Forensic Accounting Digest A Guide to Accounting Diagnostics in Asian Companies

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Table of Contents

1. A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia.............................. 4

2. Insider Diagnostics: A Repository of Short-Sell Target Asian Companies & Associated Key Insiders..........24

3. Short-Sell Strategies – How to Get Teflon Coated? ..........................................................................................39

3

Ankit Agrawal, CFA

Equity L/S Analyst

| Forensic Accounting | India

Toshiba Corp | Forensic Accounting

A Forensic AnalysisTool for DetectingAccounting Red Flags:Focus on DevelopedAsiaBy Ankit Agrawal, CFA | 29 Feb 2020

EXECUTIVE SUMM ARY

In this Smartkarma Original, we bring to you a forensic analysis tool thatscores companies across Developed Asia on their accounting risk. We use25+ accounting parameters in our framework to come up with an accountingrisk score. Our tool is based in Excel and is linked dynamically to Capital IQfor fetching latest data.

Insight Flow

1. Forensic Analysis Framework

2. Excel Model

1. How to Download and Use the Tool

2. Steps to Run the Model

3. Target Universe

4. Companies with Highest Accounting Risk

5. Summary Statistics from our Analysis

6. Key Model Limitations and Risks

7. Appendix

1. List of Companies in our Target Universe with Accounting RiskScore >= 8

2. Glossary

3. Snapshot of Capital IQ Screener Used for Filtering Universe

4. Switch Formula Calculation Option in Excel

5. Refresh Worksheet Option in Capital IQ Plugin

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 4

What's Original?Over time with experience and taking cues from past financialshenanigans, we have developed a proprietary quantitativeframework for identifying accounting irregularities. This frameworkcomprises of 25+ accounting parameters and takes into account 10years of historical data to assess the quality of accounting.

DE TAIL

Forensic Analysis Framework

Our forensic analysis framework comprises 25+ quantitative factorsdeveloped over time through personal experience, inspiration from popularshort-seller reports and relevant books like Financial Shenanigans, as well asanalysis of past fraudulent cases.

Philosophical Guide for Our Framework: Philosophically, some of theconcepts guiding our framework include mis-classification andcapitalization of expenses, aggressive revenue recognition, weak quality ofearnings, cash flow leakages, earnings leakages (e.g. miscellaneousexpenses), aggressive/fictitious capex (e.g. high quantum of CWIP relative tofixed assets, capex as % of sales vs peers), related party transactions (e.g.loans and advances), comparison of operating performance and balancesheet quality relative to peers to identify anomalies, comparison ofoperating performance and balance sheet quality relative to history todetermine unusual volatility or lack of the same, auditor independence (e.g.growth in remuneration vs sales growth), use of acquisitions for accountingmishaps (e.g. quantum of goodwill), aggressive provisioning, volatility innon-operating income, cash yield, direct changes to equity bypassingincome statement (e.g. change in reserves ex earnings and dividends),frequent accounting policy changes (e.g. volatility in depreciation rates),long-term FCF generation, off balance sheet items (e.g. contingentliabilities, pension obligations, operating leases), smoothing of earnings(e.g. actual earnings vs consensus), management compensation, trade data(e.g. unusual low volatility in volume), etc.

In our Excel model, we have tried to capture most of the above data points,except for a few cases where the data availability was limited in Capital IQ.

List of Parameters and Scoring Weights: In the below table, we discussthe list of parameters used in our framework and associated weight used inour scoring methodology. Please note that none of the parameters on astandalone basis suggest high probability of accounting risk, but togetherthese parameters provide a substantive and comprehensive framework tomeasure accounting risk of a given company.

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 5

Parameter Aggregation Threshold Weight Rationale for Including the Parameter

Cumulative Pre-Tax OCF/CumulativeEBITDA

Cumulativeover last10Y

<70% 2 Over the long run, companies' cash flows shouldlargely match their accrual accounting basedearnings. We look at cumulative Pre-Tax OCF andEBITDA over the last 10 years and flag companieswhere cash flow generation significantlyunderwhelms accounting earnings.

