation was issued in some, but not all, instances. The Second IC Report describes these new form Confirmations as having “a more limited scope (i.e. did not address issues such as transportation, harvesting, and sale, as SF did not have those rights)” (Second IC Report at 42) and only state BVIs had contractual rights, rather than addressing other ownership characteristics . The new Confirmations only confirmed the existence of purchase contracts, but they did not confirm Sino-Forest owned the standing timber. In contrast, the original Forestry Bureau Confirmations contain the statement that the Forestry Bureau confirms the Sino -

Forest BVI subsidiary “shall have the rights to harvest, transport and sell the aforementioned mature timber according to the law”. The original Forestry

Bureau Confirmations purport to confirm rights to the timber Sino -Forest never had.

[421]Mr. Henderson of PwC testified he discussed the Forestry Bureau visits with Chan. The Independent Committee advisors were instructed by the Independent Committee not to make direct contact with Forestry Bureau officials as management had cited strong concerns such contact would negatively impact Sino-Forest’s relationship with Forestry Bureaus. As such, the Independent

Committee advisors required management’s assistance in organizing Forestry

Bureau visits. However, they encountered various problems, some of which are

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detailed here. First, the Forestry Bureau Confirmations had been relocated from Sino-Forest offices in Hong Kong to John Zeng’s Kai Tong Law Firm's offices in Guangzhou. John Zeng played a central role in the Greenheart Transactions. Ip admits to issuing the request to move the Forestry Bureau Confirmations to Mainland China after the release of the Muddy Waters Report. Staff submits Sino-Forest initially tried to hide the Forestry Bureau Confirmations, but in the end had no choice but to produce them since Sino-Forest had been holding them out in support of their ownership claims to standing timber. Ip claims this was simply a miscommunication. Second, the Forestry Bureau officials were under no obligation to meet with the advisors. Third, prior to August 29, 2011, meetings were limited in time and the advisors were not permitted to ask questions to the officials. Fourth, the Second IC Report states the process for Sino-Forest employees to arrange meetings had “taken some time”. Mr. Ardell considered these visits so crucial in establishing ownership he got down on his knees asking for Ip’s help to arrange these visits.

[422]The Independent Committee advisors ultimately visited nine Forestry Bureaus. However, they were not provided with contact information for the individuals with whom they met, as they requested. Although the Independent Committee advisors planned to meet with multiple senior individuals, in five instances, they met only one individual, which, according to the Independent Committee advisors, increased the risk the individual may be impersonated. Two Forestry Bureau officials were on Sino-Forest’s payroll during the Material Time. In addition, the Second IC Report notes that gifts or cash payments were made to Forestry Bureau officials. Finally, every Forestry Bureau official confirmed they did not keep track of standing timber-only transactions, which again raises the question: How could the Forestry Bureaus confirm standing timber ownership in the BVI Model to Sino-Forest?

[423]The Forestry Bureau Confirmations were drafted by Sino -Forest, prepared after the end of the quarter and backdated to the date of the contract. As a result, the dates of the Confirmations were not the dates on which they were chopped by Forestry Bureaus, which, in some cases, were months after the date on the Confirmation. Mr. Hao agreed the date on the Confirmation should reflect the date the Forestry Bureau chopped the document, which could not be the date of the contract. Of greater significance, the Forestry Bureau Confirmations do not contain specific location information or identify the specific forest asset transferred to Sino-Forest.

ii. Comparison of PRCs and Forestry Bureau Confirmations

[424]PRCs provided specific information on the location of the forestry assets, often to the county level, along with any colloquial name. They also provided descriptions of each compartment’s boundaries to the four cardinal directions. As an example, one of the PRCs relating to the Gengma #1 Transactions includes the following location information for a plantation acquired by Sino-Panel (Gengma):

Situated at: Upper Xinhua Group, Nanmounong Village Committee, Gengma Town

Colloquial Name: Yanbabashan

Forest Compartment: 9, 49

Sub-Compartment: 9(9, 16), 49(10)

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To the Four Cardinal Directions

oEast: To Village level highway as the boundary

oSouth: To the land of Lower Xinhua as the boundary

oWest: To the boundary with Lower Xinhua collective forest o North: To the land of Yang Laosi family

[425]The forest compartment and sub-compartment numbers listed in PRCs were those maintained by the Forestry Bureau. As discussed elsewhere in these Reasons, in contrast, compartment numbers in the BVI Survey Reports did not correspond with those maintained by the Forestry Bureaus, making them useless in locating plantation assets and therefore attempting to confirm Sino -Forest’s ownership of a plantation.

[426]No location details similar to those in PRCs are provided for plantations whose ownership is evidenced by Forestry Bureau Confirmations. The information provided in Forestry Bureau Confirmations, as described in paragraph [400], was merely a brief summary of some key data (i.e., seller name, purchaser name, area, stock volume and contract date) taken directly from the purchase contract.

[427]Another distinguishing feature of Forestry Bureau Confirmations is they do not include the name of the Forestry Bureau official who chopped them. In contrast, forestry regulations required PRCs be issued by qualified persons and that those persons be identified on the PRC.

[428]We heard expert evidence from Mr. Hao and Mr. Liu on forestry regulation and registration of forestry ownership in Mainland China.

[429]Mr. Hao explained forestry reform in China began with amendments to the Forestry Act in 1998 when China began to implement a new registration system, whereby the legal proof of ownership of forestry rights is provided by the issuance of PRCs. Forestry plantation ownership in Mainland China is reviewed in greater detail elsewhere in these Reasons in our discussion of Sino-Forest’s Timber Business in Mainland China.

[430]The due diligence process undertaken to issue a PRC required the confirmation of land boundaries and a two-week public notice period aimed at identifying any disputes. This process took approximately one month. If the transfer involved forestry land owned by a village collective, the consent of two -thirds of the villagers was also required.

[431]Jinrong Liu, a lawyer licensed to practice Mainland Chinese law, was qualified as an expert in the hearing in areas that include whether a BVI entity may hold a PRC. He testified the owner of standing timber must register that ownership via a PRC, as well as any change in ownership. Mr. Liu explained the difference between a contractual right and an ownership right. In the case of a standing timber transfer, while a contract may be valid against the parties, the ownership and property rights cannot be transferred until the ownership is registered. Therefore, even if all the conditions of a purchase contract are satisfied, the transfer of ownership is not effected until registration is completed. This means , in the absence of registration, a purchaser of standing timber does not own the standing timber and therefore cannot mortgage the standing timber, obtain a harvesting permit without the assistance of the registered owner, or transfer

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(i.e., sell) the standing timber. Sino-Forest never registered its ownership of standing timber in the BVI Model.

[432]Ownership is registered through a PRC. Mr. Liu testified about the difference between a valid contract and a registered right. With a valid contract, a purchaser can enforce its rights against the other contracting party but not third parties. With a registered right, a purchaser can enforce its rights against all parties. A Forestry Bureau Confirmation is not a registered right.

[433]The Panel heard conflicting evidence as to whether or not a Forestry Bureau would issue a PRC for standing timber only, that is, without land use rights. This is further discussed elsewhere in these Reasons in our discussion of Sino-Forest’s Timber Business in Mainland China. There was evidence that Sino-Forest had obtained at least one PRC for standing timber, but only in the WFOE Model for two compartments. However, Ip and Xu Ni stated BVIs could not obtain PRCs. The Panel also heard evidence suppliers would not always obtain PRCs in their own names before selling the standing timber to Sino-Forest, further complicating the process. In any case, we have evidence Forestry Bureaus did not keep track of changes in ownership of standing timber-only transfers, and they therefore would not know if any standing timber-only transfers had taken place after a PRC had been issued.

[434]The Panel finds the Forestry Bureau Confirmations are of no use in establishing Sino-Forest’s ownership.

iii.Legal Opinions

[435]The Respondents submit legal opinions from external counsel affirmed Sino- Forest had title to standing timber purchased in the BVI Model by virtue of a contract and a Forestry Bureau Confirmation. Staff submits the legal opinions are, with one exception, very general; they do not provide sufficient context and none indicate Sino-Forest’s BVI subsidiaries legally owned the standing timber.

[436]The March 2008 legal opinion from Jingtian & Gongcheng Attorneys at Law (Jingtian), obtained by Sino-Forest for E&Y, begins with the following legal disclaimer:

Your Company [Sino-Forest] has given your assurance that the documents made available are complete and genuine, all the seals affixed to the document made available are genuine, photocopies of the documents are consistent with the original documents, and that all facts and documents that can affect this legal opinion letter have been disclosed to Our Firm without any concealment, inadvertent omissions or errors.

In this legal opinion letter, Our Firm has expressed our legal opinions only on the basis of the relevant facts confirmed by Your Company as well as Our Firm’s understanding of such facts and comprehension of the relevant laws and regulations.

It is clear from this disclaimer Jingtian is relying on the documents that Sino- Forest provided them, including the Forestry Bureau Confirmation, which states

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the Forestry Bureau is temporarily unable to issue a PRC since the "county is in the process of developing the work concerning the reissue of new forest rights certificates [PRCs]” and that PRCs will be issued to the BVI subsidiaries “according to the uniform time”. Based on the information provided by Sino- Forest, Jingtian’s opinion letter states the PRCs may be issued to the BVI subsidiaries after they have legally signed the acquisition contract (a statement we find to be incorrect). Further, the legal opinion does not reference oral agreements or the fact the Forestry Bureau Confirmations are backdated. The opinion also states it has not reviewed three of the four attachments to the contract: a second report by the survey company, the Villagers’ Resolutions or the PRC “or other documents of ownership proof”.

[437]Jingtian’s opinion letter further states that Sino-Forest can provide Forestry Bureau Confirmations as evidence to third parties on the “lawfulness of the forest rights that they possess.” Yet, the Independent Committee noted that some Forestry Bureaus indicated the Confirmations could not be shown to third parties.

[438]Jingtian also stated after the BVI subsidiaries have a legally signed acquisition contract with the supplier and processed the required approval formalities as well as obtained a PRC, their lawful rights over the acquired forests can be proved as such. Jingtian further stated if the old version of the PRC cannot be processed, the BVI can apply for a letter of confirmation as valid proof of ownership of standing timber. We have no evidence as to whether or not Jingtian knew or should have known BVIs could not obtain PRCs, but it appears Jingtian was under the impression that BVIs could obtain them.

[439]In a December 2006 Commerce & Finance Law Offices (C&F) opinion in evidence, which is in draft form and unsigned, C&F states BVIs’ rights to log, transport and sell standing timber are subject to the BVIs obtaining the authorizations and/or consents from the original owners of the plantations. This is consistent with Mr. Liu’s testimony that without registration of standing timber ownership, a purchaser does not own the timber and could not mortgage, harvest or sell the timber without the assistance of the registered owner. As we have noted elsewhere, these authorizations (i.e., Villagers’ Resolutions) were never attached to BVI purchase contracts. This condition was not included in any later opinion letter by either C&F or Jingtian. Mr. Clifford testified this point was never raised in any due diligence calls with underwriters and this condition was inconsistent with his understanding of the contract process.

[440]In their June 2009 opinion, C&F also assumed BVIs could obtain PRCs. It appears these two major Mainland China law firms believed Sino-Forest BVIs could obtain PRCs, and the reason they did not was due to backlogs and/or the slow transition to a newer version of PRCs. It is unclear to us why both firms laboured under this mistaken assumption.

[441]In addition to the Jun He opinion discussed below, we have reviewed 11 opinion letters from two law firms (Jingtian and C&F) provided between 2006 and 2010 in connection with various underwritings. The substance and wording of each of the 11 opinion letters were remarkably similar – essentially boilerplate. Each reviewed a standard purchase contract, a Survey Report and a Forestry Bureau

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Confirmation. We have already addressed the incorrect facts within the Confirmation letters.

[442]Jun He Law Offices (Jun He) was Chinese counsel retained as advisors by the Independent Committee. In closing submissions, counsel for Ip, Hung, Ho and Yeung stated that:

whatever ambiguity or whatever questions we may have about the Jingtian opinion or the forestry bureau confirmation letter, Jun He and the Independent Committee with full knowledge of all of that still said these forestry bureau confirmation letters are helpful, they’re going to give us a measure of comfort because the forestry bureau is the adjudicator of first instance.

The forestry bureau confirmation letter gets us to a half-full glass. All my clients are saying is a half-full glass is better than an empty glass and we got the best that we could on the instructions of external and internal legal counsel.

(Hearing Transcript, May 4, 2016 at 38:19-39:9)

[443]One of the assumptions of Jun He’s opinion letter to the Independent Committee was that each party to the Forestry Bureau Confirmation had the necessary capacity, power and authority to execute, deliver and perform its obligations. Yet, as the Independent Committee indicated, the Forestry Bureaus may have exceeded their authority by issuing these Confirmations to Sino -Forest. Second, the letter states the Forestry Bureau Confirmations do not serve as PRCs and are not definitive evidence of ownership of the standing timber. Third, the enforceability of the standing timber purchase contracts is subject to potential challenges from the de facto owners of PRCs or bona fide third parties. Fourth,

Jun He’s letter confirms the purchase contracts in the BVI Model are legally binding on the parties to the contract. Mr. Liu confirmed the contracts could be used to enforce rights against the contracting parties, but not against third parties. Last, Jun He stated a BVI purchase contract with only a Forestry Bureau

Confirmation would be void without a PRC or a Villagers’ Resolution. Sino -Forest would have no contractual right except a cause of action against the supplier who was counterparty to the contract. We disagree with the Respondents ; we find Jun He’s opinion did not provide comfort that the glass was “half full”.

[444]The legal opinions of Jingtian and C&F were based on the assumption that Sino- Forest provided complete and genuine disclosure of all relevant documents and facts, as is evidenced by the disclaimers in their letters. We find Sino-Forest did not provide accurate and full disclosure to its outside counsel in respect of the Forestry Bureau Confirmations.

[445]The Respondents submit Staff’s allegation regarding the availability of PRCs is a new allegation. They argue Staff only raised this allegation in its closing submissions, and they were deprived of, among other things, the opportunity to cross-examine witnesses about their knowledge of this issue. In response, Staff

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points to specific references in the Statement of Allegations that explicitly reference Sino-Forest’s disclosure of PRCs for its purchased plantations. There is no requirement to plead all evidence in the Statement of Allegations. The Panel agrees with Staff; we find the issue regarding BVIs not being able to obtain PRCs is not a new allegation.

[446]Sino-Forest’s disclosure gave the impression the reason it did not obtain PRCs in the BVI Model was because there were backlogs at Forestry Bureaus due to a change in forestry policy, and the delays in obtaining PRCs would be rectified. Ip knew foreign companies, such as BVI subsidiaries, could not obtain PRCs and Sino-Forest was not even applying for them.

