SPECIAL REPORT

In China, Silvercorp critic caught in campaign by police

BEIJING and VANCOUVER — The Globe and Mail

Canadian citizen Huang Kun, seen here in May, is now in a jail in central China, expecting to face criminal charges.

On the afternoon of Dec. 28, Huang Kun was about to board a flight to Hong Kong when his Canadian passport was flagged by officials at Beijing’s International Airport, and he was taken into custody by Chinese police.

It was the beginning of a prolonged and often frightening ordeal for Mr. Huang that has landed the 35-year-old from British Columbia in a Chinese jail – sharing a one-bed cell with 20 other men. He is expected to soon face charges of criminally defaming a Vancouver-based mining company called Silvercorp Metals Inc.

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Mr. Huang knew when he went to the airport that day that police in the city of Luoyang, where Silvercorp’s flagship mining operations are located, had arrested and interrogated two associates of his. The men had helped him prepare a scathing research report that, when its allegations were published, sent Silvercorp’s share price tumbling 20 per cent in one day on the Toronto Stock Exchange.

What he didn’t know was that in the wake of a series of scandals involving Chinese companies listed on North American stock exchanges, authorities in China had decided to push back hard against those attacking the credibility of Chinese firms. Many of these critics had made small fortunes by “shorting” the stocks of those firms, essentially betting that their share prices would fall once the new information was revealed. Mr. Huang worked for one of those short-sellers.

In this case, documents obtained by The Globe and Mail may suggest that Silvercorp and its executives were working in concert with local authorities, and helping to pay for the investigation against Mr. Huang and his associates. Legal experts say Silvercorp’s alleged actions may be in violation of both Chinese and Canadian law.

The campaign to clear Silvercorp’s name – and the apparent official support for it – appears to be part of a remarkable effort to punch back against North American short-sellers who have badly damaged the image of Chinese firms over the past two years with a stream of reports alleging fraud, flawed accounting and corporate governance failures. More than a dozen Chinese companies listed on North American exchanges have collapsed as a result.

The failures have damaged the country’s corporate reputation and prevented many Chinese companies from raising money from North American investors, at a time when China’s corporate and political leadership is trying to play a bigger role in global business and finance. This week, China’s official Xinhua newswire, a mouthpiece for the Communist Party government, praised a group of Chinese businessmen who have publicly attacked short-sellers like those who employed Mr. Huang. Xinhua connected the fight to China’s broader effort to be treated as an ordinary player on the global capital markets.

“Due to differences in political systems, economic structures and culture, foreign investors are prone to view Chinese companies with suspicion and prejudice,” Xinhua wrote. The newswire linked such “suspicions” to foreign governments blocking takeover bids by champion Chinese firms such as China National Offshore Oil Corp. (whose $15.1-billion (U.S.) bid for Calgary-based Nexen Inc. is currently being reviewed by Ottawa) and telecommunications giant Huawei Technologies Co. Ltd.

The most high-profile Chinese corporate meltdown was that of Sino-Forest Corp., which was once Canada’s largest publicly traded forestry company, boasting a market value of more than $6-billion (Canadian). Short-seller Carson Block and his firm Muddy Waters accused the timber company of fraudulent activity in June of 2011. Sino-Forest has now been de-listed from the Toronto Stock Exchange, is insolvent, and the Ontario Securities Commission has levelled fraud charges against several of its top executives.

Chinese authorities are understood to be deeply concerned about the reputational damage caused by the wave of corporate scandals. And they want the bad press to stop.

“The attacks by shorters and the issues related to a number of U.S.-listed Chinese companies have caught the attention of officials at the Ministry of Commerce and the National Development and Reform Commission,” said a Canadian lawyer with high-profile Chinese corporate clients who is well connected in Beijing and spoke on the condition of anonymity.

“They don’t think it is necessarily a single isolated action. So things like this have started to climb to the top of attention among senior officials.”

‘I was freaking scared’

That day in December, police strip-searched Mr. Huang at the airport, seizing his cellphone, cash, two laptops, his eyeglasses and his passport. He was placed in a cell in the Beijing First Detention Centre with 12 other inmates.

Within days he was in Luoyang, in China’s central Henan province, being interrogated by officers from the local Public Security Bureau, or PSB. The Canadian citizen has been prevented from leaving China for more than eight months, and was made to pay $32,000 in a form of unofficial bail, before being re-arrested in July. Mr. Huang’s lawyer, Wang Yuehong, believes he will be charged any day now with “disseminating false facts to impair another person’s commercial reputation,” a criminal offence that carries a maximum punishment of two years in prison. If charged, Mr. Huang’s chances of winning his argument in court are exceedingly small: conviction rates in China are above 98 per cent.

