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Investigators with the New York office of the Federal Bureau of Investigation raided the offices of Benjamin Wey’s New York Global Group yesterday, seizing documents and conducting interviews with employees.

According to one NYGG official, Wey’s Manhattan apartment was also raided. As of now, no charges have been filed and it was not clear what NYGG transactions were of interest to the FBI. Attempts to contact NYGG and Wey were unsuccessful; a man answering the phone at the firm’s 40 Wall Street offices refused to give his name and would only reply, when questioned about the raid, “No one is here right now.” Follow up calls were not answered. Jason Marshall, an official at Wey’s longtime publicists, said Wey and NYGG are no longer clients.

The raid was in many ways surprising in that legal repercussions from the collapse of the China reverse-merger boom had been minimal, save for some occasional de-listing activity from exchanges.

Wey is the self-appointed poster-child of Chinese reverse merger promoters and has been no stranger to the readers of The Financial Investigator, arranging any number of Chinese transactions that have collapsed under dubious circumstances.

Moreover, Wey had just helped his most recent transaction, CleanTech Innovations, launch a lawsuit against NASDAQ stock market, “For racism and discrimination” over the self-regulated exchange’s decision to delist the then-recently listed company, purportedly for the role Wey played within the company.

On June 10th last year, a hedge fund manager named Kevin Barnes got a very direct E-mail from one Neal Marder, the head of Winston & Strawn LLP’s Los Angeles litigation group. In the E-mail was a PDF of a letter that made abundantly clear two things to Barnes: The first was that in many ways Marder thought Barnes was about as dull-witted a character as could be encountered in the capital markets and the second was that Barnes was going to be spending a great deal of money in the next several years on legal fees.

Marder’s letter to Barnes was full of strongly held opinions not just because he billed nearly $1,000 an hour, but because the PDF is more properly known as a demand letter and had been written on behalf of Winston’s newest client, SkyPeople Fruit Juice, a China-based manufacturer of fruit juices and concentrates. The letter existed because Barnes, in his role as general partner of Cheyenne, Wyoming-based Absaroka Capital Management, had released a 26-page report on June 1 that claimed that SkyPeople had an armful of issues.

Barnes and his researchers in China had discovered that SkyPeople didn’t, as they had long asserted, own the largest Kiwi fruit plantation in Asia, that its factories were smaller, idled and full of older equipment and the products were on a lot fewer shelves than had been disclosed. Most importantly, a study of the documents SkyPeople filed in China describing their financial condition with the State Administration of Industry and Commerce (better known as SAIC) painted a very, very different picture of its health than those filed for investors with the Securities and Exchange Commission. If Barnes had read them correctly, SkyPeople was telling the Chinese regulators they were 10% of the size they were telling Americans.

To Barnes, and most other investors, that was a decent working definition of the word “fraud.”

That day, SkyPeople’s stock price, which had been trending south for about a year, in line with dozens of other Chinese reverse merger companies whose prospects were now seen as problematic, dropped 18%, to $2.08 from $2.55 on heavy volume.

Marder, however, didn’t see it that way. He alleged that Barnes hadn’t read the filings correctly and had made one of the biggest mistakes in recent financial history. It wasn’t just a crappy thesis but was entirely false because he had used the wrong SAIC data.

In his demand letter, Marder doesn’t even entertain the idea that Barnes, a six-year veteran of J.P. Morgan’s Natural Resource investment-banking unit, would have pulled the wrong files back in China or simply inaccurately crunched numbers; the SAIC numbers Barnes cited could have only been “fabricated to appear genuine.”

In other words, Marder’s legal theory was that Barnes did what legions of pumpers and promoters have done with Over-The-Counter Bulletin Board companies for years: position the stock and then release scripted and embellished research or press releases that move the stock price favorably. Except with thinly traded pink sheet and OTCBB stocks everyone, including investors, is in on the joke and are investing because a pump is underway.

(The trick, of course, is properly timing the sale, or dumping, of the manipulated shares.)

Barnes, per Winston & Strawn, was playing the game with a listed Nasdaq stock and that is an order of magnitude more serious. Leaving aside the complete immorality of what Barnes was being accused of, it was a dangerous game that likely would prompt an invitation to discuss the matter from lawyers less well-paid, but sharply more powerful, than Neal Marder.

In case Barnes wanted to put the possibly nightmarish civil litigation behind him, helpfully attached to the demand letter was an affidavit Winston & Strawn had drawn up that retracted the entire report. To clarify his thinking on the matter, Marder had also sent along a copy of the suit the law firm was filing in two days if the retraction affidavit wasn’t signed.

This was crisply executed hardball worthy of much larger companies than SkyPeople Fruit Juice.

Barnes, as he saw it, was on the horns of a dilemma. If he stood by his report, as was his wont, his less than a year old fund would be engaged in a multi-year legal battle with a company that had nothing to lose and could use its working capital to pay its legal bills.

That was just the beginning, however.

As Marder surely understood, Absaroka’s investors, like all institutional investors, despise litigation. It distracts the manager from their work for long periods of time and the discovery process can unearth all the details investors prefer remain private, like E-mails discussing fee structure, investor risk tolerance and their investment rationale. Despite the fund’s excellent performance, few would invest in a fund under siege and fewer still would stick around to see how the suit ended up.

Then again, if Barnes folded and signed the retraction, his fund and his career were virtually finished. He would be, in essence, Barry Minkow without the interesting back story of redemption and sin.

So Barnes hired Arlene Fickler of Philadelphia’s Schnader, Harrison, Segal & Lewis, a lawyer with a good track record of experience in successfully representing short-sellers against aggrieved companies. He instructed her to try to negotiate a deal: He’d take the report off the website and wouldn’t write another if SkyPeople stopped the demand letters and litigation threats.

It didn’t work and on July 8 they sued Absaroka and Barnes.

The failure of negotiations struck Barnes as odd.

SkyPeople didn’t have a whole lot to gain from a protracted legal battle itself, and for the cost of a new Mercedes, it could have had about 70% of a victory, silencing a critic and taking a damaging report out of circulation. Barnes was short the stock in size at $5 and had made his money and although cutting any deal with the mouthpiece for what he considered to be a bunch of crooks was bitter, he was a businessman, not a hero or a crusader.

Over a series of bike rides in and around the foothills of Cheyenne last June Barnes tried to muscle his way through what he saw as the absurdity of it all, such as why a hastily constructed reverse merger company with, as he saw it, a lot to lose during the discovery production process would sue. Eventually, they would be forced to prove how, at their current growth rates, they were en route to overtaking Dole Fruit as the world’s premier fruit processor within the decade. He was certain that this explanation would end very, very poorly for them.

SkyPeople, he concluded, was betting everything that the best defense was to go on offense. It was a guarantee for long days, busted weekends and a drain on his once promising bank account.

On his lawyer’s advice he had just retrieved, for the second time, the company’s SAIC documents. Despite using a different service, they were identical. Moreover, a class action law firm had retrieved the filings and finding what Barnes had found, used them in their suit. GeoInvesting, a research shop who had done as much China fraud busting as anyone else, posted their own analysis of (two of the four) SAIC documents and noted that they matched Absaroka’s down to the auditor’s stamp.

Quite a coincidence, all of that.

When it became more interesting was when Barnes hired China counsel via Akin Gump Strauss Hauer & Feld LLP in August and they couldn’t retrieve the documents because they had been removed. Well, not all of them, to be fair, just the 2009 SkyPeople income statement and balance sheet which were what he had centered much of his analysis on, as well as documents from several subsidiaries where he had alleged self-dealing occurred.

And that’s where it got really curious.

Because whoever was behind the SAIC document caper hadn’t known that there were ample footnotes throughout the remainder of the SAIC files, all of which refered back to the sums and line-items that Barnes had used in the Absaroka report. In other words, Barnes was still on solid legal footing, readily able to cite official Chinese documents to support his claim of SkyPeople’s having two sets of books, albeit with a whole new level of sixth-grade quality intrigue mixed in.

The backstory would soon become the main issue when, on July 25th, another lawyer Akin Gump had hired in the city of Zhouzhi to pull documents on various SkyPeople subsidiaries and transactions received an anonymous phone call on his cell phone demanding to know why he was conducting an investigation and whether he planned on suing SkyPeople.

On August 1, another person called the Absaroka lawyer and told them to drop the investigation or else the caller “Would come down hard on [the lawyer.]”

It added a Grisham-esque quality to what was, at bottom, a ordinary company-versus-short-seller dispute. The missing documents and the phone call forced Barnes and his lawyers to spend hours puzzling out what SkyPeople’s end game could possibly be. There was also the real world dimension to be considered: this was China and threats made against corporate investigators had a disturbing probability of being implemented, so ignoring them as a prank or legal bluster was to put other people’s lives at risk.