Change inReserves i.e.Change in Equity(ex changes inshare capital)/PATnet of dividends

Median overlast 10Y

<70% 2 Over a long period, on average, a company'schange in equity (ex of any changes in sharecapital) should largely mirror net profit after taxexcluding any dividends.

CAGR of CashConversion Cycle(AND)

CAGR overlast 10Y

>0% 1 Over the long run, typically companies' cashconversion cycle stays steady and range-bound.However, for companies with weak quality ofearnings and/or weak accounting standards, cashconversion cycle could get elongated and/orwitness significant variation. We flag companiesthat have seen positive CAGR (> 0%) and highvariation (CV > 20%) in cash conversion cycle. Wehave assigned it a weight of "1" vs "2" as wecapture this concept through another parameter"CAGR in Net Working Capital as % of Sales",discussed in detail later.

CV of CashConversion Cycle

CV (Ann StdDev/AnnMean) overlast 10Y

>20%

Avg Cash Yield/Risk Free Rate

Median overlast 10Y

<50% 1 Typically, companies should generate yields ontheir average cash balance equivalent to at leastthe risk-free rate prevalent for its operatinggeography. We flag companies that have a historyof generating substantially (<50%) low cash yieldsconsistently relative to the applicable risk free rate.Since the timing of these cash balances isunknown, we have provided a lower weight of "1"vs "2" to account for the lack of data availability. Alow cash yield generation could be indicative offake cash on the balance sheet.

Other Non-operating Incomeas % of Sales

Median overlast 10Y

>5% 2 Over the long run, typically companies should havelimited other non-operating income as % of sales.We flag companies that have high (>5%) proportionof income coming from other non-operatingsources. We put an additional filter to flag onlythose companies where the variation in this is high,as this could possibly indicate that other non-operating income is being used as a plug tomanipulate earnings.

CV of Other Non-operating Incomeas % of Sales

CV (Ann SD/Ann Mean) -over last10Y

>20%

Other OperatingExpenses as % ofSales

Median overlast 10Y

>5% 2 Over the long run, typically companies should havelimited other operating expenses (or miscellaneousexpenses) as % of sales. We flag companies thathave high (>5%) proportion of expenses comingfrom miscellaneous sources. We put an additionalfilter to flag only those companies where thevariation in this is high, as this could possiblyindicate that other operating expenses is beingused as a plug to manipulate earnings.

CV of OtherOperatingExpenses as % ofSales

CV (Ann SD/Ann Mean) -over last10Y

>20%

Goodwill/Equity Median overlast 10Y

>10% 1 We flag companies with consistently high (>10%)goodwill as % of equity. Goodwill assessmentstypically rely on synergy assumptions that tend toprove fragile in most cases. Accordingly,companies with high goodwill carry higher risk offuture write-offs. Also, historically companies withpropensity for acquisitions have tended to resort toaggressive accounting to justify expensivevaluations paid for acquisitions or have resorted toacquisitions in the first place to hide their ownaccounting gimmicks. We have assigned a lowerweight of "1" vs "2", as we capture another similarparameter "Intangibles (ex Goodwill) as % ofEquity", discussed later in the report.

Auditor ChangeCount

Count >2 2 Too many auditor changes could suggest intentionto hide anomalies in accounting

ContingentLiability/Equity

Median overlast 10Y

>20% 2 A high amount of contingent liability (off balancesheet) could increase susceptibility towards futureequity write-offs.

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 6

Loans andAdvances/Equity

Median overlast 10Y

>10% 2 A high quantum and consistent use of loans andadvances could signal related party transactions ornon-core activities.

Earnings Surprise%

Median overlast 10Y

<5% 2 Over the long run, given most businesses faceuncertain environment and associatedrandomness, companies that report earningswithin close range (<5%) of that forecasted byanalysts, raise suspicion of earnings manipulationand a tendency to match/beat street expectations.

Effective Tax Rate/RegulatoryCorporate TaxRate

Averageover last10Y

<60% 1 Companies with low effective tax rate (<60%) vsstipulated corporate tax rate over the long runcould raise suspicion of earnings manipulationthrough offshore entities, accounting gimmicks likeaccelerated depreciation, etc. On the other hand, inmany cases there could be legitimate reasons forlow tax rate such as subsidies, past accumulatedlosses, etc. However, in the long run, in most cases,tax subsidies and losses are not permanent, andhence the effective tax rate should come close tothe stipulated corporate tax rate. Nonetheless, wehave assigned a low weight of "1" to this parameterto account for any legitimate tax saving efforts.

