Securities Probe Traces a Shaanxi Rat Pack

In the month before Shaanxi Construction Machinery unveiled a major shareholder restructuring, the company's stock price doubled. And that ascent continued for months.
 
Now, more than two years later, the China Securities Regulatory Commission (CSRC) has accused a coal company president as well as executives at the machinery manufacturer and five other concerns with violating securities laws.

The executives were charged with "rat trading," a type of insider trading in which one or more managers with private company information likely to affect future stock prices secretly and profitably controls "rat accounts" for relatives and friends.

In addition, a separate Caixin investigation has found that companies tied to a firm called Tomorrow Group received insider information about the share reshuffle in 2007, which involved Shaanxi Construction Machinery and Shaanxi Coal Chemical Group, before the public announcement.

Tomorrow Group is a controlling or minority stakeholder in six listed companies. Caixin's probe uncovered evidence that Rongfenghang Investment Company Ltd., which served as a financial adviser to Shaanxi Coal between September 2005 and March 2007, is probably a member of the group.
 
CSRC investigators say the machinery company announced on March 26, 2007, that its controlling shareholder Shaanxi Construction Engineering Group Corp. was transferring its shares to Shaanxi Coal.

The coal company's president, Gao Yangcai, knew about the share transfer before the public announcement and, according to CSRC, illegally bought a large number of shares through a personal account and accounts held by his relatives.

Having received CSRC's investigative report, law officials are now deciding whether to press criminal charges against Gao, who was hired as the coal company's president in 2006 and has retained that post throughout the probe.

So far CSRC has withheld many case details, including the size of Gao's alleged trades. An informed source in Shaanxi said his holdings likely exceed 300,000 shares. But other insiders may have bought shares illegally as well.

"How many shares could Gao himself buy?" asked one source. "In one month in 2007, the company's share price rose more than 100 percent. Clearly, there was another heavyweight behind this."

Market Project

The coal company had started planning for a public listing in February 2007 at a time when Shaanxi Construction Machinery, due to three consecutive years of losses, was in danger of delisting.

At the urging of the provincial government, Shaanxi Coal scrapped the IPO plan and decided to pursue a backdoor listing through the machinery company. Backdoor listings were common at the time, and provincial officials supported it as a way to protect the machinery company as a shell, while saving time and money for Shaanxi Coal during its listing project.

In addition, the backdoor process apparently laid the groundwork for Gao's insider trading moves.

Gao later transferred his shares to a nephew – the son of an older brother he felt indebted to for raising him. By transferring shares to the relative, Gao apparently hoped to avoid legal impunity and repay his big brother.

"Gao just doesn't understand the law," a Shaanxi Securities Regulatory Bureau official said.

Shaanxi Coal managers led by Chairman Shen Hao supported the provincial restructuring plan.

Provincial officials then arranged for Shaanxi Construction Engineering to sign an asset transfer agreement with the coal company. The deal transferred 910 million yuan worth of group assets, including machinery company shares, to Shaanxi Coal in exchange for 128 million yuan, making the coal company the controlling shareholder of the machinery firm.

Six days later, the provincial government formally changed management at the coal company. Shen was moved to a job as chairman of Shaanxi Yanchang Petroleum (Group) Co. Ltd., while Yanchang's President Hua Wei was named Shaanxi Coal's new chairman.

Gao supported the backdoor listing plan, but Hua was opposed. In April, the two men clashed; Gao is said to have pounded the desk in Hua's office.

"Hua and Gao's disagreement was over divergent ways of thinking about the restructuring," said a Shaanxi Coal source. "Hua wanted to maintain the shell resources of the listed company and a dual A-share and H-share listing for Shaanxi Coal. Gao insisted on a backdoor listing for Shaanxi Coal's major business."

The coal company had planned to raise 8 billion yuan through a secondary offering and share allotment from the listed company. Policy restrictions made the plan look impossible, apparently turning Hua and other executives against a backdoor listing and in  favor of a partial injection of assets.

But while the restructuring plan was taking shape, the machinery company's stock was on the move. Between February 26 and March 23, 2007, its price shot up 114 percent.

The period before Hua's appointment and the conflict with Gao saw a numbers twists and turns for company shares. The price rose to about 15 yuan per share in May from 4 yuan in February, then started tumbling. By July, the share price had fallen to 8 yuan amid rumors that Hua would resign. But it soared to around 19 yuan by September.

The dispute ended with both executives getting what they wanted: A backdoor listing followed by an overall listing for Shaanxi Coal, which pursued a dual listing on Hong Kong and mainland markets, while at the same time injecting assets into the machinery company.

1 yuan = 14 U.S. cents