On the other hand, even though Barnes had zero interest in being a poster boy for the first amendment, SkyPeople had devolved in his eyes from scammers to thugs. If these guys were going to play this rough out of the gate then this could only be taken in front of a jury where the company could explain and prove their side of everything.

For more money than he cared to reflect on, his lawyers went over everything he had done, said and written. It wasn’t enjoyable but the fine-tooth comb was clean at the end of it all: Absaroka, it appeared, had done nothing that couldn’t be explained in front of a dozen strangers. Everything Barnes wrote was backed up by veteran investigator accounts, photos, multiple onsite interviews and the company’s Chinese filings.

In case it was still in the back of his mind, settling wasn’t an option as Marder had, once or twice in passing, mentioned to Barnes’ lawyers that $50 million might be a workable sum in getting this all behind them.

Barnes clearly saw that he was in the right, legally and ethically, but Marder’s gambit had worked exactly as expected: Investors were pulling out despite returns on their capital that were approaching triple-digits. New investors were, in the main, telling him some version of, “Thanks, and we’re sure you’re right, but we’ll be on the sidelines until this blows over.”

He refused to plead with them but his arguments about good returns and bad companies fell on increasingly deaf ears; eventually, one investor who seemed to genuinely have empathy for Barnes and his plight, gently told him that as an allocator of capital, he wasn’t in the “Fighting fraud business,” but had to make a buck. He couldn’t expose his investors to Barnes’ problems.

So, rather like the First World War, where for many years the cost of making peace was worse to the combatants than the cost of fighting the war, the suit would continue. The truth aside, settling would cost Barnes his fund and career. The expense of fighting the suit was en route to accomplishing the same end, just more gradually.

All of which came to strike him as precisely the point.

People with more money at stake than he did had no real interest in the suit going away.

If SkyPeople settled the suit out of court, it was a tacit admission that Barnes was correct and would likely attract regulators. There was little need for that though since the company had raised about $33 million in a pair of financings over the previous two years and despite spending $15 million on a pair of (related party) deals they had plenty of cash for legal bills.

Winston & Strawn was building a handsome franchise out of defending SkyPeople, representing them in the shareholder suit as well as the Absaroka matter, raking in tens of thousands of dollars monthly. The law firm’s China-based associate on the case, Laura Luo, was intimately familiar with the reverse merger sector’s blues, having been a longtime legal advisor to RINO International Corporation as well as SkyPeople. Crummy Chinese companies were getting nailed left and right for every conceivable scam and making a go of it for SkyPeople was an impressive calling card.

Ironically, Marder, who runs the case, had never been to China nor worked on a reverse-merger case before this one. He certainly didn’t lack for initiative, asserting in a letter to Barnes’ lawyer that SAIC documents were not actually public documents–as has long been held–and that his forwarding them to Barnes would be a violation of Reg FD. [He has since backed off this claim, likely because it is wholly inaccurate.]

[Marder and his colleague Laura Luo did not reply to detailed E-mails seeking comment; a SkyPeople spokesman, David Rudnick, spoke briefly to The Financial Investigator last week but did not reply to a pair of E-mails seeking comment.]

From where Barnes sat, Winston had discovered the proverbial fatted calf: As long as there was a scintilla of enthusiasm on SkyPeople’s end for the fight, keeping the briefs and filings flowing was a means for them to wade daily in a river of shareholder cash.

Still, like all wars, the longer it went on the uglier things were that had surfaced from the wreckage of it all.

Barnes and his legal team pored over the various filings and press releases from the shareholder action with great interest. Originally studying them Talmudically for data they could use in their own battle, they soon came to view the growing body of SkyPeople filings as more akin to a train wreck and read them in a state of disbelief.

What company, for example, in their right mind would ever consider disclosing that their U.S.-based former chief financial officer did not own any stock but that her “day-trader” husband was regularly trading blocks of its stock? [A day-trader, it should be noted, who holds on to his positions for months at a time.]

Similarly, proudly announcing the dismissal of BDO Limited Hong Kong, their semi name-brand accountant (admittedly one with a track record of signing audits for a murderers row of epic historical frauds, like China Expert Technology and China-Biotics) for Paritz & Company of Hackensack, N.J. would have normally appeared to be a hoax; for SkyPeople, it represented their considered thinking on good governance.

It struck Barnes that such a move was a case of “Features versus Bugs.” Paritz had no offices in China and a Public Company Accounting Oversight Board review that noted departures from generally accepted accounting procedures, revenue testing failures and inability to identify related party deals. Rather than reject the hiring of such a demonstrably unsuitable firm, these were the best things that Paritz had going for it. The last thing the company wanted, Barnes supposed, was an auditor becoming demanding. He took some comfort from supposing that defending that move in open court would force Winston & Strawn to earn every cent of their fee, especially when they have to assert why it was the Audit Committee’s best available option.

Depending on the day, Barnes could be forgiven for thinking himself trapped in a poorly scripted avant-garde film, walking between light and shadow and truth and lies.

There is certainly an air of nihilism about the case: It is a virtual certainty that despite submitting hundreds of pages documenting their profound moral furor over Barnes’ allegedly fraudulent research, Winston & Strawn’s client wish to keep a large ocean between themselves and an American courtroom.

Barnes has no legal remedy he can pursue in China and even doing research there is now dangerous for him; U.S. courts have proven themselves unfriendly to short-sellers often enough, so betting on a summary dismissal involves more faith than reason. The SEC is nowhere to be found. The conclusion is inescapable: It will be a long fight.

There are no moral victories in these battles but if there were, Barnes could make a plausible claim for one. The market clearly does not believe SkyPeople has $76 million of cash on its balance sheet (or, for that matter, that it has nearly anything on its balance sheet or income statement) as its price of $1.69 per share attests to.

At the end of the day, there remains only the fight for Barnes and his hedge fund. The analyst-refugee from New York’s cavernous trading floors, he has come to accept his role as the unwitting champion of freedom of speech and the right to dissent, only wishing that at some point, it would all just go away.

 

For four months between November 2010 and February 2011 the shares of Deer Consumer Products, a Chinese manufacturer of household applicances, remained ironbound in a range between $11 and $12. It’s notable for several reasons, not the least of which is that a widespread rout was then well underway among Chinese reverse merger stocks. Yet as the chart shows, DEER’s share price barely wavered even as short-sellers began to increasingly bet against it and the market for similar high-fliers collapsed.

Rather than supposing DEER had a uniquely loyal shareholder base who refused to sell because of an evangelical belief in the value of their investment–similar to those holding Berkshire Hathaway–a more likely explanation is that DEER is alleged to have paid $350,000 to a Manhattan penny stock brokerage to peddle its shares during this period. DEER is essentially running up a massive red flag: On Wall Street, a company that pays a brokerage to sell its shares is considered even more desperate a move than than hiring a firm to provide research coverage. It is a virtual acknowledgment that its shares cannot be sold through traditional means and as such, has long been relegated to the far fringes of even the penny stock world.

The payment was revealed in the Financial Industry Regulatory Authority Broker Check report of Talman Anthony Harris, a penny stock salesman then at First Merger Capital, a defunct firm of the distinctly boiler room variety. [The payment does not appear to have been disclosed in any SEC documents.]

Harris’ FINRA report suggests a host of troubling details about the interconnection of Chinese reverse merger stocks, boiler rooms and shadowy promoters. In DEER’s case, a series of linkages points to the promoter being Benjamin Wey, a familiar figure to The Financial Investigator’s readers.  

Per the FINRA report, Harris did not disclose to his clients that “Beginning in February 2010” DEER paid his firm $350,000 to market its shares to its clients, nor that an unnamed “Third Party”–identified only as someone who “Promoted DEER and HEAT” (SmartHeat Inc.)–had given his branch office “discounted rent.” The payment was described as a “Financial Services Consulting Agreement.”

Harris, reached at his new firm, Cambridge Alliance Capital said he was unfairly victimized by the FINRA report since he hadn’t received “A single penny” from DEER and “All of ‘that’ [The DEER payment] had been handled by [First Merger Capital’s] management, Mark Simonetti, John Stalanski and branch manager Maureen Gearty.” He declined to discuss the origins of the payment and what–if any–role New York Global Group’s Wey had played in the matter. His protests that he is a victim and has never had a [FINRA] complaint lodged against him before these issues aside, Harris certainly has worked at some legendarily abusive brokerages.

