Last week, in a largely "under the radar" event, one of China's wealthiest billionaires (if only on paper), Wu Ruilin, chairman of the Guangdong based telecom company Cosun Group, and whose personal fortune of 98.2 billion yuan ($14 billion) makes him wealthier than Baidu founder Robin Li who is ranked 8th on the Hurun Rich List 2016, shocked Chinese bond market watchers when he defaulted on a paltry 100 million yuan ($14 million) in bonds sold to retail investors through an Alibaba-backed online wealth management platform, citing "tight cash flow." Needless to say, many were stunned that a billionaire for whom $14 million is pocket change, blamed "tight cash flow" for defaulting on mom and pop investors. In any case, as South China Morning Post reported, despite the founder's personal fortune, according to a notice put up by the Guangdong Equity Exchange on Tuesday, two subsidiaries of Cosun Group are each defaulting on seven batches of privately raised bonds they issued in 2014. According to the notice, “the issuer had sent over a notice on December 15, claiming not to be able to make the payments on the bonds on time, due to short-term capital crunch." To be sure, yet another default in a Chinese landscape suddenly littered with bankrupting debt dominoes would have been the end of it, however this morning Reuters added to the mystery when it said that the fate of the defaulted $45 million Chinese corporate bond sold through an Alibaba-backed online wealth management platform was thrown into doubt on Monday, after a bank said letters of guarantee for the bonds were counterfeit. Quoted by Reuters, China Guangfa Bank Co Ltd (CGB) said guarantee documents, official seals and personal seals presented by the insurer of the bonds "are all fake" and that it has reported the matter to the police. The dispute highlights challenges in China's loosely regulated online finance industry, where retail investors often buy high-yielding bonds and other assets, expecting them to be "risk-free" due to guarantees provided by various parties. As first reported last Wednesday, at the center of the latest dispute are up to 312 million yuan ($45 million) worth of high-yielding bonds issued by southern Chinese phone maker Cosun Group that defaulted this month. The bonds were sold through Zhao Cai Bao, an online platform run by Ant Financial Services Group, the payment affiliate of e-commerce firm Alibaba Group Holding Ltd. Ant Financial has asked Zheshang Property and Casualty Insurance Co Ltd, which wrote insurance on the bonds, to repay investors. On Sunday, Zheshang Insurance published two documents on its website that it said were from CGB carrying the bank's official seals, and that guaranteed Zheshang Insurance policies for the Consun bonds. The letters were issued at CGB's Huizhou branch in December 2014, when the Cosun bonds were sold, Zheshang Insurance said. And yet, suggesting there is a massive landmine hiding just below the surface of China's bond market, far worse than merely the consequences rising interest rates, on Monday, CGB said the documents were fake and that it had reported the incident to police as "suspected financial fraud." While material misrepresentation of facts in Chinese finance is hardly new, the recent alleged violations usher in a whole new breed of fraud, one which is far less nuanced and far more simpllistic and includes outright forgeries of documents that backstop tens if not hundreds of billions in debt. The Cosun dispute follows similar instances of financial fraud this year including forged bond agreements that led to brokerage Sealand Securities sharing potential losses of up to $2.4 billion. In May, the government advised banks to be vigilant after several cases of bill fraud. Ant Financial on Tuesday said Zheshang Insurance "hasn't any reason to refuse repayment" which it was obliged to do "within three days" of default. Making matters worse, the fraud has taken place in the context of a bond default that, according to an Ant Financial spokeswoman cited by Reuters, was a "a one in billions incident" on the platform. Incidentally, Cosun's bond issuance totals 1 billion yuan, according to Zheshang Insurance. The insurer's total registered capital is 1.5 billion yuan. Should more such "one in billions incidents" emerge, Chinese bond investors - already freaked out by the recent record plunge in Chinese govt bond futures, soaring overnight funding rates, and fears over Fed rate hikes - will rush for the exits just as China's housing bubble is also popping as reported yesterday, leading to a rerun of the US 2006/2007 