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FCPA Blog Daily News

Entries in China North East Petroleum (3)

Friday
Jul052013

SEC targets China issuers

The U.S. Securities and Exchange Commission has charged the now-defunct China-based advertising company, China MediaExpress, with fraud and misleading investors. The company and its CEO, Zheng Cheng, are accused of massively overstating values of cash balances to the SEC by up to 40,000 percent.

Click to read more ...

Wednesday
Dec292010

The 2011 Watch List

Of the 150 files in the DOJ's hopper, our watch list includes more than half of them.

Click to read more ...

Monday
Aug232010

A House Divided

The battle at China North East Petroleum is about the FCPA and whether the company bribed Chinese officials. The escalating fight led to the loud exit two weeks ago of an American director who chaired the board's audit committee. He wanted to find out what the company's been up to, but was blocked.

Only a few months back, China North East Petroleum looked like the stuff of dreams. In March, its stock --  trading on the NYSE AMEX under the symbol NEP -- had climbed to $11 a share. A five-year investment in the company, reported the Motley Fool, would have returned 1,070.7%. And the future seemed just as bright.

In early April, TheStreet.com listed the China-based oil producer as one of the most undervalued public companies in the world. "If you believe that China is hungry for energy and the next crisis could be related to the global oil production surplus going into a deficit," it said, "this is a practical way to capitalize. It's hard to say since we're waiting on a report that could send the share price skyrocketing."

Then the dream died. By mid May the stock had fallen by 50%. And before the end of the month, AMEX halted its trading because the company failed to file annual and quarterly reports. Today the stock is still not trading and faces delisting. Meanwhile, a half dozen U.S. plaintiff firms have filed class action suits that alleged some present and former officers and directors violated federal securities laws by issuing false and misleading financial information to investors.

What happened? On April 20, the company disclosed material weaknesses in its internal controls. It said financial statements for the past few years weren't reliable and that it had been misstating net income and the value of its oil reserves. It later said senior officers at the company might have embezzled funds.

And there could be more. Last month, audit committee head Robert Bruce told his fellow directors the company needed an internal investigation to make sure it hasn't violated the FCPA's antibribery provisions.

Bruce, based in Maine and head of Oakmont Advisory Group, said, "I strongly believe that substantial additional investigation is required in order for the Company and/or the members of the board to be confident that . . . the Company has not made payments to government officials as proscribed by the U.S. Foreign Corrupt Practices Act."

When the board chairman -- a former diplomat and investment banker from Australia who sits in NEP's New York office -- refused, Bruce resigned.

We heard about the story from a reader who said: "This is a very fascinating and rare behind the scenes look at a high stakes internal dispute about FCPA compliance. I’m guessing that the inherent tension could be an emerging trend which may be why it’s playing out so publicly."

*     *     *

The letters between Robert Bruce and NEP's board are reproduced below. Those letters and the company's other SEC disclosure can be viewed here.

_________________________________


July 22, 2010
 
CONFIDENTIAL
 
Members of the Board of Directors
China North East Petroleum Holdings, Ltd
445 Park Avenue, 10th Floor
New York, NY 10022
 
Dear Mr. Wang, Mr. Li, Mr. Hu and Mr. Rule,
 
I am writing to express my strong concern that the Company faces a number of new and evolving financial reporting and accounting questions that require additional investigation, as I recommend below.
 
I have welcomed the Company's efforts to investigate and respond to accounting and internal control problems discovered during the preparation of the Company's 2009 year-end financial statements and associated 10-K filing.  However, I believe that the Company must take additional steps to investigate questions raised by the John Lees Associates (“JLA”) report dated July 10, 2010 (the “JLA Report” or the “Report”), including: a) whether the Company's previously filed financial reports and associated financial statements are materially correct under U.S. Generally Accepted Accounting Principles (“US GAAP”), and b) whether the Company has made payments to government officials as proscribed by the U.S. Foreign Corrupt Practices Act (“FCPA”).
 
The JLA Report has indicated that, in spite of a very large number and amount of unauthorized transfers of Company funds between certain Company directors (namely Mr. Hongjun Wang and Ms. Guizhi Ju) and the Company's Chinese subsidiaries, no evidence exists to indicate that funds were misappropriated, stolen or otherwise misused by Mr. Wang and Ms. Ju.  This is indeed a favorable result, and is consistent with contentions by Mr. Wang and Ms. Ju that they have not misused or stolen any of the Company funds that were transferred to them.  However, the JLA Report does not answer the two questions noted above. In fact, information contained in the JLA Report, essentially all of which was not known to me (and I presume to the other independent directors, Mr. Rule and Mr. Li) prior to completion of the Report, clearly raises important questions with respect to both the potential for material misstatements on a US GAAP basis and the ability of the Company to affirmatively attest to compliance with the FCPA (simply based on the massive internal control failures documented in the JLA Report).