All three of the First Merger Capital officials Harris cited, especially Simonetti and Gearty, have a deep and varied history in the frequently ethically challenged margins of the penny stock world, according to their FINRA reports. Gearty’s FINRA report seems to substantiate Harris’ claim that the DEER payment went to her, alleging that she “Generated misleading or inaccurate books” in concealing the payment and that she split the commissions with another First Merger Capital employee, Ronen Zakai. [The Financial Investigator made numerous attempts to contact Gearty via phone at her Queens, N.Y. residence but was unable to reach her.]

Zakai cuts an interesting figure. Though Gearty’s FINRA record says Zakai was unregistered at First Merger Capital, his own FINRA filing describes him as the firm’s managing partner. His FINRA record points to some epic violations of industry practice but he has apparently landed on his feet and now holds himself out as the managing partner of RSM Capital Partners’ Social Innovation fund. [Zakai did not respond to numerous messages left at his job and on his cell-phone.]

The connection to Benjamin Wey begins with the fact that he arranged the reverse mergers of DEER and HEAT and helped them secure U.S. market listings and has been a very aggressive proponent of DEER, as he noted in this E-mail to his trading desk contacts in September 2010, announcing his sister’s purchase of a block of shares. [Wey did not respond to repeated requests for comment.]

In addition to First Merger Capital’s sharing a 40 Wall Street address–they were located on the 34th floor, four floors below New York Global Group–Wey had used the firm to peddle his last deal, a financial wonder named CleanTech Innovations that NASDAQ began delisting proceedings on six weeks after listing it.

Great Eastern Securities, Zakai’s former employer, also helped peddle Bodisen Biotech, the first deal Wey obtained notoriety with. Great Eastern, unsurprisingly, is no stranger to regulatory woes.

The trading behavior of DEER stock certainly warrants closer scrutiny.

Beginning February 22, 2010 DEER’s stock price ramped from $9 to $12.94 in about eight trading days. The ramp coincided with a release announcing that, “DEER has initiated product sales to Wal-Mart Stores in China.”

A little over two months later, the stock sank back to the $8 range where it stayed for four months until Wey’s sister filed a SC-13D disclosing her purchase of 2.1 million shares. The stock ran to above $11 over the next month or so where it stayed until March 21, 2011 when the stock mysteriously broke, despite the release of three separate reports from Alfred Little, a short-seller and investigator with an office in China, who was deeply skeptical of DEER’s prospects.

March 21 is three days before the “Notice Date” on Harris’ FINRA report.

DEER, which is suing Little and the Seeking Alpha website alleging their participation in an illegal shorting scheme, did not respond to an E-mail request for comment as to why it apparently paid penny stock brokers to pump its stock. Robert Knuts, the former SEC enforcement division attorney DEER hired to sue Little, did not reply to an E-mail and two phone calls seeking comment.

To the casual observer, being a venture capitalist probably seems like being an American Idol judge: People kill for that one chance to show off their best moves while all you do is sit back, Sphinx-like, and with a nod of the head make a decision that will change their career forever. That it’s not remotely so cut and dry as ferreting out bad singing is irrelevant; major venture capital firms occupy an inarguably powerful place in the economics of the modern market. It is difficult indeed to trace a single technological development of the past 40 years that didn’t at some point get funding from at least one venture outfit.

The venture capital business model is simple, at least in the abstract: Find a promising company with some compelling technology or business plan and give them enough capital to get moving until they have something approaching critical mass. Depending on where the company is with its product or plan, the VC can often reap a multiple of their investment when an initial public offering occurs.

At the top of this world is Menlo Park’s Sequoia Capital, a fixture in the San Francisco–and now global–technology scene, whose track record includes providing early capital to Apple, Cisco Systems and Google. Though they are as market oriented and commercially driven as any Wall Street firm, VC’s–and Sequoia in particular–have a “white hat” reputation, in that they not only play a key role in bringing game-changing companies to the market, but unlike most of institutional Wall Street, they had no real role in the Credit Crisis. It might be said VC are the last “cool capitalists,” or barring that, at least that no VC screwup led to a bank failure.

Then there is Neil Shen.

The founding managing partner of the $1 billion Sequoia Capital China Fund and a veteran of Lehman Brothers and Deutsch Bank, Shen is the rare bird among VCs in that he hasn’t been just a funder of companies, but also founded a pair of publicly traded companies, Ctrip.com and Home Inns.

Shen’s hat color is subject to debate. According to a host of Securities and Exchange filings, publicly traded companies where Shen is a board member have a robust history of taking spectacularly ill-advised stakes in other Sequoia-backed companies.

That’s the good news.

The bad news is really, really bad.

Shen is a board member of Focus Media, a major Shanghai-based advertising company that Muddy Waters, a West Coast-based short-selling research boutique, recently savaged in an 80-page report. Authored by Carson Block, whose credits include being the first to sound the alarm over the fraud and improprieties at RINO and Sino-Forest, the report details a level of insider self-dealing and board-level incompetence at Focus rarely seen on these shores, even in the wake of the financial sector’s debacles in 2008.

Shen has a small but important role in Focus Media’s strange doings.

Consider Focus’ March 2007 purchase of Allyes Information Technology for just under $297 million. Touted then as “The largest Internet advertising company in China,” the deal was nicely timed for Allyes’ investors, where, as recently as 2005, a trade publication pegged its valuation at $120 million.

What hadn’t been known was that the selling group included Focus chief executive Jason Jiang and board member Neil Shen. Shen, whose given name is Nanpeng, controls a British Virgin Islands shell, Smart Master International Limited, that held his personal investments, including the 0.45% Allyes stake, which was worth about $540,000 before the March 2007 deal, according to Securities and Exchange Commission documents. After the deal, it was valued at $1.33-million, for a profit of $793,000 in under two years time and a 146% return on his capital.

Focus’ disclosure on this deal, to be charitable, was virtually nonexistent. Buried in an exhibit attached to page 22 of an underwriting agreement is a carve out for Focus insiders to “a passive investment” in Allyes. This, it should be noted, defines “passive” so broadly as to be pointless since Focus bought–and later sold–the company. Focus insiders, in other words, were the very opposite of “passive.”

That was merely the pre-game, however. The self-dealing really kicked in when nine months later, in December 2007, Focus wrote the Allyes investment down to $82 million–it would take $259 million in write-downs by the end of 2010–before selling 38% of the then seemingly worthless unit to company insiders for $13.3 million.

As Muddy Waters’ Block noted, the move to allow the insiders to buy-in was odd, in that 87% of the book value had been written down at that point. Odder still was that the $13.3 million figure valuing the entire company at $35 million, a $5 million discount to the cash on hand and a 42% discount to the $60 million book value. Warren Buffett dreams of buying companies at a discount to cash value in his billionaire sleep. It’s challenging–absurdly challenging–to imagine a scenario or accounting regime where a company without liabilities of note would be forced to value itself below cash value.

The reason given for the insider’s purchases are also difficult to grasp.

Ostensibly they were to “incentivize” management to find a way to rationalize the seemingly collapsing Allyes business, but chief financial officer Kit Leong Low, a former Goldman Sachs analyst who covered the company, and CEO Jiang, are both multimillionaires (with Jiang on the path to Billionaire-dom with nearly 101 million shares, amounting to a greater than 15% stake in the company,) so the notion of them not being aware of the need to turn the unit around (or of being problematically under-compensated) is far-fetched.

One can’t argue with results, however, and Silver Lake Partners, a major private equity firm, bought 90.8% of Allyes just nine months later for $181 million.

Cutting to the chase, there are two ways of viewing this sale. Seen Focus’ way, it was a fortuitous rally in the value of online advertisers allowing them to sell Allyes at over three times book value to one of the world’s most sophisticated financial shops. This argument of course assumes Silver Lake, one of the biggest players in Chinese mainland private equity, has no ability to discern or price value, especially in the Internet sector where they own (or owned) numerous high-profile companies.

On the other hand, Focus investors, who booked over $160 million in losses in two years–while insiders repeatedly reaped millions in profits from private, non-disclosed deals they could not participate in–would likely see this as self-dealing with their capital.

Evaluating Shen’s performance as an independent director is easy assuming that everyone is clear on the criteria being used. If U.S. standards were applied, he would likely have been sued into the next dimension of time and space. Alone among his fellow board members, Shen–with a dozen years of U.S. corporate executive experience prior to becoming a VC–has an understanding of what so-called best practices are in terms of conduct and disclosure.

[For what it’s worth, the SEC has expressed some interest in the Allyes transaction, having filed two comments requesting additional public information.]

Of the 9.2% remaining stake in Allyes, The Financial Investigator has been unable to discern the ownership structure of two British Virgin Island trusts that hold one-third (or 3%) of the remaining non-Silver Lake shares, Bronco Venture Ltd. and Unidex Holdings Ltd. It is highly likely those entities, however, are owned in some combination by CFO Low and Jiang.

