During the two years Kun Huang languished in the Luoyang detention centre, he spent all day locked in a cell that was 30 square metres, occupied by up to 34 men.
Every morning they rose at 6 a.m., having slept on wooden planks or on the floor with the lights on all night. The prisoners ate, defecated, worked and did their exercise in this one room. There were no books to read, with just a small TV with one state channel playing on it.
“We didn’t have much food,” Huang told me when we met two years ago. “They would take flour and water and make old bread, which is hard. I couldn’t eat the first few weeks because it was not really food.”
Luoyang is an industrial city of 6.5 million people located in central China, home to the famous Shaolin Temple. The detention centre was an old building located on the outskirts of the city, with 100 cells housing hundreds of criminals of all forms and sizes.
The stress on Huang was punishing: for long periods he didn't know what was going to happen to him. He was among strangers and did not speak the local dialect. Photos taken of him prior to his imprisonment show him as being a round-faced, slightly chubby man – shy but cheerful. By the time Huang left the detention centre in the summer 2014, he was 40 pounds lighter.
Since his release from prison three years ago, and return to Canada, Huang has had his struggles, including not being able to work full time.
“I still go to see a psychologist for PTSD,” he said in an interview in 2015. “I sometimes get depressed a lot and I have a short temper now.”
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Three weeks ago, however, Huang received some good news: the Supreme Court of British Columbia made a favourable ruling in his lawsuit against Silvercorp Metals Inc., a $163-million Vancouver-based mining company. Huang’s suit accuses Silvercorp of being responsible for his two-year incarceration in the Luoyang jail. The court's ruling brought him one step closer to proving his case.
The story of Kun Huang is also a testament to the power of resource-based companies to collude with governments to stifle criticism of their business practices – even if the companies might be committing fraud.
Finding fraud in China
I met Huang two years ago in a small glassed-walled boardroom at the law firm of Gudmundseth Mickelson LLP, located on the 25th floor of a downtown Vancouver office tower. Huang, who is now 39, was trim and dressed in a well-tailored sports jacket, sporting a neat but modish haircut and fashionable spectacles. He spoke matter-of-factly about his life.
Huang works for Eos Holdings LLC, a hedge fund that is run by Jon Carnes, an American investor who lives in Vancouver. Huang was born in China's Hubei province. He and his family moved to Vancouver in the mid-90s. Carnes recruited Huang in 2006 out of the University of British Columbia, where Huang was studying finance and accounting. Carnes hired him to help him research Chinese companies he wanted to invest in.
“He was the best (researcher),” said Carnes when we spoke in 2015.
In 2006, Carnes and Huang moved to China, eventually to the city of Chengdu, where they hired a team to conduct research on the ground. In time, they realized many Chinese companies were engaged in fraud – especially those listed on North America’s stock markets.
“We had these doubts and when we started to dig we found problems and all kinds of issues,” Huang explained to me.
So they changed their investing strategy and began looking for suspect companies. Eos could profit if they engaged in short-selling, an investing method that involves betting a company’s stock will fall instead of rising. Moreover, in order to encourage stocks to plunge, short-sellers produce critical research about a company and publish it for investors to see.
To this end, Carnes created a website and began publishing his findings about Chinese companies he felt were unethical. But Eos soon discovered Chinese businesspeople didn’t care for such scrutiny, and would fight back. One of the companies they exposed “figured out who we were,” said Carnes, “and they threatened us.”
To conduct their research without exposing themselves to physical threats, Carnes and Huang came up with a security plan, creating a fictitious investor, Alfred Little, and began posting their research on a website called alfredlittle.com.
“We created this old dude who clearly did not look like me,” said Carnes. “He would have a fake biography.”
And it worked.
Carnes’ researchers dug into many Chinese companies trading on the North American markets, such as Deer Consumer Products, Rino International, China Integrated Energy, Sino Clean Energy, Puda Coal and others. All were affected: the first four were delisted from Nasdaq, while Puda was delisted from what is now NYSE MKT, and its chairman charged by the Securities and Exchange Commission with fraud.