dual bursting of the housing/credit bubbles, only this time instead of an $8 trillion financial system, the world will have to backstop China... whose banking system at last check had over $30 trillion in liabilities. Incidentally, we wonder if now that China's bond insurers are also under the spotlight, if that means China's very own MBIA/Ambac moments is imminent, as billions in bond insurance contracts are deemed "fake" by the insurers who would rather not pay up on what is set to be an avalanche of defaults. * * * Finally, for those interested in what Bloomberg last week dubbed the "latest China Finance Scare", namely outright forgeries in various debt products, mostly focusing on Entrusted Bonds, here is a useful primer courtesy of BBG: There’s another Chinese financial practice that’s prompting high-decibel warnings. So-called entrusted bond holdings are a way for financial institutions to skirt rules on using borrowed money to invest in bonds. How? By getting a third party to buy the bonds and agreeing to purchase them at a later date. What could possibly go wrong? How about the worst rout in China’s bond market in a decade. That’s left regulators concerned about the prospect of investors failing to make good on such arrangements, estimated to involve at least $144 billion of bonds. 1. Why entrust us with this news only now? Concerns about entrusted bond holdings have worsened the tumble in the debt market. Last week, Caixin cited market rumors when it reported a brokerage called Sealand Securities Co. had refused to take over bonds held by a counterparty. That got investors worried. Oversea-Chinese Banking Corp. then said in a note, citing media reports it didn’t identify, that the entrusted holding agreement may have been tied to alleged fraud by ex-staff. Sealand cleared the air when it said it would in fact fulfill the bond contracts that had been stamped with a forged seal. The whole incident was enough to frighten an already jittery market. 2. So why do investors use entrusted holding agreements? Brokerages and other institutional investors ask counterparties to buy bonds from them when they need to circumvent internal rules on note holdings and leverage, according to Xu Hanfei, a bond analyst at Guotai Junan Securities Co. Or they can simply have third parties buy the notes directly from the market. The practice boosts leverage by effectively giving the financial institutions loans: As brokerages and institutional investors don’t carry the bonds on their books, they can use the funds freed up on paper to purchase more bonds, which can then be rolled into more such agreements. “Non-bank financial institutions, which emphasize returns, have more motivation to amplify leverage through entrusted holdings,” said Li Liuyang, a market analyst at Bank of Tokyo-Mitsubishi UFJ in Shanghai. 3. How widespread is the practice? Outstanding entrusted holdings are "in the trillions of yuan," according to Guotai Junan’s Xu. That estimate is based on the bond holdings of the brokerages and smaller banks that are major participants in such transactions. That means the amount of money tied up in such deals is at least 5 percent of the 21 trillion yuan ($3 trillion) of outstanding corporate notes in China, according to data compiled by Bloomberg. 4. What broader risks does it pose to China’s financial markets? A default in an entrusted holding could turn what otherwise might have been a problem with one company’s liquidity into a broader credit event, given that multiple parties may be involved, according to Li at Bank of Tokyo-Mitsubishi UFJ. Li says “everyone is worried about similar situations in their transactions with non-bank financial institutions.” OCBC said that things had got so bad that banks were reluctant to lend to non-bank institutions amid a breakdown in trust between investors. 5. What are regulators doing about it? Authorities including the central bank and the China Securities Regulatory Commission are investigating some financial institutions’ entrusted bond holdings after the Sealand incident, people familiar with the matter said Tuesday. The holdings run contrary to the central bank’s push to trim investments made on borrowed money, according to China Merchants Bank Co. “It’s just a question of when Chinese regulators will clean up entrusted bond holdings,” said Liu Dongliang, a senior analyst at the bank. Tommy Xie, an economist in Singapore at OCBC, says China’s market rout may prompt regulators to strengthen rules on entrusted holdings. He describes them as "a common practice in the grey area of the bond market.”