The Financial Investigator sent Shen an E-mail seeking comment trying to reconcile these transactions with the idea of being an independent director but did not receive a reply. FI called Mark Dempster, Sequoia’s chief of U.S. marketing, but he declined to comment. An E-mail sent to Focus’ Investor Relations department was not returned.

[It should be noted that this is not the only instance where a Chinese management has bought a company and shortly thereafter written nearly the entire value of the unit down. In 2008, Spreadtrum Communications purchased San Diego-based Quorum Systems for $70 million in cash and stock. Backed by some of the highest profile VCs in the US, Spreadtrum had taken $53 million in impairments from the Quorum deal by the end of the year.]

Focus Media isn’t the only battleground stock Shen is on the board of. Short-seller Andrew Left’s Citron Research website has released a series of increasingly scathing articles on Qihoo 360 Technology, an Internet portal claiming to be China’s third largest. Of special interest is the conclusion to Left’s December 7th report where he casts a critical eye on Qihoo’s claims of growing ad sales 25% quarter-to-quarter (144% annually) at a time when Sina’s Weibo, China’s most popular Internet property, reported only 26% annual growth.

Another possible trouble spot for Shen and Sequoia is VanceInfo Technologies, an information technology company in Beijing that the fund had seeded. Gradient Analytics, an accounting research shop with a track record of picking off trouble early for its subscribers, initiated coverage with an “F” rating in June, raising extensive concerns about its revenue quality, receivables, accounting controls and margins.

Then there is Shen’s circular world, a sort of movable feast of baffling deals that appear designed to reduce Sequoia’s exposure to a series of Internet companies he invested with.

As with the Allyes deal, the effects are zero sum: Sequoia and Shen profit, investors lose.

The transactions start with Sequoia’s participation in the March 2009 $180 million private placement in New Wave Investment Holdings, a holding company controlled by Charles Chao, the CEO of Sina, a large Internet portal and social media company that was a key investment for Sequoia before its 2000 IPO.

Sina, whose most valuable property is Weibo, the Chinese language equivalent of Twitter, bought a 34% stake in China Real Estate Information corporation, a real estate listings and services website, in its October 2009 IPO. Whether this was a good idea depends on where you sit. It has been a disaster for Sina shareholders, who suffered a $128.6 million write-down in their stake in CRIC in March–the American depository shares were then $6.63; they are now $4.27–but it has given Shen, a board member since the IPO, a chance to help arrange a non-binding $6.62 bid from E-House, another online real estate company where Shen holds an 11.5% stake personally and through a stake in a holding company.

Somewhat amazingly, given the deeply non-confrontational nature of the relationships between Asian equity research analysts and the companies they cover, at least one sell-side analyst has used the Muddy Waters driven debate over Focus to reiterate his bearishness of Sina. Paul Wuh of Samsung Securities has maintained a Sell rating on Sina at least in part because of the money-losing investments.

Another crummy trade for Sina has been its purchase of a $66 million block of online apparel portal Mecoxlane from Sequoia. The block, amounting to 19% of the ADS, was at an average price of $6 and including call options to purchase the stock at $8, has given Sina a $51 million hickey at current ADS prices.

[A brief aside: While looking at the investor list of Sequoia-funded Noah Holdings, several curious patterns emerged. As of November 2010, apart from Sequoia's 21.6% stake, most every major investor owned their shares through an entity whose address traced to Drake Chambers, Tortola, British Virgin Islands. Moreover, several of the entities were traceable to players in collapsed promotions like American Oriental Bioengineering, China Pacific and Lingo Media.]

Sina’s investors are far from being the only ones to come up short for having played a former Sequoia portfolio name. Nearly everyone who has played Shen’s IPOs have suffered mightily as the following chart–which looks at the performance of Shen/Sequoia backed IPO’s in the U.S. markets–shows. Ironically the two exceptions, VanceInfo Technologies and Qihoo 360 Technology, have faced heavy public criticism.

Though the concerns over Chinese macroeconomic health, coupled with growing concerns over accounting and governance, have likely weighed on Chinese stock prices, this portfolio’s blues can’t be traced to the collapse of the reverse-merger market. Every one of these companies had Sequoia and other VC backing, major Wall Street underwriters (and their uncritical research support,) big law firms signing off on the books and white-shoe legal advice. Put frankly, their share prices are sinking because of well-documented failures to execute or because their products are facing stiff competitive headwinds.

On paper, it might seem that life could get hairy for Neil Shen at virtually any second. Muddy Waters doesn’t appear to be going away anytime soon on Focus Media and Andrew Left is firmly at war with Qihoo 360. None of the U.S.-listed companies from Sequoia looks terribly robust and any future IPOs are certain to meet with much more skepticism than the first batch from 2007-2010 encountered.

But we can be assured Neil Shen isn’t suffering. Sequoia got out of its positions at many multiples of the value of its original investment and, should that prove insufficient, he has his board seats, stock holdings, his disclosure-lite deals and behind-the-scenes influence. More importantly, he appears to have the tacit approval of his colleagues in Menlo Park, who privately must wonder at how one man can get away with so very, very much.

Tianbing “Benjamin” Wey, the head of New York Global Group, a firm that functions as a sort of Grand Central Terminal for Chinese companies, appears to be a big fan of the concept of vertical integration.

In the language of business this implies that a corporation’s various subsidiaries are united in one large supply chain to deliver a product to market. That’s exactly what Wey does, except that instead of an automobile, New York Global helps bring Chinese reverse mergers to the U.S. investor.

The results have put a goodly amount of change in Wey’s pocket.

Investors in Wey sponsored and advised companies have done less well though. As matters would have it, his deals have systematically collapsed in price under the weight of claims of poor governance, self-dealing and outright fraud.

Wey strikes a colorful figure, a well-dressed Sino Donald Trump type (in whose building at 40 Wall Street New York Global Group has an office) whose parody like press releases unapologetically promote both himself and the promise of closer U.S.-China ties via Wall Street. The reality is more mundane, however. A background full of regulatory intrigue–including a subtle but effective surname change to Wey from Wei and the placement of New York Global’s ownership in his wife’s name–and old-fashioned stock promotion puts Wey closer to Robert Brennan than Trump.

Describing what Wey does is no easy task and that’s probably because both the companies and Wey want it like that.

Perhaps the best way of putting it is that his New York Global group acts like a supermarket for a certain kind of Chinese company seeking access to the deep and liquid U.S. capital markets without the messy disclosures that serve as red flags for cautious investors. So Wey and his team shepherd them thru the reverse merger process: He finds a corporate shell, helps with attorney selection, raises some money through an initial PIPEs deal, promotes the stock and, most importantly, has an auditor lined up. He presumably gets a handsome slice of equity but tracking his trades has proven difficult.

Above all however, the one constant in Wey’s “success” is his use of an accountant named Ahmed Mohidin.

A former partner of Kabani & Co., a firm whose work the Public Company Accounting Board memorably savaged in this report, Mohidin–starting in February 2004 with Wey’s first deal–has been the lead audit partner in all of Wey’s deals. It is a lineup worthy of pause; outside of Harbin Electric and Deer Consumer Products, both of which have their own well-documented controversies, Wey’s deals have become graveyards of investor capital. [In disclosure, it should be noted that Deer is suing the author of the report linked above.]

A buried key to the Wey-Mohidin relationship–both at Kabani and at his current firm, Goldman, Kurland Mohidin–are a pair of small Chinese accountancies, Ever Trust CPA Co. Ltd. and Beijing AnShun International CPA Co. Ltd.

These firms fill a crucial role in the Chinese reverse-merger continuum since firms like Kabani don’t have Chinese offices (despite having a roster of China-based clients.) In theory, the small firms do the crucial scutwork for the audit, such as verifying contracts, counting inventory and reconciling account balances at banks. In reality, however, they did the work enabling Kabani to sign off on the Wey-promoted companies’ consistently fantastic earnings just as the Chinese reverse merger market exploded. [Practically put, the notion that two accounting firms, one based in the U.S., and each with under two dozen employees could adequately audit fast-growing companies with hundreds of millions of dollars in revenue is difficult to conceive.]

The numbers were so otherworldly that most analysts and investors–to say nothing of the media–forgot that many of these annual reports were treading on the outer limits of rationality. Household appliance maker Deer Consumer Products grew revenues 400% between 2008 and 2010 and reported operating margins of 21%, hundreds–and occasionally thousands–of basis points higher than even its Chinese competitors. Bodisen Biotech, a fertilizer manufacturer, reported operating margins of 31% for 2006 and grew revenues just under 50% at a time when its rivals were happy to grow at a tenth of that rate. [Bodisen has paid for its “growth,” having been delisted from the American Stock Exchange for a host of reasons, some relating to nondisclosure of payments made to Wey.]

