The SEC on Wednesday charged 2 China-based executives with defrauding investors into believing they were investing in a Chinese coal business when in fact they were investing in an empty shell company.   The Chairman and CEO of Puda Coal Inc. allegedly colluded on a scheme to steal and sell Puda Coal’s sole revenue-producing asset - a coal mining company named Shanxi Puda Coal Group. The SEC Connection. According to the SEC’s complaint filed in U.S. District Court for the Southern District of New York, Puda Coal entered the U.S. capital markets through a reverse merger in July 2005.  Puda Coal’s common stock was listed and traded on the NYSE from September 2009 until August 2011. SEC Findings and Allegations. Chairman Zhao is alleged to have secretly transferred Puda Coal’s controlling interest in Shanxi Coal to himself, and then sold a substantial portion to a fund controlled by what is reported to be China’s largest state-owned financial firm.  All the proceeds went into Zhao rather than to the company, Puda Coal. It goes without saying that the pair, presuming they committed the crime, failed to disclose these transactions in Puda Coal’s periodic reports to the SEC.  And, they or the firm continued to raise funds from U.S. investors through 2 public offerings that purportedly was raising capital for the Shanxi Coal unit to acquire additional coal mines.  Unbeknownst to investors, Puda Coal no longer had an ownership stake in that company. The SEC began an investigation, though it's unclear how the SEC was tipped off about the possible crime - not explained in the press release.  Zhao and Zhu responded to the SEC with a forged letter from the Chinese financial firm that purchased the controlling interest, purporting to say that Puda Coal investors weren’t harmed by the asset transfers.  In reality, Puda Coal, at that point, was a shell company with no ongoing business operations.

“The massive fraud perpetrated by Zhao and Zhu wiped out hundreds of millions of dollars in shareholder value and was compounded by their brazen obstruction of the SEC’s investigation.” -- George Canellos, SEC NYRO Director.

Further Details into the Allegations. The scheme allegedly began in September 2009, just weeks before Puda Coal announced that Shanxi Coal had received a highly lucrative mandate from the provincial government authorities to become a consolidator of smaller coal mining companies.  Zhao quietly transferred Puda Coal’s 90% stake in Shanxi Coal to himself.  Nearly a year later, in July 2010, Zhao transferred a 49% equity interest in Shanxi Coal to CITIC Trust Co Ltd., a Chinese private equity fund controlled by state-owned investment firm CITIC Group.  CITIC Trust placed the 49% stake in a trust and then sold interests in the trust to Chinese investors. Chairman Zhao also caused Shanxi Coal to pledge the remaining 51% of its assets to CITIC Trust as collateral for a loan of RMB 3.5 billion - the Chinese currency, renminbi which, in this transaction, was equivalent to $516 million - from the trust to Shanxi Coal.  In exchange, CITIC Trust gave Zhao more than 1.2 billion preferred shares in the trust. To cover up their fraud, Zhao had Zhu forge a letter purportedly from CITIC Trust falsely stating that no funds had actually been loaned to Shanxi Coal and disclaiming any interest in Puda Coal’s or Shanxi Coal’s assets.  Zhao’s counsel provided the forged letter to the SEC’s investigative staff and Puda’s audit committee.  After Puda Coal disclosed the letter in an SEC filing and further misled shareholders about the ownership of Puda Coal’s assets, Zhu admitted forging the letter and resigned as CEO.  Zhao remains the chairman. SEC Charges. Zhao and Zhu 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 violating the proxy solicitation rules and various corporate reporting, recordkeeping and internal controls provisions of the Exchange Act. The SEC seeks to disgorge the pair of their ill-gotten gains, apply prejudgment interest, impose financial penalties, bar them from acting as officers or directors of a public company, and permanently enjoining them from committing future violations of these provisions. SEC NYRO Staff Credits. Investigation, which continues, conducted by:  Sheldon Pollock, Scott York, George Stepaniuk, with support from Neil Hendelman, Desiree Marmita. The SEC’s Cross Border Working Group, which has representatives from each of the SEC’s major divisions and offices and focuses on U.S. companies with substantial foreign operations, assisted the New York Regional Office enforcement staff in the investigation. For further details, go to:  [SEC PR 12-31, 2/22/12].