I know how it feels to be falsely accused. I know how it feels to be pursued for seven years by an overzealous government agency determined — no matter how the facts cut against them — to pursue unfounded charges. I know because it happened to me. And that is why I am fighting back to clear my good name, to expose overreaching SEC regulators, and to spare others the nightmare of my experience. In 2000, I pioneered the field of investment grade distressed debt collateralized loan obligations (CLOs). I invested in distressed companies, often those left to liquidate or emerging from bankruptcy, and repackaged their debt into CLO products purchased by Wall Street’s most sophisticated institutional investors. Through active management of these distressed loan portfolios, I restructured and infused value into failing companies and generated large returns for me and my investors. My family office and the investment vehicles allowed me to acquire and rebuild iconic American companies, primarily manufacturing companies, saving hundreds of thousands of jobs across America’s rust belt. After the success of my first funds, the Arks, I launched a new set of distressed debt funds called the Zohars. My “own to loan” strategy for the Zohar funds was simple but innovative: I would invest my own money in the equity of distressed companies, manage the companies through my board roles (as well as oftentimes acting as their CEO), and provide the companies with liquidity through loans and flexible repayment terms, usually as their sole lender. The Zohar funds were designed so that I could exercise my discretion and my reasonable business judgment to actively manage these companies and their capital structures so that, with time, the companies could become successes again. Everyone understood this model, including the noteholders, ratings agencies, and the trustee—all sophisticated financial institutions. Everyone knew that distressed companies could not always pay all of their interest, on time, each month. Everyone understood the deal was designed specifically to give me the authority and discretion to amend and extend loans and to defer the companies’ interest payments to enable them the time and liquidity they needed to recover. Unfortunately, though, the SEC seems unwilling or incapable of understanding the business model. Even though there was no actual evidence of wrongdoing, the SEC went ahead and brought charges, claiming that my firm was not entitled to management fees where the companies were not able to pay full interest. Tellingly, the vote among the SEC Commissioners to approve the charges was 3-2, the slimmest of margins and split across political party lines. Betraying its lack of confidence in the merits of its case, the SEC steered the litigation to its own in-house system, overseen by administrative law judges appointed and employed by the SEC. In the SEC’s internal tribunals, the accused face harsh, quasi-criminal sanctions, like lifetime industry bars and disgorgement, yet they do not receive the due process rights afforded in federal courts, like basic discovery and the right to a trial by jury. Moreover, the cases proceed on a lightning fast schedule, to the unfair advantage of the SEC (which has the benefit of conducting multi-year investigations). Not surprisingly, the SEC’s win rate of 90 percent in its home court tribunals is much higher than in federal courts. For all these reasons, I went to federal court to have the SEC administrative process declared unconstitutional; trial by ambush is inherently unfair. But federal courts determined I had to first exhaust the SEC administrative process before raising my constitutional challenges. So that’s what I have done. Over the past month, the SEC was put to its proof and came up empty at trial. The SEC called only three noteholder witnesses. All of them admitted that they understood the design of the deal and the discretion that it afforded me. Moreover, they testified that, from reports they regularly received, they had all the information necessary to enable them to see that some companies had not paid full interest every month and also to see the basis on which the trustee authorized the payment of fees. The SEC knew these facts before the trial began but refused to recognize the truth because it did not support its agenda. Documents at trial also revealed investor witnesses were privately making sexist comments about me in internal emails—an unfortunate reality for a successful woman in the still male-dominated finance world. The SEC is seeking to have me disgorge more than $200 million in management fees. But the reports to the noteholders were transparent, and the SEC, which has the burden of proof, never even dared to call the trustee to the stand—doubtless because the trustee had, of course, acted properly in disbursing the fees. Exposing the absurdity of the SEC’s position, the proof at trial showed that I have put more than $440 million of my own money back into the funds and companies to protect noteholders and support the companies, and have deferred more than $60 million in fees still owing to me. During the financial crisis, I deferred taking some of the fees to which my firm was entitled for almost four years. Equally troubling, the SEC’s lawyers have engaged in egregious misconduct throughout this case, apparently blinded by their single-minded obsession with winning my case. The SEC’s lawyers repeatedly failed to honor their most basic disclosure obligations and proffered multiple witnesses they compromised through side deals, including the sharing of my confidential information with MBIA, the insurer of the notes and a longtime litigation adversary, to use in commercial litigation against me and hiring my accounting firm to give testimony elsewhere. Thus far, these transgressions have gone unremedied and considered irrelevant in the SEC’s tribunal system. The SEC has no case, plain and simple. But for the past seven years, its lawyers have dragged me through the mud and tarnished my reputation. They have misunderstood me and my business and, in their pursuit, refused to acknowledge the truth. I now await the verdict of the SEC’s administrative law judge. It is a comfort to me that anyone who sat in the courtroom knows that I was vindicated at trial and proven to have done nothing wrong. So now we will see whether justice can prevail in the SEC’s administrative system. No matter what happens there, however, I will continue to fight for justice—not just for me, but for everyone wrongly targeted by overreaching SEC regulators. -- This feed and its contents are the property of The Huffington Post, and use is subject to our terms. It may be used for personal consumption, but may not be distributed on a website.