[447]Xu Ni raised problems of missing key documents with Chan, specifically, with respect to ownership of title, existence of timberland and location of trees. Given his strong understanding of the forestry business and industry in China, his close connections to government and his intimate involvement in the process for every purchase of standing timber, we find Chan was fully aware Sino -Forest BVI subsidiaries could not obtain PRCs.

[448]We find Chan, Ip and Sino-Forest did not disclose that Sino-Forest’s BVI subsidiaries could not obtain PRCs and thus could have no ownership claim to the BVI standing timber assets because those rights had not been registered.

[449]Given the fact Forestry Bureau Confirmations did not provide registration of ownership of standing timber, the questionable due diligence process undertaken by Forestry Bureaus and the lack of any specific location information included in the Forestry Bureaus Confirmations, the Panel finds the disclosure relating to Forestry Bureau Confirmations as proof of legal ownership to be deceitful. We find the Forestry Bureau Confirmations do not establish Sino -Forest’s legal ownership of standing timber in the BVI Model.

(c)Villagers’ Resolutions

[450]Villagers’ Resolutions are explained in the Second IC Report. It notes if forestry land is owned by a village collective, the validity of each standing timber purchase contract is subject to the authorization of that village collective, which takes the form of a Villagers’ Resolution.

[451]No examples of Villagers’ Resolutions were submitted in evidence. As noted above, Ms. Man testified she did not recall ever having seen a Villagers’

Resolution attached to any BVI standing timber purchase contract.

[452]Xu Ni also testified she had never seen a Villagers’ Resolution attached to any contract, despite the fact every purchase contract listed one as an attachment .

[453]Hung testified he did not know the importance of Villagers’ Resolutions:

Q.Just again on the issue of farmers' authorizations, did you yourself have any insight as to whether or not these documents were important for purchases of standing timber?

A.I do not know.

Q.So you don't know whether they were important or unimportant?

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A.Because I was not involved in the process I do not know whether it's important.

Q.Do you know whether or not they were referenced as attachments to purchase contracts?

A.I know.

Q.And these were purchase contracts that you directed their creation of?

A.Yes.

(Hearing Transcript, October 23, 2015 at 37:7-21)

[454]We find Hung’s response incredible. Hung was a process owner for the purchase documentation process which we describe elsewhere in these Reasons . The Villagers’ Resolution was a key missing element of the purchase documentation.

(d)Locating the Standing Timber

[455]Neither the BVI purchase contracts nor their attachments enabled one to locate the standing timber assets Sino-Forest purported to own.

[456]Part of the Independent Committee’s asset verification process was intended to locate specific plantations owned by Sino-Forest using Survey Reports that accompanied each BVI standing timber purchase contract. The Second IC Report recounts the inability of the Independent Committee advisors to verify locations of standing timber based only on location descriptions that were general in nature. Mr. Pomeroy was asked if the Independent Committee advisors ever considered buying a chain saw. He responded: “… it was a bit of a running joke that we should cut down a tree and see who comes running, and that's how you'd find the true owner of the trees”. The Independent Committee advisors never participated in such an exercise because “… No one on our team ever made it to a plantation” (Hearing Transcript, December 9, 2014 at 94:3-6 and 9- 10). It is clear from the testimony of Mr. Pomeroy and Mr. Henderson the Independent Committee advisors exhausted every available avenue trying to locate BVI plantations, but ultimately failed.

[457]One of the main objectives of the Independent Committee investigation was to locate the plantations in order to help prove existence, ownership and value of Sino-Forest’s standing timber assets — in other words, it would help answer the question, “Where are the trees?” Sino-Forest did not maintain records of locations of specific plantations, and the Independent Committee advisors found the contracts, Survey Reports, maps and Forestry Bureau Confirmations did not contain sufficient detail to identify the plantation locations.

[458]Ip admitted a plantation could not be located using solely a purchase contract and a Survey Report. The Independent Committee arrived at the same conclusion. Ip explained when Sino-Forest needed to obtain the exact location of a plantation in the BVI Model, it would get this information from the survey company. The location descriptions in the BVI contracts are general, and Ip

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testified Chan instructed: “We should keep secret the location of the forest purchase, not letting other people know because we discovered that wherever Sino-Forest went, other competitors followed, causing prices of forest purchase to rise and the forest purchase not being that smooth” (Hearing Transcript, May 7, 2015 at 38:25-39:5). WFOE purchase contracts, in contrast, provide detailed information through the attached PRCs, which reference the village name and the plantation’s boundaries to the four cardinal directions. The Panel was not provided with any explanation why WFOE plantation locations did not have to be kept secret, in contrast to Ip’s explanation about the need for secrecy for BVI plantation locations.

i.Maps

[459]Ip testified that Sino-Forest’s BVI subsidiaries could not retain maps because of their military significance. The possession of maps was a sensitive security issue in China, and we heard anecdotal evidence regarding an individual who was imprisoned by the Chinese government for losing a map and Pöyry employees who were expelled from town for being in possession of maps. Mr. Hyde testified this fear of criminal sanctions was a reason other forestry companies in China do not retain maps. We note Pöyry reports reference maps; however, there was no explanation as to how this foreign company retained maps legally.

[460]Mr. Clifford of E&Y testified he understood Sino-Forest and Pöyry could locate the timber. He attended site visits with Pöyry and observed the timber. He did not, however, know the approximate area covered in Pöyry site visits.

[461]Mr. Hao testified there is a legal restriction on maps of a certain scale. In the forestry industry, only maps to the legal scale may be held. Mr. Hao acknowledged that, in his experience, maps were attached to contracts.

[462]The Second IC Report concluded:

Management has explained that it reviews maps that allow them to locate the properties but does not retain them. The IC has not been able to verify this explanation and notes the Plantation Rights Certificates in the Company’s possession in respect of WFOE timber transactions have detailed location descriptions. The IC Advisors were able to verify that most Mandra and SW [Sino-Wood] purchase contracts have attached to them either a map or a description of boundaries or both. It is not clear to the IC Advisors how the Company would be able to identify the relevant areas of timber purchased by the BVIs at the time of sale or harvesting.

Mr. Hyde confirmed the Independent Committee was told other forestry companies in China similarly do not retain maps, which were considered state secrets, for fear this practice could subject them to criminal sanctions.

[463]The Respondents submit Pöyry reviewed plantations annually and never had any issues regarding the adequacy of the maps provided. Pöyry reviewed less than 1% of the area that Sino-Forest reported it owned every year (0.5%, 0.5% and 0.3%, respectively, in each of 2007, 2008 and 2009). We do not know whether or how much of this area was owned through the BVI or WFOE Models. It is also

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important to note that Pöyry did not review contracts, PRCs, Forestry Bureau Confirmations or Survey Reports and did not address ownership of the assets. Rather, Pöyry’s assumption was that title to forest assets was in accordance with data provided by Sino-Forest. On a conference call with analysts on June 2, 2011 at 1:00 a.m. GMT, Pöyry agreed the area reviewed was “extremely small” and that the area where satellite imagery information was compared with mapping information “was about 0.1 [%] of the forest estate”. Pöyry goes on to state: “…we are not holding this out that this is a verification of the total area … we … largely rely on the area estimates provided by the client”. Pöyry’s role in the annual valuation of Sino-Forest’s forestry assets is discussed elsewhere in these Reasons in our discussion of Sino-Forest’s Timber Business in Mainland China.

[464]Following the release of the Muddy Waters Report, the Independent Committee undertook a proof of concept exercise. The Independent Committee selected two compartments to test, which were successfully located using maps provided by Sino-Forest. These compartments represented only 147 hectares out of the 466,826 hectares Sino-Forest owned in the BVI Model as of 2010. Given the sample size, the results could not be extrapolated to all of Sino -Forest’s holdings. Further, the asset verification did not address title to, or value of, the assets.

[465]Following the initial proof of concept exercise, a broader asset verification test was implemented. This test was discontinued at the request of Sino -Forest’s bondholders due to cost constraints and difficulties in obtaining maps for non- leased land (i.e., BVI holdings). Of the 520,435 hectares Sino-Forest reported owning in the BVI Model as of December 31, 2011, the independent forestry experts were only provided maps for 5,542 hectares for BVI plantations, representing approximately 1% of BVI holdings. At that date, the total BVI standing timber book value was US $2.9 billion.

ii.Survey Reports

[466]Sino-Forest used the company Zhanjiang Southern Forestry Projects Quality Supervision Co. Ltd. (Zhanjiang Southern) exclusively to prepare Survey Reports for BVI purchase contracts. Lu Qiding was Vice-President, Wood Resources of Sino-Panel (China) Investments Ltd. until November 2008. Throughout the Material Time, he functioned as the head of Sino -Panel’s Resource Department, reported to Ip, was involved in the due diligence process to determine the suitability of timber acquisitions, and was a 10% shareholder of Zhanjiang Southern. Subsequent to November 2008, Lu Qiding retired but worked for Sino-Forest as a consultant and received monthly compensation of

RMB 24,000. From Ip’s testimony, it did not appear that his responsibilities changed after November 2008. Lu Qiding retained Zhanjiang Southern to prepare Survey Reports, and he oversaw survey preparations and survey company field visits. Further, Qi Shuxiong, a former director of two Sino -Forest subsidiaries and a former supervisor of a Sino-Forest subsidiary was an 80% shareholder of Zhanjiang Southern. According to the Second IC Report, Zhanjiang Southern was paid a consultancy fee of RMB 883,750 for its work for Sino-Forest during 2010 and Q1 2011.

[467]Survey Reports were prepared in batches after quarter-end and backdated. Survey Reports were purportedly completed before the date of the oral purchase agreement. They were all signed by a single person, notwithstanding they related to plantations located all over Mainland China. In addition, they did not

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include specific location descriptions necessary to locate the plantation being purchased. Evidence shows Sino-Forest staff was involved in preparing the Survey Reports and making changes to the completed reports. Locations were changing in Survey Reports even after financial statements had been filed and made public. For example, locations changed in February 2011 for contracts purportedly entered in October and November 2010 with a value of RMB 436 million. Corresponding Survey Reports were revised in April 2011. The assets at issue would have been included in the 2010 financial statements which were filed on SEDAR on March 15, 2011. Evidence was presented that indicates Sino-Forest employees reverse-engineered some Survey Reports in order to arrive at the desired area, volume and yield. This is discussed in more detail in our review of the Q4 2010 purchase documentation process.

[468]It is significant the compartment numbers identifying the land that was the subject of the Zhanjiang Southern Survey Reports were specific to Sino -Forest and did not correspond to any official centralized Forestry Bureau database. This is in contrast to the compartment numbers listed on PRCs found in the WFOE Model, which did correspond to the official database. As a result, there was no way to ensure the compartments outlined in a particular Forestry Bureau map were, in fact, the compartments referenced in a particular Survey Report or contract. This meant third parties could not independently confirm ownership of Sino-Forest’s standing timber in the BVI Model since they would be unable to locate the plantation.

[469]When asked whether Sino-Forest assigned the compartment numbers in the Zhanjiang Southern Survey Reports, Ip responded:

According to my understanding, after the survey, some of the compartments were changed and there were changes, therefore, to the numbering of the compartments. From what I understand, when doing the survey work, the survey company would get the maps from the supplier, from the forestry bureau, and the survey company will, according to the maps, carry out the work, and the compartments at times will be changed and given new numbers after that.

(Hearing Transcript, October 7, 2015 at 94:14-22)

[470]When asked whether he was aware the compartment numbers in the PRCs did not match those in the Survey Reports, Ip said: “It was not brought to my attention. … It is possible that the survey companies would rearrange the compartment numbers” (Hearing Transcript, October 7, 2015 at 95:3-4, 8-9). Although Ip referred here to “survey companies,” the Zhanjiang Southern Survey

Reports were the only ones in evidence that provided compartment numbers for land in respect of purported BVI purchases that did not correspond to compartment numbers at the Forestry Bureaus.

[471]The lack of specific location identifiers in the Zhanjiang Southern Survey Reports does not appear to be consistent with industry standards. Mr. Hao testified he would expect a Survey Report to specify the location of assets, with references to the village name and the plantation’s boundaries to the four cardinal

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directions. He also testified it was important for a survey company to be an independent source of verification.

[472]The Respondents deny having any improper role in creating and reverse- engineering Survey Reports. They also deny having any knowledge that Lu Qiding was a shareholder of Zhanjiang Southern. Lu Qiding advised Sino -Forest he received shares of Zhanjiang Southern in 2003, did not pay for them and shortly after resigned from that company in 2004, at which time he no longer considered himself to be a shareholder of Zhanjiang Southern. The SAIC filings in respect of Zhanjiang Southern however, continued to report Lu Qiding as a 10% shareholder.

[473]Neither Survey Reports nor maps in the BVI Model during the Material Time provided sufficient information to locate the trees owned by Sino -Forest. This failure to disclose specific locations contributes to our finding that Investors’ pecuniary interests were put at risk.

(e)Timing and Scope of the Purchase Documentation Process

[474]Sino-Forest prepared, approved or revised documentation (including the Forestry Bureau Confirmations) at the end of, or after, each quarter.

i.The BVI Model

[475]The BVI Model is described in detail elsewhere in these Reasons in our discussion of Sino-Forest’s Business Models. While the rationale for using BVIs ended in 2004 with the change in Chinese government policy and law, Sino -Forest continued to conduct the majority of its business through the BVI Model during the Material Time. Staff submits the reason for this was because the BVI Model was opaque and malleable.

[476]The BVI Model was opaque because there was no cash audit trail. BVI companies could not have bank accounts in Mainland China. Currency controls in China restricted payments of cash by Chinese companies to BVI companies. As a result, the BVI accounts receivable and payable were all settled through offset payments, the authenticity of which could not be verified because there was no evidence of cash changing hands for any of the transactions (further explained below). There were no maps attached to, and no specific locations described in, the contracts, the Forestry Bureau Confirmations or the Survey Reports. Finally, the BVI Model involved a concentration of duties among a small group of senior management, including Chan, Ip, Poon, Hung, Lu Qiding and Mr. Zhao (Senior Vice-President of Sino-Forest).

[477]The BVI Model was malleable because the entire model existed entirely on manual spreadsheets created and maintained by Hung, which could be edited at any point in time and could accommodate the backdating of contracts . This method of record-keeping is in contrast to the Kingdee accounting software used in the WFOE Model, which did not allow for the backdating of contracts. The Survey Reports were all prepared by a company in which Lu Qiding had a 10% ownership. Lu Qiding reported to Ip and was directly responsible for purchasing forestry assets and hiring the survey company. Evidence indicates Sino -Forest employees made changes to Survey Reports long after purchase contracts were signed and settled, and even after financial statements reflecting those purchases were published. Internal approval forms were backdated and Forestry Bureau Confirmations were prepared by Hung and his team at the same time

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purchase contracts were prepared at or after the end of the quarter when the purchase was made and recorded in the financial records of Sino -Forest. Essentially, all relevant documentation was prepared by Sino -Forest and backdated.