Unsurprisingly, Wey’s stocks soon attracted a cult-following of short-sellers, investigative reporters and bloggers whose efforts in drawing attention to dubious governance and implausible accounting led to an eventual stock-price collapse for many of them.

The chart below shows the fleeting glory–and lasting pain–upon corporate stock prices in companies where Wey played a role in bringing them to the U.S. markets. In many cases, when Wey exited and new auditors were obtained, their miraculous revenue growth levels suddenly slowed down.

Click here to see a chart of Wey’s clients and how they’ve fared.

That these small accounting firms found it easy to sign off on astonishing financial figures is not surprising since it appears they were literally created for that purpose.

To start: Ever Trust’s May 2006 application to the Public Company Accounting Oversight Board, Ever Trust only “Played or expect[ed] to play a substantial role in audit[ing]” Bodisen Biotech, China Natural Gas and China Housing and Land. Kabani deals all, Ever Trust noted only that it “Assist[ed] [Kabani] in some areas.”

The first appearance of Ever Trust in a U.S. filing occurs in May of 2007 in a letter from the Securities and Exchange Commission to Wey’s client AgFeed Industries that noted, among other things, whether it was “appropriate” for Goldman Parks, “an auditor located in Tarzana, California,” to audit Chinese corporate books. In reply, Agfeed argued that Ever Trust’s services were necessary and equivalent to other accounting firm’s as its “International Department” chief was a seven-year veteran of public accounting and a graduate of Canada’s York University with a Delaware CPA license. [AgFeed just announced it is forming a special board committee to investigate its Chinese accounting practices.]

The small accountancies came to have a lot in common.

For example, in a filing from China Recycling Energy (a company Wey had no role in) answering questions from the SEC over whether Goldman Parks could effectively audit from a suburb of Los Angeles, the company said that Beijing Anshun International’s “International Department” had been, “In substance, [Goldman’s] office in China” for the previous four years. The chief of Anshun’s International Department, the company noted, went to York University and was a Delaware-registered CPA.

The connection between the “International Department” chiefs becomes a little more clear when their PCAOB applications are looked at closely. The signer of Ever Trust’s form, Xuefei “Nancy” Na, is also the signer of Beijing Anshun’s application and holds a Delaware CPA license. The phone numbers of the two firms are the same as Na’s.

Finally, Na told The Financial Investigator she graduated from York University.

Ms. Na’s signatures weren’t the only similarity. In August 2008, as the Chinese reverse merger market began its tear, the accountancies also shared the same building address in Beijing: HeQiao Building, 8A Guanghua Road in the Chaoyang District. As matters would have it, that’s also the address of Benjamin Wei’s Beijing office.

Despite listing their office number as Suite A310 in the filings, Beijing Anshun, per an August 2008 photo below of the lobby directory in its lobby, was based in Suite 509, right next door to several Wey-controlled business as the translation below indicates.

502 Fubon Life Insurance- Beijing Representative Office

503 American New York Global Capital- Beijing Representative Office

504-507 Tianjin NYGC International Capital Consultants

508 China Due Diligence

509 Beijing Anshun International Accountant Business Office

510A Napier Overseas Development Ltd

511A Singapore Linong Agrolex Beijing Representative Office

511B Shanghai Minzhao Jishuanji Tech Company – Beijing Subsidiary Company

512A Beijing Dingjiachuangxin Investment Advising Company

But additional photos inside the He Qiao building taken on the same day in August 2008 show Ever Trust’s name on the door of Suite 509, rather than Anshun’s.

Translation: Beijing Ever Trust Fair Accounting Business Office Company

A business card collected the same day from an employee inside Suite 509 also says Ever Trust:

Ms. Na told The Financial Investigator that she was unsure about the issue of location since she had left Ever Trust at the end of 2007 to build her own business with Anshun. She did not answer follow up questions about the proximity of the offices to Wey’s New York Global Group or why the two different accounting firms, out of all the companies in the building, would be confused for one another.

Wey’s New York offices were contacted repeatedly for this article over the past month, mostly by phone but several times via E-mail. None of the detailed messages were returned. His publicists at 5WPR, though not shy in referencing Wey’s role as a client, did not return a phone call or E-mail seeking comment on his behalf. Oddly, shortly before Wey’s publicist lamented his reticence to discuss his work, Wey put out a press release praising himself for his work.

Ahmed Mohidin did not return several phone calls and an E-mail seeking comment.

The offices next to Ever Trust/Anshun are another Wey controlled company, China Due Diligence, whose Chinese language website has a link to the Garner Group International, whose Chairman, former Hempstead, N.Y. Mayor James Garner, sat on the board of Wey and Kabani client China Natural Gas. Garner wound up suing the company in 2008 because, he claimed, they pressured him to resign and retaliated against his request for allegedly materially incorrect SEC filings to be fixed.

[Wey recruited several board members for his client companies from the ranks of retired American mid-sized city mayors, probably because in China, the position of Mayor is politically powerful. Garner, in addition to China Energy, served alongside former Lynn, Mass. Mayor Patrick McManus on the Bodisen board. McManus, before he died suddenly in 2009, also served on the Harbin board. Also serving on the Harbin board is David Gatton, who was executive director of the U.S. Conference of Mayors.]

The coincidences continue. Wey’s New York Global offices have side doors opening directly into the Anshun/Ever Trust offices. They also, one visitor to both offices told The Financial Investigator, apparently share a computer server.

It is a perfect symmetry of disclosure failures since investors never were informed of the interlocking relationships between the auditors and Wey–who was almost certainly their largest source of revenue–as well as the physical proximity to Wey’s operation.

Maybe a better word for the methodology Wey and New York Global Group used to bring his group of troubled and troubling companies to the U.S. and its investors is “rig.”

On page nine of Harbin Electric’s 2010 annual report is a real snoozer of a paragraph, a combination of mandatory disclosure and corporate boilerplate drearily familiar to investors the world over:

No customer accounted for more than 10% of the total revenues for the fiscal year ended December 31, 2010. Two major customers accounted for approximately 22% of the net revenue for the fiscal year ended December 31, 2009, individually accounting for 12% (Daqing Xinchengtai Technology Co., Ltd.) and 10% (Jiangsu Liyang Car Seat Adjuster Factory), respectively. At December 31, 2009, the total receivable balance due from these two customers was $22,835,846, representing 24% of total accounts receivable. Three major customers accounted for 43% of the net revenue for the fiscal year ended December 31, 2008, with each customer individually accounting for 16% (Jiangsu Liyang Car Seat Adjuster Factory), 15% (Daqing Xinchengtai Technology Co., Ltd.) and 12% (Guiyang Putian Logistic Co., Ltd.), respectively. At December 31, 2008, the total receivable balance due from these customers was $26,253,907, representing 87% of total accounts receivable.

Not quite riveting to be sure, but it’s the sort of textual sludge that the Financial Investigator wades through religiously, seeking insights about revenue concentration and potential threats to corporate balance sheets and cash-flow statements from problematic receivables.

There is an important caveat, however. Most corporations actually have the customers they disclose in these filings; Harbin does not.

Harbin has made up tens of millions of dollars of annual revenue and receivables for several years running, according to assertions made in a pair of interviews with the senior management of Jiangsu Liyang, a company that Harbin has asserted in its 10-Ks is one of its best customers.

An American investigator living in Beijing conducted the interviews last week posing as a buyer for a fictional American auto parts wholesaler. The interviews, with Wei Shen, Liyang’s sales director, and Ms. Ma, its general manager and head of quality control (a position broader than just quality assurance, involving oversight of manufacturing and delivery processes) are here and here. The tapes are unedited, save for the removal of the investigators name.

[Here is a picture of Mr. Shen’s business card and here is a photo of the investigator and Mr. Shen at Jiangsu Liyang’s offices.]

The interviews have both executives stating that Jiangsu Liyang barely does any manufacturing of electric car-seat adjusters, a fact contradicting Harbin’s filings. While there remains some chance that Harbin does some small amount of business with the company, both executives remarked that what little electric business they do is primarily supplied by a China-based unit of Johnson Controls.

Moreover, with approximately $27 million and $30 million in annual sales for 2009 and 2010, respectively, the Jiangsu Liyang portrayed by its executives is in no way big enough to do the business volumes Harbin’s filings claim. For example, with roughly $27 million in 2009 revenues–which, according to the executives, is 98% manual car-seat adjusters–the $19.3 million or so in motors Harbin asserts it is selling the company represents a big disconnection.

