Puda Coal faces class-action lawsuit (May 04, 2011)

Allegations of fraud and untrustworthy financial statements that have lead to a class-action lawsuit against former stock market darling Puda Coal (PUDA-X) underscores just how risky doing business in China can be.

The lawsuit charges that the company failed to disclose to investors that its chairman, Ming Zhao, was involved in unauthorized transfers of the ownership of its subsidiary, Shanxi Coal, and that Puda’s ownership stake was “substantially less than what it detailed to investors.”

The claimants also charge that the company had improperly consolidated Shanxi Coal’s financial results into Puda’s financial results, that it “lacked adequate internal controls” and that its financial statements were “materially false and misleading.”

Puda Coal supplies high-grade metallurgical coking coal used to produce coke for steel manufacturing in China and is also a coal mine consolidator of twelve coal mines in Shanxi province.

“On April 8, 2011, investors were astounded when a report surfaced detailing illicit and unreported transactions by the company’s chairman, Ming Zhao,” law firm Barroway Topaz Kessler Meltzer & Check outlined in a press release on Apr. 15.

The report alleged that in 2009, Zhao transferred ownership of Shanxi Coal to himself without getting approval from shareholders and accomplished this with the help of his brother, Yao Zhao.  

A year later, according to the law firm, “Zhao sold 49% of Shanxi Coal to a Chinese private equity firm for $37.2 million, and pledged the remaining 51% of Shanxi Coal to the private equity fund as security for a $379 million loan (which was subsequently increased to $530 million) at a 14.5% annual interest rate, in order to finance the development of coal mines.”

“At no time were the company’s shareholders ever informed or made aware of these occurrences,” the firm continued. “Therefore, during the class period, Puda became nothing more than a shell corporation with no operating entity.  Moreover, at no time during the Class Period did Puda have the stake in Shanxi Coal that it continuously told investors that it owned.”

As soon as the report became public on Apr. 8, shares of the company plunged $3.10 per share, or more than 34%, to close at $6 apiece on unusually heavy trading. Trading of the company’s shares was subsequently halted on Apr. 11, 2011.

The same day, Puda announced that it had started to investigate the transactions. It also said that while it was still very preliminary, there was some evidence to support allegations  that “there were transfers by Mr. Zhao in subsidiary ownership that were inconsistent with disclosure made by the company in its public securities filings.”  In addition the company said Zhao had agreed to a voluntary leave of absence as chairman of the board until the conclusion of the investigation.

On Apr. 29, Puda issued a press release stating that it had received a preliminary, non-binding proposal from Zhao to acquire 100% of the outstanding shares of common stock in a private transaction at up to $12 per share with a combination of existing cash on hand and external financing sources.

Puda Coal, one of the largest non-state-owned coal washing companies in Shanxi province, raised about US$94.2 million in a public offering in December 2010 priced at $12 per share.