SEC Charges China-Based Executives with Securities Fraud
The Securities and Exchange Commission today charged two China-based executives with defrauding investors into believing they were investing in a Chinese coal business when in fact they were investing in an empty shell company.
The SEC alleges that Puda Coal Inc.’s chairman Ming Zhao schemed with former CEO Liping Zhu to steal and sell Puda Coal’s sole revenue-producing asset, a coal mining company named Shanxi Puda Coal Group. Zhao secretly transferred Puda Coal’s controlling interest in Shanxi Coal to himself and then sold a substantial portion to a fund controlled by what is reported to be China’s largest state-owned financial firm. The scheme enabled Zhao rather than Puda Coal’s public shareholders to profit from a lucrative business opportunity.
The SEC alleges that Zhao and Zhu failed to disclose these transactions in Puda Coal’s periodic reports to the SEC, and continued to raise funds from U.S. investors by conducting two public offerings to purportedly raise capital to enable Shanxi Coal to acquire coal mines. Unbeknownst to investors, Puda Coal no longer had an ownership stake in that company after Zhao’s secret maneuvers. After the SEC began investigating, Zhao and Zhu further schemed to forge a letter from the Chinese financial firm purporting that Puda Coal investors weren’t harmed by the asset transfers. In reality, the scheme left Puda Coal as a shell company with no ongoing business operations.
“Zhao and Zhu duped investors with promises that their money would be invested in a Chinese coal company when in fact the company was an empty shell that had been looted by the defendants,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “This enforcement action reflects our continuing commitment to hold accountable officers and directors of issuers who misuse their access to the U.S. capital markets to commit fraud for personal gain.”
George S. Canellos, Director of the SEC’s New York Regional Office, added, “The massive fraud perpetrated by Zhao and Zhu wiped out hundreds of millions of dollars in shareholder value and was compounded by their brazen obstruction of the SEC’s investigation.”
According to the SEC’s complaint filed in U.S. District Court for the Southern District of New York, Puda Coal entered the U.S. capital markets through a reverse merger in July 2005. Puda Coal’s common stock was listed and traded on the NYSE Amex from September 2009 to August 2011.
The SEC alleges that Zhao embarked on the scheme with Zhu in September 2009 to enrich himself at the expense of Puda Coal’s public shareholders. Just weeks before Puda Coal announced that Shanxi Coal had received a highly lucrative mandate from the provincial government authorities to become a consolidator of smaller coal mining companies, Zhao quietly transferred Puda Coal’s 90 percent stake in Shanxi Coal to himself. In July 2010, Zhao transferred a 49 percent equity interest in Shanxi Coal to CITIC Trust Co Ltd., a Chinese private equity fund controlled by state-owned investment firm CITIC Group. CITIC Trust placed its 49 percent stake in Shanxi Coal in a trust and then sold interests in the trust to Chinese investors. Zhao caused Shanxi Coal to pledge 51 percent of its assets to CITIC Trust as collateral for a loan of RMB 3.5 billion ($516 million in U.S. dollars) from the trust to Shanxi Coal. In exchange, CITIC Trust gave Zhao 1.212 billion preferred shares in the trust.
According to the SEC’s complaint, the transactions were not approved by Puda Coal’s board or shareholders and not disclosed in Puda Coal’s SEC filings, which Zhao and Zhu signed knowing that they were materially false and misleading. During the two Puda Coal public offerings in 2010, CITIC Trust was separately selling interests in Shanxi Coal to Chinese investors while Zhao and Zhu were still telling U.S. investors that Puda Coal owned a 90 percent stake in that company.
The SEC further alleges that Zhao and Zhu continued their fraudulent scheme to deceive public investors even after the SEC began its investigation. Zhu forged a letter purportedly from CITIC Trust falsely stating that no funds had actually been loaned to Shanxi Coal and disclaiming any interest in Puda Coal’s or Shanxi Coal’s assets. Zhao’s counsel provided the forged letter to the SEC’s investigative staff and Puda’s audit committee. After Puda Coal disclosed the letter in an SEC filing and further misled shareholders about the ownership of Puda Coal’s assets, Zhu admitted forging the letter and resigned as CEO. Zhao remains the chairman.
Zhao and Zhu are charged with violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, as well as violating the proxy solicitation rules and various corporate reporting, recordkeeping and internal controls provisions of the Exchange Act. The SEC’s complaint seeks a final judgment ordering Zhao and Zhu to disgorge their ill-gotten gains plus prejudgment interest, imposing financial penalties, barring them from acting as officers or directors of a public company, and permanently enjoining them from committing future violations of these provisions.
The SEC’s investigation, which is continuing, has been conducted by Sheldon Pollock, Scott York and George Stepaniuk of the SEC’s New York Regional Office with investigative support from Neil Hendelman and Desiree Marmita. The SEC’s Cross Border Working Group, which has representatives from each of the SEC’s major divisions and offices and focuses on U.S. companies with substantial foreign operations, has assisted the New York Regional Office enforcement staff in the investigation.
* * *
Over the past year, the SEC has moved to protect U.S. investors in U.S. companies with substantial foreign operations through:
- Trading suspensions of at least 20 U.S. issuers based abroad.
- Stop orders against two U.S. issuers based abroad to prevent further stock sales under materially misleading and deficient offering documents.
- Filing a subpoena enforcement action against a foreign-based audit firm to obtain documents.
In addition, the SEC has revoked the securities registration of at least a dozen U.S. issuers based in the People’s Republic of China and instituted administrative proceedings to determine whether to suspend or revoke the registrations of 27 more issuers.