The interviews put matters into stark relief for investors: If Harbin’s SEC filings are to be believed, both Jiangsu Liyang executives would have to be profoundly incompetent, having no knowledge of their products and key suppliers. Or, alternately, they both simultaneously lied to a prospective client when it would be to their benefit to represent their company as larger and higher tech than it is.

If the Jiangsu Liyang’s executives are credible, however, then Harbin is perpetrating a financial fraud sharply larger than the many red flags already suggested in its filings. As such, the rank nature of the fraud alleged makes it difficult to imagine that this is the only customer where revenues are problematic.

Regardless, on-the-record evidence from a key customer that casts doubt on 10% or more of a company’s revenues should absolutely serve to put its auditors and regulators on notice. [Harbin’s auditors, the truly beleaguered outfit of Moore Stephens--the former Frazer Frost--has been the auditor of record for a host of frauds so spectacular they literally call out for cinematic treatment. Here is their resignation letter for Puda Coal, a company that did to its investors what the Germans did for Russian real estate values during the Second World War.]

The interviews also broadly jibe with Jiangsu Liyang’s credit report referenced in an August 3 story on short-seller Andrew Left’s Citron Research site estimating that the car-seat company was doing about $24 million in revenue.

Mostly, however, the interviews raise a much more fundamental question about market integrity: Exactly what does it take to get market surveillance officials at NASDAQ to start requesting documents and asking some uncomfortable questions of companies like Harbin that pay the for-profit exchange handsome fees to list there?

Based on recent history, it takes an auditor’s resignation for them to act, which is troubling since the stock regularly trades hands more than a million times daily and, as noted above, those investors have been making decisions without the faintest outline of Harbin’s actual financial condition.

Though frauds–and that is a word now fairly applied to Harbin in light of the Jiangsu Liyang executive interviews–are often shocking, there is little about Harbin that wasn’t fully foreshadowed in many, many places.

Nor should investors be faulted for taking some risk and playing what looks like the easiest arbitrage in recent memory.

Where the problems arise is the American regulatory apparatus that has blown through a host of warning signs and allowed Harbin to stage its drama for going on a full year now. These tapes, if the vows made after the sub-prime and Madoff scandals are to be taken seriously, should be the script for the much overdo final act.

Editor’s Note: In response to reader questions, I added both a paragraph of text and a small chart illustrating the pricing difference between Department of Defense customers and collegiate customers.

It looks to be easy street time for software developer Blackboard Inc. with the recent announcement of private-equity firm Providence Equity Partners’ offer to buy them for just under $1.65 billion.

Telegraphed since April, the deal appears to make sense.

Over the past decade Washington, D.C.-based Blackboard has made a name for itself with its nearly ubiquitous learning management system software. It sounds like a mouthful, but what LMS does is straightforward, enabling the student to communicate with a professor, log on to a private discussion board, download materials or to get their grades.

Just under 15 years old, this educational software niche has been a successful one for Blackboard. It’s not a terribly complex business model: They earn annual license fees from the software based on the number of students enrolled in a given “band” (i.e. between 4000-6000 enrollees,) by charging fees if customers choose to have them host the software and in selling ancillary software to expand their core LMS product.

It all worked well enough so that the company’s chief executive, an energetic promoter named Michael Chasen, will have a $30 million nest egg when the deal closes in the fourth quarter.

But Chasen and Blackboard’s investors would do well not to count the money just yet.

When Blackboard’s business is carefully pulled apart, a very different picture emerges from what management has shown the world. In reality it is two companies: The company that Providence thinks it is buying has grown rapidly and moved aggressively to expand its product offerings. Widely held, it is a market leading software company whose brand is well-known.

Then there is the real Blackboard, the very opposite of what a leading software company traditionally is. Michael Chasen doesn’t talk about this company on conference calls and its cadre of enthusiastic analysts never got around to going behind the numbers, where a declining competitive position, baffling acquisition binge and weakening financial state all merited research. Revealed in obscure footnotes and buried documents, Blackboard would just as soon it stay buried.

Consider, for example, Blackboard’s expanding footprint in the defense sector.

Though hardly a name brand defense contractor, since 2007, according to General Services Administration records obtained by The Financial Investigator, Blackboard has been awarded at least 16 contracts to provide its core LMS product, Learn, to the military’s archipelago of accredited undergraduate and postgrad universities as well as specialty instruction centers.

The arrangement works well. The Pentagon gets a manageable software program that helps instructors in subjects like military logistics and infantry tactics get a handle on the coursework flow of thousands of occasionally far-flung active duty military personnel.

Blackboard, on the other hand, has a neat little honeypot that has, in many ways, saved the company.

Consider this GSA contract, governing Blackboard’s pricing and licensing terms from 2007-2012, where the cost of Learn software licenses (for between one and 2000 users) is quoted at $52,833.30 on page 119. In contrast, this 2008 pricing list for the State University of New York quotes the same software at $33,500. Though Blackboard’s rate card does have an outline for providing discounts to its ProEd customers–see page 20–it is not clear in analyzing these contracts that they were ever extended. In contrast, the often substantial discounts given to Higher Ed customers are clearly described in their contracts, such as this one for the Cal State University system. [For examples of actual ProEd unit contracts, click here, here and here.]

Differences in prices don’t fully illustrate how wide the cost gap is between the two sets of customers.

For example, this spring the California State University at Channel Islands selected Blackboard Learn version 9.1 for a total outlay of $81,742 or $20.42 for its 4,000 students (including hosting.) Last year, the Naval War College in Newport, R.I. licensed Blackboard’s Learn for $201,091.98, including hosting and so-called Community licenses, for an average total cost of $100.55 for its 2,000 students.

Compare the list above to this list of  colleges, all of whom use Blackboard’s Learn, on a cost per user basis. [Note: In the LMS business, a general rule of thumb holds that Higher Ed customers usually won’t pay more than $25 per user for software and related services.] Outside of the University of Oklahoma Health Sciences System, which Blackboard classified as a ProEd customer,  these schools are generally paying less than $25 per user. With a few exceptions, the military schools are paying well north of $25. The divergence between the Higher Ed and ProEd contracts becomes even more apparent when the software price per user numbers from companies Blackboard has purchased–WebCT and Angel Learning–are factored in. [These older software packages are not Blackboard Learn.]

Another factor increasing costs for the military schools is the frequency with which they purchase the full suite of options Blackboard offers. For example, traditional colleges frequently choose not to buy additional data storage whereas military ones often do. This is a handsome boost for Blackboard since it charges $37,000 per year for one terabyte of storage; Amazon’s S3 service costs about $1,800. [Blackboard is far from the only LMS provider to do this however: Hosting providers for competitors Moodle and Desire2Learn charge at least $21,000 per year per terabyte of storage.]

Nor can Blackboard claim this is standard operating procedure in the LMS industry as Desire2Learn, a Kitchener, Ontario-based competitor, has long used a single pricing list for its customers.

The effect of these contracts on Blackboard’s bottom line is not entirely clear. The company doesn’t break out the performance of its ProEd unit–whose client base is various Federal departments and corporations–but it is virtually assured to be Blackboard’s most profitable.

Which is not exactly how the rules governing doing business with the federal government are set up. According to the letter of the law, if not its spirit, companies selling to the government are supposed to the abide by the “Most Favored Nation” principle in which the sale of goods or services is at a discount from list price “Equal to or greater than the discount given to the firm’s most favored customer.”

It’s difficult to see where Blackboard honored this idea.

FI.com asked Blackboard’s Michael Stanton about the pricing discrepancies. In an E-mail reply to a list of questions, he said, “Blackboard is fully compliant with all GSA requirements as confirmed by a recent comprehensive GSA audit. As is the case with most software and services companies, our pricing differs among clients based on a variety of factors including the version of the software licenses, the terms of the licenses, the quantity of software users, and various other customizable options.”

Jonathan Doorley, an outside spokesman for Providence Equity Partners, declined to comment.

The outsized profits from the ProEd unit serve to cover up one of the central realities of Blackboard’s world: Its core business is declining. Its Learn product, according to the most recent 10-Q, was down at least 3% last quarter–and, once earlier, non-Learn versions of Blackboard LMS are considered, the drop could conceivably be as high as 7%–even with many contracts bearing annual 5% price hikes.

Dropping Blackboard, it would appear, is quickly taking root as the new campus tech fad.

