Last week, a firm called China 360 Solutions announced that it had completed an investigative review of Lihua International (LIWA or the "company"). The firm's report was made public and addressed a variety of topics such as "Operational Overview," "Licenses and Certificates," "Tax Reconciliation," "Cash Verification," etc.
The report did not have an overall conclusion as to whether it believed that the company was accurately representing itself in its SEC financial statements; instead, it had conclusions for certain subsections. While we certainly have our own thoughts as to the conclusions made by China 360 (we are of the firm opinion that Lihua International is misrepresenting itself in its SEC financial statements), the point of this article is not to discuss the contents of the China 360 report.
Rather, we want to address the lack of an up-front disclaimer regarding whether China 360 has an indirect "financial interest" with respect to the findings of its report. When we write reports, as we have with China Education Alliance (CEU) or Advanced Battery Technologies (OTCPK:ABAT), we state clearly that we are biased third parties. In both reports, we state in bold, on the front page, that we have a financial interest in the stock and benefit if it declines. Therefore, readers know that they should view us as a subjective party.
The China 360 report had no such disclaimer. Rather, in its press release, the firm wrote "China 360° Solutions does not have a position, long or short, in Lihua International," which, in our opinion, made readers consider that China 360 could be an objective observer of Lihua, rather than an interested party.
We think that such a view of China 360 is inaccurate. More to the point, we do not view China 360 Solutions as a disinterested third party with respect to their report last week on Lihua International.
Who is China 360 Solutions?
As can be seen from this link, China 360 was formed in June 2011. The newly founded firm "provides an array of world class financial, forensic accounting, compliance, due-diligence, risk management, strategic communications and financial advisory and other services for U.S. listed Chinese companies, their boards, investment banks, funds or investors." The firm is a co-venture of "Thornhill Capital, Inc., Grandview Capital Advisors, Inc. and Trilogy Capital Partners, Inc." We discuss the backgrounds of these firms later in this article.
China 360 Solutions "Approved" by Global Hunter
In the image below, we've pasted an "Investor Education Conference Call" notice circulated electronically by Global Hunter Securities in mid-July to Global Hunter clients. This notice was made public last week via this link that was posted on internet message boards.
Based on the notice, we can see China 360 is a "GHS-approved third party diligence provider." Global Hunter scheduled a call to "introduce" China 360 Solutions to its clients, providing evidence that Global Hunter and China 360 have a relationship. Discussions with Global Hunter clients have further confirmed that China 360 Solutions has a relationship with Global Hunter.
Most followers of Chinese Reverse Take-Overs ("RTOs") are familiar with Global Hunter. Global Hunter is a leading underwriter of equity offerings for U.S.-listed Chinese companies that have gone public via reverse mergers. The firm has underwritten or acted as placement agent for offerings for numerous Chinese RTOs, including Shengdatech (OTC:SDTH), China Marine Food, Wonder Auto (OTCPK:WATG), China Sky One Medical and Yuhe International (OTCPK:YUII), to name a few. Of those companies mentioned, several (YUII, SDTH, WATG) are halted or have been de-listed and we have serious concerns about the others.
Global Hunter's research team has also historically had a high proportion of buy recommendations among the Chinese RTO stocks they cover. For instance, in this Zerohedge article, Zerohedge shows a snapshot of Global Hunter's China Coverage Universe from earlier this year:
More than 90% of the Chinese stocks shown that are not suspended were rated as Buys by Global Hunter (four of these buys would later be halted in the coming months).
Generally speaking, underwriters and placement agents of Chinese reverse mergers have an indirect financial interest in witnessing a lower proportion of Chinese RTOs turn out to be frauds: fewer frauds mean greater investor acceptance of the asset class and higher underwriting/placement fees for Chinese RTO equity offerings. As well, research divisions have an indirect financial interest in seeing a lower proportion of their Buy recommendations turn out to be frauds: fewer frauds mean that clients place greater faith in the research division's recommendations and therefore devote more commission dollars to trades with the sales and trading arm of the investment bank.
As such, Global Hunter has a financial interest in seeing a lower proportion of frauds within Chinese RTOs and stocks for which it has Buy recommendations, such as LIWA.
Again, the point of this article is that China 360 Solutions is not a disinterested third party. China 360's relationship with Global Hunter Securities, a longtime underwriter of Chinese RTO stocks and a firm with a historically high proportion of Buy recommendations in the Chinese RTO space, indicates that China 360 may not be an appropriate third party arbiter of whether certain U.S.-listed Chinese RTOs are misrepresenting themselves in their SEC financial statements.
