Gulf Resources: Due Diligence Raises Serious Questions

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We recently conducted extensive due diligence on Gulf Resources, Inc. (GFRE) (“GFRE” or the “company”). Our research included factory visits, examinations of U.S. and Chinese financial filings, and discussions with company representatives, vendors and local government officials.

In our report, which summarizes our findings and is available here, we present compelling evidence that a rival, privately-held Chinese conglomerate owned by GFRE’s chairman and founder is actually the legal owner of GFRE’s factories and operating assets. We believe that, given the difficulty of litigation in China and the complex multi-jurisdictional organizational structure of GFRE, shareholders are most likely left without a remedy.

In short, investors in this NASDAQ-listed company are likely holding worthless paper in a shell company.

In addition, we present evidence that GFRE engaged in an inappropriate self-dealing transaction, the details of which GFRE intentionally concealed from the SEC and investors, that GFRE’s largest customer is privately owned by GFRE’s chairman, that GFRE engaged in dubious capital expenditures that may have been a smokescreen for transfers of cash to insiders, and that GFRE is exaggerating the size of the company’s operations. We also present evidence that the company’s CEO has a close relationship with a notorious puppet master of Chinese small cap scams.

Below are the highlights of our report:

  • A privately held Chinese company, owned by the founder and chairman of the board of GFRE, claims to own and operate all of GFRE’s assets and business. This suggests that the chairman sold investors shares of a worthless shell entity while keeping the underlying business under a separate privately held conglomerate. Given the difficulty of litigating in China and the complex multi-jurisdictional corporate structure of GFRE, shareholders may have great difficulty in recovering any value from the company.
  • GFRE engaged in inappropriate self-dealing by massively overpaying for a business owned by its chairman and his family.
  • GFRE has failed to disclose that its largest customer is a related party.
  • We visited each of GFRE’s factories and each appeared far smaller than indicated in GFRE’s SEC filings. A representative from a local government office confirmed that GFRE’s production was substantially smaller than GFRE’s claims in its public filings. Videos of GFRE’s factories can be seen here, here, here and here.
  • GFRE’s CEO has omitted the fact that he was formerly the CFO of China Finance Inc., a notorious purveyor of fraudulent Chinese microcap companies. Suspiciously, GFRE’s CEO was appointed a mere seven days after GFRE issued shares equal to 15% of its outstanding equity to China Finance Inc. This CEO then struck a deal that appeared to enrich China Finance Inc. at the expense of GFRE’s shareholders, potentially creating a “death spiral” for GFRE’s stock.
  • GFRE commissioned two contractors to perform two expensive capital expenditure projects. Despite a thorough investigation, we have been unable to find any evidence that either contractor is a working business. We believe that management may have used these suspicious capital expenditure projects as a vehicle to transfer money out of the company.
  • BDO Limited is GFRE’s 3rd auditor in 4 years. GFRE dismissed its previous auditor, which had questioned the effectiveness of its internal controls, immediately prior to the release of GFRE’s FY 2009 form 10-K, and replaced it with BDO limited, an auditor that has represented other publicly listed Chinese companies which have committed, or are accused of committing, fraud.

Who Really Owns GFRE’s Business?

A privately-held Chinese conglomerate owned by Ming Yang, the chairman and founder of GFRE, claims to own GFRE’s assets and business. This suggests that Ming Yang never transferred the underlying business to GFRE, meaning investors hold the shares of a worthless shell company.

The Shandong Haoyuan Group (the “Haoyuan Group”), which can be found on this website, claims to, among other businesses,

specialize in the manufacturing, sales and management of … Bromides, Chemical auxiliaries for oilfield, Chemicals for paper making, Sewage treatment chemicals, specialized detergents, Bromine, Brominated flame retardants … Crude salt, Oil accessories, Services of oilfield drilling mud.

(see here).

This description is strangely similar to the business of another company operating in Shandong: Gulf Resources, Inc.

When we dug deeper we found that the Haoyuan Group does not just sound like GFRE, it claims to own the same assets that GFRE claims to own.

