The Securities and Exchange Commission brought fraud charges against S. Paul Kelley, a stock promoter who orchestrated a series of reverse mergers between Chinese companies and U.S.-listed shells.
The SEC said in its complaint that Kelley and certain associates secretly acquired control of the shell companies used in two of the reverse mergers, concealed their holdings in the post-merger companies, manipulated the share prices and then sold millions of dollars of stock at inflated prices.
The two companies that were used as vehicles for the schemes are China Auto Logistics Inc. (Nasdaq: CALI), an automobile importer based in Tiajin, and Guanwei Recycling Corp. (Nasdaq: GPRC), a plastics recycler in Fuqing.
The SEC said some of the defendants also engaged in a scheme to artificially inflate the share price and trading volume for a third Chinese company that Kelley helped bring public - Kandi Technologies Group Inc. (Nasdaq: KNDI).
The SEC's complaint implicated Kandi's chairman and chief executive officer, Xiaoming Hu, in that scheme, which began in late 2009. It said he provided 350,000 shares of stock to two of the defendants, who agreed to pay stock promoters to tout Kandi and to orchestrate a manipulation campaign to lift the shares to a predetermined price.
Over the next few months, Kandi's stock quadrupled, and volume also soared.
Kelley, a Canadian who lives in the suburbs of Toronto, agreed to settle the charges related to China Auto Logistics and Guanwei Recycling and will pay more than $6 million in disgorgement, penalties and interest.
The SEC said that a second defendant, a former stockbroker from Arkansas named Roger D. Lockhart, also agreed to a settlement that calls for him to pay more than $3 million.
Kandi - which also has been the subject of several Sharesleuth stories (here and here) - said in March that the SEC was conducting an investigation titled "In the Matter of Kandi Technologies Group Inc."
Kandi offered no details on the nature of the probe, but said the SEC had issued a subpoena for documents and other information. Kandi added that it did not anticipate a negative result. But it also noted that it could provide no assurances that the outcome would not have a "material and adverse effect on the company's financial condition and results of operations."
We believe the Kandi investigation is separate from the SEC case announced Monday.
Our continuing investigation into Kandi has turned up evidence that the company greatly exaggerated the number of electric cars that it sold in 2009 and 2010. Kandi said in SEC filings and press releases that it sold 3,510 electric cars in that period, primarily in the United States, which was its main market at the time.
However, our survey of Kandi's U.S. dealers, as well as an analysis of Customs records for electric-car shipments into American ports, found that fewer than 1,200 of the company's vehicles were sold or delivered here.
The wide discrepancy between the figures was significant because electric-vehicle sales accounted for roughly 20 percent of Kandi's reported revenue for 2009 and 2010. In addition, Kandi raised more than $26 million through share placements that relied partly on representations about the progress of its car business.
Kandi later disclosed, in its annual SEC filing for 2012, that 960 of the cars it reported selling in 2010 were gasoline-powered rather than battery-powered.
A STRING OF FAILED COMPANIES
Kelley and a common group of financiers and promoters were involved in 11 reverse mergers between Chinese companies and U.S. shells. The other companies they helped bring public include Telestone Technologies Corp. (delisted from the Nasdaq in 2013, now Pink Sheets: TSTC); New Oriental Energy & Chemical Corp. (delisted from the Nasdaq in 2012, now Pink Sheets: OTCPK:OTCPK:NOEC); Orsus Xelent Technologies Corp. (delisted from the American Stock Exchange in 2011, now Pink Sheets: OTCPK:OTCPK:ORSX).
The three other defendants charged in the case involving China Auto Logistics and Guanwei Recycling are:
- Robert S. Agriogianis, a former stockbroker who owned Focus Asia Partners LLC, which handled investor relations for the Chinese companies involved in the scheme. He also has agreed to a settlement and is cooperating with the SEC.
- George Tazbaz, an investor from the Toronto area who controlled various entities in Canada and Asia that received large amounts of stock in the Chinese companies.
- Shawn A. Becker, a former broker from Overland Park, Kan., who now operates as a stock promoter. Becker owns Grace Consulting Corp., which the SEC described as a "purported investor-relations firm" that was used in the schemes.
The SEC said in its complaint that Kelley and his associates secretly acquired controlling interests in the shell companies that became China Auto Logistics and Guanwei Recycling. The deals were structured so that they would emerge with 30 percent to 40 percent of the shares in the post-merger companies, an amount that greatly exceeded the usual stake allotted to shell holders in a reverse merger.