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More than 25 years ago, William Sahlman wrote the HBR article “Why Sane People Shouldn’t Serve on Public Boards,” in which he compared serving on a board to driving without a seatbelt, that it was just too risky—to their time, reputations, and finances—for too little reward. Board service has always been very demanding. When Warren Buffett retired from Coca-Cola’s board in 2006, he said he no longer had the time necessary. When you consider all of the retreats, travel, reading, meeting prep time, transactions, and committee meetings involved, it is a wonder anyone serves at all. So why would a busy executive agree to sit on a board? Why is there is a cottage industry of executive search firms focusing on “reverse board searches,” where they proactively work to place executives on outside corporate boards? What do executives gain from serving on boards? This question was at the heart of a recent study we conducted that is forthcoming at the Academy of Management Journal. In an effort to explore executives’ motivations for serving on boards, we looked at how board service is evaluated in the executive labor market. Specifically we studied whether or not board service increased an executive’s likelihood of receiving a promotion, becoming a CEO, and/or receiving a pay increase. We hypothesized that being a board director would help an executive in two main ways: First, sitting on a board serves as an important signal or “seal of approval,” for an executive. It means that other people think this executive has potential and value as a result of being selected to serve on a board. Second, board service is an avenue for an executive to gain access to unique knowledge, skills, and connections, so firms actively use external board appointments as a way to groom and develop executives. As Mary Cranston, former CEO and Chairman of Pillsbury, LLP said in an interview, “Being on that board really helped me develop as a CEO because I had another CEO to watch. It was an incredible leadership school for me. On a board you’re together a lot, and you’re working on problems together and you have a shared fiduciary duty, so it creates very tight bonds of friendship.” Similarly, Sempra CEO Debra L. Reed has also said that sitting on the board of another company is “better than an M.B.A.” To test our idea that board service would help advance the careers of executives, we created a sample of roughly 2,140 top executives in S&P 1500 firms from 1996-2012. We matched executives who were serving on boards with executives at similar firms and with similar job profiles who had never served on a board. We found that serving on a board increases an executive’s likelihood of being promoted as a first-time CEO to an S&P 1500 firm by 44%–and even if they weren’t promoted, we found that serving boosts an executive’s subsequent annual pay by 13%. For instance, executive Glenda Jane Flanagan joined the board of Credit Acceptance Corp. in 2004, and in 2005, her total compensation from her home firm, Whole Foods Market Inc., increased by over $300,000. And consider the example of Jeffery W. Yabuki, who was the COO of H&R Block Services Inc in 2003. In 2004, he joined the board of Petsmart Inc., and later that of MBIA Inc. Just two years later, Yabuki was appointed the CEO of Fiserv, a Fortune 1000 firm. It appears that board service directly contributed to his promotion. So what do these findings mean for today’s boards of directors and aspiring CEOs? The evidence shows that board appointments increase an executive’s visibility and give him/her access to unique contacts and learning opportunities. Further, these opportunities translate into tangible economic benefits, specifically promotions and raises, which help explain why a sane person would choose to sit on a board. Further, our findings suggest that if firms are looking for external talent, looking at which executives have received board appointments in their home firm or at other firms is a strong signal that these leaders have potential. This finding is important as hiring external CEO candidates is becoming more common, CEO turnover is on the rise, and the majority of newly appointed CEOs have not previously served as CEOs. Ultimately board service is a key professional development tool in grooming potential CEOs that executives and boards alike are beginning to recognize and value. Finally, our findings have implications for firms seeking new board members. Following the Sarbanes-Oxley Act, which was passed in 2002 and created a number of new governance rules for firms as well as stricter penalties for governance misconduct, the number of current CEOs willing to serve on outside boards has dwindled. In part, the workload of boards has sharply increased, so serving offers limited benefits relative to the risk endured by current CEOs. Further, many companies have also created rules limiting the number of external board seats that their CEOs can fill, which has reduced the supply of CEOs available to serve as directors. To fill this void, firms may look to the executive ranks below the CEO level. Our research suggests that these individuals may be motivated to join outside boards to reap the benefits that increase their career trajectories.
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