[478]The Panel finds the BVI Model was opaque and malleable and enabled the Respondents to perpetrate fraud, as we conclude elsewhere in these Reasons.

[479]Hung was at the centre of the BVI documentation process and was a key player in the concealment of Sino-Forest’s internal control weaknesses, described in greater detail elsewhere in these Reasons. He created spreadsheets , which recorded the details of purchase and sale transactions. He stated that he obtained these details about the purchase and sales transactions in phone conversations with Ip and Albert Zhao, respectively. He testified that during these phone calls, he recorded the details of transactions worth billions of renminbi on sticky notes that he kept in his office and later transferred those details onto his spreadsheets. Hung also created the schedules for offset payments, deciding which customer should pay which supplier according to the aging of receivables. From these schedules, the set-off documents described below were derived. Further, Hung attended all the customer and supplier interviews during E&Y’s annual audits. We find Hung was the central and crucial figure in the Deceitful Documentation Process.

[480]The documentation process for BVI purchase contracts was generally unchanged throughout the Material Time. To illustrate the process, we have reviewed the evidence Staff submitted for Q4 2010 and Q3 2009 and highlight certain noteworthy facts. These examples provide clear evidence Sino -Forest’s post- quarter documentation process was not merely an exercise of transcribing oral agreements entered into during the previous quarter. Changes to fundamental aspects of purchase contracts and supporting documents occurred long after the dates of the oral agreements and after the quarter in which Sino-Forest recorded the acquisition of the asset.

ii.Q4 2010

[481]We reviewed the process documentation for the Q4 2010 transactions, which began a few days prior to the quarter-end. This started with email exchanges between Ip, Chan and Hung dated December 28 and 29, 2010, which discuss the purchases to be recorded for Q4 2010.

[482]On January 4, 2011, the Resource Department sent Hung a spreadsheet of purchases without dates, prices or names of the BVI subsidiary making the purchase or the supplier. When questioned as to why this information was missing, despite the fact it all would have been available at the time of purchase, Hung could not provide an explanation. Hung then added this missing information, as well as the sequential numbering of transactions. Hung testified he received this missing information from Ip during the course of the quarter, which he would have recorded on sticky notes. Purchase contracts for Q4 2010 had not yet been prepared at this time in January 2011, after the end of Q4.

[483]Throughout January 2011, changes were repeatedly made to details of purchases in order to meet certain volume targets. The first summary table sent

to Hung on January 4, 2011, lists 14 purchases with a stock volume of 9,174,846.98 m3 . On January 6, 2011, an employee of Sino-Forest’s Resource

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Department sent Ip an email with a revised summary table. The email states: “700,000 cubic metres have been added according to your instruction.” The revised table lists an additional two purchases, for a total stock volume of 9,910,086.56 m3 . Hung explained he had recorded more purchases on his sticky notes than those in the original summary table provided, and he asked Ip to have employees from the Resource Department check their records.

[484]On January 7, 2011, the same employee from the Resource Department sent

Hung an email attaching a further revised summary table that records an increase in total stock volume by 800,000 m3 and asking Hung to provide the

“contracting parties, amounts, etc., so that the timber acquisition documents can be completed.” We note the Resource Department is asking Hung for information it should already have.

[485]The Respondents submit there is some confusion regarding the translation of this email which makes it unreliable. Ip testified he understood the employee to be asking for the contract format or template, not the parties to the contract. However, the Resource Department had no need for contract templates as these were prepared by Hung’s department. Hung testified the employee knew the missing purchase information and was merely being sarcastic, or “ironic,” as Hung had notified Ip of the Resource Department’s error with respect to the missing recorded purchases. In reading this last email in conjunction with the previous emails, we reject Ip’s and Hung’s explanations.

[486]An attachment to an email dated January 9, 2011 lists 17 purchases in five provinces for a total stock volume of 9,972,230.53 m3 . This contrasts with the

first summary table that lists 14 purchase contracts with a total stock volume of 9,174,846.98 m3 . At this stage, Kenny Wong, Hung’s subordinate, inserted the information from the latest spreadsheet into standard template purchase contracts by doing a “mail merge”.

[487]On that same date, contract numbers were added sequentially to the final iteration of the table. The sequential numbering of the purchases listed in the table was designed to be a control feature. As each purchase was made, it would be added to the table and assigned a number in sequence, chronologically. This was important from a cut-off perspective as it was designed to ensure the transactions entered into within the reporting period were properly recorded. The process that actually happened with the purchases in Q4 2010 did not have the control benefit of sequential numbering. Rather, the contracts were sequentially numbered after the end of the quarter, a process which adds no value from a control perspective.

[488]On January 11, 2011, an email from another employee of Sino -Forest’s Resource Department to Kenny Wong indicates the contracts had been “split up” and the Survey Reports were “currently under preparation”. The splitting of contracts refers to the splitting of one large purchase into smaller purchases. This enabled Sino-Forest to obtain Forestry Bureau Confirmations from county Forestry Bureaus rather than from provincial Forestry Bureaus, whose approval would be required for larger plantations. Instead, Sino-Forest applied to the local level

Forestry Bureaus, which according to Kenny Wong, was less “troublesome.”

Kenny Wong never prepared a Confirmation for a provincial level Forestry Bureau. The comment in the January 11 email regarding the Survey Reports being “currently under preparation” contradicts Sino-Forest’s process documents,

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which indicate the Survey Reports needed to be completed before the stock volume could be determined.

[489]On January 12, 2011, an email to Hung and others includes attachments showing the purchase contracts, purchase requisition forms (approval forms to enter into these contracts) and Forestry Bureau Confirmations were prepared after the quarter-end and backdated. According to the process description described below, requisition forms were required to be approved and signed before purchases were entered into.

[490]On January 13, 2011, Mr. Horsley advised Chan in an email most source documents for Q4 2010 purchases were still outstanding. Ten minutes later,

Chan forwarded Mr. Horsley’s email to Ip and Hung without adding any commentary, which indicates to the Panel Chan was aware of the Deceitful Documentation Process. Had Chan not been aware of the Deceitful Documentation Process, it is reasonable to assume he would have added some commentary asking why there was a delay before forwarding the email to Ip and Hung. As we discuss further below, we find Chan was involved in the Deceitful Documentation Process. Although Hung had the unsigned versions of purchase requisition forms, purchase contracts and Survey Reports at the time of

Horsley’s email, he did not forward them to Horsley.

[491]Purchase contracts remained unsigned as late as February 1, 2011. Chan signed all purchase requisition forms for Q4 2010 between January 17 and February 1, 2011.

[492]A February 24, 2011 email indicates three sets of contracts needed to be replaced “[a]ccording to the instruction of the leaders” and that Survey Reports and the relevant timber acquisition documents also needed to be replaced to reflect locations which had been changed. Hung agreed changing the location of standing timber is a significant change in a contract (particularly for these contracts, which represented RMB 436 million of assets) and is a matter that would have been reported to him. When asked if this error would have been discovered during the Forestry Bureau’s due diligence process for determining ownership, Hung replied:

The details as to what the forestry bureau base on, I do not know. From my knowledge, they would have to confirm that the ownership of the plantation had been transferred.

I really do not know about the details and specifics regarding this.

(Hearing Transcript, October 28, 2015 at 29:6-14)

This discrepancy, which went undiscovered by the Forestry Bureau during the due diligence of RMB 436 million of standing timber assets, casts further doubt on the authenticity and value of Forestry Bureau Confirmations in establishing ownership.

[493]Changes were made to these Survey Reports in the quarter after purchase contracts were signed and settled and two quarters after the oral agreements so

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as to ensure the details in the Survey Reports aligned with those in the purchase contracts. Four out of 17 Survey Reports were revised after January 24, 2011 and another three were revised after April 8, 2011, which is several weeks after the filing on SEDAR on March 15, 2011 of Sino-Forest’s financial statements as at and for the year ended December 31, 2010. Changes in the Survey Reports included the afforestation year, average height and stock volume. These revisions are also discussed below in our analysis of the Dacheng allegations where we find the location descriptions and other information in Survey Reports continued to change into April 2011.

[494]For the three Survey Reports revised after April 8, 2011, reflecting a value of RMB 436 million, the change in locations could not have been reflected in the 2010 year-end financial statements filed in March 2011. The change in standing timber assets does not indicate the asset value is equivalent. The Forestry Bureau confirmed a purchase of assets, which were not ultimately purchased by Sino-Forest. This calls into question the proof of ownership of the asset when the underlying Forestry Bureau Confirmation proving ownership is wrong.

[495]The Panel finds at least some Survey Reports were reverse-engineered to match the purchase contracts. Survey Reports were created at the same time as purchase contracts although the purchase contracts indicate the survey has verified details such as area and stock volume. The process for preparing Survey Reports in Q4 2010 was not independent of Sino-Forest, as discussed below in our analysis of the Dacheng allegations. This example of the Q4 2010 BVI documentation process supports Staff’s position the BVI Model was opaque and malleable.

iii.Q3 2009

[496]The evidence related to the Q3 2009 purchase documentation process focuses on two purchases from a company called Yongzhou City Maoxiang Forestry Development Co. Ltd. (Maoxiang). The documentation indicates the dates of these two purchase contracts for just under RMB 400 million were changed from July 24 and July 30, 2009, to dates on or after August 7, 2009, because Maoxiang was not incorporated until August 7, 2009. An attachment to an email dated October 6, 2009 indicates purchase contracts were initially dated July 24 and July 30, 2009 and were settled through set-offs with full payments to Maoxiang between July 27 and August 7, 2009. Maoxiang confirmed receipt of these payments between July 31 and August 11, 2009. Five of the set -off payments were recorded as received before Maoxiang was even incorporated on August 7, 2009. Maoxiang could not have had a bank account to receive payment before that date. In another attachment to an email dated October 13, 2009, the contract dates and the set-off settlement dates of the two purchase contracts were changed to dates either on or after August 7, 2009, Maoxiang’s incorporation date.

[497]Upon discovering Maoxiang was not yet established, Ip asked Hung to have the payments rescinded. Ip’s understanding of this process was that it would involve a third company Maoxiang directed to receive payments on its behalf. This third company may, in turn, have directed a fourth or fifth company to receive payments; this has been referred to as the “daisy chain of cash”. When questioned about this process, Ip testified, “[t]here are things that I do not know concerning the actual operation of the arrangements” (Hearing Transcript,

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September 14, 2015 at 58:10-12). When asked if he would know who would be accepting payment on behalf of a supplier, as he was responsible for all purchases in the BVI Model, Ip responded, “I really didn’t know the identities” (Hearing Transcript, September 14, 2015 at 59:4-5). Ip’s response is not credible.

[498]When Hung was asked how Sino-Forest retrieved the funds paid in July before Maoxiang was incorporated, he first said the funds were “recovered subsequently, and then paid again to Maoxiang” (Hearing Transcript, October 26,

2015 at 81:15-16). The recovery of the full amount is consistent with the information recorded on the revised spreadsheet. The following day, Hung changed his testimony to indicate that only part of the payments may have been recovered because the “payment process was a very dynamic one”:

The AIs only told me that they will ask Maoxiang to return the money. As to when they were able to recover all of the money, they didn’t tell me. They only told me that they have paid a certain company, into certain accounts, and that the money should come back from this company. That’s all they said.

(Hearing Transcript, October 27, 2015 at 11:12-19)

[499]Hung did not mention the intricate “daisy chain of cash,” which would have required rescission of payments. When Staff suggested to Hung he was making up evidence as he went along regarding the dates of payment and receipt, Hung denied this. We reject Hung’s evidence regarding the payment chronology as not credible.

[500]Emails indicate Survey Reports were prepared at the same time as the purchase contracts and after Hung’s spreadsheet of purchase details was finalized.

Purchase requisition forms were backdated to before the date of the purchase contracts to give the impression the purchases were approved before entering into the contracts. The Forestry Bureau Confirmations were backdated to the date of the purchase contract, which purportedly was the date of the oral agreement. The Q3 2009 documentation process was similar to the Q4 2010 process described above. This example also supports Staff’s position the BVI

Model was opaque and malleable.

iv.Process Documents

[501]Staff submits that Sino-Forest’s formal process descriptions failed to accurately describe the purchase, sales and the AR/AP Set-Off processes for standing timber in the BVI Model. These documents were associated with an internal control certification project required to comply with NI 52-109. Mr. Maradin had a major role in working with Sino-Forest management to create the process descriptions. E&Y was retained to implement NI 52-109 requirements and also helped to create the process descriptions.

[502]The process documentation described the processes purportedly followed by Sino-Forest to document the purchases, sales and set-off payments for standing timber in the BVI Model, and described the segregation of duties. Both Ip and

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Hung were process owners for the standing timber purchase process and Hung was the process owner for the sale and set-off processes.

[503]The process owners were the sources for the detailed step-by-step description of each process. E&Y would create the document; the process owners would review the process narrative for accuracy and consistency with how they operated the business. Ms. Man testified she spoke with Hung and Mr. Maradin to gather the information for these descriptions. Hung acknowledged in his testimony it was his responsibility to ensure these were complete and accurate.

[504]E&Y made any revisions received from the process owners. The final versions were sent to Mr. Maradin. After he consulted with the process owners annually these documents were updated by Mr. Maradin.

[505]Initial versions of these documents were finalized in February 2009; subsequent versions were substantially similar.

[506]E&Y used these process descriptions as input for their audit process and to identify internal controls, or lack thereof. Mr. Clifford testified that as part of the audit process, these documents helped E&Y gain an understanding of Sino-Forest processes, and the internal control environment and infrastructure. They informed E&Y’s foundational knowledge of the operations of Sino -Forest.

[507]The Audit Committee reviewed the process documents as part of their oversight role. The process descriptions helped the Committee to understand what management was doing, and to ensure management had sufficient resources to meet the requirements of NI 52-109. Mr. Hyde indicated these documents were also used to identify gaps in internal controls and provided a full picture of who did what.

[508]The evidence, as described throughout these Reasons, shows the process documentation for purchases, sales and set-off payments for standing timber in the BVI Model was almost entirely inaccurate.

[509]The purchase process document described a chronological process, initiated by the Resource Department, which began with a preliminary survey of the identified plantation, followed by the preparation of the purchase requisition form, which was signed by Ip and approved by Chan. The Resource Department then prepared an application for a full scale survey, which was approved by Ip. Ip would have received approval from Chan to perform a full scale survey of the target standing timber plantation. The BVI purchase process document describes a process whereby Sino-Forest would have already obtained a signed purchase agreement and a signed Forestry Bureau Confirmation by the time a purchase is recorded in the books of Sino-Forest. This did not occur in practice.

[510]Hung was asked about the purchase process description:

Q.And I believe you've told us earlier that during this purchase process you would receive information from Mr. Ip that an oral agreement or handshake agreement had taken place with a supplier.

Do you recall that as a step in the purchase of BVI standing timber?