The University System of Georgia, the Brigham Young University System, the Utah Education Network, the Pennsylvania State System of Higher Education and the University of North Carolina System have announced plans to quit Blackboard. What’s scary for Providence is that given the multiyear lag between the announcement of a new LMS vendor and the expiration of Blackboard’s contract, their absence won’t be seen until fiscal 2012 and 2013. Moreover, this is just a partial list. The previous four years saw UCLA, University of Hawaii, the Colorado Community College system, Bridgepoint University, Auburn University and Louisiana State University all depart.

The reasons for this exodus are naturally varied–and include pricing–but for the most part, however, they boil down to dissatisfaction with a nearly decade old software framework seen as, well, obsolete.

The Utah Education Network is a case in point. It left Blackboard, the market leader, for Instructure, a year old Utah-based developer with an open source product called Canvas. Consider the way messages are sent and received on Instructure’s Canvas: The receiver has a choice between traditional university E-mail, gmail, Facebook and text messaging; Blackboard’s system uses traditional E-mail and was designed before Facebook was created. For a student body that uses social media the way earlier generations used pencil and paper, the differences between the two competitors are profound.

Despite actively marketing Blackboard 9.1, many university technology administrators view Blackboard as having skimped on research and development to focus on growth via acquiring LMS competitors like WebCT and Angel at the expense of expanding and refining their products. (There is also a mounting body of snafus that has given momentum to an anti-Blackboard movement on the Internet and among university technology staffers.)

Even Blackboard’s much-touted mobile capabilities are in danger. A legal battle with Sprint over Blackboard’s purported distribution of a WiFi version of Mobile Learn–something that would likely cut into Sprint’s potential revenues–threatens to derail its ability to offer a compelling mobile product as well as cutting into revenue growth at a time when all software applications are being sold to run on “Smartphones” and the like. Estimates of the annual revenue from its joint venture with Sprint run as high as $15 million.

Regardless, the loss of these customers is more than a business cycle issue. Peddling educational software isn’t like selling beer to a bar-owner; no minds are going to change next month. These revenues are gone for at least five years, if not forever. Also gone is the crucial, high-margin revenues from selling ancillary products like mobile and data storage that has become increasingly central to its business. Because of the multiyear nature of these contracts, the full effect likely won’t be seen in the financials until 2012 and especially 2013.

If Blackboard’s business fundamentals are seemingly slowing down, its financials are becoming downright ugly. For a company in the software business, where large profit margins and rivers of cash flow are the norm for market-leaders, Blackboard’s 7.6% operating margin last year–it was 5% in 2009–seems more suited to an auto parts supplier. Even media conglomerate Pearson PLC’s North American Education unit–whose educational software rival Pearson LearningStudio (formerly eCollege) competes with Blackboard for online college business–managed a 17.7% operating margin last year.

The conclusions are stark: Blackboard does not have a product that the marketplace is willing to pay up for and that if the ProEd unit’s customers either get wise to what they are paying or, like so many colleges, decide to hoof it, Blackboard is in dire straits.

How “un-software company like” are Blackboard’s financials? To whit: Days sales outstanding spiked to 115 from 73 year-over-year and the company posted negative free cash flow of $20.3 million for the first six months of the year. The poor free cash flow and the principal and interest due on a $160 million convertible bond issue led to a near-disastrous quick ratio–a barometer of short-term corporate liquidity–of 0.5x, down from 1.2x. In other words, without a looming buyout, there would be some very, very pointed questions directed at management because of their troubling working capital efficiency.

As it is, Blackboard’s financial reality is so wan because the company has spent five years and more than $350 million buying companies that provided them with analyst- and shareholder-pleasing revenue growth–often in ancillary business lines–but little else. Case in point: The July 2010 purchases of educational software providers Elluminate and Wimba for $116 million in cash. Both companies were in the red, and sinking deeper at the time of the deal. While at least $25 million in revenue was added to the top line, keeping the growth bulls sated, Elluminate and Wimba likely need a few years, if not more–Elluminate, for one, was down to $211,000 in cash (from $7.8 million the prior year) and its annual revenues had dropped 11%–to restore both growth and profitability. The company hasn’t even bothered to disclose the cost to acquire Presidium and iStrategy, a call-center operator and data/analytics shop, respectively. The Presidium acquisition is especially baffling in that call centers traditionally have margins lower than Blackboard’s already anemic levels.

The spate of purchases has made Blackboard the software equivalent of the Island of Misfit Toys, a company whose spectrum of deals did little to add to corporate long-term value, are hard to turnaround or rationalize and are brutal on the company’s return on capital. Perhaps the best that can be said of them is that like the Island’s toys, most of these deals seemed like a good idea at the time.

There is a frenetic quality to the purchases, as if Blackboard would get around to “the details” later. An example of this is the May 2009 pickup of Angel Learning Systems for $95 million.

Paying more than four times Angel’s $21 million in revenue, the company had three large university customers–Michigan State, Penn State and SUNY–and also specialized in the smaller school market. Things might have stayed all right had Angel not struck a deal with its then largest customer, publishing giant Houghton Mifflin, to develop the software for an LMS system Houghton called Think Central 2. It was, in the purest sense of the word, a disaster. The lawsuit stemming from the deal is eye-opening, claiming that despite numerous attempts, Angel was unable to create a workable product. This summary judgement lays out a breathtaking chronology of failures, suggesting Angel’s software development abilities were highly limited, if nonexistent.

Making things worse, several other customers have declined to re-sign with Angel, including many of the SUNY colleges.

Blackboard’s Stanton declined to discuss the specifics of the case but said that Angel’s renewal rate is “A couple points higher” than the corporate renewal rate of 90%-92% of customers.

Blackboard CEO Michael Chasen pulled off a fantastic trade: He sold a company that was in the early stages of becoming a victim of marketplace dynamics to a private-equity shop that appears not to have done its homework. Eventually, however, the truth will out.

Their key customer, the Pentagon, is going to figure out that in a time when it is fighting multi-front wars and might be facing steeper budget cuts, it bought software colleges are increasingly taking a pass on at prices higher than anyone else.

The recourse stands to be a bitch.

The Pentagon will either pay much less when they renew those contracts or they will go with another LMS provider and take Blackboard’s last profit margin with them.

Where Providence falls along this line, well, that’s a very different story. They caught the falling knife and paid a premium for the right to do so. It’s not clear whether they continue to ignore the facts and pretend Blackboard has a product base primed to explode and is throwing off the river of cash private-equity shops dream about or if they acknowledge their mistake and demand a lower price.

Either way, Michael Chasen deserves credit for having kept the show going for so long. His future in American business is secure: There will always be a place in the world for a man who can sell people what they don’t need at a price they can’t afford.

Hong Kong-based hedge fund Abax’s interlinking ties to Chinese reverse-merger battleground stock Harbin Electric is a matter of record: It has contributed almost $64 million to Harbin’s proposed management buyout and a former director of its funds is chair of the company’s audit committee.

New information, however, suggests that Abax and Harbin’s ties are so deep that you can’t tell where the hedge fund ends and Harbin begins.

Evidence the first is a corporate finance transaction chronology on the webpage of Tokyo-based Skadden, Arps, Slate, Meagher & Flom partner Michael Mies. Buried deep on the page, it notes his role in advising Abax Lotus Ltd. on a personal $25 million “bridge loan” to Harbin Chairman (and sole MBO bidder) Tianfu Yang’s Hero Wave Investments Limited, a British Virgin Islands-domiciled entity that he is the sole owner of.

The Skadden lawyer confirmed that the loan was structured in 2007 but declined to discuss the matter further, citing client confidentiality. That’s unfortunate because there are a universe of questions that want for answering. The first off is what exactly was the loan bridging? There doesn’t seem to be any public record of Yang buying or investing in anything, let alone for that much money, in the following year. As such, what was that money for? Second, was this loan open when Boyd Plowman came into the equation for Harbin?

Most importantly, the loan is apparently not disclosed in any Harbin filing, then or now, despite Abax being the company’s most important investor and source of funds.

The issue of disclosure is crucial in that it is highly unlikely Abax did not demand ample collateral for a loan amounting to around 4% of its then $600-$650 million under management in 2007, the year of its launch. Though Yang likely had some hard assets to pledge to Abax, it is a virtual certainty he had to put up at least some of Hero Wave’s 2.7 million shares as collateral.

To that end, the only document that might connect the Abax loan to Hero Wave is a registration statement from January 30, 2008 where Harbin registered 700,000 shares of Hero Wave’s previously restricted shares for transfer to Abax Lotus. Though Harbin’s share price closed at $23.14 on February 1, 2008, the almost $16.2 million in value block seems mighty thin collateral for a loan that size.

It should be noted that if any of that loan money found its way into Harbin’s coffers, the company is done for, since at least four year’s worth of financials would have to be recalculated.