“We exposed a company where the CEO was a convicted convict, which he’d never disclosed to investors,” said Huang. “We exposed that and on the same day the stock dropped 25 to 30 per cent.”
But Huang and Carnes’ streak of good fortune would run out when they turned their attention to Silvercorp.
Silvercorp's mines investigated and questioned
Silvercorp was established by Rui Feng, a geologist born in China. Feng did a PhD at the University of Saskatchewan before working as a research scientist in Calgary. He then went into mining.
Silvercorp landed on the Toronto Stock Exchange through a shell company. By 2003, Silvercorp had entered China and was buying up mines in the province of Henan in central China, near Luoyang.
The company’s biggest asset is the Ying silver mine. Silvercorp runs the mine through a company it indirectly controls called Henan Found, a joint venture with a Chinese government-owned entity (which controls 23 per cent of Henan Found).
The Ying area had been mined for a long time, but Silvercorp soon claimed it was the “largest primary silver producer” in China. By 2006, it was releasing glowing reports about its high grade of ore, on par with the richest silver mines in the world. By 2011, its market capitalization was around US$2 billion and it had sales of US$167 million. Its shares were trading on the TSX and NYSE in the $10 to $12 range, and it was earning net profits of US$69 million.
Carnes, however, was hearing disturbing things about Silvercorp. “When I asked around [in China] about Silvercorp, everyone said it had red flags,” he recalled.
Henan government officials were telling them the Ying mine was less rich, and was being depleted faster, than Silvercorp was publicly saying. Led by Huang, Eos’ researchers began collecting information on the company.
“It looked like it was a company that was too good to be true,” Huang told me.
Carnes could profit from shorting Silvercorp’s stock if he found evidence it was misleading North American investors. Huang and their researchers focused on whether its mines were truly as rich as the company claimed. They even scooped up samples of ore that had fallen off trucks exiting the mines.
Finally, in September 2011, on the Alfred Little website, Carnes anonymously released an eight-page report about Silvercorp, detailing their investigation and blasting it for allegedly overstating its production, the grade of its silver, and suggesting the value in the mines did not come close to supporting Silvercorp’s market capitalization. He noted the ore quality had not been independently tested for several years, and that while Silvercorp told investors it had produced 316,522 tonnes of ore in 2010, the Henan resource bureau, which receives data on local mines, said it had produced only 207,037 tonnes.
“These are facts that (Silvercorp), its independent directors, auditors and regulators urgently need to address,” the report concluded.
The impact on Silvercorp’s stock was immediate – it fell 20 per cent in one day. Carnes soon cashed in his short position, making a profit of $2.8 million.
Silvercorp fights back
Yet the timing of Huang and Carnes’ investigation of Silvercorp was, as it turned out, bad. By then, the Chinese government was angry about North American short-sellers exposing their local companies.
Earlier in 2011, a Chinese-Canadian company, Sino-Forest Corp., had been revealed to be a massive fraud by an American short-selling firm. At the time, Sino-Forest was the largest timber company on the TSX, valued at more than $6 billion. The ensuing scandal destroyed the company and wiped out shareholders.
Rui Feng was determined this fate would not befall Silvercorp. He fought back against Carnes’ report, saying his company was the victim of a “short and distort” campaign by unscrupulous short-sellers and that he was “going to fight to the death.” The company struck a special committee and hired the accounting firm KPMG to investigate the allegations, as well as a large mining engineering firm, and issued press releases defending its position.
Was Silvercorp misleading investors about the quality of the ore in its mines? The company has produced reports from its experts denying the charge. But experts hired by short-sellers and law firms suing Silvercorp have found evidence that support Carnes’ findings.
Moreover, a lawsuit launched by U.S. investors, accusing the company of fraud, was settled by Silvercorp in 2014 for US$14 million, although Silvercorp did not admit any wrongdoing (in contrast, a Canadian class action shareholders' lawsuit failed to get certified and was thrown out of court). The BC Securities Commission (BCSC) also investigated the company and found so many problems with the company’s technical reports that they threatened to put it on their default list unless changes were made. And even after the BCSC charged Carnes with fraud in 2013 because of his accusatory reports about Silvercorp, the commission acquitted him of the allegation two years later.