Backgrounds of Grandview, Thornhill and Trilogy
China 360 Solutions is a co-venture of three firms: Thornhill Capital, Inc., Grandview Capital Advisors, Inc. and Trilogy Capital Partners, Inc. In terms of analyzing whether China 360 Solutions is a disinterested third-party with respect to its diligence reports on Chinese RTOs, it makes sense to examine the backgrounds and relationships of these firms.
First, we will mention that Thornhill, Grandview and Trilogy have all previously been placement agents, consultants or IR representatives for U.S.-listed Chinese RTOs. In the below paragraph, we mention several of each firm's former clients, with a link to the referenced company's SEC filing.
Thornhill's client list includes Anhui Taiyang Poultry Co., Inc and Sino-Green Land Corp. (OTCPK:SGLA) and their assignments have been in consulting / CFO capacities. Chinese RTOs that have hired Grandview at some point in the past include Oriental Dragon Corp. (placement agent), China Renewable Energy Holdings, Inc. (consulting / investment banking services) and Green Solutions China, Inc. (placement agent). Trilogy's client history includes Tibet Pharmaceuticals, Inc. (OTC:TBET) (IR firm), Bohai Pharmaceuticals (IR firm) and China Organic Agriculture (OTC:CNOA) (IR firm).
We can see that Thornhill, Grandview and Trilogy are not outsiders to the U.S.-listed Chinese RTO universe; rather, they have previously generated revenue from U.S.-listed RTO companies.
In the case of Thornhill, we can see that the firm has strategic partnerships with other service providers in the U.S.-listed Chinese RTO universe. On its website, Thornhill lists its "Partners," with the following introduction:
"In addition to the network of professionals that make up our own team, Thornhill Capital has strategic partnerships and relationships with other elite organizations:"
These organizations include Marcum Bernstein & Pinchuk, Sichenzia Ross Friedman Ference LLP, Anslow + Jaclin, Schwartz Levitsky Feldman LLP and Larry Isen's Emerging China Stocks newsletter, among others. The firms just mentioned all have generated substantial revenue from the U.S.-listed Chinese RTO sector, as well as the general RTO sector as a whole. Their list of Chinese RTO clients are too long to mention, but Anslow + Jaclin's extensive experience with Chinese RTOs can be seen by examining historical transactions here and Sichenzia Ross's extensive experience with Chinese RTOs can be seen by examining historical transactions here. Schwartz Levitsky's audit clients have included CAAS, HQS, SCEI, CBAK, etc. Marcum Bernstein & Pinchuk and its predecessor firms have extensive history with Chinese RTO clients and our quick initial count found at least a dozen Chinese RTO audit clients. As for Larry Isen's Emerging China Stocks newsletter service, we will let the name speak for itself.
Grandview and Trilogy do not list their strategic partnerships, although Trilogy includes counsel at Sichenzia Ross on its "Associated Professionals" page.
In this section, we provide evidence that Thornhill, Grandview and Trilogy have previously generated revenue from the U.S.-listed Chinese RTO sector. As well, Thornhill, as implied by its strategic partnerships, has considerable relationships with other service providers that have strongly benefited from the emergence of the U.S.-listed Chinese RTO sector.
Naturally, we presume that all of the firms discussed herein are of the highest quality. Nevertheless, there is considerable evidence that Thornhill, Grandview and Trilogy are not disinterested third parties when it comes to conducting investigations into whether U.S.-listed Chinese RTOs are committing fraud.
We do not think that China 360 Solutions should be viewed as a disinterested third party with respect to the report on Lihua International that was issued last week. We're certain that a due diligence investigative firm backed by Citron Research, Muddy Waters and Glaucus Research would not be viewed as an independent third party if it were to write a negative report alleging fraud about a Chinese company, even if those firms did not have short positions in the target stock. Similarly, China 360 Solutions, given its relationship with Global Hunter and its three backers' histories generating revenue from Chinese RTOs, should not be viewed as a disinterested third party with respect to its report on Lihua International, a Chinese RTO whose red flags have been discussed in numerous articles, including ones here, here, here, here and here.
Disclosure: The author is short LIWA. 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.
Additional disclosure: Read our full disclaimer at kerrisdalecap.com/legal-disclaimer-3. I have short positions in and own options on LIWA (Lihua International, Inc.) and stand to realize gains in the event that the price of the stock declines. I am also short and may own options in CEU, ABAT, CMFO, CSKI, WATG, YUII, CAAS, HQS and SCEI. To the best of my knowledge, all information in this article is accurate and reliable, but I present the information "as is". I will not necessarily update or supplement this article in the future. Following publication, we may transact in securities of the company covered herein