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.