A.Yes.

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Q.I'm going to suggest to you, sir, that we don't see any reference to oral agreements or handshake agreements within this process description for the purchases of plantations.

A.We don't see it here.

Q.But you would agree with me this would be a very important part of the purchase of standing timber plantations; correct?

A.I agree.

Q.Because that is the date, I believe, that you thought the purchase agreement would be effective; correct?

A.Yes.

Q.Can you provide any explanation as to why there was no mention of this oral agreement or handshake in this process control?

A.First of all, the draft of this process description was not prepared by me. I told Tom [Maradin] everything I knew about this process. And after that, I also told Josephine Man of E&Y, and they did the first draft. After that, the finalized process document was completed and put into use.

And after that, every year I would go back to the process description to find out whether there were any changes or differences, and I do not know what is relatively more important in the process description. I would leave this decision to Tom and Josephine Man.

Q.But weren't Tom and Josephine Man looking to you to describe the process of purchasing standing timber and the details, the important details of that process?

A.Well, I had told them about the process, and there were others who had told them about the process.

(Hearing Transcript, October 23, 2015 at 9:21-11:12)

[511]We find the actual purchase process did not occur as set out in the process documents. We have received overwhelming evidence showing virtually all steps in the purchase process began after the period in which the purchases were recorded. Thus, the purchase process description was incorrect. As well, it was incomplete. It did not address how confirmations were prepared, it did not

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mention sticky notes, batching, oral agreements, handshake agreements or the post-quarter process in which substantially all documentation was prepared, including, for example, the initial purchase requisition form. In reality, this requisition form was prepared at the same time as the purchase contract, which was based on an oral agreement. In effect, the approval to purchase was signed after the oral agreement.

[512]Ip and Hung were the process owners for the process descriptions in the BVI Model and annually confirmed their accuracy. Chan reviewed at least first versions of these process descriptions. E&Y relied on the process descriptions during their audits of Sino-Forest and assumed they were a true reflection of what actually occurred.

v.Backdating of Purchase Documentation

[513]The Respondents submit the timing of contract preparation was well known within Sino-Forest and it was simply a more efficient way of getting the paperwork done. Ip testified Lu Qiding and his staff of the Resource Department travelled a great deal throughout the quarter and dedicated the last couple weeks of each quarter to complete the necessary documentation, a task which they found frustrating. Ip described Lu Qiding in the following way:

Lu Qiding, well, I would liken him to a monkey running around in the mountains looking for forests, and he and his team at quarter end will have to come back to the office in time to prepare the paperwork.

(Hearing Transcript, September 11, 2015 at 51:15-19)

[514]The Respondents submit although the written purchase contracts were backdated, they reflected oral agreements entered into on the date reflected in the final written contract. The legal enforceability of oral contracts in Mainland China was an issue raised in the hearing. Gavin Hao, an expert in the Chinese forestry industry, testified, based on his experience, “a contract with a villager is not very much different from a piece of blank paper” (Hearing Transcript, April

28, 2015 at 89:5-6). He explained private companies or state-owned enterprises are often helpless when it comes to contract disputes with villagers. Many courts will support the villagers, even when written contracts exist, and, even if penalties are imposed on villagers for breach of contract, enforcement can be very difficult. Although contracts were technically enforceable between the parties to the contract, Mr. Hao’s evidence about the practical enforceability of contractual obligations regarding the transfer of standing timber rights in Mainland China demonstrates the importance of additional proof of ownership.

[515]Assuming one accepts the Respondents’ submission that an oral agreement was a valid contract for revenue recognition at the time of the handshake, significant changes to the original terms would invalidate the original oral agreement, according to the expert evidence on Chinese law.

[516]Jinrong Liu testified that under Chinese law, oral agreements are valid and enforceable, but a written contract is required to register the transfer of ownership and obtain a PRC. To be valid, an oral contract would generally include the names of the parties, the targeted matter, quantity, quality, price or

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remuneration, time, place and mode of fulfillment, liability for breach of contract and dispute mechanism.

[517]As we discuss elsewhere in these Reasons, we saw evidence of changes to names of the parties, the location of the timber, quantity, quality (tree species), and price from the time of the oral agreement to the time of the executed written contract. Thus, the oral agreement would not be valid and recording the assets based on the oral agreement would be misleading.

[518]Mr. Liu explained that a buyer with a written contract, but no registration (a PRC) would not defeat a claim of a purchase from a registered owner; a buyer who has not registered cannot mortgage the standing timber, nor can the buyer obtain a harvesting permit without the assistance of the registered owner. And while legally a buyer who has not registered cannot transfer the standing timber, in practice this can be done, as long as the registered owner accompanies the non-registered owner to the Forestry Bureau to transfer the ownership to the third party.

[519]A written contract without registration allows the buyer to enforce his or her rights against the other contracting party, but not against third parties, whereas a contract and registration allows a buyer to enforce his or her rights against all parties. Registration demonstrates ownership.

[520]Mr. Liu stated in his expert report a purchase agreement may become effective when duly entered into by the parties. Upon cross -examination, he agreed that the effectiveness of a contract can also be impacted by the parties attaching a condition or conditions. A contract is not necessarily effective on the date it is entered into as there may be conditions attached which go to its effectiveness.

[521]He further testified parties to an oral agreement cannot back out of the deal just because the agreement has not yet been put in writing. He clarified, however, this is not true in cases where the oral agreement and the written agreement differ – for example, if the parties or the terms of the agreement change.

[522]Even if they were based on earlier oral agreements, Sino-Forest’s written purchase contracts raise additional concerns. According to Ip: “The date of the handshake deal would be the date on which Sino-Forest and the supplier confirmed the transaction. And when I say ‘confirmed the transaction’, I mean when the area and the unit price is fixed” (Hearing Transcript, September 11,

2015 at 23:9-13). Yet, we saw emails and heard testimony that areas, stock volumes and prices changed well after the date of the purchase contract, which was the date of the handshake agreement. Ip testified “What is most important in the contract is the price. So once we agree on the price of them there is nothing to change except perhaps the location or some detailed information”

(Hearing Transcript, May 6, 2015 at 63:21-24). Ip’s testimony further convinces us whatever oral discussions may have occurred between Sino -Forest and a supplier, these discussions would not necessarily reflect the economic and legal reality expressed in the written contracts, as the Respondents claim.

[523]The Respondents submit the practice of backdating written contracts to the date of the oral agreement was in fact appropriate because it reflected the date of the actual contractual obligation to purchase. Oral agreements may be an accepted practice in China; however, if volumes and locations, among other key contract terms, changed well into the subsequent quarter, then the original handshake

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agreement would no longer be valid. It follows, then, those contracts would reflect terms and details that differ from those which had been agreed to at the time of the handshake deal.

(f)Conclusion on Purchase Documentation

[524]The Respondents’ description of the purchase process, based on handshakes, phone calls and sticky notes involving billions of renminbi, is simply not believable.

[525]We find the purchase contracts and their three key attachments were fundamentally flawed. The Forestry Bureau Confirmations do not establish Sino -

Forest’s ownership of standing timber in the BVI Model. Standing timber locations could not be located based on the contract, Forestry Bureau Confirmation or Survey Report. The Survey Reports were prepared by one survey company in the quarter after the purchase took place, and we saw examples of Sino-Forest employees reverse-engineering them. Finally, although the purchase contracts referred to Villagers’ Resolutions and PRCs as attachments, there were never any such attachments to BVI contracts. We find there is no evidence that ownership of standing timber was ever transferred to Sino-Forest in the BVI Model. We find Sino-Forest employed a deceitful documentation process whereby Sino-Forest drafted and executed purchase contracts and Forestry Bureau Confirmations in the quarter after they were dated and the subject assets were recorded. We also find that the purchase documentation does not establish proof of ownership and does not identify the location of the standing timber such that its existence can be readily and independently verified. We find the purchase documentation process was deceitful.

3.BVI Sales Documentation

(a)Sales Contracts

[526]The sales contracts and sales process are described in the Second IC Report:

the BVIs sold standing timber through sales contracts. These contracts were signed between BVIs and AIs, Mainland Chinese-incorporated companies that engage in timber trading. Under a typical sales contract, the AI is entrusted by the BVI to sell the BVIs’ standing timber assets located in Mainland China on its behalf;

notwithstanding its role as “agent,” the sales contracts stipulate that the AI is directly liable for paying Sino-Forest. The AI’s obligation to make payment to Sino-Forest is not conditional upon the AI selling the standing timber to its customers. For this, the AI receives no commission or fee from Sino-Forest; and

in reality the sales contracts are principal-to-principal contracts and do not involve an actual “agency” arrangement. The Independent Committee understood, for revenue recognition purposes, management treated BVI sales transactions as being complete upon the sale to the AIs.

(Second IC Report at 51)

[527]The documentation process for the BVI sales contracts was generally unchanged during the Material Time. To illustrate the documentation process, we have

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reviewed the evidence Staff submitted for Q4 2010 and highlight certain noteworthy facts. These examples provide clear evidence Sino -Forest’s post- quarter documentation process was not merely an exercise of transcribing oral agreements entered into during the previous quarter.

[528]The initial document evidencing Sino-Forest’s revenue in the BVI Model was the sales contract.

(b)Timing and Scope of the Sales Documentation Process

[529]Similar to the purchase documentation, Sino-Forest prepared, approved and revised the sales documentation after the end of each quarter. Sino -Forest relied on its sales contracts to determine revenue; however, as discussed in greater detail below, Sino-Forest recorded revenue prior to executing the sales contracts.

i.Q4 2010

[530]Sino-Forest began to prepare documentation for Q4 2010 sales on January 3, 2011.

[531]Similar to the purchase process, Hung testified he received the details of sales transactions throughout the quarter and would record them on sticky notes, which he then transferred to a spreadsheet. Hung began the sales documentation process for Q4 2010 by sending a spreadsheet containing information necessary to prepare the sales contracts to Kenny Wong in an email

dated January 3, 2011. The attached sales summary lists 73 sales in three provinces with a stock volume of 6,608,265.25 m3 and a total sales price of RMB 3,604,252,380. Of that total, RMB 2,978,388,099 (or 83%) represented sales of logs, which we now know to be simply uncut trees. The original purchase dates, purchase contract numbers, locations (province level), species, area, and yields are identified for each sale. The sales contract dates, prices and customers are identified for each sale; however, no sales contract numbers are indicated. No sales contracts had yet been prepared as at January 3, 2011.

[532]None of the sales contracts included a village name, which means the plantation location could not be sufficiently identified. For example, in a sales contract between Suri-Wood and Nanchang City Tongdasheng Industry Co., Ltd, the place of delivery is the “forest site of [Suri-Wood] where Such Timber is located”, which was Rongshui County, Guangxi Province. No more specific location description is provided.

[533]On January 13, 2011, Mr. Horsley advised Chan most source documentation for the BVI and WFOE Q4 2010 period was outstanding, including sales contracts and acknowledgment of receipts of logs. Mr. Horsley requested Chan ask Hung,

Ip and Albert Zhao “to get the info in asap”. Ten minutes later, Chan forwarded Mr. Horsley’s request to Ip and Hung (but notably not to Mr. Zhao, who was responsible for BVI standing timber sales), without adding any commentary. Similar to the purchase documentation process, Chan was clearly aware that the sales documentation process was batched and backdated.

[534]On January 14, 2011, Hung produced a revised sales summary, which was identical to the sales summary from January 3, except for the addition of the contract numbers and revised contract dates. Hung testified contract numbers are meaningful, as they show the order of contracts according to the dates of the

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contracts. This is consistent with Mr. Maradin’s testimony. Therefore, this reordering to reflect revised dates with corresponding contract numbers destroys any relevance of the sequential ordering. Kenny Wong’s transcript evidence shows he would drop the information from the spreadsheet into standard template sales contracts by doing a “mail merge”, similar to the purchase process.

[535]On January 18, 2011, the dates of the Confirmations of Sales Situations (documents provided to Sino-Forest by customers which confirm the execution of the sales contract and purport to indicate the actual harvested volume of, and yield of, the standing timber sold) were revised to post-date each respective sales contract (previous versions of confirmations were all dated September 30, 2010). For example, in the contract noted above (between Suri-Wood and City Tongdasheng Industry Co., Ltd.), the contract is dated October 6, 2010, whereas the Confirmation of Sales Situation, which states harvesting is complete, is dated September 30, 2010. This Confirmation of Sales Situation states , “…we confirm…

the actual sales quantity” and indicates harvesting is complete with quantity of

108,443.61 m3 . This statement is misleading as the trees remained uncut, but it implies, with a precision to two decimal places, that timber has been harvested.

[536]Kenny Wong emailed Hung regarding this date problem on October 14, 2010. He stated: “For the log sales contract[s], since I still havent confirm [sic] the date for the ‘confirmation’ w/ you, I have just put 9/30 … .” Mistakenly, they had all been sent to the Finance Department. He goes on to state that he “can still ‘re- do’ the ‘confirmation’” (so as not to raise E&Y’s concern) but that later contracts should “be changed to standing timber sales contracts to avoid the issue with the ‘confirmation’”. When asked why “re-do” was in quotation marks, Hung stated that he found it to be “strange” (Hearing Transcript, October 23, 2015 at 51), but the Finance Department suggested the term “re-do” included “something of impropriety” (Hearing Transcript, October 23, 2015 at 53). When asked why the word “confirmation” was also in quotation marks, Hung stated it corresponded t o the same word in the previous paragraph (which did not explain why the previous “confirmation” was in quotation marks) and he did not think it was related to the suggested impropriety surrounding the word “re-do”. We reject Hung’s evidence on this point.

[537]The October 14, 2010 email also raises the issue of dating Confirmations of Sales Situation late in August 2010 such that E&Y would not accept them for the cut - off date of August 31 (the cut-off date referred to a proposed financing). The problem arose because, logistically, the customer could not harvest the timber in such a short time period, which would be a red flag to E&Y. Kenny Wong notes in the email another employee suggested changing the contracts dated close to the end of August to be standing timber sales contracts, thus avoiding the problems with the “confirmation”. The casual ease with which Sino-Forest employees suggest altering contracts post-quarter-end further supports our finding below that the sales documentation process was deceitful. Further email correspondence indicates Chan signed all 73 Q4 2010 contracts on or shortly before February 1, 2011.

ii.Sales Documentation Process

[538]Evidence shows all of the documentation to substantiate sales transactions actually took place were prepared by Sino-Forest. All sales contracts and

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supporting documents were batched, backdated and signed after quarter-end. Contract numbers were assigned sequentially after the initial draft of the spreadsheet was prepared, thus rendering the chronological numbering irrelevant. Any changes to such documentation were made after the transactions were reported to have occurred. There is no evidence Sino-Forest applied for revised Forestry Bureau Confirmations for partial sales of standing timber plantations, although this step is outlined in the process description. As with the purchase process, Chan was aware the sales contracts were prepared in batches and backdated. Similar to the purchase process, what actually took place did not match the process description whatsoever, the accuracy of which was Hung’s responsibility and which he confirmed annually was a true reflection of what actually occurred.