But Silvercorp fought back in a much more heavy-handed fashion: they demanded Chinese police investigate who was behind the Alfred Little persona. By November 2011, the Chinese police had an idea of who was in the Eos team and had begun hunting them down. Carnes was out of the country when he got word they were being pursued.
Huang and the rest of his team were not so lucky. They were arrested one by one, with Huang being grabbed on Dec.28, 2011 at the Beijing airport as he was trying to leave China.
“I was so worried,” he explained to me. “I had no lawyer. I was thrown into a place with 20 guys in a freaking tiny cell... You could sleep for only three hours.”
Thus began Huang’s long nightmare.
Huang imprisoned, Silvercorp's involvement
After three days at a detention centre, Huang was driven by police to Luoyang, near Silvercorp’s mines. For the next month, he was interrogated frequently by the Luoyang police, who asked him about Carnes and their research.
Huang also noticed something curious: for the first few days, the police were receiving texts and phone calls before and during these sessions.
“I have a strong suspicion it was someone from [Silvercorp],” he said, believing Silvercorp was supplying the police with questions to ask him. By then, the police had seized his laptop computer too.
In 2012, a Globe and Mail investigation revealed that Silvercorp helped pay for police expenses in the investigation of Carnes’ operation.
Moreover, the company was passing the information it was receiving from the Chinese police to the BCSC, which had begun an investigation into both Carnes and Silvercorp. At one point, Silvercorp provided the BCSC with a three-inch binder of material from their investigations into Carnes and his people. Other evidence shows Silvercorp obtained private information from Huang’s laptop, despite it being in the Luoyang police’s possession.
Huang's fate, though, remained up in the air for months, as he stayed under house arrest. His Canadian passport had been taken away from him. Eventually, in the summer of 2012, he was placed in the Luoyang detention centre where he would spend the next two years in the overcrowded cell. There was little Canadian officials could do, and it was almost impossible for family to visit him.
“For the first few months, I had to sleep on the floor because there was no room on the beds,” he related to me. “It was really dirty and filthy.”
He could receive few visitors, except for his lawyer and the occasional Canadian foreign affairs official. In a court claim, Huang says at one point he was forced to clean the detention centre’s sick bay “using his bare hands, ie. without equipment or sanitary protection, causing his hands to bleed and exposing him to disease and infection.”
Finally, in the summer of 2013, Huang was charged with “criminal defamation” for criticizing a Chinese company. His trial in September of that year lasted one day and was closed to the public, at Silvercorp’s behest. Silvercorp was also granted standing. Huang received a two-year sentence and was returned to the same squalid cell to serve out the rest of his term.
He was released in the summer of 2014 and flew back to Canada.
Judge blasts Silvercorp's privilege claim
Once home in Vancouver, Huang promptly sued Silvercorp, accusing the company of false imprisonment and defamation and of orchestrating his detention and incarceration. Huang believes Silvercorp used its influence, as one of the parent companies of Henan Found, to enlist the Chinese police to investigate Eos’ researchers. He argues Silvercorp did this to silence them and obtain information the company could use in its counter-offensive strategy against the short-sellers.
Huang alleges the police officers who interrogated him were in direct communication with Silvercorp and the company was influencing the interrogation, including providing the police with questions. Huang’s suit says that during the time he was under house arrest, he was required to travel within China in the custody of the police – and a representative of Silvercorp accompanied them on some trips.
Silvercorp has denied these charges, saying Huang was arrested for engaging in illegal surveillance and other activities as part of a “short and distort campaign” and they were not responsible for the police’s actions. Silvercorp refused to be interviewed for this story, as the matter is still before the courts.
Huang’s lawsuit soon ran into a roadblock. In discovery, his lawyers were demanding all of Silvercorp’s documents that dealt with their communications with Chinese police. In the fall of 2015, Silvercorp presented its first list of material. Few of these documents, however, were relevant to what Huang’s lawyers had asked for. Instead, the company said the documents Huang was seeking were privileged, meaning they involved the company’s lawyers. So Huang’s attorneys went to court to get a ruling on this issue.