The CEO of the Haoyuan Group is Ming Yang, the founder and chairman of GFRE. The top picture below is a picture of Ming Yang from the website of the Haoyuan Goup. On the bottom is a picture of Ming Yang ringing the opening bell (he is on the right) at the NASDAQ exchange with fellow GFRE executives, which can be found on GFRE’s website. It is clearly the same person.

A picture of Ming Yang from the website of Haoyuan Goup:

A picture of Ming Yang and company officials at GFRE’s bell-ringing ceremony:

Ming Yang is the founder, former CEO and current chairman of the board of directors of GFRE (see here).

But rather than having transferred the underlying business to GFRE as the company claims to in SEC filings, it appears that, according to the Haoyuan Group, Ming Yang has actually retained the operating assets under a privately-held conglomerate.

Bromine and Crude Salt Business

The Haoyuan Group claims to own a subsidiary called Shouguang Haoyuan Chemical Company Limited, which has a name almost identical to GFRE’s primary subsidiary, Shouguang City Haoyuan Chemical Company Limited (“SCHC”), which accounts for 77% of GFRE’s FY 2010 gross revenue.

In the following table we compared the description of Haoyuan Group’s subsidiary against the information about SCHC taken from Haoyuan Group’s website. The similarities are beyond coincidence.

GFRE's Public Filings The Haoyuan Group's Website
Subsidiary Name Shouguang City Haoyuan Chemical Company Limited Shouguang Haoyuan Chemical Co., Ltd.
Location of Company "Our production sites are located in the Shandong Province in northeastern China... in the north region of Shouguang city" "Shouguang Haoyuan Chemical Co., Ltd., is located in the north of Shouguang city"
Products "We manufacture and trade bromine and crude salt" "manufacturing of... Bromine and Crude salt"
Capacity FY 2010, SCHC sold 30,000tons of Bromine and 370,437 tons of crude salt. "Now Haoyuan Chemical has a bromine plant with the capacity of 30,000 tons per year, salt field of 12,000 acres with the capacity of 20,000 tons per year."
Research "[the company] has been engaged in product innovation and research and development projects with Shandong University." "Haoyuan Chemical ... relying on Shandong University, increase Scientific and technical input, absorb the experienced technical personnel and strengthen the management"

The Haoyuan Group claims to own a subsidiary with almost the exact same name as GFRE’s SCHC. The Haoyuan Group’s subsidiary manufactures and sells bromine and crude salt, just like SCHC. It operates out of exactly the same location as SCHC and has an almost identical capacity for bromine production. Haoyuan Group’s subsidiary has a research and development relationship with Shandong University, just like SCHC. Coincidence? We think not.

Rather, the Haoyuan Group is in effect representing that it owns GFRE’s bromine and crude salt business. Unfortunately for investors, the Haoyuan Group also claims to own and operate GFRE’s chemical products business.

Chemical Products Subsidiary

The similarities are even more striking with respect to GFRE’s chemical products subsidiary, Shouguang Yuxin Chemical Industry Co., Limited (“SYCI”). The Haoyuan Group claims to own a subsidiary: Shouguang Yuxin Chemical Co., Ltd., which specializes in producing chemical products used in oil and gas exploration. That name and business model should look familiar to GFRE’s shareholders. Not only does it share an almost identical name to GFRE’s subsidiary, SYCI, but the description of the business is virtually identical.

In the table below, we show the similarities between GFRE’s chemical products subsidiary, SYCI, which accounts for 23% of the company’s FY 2010 total revenue, and the subsidiary by a similar name that the Haoyuan Group claims to own.

Note that the second column is populated with language taken directly from GFRE’s public filings. The language in the third column is taken directly from the Haoyuan Group’s website. From the table below, it is evident that both companies claim to own SYCI.

