What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing with the luck and coffee and wire card accounting frauds being exposed in the last couple years is increasingly important for investors to do deep, due diligence to Make sure that companies financial statements are accurate in this video we're looking at one of the biggest and most blatant fraudulent chinese companies from the last decade, we're talking about cyano forest, an almost non-existent company that was somehow able to amass a 5 billion valuation on the Toronto stock exchange when they were exposed as a fraud in 2011, it came as a massive shock, because chinese socks had become very popular among western investors, who wanted a piece of the country's rapidly growing economy. Sophisticated investors, including hedge funds, lost billions of dollars overnight when they found out their shares of cyano forest were worthless. In this video we'll explain what cyano forest was, how it grew to a five billion dollar valuation and what steps you can take to avoid investing in fraudulent companies going forward. Cyano forest was founded in 1994 and claimed to be the leading forest plantation operator in china.

Here's a short clip of co-founder and ceo alan chan, explaining the company's business model we're operating plantations in china. That's with the two models, one that we buy trees standing timber which are trees we buy we hold and later on. Then we sell them as trees. We don't lock them and we're also running another model of our planting trees on bear land when they mature.

We lock them and sell them as logs. On the surface, it sounds like a great business. The chinese economy was rapidly developing and they needed tremendous amounts of wood for things such as residential construction. They didn't produce enough wood domestically, so about 50 of wood was imported from other countries.

Transporting wood overseas is very expensive, so if any company could successfully grow trees domestically, they could make huge profits. Cyano forest business model was simple. They would buy young trees from tree farmers and hold them for a few years as they grow. Once the trees had reached maturity, they would sell them to lumber companies who wanted to buy wood.

Importantly, cyano force would not log the trees, they would only sell them and the buyer would have to come to the field and cut them down themselves. This was great for sino forest because it means that they didn't need to invest in expensive logging equipment or hire. Lumberjacks, at first glance, this business model should have been suspicious. They would buy trees, hold them for a few years and then sell them at a profit.

They didn't really do anything that created value. It just seems odd that any farmer would sell a premature tree at a steep discount when they could just hold it themselves and sell it once it matures, but regardless they enjoyed tremendous success in 1995, just one year after being founded, they listed their shares on the Toronto stock exchange through reverse takeover or rto an rto is something similar to a spac sino. Forest founders required a penny stock company that trades on the toronto stock exchange for a few million dollars. They then had this panasonic company acquire sino forest.

This reverse merger allowed sino-force to become a publicly traded company without going through a traditional ipo process in the associated due diligence by the mid 2000s. Investors were starting to take note of the company's impressive growth from 2004. Through 2010, their assets had increased eightfold from 700 million dollars to 5.7 billion dollars. Their revenue had similarly increased from 500 million dollars to almost 2 billion.

They also posted strong profitability, as they claimed to sell their trees for prices far in excess of the prices they paid to acquire them, but instead of returning capital shareholders in the forms of dividends or buybacks, they invested everything into growing the business. In fact, they raised a cumulative three billion dollars of debt and equity from the public market. Since they listed on the toronto stock exchange. They claimed to use this money to buy more trees and by 2009 they had over 750 000 hectares worth of trees under management.

Sino-Force stock became very popular both in the us and canada, as investors want to get a piece of this growing and highly profitable company by 2011, their market cap had exceeded 5 billion and was owned heavily by sophisticated institutional investors such as hedge funds. In fact, their single largest shareholder was the legendary hedge fund manager, john paulson, who owned close to one billion dollars of sign up for his stock. Everything was looking good for the company until the summer of 2011, when activist short seller, carson block of muddy waters, research released a damning short report calling the company a near-total fraud. The report mainly focused on the company's use of so-called authorized intermediaries.

Cynoforce didn't directly sell trees to end buyers. They used these intermediaries, which were separate legal entities to sell the trees on their behalf. The intermediaries would collect payment from the end buyers and pass this along to sino forest muddy waters found out that many, if not all, these intermediaries were fake, they sent field agents into china to look at the registered addresses for these companies headquarters. In one case, an intermediary which supposedly handled 200 million dollars worth of tree sales, was headquartered in a residential apartment.