Mr. Huang’s troubles are connected to research he helped compile for a report published in September, 2011, on a website called Alfredlittle.com. The report alleged Silvercorp had overstated its production and the amount of precious metals contained in its mines.

The company aggressively denied the allegations in a series of press releases and statements by its chairman and chief executive officer, Feng Rui. In a recent interview with The Globe and Mail, Mr. Feng attacked the credibility of Mr. Huang, his associates and his employer, Jon Carnes, whose firm EOS Funds has, through short positions, profited from a decline in Silvercorp’s share price.

“These people have a habit to lie,” Mr. Feng said, adding “These guys have a habit of fabricating things.”

Documents and evidence obtained by The Globe and Mail – including a number of receipts for police expenses, if authentic – may support allegations that Silvercorp helped fund the PSB investigation against Mr. Huang and his associates. During the investigation, Chinese police seized Mr. Huang’s laptop; it appears that personal information from it, including addresses and phone numbers, was later used in a court filing by the company in the United States.

Mr. Feng strongly denies these allegations and asserts the documents obtained by The Globe have been falsified. He also said that information in the court filing was obtained from publicly available documents, or from the company’s own private investigators.

The company and its share value have, so far, fared much better than other Chinese companies that became the target of short-sellers. In 2011, the company hired KPMG Forensics to probe its financial results. Silvercorp said the firm produced a report that, although it was not made public, cleared it of any financial fraud allegations.

Its stock rebounded sharply after it announced the findings of the KPMG report in response to the Alfrelittle.com allegations.

Silvercorp’s offensive appears to be part of a co-ordinated counterattack by Chinese companies and government authorities – who are often closely linked – against North American short-sellers. Mr. Huang’s lawyer, Ms. Wang, said the officers handling the case made it clear to her that the only way her client could expect lenient treatment was if he gave them information related to other recent short-seller reports that caused sharp drops in the share prices of U.S.-listed Chinese companies.

She said the Luoyang PSB specifically sought information about negative reports on China’s No. 2 property developer, China Evergrande, and on New Oriental Education & Technology Group Inc. Ms. Wang said Mr. Huang has no knowledge of either case.

Others individuals who, like Mr. Huang, have made money investigating whether Chinese firms are accurately representing themselves to foreign investors, admit they have been temporarily chased out of the mini-industry. “There was something about the way [Silvercorp] defended itself – the obvious government connections it had – that made it obvious to me that I should leave it alone for a while,” said one investigator who had played a role in uncovering Sino-Forest’s flaws and now says he no longer takes on such jobs in China. He spoke on condition of anonymity.

Mr. Huang’s experience is instructive. Three days after his arrest at Beijing airport, he was transferred into the custody of PSB agents, who put him in the back seat of a rental car and drove 900 kilometres southwest of Beijing to Luoyang. It was 11 p.m. on Dec. 31 when they reached Luoyang, a gritty industrial city of 1.5 million residents, and Mr. Huang was taken straight to the office of the local PSB’s economic crimes unit and interrogated. He said the PSB wanted to know who had hired him to investigate Silvercorp, how the investigation had been done, and who made money off it.

“I was freaking scared. I had been in jail for four days, and I didn’t know what they were going to do to me,” Mr. Huang said in an interview in Beijing before his re-arrest in July. “I mean, I hadn’t even been able to call anybody. So I started telling them.”

Mr. Huang said the PSB told him that his interrogation was part of an international investigation, one that had been approved at the highest levels in Beijing, and one in which the RCMP was also taking part. When contacted by The Globe and Mail, Feng Yi, the PSB officer responsible for the case, acknowledged Mr. Huang was in custody and predicted a conviction. He said other cases where Chinese firms were targeted by foreign short-sellers would also be investigated.

It was during that initial questioning that Mr. Huang said he first noticed the lead PSB officer was receiving text messages on his mobile phone that seemed to spark new and more-specific lines of questioning.

Mr. Huang said he explained to the police that he had worked for EOS Funds – the Vancouver-based investment fund – since 2006, and that his main job was to “investigate investments,” focusing on Chinese companies that had obtained listings on North American stock exchanges via a tactic known as a “reverse takeover.” That involves acquiring an already-listed shell company, and thereby bypassing an exchange’s lengthy approval processes and the scrutiny of securities regulators.