GFRE's Public Filings The Haoyuan Group's Website
Subsidiary Name Shouguang Yuxin Chemical Industry Co., Limited Shouguang Yuxin Chemical Co., Ltd.
Location of Company "The physical location of SYCI is 2nd Living District, Qinghe Oil Factory, Shouguang City, Shandong Province, P.R. China." "Living Area No. 2, Qinghe Oil Extraction Plant, Yangkou Town, Shouguang, Shandong, China"
Location of Customers "Shengli Oilfield, Daqing Oilfield, Zhongyuan Oilfield, Huabei Oilfield, and Talimu Oilfields" "Shengli Oilfield, Daqing Oilfield, Zhongyuan Oilfield, etc."
Customers "large domestic papermaking manufacturers and major oilfields" "large oilfields... large and medium-sized paper-making enterprises and also some large and medium-sized pesticide manufacturers"
Certifications "The company has certified with ISO9001-2000" "The company has been ISO 9001-2000 approved"
Awards "The company... is a Class One supplier for... China Petroleum & Chemical Corporation (SINOPC)" "The company... has been awarded as the internet member of Sinopec first-level supplier, the No. 1 internet member of China Oil Energy"
Products "SYCI concentrates its effort on the productions and sales of chemical products that is used in oil and gas field explorations, oil and gas distribution, oil field drilling, wastewater processing, papermaking chemical agents, and inorganic chemical." "For years, Yuxin Chemical is specialized in the manufacturing and R&D of Chemical additives for oilfield, Chemicals for paper-making, Pesticide emulsifiers, Detergents and Brominated flame retardant."

Both GFRE and the Haoyuan Group claim to have subsidiaries which operate under an almost identical name, operate from an identical location, sell virtually the same chemical products to the same types of customers in the same oilfields, and claim to have the same certifications and awards. Put simply, the Haoyuan Group claims to own SYCI.

Other evidence of a common claim to ownership abounds. The organizational chart below is copied from the Haoyuan Group’s website, which clearly shows both the bromine and crude salt and the chemical products subsidiaries as part of the larger conglomerate.

This organizational chart is telling. In it, the conglomerate represents that GFRE’s bromine, crude salt and chemical products fit snugly into its structure.

Our independent investigation revealed circumstantial evidence corroborating that GFRE is operating as part of the Haoyuan Group. When our investigators visited one GFRE factory, they noticed that part of the factory was devoted to building environmentally friendly light bulbs. The Haoyuan Goup has a subsidiary, abbreviated above as Caiting Ecological Lighting (described on the web site here), which makes light bulbs. This evidence supports our conclusion that GFRE’s business is part of the Haoyuan Group’s conglomerate, along with other unrelated businesses.

In sum, the Haoyuan Group, led by GFRE’s founder Ming Yang, claims to own all of GFRE’s business. The chairman and founder of a public company is advertising on a website that a privately held conglomerate actually owns the underlying business and that GFRE investors hold the securities of a worthless shell company.

What Can Investors Do?

The outlook is bleak. A dispute between shareholders and a local Chinese conglomerate over assets located in China is an unappetizing prospect.

Chinese courts are notoriously corrupt, arbitrary and protective of local businesses and industry. Notions of judicial independence do not apply. As a result, for foreign investors, litigating against a Chinese conglomerate in a Chinese court is a Sisyphean task. We believe that, given the difficulty of litigation in China and the complex multi-jurisdictional organizational structure of GFRE, shareholders are most likely left without a remedy.

Inappropriate Self-Dealing

GFRE has a disturbing history of inappropriate self-dealing. Immediately after going public, GFRE purportedly acquired a target company at a massively inflated price. This target was owned at the time by the chairman of the board of directors of GFRE, Ming Yang, and his family. In order to make the transaction appear appropriate, GFRE submitted false financial statements for the target company.

On February 5, 2007, shortly after consummating the reverse-merger transaction that enabled GFRE to list on US capital markets, GFRE purportedly acquired SYCI for an aggregate purchase price of $18,900,000. The owners of SYCI received 8,094,059 of newly issued shares of GFRE’s common stock and $2.55 million in cash. The value of these shares would climb to as high as $120 million.

According to publicly available records obtained in China, SYCI was actually far less valuable at the time of the acquisition than the financial statements of SYCI filed with the SEC lead investors to believe. In the following table, we have set forth a comparison between the financials of SYCI for FY 2006 filed with the SEC and the financials filed with the SAIC.

($ in USD) SEC Filings SAIC Filings
FY 2006 FY 2006
Shouguang City Yuxin Chemical Co. "Chemical Products" "SYCI"
Revenue $13,911,119 $770,161
Operating Income $3,714,475 $359,769
Total Assets $5,069,584 $2,856,327

According to SAIC filings, SYCI made one-thirteenth the revenue and owned less than one-half the total assets that GFRE claimed in its SEC filings.

