My name is Mark Goodfield and I am a tax partner and the managing partner of Cunningham LLP in Toronto. This blog is about income tax, business, the psychology of money and investing topics and is meant for taxpayers no matter their income bracket, but in particular for high net worth individuals and entrepreneurs who own private corporations. I also blog about whatever else crosses my mind; I have to entertain myself. This is my personal blog and the views and opinions expressed in this blog do not reflect the position of Cunningham LLP. I am blunt and opinionated (at least for a Chartered Professional Accountant). You've been warned.

The blogs posted on The Blunt Bean Counter provide information of a general nature and should not be considered specific advice, as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Wednesday, June 8, 2011

The power of free flowing information-Sino Forest Shareholders pay the price

Sino Forest Corporation (“Sino Forest”), ticker symbol TRE, has been a high-flying stock over the past couple of years, going from $6 in 2008 to a high of $25 in 2011. Sino Forest is a commercial forest plantation operator in China. On June 2, 2011 the stock began the day priced at $18.21. However, that day, Muddy Waters Research, a relatively new research firm initiated coverage on Sino Forest with a strong sell, saying the company's value was less than $1and stating “Like Madoff, TRE is one of the rare frauds that is committed by an established institution. In TRE’s case, its early start as an Reverse Takeover Over, fraud, luck, and deft navigation enabled it to grow into an institution whose “quality management” consistently delivered on earnings growth.”

Following the initiation of Muddy Waters coverage, Sino Forest’s stock price fell to $14.46 from $18.21. The next day as the report gained widespread media coverage; the stock price took a further hit and fell to $5.23, a 71% drop in stock price. Sino Forest's stock closed at $4.01, on June 7th, the day before I post this blog.

As of this writing, it is not clear if Muddy Waters is accurate in its accusations or how much it has made by selling short. However, I do not wish to focus on either of these very important aspects, but rather, I wish to discuss the fact that a little known research firm can issue a single report that can cause a publicly listed stock to lose 71% of its value in two days.

With the advent of the internet, information flows freely and it can be digested by the markets instantly. I have no issue with the consequences of this report should the report prove to ultimately be accurate. However, what are the consequences if Muddy Waters’ allegations are proven incorrect? I would suggest Muddy Waters would face significant legal action, but what about the investors that fled the stock as the price fell off the cliff? They could be out as much as $14 a share. In this era of instant information, how can the stock exchanges protect investors from erroneous reports and/or manipulation through false information or do they even have a responsibility?

In this case, the Toronto Stock Exchange halted Sino Forest on June 2nd. Sino Forest came out with a statement saying “The board of directors and management of Sino-Forest wish to state clearly that there is no material change in its business or inaccuracy contained in its corporate reports and filings that needs to be brought to the attention of the market. Further, Sino-Forest recommends shareholders take extreme caution in responding to the Muddy Waters report”. However, once the halt was lifted, the stock dropped from $14.46 to $5.23; so much for protecting investors.

So how could/should the world stock exchanges deal with this issue? Should they halt the trading of every stock that has an accusation against it until a full investigation is done? As an investigation could take months, a full halt would be impractical and paralyze companies. One thought I have is, maybe there has to be a standard unwind process, where the exchange advises all purchasers that any purchases from a point in time will be subject to an unwind provision should certain information prove false. However, that would be punitive to purchasers while protecting the sellers. Maybe it is just caveat emptor and if you have done your due diligence, you use unprovoked unsubstantiated attacks to add to your position. I would suggest this alternative requires unshaken confidence in your own due diligence and nerves of steel.

I really don’t have an answer to this perplexing issue and I am not sure there is an answer; but the world exchanges will need to address how they handle potentially erroneous information that is disseminated worldwide within minutes.