My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a tax partner and the managing partner of Cunningham LLP in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog do not reflect the position of Cunningham LLP. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

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.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts 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.

9 comments:

  1. This is an interesting case. I agree with you that there likely isn't much that regulators can do. This comes mainly from the fact that they don't know if the allegations are true or false. If the allegations were know to be true, then little action is required. If they were known to be false, then halting trading until a strong counterstatement is disseminated makes sense. But I doubt that future cases like this are likely to have any certainty either.

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  2. Mike, thx for your thoughts.This is really a quagmire for investors, especailly smaller retail investors. In the end, the exchanges really have a perplexing issue on their hands. I imagine there are very many angry Sino Forrest shareholders out there right now, with no clue whether their shares are worth $18 or $1.

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  3. Maybe this is a stupid question, but... If Sino Forrest is a commercial forest plantation operator in China, why does their stock trade on the Toronto Stock Exchange? who pays for their forests? The Chinese government? This sounds like a terrible investment anyway.

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  4. Re: double-r forest:

    I'm not sure if it's a typo, or a commentary.

    "Life is like a box of chocolates... you never know what you're gonna get."

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  5. Opps, Thx Potato. I guess thats what you get when your writer, editor and chief bottle washer. I am an ideas man, forget the details :)

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  6. "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?"

    No! This is basically a twist on "the government should..." as made by people who can't make decisions for themselves, so insist on having it done for everyone by force. (Not that you would advocate this position yourself.)

    People need to be responsible for their own decisions. We do not need big brother filtering information and preventing responsible individuals from making their own assessments and risk/return determinations. Who would you trust to suspend your own freedom of choice? Hopefully no one.

    If the information is credible, then the fall can be justified. If the information is bogus, and it still falls, then it's a fair opportunity for the smart capitalists to profit from the follies of the dumb ones - and provides the ancillary benefit of rewarding and strengthening those able to make independently correct decisions against the herds of sheeple.

    And that's the way it must be if there's to be any semblance of a free market left in the West... interference in markets only reduces wealth.

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  7. Skuj, in the end, I think you are correct. I don’t think there is a practical alternative, nor should there probably be one. However, maybe the exchanges need to consider longer halts to at least allow time for the deflection of misinformation fired by those with insincere motives.

    Where the sp has dropped due to misinformation and you want to take advantage of the "sheeple" as you say, I say in my blog “I would suggest this alternative requires unshaken confidence in your own due diligence and nerves of steel." You appear to qualify on both counts.

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  8. There should not be any trading halt.

    Who does the halt protect? No one.

    If I want to believe a report by some "no name" firm, then I should be allowed to sell the stock.

    If I want to believe that this company isn't fraudulent, then I should be allowed to invest.

    And if I have no clue either way, then (i) I shouldn't have invested in this company without having done the research; and (ii) I can just hold my position until a week or month go by and the truth comes out.

    Either way, a trading halt only harms everyone.

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  9. Anon- I actually agree. The blogs intent was to stimulate some discussion on what the exchanges should do in these cases or whether they should do anything. Other then an initial halt to provide for the disimenation of information, I have concluded there is not much they can do.

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