GFRE’s Largest Customer Is (Secretly) Related

GFRE's largest customer is a subsidiary of the aforementioned Haoyuan Group, the privately held company for which the chairman of GFRE serves as the CEO and which claims to own GFRE’s business.

GFRE’s largest customer in FY 2010 was Shouguang City Rongyuan Chemical Company Limited (“Rongyuan”), accounting for 13.2% of the company bromine’s revenue and 24.3% of its crude salt revenue (see here). Rongyuan accounts for 10.6% of GFRE’s total FY 2010 revenue.

The Haoyuan Group and Rongyuan have the same address, same phone number, same fax number and same website. Even Rongyuan’s website has the name “Haoyuan” in the URL address. Further, Rongyuan’s SAIC filings show the same registered address as the Haoyuan Group.

Our investigators called the Haoyuan Group and a representative confirmed in no uncertain terms that Rongyuan is a subsidiary of the Haoyuan Group. Suffice it to say that they are related.

GFRE failed to disclose in its SEC filings that its largest customer is a related party. Further, the fact that Rongyuan is a related party casts doubt on GFRE’s sales figures. Is Rongyuan paying above market for GFRE’s products? Does GFRE have sufficient internal controls to ensure that sales to Rongyuan are genuine or accurately reflected in the company’s SEC filings?

GFRE’s Business Is Not as Advertised

Our investigators visited every GFRE factory and found that the factories were not in the locations described in the company’s SEC filings. To boot, each factory was much smaller than GFRE claims in its SEC report.

Where’s Waldo?

Our investigators had trouble locating each of GFRE’s factories because they were not in the locations that GFRE claimed in its public filings. GFRE's 10-K’s states that Factory 3 is located in Dong Ying City, Liu Hu Village. This is incorrect. Our investigator found Factory 3 in Shouguang City, Yangkou Township, Dingjia Village. These two locations are almost 100 km apart.

The same was true for Factory 5. GFRE states that it is located in Shouguang City, Houxing Village but our investigator found the factory over 20 km from its reported location in Shouguang City, Yingli Township, Yangzi Village. Similarly, GFRE’s public filing states that the factory is located in Shouguang City, Hanting District. We found Factory 6 in Weifang City, Hanting District.

GFRE is not only misrepresenting the location of certain factories, but the size of its operation. The following table compares, for each factory, the acreage listed in GFRE’s SEC filings and the estimates of our investigators of the size of each factory.

Factory Name Reported Land Area Estimated Actual Land Area Glaucus Video Links
1 Haoyuan General Factory 6,442 22
2 Yuwenbo 1,846 6
3 Yangdonghua 2,318 15
4 Wangjiancai 2,310 7
5 Liuxingji 2,165 15
6 Yangxiaodong 2,641 15
7 Qiufen Yuan, Han Wang & Yufen Zhang 1,611 20
8 Yuliang Gao, Han Wang & Qing Yang 2,723 20
9 Jinjin Li & Qiuzhen Wang 759 20
Total 22,815 140

Note that the “Actual Land Area” column is an estimate of the area of the factory that is walled off. As demonstrated by our videos, each factory is surrounded by brine ponds, which we did not include in our “Actual Land Area” calculation. As such, our estimate for “Actual Land Area” likely underestimates the size of the respective factories. However, we believe that even including the fields surrounding such factories, management is exaggerating the size of its factories in its public filings.

In order to corroborate these observations we called the Shouguang City State Land & Resources Bureau (“Land & Resources Bureau”) for the locality in which operates. When asked, the Land & Resources Bureau representative stated that the land area of Factory 7 was only 7.4 acres. This is much smaller than the 1,611 acres claimed by GFRE.

More importantly, the Land & Resources Bureau representative said that the total bromine production area registered under GFRE’s operating subsidiary was 282 acres, which is 10 times smaller than the land area claimed by GFRE in its SEC filings and much closer to the size of the production area observed by our investigators.

Affiliation with China Finance, Inc.