[539]Hung knew the sales contracts were prepared and signed after the end of the quarter, and, as a member of Sino-Forest’s Disclosure Committee, he knew Sino-

Forest’s revenue recognition policy did not disclose this practice.

[540]Sino-Forest included in each BVI purchase contract a clause which gave Sino - Forest the right of first refusal to acquire the land use rights after harvesting of the plantation purchased by the BVI, or equivalent forest land use rights, for up to 50 years. The contracts also included a clause which allowed those rights to be transferred to other companies within Sino-Forest. According to Ip, since a BVI could not hold land use rights, a WFOE would acquire them. Ip agreed Sino - Forest was acquiring a valuable right but testified Sino-Forest never exercised this right. He explained in Yunnan Province, there was no need to because the plan was to start planting forests in Hunan and Guangxi Provinces. Earlier that day, however, Ip testified he recalled two occasions when Sino -Forest exercised this right for property in Guangxi Province and Yunnan Province. Although Ip’s evidence is conflicting, overall it appears, except for these two instances, Sino- Forest never exercised these rights in any province in which it operated or planted trees.

[541]Mr. Hyde testified Chan explained the company never ascribed any value to the right of first refusal as the legal regime had not changed to permit a BVI to lease land. This explanation contradicts Ip’s testimony, that the right could be transferred to a WFOE. Mr. Hyde further testified Chan explained, in many cases, Sino-Forest had no intention of ever exercising the option because the land was not consistent with land on which they wanted to enter into long -term leases. Yet, Sino-Forest did enter into long-term leases wherever it planted trees. Moreover, the right of first refusal allowed Sino-Forest to require the supplier to swap the land for equivalent land elsewhere, such as in Hunan and Guangxi, where Sino-Forest planted trees.

[542]Both Ip and Hung stated they did not keep track of any harvesting done by Sino- Forest or its customers. Sino-Forest itself never harvested a single tree in the BVI Model from 2007 through 2010. When asked if Sino -Forest ever hired sub- contractors over this time period to carry out the harvesting, Ip stated, “I don’t recall”.

[543]If Sino-Forest never tracked harvesting, then it could not exercise this right of first refusal, which Ip agreed was valuable. We find it unbelievable Sino -Forest, a for-profit enterprise, would ignore this right which it explicitly wrote into every

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purchase contract since at least 2004. We find Ip’s and Chan’s explanations not credible.

iii.Process Documents

[544]The sales process description, for which Hung was a process owner, described a chronological process in which sales contracts, harvesting agreements and Confirmations of Sales Situation were signed. It stated that by the end of each quarter, the accounting department would obtain from Hung all the sequential indexed sales contracts. This did not occur: for the quarter ended December 31, 2010, for example, evidence shows an email dated January 3, 2011 from Hung to Kenny Wong, attaching a spreadsheet for Q4 2010 timber sales. The spreadsheet lists 73 sales but no contract numbers have been assigned. The sequential numbering of contracts had not occurred by mid-January 2011 and sales contracts had not been prepared.

[545]Hung admitted the sales process description made no reference to the preparation of contracts in a batch.

[546]We find the sales process documents were inaccurate, incomplete and did not represent what actually occurred. There is no mention of batching or oral agreements. There is no mention Hung recorded on sticky notes sales information he received via phone calls from Sino-Forest employees in remote regions in China. When asked why information was not relayed to him through emails for written confirmation, Hung responded: “… I think my colleagues wanted to tell me as soon as possible after they have done their work to inform me of the information so I could start preparing the contracts…” [emphasis added]. (Hearing Transcript, October 23, 2015 at 28:15-18) and “…I would write (the information) down on sticky notes…I tried my best to have them stay in place. I admit over the years there have been certain notes which have fallen and had been moved inadvertently to one side” (Hearing Transcript, October 23, 2015 at 29:10-11 and 29:14-17).

[547]Hung’s response is not credible: he did not start preparing contracts during the quarter but prepared them in batches after the quarter.

(c)Misleading the Commission Regarding Revenue Recognition

[548]Staff alleges, during the Material Time, in its correspondence to Staff, Sino - Forest misled the Commission about its revenue recognition practice.

[549]In November 2005, prior to the Material Time, the Commission sent Sino-Forest a letter regarding its financial disclosure, as part of a Continuous Disclosure Review. In his written response, Mr. Horsley confirmed:

Revenue from the sale of standing timber is recognized when the significant risks and reward of ownership have been transferred to the buyer which occurs when the contract is entered into…The Corporation confirms that it believes the significant risks and rewards of ownership to be transferred to the customer at the time the relevant sales agreement is signed…The Corporation does not recognize revenue from standing timber sales unless a sales agreement has been executed by both parties.

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If requested, we assist the buyer in applying for logging and transportation permits…the Corporation has not historically experienced any difficulty with its buyers’ ability to secure the necessary permits.

[550]The Commission made another enquiry regarding Sino-Forest’s financial disclosure in May 2008, during the Material Time. In his written response, Mr. Horsley confirmed:

The Corporation confirms that it believes the significant risks and rewards of ownership are considered to be transferred to the customer at the time the relevant sales agreement is signed…The Corporation does not recognize revenue from standing timber unless a sales agreement has been executed by both the Corporation and the buyer.

[551]Sino-Forest reiterated it had minimal involvement following the sale but would assist the buyer in obtaining necessary permits to complete harvesting, which it historically had not experienced any difficulty with its buyers’ ability to secure.

[552]Mr. Horsley, as CFO, signed both letters.

[553]We have previously found sales contracts were signed by Chan in the quarter following the dates on the BVI sales contracts, contrary to the statements made to the Commission, as illustrated above. Moreover, the statement regarding the absence of difficulty in securing harvesting permits is misleading. Evidence shows Sino-Forest could not obtain harvesting permits with only a Forestry Bureau Confirmation, which was the document obtained by Sino-Forest from the Forestry Bureau in lieu of a PRC; the holder of the PRC would also have to attend at the Forestry Bureau in order to secure the harvesting permit. Therefore, if there was any difficulty in post-sale delivery and performance in obtaining the permits, this would impede or delay the recognition of revenue.

[554]Both statements in 2005 and 2008 to the Commission were misleading: revenue was recognized in the quarter before a sales contract was executed and harvesting permits would have been impossible to obtain with only a Forestry Bureau Confirmation.

[555]Mr. Maradin testified he was responsible for drafting this section of the letters responding to the Commission in 2005 and 2008. He testified these sections of both letters were substantially the same. Mr. Maradin had reached out to others in Sino-Forest to gather this information. Particularly with respect to the 2005 letter, he relied on others, as he had only been involved with Sino -Forest for one month when tasked with preparing the response to the OSC. Mr. Maradin emailed the 2005 Sino-Forest response to those who had advised him, including Chan, to ensure its accuracy, prior to sending the letter to the OSC. Mr. Maradin stated: “I remember him [Chan] confirming that he was fine with the draft… He would know that the OSC letter was important, as a public company” (Hearing

Transcript, October 31, 2014 at 98).

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[556]The Panel finds Chan read the 2005 Sino-Forest response to the OSC; he understood its importance and was aware that it was misleading. There is no evidence Chan read the 2008 letter. It is reasonable to assume, however, following the practice of the 2005 letter, Chan would have been aware of the contents of the 2008 letter to the OSC regarding revenue recognition. As Mr. Maradin stated, a letter to the OSC was important. The Audit Committee, E&Y and Sino-Forest’s legal counsel were aware of these responses. As such, the Panel finds Chan, as a hands-on CEO, would have been aware of the 2008 letter and its contents.

[557]The Panel finds Sino-Forest misled the Commission about its revenue recognition practices in 2008, during the Material Time.

(d)Conclusion on Sales Documentation

[558]The sales contract process was fundamentally flawed. We find Sino-Forest employed a deceitful documentation process whereby Sino-Forest drafted and executed sales contracts in the quarter after they were dated and the revenue was recognized. We find this resulted in Sino-Forest recognizing revenue in the BVI Model in a manner that was deceitful. In addition, we find Sino-Forest misled the Commission regarding its revenue recognition process.

4.The Set-Off Process

[559]In the BVI Model, because BVI subsidiaries could not have bank accounts in Mainland China, Sino-Forest’s accounts receivable and accounts payable were recorded as settled through the AR/AP Set-Off Process, whereby Sino-Forest customers (or AIs) were directed to make payments to its suppliers rather than to Sino-Forest directly. The process description for the AR/AP Set -Off Process indicates AIs made payments directly to Sino-Forest suppliers. Audit Confirmation Letters provided to E&Y were also designed to confirm direct payment from a Sino-Forest AI to a Sino-Forest supplier. However, both AIs and suppliers often utilized three, four, five or more layers of parties in making payments, a process which Mr. Clifford referred to as the “daisy chain of cash”.

In effect, Sino-Forest had no way of knowing who ultimately settled the accounts payable and receivable, assuming they were settled at all. The process description was also deficient in mentioning that payments were made on the basis of oral agreements.

[560]The Second IC Report describes the AR/AP Set-Off Process as follows:

Set-off arrangements are not stipulated in the Entrusted Sale Agreements [sales contracts] themselves but rather are stipulated in separate documents which SF refers to as “Set- off Documents.” The set-off documents are organized into sets and use standard wording and formatting, with each set containing the following documents:

written instructions from a BVI with accounts receivable from an AI for that AI to make payment to a particular Supplier as payment for a new timber purchase by that same BVI or another BVI. These written instructions feature the name of the BVI at

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the top and are dated, signed and stamped and set out the amount to be paid;

written notification from SF to the Supplier that payment is being made through the AI via set-off on behalf of the purchasing BVI. This written notification features the name of the BVI at the top and is dated, signed and stamped and set out the amount to be paid;

written confirmation from the AI that payment has been made to the Supplier as requested by the instructing BVI. This written confirmation features the name of the AI and is undated and stamped and sets out the amount and date of payment; and

written confirmation from the Supplier to the instructing BVI and paying AI that payment has been received from the AI. This written confirmation features the name of the Supplier and is dated, stamped and sets out the amount and date of payment received.

The set-off documents are only produced after the Company enters into a new BVI Timber Purchase Contract and therefore reflect the payment of the consideration for this new BVI Timber Purchase Contract using proceeds from earlier Entrusted Sale Contracts held by the AIs on behalf of the Company. The set-off documents do not explicitly relate to any particular Entrusted Sale Contract and are not a record of BVI sales transactions. Apart from the Entrusted Sale Contract itself, and until set-off documents are produced pursuant to a new BVI timber purchase, there is no other document produced dealing with payment or settlement of BVI timber sales.

The IC Advisors have received copies of the Set-off Documents related to all the BVI standing timber purchase transactions between the first fiscal quarter of 2006 and the first fiscal quarter of 2011. However, the IC Advisors have not been provided with any documents showing movement of money to confirm that such set-off arrangements have been carried out. During meetings of the IC Advisors with AIs and Suppliers, representatives from the AIs and Suppliers declined to produce such documents showing movements of money. Common reasons cited for declining to produce documents included “tax reasons” and sensitivity towards the MW allegations and the resultant publicity. Further, some AIs visited stated that they may

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not in fact make payment themselves as instructed by SF but would instead arrange for other parties (“fourth parties”) to make payment on their behalf. Those fourth parties may then instruct “fifth” or “sixth” parties to make payment. [emphasis added]

(Second IC Report at 52-53)

[561]Sino-Forest prepared all of the documentation, which purportedly showed customers paid suppliers the amounts on the dates indicated. As discussed elsewhere in these Reasons in our analysis of the undisclosed control allegations, E&Y sent Audit Confirmation Letters to obtain independent confirmation of these set-off arrangements. Evidence shows that Sino-Forest was directing responses to E&Y from suppliers and AIs which rendered these supposedly independent Confirmations worthless.

[562]It is significant a receivable was only settled through the purchase of more standing timber rather than with the receipt of cash, which is how revenue is ultimately realized. It is the payment to a supplier for yet more standing timber that triggers any movement of money, which, as described above, the Independent Committee advisors were unable to trace or confirm. This is the feedback loop which trapped any BVI money in Mainland China and forced Sino - Forest to continually buy more trees in its BVI Model in order to show E&Y that accounts receivable from sales were ever settled.

[563]As we have seen in the Q3 2009 analysis of Sino-Forest’s purchase transactions with Maoxiang, documentation was altered to adjust for the fact that contracts were recorded and set-off payments were recognized as received before Maoxiang was incorporated. We find the preparation and dating of documents used in the AR/AP Set-Off Process was as flawed and as deceitful as every other aspect of the BVI purchase and sales documentation process.

[564]Staff reviewed Sino-Forest’s records of settlement of payables arising from all of the standing timber purchases recorded by Sino-Forest in 2010. Staff’s review showed:

total purchases amounted to RMB 7.98 billion and were settled through set-offs; and

RMB 7.48 billion of these payables were settled before the corresponding standing timber purchase contracts were prepared.

Therefore, Sino-Forest directed payment for purchases for which they did not yet have written contracts, but instead, RMB 7.48 billion was paid simply on the basis of a handshake agreement.

[565]Staff prepared a chronological summary of the Q4 2010 set -off process. It shows the process commenced on January 7, 2011, after the quarter-end. The evidence indicates all payables arising from standing timber purchases recorded in Q4 2010 were settled within the same quarter as the purchase, notwithstanding that contracts only required Sino-Forest to make payments within 30 days. Purchases totalling approximately RMB 886 million were made in December 2010 and settled that month, including same-day settlements as of the date of the

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purchase, which is the date of the oral agreement, according to the Respondents. Further, all documentation purporting to evidence the settlement of the standing timber purchases in Q4 2010 was prepared by Sino -Forest, including the four set-off documents, two of which should have been prepared by the supplier and AI who received and paid amounts, respectively, as instructed by Sino-Forest. This documentation was not prepared at the time of the settlement but prepared in batches after quarter-end and backdated.

[566]Hung orchestrated and oversaw the entire AR/AP Set-Off Process. He could alter the set-off schedules and had sole control. This control weakness is discussed in greater detail elsewhere in these Reasons in our analysis of the internal control weakness allegations. The accounting department used Hung’s records as data input into the accounting process which ultimately produced the financial statements upon which investors relied. Hung knew about the “daisy chain of cash”; he testified he heard about this from Chan. He testified he did not know the actual route of payments, despite being the process owner for the AR/AP Set-Off Process. If true, it is clear Hung took no interest in discovering what actually occurred.

[567]Hung’s Affidavit evidence states he asked Chan about Sino-Forest’s practice of paying suppliers before a written contract was prepared and “Chan told [him] that it was fine to do so and that [he] should continue doing so”. Hung further states Chan explained to him counterparties sometimes preferred the payments to be structured in this way so as to avoid taxes.