Deferred TaxLiabilities as % ofEquity

Median overlast 10Y

>10% 2 Deferred tax liabilities are frequently used to frontload earnings. Companies with high level (>10%) ofdeferred tax liabilities across many years areflagged by our model.

Deferred TaxAssets as % ofEquity

Median overlast 10Y

>10% 1 Deferred tax assets face impairment risks or canbe used for smoothing future earnings.Accordingly, companies with high level (>10%) ofdeferred tax assets across many years are flaggedby our model.

Non-currentInvestments as %of Equity

Median overlast 10Y

>10% 1 High levels of non-current investments couldsuggest presence of non-core investments orrelated party investments.

CAGR of NetWorking Capital(ex Cash andEquivalents)/CAGRof Sales

Ratio ofCAGR overlast 5 Years

>1 1 This is supplementary to our cash conversion cycleCAGR metric. It helps in detecting any cash flowleakages happening through working capital butnot captured by cash conversion cycle which islimited to accounts receivables, inventory andaccounts payable.

CAGR in PerEmployee Salaryvs CAGR of 5YInflation

Ratio ofCAGR overlast 5 Years

>2 1 High growth (>2x) of employee salary relative toinflation could suggest leakage of earnings andcash flow. Some exceptions to this could be highgrowth companies and as such we have kept theweight of this parameter low at "1".

CV of D&A as % ofDepreciableAssets (Net PP&E+ Goodwill +Intangibles)

CV (Ann SD/Ann Mean) -over last10Y

>30% 2 Signification variation in Depreciation andAmortization could suggest earnings manipulationthrough changes in Depreciation and Amortizationpolicies. While some of the variation could be legitled by the change in asset mix, a large variationdemands further probe.

CV of EmployeeExpenses/TotalOperatingExpenses (exCOGS)

CV (Ann SD/Ann Mean) -over last10Y

>20% 1 Typically, employee expenses tend to be fixed and/or are at least sticky in nature and unlikely to varysignificantly relative to total operating expenses (exCOGS). However, we have assigned a low weight of"1" as the high variation in many cases could bejustified due to reliance on contractual labor andother variable operating expenses.

Count of IncomeStatementRestatements

Count >4 1 High frequency of accounting statementrestatements suggests weak internal accountingcontrols. Note that some of the restatements couldbe legit as these could be due to discontinuedoperations, mergers, etc. However, we consider >4restatements in a span of 10 years to be high.

Count of BalanceSheet StatementRestatements

Count >4 1 High frequency of accounting statementrestatements suggests weak internal accountingcontrols. Note that some of the restatements couldbe legit as these could be due to discontinuedoperations, mergers, etc. However, we consider >4restatements in a span of 10 years to be high.

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 7

Pension and OtherRetirementLiabilities as % ofEquity

Median overlast 10Y

>10% 2 High level of Pension and Other RetirementLiabilities on balance sheet could incentivizemanipulation of assumptions or could lead toincrease in future liabilities in case of any shifts inunderlying assumptions.

Intangibles (exGoodwill) as % ofEquity

Median overlast 10Y

>25% 1 High levels of intangibles (ex Goodwill) suggestshigh risks of future write-offs or could be indicativeof acquisition accounting where assumptions usedcould be too favorable to justify high acquisitionprice. This along with Goodwill as % of Equityprovides good indication of any acquisition ledaccounting manipulation. Note that high levels ofintangibles could be justified for certain industrieslike IT, etc. To account for any such concerns aswell as duplication issues with our Goodwill as % ofEquity parameter, we have kept the weight low at"1".

Decline in Long-term Shareholding

Max overlast 10YminusCurrent

>20% 1 Significant decline in long-term shareholding asmeasured by decline in free float could indicateweakening alignment of interests.