Therefore, I formally recommend that the Company immediately take the following steps:

1.     Authorize the Audit Committee of the Board of Directors (the “Committee”) to undertake a thorough and independent review of the Company's prior financial statements, associated SEC filings, and cash payments to persons who may be deemed “government officials” under the FCPA, over the past five years;
            
2.     Authorize necessary funding for this Committee review process;
            
3.     Authorize the Committee to retain additional outside investigative and accounting resources, as required or beneficial in the Committee's sole judgment, including:
            
a.     A U.S. legal firm that has a strong SEC enforcement and FCPA practice;
                  
b.     A forensic accounting firm with a strong understanding of U.S. GAAP;
                  
c.     Other investigative resources, as necessary, to answer definitively the questions referred to above.

I recognize that these recommendations have significant ramifications for the Company.  Namely, a full and complete investigation will likely require at least three months to complete, and possibly as long as twelve months.  Additionally, the costs would be likely be very significant - I estimate that these efforts would require $2 million to $5 million, in addition to the amounts spent to date for the JLA Report and related legal costs. This investigative effort would require that the Company's financial statement and SEC reporting process would be further delayed, most likely until the investigations could be competed. This in turn would likely lead to the Company's delisting by NYSE AMEX and possible additional shareholder litigation.
 
However, failure by the Company to undertake what I believe are necessary additional investigative efforts as outlined above will, in my opinion, lead to an end result that is likely worse for shareholders, Company management and directors.  Absent these immediate additional investigative efforts, I would be unable to continue in my capacity as an independent director for the Company.
 
On a related note, I believe that the findings of the JLA Report require that the Company immediately initiate a self-reporting process with the Enforcement Division of the SEC. The Company cannot consider its prior communications with the SEC's Division of Corporate Finance to constitute any form of communication to the Enforcement Division. Given the internal control problems and the possible US GAAP issues with the Company's historical financials statements identified in the JLA Report, self-reporting will establish a record with the SEC of the Company's commitment to investigate and remediate historic issues, which the SEC would certainly take into account when considering sanctions for potential regulatory or legal violations that the Company may ultimately be found to have committed.

I would like to make clear that by recommending these additional investigative efforts, I am not implying or stating knowledge of any violations of FCPA, that Company funds have been misused, or that the Company's financial statements and prior SEC filings are materially misleading (other than findings with respect to each of these areas outlined in the JLA Report, and with respect to the previously announced restatement effort).  Rather, I believe that the information and findings contained in the JLA Report unambiguously indicates that neither the Company nor the directors can state with confidence that: a) the Company is free of FCPA violations, b) that Company funds have not been misused in periods prior to January 1, 2009, or c) that the Company's financial statements and prior SEC filings are free of material misstatements.
 
Unfortunately, the only way to arrive at an affirmative conclusion regarding these important questions is through the further in-depth investigation I have recommended above.  I therefore request that the board convene a meeting at the soonest possible opportunity to consider these recommendations.
 
Sincerely,
/s/ Robert C. Bruce
Robert C. Bruce

Director, and Chair of the Audit Committee

_________________________________________

August 5, 2010
 
Robert C. Bruce
Oakmont Advisory Group, LLC
477 Congress Street, Suite 1002
Portland, ME 04101
 
Re: The letter to the Board of Director
 
Dear Mr. Bruce,
 
As Chairman of the NEP Board of Directors, I would like to thank you for your letter dated July 22, 2010.  The Company very much appreciates the thought you devoted to the letter.  I also want to acknowledge the hard work you have expended on behalf of the Company and your commitment to improving the quality and productivity of its business. I would like to take this opportunity to respond briefly to the concerns and assertions in your letter.
 
I appreciate that you “welcome the Company’s efforts to investigate and respond to the accounting and internal control problems” that recently have emerged.  I also appreciate your express acknowledgement that, after the painstaking forensic audit of John Lees Associates (“JLA”), “no evidence exists to indicate that funds were misappropriated, stolen or otherwise misused” by anyone. I assume you also appreciate the substantial and costly efforts of the Company in assembling the restated 10Qs for the first three quarters both of 2008 and 2009, as well as finishing the 10K for 2009 and the 10Qs for the first two quarters of the year.  Your input into these efforts was invaluable.
 