[568]Ip contradicts the evidence he provided during his examinations in August 2011. At that time, he stated Hung would release payments to suppliers after the agreement to purchase was signed. During the hearing, Ip testified he asked Hung to arrange payments to suppliers before having a written purchase contract in place, much less a signed contract.

[569]Ip testified the risk associated with making payments in the absence of a signed contract was not great: “[W]hat was most important in doing a deal was the handshake, the credibility. So even if you have a signed contract, the person can very well go back on his word on the contract” (Hearing Transcript, September

14, 2015 at 25:12-16). As discussed elsewhere in these Reasons, this comment reflects on the efficacy of contracts in China.

[570]Ip emphasized the importance of relationships and trust. This also contradicts the Respondents’ evidence the monitoring of suppliers’ bank accounts was a necessary means in which to effect some leverage over them.

[571]Hung could not explain why customers were willing to pay the full amount owing before the 270 days allowed under the contract terms. In the BVI Model during the Material Time, Sino-Forest had a perfect receivables collection record, which is in stark contrast with Mainland China’s general business climate, where

Chinese businesses often experienced severe cash flow problems. This perfect record also contrasts sharply with Sino-Forest’s complete failure to collect any receivables after June 2, 2011. As at March 30, 2012, US $887.4 million was owing and remained unpaid to BVI subsidiaries of Sino-Forest from AIs for standing timber sales.

[572]The AR/AP Off-Set process documentation, for which Hung was responsible, indicated that AIs made payments directly to suppliers. There was no mention of

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third, fourth or fifth parties involved in the “daisy chain of cash”. There was no mention that payments of hundreds of millions of RMB were made on the basis of oral agreements, without signed contracts.

[573]We find the AR/AP Set-Off process descriptions to be inaccurate, incomplete and deceitful.

[574]We find the AR/AP Set-Off Process in the BVI Model was used to facilitate Sino- Forest’s overstatement of assets and revenues.

5.Who Knew What When

[575]The Respondents submit they disclosed their process accurately to Mr. Maradin, Horsley, the Board and the Audit Committee, and it was up to them to decide how to characterize the facts they were given. The Respondents submit it was not up to them to second-guess Canadian experts.

[576]The Respondents submit, although Horsley denies any knowledge of the contracts being signed after the quarter-end, he should have been aware of this practice. He had received emails plainly indicating contracts had not been signed during the quarter in which the transactions were recorded. As well, Horsley admitted Hung and Ip would have reasonably relied on him, as a chartered accountant, for revenue recognition issues. Based on email evidence and testimony, we find Horsley was aware contracts were signed after the quarter- end.

[577]The Respondents also submit Mr. Maradin and the members of the Audit Committee were aware, or should have been aware, of this practice. There is no evidence the Audit Committee was aware of this. Mr. Hyde testified it was “new news” to them (and Mr. Maradin) after the Muddy Waters Report.

[578]Mr. Hyde testified, prior to the Muddy Waters Report, he understood changes in land reform meant PRCs could be issued to BVIs, but not all levels of government had implemented the reforms. As a result, Sino -Forest continued to rely on Forestry Bureau Confirmations. Mr. Hyde testified Chan and Horsley told him “as they had the ability to apply for [PRCs] they were applying for them” in the BVI Model (Hearing Transcript, November 5, 2014 at 128:14-16). Mr. Ardell testified that prior to June 2, 2011, he knew nothing about Forestry Bureau Confirmations. After the Muddy Waters Report, Mr. Hyde and the Independent Committee learned “it was next to impossible to get [PRCs] for the BVI timber contracts because they just had never been issued” (Hearing Transcript,

November 5, 2014 at 174:13-15). We find Chan knew BVIs could not obtain PRCs yet he deliberately told Mr. Hyde otherwise.

[579]Mr. Hyde testified, before the Muddy Waters Report, he was unaware a key attachment (Villagers’ Resolutions) to purchase contracts was never attached. Subsequently, Chan and Horsley told him Villagers ’ Resolutions were reviewed, but not retained, as part of the due diligence process. The missing attachment had not been reported to the Audit Committee before the Muddy Waters Report by the auditors or by lawyers during the due diligence process for underwritings.

[580]Mr. Hyde testified, before the Muddy Waters Report, Chan explained the lack of maps to him as due to “Beijing secrecy requirements” (Hearing Transcript,

November 5, 2014 at 178:11). The Second IC Report notes there was no centralized system to connect compartment numbers on maps to specific

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locations. Mr. Hyde testified that level of detail was not available to the Audit Committee, as the Committee did not review source documents. He said the Audit Committee relied on advisors who were doing site visits, and legal and accounting advisors who were reviewing contracts. No concerns related to the lack of location specificity were brought to the Audit Committee’s attention.

[581]Regarding Sino-Forest’s revenue recognition policy, Mr. Hyde testified, during the course of the Independent Committee Investigation, he and the rest of the Independent Committee learned that contracts were signed following quarter- end. This was inconsistent with the information the Board and Audit Committee had pre-Muddy Waters. Mr. Hyde described his reaction to learning this as:

Absolute shock. It was completely inconsistent with the understanding we had…I know the OSC had asked on two different occasions about revenue recognition … and the information that was responded to the Commission was that contracts were signed – well, revenue was recognized when the contracts were signed, so it was completely inconsistent with the concept of signing contracts after the quarter-end.

(Hearing Transcript, November 6, 2014 at 117:5-15)

[582]The Audit Committee, as a matter of practice during their in camera sessions with E&Y, asked if E&Y had any concerns with Sino-Forest management. Hyde stated E&Y never raised any concerns.

[583]Mr. Ardell, who was also on the Audit Committee, testified he was unaware, before the Muddy Waters Report, there was no internal audit function at Sino- Forest or that Chan signed all sales contracts.

[584]There is evidence the Audit Committee was aware contracts were batched and signed once a quarter. It appears to us the Committee assumed the contracts were signed during the quarter in which revenue was recognized. It further appears to us, however, from Mr. Hyde’s testimony as Chair of the Audit

Committee and his role on the Independent Committee, the Audit Committee was not aware of the scope of the post-quarter-end documentation process. There is no evidence the Audit Committee was aware virtually the entire documentation process began after the quarter-end, or that any documents were signed after quarter-end.

[585]While the Respondents may be entitled to rely on those at Sino-Forest who have greater Canadian financial disclosure expertise, this reliance must be premised on accurate and complete communication of the relevant facts by the Respondents to those with greater expertise. The Respondents did not do this. We reject the Respondents’ submission that Mr. Maradin, the Audit Committee and the Board were aware of the actual purchase, sale and set-off process. Chan, Ip and Hung knew the process documents relied on by E&Y in its audit of Sino-Forest’s financial statements were inaccurate, incomplete and did not represent what actually occurred.

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6.The Roles of Chan, Ip, Hung and Ho

[586]Chan submits there were no red flags for Chan that should have alerted him to potential issues in Sino-Forest’s business, and cites the expert evidence of Dr. Peerenboom in support thereof.

[587]Dr. Peerenboom testified the following, among other practices, are generally- accepted business practices. He later clarified, on cross -examination, he meant business practices that are accepted or permissible in China:

the use of multiple BVI companies;

the absence of attachments referenced in the contract;

the use of contracts which did not identify the specific location of the purchased timber; and

the reliance on comfort letters (in the case of Sino-Forest, Forestry Bureau Confirmations).

[588]In Dr. Peerenboom’s opinion, a reasonably competent CEO, born and educated in

Hong Kong with a deep knowledge of Chinese culture and business practices, would not view these business practices as red flags.

[589]Under cross-examination, Dr. Peerenboom qualified significant areas of his testimony in chief. The Panel’s impression is the scope of his review of Sino -

Forest’s business practices and the BVI and WFOE Models was limited. For example, he was not aware whether BVIs could have bank accounts in Mainland China, nor was he aware whether Sino-Forest BVIs were paying taxes. When asked about his expert opinion that BVIs were restricted from selling in China, despite the fact Sino-Forest disclosed in its public documents it was selling to

AIs, he stated “I’m a bit confused as to what’s going on” (Hearing Transcript, April 2, 2015 at 103:24).

[590]While his expert opinion was the use of BVIs is common in Mainland China, he was not aware of any other company using the BVI model in the manner Sino - Forest used it. He then explained the use of BVIs is common as holding companies for investment purposes but he was not aware of any other company using the BVI structure as an operating company, as Sino -Forest did.

[591]Dr. Peerenboom testified as a general rule, comfort letters (here, Forestry Bureau Confirmations) are difficult to obtain. In rural areas, where Sino-Forest operated, the administrative regulatory structures are weaker and more inefficient than in urban areas, resulting in longer delays for these letters. He stated although there was no law expressly authorizing the issuance of Forestry Bureau Confirmations, there was no law expressly prohibiting their issuance. We find this opinion to be of little value.

[592]Regarding missing attachments to contracts, Dr. Peerenboom stated it was very common in practice. He then went on to say common is not necessarily the same thing as generally accepted and Staff’s questioning had forced him “to think more carefully about what is the relationship between ‘generally accepted’ and ‘common’” and he would have to go back and be more specific which practices were generally acceptable (Hearing Transcript, April 8, 2015 at 124:16- 18).

[593]He then went on to state “generally accepted” practices are those accepted or permissible within the relevant context, but did not necessarily mean they are

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common or frequent: “So in that context, there's a distinction between absolute or even relative frequency and a practice being generally accepted” (Hearing Transcript, November 8, 2014 at 123:10-12). Dr. Peerenboom agreed “generally accepted” does not necessarily mean legal or in compliance with regulations.

[594]Dr. Peerenboom testified the significance of a missing attachment depends on further contextualization and the determination of what type of significance:

Q.So sticking with that same point, you would agree that if the missing attachment is intended to identify the asset being purchased, that is a significant issue if it's missing?

A.I'm unable to answer that question.

Q.You would agree that if the missing attachment is intended to demonstrate that the seller of the asset owns the asset being sold, that is a significant issue?

A.Again, I'm unable to answer that.

(Hearing Transcript, April 8, 2015 at 131:20-25 and 132:6- 10)

[595]With so many qualifications to the term “generally accepted” and the blurred distinction among the terms “common”, “permissible” and “accepted”, the Panel finds Dr. Peerenboom’s evidence of little value.

[596]We find there were many red flags at Sino-Forest, which included:

the use of multiple BVI companies, not just as holding companies, but as operating companies in Mainland China;

the absence of key attachments referenced in the contract which would evidence ownership;

the use of contracts that did not identify the specific location of the purchased timber, and which were not supported by any additional documentation enabling one to locate the plantations; and

the reliance on Forestry Bureau Confirmations, which contained incorrect information about future issuances of PRCs .

We find Chan, a reasonably competent CEO, born and educated in an advanced modern financial centre such as Hong Kong, was aware or should have been aware these were red flags.

[597]Chan and Hung were educated in Hong Kong and Ip was educated in Canada. Hong Kong is an advanced modern financial centre and the quality of its corporate governance regime is regarded as on par with, or above, Canada’s.

[598]When asked to clarify Chan’s role in the BVI purchase process, Ip replied:

Allen Chan would be the person to give the final approval in forest purchase. As for K.K. Poon, he would follow up upon

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the final approval; that is, he [Poon] would follow up. After the final approval had been given by Allen Chan, he [Poon] would go through the documents and sign on the contract.

(Hearing Transcript, September 11, 2015 at 53:12-17)

[599]Chan submits he relied on K.K. Poon’s review of purchase contracts and survey reports because Chan was not a forestry expert. This is inconsistent with Chan’s conduct. He pre-approved the purchases, knew which forests to purchase, and identified the provinces where Sino-Forest was going to purchase additional assets.

[600]Chan indicated to Mr. Clifford, in managing fraud risk, he was seeing all the purchase and sale contracts, was signing off on the contracts, decided which entity would acquire the standing timber, was signing cheques and was seeing each transaction. As noted previously, a March 2011 internal E&Y memorandum notes “Allen [Chan] is very involved in the day to day operations. He reviews cheques and key transactions as they occur. He also has an intimate knowledge of the business and would be able to spot anomalies as they occur”. Mr. Clifford described Chan as having “a great degree of visibility around what the company was doing at any moment in time”, and testified Chan took “great comfort from the fact that he was seeing these transactions one by one and could spot something that was an anomaly” (Hearing Transcript, November 17, 2014 at

61:1-5).

[601]Chan and Ip had weekly meetings, at which Chan would indicate whether he had any objections to proposed purchases. Chan had final say on every purchase at the time the contract was signed. Chan knew when changes were made to purchase contracts in the quarter following the quarter in which they were recorded. Hung testified he would need to obtain a new purchase requisition form, which required Chan’s approval. Hung checked with Chan for authorization to pay suppliers when there was no written contract in place. Chan understood the documentation process and Horsley contacted him directly when documentation was late. He was a knowledgeable, experienced, sophisticated and hands-on CEO. He was also involved in the late December 2010 initiation of purchase documentation for Q4 2010. Chan therefore knew the purchase documentation process only started at the end of the quarter.

[602]Xu Ni stated in her interview she discussed the deficiencies in the purchase contract templates with Chan; he was aware of the deficiencies in the purchase contract templates, specifically that contracts listed Villagers’ Resolutions and

PRCs as attachments although these documents were never attached to the purchase contracts. Chan knew Sino-Forest BVIs could not obtain PRCs.

[603]Chan submits he relied on the Board of Directors, the Audit Committee, Horsley, Mr. Maradin and financial and legal advisors, who were all far more sophisticated than he was in the public disclosure obligations required by Ontario securities laws. The Panel agrees Chan was entitled to rely on these individuals, but reliance on others must be reasonable and must start with honest and complete disclosure of the facts. Chan did not truthfully or completely disclose the facts to those parties on whom he claimed to rely.

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[604]Chan submits his “frontline” role at Sino-Forest was largely ceremonial, and as CEO, his role was to set the strategy for the company. However, we find Chan was deeply involved in the operations of Sino-Forest. As the “ultimate and compensating control” over transactions, the approver of all purchase contracts and the signatory on all sales contracts, Chan’s frontline role was much more than ceremonial.

[605]Because Sino-Forest BVIs could not obtain PRCs, Sino-Forest was never the legal or registered owner of the standing timber in the BVI Model. Chan and Ip knew failure to disclose these crucial facts would result in a risk of deprivation to Investors.

[606]Ip, as head of Sino-Panel, approved all purchases and, from the second quarter of 2010, signed all purchase contracts. He was responsible for the Sino-Panel Group, which included 48 subsidiaries and over 1,000 employees. He oversaw the Resource Department, which sourced all the standing timber for the BVI subsidiaries.