Sum ofCumulativeOperating CashFlow + CumulativeInvesting CashFlow

Cumulative <0 2 We flag companies that have failed to generate asingle penny of positive cash flow over the last 10Yin aggregate including both operating cash flowand investing cash flow. In some cases, this maybejustified as the company could have significantreinvestment opportunities, however, ourexperience is that in many cases this is anindication of cash flow leakage.

Total Parameters:28

Total:37

Scoring Approach: We use absolute score and relative score to identify highaccounting risk candidates. To come up with absolute score, we run ourmodel across the above parameters for each company in our universe. Weflag parameters that breach our set threshold and add up these in accordancewith their weights to come up with an absolute score. Higher the absolutescore, more the accounting risk. Note that we have been quite conservativein using stringent thresholds to lend enough margin of safety to ourframework from any noise in the data and the model parameters.

Next we calculate relative score. Given that certain parameters are morelikely to be red flagged for certain sectors/geographies than the rest, it isimportant to score each of the companies in our universe relative to theirpeer group so as to remove any sector/geography specific biases. Forexample, certain sectors like Real Estate, Construction and Engineering, etc.may show up high on absolute score but when compared to peers, their scoremay not deviate much. We eliminate such candidates. Below commentaryfurther highlights our relative scoring approach.

Accounting for Sector/Geography Level Noise: For some of theaccounting parameters, it could have been great to run a peer groupanalysis. However, we refrained from doing so, as at the individualparameter level there is significant noise in the data for each of the peersgiven they are not always like for like and can have material differences inthe business model and strategy despite being in the same sector/industry.Accordingly, to us a more robust approach to minimize any sector/geographybiases in our evaluation, is to use relative scoring at the aggregate level. Foreach of the companies in our universe, we run their peers through ouraccounting risk model to come up with absolute score for each of the peers.For each company in our universe, we then determine the top-quartile score

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 8

(i.e. top-quartile here means top 25% peers that have the highest accountingrisk score) based on its specific peer group. To account for margin of safety,we then apply a factor of 1.5x to this peer group score to get the relativescore. Now, once this relative score is available per company in our universe,we flag only those companies as high risk candidates whose absolute score isequal to or higher than the relative score. Higher the difference by which theabsolute score exceeds the relative score, higher the accounting risk. Notethat our relative score calculations are based on >7.5 peers per company, onaverage, providing enough robustness and comprehensiveness to ourcalculations.

Margin of Safety: Given that there can be significant noise in our modelfrom the underlying data, individual parameters, nuances betweenaccounting standards and reporting standards across companies/sectors/geographies, at various steps, we have tried to keep significant margin ofsafety.

• Thresholds at individual parameter level have been kept stringent

• Relative scoring has been used alongside absolute scoring

• Within relative scoring, we have used top-quartile score (for scoringrelative to peers) rather than median and are applying a factor of 1.5xover and above this to obtain the relative score.

• Additionally, we calculate relative score only for those companies thathave at least 5 peers with absolute score. Furthermore, we use onlythose peers where at least 5Y historical data is available for a minimumof 15 parameters.

Signal vs Noise Dilemma: On one hand, we wanted to include as manyparameters as possible, as the use of this model is not just to flag candidateswith highest accounting risk but also spot areas that require further probefrom an accounting standpoint for a given company. On the other hand,including too many parameters adds noise to the model and also bringsduplication issues. As a result, we faced the dilemma of which way to go. Wetried to balance this through weighted scoring mechanism and haveassigned a low weight of "1" for a few parameters where there wereduplication issues or where our conviction was low. For rest of theparameters, we have assigned a weight of "2".

Consistency Matters: In flagging potential accounting risk, we have flaggedonly those instances where we have consistently witnessed outlier data.Accordingly, in most cases, we have used median statistic on 10Y historicaldata to make sure that we have enough instances of outlier data above ourthreshold before flagging it as an accounting concern.

Focus on Forensic Accounting: We have intentionally not included someof the financial strength parameters like Leverage (Debt to EBITDA), InterestCoverage, etc. This is because we want our model to be focused on forensicaccounting rather than mix it with other forms of accounting based analysislike credit analysis, financial strength, etc.

