China Stocks: Who Is Richard Azar?

(Corrects 19th paragraph to show attorney Allan Lerner represented Spear & Jackson in a lawsuit brought by the SEC, clarifies other background details and adds responses from Lerner. This column was originally published May 20, 2011.)

BEIJING (TheStreet) -- Investors in the China space simply aren't getting it. I have tried to make the point over and over, but for some reason, it doesn't seem to sink in.

Question: What is the difference between a 10% fraud and a 90% fraud.

Answer: nothing.

It amazes me that investors are willing to place large bets on companies when there is a strong suspicion of fraud. Rino International(RINO.PK) does have a business and substantial assets. So does Duoyuan Printing(DYNP.PK). Same goes for China MediaExpress Holdings(CCME.PK). This list could go on and on. Yet each of these companies was delisted for different degrees of fraud. From a shareholders perspective, the extent to which they have a real business and assets is completely irrelevant. The only thing that matters is where the stock trades, and once a stock gets delisted, its fate is basically sealed.

Many investors that I speak with try to handicap the price versus the amount of fraud, assuming that if there is 10% fraud, a company will trade at a certain discount to fair value, whereas if there is 30% fraud, it will trade lower. The facts are that companies who are committing even a slight amount of fraud are doomed to be delisted and trade below $1. Period.

In recent months, there has been an onslaught of short seller "hit pieces" where shorts create a detailed report alleging fraud at a Chinese company causing the share price to plunge. The same pattern emerges over and over. First come the "categorical" denials by management, then comes more detailed documentation by management. As the hit piece is partially debunked, the stock price bounces back under the assumption that it was either deliberately false or grossly overstated information disseminated by short sellers.

The problem here is that the short sellers are at a distinct advantage over the companies they target. In order to "win," the short sellers need only be 10% right in their allegations whereas the companies need to be 100% right on everything. If management successfully rebuts only half of the arguments made by the shorts, then you know you have a big problem, particularly if they can't rebut the financial aspects.

I have never called Sinoclean Energy(SCEI) a fraud. Many investors have emailed or called me to ask my opinion on SCEI. I answer them by asking: "Do you believe it is possible to combine ordinary coal with ordinary water and double your money every time you do it?" Some raised the point that CWSF produces the same amount of energy as an equivalent amount of coal, despite the fact that it is simply coal mixed with around 40% water. Again, I ask: "Do you believe the physics of this are possible?" After asking those two simple questions, I encourage investors to come to their own conclusions and invest accordingly.

With China Biotics(CHBT), the questions begin with "Is it possible to close 95% of the company's stores and not report any change in head count?" And "Is it possible to close 95% of the company's stores and still perfectly meet earnings guidance?" Obviously, the list of questions is much longer.

Recently, a heretofore unknown investor by the name of Richard Azar has been buying up big chunks of CHBT immediately before earnings despite fraud allegations that are widespread and growing. If you Google the phrase "CHBT fraud," you get nearly 9,000 hits.

Richard Azar and his unknown fund "Value Holdings" have quickly become a 10% holder of CHBT. Press articles from years past describe Azar as a Warren Buffett aficionado and a genius investor worth somewhere "in the low nine figures." The CHBT position, in which Azar is a "long" investor, was published in an SEC document outlining major shareholdings.

A quote attributed to Azar says the following:

"My concentration levels were at various times 40% to 50% of my net worth and today the four major positions I own represent 85% of my net worth."

What I found puzzling was that when I looked for SEC filings by this concentrated investor worth a minimum of $100,000,000, I could find only one company for which he had submitted SEC filings. That company is CHBT. There are no filings for him prior to May 2011. This is despite the fact that he has done nothing but investing for over 20 years and describes extreme concentration in his positions.

Azar's purchases are notable in that they all occurred in the $11 to $12 range, pushing up the price of the stock and giving much encouragement to investors, some of whom jumped on the bandwagon. Clearly, none of these investors had ever heard of Azar prior to this month.

Here's a list of Azar's SEC filings. Azar "duly and timely" reported his holdings, and the investor has "never been associated or linked to any form of securities fraud or misconduct involving any public company," said his lawyer, Allan Lerner, in an email.

Lerner is a Ft. Lauderdale, Fla.-based attorney who represented several small RTO Internet companies, including several that eventually went bankrupt. Lerner, a former enforcement attorney at the SEC, said in an email that he has represented hundreds of companies, and "most have succeeded and some have failed." Here are links to his previous filings.

Lerner also represented Charles Adams of Pegasus Wireless (a proven fraud) in connection with a default on a convertible stock loan in 2008.

In addition, Lerner represented Florida-based Spear & Jackson when its CEO, Dennis Crowley, was convicted of illegally dumping insider shares offshore. Lerner said in the email that any company he represented that may have failed did so "well after I terminated my representation."

I was surprised to see a post on CHBT by Larry Isen this week, highly recommending CHBT just before earnings and after the stock had already risen by over 60%. Isen was previously convicted of taking restricted stock from one or more companies in exchange for promoting them. He then illegally sold those shares. As usual, the sales were made offshore in a failed attempt to avoid regulatory scrutiny.

But back to Azar. It strikes me as odd that this unknown investor suddenly acquires a 10% stake in a company immediately before a critical earnings report and selects this particular attorney to represent him. Other high-net-worth investors I speak with hire high-end law firms from Wall Street to do their filings and manage their securities transactions. Azar could seemingly afford whoever he wants.

I am currently in Hong Kong speaking with a number of securities lawyers and other financial types. I am 100% convinced that within the China space there is a new and unreported phenomenon going on. Management at fraudulent Chinese companies are effectively "monetizing" their stock before the share price plunges and pulling in hundreds of millions of dollars by doing so.

Here is how it works. A company chairman/CEO (let's call him Chairman Wang) uses his stock as collateral for a loan. The stock is worth $100 million, so he gets a loan secured by stock valued at, say, $80 million (giving the lenders a nice cut). When the stock plunges, he simply defaults on the loan and keeps the cash. It's easy and no SEC disclosure is required.

Chairman Wang gets the loan and provides the stock as collateral to Party A. Party A now holds the stock and "lends" it to Party B (this creates stock borrow). Party B then shorts the stock, so that the risk is completely hedged. Obviously, Party A and Party B have an agreement to share the economics.

Bingo. Chairman Wang "monetizes" his stock, keeps the cash and the lenders of the money are protected. The shares are delivered to the lender before the loan is even made, such that the proceeds of the short sales fund the loan. In other words, the lenders don't even need to have their own money to lend, they just need to be able to facilitate the short sales. Obviously, the short sales will put significant pressure on the share price, to the disadvantage of those still holding shares.

This type of fraud has gone totally undetected and I am now of the opinion that the dollar amounts involved far exceed the amounts raised from U.S. investors in equity offerings. I am currently doing much more digging on this and speaking with as many well-informed experts as I can. If anyone has comments or observations on this, they would certainly be welcome at my email address below.

Disclosure: The author is extremely short CHBT. The author can be reached for comments at [e-mail]

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