[607]Both Chan and Ip knew Sino-Forest’s BVIs could not obtain PRCs and Sino-Forest was not even applying for them, contrary to its financial statement disclosure. Chan and Ip knew the purchase contracts and Survey Reports did not provide location details and Sino-Forest’s BVIs did not retain maps. Further, without

PRCs, there is no record of the location of the standing timber Sino-Forest’s BVIs purchased. Based on Sino-Forest’s documentation, there is no way to locate the standing timber assets held in the BVI Model. Both Chan and Ip knew this.

[608]Chan and Hung knew that receivables and payables were settled prior to the existence of written signed contracts. Chan, Ip and Hung knew documents were prepared in batches and backdated and that process documents, relied upon by E&Y, were deceitful.

[609]Hung, Vice-President, Corporate Planning and Banking for Sino-Forest, was a Chartered Financial Analyst. In order to become a CFA, he had to complete a minimum three year self-study program, which included an accounting component, and successfully pass three six -hour exams. He had to certify annually his adherence to the CFA Code of Ethics, which emphasized integrity, professionalism and competence. As a professional with a CFA designation, he would have understood Sino-Forest’s revenue recognition policy was misleading.

Yet throughout his testimony, Hung was evasive about his knowledge of the revenue recognition policy and testified he would need an accountant to help him understand the policy. The Panel finds Hung had sufficient education to understand Sino-Forest’s revenue recognition policy and to know it was misleading.

[610]Hung was a member of the Disclosure Committee since 2005. Sino-Forest’s Disclosure Policy states the Disclosure Committee was established “to assist the

Senior Officers in fulfilling their responsibility for oversight of the completeness, accuracy and timeliness of the disclosures made by the Corporation [Sino-

Forest]”. Further, the Disclosure Committee’s policy statement states: “The

Corporation [Sino-Forest] is committed to a policy of full, true and plain public disclosure of all material information in a timely manner, in order to keep shareholders and all members of the investing public equally informed about the

Corporation’s operations” [emphasis added].

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[611]Hung signed sub-certifications in relation to Sino-Forest’s public disclosure each quarter and at year-end. As an example, in one such sub-certification, Hung certified no covered report “contained an untrue statement of a material fact” or “omitted to state a material fact necessary to make the statements in the covered report … not misleading”. Such covered reports included 2010 year-end financial statements, AIFs, a press release and a Management’s Discussion and Analysis (MD&A), as well as any amendments to these documents. Hung knew these reports were misleading.

[612]In addition to his CFA designation, Hung obtained an undergraduate degree in mathematics from the University of Hong Kong, a Master of Finance from the City University of Hong Kong and a Master of Business Administration from Hong

Kong Chinese University. We reject Hung’s submission he did not understand Sino-Forest’s disclosure on revenue recognition. Hung insisted an accountant’s qualification would be needed to understand the concepts of revenue recognition and related party transactions. His evasiveness and continuous denial of responsibility under cross-examination undermine his credibility significantly.

[613]Hung was the central figure in, and controlled, the Deceitful Documentation Process. He knew payments were made before written contracts were prepared. He knew at a minimum to check with Mr. Horsley as to whether the documentation process and practices were acceptable; with Hung’s education and experience, questions to Mr. Horsley, Mr. Maradin or the Audit Committee would have been the minimum expected of him, as a senior officer of Sino - Forest.

[614]We find Chan, Ip and Hung are all accountable for their roles in the Deceitful Documentation Process.

7.Conclusion

[615]Sino-Forest’s documentation process in the BVI Model involved preparing documents in batches and using manual systems which allowed for the backdating of contracts and post-quarter-end revisions. All documentation originated with Sino-Forest – there was no independent record. The Forestry Bureau Confirmations, which could not be disclosed to anyone outside of Sino - Forest, do not confirm Sino-Forest’s legal ownership of standing timber. It was not possible to locate the specific standing timber plantations from the purchase contracts, Survey Reports or Forestry Bureau Confirmations. There was no record of payments by multiple AIs to multiple suppliers on behalf of Sino -Forest, and payments were often made prior to the preparation of purchase contracts. Sino-Forest did not keep track of harvesting and no new Forestry Bureau Confirmations were requested from the Forestry Bureaus when partial areas of standing timber plantations were sold.

[616]The process documents described a very different process. Transactions were described as being processed during the quarter sequentially and chronologically. There was no mention of batching and backdating or payments in advance of contracts being prepared or signed. Although, according to the Respondents’ description of the process, oral agreements were the most critical event that initiated the entire purchase transaction, there was no mention of oral agreements or handshakes in the process documents. There was also no mention the AR/AP Set-Off Process involved three, four, five or more parties on

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both the supplier and the AI sides, which implied up to 12 parties could be involved in one settlement.

[617]We have found:

PRCs could not and would not be issued to Sino-Forest’s BVIs during the Material Time for two reasons: they only traded in standing timber, and they were foreign offshore companies.

PRCs and Forestry Bureau Confirmations are not equivalent.

Forestry Bureau Confirmations were not official documents, were not issued pursuant to a legislative mandate or published policy and were not documents of title that could be relied upon in the event of a dispute in a court of law. They are of no use in establishing Sino- Forest’s ownership in the event of any dispute with third parties over ownership of forestry rights, a frequent occurrence in Mainland China. Forestry Bureau Confirmations do not establish Sino-Forest’s legal ownership of standing timber in the BVI Model. Sino-Forest’s stated reliance on Forestry Bureau Confirmations as proof of legal ownership was deceitful.

The geographic distances, the many steps involved to get the contracts prepared and signed, and the Forestry Bureau Confirmations issued, make it more likely than not that the Forestry Bureau’s process for confirming ownership simply did not happen.

When new form Confirmations were issued by Forestry Bureaus during the Independent Committee investigation, they only confirmed the existence of a purchase contract and not ownership of the standing timber. The fact that these differed from the original Forestry Bureau Confirmations, which confirmed additional rights, calls into question what due diligence the Forestry Bureau conducted before chopping the original Confirmations.

Sino-Forest never registered ownership of its standing timber in the BVI Model.

Chan, Ip and Sino-Forest did not disclose that Sino-Forest’s BVI subsidiaries could not obtain PRCs and thus could have no ownership claim to the BVI standing timber assets because those rights had not been registered.

Neither the Survey Reports nor maps provided sufficient information to locate the trees owned by Sino-Forest. This failure to demonstrate specific locations for BVI standing timber assets contributes to our finding that Investors’ pecuniary interests were put at risk.

The BVI Model was opaque and malleable and enabled the Respondents to perpetrate fraud, as we find elsewhere in these Reasons.

Hung was the central and crucial figure in the Deceitful Documentation Process.

Changes to fundamental aspects of purchase contracts and supporting documents occurred long after the dates of the oral agreements and after the quarter in which Sino-Forest recorded the acquisition of the asset.

The process descriptions failed to accurately describe the processes for the purchase, sale and set off process for Standing Timber in the BVI

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Model. They were almost entirely inaccurate. Ip and Hung were the process owners for these process descriptions and annually confirmed their accuracy.

Virtually all steps in the purchase process began after the quarter in which the purchases were recorded.

The purchase contracts and their three key attachments were fundamentally flawed:

o As noted above, Forestry Bureau Confirmations do not establish Sino-Forest’s ownership of standing timber;

o Villagers’ Resolutions and PRCs were never attached to BVI purchase contracts.

o Survey Reports were prepared in the quarter after Sino-Forest recorded the purchase and were in some cases reverse- engineered by Sino-Forest employees; and

o Standing timber locations could not be located based on these documents.

Sino-Forest’s post-quarter documentation process was not merely an exercise of transcribing oral contracts entered into during the previous quarter.

The sales process documents were inaccurate, incomplete and did not represent what actually occurred.

Sino-Forest misled the Commission about its revenue recognition practices in its 2008 letter to the Commission. Chan was aware of the letter and the misleading statements.

The dating of documents used in the AR/AP Set-Off Process was inaccurate.

The AR/AP Set-Off descriptions were inaccurate, incomplete and deceitful.

The AR/AP Set-Off Process in the BVI Model was used to engage in a scheme to overstate Sino-Forest’s assets and revenues.

There were many red flags that Chan, a reasonably competent CEO, born and educated in an advanced modern financial center such as Hong Kong, should have been aware of.

[618]The process actually followed by Sino-Forest in documenting its BVI purchases and sales was fundamentally flawed and put Investors’ pecuniary interests at risk. On the purchase side, Sino-Forest had inadequate proof of ownership for the assets it purportedly purchased and recorded under the BVI Model:

Sino-Forest’s BVI subsidiaries did not obtain official proof of ownership through PRCs;

Sino-Forest’s BVIs did not obtain the requisite Villagers’ Resolutions;

Locations of the assets purportedly purchased could not be ascertained; and

Forestry Bureau Confirmations were not legal proof of ownership.

As a result, Sino-Forest deceived Investors by disclosing to them that it owned standing timber for which it could not prove ownership.

[619]Virtually all purchase, sales and set-off documentation were created after the end of the quarter in which Sino-Forest claims the transactions occurred. The

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result of the flawed sales documentation is that Sino -Forest recognized revenue in the BVI Model before sales were executed (and, in addition, misled the Commission about how and when revenue was recognized). Among other evidence discussed elsewhere in these Reasons, changes to fundamental aspects of transactions post-quarter-end provide sufficient evidence for us to find Sino- Forest’s regular quarterly and annual disclosure of its assets and revenue was misleading and could not be relied upon by Investors.

[620]We find Sino-Forest falsified evidence of ownership of assets and recognized revenue in a manner that was deceitful.

[621]The Panel finds Sino-Forest’s documentation process was deceitful and this process underpinned the BVI Model and facilitated fraud, as we find elsewhere in these Reasons. We find Chan, Ip and Hung controlled the BVI Model, created the actual documentation process, and knew this process was deceitful.

[622]We do not find Ho authorized, permitted or acquiesced in the Deceitful Documentation Process. The evidence does not support a finding that he was involved.

D.Undisclosed Internal Control Weaknesses or Failures Allegations

[623]The third element of the Standing Timber Fraud alleged by Staff is undisclosed internal control weaknesses or failures at Sino-Forest.

1.Positions of the Parties

(a)Staff

[624]Staff alleges Sino-Forest dishonestly concealed internal control weaknesses or failures which obscured the true nature of transactions conducted within the BVI Model and prevented the detection of the Deceitful Documentation Process. Staff submits Sino-Forest failed to disclose the extent of the concentration of duties in a small group of senior management (including Ip, Hung and Chan), who completely controlled the operation of the BVI Model. This included the fraudulent creation and execution of the BVI purchase and sales contracts and their key attachments, and the AR/AP Set-Off Process. Staff alleges this concentration of control facilitated the fraudulent course of conduct perpetrated in the BVI Model. Staff further alleges the undisclosed control weaknesses and deficiencies facilitated and concealed the fraudulent conduct within the BVI Network and the Deceitful Documentation Process.

[625]Staff also alleges Sino-Forest’s statements in its public disclosure record regarding the extent of its internal control weaknesses were wholly inadequate and misleading.

[626]Staff submits Sino-Forest’s failure to properly disclose one of its material weaknesses – the lack of segregation of duties – was a key pillar of the Standing Timber Fraud. Staff submits Hung was in complete control of the deceitful documentation of the transactions in the BVI Model, including the documentation of the AR/AP Set-Off Process and the preparation of the purchase and revenue data for entry in the books and records by Sino-Forest’s accounting department. Staff submits this material weakness permitted the Deceitful Documentation Process. Staff further submits Chan could have, but did not remedy, this material weakness, which, if remedied, would have risked exposing the Standing Timber Fraud, particularly the Deceitful Documentation Process.

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[627]Staff submits, as the leader and prime mover of Sino-Forest, Chan could have split up Hung’s duties with ease. Staff submits, through his failure to address this material weakness, Chan ensured Hung’s control remained. Staff submits people other than Hung can answer the phone, write on sticky notes and enter data in spreadsheets. However not everyone could be trusted by Chan to reverse engineer purchases and sales and churn the paper required to keep the Standing Timber Fraud alive.

[628]Staff submits Chan and Sino-Forest are directly responsible for the facilitation of fraud as a result of the internal control deficiencies and that Hung authorized, permitted or acquiesced in Sino-Forest’s conduct.

(b)Chan

[629]Chan submits Sino-Forest disclosed material weaknesses with its internal controls. He submits the evidence establishes that the Respondents, including

Chan, did not conceal Hung’s role or the extent of the off-book cash flow.

[630]Chan specifically submits Sino-Forest disclosed the concentration of authority, or a lack of segregation of duties, was a material weakness in its internal controls public disclosure. Chan submits Sino-Forest devoted significant financial and human resources to its internal controls project.

[631]Chan also submits the Respondents did not conceal the size of the BVI Model. In

Chan’s submission, the facts that Sino-Forest’s core business was the standing timber business and that it was transacted through BVI subs idiaries, which could not have bank accounts in China, and therefore engaged in a set -off process, were in plain view at all times.

(c)Hung

[632]Hung submits the Audit Committee was given material dealing with internal control deficiencies which indicated that the ultimate compensating control on sales contracts was Chan, who signed all sales contracts. Hung submits Mr. Maradin, who was the Vice-President of Risk Management at Sino-Forest, had spent 15 years at E&Y and was a senior consultant to several multinational companies, where his responsibilities included internal control and regulatory compliance. Mr. Maradin was responsible for risk management, internal controls and financial reporting at Sino-Forest and was particularly aware of Chan’s role in signing and approving contracts

[633]Hung submits the remediation of significant deficiencies in internal controls was arguably a matter which warranted close attention by the Audit Committee. Hung further submits the Audit Committee had received a series of reports from Mr. Maradin about the nature of the significant deficiencies including ways of correcting them, and this was an issue of some focus for the Audit Committee.

[634]Hung submits Mr. Maradin prepared internal control reports for the Audit Committee, which highlighted the oral nature of communications with respect to the notification of customers and suppliers about setoff payment arrangements. Hung submits the Respondents were transparent with Mr. Maradin and others in Sino-Forest about the nature of the AR/AP Set-Off Process. Nevertheless, the Audit Committee, Mr. Maradin and Mr. Horsley were all content to allow the oral notification process to continue.

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[635]Hung submits his method of recording information by hand, then transferring the information into an Excel spreadsheet was substantially faster, more respectful to the person who was providing the information over the phone and more service-oriented. He submits nothing in the circumstances made his approach unreasonable.

[636]Hung submits the only evidence about training the Respondents on issues in Ontario capital markets involved mention of a manual Mr. Maradin had prepared about internal controls and a one-day training session in the Fall of 2007, which included some discussion about internal controls but was not about training on Ontario regulatory standards.

[637]Hung also submits it would be unrealistic to expect him to correct the control deficiency arising from the concentration of duties, because he was carrying out duties asked of him by his superiors. Hung submits a change in his job functions was a decision to be made by his superiors and Sino -Forest’s Board of Directors.