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 9

Excel Model

Our Excel model is dynamically linked to Capital IQ to fetch latest data forthe companies in our target universe. We rely on last 10 years’ data to fetchthe accounting and financial parameters in our framework.

How to Download and Use the ToolPlease use this link https://www.smartkarma.com/home/red-flags-monitor/ to download the tool. The downloaded file will be a zip filewhich on decompression will yield a folder named "Forensic AnalysisTool" with five Excel files named - "Score Aggregator"; "ForensicAnalysis - Target Universe"; "Forensic Analysis - Comps 1 Universe";"Forensic Analysis - Comps 2 Universe"; "Final Universe IncludingComps".

Steps to Run the Model: The model is computationally intensive as >40accounting parameters with 10Y historical data are processed for over 1750companies. To run the model successfully at your end, we strongly advise theusers to follow the below steps sequentially:

1. Please install S&P Capital IQ Excel Plugin if not already installed.Given that our model fetches large quantum of data from Capital IQ,please un-check the automatic data retrieval feature in "S&P CapitalIQ" Plugin, as shown below.

2. From the "Forensic Analysis Tool" folder, open all the five Excel files -"Score Aggregator"; "Forensic Analysis - Target Universe"; "ForensicAnalysis - Comps 1 Universe"; "Forensic Analysis - Comps 2 Universe";"Final Universe Including Comps" in a single Microsoft (MS) Excel shell.Note that since all these files are linked to each other, for automaticupdates it is important to open all these files in a single MS Excel shell.

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 10

3. Go to each of the Excel files and go to "Excel Options". From theformulas tab in the left pane, change the workbook calculations optionto "Manual" (un-check “recalculate workbook before saving” option aswell if checked by default) from "Automatic" for all these Excel files.Please refer to "Switch Formula Calculation Option in Excel" section inAppendix for more details on following this step.

4. Go to “Raw Data” worksheet in the “Forensic Analysis - TargetUniverse” Excel workbook. Now go to “Refresh” button in the “Data”section of the "S&P Capital IQ" Plugin. From the "Refresh" drop-down,select the “Refresh Worksheet” option (if needed, please refer to "RefreshWorksheet Option in Capital IQ Plugin" section in Appendix for moredetails on executing this step). This will begin the process of fetchinglatest data from Capital IQ. Note that this may take a few minutes(about 3-5 minutes at my end) as there are over 250,000 data pointsbeing fetched per Excel sheet. Please let this process run without anyinterruption including any other operations outside of Excel on yourcomputer. Please make sure that automatic data updates in the Capital IQPlugin settings has been disabled as guided in Step 1. The quantum of datafetched from Captial IQ is large and since the data involved pertains to last10Y historical accounting data, it does not change unless restated or unlessthe fiscal year shifts with time. Accordingly, we advice users to use the“Refresh Worksheet” option only on a periodic basis and not use it everytime you open or use the sheet.

5. Repeat above step for "Forensic Analysis - Comps 1 Universe" and"Forensic Analysis - Comps 2 Universe" Excel files.

6. Once this is done, go to “Country Data” worksheet in the “ForensicAnalysis - Target Universe” Excel workbook and use the “RefreshWorksheet” option from the "S&P Capital IQ" Plugin to download thecountry specific data. This step should be fairly quick.

7. Once all the data is fetched, go to Excel Options and reverse theformula calculation setting done in Step 2 back to “Automatic” for allthe Excel files

8. Now open the Score Aggregator Excel workbook while keeping the restof the Excel files open. Refer to the "Results" sheet in this file and clickon "Update Results" custom button in the top rows to run the VBAmacro to fetch the forensic accounting score and highlight the high riskaccounting candidates. Please use the filter buttons in the header rowto customize the universe as per your interested geography/sector. Notethat the "Score Aggregator" Excel workbook is linked to other Excel files andfetches accounting risk score for all the companies in our target universeand their peers.