Kelley and his associates also agreed to cover the companies' U.S. legal and accounting fees, listing expenses and investor-relations expenses.
The stock they received in China Auto Logistics and Guanwei Recycling represented nearly all of the public float, which allowed them to control the market for the shares. The SEC said that Kelley, Lockhart, Agriogianis and Tazbaz acted as a group for all major decisions involving the shares, including their distribution and sale.
CONCEALED OWNERSHIP, MANIPULATIVE SELLING
The SEC said the defendants not only failed to disclose that they had significant ownership interests in the two Chinese companies, but actively sought to conceal those interests by distributing the stock to entities they controlled in the United States, Canada and Hong Kong. In some case, they installed straw parties as owners.
According to the complaint, once the shares of the two companies started trading on the U.S. market, the group engaged in manipulative trading to boost the price, then dumped stock at inflated prices through private sales and open-market transactions.
The SEC said that Becker played a key role in touting the companies and manipulating their stock. It alleged that after shares of China Auto Logistics began trading in 2008, the group hired a dozen stock promoters to solicit potential investors.
The complaint said that the group compensated those promoters by giving them at least 700,000 shares of the company's stock. The SEC said the group followed virtually the same playbook at Guanwei Recycling.
THE MANIPULATION OF KANDI'S SHARES
The SEC said that Lockhart, Tazbaz and Becker participated in a separate scheme to defraud investors by manipulating the shares of Kandi, which makes go-karts, low-end electric cars and other types of vehicles.
Kandi went public through a reverse merger in 2007, and was approved for trading on the Nasdaq exchange in March 2008. The company's stock hit a high of $6.82 the following month, but sank to less than $1 a share by the end of 2008.
The SEC said the price drop left Lockhart and Tazbaz with large amounts of Kandi stock that they were unable to liquidate. They went to China in September 2009 and met with Kandi's chief executive, who is the company's biggest single shareholder.
According to the complaint, they reached the following oral agreement:
- Kandi would provide Lockhart and Tazbaz with an additional 350,000 shares of stock.
- Lockhart and Tazbaz would pay U.S. promoters to tout Kandi.
- Lockhart and Tazbaz would arrange for U.S. promoters to manipulate the trading of Kandi's stock so that the share price would top $3 within three months.
The SEC said around the same time, Tazbaz received a proposal through an intermediary to enlist Becker to help boost Kandi's share price. The plan called for Becker to receive stock for increasing the company's share price or trading volume.
Records shows that Kandi's stock was at $1.39 at the start of September 2009, with an average trading volume of less than 20,000 shares a day. By mid-October, it was above $3, and hundreds of thousands of shares were trading daily.
The SEC said that in November 2009, Tazbaz provided 350,000 shares of Kandi's stock, free of charge, to three promoters, including Becker. By December, Kandi's stock topped $6.
Sharesleuth's research found that a third defendant in the SEC case - Agriogianis - was listed as an investor-relations contact on Kandi's press releases until the end of 2009.
The SEC alleged that Lockhart and Becker continued to engage in manipulative trading in Kandi's stock through 2010. The timing of that activity coincides with the period in which Kandi appears to have been overstating its electric-vehicle sales.
We noted that Lockhart is a longtime associate of Arthur J. Porcari, a former brokerage owner who has been one of Kandi's biggest online boosters, and helped set up a private Yahoo message board for company investors.
Porcari previously touted the shares of a company called Host America Corp. on investment message boards.
Lockhart was one of the biggest shareholders in Host America, whose shares quadrupled in the summer of 2005, after it issued a false press release saying it was preparing to install energy-saving systems in 10 Wal-Mart stores as the first phase of a bigger deal with the retail giant. No such agreement existed.
Lockhart sold more than $6 million in stock as Host America's share price neared its peak. The SEC halted trading soon after and began an investigation. Although the company's stock collapsed when trading resumed, the SEC never brought charges.
Porcari also was a consultant to a company called House of Brussels Inc., whose stock had a sharp rise and fall in 2004. SEC filings show that Lockhart and his wife, Davina Lockhart, were large shareholders of that company.
Porcari and the Lockharts also show up as investors in a third public company, Spine Pain Management (OTC: OTCQB:SPIN).
Tazbaz and Becker have not settled with the SEC. Their attorneys have said they plan to contest the charges.
Additional Disclosure: Mark Cuban, majority owner of Sharesleuth.com LLC, does not have a position, short or long, in any of the companies mentioned in this article. Chris Carey, editor of Sharesleuth, does not invest in individual stocks. No third-party paid for the research.
Editor's Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.