No One Saw the Sino-Forest Story Coming?

| About: Sino-Forest Corp. (SNOFF)

Last week, I wrote about my growing doubts about China and investing in Chinese companies despite China’s growing place in the world economy. I did write a line or two about reverse mergers, and about Sino-Forest (OTC:SNOFF) specifically. The company listed on a Toronto stock exchange (and as a pink sheet in the US) is based in Hong Kong and up until a few weeks ago, very few would have believed that such strong allegations could be made about it.

Independent research company Muddy Waters released a very striking report calling the company a Ponzi scheme, saying that financial statements were mostly exaggerations if not pure fabrications, etc. The report is very telling and given Muddy’s past success in finding such frauds, the market gave Sino’s stock a serious beating right before the stock was halted by the exchange.

In such circumstances, it becomes very difficult for retail investors such as myself to judge a company like Sino-Forest. On one hand, Muddy Waters has been successful in finding such frauds in the past. However, wouldn’t institutional investors such as John Paulson, research analysts in major banks and brokers, regulation agencies and audit firms have found clues years ago? If the Muddy Waters conclusions were even partially true, how could everyone miss it? It seemed impossible to many and like many others, I was anxious to see how all of these parties would defend their work on Sino-Forest…. Weeks later, I am still waiting.

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Yesterday, John Paulson confirmed that despite being the company’s largest shareholder just a few weeks ago, he has now sold all holdings of the company, even selling off his bond positions thus realizing a loss of $750 million. That is incredible. Is it just me or should I be surprised/shocked that this is happening? I can understand the fact that as a retail investor, it is difficult and probably unthinkable to investigate such companies in order to determine if there is a scam. However, when an investor is going to put in over $1 billion, wouldn’t it make sense to send a few analysts over for a few weeks to investigate the company, its holdings, financial statements, etc? Am I crazy to think that? Are guys like Warren Buffett and John Paulson relying on the same financial statements that I use when investigating these companies?

How about the analysts? Several of them had buy or strong buy ratings on Sino-Forest. What were those based off of? If there were so many inaccuracies in the financial statements, shouldn’t they have been able to find those and accumulate enough doubts to be more reserved? Also, this company was publishing audited reports… so an auditor, as well as regulatory agencies were supposed to be confirming what the executives were reporting. I do understand that investigating what is mostly a Chinese company is an enormous challenge but isn’t that what they are being paid to do?

What am I missing here? How do so many powerful agencies get conned by a company like Sino-Forest?