- FAB internal investigation found that only a “small number” of kiosks have media download capability.
- Cash balance confirmations cannot be relied upon in China.
- Most “Intelligent Media Kiosks” actually contain no media at all.
- FAB falsely claims Wang Lirong never worked for the company and claims to have filed a lawsuit against her.
- Eight-month NYSE trading halt served no purpose whatsoever and damaged all investors, long and short.
On August 13th, 2014, FAB Universal (OTC:FABU) issued a press release providing a "summary of major findings" of the "internal investigation" effort of Loeb & Loeb LLP ("Loeb"), retained by FAB's Board of Directors. Both the investigation and its vague findings are inherently flawed, as I will show in this report.
When the investigation was first announced, FAB described it as an "independent investigation." FAB's press release now confirms that the investigation was not independent, but merely "internal," which seems incredibly misleading.
Below I will address each one of the findings, point by point:
"Cash in Banks Confirmed."
Cash confirmations in China cannot be trusted. Loeb retained FTI Consulting ("FTI") to obtain "…direct bank confirmations or statements from the two banks holding 95% of the Company's cash." What this means is simply that the bank staff provided confirmations or statements confirming the year-end 2012 cash balances. It in no way suggests that the confirmation statements are true, nor does it address the manner in which any and all funds were generated in the first place. No one from FTI or KCCW was at the banks viewing the balances at year-end. Even if you did view the balances at year-end, those balances could have still been false, with the help of complicit bank management, or alternatively consisted of short-term borrowed funds from another party. The unreliability and truthfulness of bank balances is why I never bother challenging them. There is simply no point debating whether FAB's purported cash is real. The real focus of any investigation should always be on the business.
"No Evidence of Overstatement of Number of Kiosks in Beijing."
FAB falsely claims that "short sellers" alleged that "…FAB has overstated the number of kiosks that it has deployed in Beijing." FAB knows that my primary allegation was that FAB overstated the number of "Intelligent Media" kiosks ("media kiosks") in Beijing. I made no allegation regarding the non-media kiosks in Beijing, which should have included the roughly 1,000 self-service payments kiosks FAB obtained via its 2013 undisclosed acquisition of Beijing Vanpos Telecom. This appears to be obfuscation via wordsmithing to give the impression that the company is refuting my original claims, when it is instead walking itself in a circle around them.
Without disclosing the number of media kiosks FTI found in Beijing, this finding of the internal investigation has little to no value.
Once again, instead of playing games with the scope of FTI's kiosk search, FAB should have simply disclosed the addresses of all of the Beijing media kiosks long ago so that anyone interested could go verify them.
FAB then falsely claims that:
"…some confusion may have resulted from the fact that [FAB] refers to all of its kiosks, even those that do not offer content for download, as Intelligent Media Kiosks or 5C kiosks…"
But as anyone who read FAB's historical SEC filings can see, as recently as the 2013 Q3 10-Q filed November 14th, 2013, FAB described its "Intelligent Media Kiosk" as follows:
"FAB Intelligent Media Kiosks, based on 61 proprietary national intellectual property rights, are ATM style terminals where consumers can download copyrighted music, video games, ringtones, digital books and movies directly to their cell phones, memory sticks or other mobile storage devices." (Page 23)
FAB then falsely claims that:
"…only approximately .3% (three tenths of one percent) of the Company's revenue comes from download fees, which is consistent with the Company's financial records."
This claim doesn't even make any sense. FAB media kiosk download revenue is driven by sales of FAB prepaid membership cards, which FAB reported on page 29 of its 2014 Q1 10-Q to be $2.8 million, or 19% of FAB's revenue for the quarter. FAB membership cards, issued in 100-500RMB denominations, are purportedly used by FAB customers to purchase and download media from the FAB media kiosks (in Beijing only, according to the 10-K.)
FAB's falsely reported .3% of revenues attributable to media kiosk downloads is simply an effort to marginalize its questionable media kiosk business.
I am not surprised to see that FTI found that FAB let its "maintenance contract" with Huzhong lapse in 2013, such that "…many of the kiosks did not function, either because of their condition or because they were not plugged in." Does that make any sense for a business that purportedly generates so much income for FAB? If "many" of the kiosks are not functional, then how is FAB still generating $2.8 million in membership revenues in Q1?