Target Universe

We have designed our Excel tool with Developed Asia as our targetgeography. Accordingly, we have focused on companies with primarypresence in countries like Japan, Hong Kong, China (via Hong Kong),

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 11

Singapore, South Korea and Australia. We have further filtered this universeto include only those companies that have a market cap > USD 2bn, anaverage daily traded value (average over last 3M) > USD 10mm and are listedon stock exchanges in Japan, Hong Kong, Singapore, South Korea andAustralia. This yields us with a target universe of 658 companies acrossDeveloped Asia. Note that these 658 companies in aggregate have >1700 peercompanies. Together after removing duplicates, we end up with 1780 uniquecompanies for which we calculate absolute accounting risk score. Of these, forthe 658 companies in our target universe, we also calculate the relative score(based on peers' absolute score) to flag the highest accounting risk candidates.

Note that we exclude Financials sector companies from our analysis, as thesecompanies tend to have different accounting conventions and many of theaccounting parameters used in our model are not applicable to the sectorgiven the nature of their business. Ex Financials sector, our targetuniverse comprises of 572 companies.

Companies with HighestAccounting Risk

We ran our Excel model to identify the most risky candidates acrossDeveloped Asia from an accounting standpoint. This yielded 41 companies(ex Financials sector) with absolute accounting risk score of 8 and above.Please refer to the Appendix section to go through the full list of these 41companies.

We further filtered this to select only those companies that have a relativescore of at least 1.5x that for the top-quartile peers with the highestaccounting risk, leaving us with 12 high accounting risk candidates. Of these12, we further eliminate two companies - (SEHK:267 - Citic Limited) and(TSE:9984 - SoftBank Group) - as while these companies are classified asnon-financials, both these companies have significant profits coming frombusinesses in the financials sector. We enlist the remaining 10 most riskycompanies below.

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 12

ToshibaCorp (6502JP)Sector:IndustrialsCountry:Japan

• High absolute score of 10 that also exceeds the relative score of 6, suggestssignificant accounting risks.

• Translation of PAT (ex Dividends) into reserves has been low at 42%, on a medianbasis over the last 10 years, raising suspicion of changes to reserves directly at thebalance sheet level while bypassing the income statement. Ideally, this ratio shouldbe close to 100%.

• Deterioration in working capital requirements suggests weak quality of sales(channel stuffing, etc.). Cash Conversion Cycle has grown at an annualized pace(CAGR) of 18% over the past 10 years.

• Deferred Tax Assets are as high as 18% of equity, raising risks of any write-offs in thefuture. This compares with a median of <2% for our universe (ex Financials) and vsour absolute threshold of 10%.

• Non-current investments are high at 38% vs a median of <16% for our universe exFinancials and <22% for Japanese Industrials suggesting that the level of non-coreactivities or related party transactions could be high.

• Count of past income statement and balance sheet restatements have been as highas 6 times each, over the last 10 years, raising concerns around the robustness ofinternal accounting controls.

• Pension and other retirement liabilities are as high as 52% of equity, suggestingsusceptibility to assumptions and potential for rise in future liabilities. This compareswith a median of 3% for our universe (ex Financials) and 5% for the JapaneseIndustrials segment.

• Intangibles (ex Goodwill) are as high as 26% of equity, raising risks of future write-offs. This compares with a median of 4% for our universe (ex Financials) and <4% forthe Japanese Industrials segment.

ZoomlionHeavyIndustry S A(000157CH)Sector:IndustrialsCountry:China/HK

• High absolute score of 10 that also exceeds the relative score of 7.5, suggests highaccounting risks.

• Three auditor changes over the past 10 years vs 0.67 on average for Chinesecompanies in our universe, raises suspicion of accounting manipulation.

• The company has failed to generate positive cash flows in aggregate from itsoperating and investing activities. While this could be because of re-investments intothe business, negative cash flow generation over such long periods (10 years) raisessuspicion of cash flow leakage.

• Deteriorating cash conversion cycle (CAGR of 10% over the last 10 years) suggestspotentially weak quality of sales (channel stuffing, etc.).

• Weak translation of PAT ex Dividends to reserves, suggests that the company couldbe potentially knocking off some of the equity directly from the balance sheetthrough various accounting adjustments rather than passing the changes throughthe income statement. Median change in reserves vs PAT (ex Dividends) over the last10 years has been low at 54%. This should ideally be close to 100%.

• Income statement and balance sheet restatements have been as high as 7 timeseach over the last 10 years, raising concerns around the robustness of internalaccounting controls.