Building another intermediary called orchid garden, was headquartered in the personal residence of the company's executive director. It's pretty obvious that these were not real companies and were not selling any significant number of trees. Furthermore, cyano forest claimed that almost half of their standing timber sales were from the remote yunnan province. The 230 million dollars worth of timber that they supposedly sold in this region far exceeded government logging quotas and the rugged mountain terrain would make such large-scale extraction economically unviable.

Anyway, it was pretty clear that a substantial portion - if not the vast majority of the company's sales were fabricated, very few trees were changing hands and the founders were likely using the complex corporate structure to siphon cash into other entities which they controlled. Do you believe this company really is a nothing you say in your research? In fact, you, the first two words of your research report are like madoff. How is this a ponzi scheme? It doesn't look like a classic ponzi scheme. Well, it's a ponzi scheme in that the company just perpetually issues securities in order to fund itself, even by its own fraudulent numbers.

The company does not generate any free cash and has not done so in 16 years. We're the company to be unable to issue additional securities to fund itself. It would collapse that to me is the definition or epitomizes the definition of a ponzi. It's again, 16 straight years, burning cash! No, you know! No, you know no guidance as to what the rationale is to acquire so many trees.

So far ahead of customer orders um now i i just this is uh. This is taking a capex fraud which you find if we found a several of these in china, it's taking it to the next level, where you're not constrained by the walls of a factory and nobody's able to really see the movement of physical goods. So it could grow to be infinite. Um.

You know, provided that the capital markets continue to fund it right after the muddy waters. Short report was released. The stock price fell from almost twenty dollars down to five dollars and continued its decline down towards zero. Over the next few weeks, john paulson's hedge fund sold his shares at the lows for an estimated loss in excess of 700 million dollars.

The sign of forest fraud lasted for more than 10 years, and investors collectively lost close to 3 billion. Part of this can be attributed to the fact that their audits were conducted out of the canadian office of ernst young. They thus had limited capabilities to conduct field visits in china, so they mainly relied on disclosures provided by sino-force itself and with the fraud being so sophisticatedly orchestrated. They had no way of cracking the case remotely from canada after the short report was published, sino-force hired pwc as an independent auditor, but they were unable to verify the company's supposed vast reserves of valuable timber.

Later that summer, the ontario securities commission suspended trading of sign of forest shares and said that the company had engaged in fraud unable to raise additional capital. They were forced to declare bankruptcy in march of 2012., one day before filing for bankruptcy. They sued mighty waters. For defamation bloc pointed out that their bankruptcy filing vindicated the accuracy of his report and the lawsuit never went anywhere.

In 2017, the ontario securities commission found ceo alan chan, as well as other high-ranking executives guilty of defrauding investors. However, it appears that chance stayed in china and has never answered for his crimes. He easily could have kept a few hundred million dollars and be living a life of luxury. To this day after the bankruptcy sino, forest assets were transferred to a new entity called emerald plantations holdings, which was to be owned by the creditors.

It started trading on the otc markets in 2013 and has since lost 98 of its value. This just goes to show that sign of force, business model of buying and selling trees was never viable without the aid of fraud. It's pretty much impossible to turn this into a profitable business. The case of sino forest shows how important it is to do extensive due diligence, especially when investing in chinese stocks.

It was nearly impossible to tell that they are fabricating their revenues unless you actually had field agents on the ground in china. This is how they were able to fool even some of the most sophisticated of investors. It's probably a good idea to stay away from obscure small cap companies that don't get any coverage in the non-financial media, even if the business looks good on their financial statements. The company may not actually exist in any significant capacity, alright guys that wraps it up for this video.

What do you think about cyano forest was john paulson negligent when he spent close to one billion dollars of his investors money on their stock. Let us know in the comments section below as always. Thank you so much for watching and we'll see you in the next one wall, street millennial, signing out.