I also appreciate your express acknowledgment that, by suggesting certain action, you do not intend to imply or state “any knowledge of any violations” of the Foreign Corrupts Practices Act (“FCPA”).  As you know, in its meticulous forensic report, JLA did not identify a single violation of the anti-bribery provisions of the FCPA or identify a single transaction in which such a violation even may have occurred. Nor did JLA recommend any investigation into any prior transactions.
 
Regarding the “additional steps” to which you allude, we wish to make some brief comments.  As you know, the Board of Directors has now received a confidential memorandum from company counsel, the Crone Law Group, that recommends certain action and changes for the Board to consider regarding the FCPA.  The Board will duly consider the recommendations at its upcoming meeting.
 
I anticipate that the Board also will undertake, at the appropriate time, through the appropriate personnel, a review of the Company’s financial filings prior to 2009, although based at least on the JLA report, it seems unlikely the review would necessitate any material changes.  Nor does it appear that such an undertaking is urgent or at all time sensitive.  The Company is focused on the goal of completing the compliance plan that NYSE-AMEX has approved and thus ending the current trading halt of its stock. I believe this goal is in the best interests of our shareholders, and see no basis to jeopardize this goal with a review of the 2008 and 2007 filings at this time for the reasons stated.  Further, as you note, you are unaware that any of the filings in those years contain any “materially misleading” statements.
 
I also do not believe, however, as you apparently do, that taking action that results in the delisting of the Company from NYSE AMEX is in the best interests of our shareholders.  You suggest that rather than focus on completing the current compliance plan that NYSE AMEX has approved, the Company instead conduct an FCPA investigation, which you project could last as long as a full year and cost the Company as much as several millions of dollars,  notwithstanding  that a recent forensic audit did not find any basis to presume the likelihood  of a single FCPA violation. And, you admit that this action “would likely lead to the Company’s delisting by NYSE AMEX and possible additional shareholder litigation.” As you know, a delisting could destroy shareholder value.  Thus, the course of action you recommend that the Board pursue seems at odds with the prudent discharge of duties to the shareholders.
 
I look forward to discussing these matters further at the next board meeting

Very truly yours,

/s/ Edward Rule
Edward Rule
      
Chairman of the Board of Directors
China North East Petroleum

_______________________________________

 

August 8, 2010

Members of the Board of Directors
China North East Petroleum Holdings, Ltd
445 Park Avenue, 10th Floor
New York, NY 10022

Dear Mr. Wang, Mr. Li, Mr. Hu and Mr. Rule,

I am writing to tender my resignation as a member of the board of directors of China North East Petroleum Holdings, Ltd (the "Company" or "NEP"), effective immediately. I have reached this difficult decision as a result of a conclusion that there is a substantial disagreement between me and you regarding the appropriate action of the Company with respect to further investigation into the Company's prior period SEC filings, internal controls and cash activity.

As I noted in detail in my letter to you dated July 22, 2010, a copy of which I attach and incorporate as part of this letter, I strongly believe that substantial additional investigation is required in order for the Company and/or the members of the board to be confident that the Company's previously filed financial reports and associated financial statements are materially correct under U.S. Generally Accepted Accounting Principles ("US GAAP"), and that the Company has not made payments to government officials as proscribed by the U.S. Foreign Corrupt Practices Act ("FCPA"). In his capacity as Chairman of the board, Mr. Rule responded to my July 22nd letter on August 5, 2010, and presumably did so on behalf of the Company and other members of the board. In his August 5th letter, Mr. Rule makes it quite clear that he and the Company disagree with and will not support my recommendations.

With all due respect, as I detailed in my July 22nd letter to the board, I believe that the Company can best serve the interests of its shareholders by taking the steps that are necessary to regain confidence that it's previously filed financial statements, the pending restatements and related internal controls are in compliance with applicable securities laws and regulations.

As noted above, I believe our differing views on this critical question represent a fundamental disagreement that I have with the Company and the board relating to a matter of operation, policy or practice. Therefore, I believe I have no choice but to tender my resignation, effective immediately, and note that this letter, as well as my attached letter of July 22, 2010, should be filed as an exhibit as part of the Company's required report under Item 5.02 of SEC form 8-K.

Sincerely,
/s/ Robert C. Bruce
Robert C. Bruce