• Long-term shareholding has declined significantly by 37% as indicated by theincreased free float during the past 10 years. This suggests potential weakening ofalignment of interest.

TechnoproHoldings(6028 JP)Sector:IndustrialsCountry:Japan

• High absolute score of 9 that also exceeds the relative score of 7.5, suggests highaccounting risks.

• Cumulative pre-tax cash flow generation from operations has been weak at 56% ofcumulative EBITDA over the last 10 years, raising suspicion of cash flow leakages.This is further concerning as there has been no significant deterioration in workingcapital, which is usually a legitimate reason behind weak conversion of earnings tocash flows. This should ideally be close to 100%.

• Goodwill as % of equity is as high as 127%, raising risks of future write-offs. Thiscompares with a median of 4% for our universe (ex Financials).

• Deferred tax assets as % of equity is high at 13% vs a median of <2% for our universe(ex Financials), raising risks of future write-offs.

• Very high variation in depreciation and amortization rate at 94% (CV) relative todepreciable assets indicates potential tendency to manage earnings throughfrequent shifts in depreciation and amortization policies.

• Pension and other liabilities are high at 16% vs a median of 3% for our universe (exFinancials) and a median of 4% for Japan focused universe.

• Long-term shareholding has declined by 30% points as indicated by change in freefloat over last 10 years, suggesting weakening of alignment of interest.

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 13

Name Comments

MitsuiFudosan(8801 JP)Sector: RealEstateCountry:Japan

• High absolute score of 9 that exceeds the relative score of 8.6, suggests highaccounting risks.

• Conversion of earnings to cash flow has been weak with cumulative pre-taxoperating cash flows just 65% of cumulative EBITDA over the last 10 years. Thisshould ideally be close to 100%. This has been partly driven by deterioration inworking capital. Cash conversion cycle has grown at >6% annualized over the last 10years. Annualized growth in net working capital (ex cash and equivalents) relative togrowth in sales has also been more than twice.

• Cumulatively over the last 10 years, the company has failed to generate positive cashflow in aggregate from operating and investing activities. While this could be becauseof re-investments into the business, negative cash flow generation over such longperiods (10 years) raises suspicion of cash flow leakage.

• Non-current investments as % of equity at 42% is high vs a median of 16% for ouruniverse (ex Financials) and a median of <17% for the Real Estate sector focuseduniverse.

• Deferred Tax Liabilities as % of net worth at 17% is high vs a median of <3% for thewhole universe (ex Financials) and a median of <4% for the Real Estate sectorfocused universe.

Hlb Inc(028300 KS)Sector:ConsumerDiscretionaryCountry:South Korea

• High absolute score of 9 that is equal to relative score of 9, suggests high accountingrisks.

• Three auditor changes vs 1.7 on average for South Korea focused universe, raisessuspicion of accounting manipulation.

• Working capital requirements have deteriorated over the last 10 years, indicatingpotentially weak quality of sales. Annualized growth in net working capital (ex cashand equivalents) has been 4x that of sales over the last 5 years. This is while thecash conversion cycle has improved during this period, suggesting that the stretchedworking capital is probably coming from other current assets and liabilities.

• Very high variation in depreciation and amortization rate at 96% (CV) relative todepreciable assets indicates tendency to shift depreciation and amortization policiesfor earnings management.

• Variation in employee expenses as a % of total operating expenses (ex COGS) is highat 38% (CV) vs a median of <9% for our universe (ex Financials), indicating potentialearnings manipulation through shift in employee expenses.

• Income statement restatements have been as high as 7 times over the last 10 years,raising concerns around the robustness of internal accounting controls. Thiscompares with 4.9 on average for the South Korea focused universe.

• Cumulatively over the last 10 years, the company has failed to generate positive cashflow in aggregate from operating and investing activities. While this could be becauseof re-investments into the business, negative cash flow generation over such longperiods (10 years) raises suspicion of cash flow leakage.

MineralResources(MIN AU)Sector:MaterialsCountry:Australia

• High absolute score of 9 that is equal to relative score of 9, suggests high accountingrisks.