Mr. Huang said he hired local investigators who made videos of the trucks going to and from Silvercorp’s main mining property, and collected ore samples from the side of the road. That evidence led to the report alleging that Silvercorp had overstated the production, quality and resource estimates of one of its mines. Silvercorp strongly denied the allegations.

Mr. Huang slept the night of Jan. 1 on a couch in the PSB office before being moved next door into Green Tree Inn, a two-star hotel that would be his home for the subsequent three weeks of off-and-on interrogations.

The PSB still had his passport, cash and laptops, and Mr. Huang was told that he wouldn’t be allowed to leave Luoyang until he paid 200,000 yuan (about $32,000), a seemingly arbitrary amount that the PSB officer said Mr. Huang needed to hand over because he had made “illegal proceeds” from his investigation of Silvercorp.

Mr. Huang began to get suspicious about who was really investigating him when the PSB officers asked him to provide passwords for his company e-mail and trading accounts.

The police officer, he said, didn’t have the laptop with him, and wasn’t familiar with the English-language programs. He was getting instructions over the phone from someone who didn’t appear to work for the PSB.

“I heard a female voice on the other end asking ‘does your [PSB] office in Luoyang have anyone who knows Outlook Express?’ ” Mr. Huang recalled. “They were getting orders from the other side of the phone … it had to be from the company.”

While Mr. Huang was allowed to leave Luoyang at the start of the Chinese New Year in late January, he was told he could not leave China and was repeatedly summoned back to Henan province for further questioning.

Mr. Huang’s belief that Silvercorp was managing the PSB investigation grew firmer after he and the lead PSB agent travelled together in February to the city of Wuhan, where Mr. Huang was born. The trip was made in order to cancel his Chinese passport and extend the visa in his Canadian one, a necessary precondition to keeping Mr. Huang in the country for further questioning. (China doesn’t allow its citizens to be dual nationals.)

When Mr. Huang and the PSB agent checked out of the Home Inn on Feb. 10 after a two-day stay, Mr. Huang paid his own room bill. But he said he was shocked to hear the officer ask to have the second room’s receipt made out to Henan Found Mining Co., a subsidiary owned 77.5 per cent by Silvercorp. Later, while free from Luoyang but still unable to leave China, Mr. Huang returned to the hotel and asked for a copy of the two receipts.

The Globe and Mail confirmed with the local tax office in Wuhan that the sequential tax receipts Mr. Huang obtained were indeed issued by the Home Inn. The hotel itself confirmed that someone with the name of Feng Yi, the PSB officer who led the investigation of Mr. Huang, checked out of the hotel on Feb. 10 and paid a bill of 493.30 Chinese yuan, an amount identical to that on the receipts provided by Mr. Huang.

A similar paper trail appears to exist for a later trip to Chengdu. Luoyang PSB officers escorted Mr. Huang to the southwestern city so they could interview other researchers. The room bill for a March 13 stay at the Kang Ting Wen Miao Hotel in Chengdu is made out to Feng Yi, but the matching tax receipt, seen by The Globe and Mail, is made out to Henan Found Mining. The red stamps on the receipt match the numbered stamp issued to the hotel by the National Administration for Code Allocation in Beijing.

Mr. Huang claimed Officer Feng was at times less-than-guarded in front of him, at one point asking someone over the phone if someone from the mining company could provide a car. The next day, Mr. Huang was driven to Zhengzhou, a city 150 kilometres away from Luoyang, in a black Lexus 240. Mr. Huang wrote down the licence plate number and, according to a search conducted for The Globe and Mail by a private investigator in China, the plate number belongs to a black Lexus owned by Henan Found Mining.

Silvercorp’s apparent financial backing of a Chinese police investigation, if proved, and the sharing of information between Chinese law enforcement officials and a private company, could represent a violation of Canadian law, according to legal experts. Mr. Huang’s Chinese lawyer claimed such tactics would also be a clear violation of Chinese law, although she said it’s not a widely enforced section of the country’s criminal code.

Chinese law stipulates that police cannot accept any form of payment for an investigation, including having an outside party pay for an officer’s expenses. “It’s illegal,” Ms. Wang said of Silvercorp allegedly subsidizing the PSB investigation against Mr. Huang. “But this kind of behaviour is taken as common practice in China.”

