In China, Detecting Fraud Riskier Than Doing It

It can be very risky to do things in China that are taken for granted in other countries.

Kun Huang, a Chinese-born Canadian citizen, is back in Vancouver after spending two years in a Chinese jail. His crime was contributing to research that led his employer to recommend short sales of Silvercorp Metals, a silver producer that is based in Canada but does its mining in China.

Mr. Huang, now 37, returned to his native China in 2006 after graduating from the University of British Columbia with a degree in commerce. His parents immigrated to Vancouver in 1997, when he was 20 years old, and he became a Canadian citizen in 2002.

Kun Huang, a Chinese-born Canadian citizen, who is back in Vancouver after spending two years in a Chinese jail, at his lawyer’s office in Vancouver, Canada, Aug. 22, 2014.
Kim Stallknecht | The New York Times
Kun Huang, a Chinese-born Canadian citizen, who is back in Vancouver after spending two years in a Chinese jail, at his lawyer’s office in Vancouver, Canada, Aug. 22, 2014.

His job was to research Chinese companies, which were beginning to list on stock markets in the United States and Canada. He had been hired by Eos, a hedge fund run by Jon Carnes, a Canadian money manager, to ''go through all the financial records in Chinese, talk to management and customers and suppliers,'' he said in an interview.

At first, Eos looked for good stocks to buy, but Mr. Carnes eventually gained a reputation for spotting Chinese frauds, which he publicized online under the name Alfred Little.

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Mr. Huang had worked on some of those reports but had no run-ins with the Chinese authorities until 2011. In June of that year, he was asked to look into Silvercorp. He said he found that some Silvercorp reports to the Chinese government showed its mines were not doing as well as they were in reports that the company issued in Canada.

He sent associates to the Ying Mine, Silvercorp's largest operation, in Henan Province, about 500 miles southwest of Beijing. They filmed trucks leaving the mine with ore and picked up samples of the ore that fell off trucks.

In September, an Arthur Little report questioned whether Silvercorp had exaggerated the mine's production. It said the samples it had picked up had substantially less silver in each ton of rock than the company claimed and that the volume of truck traffic was too light to account for all the ore Silvercorp said it had mined. (Related: Best performing frontier markets)

The company responded indignantly and demanded investigations into those who had attacked it.

Mr. Huang was arrested on Dec. 28 when he tried to fly to Hong Kong from Beijing. A police officer from Luoyang, the city closest to the mine, warned him that if he did not cooperate he could spend four or five years in jail. The officers questioning him took frequent calls -- Mr. Huang says he believes they were from Silvercorp officials -- and then demanded such information as ''the password to the Eos mail server.''

Within a few days, Mr. Huang was released on bail, prohibited from leaving China. But that status ended abruptly in July 2012 after a column I wrote for The New York Times appeared, quoting Mr. Carnes as saying the Luoyang police ''arrested, terrorized and forbid my researchers from communicating with me or performing any further research on Chinese companies.''

Mr. Huang was rearrested, he told me, with police officers making clear that action was ''directly in retaliation'' for the column. He spent the next two years in the Luoyang detention center, in a 300-square-foot cell that held as many as 34 other prisoners, according to a lawsuit Mr. Huang filed this month against Silvercorp in Vancouver.

In September, The Globe and Mail of Toronto published a long article on Mr. Huang and Silvercorp, including statements Mr. Huang had made during an interview while he was out on bail. That made the police even angrier, Mr. Huang said in his lawsuit. He was required, according to the suit, ''to scrub the sick bay using his bare hands.''

Mr. Huang told me the Luoyang detention center ''is the most unbearable imprisonment in China.'' He has not seen most Chinese jails, of course, but he said it was much worse than the Beijing detention center, the other one he has seen.

Finally, in June 2013, he was charged with criminal behavior and convicted in a one-day private trial in September. He was fined 500,000 renminbi, about $80,000, and sentenced to two years in prison. He was given credit for the time he was jailed after his second arrest and was released and deported in July.

What was his crime? An appeals court decision that rejected his appeal said he committed ''the crime of impairing business credibility and product reputation,'' according to a translation of the decision provided to me by Silvercorp. He was acquitted of the second charge, that of illegal use of spy equipment -- the cameras that filmed the trucks leaving the mine. He had not been the one who bought the cameras or did the filming. Nor had he written the reports, although he did provide information for them.

The appeals court ruling sounds as if simply selling stocks short is a crime under Chinese law. ''This court has determined that Huang Kun clearly knew that the purpose of gaining production information and pictures of the said Chinese enterprises, as requested by Carnes, was to short the stocks,'' the judges wrote.

Silvercorp's efforts to sue people involved in the reports in Canada and the United States have not been fruitful, but last December the British Columbia Securities Commission did file fraud charges against Mr. Carnes, saying that he published his original report in part because put options he had purchased on Silvercorp were about to expire.

It said he made millions of dollars on those options as a result of the report. Mr. Carnes denied the allegations, and a hearing is scheduled for this year.

A Silvercorp official declined to discuss the cases with me, and the police in Luoyang did not respond to calls and faxes seeking comment.

Meanwhile, business has declined at Silvercorp. Last year it said there was fraud at the Ying Mine, committed by contract miners who were paid by the ton of rocks they dug out. The company said the miners had mixed in refuse to get paid more. The amount of silver produced by Silvercorp fell from 5.6 million ounces in the 2012 fiscal year ended in March, to 4.9 million ounces in 2013 and 3.85 million ounces in 2014, according to Chris Thompson, an analyst at Raymond James in Canada. He said production of lead, zinc and gold also declined.

But the company said this month that results improved in the first quarter of the 2015 fiscal year, which ended in June, although silver sales were lower than they were in the period a year earlier.

The company's stock price, which peaked at $15 in April 2011, was below $8 when the first report from Mr. Carnes was released. Now it is about $1.85. Part of that decline was caused by falling silver prices, but Silvercorp shares have underperformed those of other silver producers.

Mr. Huang is still working for Eos and says he still wants to be a stock analyst. ''It is what I learned in school,'' he said, adding that he believes he is good at it. He won't be able to visit China while conducting his research.

China remains a closed society in some ways, too big for foreigners to ignore but with a language few of them can master. Many of the frauds that have come to light in recent years have involved lies that would have been obvious if documents filed with Chinese government agencies had been analyzed by underwriters, auditors and analysts involved with the companies. But China has shown more hostility to those who found the frauds than to those who committed them and has been reluctant to share information with investigators for the Securities and Exchange Commission.

Mr. Carnes says seven companies he identified as frauds have been delisted in the United States. The S.E.C. has filed fraud suits regarding three of the companies.

It may be that China's government is especially resentful of those Chinese who returned after moving overseas, as Mr. Huang did. Early this month, Yu Yingzeng, a Chinese-born United States citizen, was convicted, with her husband, Peter Humphrey, of violating Chinese law in investigating a former employee of GlaxoSmithKline at the request of the pharmaceutical company. She was sentenced to two years in prison, the same sentence that Mr. Huang received.

-- Chen Jiehao contributed research.