2.Disclosure Requirements under NI 52-109 for Internal Control Weaknesses

[638]In order to fully understand and appreciate the importance of undisclosed internal control weaknesses by a reporting issuer, it is useful to look at the requirements under Ontario securities law, which give direction and guidance to reporting issuers on how to structure and disclose their internal controls.

[639]NI 52-109 sets out disclosure and filing requirements for all reporting issuers, other than investment funds. The objective of these requirements, as set out in Companion Policy 52-109 (52-109 CP), is to improve the quality, reliability and transparency of annual filings, interim filings and other materials that issuers file under securities legislation. We view this objective as critical to the protection of investors and maintaining the integrity of the capital markets.

[640]Under Part 3 of NI 52-109, Sino-Forest was required to disclose any material weaknesses in its disclosure controls and procedures or its internal controls over financial reporting (ICFR) in its MD&A, a disclosure document that is required to be filed by a reporting issuer such as Sino-Forest under Part 5 of NI 51-102.

[641]Section 3.2 of NI 52-109 provides:

…if a non-venture issuer determines that it has a material weakness which exists as at the end of the period covered by its annual or interim filings, as the case may be, it must disclose in its annual or interim MD&A for each material weakness

(a)a description of the material weakness;

(b)the impact of the material weakness on the issuer’s financial reporting and its ICFR; and

(c)the issuer’s current plans, if any, or any actions already undertaken, for remediating the material weakness.

[642]In 52-109 CP, guidance is provided on the interpretation and application of provisions in NI 52-109, including with respect to disclosure controls and procedures and ICFR. In particular, subparagraph 6.3 states that the definition of ICFR includes reference to reasonable assurance regarding the reliability of

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financial reporting and the preparation of financial statements in accordance with accounting standards. 52-109 CP indicates reasonable assurance is a high level of assurance but does not represent absolute assurance.

[643]In identifying risks, 52-109 CP calls for a top-down, risk-based approach whereby certifying officers focus their resources on the areas of greatest risk and avoid expending unnecessary resources on areas with little or no risk, considering the size and nature of the issuer’s business, and the structure and complexity of business operations.

[644]Subparagraph 6.6(3) of 52-109 CP specifically focuses on fraud risk and calls for certifying officers to explicitly consider the vulnerability of the entity to fraudulent activity, citing as examples fraudulent financial reporting and misappropriation of assets. That provision requires certifying officers to be concerned with fraud that could cause a material misstatement in the issuer’s annual filings, interim filings or other reports filed or submitted under securities legislation.

[645]Paragraph 6.7 of 52-109 CP discusses the importance of a control environment which includes having the appropriate tone at the top, which can help develop a culture of integrity and accountability at all levels of an organization.

[646]Subparagraph 6.11(a) of 52-109 CP provides for segregation of duties to act as a check and balance on the activities of the entity so that no one individual has control over all steps of processing a transaction or other activity. Subparagraph 6.11(c) of 52-109 CP lists instances where an issuer might be dominated by a founder or other strong leader who exercises a great deal of discretion and provides personal direction to other employees, and warns of the danger this concentration of knowledge and authority could allow the individual an opportunity to override established policies or procedures or otherwise reduce the likelihood of an effective control environment. As will be discussed below, the lack of segregation of Hung’s duties and Chan’s role at the top strike at the heart of the danger that NI 52-109 seeks to remedy.

3.Were there Undisclosed Internal Control Weakness?

(a)Identification of Weaknesses

[647]In Sino-Forest’s 2006 MD&A, it disclosed four material weaknesses in its ICFR. Sino-Forest described these material weaknesses as follows:

a.“segregation of duties,”

b.“[Sino-Forest] does not have the optimum complement of financial personnel with the technical accounting knowledge in the foreign subsidiaries to address all complex and non-routine transactions that may arise,”

c.“completeness and accuracy and timeliness of the period close process including reviewing and monitoring recording of reoccurring and non- reoccurring of journal entries and translation of foreign currency transactions and subsidiary company results,” and

d.“information systems are subject to general control deficiencies including lack of effective controls over spreadsheets”

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[648]These four material weaknesses were also disclosed in each of its first three quarterly MD&A 2007 interim filings. In its 2007 annual MD&A, Sino -Forest disclosed it “made improvements to its financial processes and information systems” and as a result, in Sino-Forest’s view, “two of the four material weaknesses … [had] been effectively remedied”. In particular, Sino -Forest disclosed it implemented compensating review and monitoring controls by corporate accounting staff on a quarterly basis; added qualified senior financial resources with oversight responsibility for the financial statement close process ; and implemented changes in the roles and responsibilities within the senior finance group. In its 2007 annual MD&A, Sino-Forest indicated two material control weaknesses – the lack of segregation of duties and control deficiencies in information systems – continued to exist.

[649]In its 2008 annual MD&A, Sino-Forest addressed the internal control weakness relating to information systems, and indicated it “implemented further changes in roles and responsibilities within the information technology department”, which together with other changes effectively remediated this internal control weakness. This left the lack of segregation of duties as the only remaining material weakness.

(b)The Lack of Segregation of Duties

[650]Sino-Forest disclosed the material weakness of the lack of segregation of duties as follows in its 2008 annual MD&A:

The success of the Company's vision and strategy of acquiring and selling forestry plantations and access to a long-term supply of wood fibre in the PRC [People’s Republic of China] is dependent on senior management. As such, senior management plays a significant role in maintaining customer relationships, negotiating and finalizing the purchase and sale of plantation fibre contracts and the settlement of accounts receivable and accounts payable associated with plantation fibre contracts. This concentration of authority, or lack of segregation of duties, creates risk in terms of measurement and completeness of transactions as well as the possibility of non-compliance with existing controls, either of which may lead to the possibility of inaccurate financial reporting.

Horsley testified the “senior management” being referred to here was Chan, Albert Ip, Albert Zhao and Hung.

[651]The same description of the lack of segregation of duties material weakness appears in both Sino-Forest’s 2009 and 2010 annual MD&A.

[652]Notwithstanding this was the only remaining material internal control weakness not remediated, Mr. Maradin testified it was “the most important” (Hearing Transcript, October 29, 2014 at 68:16). Mr. Maradin testified he received “very little support” from senior management with respect to remediating this material weakness (Hearing Transcript, October 29, 2014 at 68:2).

[653]Mr. Maradin testified he had limited support from the Audit Committee in 2008. Mr. Maradin testified this lack of support from the Audit Committee changed by 2010, by which time the Audit Committee had become more concerned.

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[654]In an email dated November 18, 2007, Horsley writes to Chan about the importance of being able to certify that the processes, systems and internal controls of Sino-Forest are operating effectively. Horsley warns Chan “[i]f we do not get to that position, the market cap of the Company will be reduced significantly (you heard Jud [Martin] say cut in half)”.

[655]Mr. Martin testified, in reference to his comment, it was important for a company to demonstrate it could meet regulatory guidelines; this was “top of mind after the Enron days” (Hearing Transcript, December 1, 2014 at 34:4-5). This was the “first question I received when I was visiting shareholders in my previous life.”

(Mr. Martin had previously been a Senior Vice President and CFO of a reporting issuer, where he had oversight over internal control matters.) Mr. Martin described Chan’s role in relation to the implementation of NI 52-109. Chan was seen as a “very strong leader, a very respected leader, and it was up to Allen … to try and get results” (Hearing Transcript, December 1, 2014 at 36:9-11). Chan’s role was to set the tone at the top.

[656]Mr. Maradin testified the lack of segregation of duties was identified in 2006 and 2007 during the creation of process documentation for BVI transactions. He explained the lack of segregation of duties consisted of Hung managing the documentation for the purchase and sale of standing timber and the AR/AP Set - Off Process. Mr. Maradin testified Hung had a significant role in terms of recording BVI timber purchases and sales, reporting the information to the Sino- Forest accounting department, and providing all supporting documentation. Mr. Maradin also testified Hung was the individual responsible for the settlement of accounts payable and receivable in the BVI Model.

[657]The failure to segregate duties was the most important material weakness and was identified as the concentration of duties with Hung. Mr. Hyde tes tified this material weakness was related to “the settlement agreements, on one person being responsible for many aspects of producing the settlement agreements among the AIs and suppliers” and that person was Hung (Hearing Transcript, November 5, 2014 at 99:2-17). Mr. Hyde testified, in his experience with businesses, there is not as much concentration in one person related to significant transactions.

[658]Hung submits the Respondents were transparent with Mr. Maradin and others in Sino-Forest about the oral nature of the communications with respect to the AR/AP Set-Off Process and submits the Audit Committee, Mr. Maradin and Mr. Horsley were all content to allow the oral notification process to continue. However, the crux of the issue with respect to this internal control weakness is not the oral nature of the communications but, more important, the concentration of duties in one individual, Hung.

[659]We find the concentration of duties in Hung was neither reflected in Sino-Forest’s MD&A disclosure nor otherwise adequately disclosed for the following reasons. The MD&A disclosure provided by Sino-Forest in respect of 2008, 2009 and 2010 spoke in broad terms of the role of “senior management” but did not disclose that the concentration of duties rested on one individual (Hung), nor the scope of the BVI Model. Sino-Forest Investors were not aware that this material weakness related to approximately 70% of Sino-Forest’s revenue every year from 2007 to

2010. The same person – Hung – was responsible for recording purchases and sales and for the AR/AP Set-Off Process in the BVI Model.

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[660]Mr. Clifford of E&Y testified that the problem with the lack of segregation of duties was that “it’s a small group of individuals that are involved in the contract negotiation and settlement process. So more specifically, it’s Allen, and Allen

Chan and Albert Ip and Alfred Hung in terms of that process by which they purchase, they sell, and they net settle” (Hearing Transcript, November 17, 2014 at 107:23-108:3).

[661]In a letter dated October 28, 2010 from E&Y to the Audit Committee, E&Y indicated that “all information for the settlement arrangement is solely kept by one senior member of management in the Hong Kong office”, whom Mr. Martin confirmed was Hung.

[662]Sino-Forest’s repeated disclosure in its MD&As for 2008, 2009 and 2010 in respect of the lack of segregation of duties material weakness indicates that

“senior management plays a significant role in maintaining customer relationships, negotiating and finalizing the purchase and sale of planation fibre contracts and the settlement of accounts”. The real significance of the lack of segregation of duties weakness was also concealed given that the scope of the BVI Model, which accounted for approximately 70% of Sino -Forest’s revenue between 2007 and 2010 was also not disclosed. Accordingly, the danger emanating from this internal weakness was heightened, given the size of transactions booked through the BVI Model. We find this disclosure is incomplete because as the evidence demonstrated, all of these duties, specifically the recording of the purchase and sale of standing timber contracts and the settlement of accounts, rested on the shoulders of a single member of senior management: Hung.

[663]Hung submits even someone not mathematically astute would have been able to determine the approximate revenue in the BVI Model fairly easily. He submits one could do this by working from the increase in Sino -Forest’s provision for tax relating to profits from the sale of standing timber in the BVI business from 2009 to 2010 multiplied by a factor that includes the PRC enterprise tax rate of 25% and the PRC income tax based on a deemed profit of 15%. We disagree. We find the computation and the elements of it are neither straightforward nor easily determinable and find that this information ought to have been fully and clearly disclosed to Investors.

(c)The failure to remediate the lack of segregation of duties

[664]Throughout the Material Time, efforts were made to remediate this internal control weakness. In 2005, Sino-Forest hired Mr. Maradin as an internal control expert for the NI 52-109 internal controls project. Chan submits he supported the internal controls project, adding Sino-Forest personnel and external consultants to support the internal controls project.

[665]Hung submits the only evidence about any training for the Respondents in Ontario public markets issues involved mention of a manual that Mr. Maradin prepared about internal controls, which was not entered into evidence, and one day of training in the fall of 2007 at the Gold Coast Hotel in Hong Kong. Mr. Maradin testified his first task when he went to Hong Kong was “understanding the company more” and “doing a training manual because I thought it was very important to make sure that people understood what was required, what was required from a 52-109 perspective, but also what was also required from being

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a public company” (Hearing Transcript, October 29, 2014 at 35:4-12). Mr. Maradin also testified this training manual provided “a person understanding of what the regulatory requirements were as they applied to disclosure controls and procedures, internal controls or financial reporting” (Hearing Transcript, October 29, 2014 at 50:21-25) and “it was relevant to educate and train and give people guidance as far as the regulatory requirements” (Hearing Transcript, October 29, 2014 at 51:9-11). Mr. Maradin testified this training manual was also translated into Chinese. Mr. Maradin testified certain Sino-Forest people in Hong Kong and Mainland China were designated to help him build process documentation and the training manual would help those people in that process. Mr. Maradin also testified he held training sessions in 2006 in Hong Kong and Guangzhou with certain Sino-Forest personnel, including Ip, and, prior to that, held a separate session with Chan, among others, regarding the training manual.

[666]Chan submits Sino-Forest made significant improvements to its internal controls by 2011 and devoted significant financial and human resources to its internal controls project, including several independent expert advisors. Chan further submits he spoke of the importance of internal controls at a management workshop off-site at the Gold Coast Hotel in Hong Kong in 2007 which, in his submission, set the tone at the top for internal controls. Maradin testified Chan spoke to senior management at the Gold Coast Hotel about internal controls. However, we find Chan did not follow through and remediate the most significant internal control deficiency – the lack of segregation of duties.

[667]Mr. Maradin testified, by March 2007, he had drafted policies and procedures in respect of internal controls, and asked Chan, Horsley, Ip and Hung for comments on these policies and procedures.

[668]Mr. Maradin testified E&Y became auditors of Sino-Forest in Q3 of 2007 and at that time, Mr. Maradin “provided them all the documentation, whether it was financial reporting or internal controls” (Hearing Transcript, October 29, 2014 at

71:13-14).

[669]He testified he was frustrated with the lack of progress in remediation and in documenting the processes. He was also frustrated with the lack of assistance from staff. Staff that had been assigned to him in Hong Kong would be assigned to do other things when he returned to Canada. This would slow down the documentation of processes.

[670]Chan submits Sino-Forest hired E&Y in 2008 to help Mr. Maradin draft the process descriptions, which identified the internal control weakness of the lack of segregation of duties. Chan further notes Sino-Forest hired an external consultant, Control Solutions, in 2009 to work with Sino-Forest on internal controls and risk management. Mr. Maradin testified this consultant, however, was hired to work with Sino-Forest’s WFOE subsidiaries and did not address any weakness in the BVI Model.

[671]An email dated May 8, 2008 from Mr. Hyde to Mr. Martin, which was then forwarded to Horsley, indicates “I don’t have a sense of moving forward from a financial reporting perspective” and “[i]nternal control remains behind. We expressed concern and need for better and more frequent reporting. It did not happen. We have a new report but my sense is we should have a third party conduct a review of the state of affairs. We need to turn the heat way up…” Mr.

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