"No Evidence of Overstatement of Number of Kiosk Licenses Outside of Beijing."
I never challenged the media kiosks located outside of Beijing. Considering that my research concluded that the Beijing media kiosks do not exist, it is still totally doubtful that the media kiosks outside of Beijing exist, in my opinion.
"Confirmation of Copyrighted Content on Kiosks."
FAB discloses that:
"… Loeb confirmed that the Company had obtained rights to a large amount of content offered on the small number of kiosks from which patrons could download that content…" [Emphasis added]
Once again, how is FAB generating such substantial membership revenue with only a small number of media kiosks to serve their members? How hard can it be for FAB to quantify how many media kiosks really exist in Beijing? Why must the media kiosk locations remain a secret? FAB then admits, "…that a small number of the kiosks offered some pirated content…" Of course, as I documented in my November 19th, 2013 report, in reaction to my first report published the week before, FAB quickly removed the obviously pirated movies from the 20 media kiosks my investigators found in Beijing. Thus, I would not have expected Loeb to find much continued evidence of piracy on the "small number" of media kiosks found in Beijing.
FAB again repeats its claim that only .3% of its revenue was generated by download fees, while ignoring that the supposedly highly lucrative FAB Membership card program is purportedly the way that most users pay for downloaded media content from the media kiosks.
"No Evidence That Any Licensee Was Guaranteed a Return."
FAB claims that Wang Lirong, the director of franchisee sales who my investigators interviewed in the FAB's Xidan Joy City office:
"…was and is not, in fact, the director of franchisee sales or even an employee of the Company and was not authorized to make any such offer on behalf of FAB."
FAB claims it commenced legal action against Ms. Wang for her purported deception. However, my investigators secretly recorded the interviews (both in person at FAB's office and over the phone). I will soon publish these interviews so that the public can judge for themselves whether FAB is correct. Once again, I am certain that Ms. Wang was who she claimed to be and that her representations and the minimum guaranteed return on investment she claimed FAB offered franchisees was a valid offer at the time, and was accurately described in the FAB's franchising brochure she presented to my investigator. Assuming FAB is really suing Ms. Wang, my recorded interviews of her give a very powerful defense and I will try to reach out to her in the coming weeks to offer her a chance to be a whistleblower to the SEC along with other FAB employees and ex-employees willing to come forward.
"The Proceeds of the Undisclosed Bond Offering Have Been Identified and Transferred into the Custody of the Company's Primary Bank."
Not surprisingly, FAB fails to disclose the details of the secret bond issuance. Whose bank account did Chairman Zhang initially wire the proceeds into? What did Zhang do with the proceeds, and what did Zhang plan to do with the proceeds, prior to being exposed by GeoInvesting? Why was Zhang not terminated as Chairman? Exactly how many shares of FAB stock were denied to Zhang as a result of this corporate governance failure? Will Zhang be allowed to obtain the forfeited shares in the future if certain targets are met?
"No Evidence that FAB's Chairman has an Undisclosed Controlling Interest (or any Interest) in Huzhong."
Once again, FAB failed to address the key point and appears to be trying to represent a defense through obfuscation and wordsmithing. No one has claimed that Chairman Zhang owns any portion of the equity of Huzhong. The allegation is that he controls it, indirectly or directly, through his friends or nominees or through an undisclosed agreement. The secret bond prospectus, Ernst & Young ("EY"), and King & Wood ("KW") reports all raise these concerns. One KW report also shows that the Beijing media kiosks were apparently just as hard to find in January 2012 as they were in November 2013. Loeb should have been aware of the concerns raised in the EY and KW reports, which were recently leaked onto the Internet and then removed at the request of FAB.
Conclusions - Investors Defrauded, Then Denied Right to Trade, Then Further Deceived
Trading of FAB was unnecessarily halted for over eight months, depriving investors of the right to buy and sell the stock on any exchange. As a result, long investors never had the opportunity to sell at prices between $3.07 and $1, where FAB reopened on the OTC. Short investors had to pay 8 months of usurious borrow fees. Thus, both long and short investors suffered substantial economic losses from the long halt.