Whatever the use of the loan, it’s not clear that it terribly much matters to Abax because it is not clear that there is any real difference between the fund and Harbin.

When Harbin, a company that is content doing business with a tragically amusing reverse merger cast-of-characters like Benjamin Wey, Frazer Frost and Loeb & Loeb, needed an investment banker to solicit potential suitors, they hired Morgan Stanley, whose investment management unit is a big investor in Abax. When they needed a management buyout loan, they got one from China Development Bank, the “strategic partner” for Abax’s private equity investment unit; CDB also took them out of a toothache of a five-month loan from, of all places, Abax with a $35 million working capital facility. [CDB took a more direct view of collateral and required seven million of Yang’s 9.6 million shares as collateral for the loan.] Skadden Arps had represented Abax in the undisclosed loan above but Yang hired them to advise him. When Harbin needed a “financial expert,” or a former chief financial officer of a collapsed manufactured housing company, after a director’s death they lifted one from Abax. [Perhaps at this juncture, given the clear connections between Abax and Harbin and Plowman and Ajax, it is best to drop the pretense that he is an independent director in any meaningful sense of the word.]

If a little more proof is wanted, then consider the often overlooked Special Committee Discussion Materials, filed in June by Morgan Stanley. To the uninitiated it is a hodge-podge of notes from what must have been one hell of a frustrating M&A assignment; to a more experienced reader it is a roadmap for litigation.

As seen on pages eight and nine, this was no ordinary attempt to gin up a deal.

Of the 73 “financial” or “strategic” targets Morgan identified and approached, Harbin only received a single bid: Abax. That’s because, as one suitor noted to Morgan Stanley, “Management, with the support of the board, was unwilling to share information.” Another noted, “It’s difficult to conduct [due] diligence without CEO support.”

In non-Wall Street jargon this means that executives who were being asked to pony up hundreds of millions of dollars for Harbin were prohibited from analyzing the company’s internal operations, see its bank accounts or speak to its customers. So they walked away.

The man who put a stop to all of this was, in the words of the investment bankers and the suitors themselves, Tianfu Yang.

Which is odd behavior from a man who had made a very big deal of seeking the best possible purchase price for his investors.

If Yang had honestly wanted a deal done, he would have negotiated with the prospective suitors. Instead, he refused to even start a dialogue with them. Despite taking the phrase “good faith effort” in a bold new direction, it does suggest one final question for regulators and investors in both Harbin and Abax: “Why?”

The likely answer is because there only ever was one suitor Yang could safely share Harbin’s real financials with.

The Securities and Exchange Commission has begun an investigation into Harbin Electric, The Financial Investigator has learned. The company received the SEC’s notice late last month and is using its longtime law firm, New York-based Loeb & Loeb, to advise it.

The Loeb firm, whose China Practice chair Mitchell Nussbaum is an outspoken proponent of reverse mergers–and has sued a short-seller on behalf of a client–is advising Harbin on the process of complying with the SEC’s document request. Neither Nussbaum nor the SEC replied to requests for comment. Harbin board member David Gatton told FI.com that,“I am not authorized to comment on anything about Harbin right now.”

The investigation is a blow to Harbin, a company that many battered investors in the Chinese reverse-merger space hold out as the strongest player in the sector because of the cast of financial world luminaries that has advised either the board of directors or its suitor, founder and chairman Tianfu Yang, in his bid to take the company private. Firms like Lazard, Morgan Stanley and Goldman Sachs are broadly percieved to have given an imprimatur of seriousness to Yang’s $24 per share offer.

To that end, Harbin has become the premier Chinese “battleground stock,” with a bitter war of words waged between critics such as short-seller Andrew Left–FI.com has written a series of critical articles on the company and its prospects–and its management, led by Tianfu Yang.

Yesterday was a case in point: Left’s Citron Research article contained the results of a multi-month investigation into Harbin’s customer base that was overtly dismissive of the company’s claims to be doing the level of business its financials assert. Harbin fought back and dismissed the posting as “Clearly biased and dishonest reporting” in a lengthy press release.

As a reply to Left’s assertions, Harbin’s press release did not, however, directly refute his primary argument–that documents prove Harbin’s main customers do little of the business it has claimed–instead insisting that it was not likely that its customer would have provided Left’s investigators with the documents he posted.

Nonetheless, it was a red letter day for Harbin’s investors as its shares bounced off a low of $14.01 before ripping back to $17.65. Buoyed by the strongly worded rebuttal, the shares climbed another 37 cents today, to $18.05, on a day the Dow Jones Industrial Average dropped almost 513 points.

It is uncertain how many more red letter days are in store for Harbin in the near future. While the scope of the investigation is not known, no Chinese reverse merger companies have managed to stand up to prolonged regulatory inquiry.

Editor’s Note: In its response, Zagg insists that everything is acceptably disclosed because Harmer and Pedersen are one step removed from brothers-in-law. This begs the question of why didn’t they just disclose “Our chief executive’s sister is married to our audit chair’s brother?”

As a work of public relations, this is high art. As a signifier of corporate candor, it is less than satisfying. I have edited the copy in several places to reflect Zagg’s interpretation.

The money given the company Harmer had a stake in for the development of the ZaggBox was not initially a loan as originally reported, but was later accounted for as a “Note Recievable.” The change has been noted.

ZAGG never fails to reward persistent investigation.

The latest treasure to be pulled from the cellphone shield maker’s murky depths is an absolute stunner. Lorence Harmer, the recently departed chairman of the audit committee, has familial ties to chief executive Robert Pedersen. To whit: Pedersen’s sister Michelle married Lorence’s brother Howard.

For three years, this was apparently considered an immaterial issue to Zagg’s management.

So in Zagg’s 2010 Proxy, in Harmer’s biographical description, None appears in the “Family Relationships” line. Exactly how this decision was arrived at is unclear; the primary reason for disclosure regulations are situations like this. The meaning of the section is longstanding and plain as day: Is there any familial relationship by blood or marriage between yourself and another senior executive or board member? It is inconceivable that Harmer, whose description notes that he is fluent in Mandarin and holds multiple college degrees, could not comprehend that a relationship that many term “brother-in-law” qualifies under this standard.

[There’s yet another Harmer at Zagg, albeit in a smaller role. This was not the first time that Lorence Harmer worked with the Pedersen's, having directed the Asian operations of a company that Pedersen's father, Robert Sr., ran called Intec-Innovative Technologies.]

It is equally absurd to argue that CEO Pedersen and chief financial officer Brandon O’Brien, the two men who appear to control all aspects of Zagg’s operations, did not understand the meaning of the standard, nor that it was highly material and that all serious publicly traded companies would disclose the relationship.

In other words, it took a group effort to let a lie that big stand.

The record between Harmer and Zagg is part comedy, part tragedy and entirely problematic.

Recall: He got the company to front money for the development of some Rube Goldberg type thing called the ZaggBox that won’t see the light of day any time soon and cost them $4 million. He failed to disclose that he owned 25% of the ZaggBox maker and eventually signed a promissory note to pay back the whole thing, but collateralized it with properties that were heavily in hock and which, at any rate, had dropped in value. When he quit, as Citron Research’s Andrew Left noted, Zagg chose not to disclose it for four months.

Regardless, the role of audit chair is the last line of shareholder defense in ensuring a company uses best accounting practices. The Pedersen and Harmer coverup inverted that, turning the position into a profitable for Harmer and making it likely that his interests were placed before shareholders.

The only question, of course, is how on earth any prudent investor could trust a single word from Pedersen’s mouth again. The issue of integrity is a settled matter. A company, after all, that intentionally allows its shareholders to vote on provably false information so a familial relationship between board members can be hidden is assuredly open to many other things even less welcome.

To that end, a brief listen to CEO Pedersen’s response to a question posed to him about the Harmer collateral yesterday during a conference call–Ladenburg Thalmann, one of the more established underwriters of dubious companies on Wall Street, sponsored the call-is illustrative. Within the context of the familial coverup, it takes a fair amount of faith to believe Pedersen’s rambling assertions (around the 21 minute mark) that Zagg’s lawyers are poring over the collateral to see if it is adequate are true.

Pedersen’s dismissal of his critics on the call as liars is too cute by half.

Citron Research’s Left and Joseph Ramelli of Worthless Pennies might be wrong on some claims or overstate others–and investors have pushed the stock higher in spite of their attacks, causing them plenty of headaches–but they document what they assert and their economic agenda is clear.

The only deceit to be seen here is Pedersen’s and it’s not at all clear what his agenda is.

Zagg’s  PR spokeswoman sent this note in response to FI.com questions about the matter.