Such accusations might have more weight in Canada. Milos Barutciski, an expert on international corruption cases, said the documents obtained by The Globe and Mail suggest Silvercorp’s actions “may also contravene Canadian law where related acts or communications have occurred in Canada.”

 

Contact list

In mid-March, Silvercorp, which was already suing EOS and its founder Jon Carnes in the Supreme Court of New York, filed a motion to obtain documents from Royal Bank of Canada and RBC Dominion Securities. In the filing, which was withdrawn about two weeks after it was first made, Silvercorp provided what appeared to be 44 phone numbers and 20 addresses. The filing asked that RBC be ordered to provide any trading account numbers and contact information associated with the phone numbers and addresses.

Mr. Huang says the list filed by Silvercorp’s lawyers could only have come from a contact list he keeps on his laptop, which has been out of his hands since it was seized at Beijing airport. “They even had my boss’s wife’s Asia Air Miles number [appearing as a phone number in the court filing],” Mr. Huang said. “They could only have gotten it from my laptop.”

Mr. Huang says he confronted Officer Feng at one point about Silvercorp’s involvement in the investigation. He said the PSB agent’s reply was aggressive. “He said, ‘You have to take responsibility for what you have done. This company is very powerful at the local level. They pay a lot of tax to the local government and Luoyang is a very poor city. They contribute a lot to the local economy.’ ”

But Silvercorp CEO Feng Rui said his company had no involvement in helping to pay for the PSB investigation of Mr. Huang and his associates. He insisted that Mr. Huang, Mr. Carnes and others are fabricating the evidence.

“These are bad people for me. They are my enemy. I am raped. I tell police. Right? The police sometimes do contact me and with us. We are victims. We are big taxpayers in the Luoyang County,” Mr. Feng said in a telephone interview from Beijing.

When asked why the hotel receipts for the PSB officer were made out to a division of Silvercorp, the CEO suggested they were fakes. He noted that it is relatively simple to create false receipts in China.

As for the allegation that the PSB had used a company car to transport Mr. Huang, the Silvercorp CEO suggested that Mr. Huang had recorded the car makes and licence plates of the mining company’s vehicles when he and other researchers were secretly videotaping the company’s operations in 2011.

Mr. Feng also denied that Silvercorp has received any information from the Luoyang PSB that was obtained from the investigation. When asked about the addresses and phone numbers submitted in New York court, Mr. Feng said some of the data was publicly available on the Internet while other parts were uncovered by Silvercorp’s own investigators.

EOS founder Jon Carnes said Mr. Feng’s explanations were “preposterous.” In an interview in Vancouver, Mr. Carnes said that the data entered into court by Silvercorp could only have come from Mr. Huang’s laptop as his own laptop and that of another associate with the same information had not been compromised. He confirmed that one of the “phone numbers” filed in New York court was, in fact, his wife’s Asia Miles frequent flier number.

Mr. Carnes conceded that he currently has a $2-million (U.S.) short position on Silvercorp shares and will benefit financially if the stock declines. He pointed to his lengthy track record of exposing frauds or unscrupulous behaviour at other Chinese companies as proof that he and his researchers are not fabricating evidence in Mr. Huang’s defence.

“In the Silvercorp case, I would say I have absolutely no reason to fabricate any of this stuff. I have built up a substantial track record exposing fraud and to do something as stupid as fabricating evidence would be stupid,” Mr. Carnes said.

Huang Kun’s father, Huang Youcai, said he just wants his son to get out of China. In an interview from his Vancouver home, the elder Mr. Huang said he and his wife were unaware of his son’s legal troubles until he was arrested for the second time in July and lost all communication. Now Mr. Huang is pleading with the Canadian embassy in Beijing and the Department of Foreign Affairs in Ottawa for help.

Ms. Wang, the lawyer, said the Canadian embassy has met with Mr. Huang twice, including once in the Luoyang PSB office since his most recent detention. “The embassy says it will go on working through diplomatic channels but they’re not sure how much effect they will have,” she said.

Before his latest arrest, Huang Kun said he was worried that Silvercorp’s connections to the police investigation meant he would likely spend a prolonged time in jail.

“Yeah, of course I’m worried … there’s not enough evidence to charge us, but [the police] are getting pressure from the higher officials – the provincial level and the federal level … to investigate this case and punish us,” he said in mid-May, drinking green tea in the lobby of a five-star hotel in Beijing while out on bail.

“The law in China is very flexible.”

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