What did anyone gain from the incredibly long halt? Trading halts are supposed to protect investors and give time for news and material discrepancies to be resolved. Do any investors today, long or short, feel like they were actually protected, benefited, or better informed by the long halt than they were before?
The vast majority of investors probably found FAB's internal investigation results to be dishonest and totally unconvincing even when viewed merely as rhetoric. Basically, there is little more substance disclosed by FAB today than there was on December 10th, 2013, when FAB admitted to the secret Chinese bond issuance and piracy issue, which was grounds for immediate delisting from NYSE. FAB has still not even published a list of addresses of the Beijing media kiosks.
Do investors today feel assured and protected by NYSE's investigation, which in eight months publicly concluded only that FAB's business operations were not in the public interest? Investors had certainly all reached this conclusion themselves on December 10th, 2013, the day FAB admitted to the secret Chinese bond issuance it had previously denied. What did the long trading halt possibly accomplish?
From my own experience, I was surprised that the NYSE repeatedly delayed meeting me to review my evidence for over four months. Thus, for the first four months of NYSE's "investigation," the exchange did not even have a copy of the evidence to review. It is my understanding that the NYSE has no resource and/or no desire to conduct investigations in China that could land NYSE investigators in Chinese prison. Perhaps when you don't have the resources or will to effectively investigate, there's no point having the evidence, either. This further shows that the only effect of the long trading halt was to harm investors by depriving investors of the right to buy and sell.
Investors are hardly more informed today than they were on December 10th, 2013, and will have to wait to see the results of the SEC's likely investigation of these matters. I am hopeful that the SEC will find the truth. Over the next several days, I will continue to publish the evidence I shared with the NYSE, SEC, and Loeb*, in order that the public has a better understanding of the extent of FAB's fraud.
* On April 3rd, 2014, I presented all of my evidence to FAB's internal investigation counsel, Loeb & Loeb. At the time it seemed the "right" thing to do. After all, it is the duty of FAB's board of directors (including one of my favorite investors, Jim Rogers) to investigate and protect investors from the fraud perpetrated by FAB's Chinese Chairman Zhang. Any hopes of FAB's board protecting shareholders vanished when during my meeting with Loeb, the lawyer informed me that the investigation was not an "independent" investigation as stated in FAB's March 5th, 2014 press release, but rather an internal investigation, which often seems undertaken merely to clear a company of any wrongdoing rather than to find the truth.
I was also greatly disturbed by FAB's choice of counsel, Loeb & Loeb, which has a bad track record of defending alleged Chinese frauds. Loeb had overseen the internal investigation of Sino Clean Energy, a company that I exposed to be a fraud. Loeb played a conflicted role, responsible for "clearing" Sino Clean of my fraud allegations and representing Sino Clean to sue me for defamation. Loeb prematurely claimed "victory" in a February 2012 press release.
Loeb turned out to be wrong on both counts. Sino Clean lost its defamation lawsuit and after both GeoInvesting and I presented additional evidence to the NASDAQ, the exchange announced it would delist the company just six months after Loeb declared "victory." All of Loeb's work did nothing to protect shareholders, it merely let a major fraud persist a little longer. Having performed extensive investigations of each company, I can attest with 100% certainty that FAB will suffer the same fate as Sino Clean. The bad actors at Loeb & Loeb will collect a few more paychecks, but their work on FAB is no better than their work on Sino Clean.
Regarding FTI Consulting, the firm Loeb retained to verify the "kiosks" in Beijing, I can only say that obviously the scope of the work they were hired to do appears to have been deeply flawed. They should have been verifying the existence of the "media kiosks" in Beijing, which FAB had repeatedly claimed amounted to 3,954 units. I would also point out that in 2011-2012 FTI was retained by Shearman & Sterling to independently investigate my allegations against China Integrated Energy (OTCPK:CBEH). I cooperated with FTI's investigation, providing them with copies of all my time-lapse images of CBEH's shuttered biodiesel facilities. CBEH would later announce that the investigation more or less "cleared" it of all wrongdoing. Nevertheless, CBEH failed to ever get its 2012 or 2013 financials audited even after downgrading its auditor two times. The SEC is now in the process of deregistering CBEH so that it will never trade again on any U.S. exchange.
Disclosure: The author is short FABU. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more stocks 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.