Hard Lesson for China Concept-Stock Investors

Imagine discovering on your first day as a new CEO that your employer is merely a shell that may be destined for a shameful delisting on the Nasdaq Stock Market.

That’s what happened recently to ChinaCast Education Corp. CEO Feng Yiyi, who is now trying to sort out what’s left of a gutted business that once attracted US$200 million from American investors and ran three Chinese universities with a combined 35,000 students.

Hundreds of millions of yuan, accounting records, and other property mysteriously vanished from ChinaCast Education Corporation holdings. The company is now in danger of being delisted. Some suspect the trouble started with senior company officials.

In the weeks before Feng’s appointment in March, someone apparently transferred several hundred millions of yuan from company accounts without approval from the board of directors. The company’s business license, registration seals, accounting and computer records vanished as well.

In February, company auditor Deloitte said its attempts to check the books at the company’s Shanghai office had been blocked. Moreover, no one at ChinaCast had paid the auditor’s fees.

And later, the new management team led by Feng learned that ownership of ChinaCast’s colleges—Hubei Polytechnic University School of Business, Guangxi Normal University Lijiang College, and Chongqing Normal University’s College of Foreign Trade and Business—had been transferred to several people, including a former company president, without board approval.

The trouble started brewing last year when Feng’s predecessor, ex-CEO and chairman Chen Zi’ang, was ousted as part of executive shakeup initiated by the company’s American shareholders. Caixin tried unsuccessfuly to contact Chen for this report.

The leader of the revolt, an investor named Ned Sherwood who held 800,000 shares, says he never authorized the asset transfers and was later stunned by the financial maneuvering that eventually hollowed out the company.

Sherwood’s complaints were brushed off by ChinaCast’s former president Jiang Xiangyuan, who was also removed in the shakeup and, according to records obtained by Caixin, may have played a role in the disappearance of funds.

Speaking with Caixin, Jiang criticized U.S. investors for what he called their blind interventions in company affairs.

“After the Americans reorganized the board of directors, they did a lot of things detrimental to the development of the company not only on the financial and investment levels, but also through in-depth intervention,” Jiang said. “Without communicating with us, they fired our most important business pillar.”

Meanwhile, a recent probe by Feng’s management team found that Jiang once had been convicted by the Shanghai Hongkou District Court for misappropriating public funds and given an eighteen-month suspended sentence.

Jiang’s conviction had gone undetected during due diligence long before ChinaCast crumbled.

Toppled Concept Stock

ChinaCast stock debuted on the Nasdaq exchange in 2007 through a reverse merger, nine years after its launch as a telecommunications company.

ChinaCast has main offices in Beijing, home to operations management and Chief Operating Officer Li Wei, and Shanghai, its financial headquarters.

Chen, a Hong Kong native, joined as CEO in 2001 and two years later tapped the company’s technical expertise in long-distance education services to change the company’s focus to content providing.

The US$200 million raised in the start-up stock offering was used to buy the three colleges, which last year accounted for up to 75 percent of the company’s revenues, based on average tuitions of about US$2,000 a year. Long-distance education services account for the rest of company revenues.

After getting on Nasdaq, Chen held a 6 percent stake. The company’s ten largest American shareholders controlled 55 percent.

All was going well until early 2011, when U.S.-listed shares in a variety of Chinese companies started falling on reports of financial fraud. Concept-stock companies such as ChinaCast that had legally dodged U.S. disclosure rules by listing through reverse mergers were hit by a broad sell-off.

ChinaCast’s share price fell to US$5.87 in March. It had been US$7.84 the previous November.

Sherwood told Caixin that at the time he thought the company’s performance in the face of this falling share price signaled that it was time for ChinaCast to launch a share buyback. Investors were then pleased when Chen announced a plan to repurchase US$50 million worth of common shares over twelve months.

Shareholders then waited for the buyback to begin, but nothing happened. Frustrated, they demanded the company commit to Chen’s plan. But management remained mum.

Soon the two sides were fighting. Chen went on the offensive by accusing Sherwood of insider trading. Sherwood charged that the Chen-led management had lied with news of potential company buyers.

Investors wanted a settlement. A board source said Chen was offered but refused two years compensation in exchange for a voluntary resignation. He was then removed by the seven-member board, four of whom backed Sherwood, and replaced with Feng.

Jiang and legal adviser Gao Xing were also dismissed.

Shredding Records

According to Sherwood, Chen afterward told Deloitte auditors that during the episode he had lost face and therefore could not control his subordinates.

On March 28, Feng was told the company’s paper files had been shredded and computer records removed. Chen later claimed he had no knowledge of the missing seals.

Later, after a data recovery firm from Hong Kong was hired to recover data erased from company computers, a dozen people broke into the office and stole six hard drives.

Feng hired a law firm to investigate. On April 2, Nasdaq announced the suspension of ChinaCast stock trading. A month later, the exchange said the company would be delisted over its lost assets, registration seals and bank deposits, as well as the fact that the company had yet to file an audit for the previous fiscal year.

So far, the Feng-led investigation has found that ChinaCast subsidiaries Shuangwei Co. and Yupei Co. each had 100 million yuan in Shanghai’s Bund Branch of Huaxia Bank. The money was used as collateral last September for loans issued to three other companies unrelated to ChinaCast.

Based on these and other details, Feng’s management team filed a lawsuit in a Shanghai court against Chen, claiming he and others were hiding the seals and business license. The chief executive said the court accepted the case, and that he hopes to recover the missing assets. Meanwhile, he said, ChinaCast will ask Nasdaq not to delist its stock.

An independent firm’s 2011 review of the company’s financial position found it held US$132 million in cash, cash equivalents and short-term deposits.

But a recent review by Feng’s team told a very different story. For example, missing were Yupei’s 80 million yuan deposit in the Shanghai Pudong Branch of the Bank of Ningbo, and Shuangwei’s 100 million yuan in the Zhoujiadu Branch of the Bank of Shanghai.

In April, management learned that someone had withdrawn 60 million yuan from the Hubei Polytechnic University School of Business bank account.

Jiang, the former president, may have played a role.

ChinaCast had originally invested in the Hubei school through its subsidiary Shengshi Hanyang (Beijing) Education Technology Co. Ltd., which in turn controlled the school’s official majority owner, Wuhan Jiyang Education Investment Co. Ltd.

On March 7, Shengshi transferred 70 percent of its stake in Wuhan Jiyang to Jiang and 30 percent to a businessman named Shi Shicheng. About a month later, Jiang and Shi transferred their stakes to three other people.

Shengshi also held a stake in Guangxi Normal University Lijiang College through its subsidiary China United Biotechnology Co. Ltd.

Records show ChinaCast owned Chongqing Normal University’s College of Foreign Trade partially through its subsidiary Chongqing Hailai Education Technology Co. Ltd., which together with Yupei were still shareholders of Chongqing Hailai as of late April but had a new legal representative who had replaced Chen by the name of Shi Meiqin.

Sherwood said he was amazed by the twisted trail of asset transfers. He told Caixin he had conducted due diligence before buying ChinaCast stock on the Nasdaq exchange, only to find out later that the company was tied to transactions with no written records.

“Due diligence can do very little,” Feng explained. “The shell is in America, the content is in China. It’s difficult for U.S. investors and regulatory agencies to understand the true situation.”

Wang Xiaoqing, Shen Hu, and He Xin are Caixin staff reporters. Zhang Tao and Ni Weifeng are Caixin correspondents in Washington, DC.

Business, Law
Stock Market, Investment, Fraud