In a Supreme Court of British Columbia decision released three weeks ago, Justice Lisa Warren blew a hole through Silvercorp’s privilege claim. The ruling also explores the relationship between Silvercorp and the Chinese police.
Warren’s decision confirms the company was receiving information from the Chinese police about its investigation of Huang, and passing this onto the BCSC and others.
“Silvercorp was receiving such information in real time,” she noted. “Some of the documents Silvercorp has produced suggest that… it was in direct contact with the (police) at the material time.”
During one of his interrogations, Huang became convinced that Silvercorp had drafted the questions the police were putting to him. One of the documents over which Silvercorp has claimed privilege was an email from someone named Jessy Xu using a Silvercorp email address that was sent to Rui Feng, titled "Questions to Kun Hunag [sic]." That email was dated Jan. 4, 2012, the same day Huang said he was interrogated.
The decision also notes that in May 2012, one of Huang’s researchers in China, Michael Wei, met with a police officer who was investigating Huang and the other Eos researchers. Wei recorded the meeting using a buttonhole camera and an iPhone. That recording indicates the officer said words to the effect that Wei and Huang were stupid to have complained about Rui Feng and that they had “now messed with Silvercorp and the issue is magnified.” Wei also photographed documents on the officer’s desk which include a Henan expense reimbursement form with a signature on it that resembled the signature of a Silvercorp employee.
Moreover, Wei and Huang testified the police were in touch with a woman, Wang Mei, who worked for Silvercorp. Later, Rui Feng acknowledged that Mei communicated with the police regarding Huang. In discovery, Feng also said he did not know whether he or someone at Silvercorp provided the police with questions. Silvercorp produced some email communications between Mei and one of the key police officers. Other documents show Mei was also communicating with Feng concerning the police’s investigation, the judgment notes.
Warren found there was plenty of evidence connecting Silvercorp and Feng to the Chinese investigation of Huang.
“Some of the documents produced by Silvercorp, such as (Silvercorp senior vice-president Lorne) Waldman's Dec. 30, 2011, email to Ms. Chan, suggest there was direct contact between Silvercorp and the (Luoyang police),” she wrote.
Warren also concluded “there is evidence that Henan was paying expenses incurred by the (police) in its investigation of Mr. Huang, at least some of those expenses are linked to Wang Mei and, as noted above, there is evidence linking her to Silvercorp.”
Silvercorp strongly challenged the veracity of the evidence of Huang and Wei, while Rui Feng denied either Silvercorp or Henan funded the police’s investigation and that a representative of Silvercorp accompanied the police on trips during the investigation.
In the end, Warren noted that “there is no suggestion that Silvercorp has attempted to rely on actual legal advice or its understanding of the law to explain or justify its conduct (of withholding documents sought by Huang). Nevertheless, Silvercorp is attempting to use documents over which it has asserted privilege as a sword to explain its role in the (Chinese police) investigation, and in particular its possession of the fruits of the investigation, while at the same time as a shield by attempting to shelter behind those documents.”
She ruled that Silvercorp had to hand over most of the documents that Huang’s lawyers were demanding.
Silvercorp sues for defamation
After Huang returned to Canada, he continued collaborating with Carnes at Eos, but has found it difficult to work because of the repercussions of his trauma. Last summer, Silvercorp launched a defamation lawsuit against Carnes, saying he had made false claims to the media about the company paying off police and having Huang arrested.
Silvercorp refuses to comment on any issues related to these matters, and company senior vice-president Lorne Waldman told National Observer that company policy prevents him from speaking about anything that is still before the courts.
Huang, his lawyer and Jon Carnes were not available for comment.
When I spoke to Huang two years ago, he was angry about how Canadian authorities had taken no action against Silvercorp over what had happened to him, in particular the BCSC. "(The BCSC) does not look out for investors and for people who are treated unlawfully by this company," he remarked. "I just don’t believe how can a company do this and get away with it."
Editor's Note: Some of the reporting for this article was previously published in an article in 2015 in the Globe and Mail Report On Business Magazine. It was also written by Mr. Livesey