GFRE’s reverse merger was organized by China Finance, Inc. (OTCPK:CHFI), which trades on the pink sheets as CHFI. China Finance has a troubling legacy: it is a notorious China small cap which traded on the OTC before it vanished in 2009, became delinquent under SEC filing rules and was relegated to the pink sheets. CHFI and its affiliates helped take public numerous U.S.-listed Chinese RTOs that have been accused of fraud, including Orient Paper (NYSEMKT:ONP), Universal Travel Agency (UTA), and others.

We believe that CHFI was involved in, and may have orchestrated, one of the largest pump and dump schemes in the history of US capital markets. China Finance’s principal business was

providing financial support and services - primarily in the form of surety guarantees or short-term loans - to privately-owned small and medium sized enterprises in China when they seek access to capital or to be acquired by a United States reporting company.

(see here)

China Finance would then take a slice of equity and in exchange help small cap Chinese companies go public.

China Finance helped take GFRE public. In 2006, China Finance, through its subsidiary Haoyuan Chemical Company Limited, received 6% of GFRE’s equity in exchange for its services in connection with going public.

Furthermore, GFRE’s CEO Xiaobin Liu served in 2004 as CFO of China Finance, Inc.

Many of the Chinese small cap companies that China Finance shepherded to US capital markets have been accused of fraud or so poorly managed that their shares are virtually valueless. This table gives just a few examples of the detritus left in China Finance’s wake:

Company Symbol Current Status Exchange High Price Recent Price % Off Its High
Jada Art Group JADA Delinquent in SEC filings Pink Sheets $5.25 $0.05 99%
China Organic Agriculture CNOA Delinquent in SEC filings OTC $3.90 $0.12 97%
Home Systems Group HSYT Delinquent in SEC filings Pink Sheets $4.08 $0.15 96%
Universal Travel Group UTA Accused of fraud; trading halted (.pdf) NYSE $17.20 Trading Halted n/a
Orient Paper ONP Accused of fraud (.pdf) AMEX $15.15 $3.89 74%
China Ivy School CIVS Current in SEC filings OTC $4.10 $0.02 99%
Beijing Logistics BJGL Delinquent in SEC filings Pink Sheets $0.75 Trading Suspended n/a
China 9D Construction Group CNAG Delinquent in SEC filings Pink Sheets $2.00 Trading Suspended n/a
Gulf Resources GFRE NASDAQ $14.74 $4.24 71%

The table above should alert regulators and scare investors.

Finally, not only did GFRE’s current CEO serve as the CFO of China Finance, but he was appointed to CEO of GFRE a mere 7 days after GFRE granted China Finance a considerable equity stake in the company. The structure of this equity stake and the ensuing selling pressure has exerted a substantial decline in GFRE’s stock price, in our opinion, and we discuss it at length in our full report.

SAIC Filings

We obtained income statements and balance sheets for SCHC and SYCI from local filing offices of the State Administration of Industry and Commerce (“SAIC”) showing that GFRE’s business is considerably smaller than the company has represented to investors. The SAIC filings, summarized on the chart below, corroborate other evidence we found that the company’s revenues and net income are much smaller than stated in GFRE’s SEC filings.


The cumulative evidence that GFRE is omitting material information from its SEC financial statements should give pause to anyone owning GFRE’s shares. Given that the chairman and founder publicly advertises on a website that he effectively holds the business in a privately held conglomerate, it is staggering that GFRE has thus far duped investors and escaped the attention of regulators.

Disclaimer: As of the publication date of this report, Glaucus Research Group and other contributors to this report have short positions in GFRE (and/or options of the stock), and therefore stand to realize significant gains if the price of GFRE’s stock declines. Following publication of this report, Glaucus Research Group and other contributors to this report intend to continue to buy or sell securities issued by GFRE and may take long, short or neutral positions at any time hereafter regardless of our initial recommendation. This is not an offer to sell or a solicitation of an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction. We have obtained all information set forth in this report from public sources which we believe to be credible. All information set forth in this report is presented “as is” without warranty of any kind, whether express or implied. Glaucus Research Group makes no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with the results obtained from its use. Glaucus Research Group’s research, opinions and conclusions should be used at your own risk. All expressions of opinion are subject to change without notice, and Glaucus Research Group does not undertake any duty to update or supplement this report or any information contained herein.

Disclosure: I am short GFRE.