[ By Howard Haykin ] Broker-dealers should be reluctant about recommending to customers that they invest in China-based companies.  On Monday, the SEC struck yet another blow to the damaged reputations of China-based firms when it charged China Natural Gas Inc. and its Chairman (and ex-CEO) Qinan Ji, of defrauding investors by secretly loaning company funds to benefit his son and nephew while failing to disclose the true nature of the loans. SEC Findings and Allegations. Qinan Ji allegedly coordinated 2 short-term loans totaling more than $14 million in January 2010.  One loan went to a real estate firm co-owned by Ji’s son and nephew through a sham borrower.  The other loan went to a business partner of the real estate firm.  Ji signed the company’s SEC filings that falsely stated the loans were made to 3rd parties.  Ji then lied about the true borrower to China Natural Gas’s board, investors, and auditors as well as during the company’s internal investigation.

"Ji betrayed China Natural Gas investors by misusing company funds to benefit his family and repeatedly lying about it.  Ji’s misconduct caused China Natural Gas to file a series of false reports with the SEC and showed total disregard for his obligations as an officer and director of a company whose stock trades in the U.S." -- John McCoy III, Associate Director of SEC L.A. Regional Office.

In its complaint filed in U.S. District Court for the Southern District of New York, Ji’s nephew approached China Natural Gas in late 2009 to obtain a loan for a large real estate development project being run by Demaoxing Real Estate Co., a firm that was 90% owned by Ji’s son and 10% owned by Ji’s nephew. Ji recognized it was inappropriate for China Natural Gas to loan money directly to his nephew, so he asked his niece’s husband, who was the company’s internal audit chief, to use a sham borrower.  The internal audit chief located an individual named Taoxiang Wang, and fabricated notes of a meeting with her to discuss loan terms.  Wang signed a loan agreement for $9.9 million, and the money was wired directly into a Demaoxing bank account with a note stating that  the amount was for "raw material expenses." Around the same time, China Natural Gas made a $4.4 million loan to Shaanxi Juntai Housing Purchase Co., a business partner on Demaoxing’s real estate development project.  Shaanxi Juntai’s then-general manager was Ji’s friend.  The internal audit chief  talked with Ji’s nephew about the project when arranging the loan, which directly benefitted Demaoxing. According to the SEC’s complaint, Ji was the company CEO until he resigned in October 2011.  He approved both loans without obtaining prior authorization from the board or informing the CFO. Ji repeatedly lied to conceal the related party nature of both loans.  When questioned about the loans by the China Natural Gas board, Ji falsely stated that the loans involved senior Chinese government officers who were in charge of the company’s liquid natural gas project.  During a May 10, 2010 conference call about quarterly earnings, Ji responded to a question about the loans by again stating that they were made to obtain approvals from government officials.  He later told the board that he made the loans to earn quick and lucrative interest, and lied about the true nature of the loans during the company’s internal investigation.  Ji also lied to the company’s auditors by signing a letter stating that the two loans were for business purposes and the borrowers were not related parties. Alleged Violations, Proposed Sanctions. Ji and China Natural Gas are charged with violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, as well as the proxy solicitation rules and various Exchange Act provisions including corporate reporting, record-keeping, internal controls, and false statements to auditors. Ji also is charged with violating provisions of the Sarb-Ox Act that require him to repay China Natural Gas the bonuses and stock sale profits he received after the company filed false reports with the SEC. The SEC seeks to impose financial penalties, bar Ji from acting as an officer or director of a public company, and permanently enjoins Ji and China Natural Gas from future violations of these provisions. The SEC’s investigation continues. For further details, go to:   [SEC PR 12-92, 5/14/12] and [SEC Complaint].