• Three auditor changes vs an average of 0.5 for the Australia focused universe,suggests potential for accounting manipulation.

• High (6% of sales vs a median of 0.4% for our universe) and varying level (CV of 31%)of operating expenses as % of sales suggests potential for earnings manipulationthrough miscellaneous and/or other operating expenses.

• Deferred tax liabilities as % of equity is high at 15% vs a median of <3% for ouruniverse (ex Financials) and 6% for the Australia focused universe.

• High variation in depreciation and amortization rates (CV of 58% vs a median of 17%for our whole universe ex Financials) indicates tendency to shift depreciation andamortization policies for earnings management.

• Long-term shareholding has declined by 33% points as indicated by change in freefloat over last 10 years, suggesting weakening of alignment of interest.

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OlympusCorp (7733JP)Sector:HealthcareCountry:Japan

• High absolute score of 8 that exceeds the relative score of 4.5, suggests highaccounting risks.

• Conversion of earnings to cash flow has been weak with cumulative pre-taxoperating cash flows just 65% of cumulative EBITDA over the last 10 years. Thiscompares with our absolute threshold of 70% and a median of 96% for our universe(ex Financials). This has been partly driven by deterioration in working capital. Cashconversion cycle has grown at >17% annualized over the last 10 years, suggestingweak quality of sales (channel stuffing, etc.).

• Goodwill as % of equity is high at 32%, raising risks of future write-offs. Thiscompares with a median of 4% for our universe (ex Financials).

• Deferred tax liabilities as % of equity is high at 11% vs a median of <3% for ouruniverse (ex Financials).

• Non-current investments as % of net worth at 43% is high vs a median of 16% for ouruniverse (ex Financials).

• Long-term shareholding has declined by 23% points as indicated by change in freefloat over last 10 years, suggesting weakening of alignment of interest.

MitsubishiMaterials(5711 JP)Sector:MaterialsCountry:Japan

• High absolute score of 8 that exceeds the relative score of 6.75, suggests highaccounting risks.

• Deferred tax liabilities as % of equity is high at 10.5% vs a median of <3% for ouruniverse (ex Financials) as well as for the Japan focused universe.

• Non-current investments as % of equity at 49% is high vs a median of 16% for ouruniverse (ex Financials). It is also high relative to a median of 21% for the Materialssector focused universe.

• High variation in depreciation and amortization rate at 32% (CV) indicates tendencyto shift depreciation and amortization policies for earnings management. It is alsohigh relative to a median of 22% for the Materials sector focused universe.

• Pension and Other Retirement Liabilities as % of equity is high at 10% vs a median of3% for our universe (ex Financials). This is also high relative to a median of 3% for theMaterials sector focused universe and a median of 4% for the Japan focuseduniverse.

• Long-term shareholding has declined by 20% points as indicated by change in freefloat over last 10 years, suggesting weakening of alignment of interest.

Fila KoreaLtd (081660KS)Sector:ConsumerDiscretionaryCountry:South Korea

• High absolute score of 8 that exceeds the relative score of 6.75, suggests highaccounting risks

• Conversion of earnings to cash flow has been weak with cumulative pre-taxoperating cash flows just 57% of cumulative EBITDA over the last 10 years. Thiscompares with our absolute threshold of 70% and a median of 96% for our targetuniverse (ex Financials). This has been partly driven by deterioration in workingcapital with annualized growth in net working capital (ex cash and equivalents) being1.4x that of annualized growth in sales over the last 5 years.

• Variation in employee expenses as a % of total operating expenses at 32% is high vsa median of 9% for our universe (ex Financials).

• Income statement restatements have been as high as 5 times each over the last 10years, raising concerns around the robustness of internal accounting controls.However, this is in line with a median of 5 for the South Korea focused universe.Nonetheless, further probing of the rationale driving these restatements is advisable.

• Intangibles (ex Goodwill) as % of equity is very high at 82% vs a median of 4% for ouruniverse (ex Financials), raising risks of future write-offs.

• Cumulatively over the last 10 years, the company has failed to generate positive cashflow in aggregate from operating and investing activities. While this could be becauseof re-investments into the business, negative cash flow generation over such longperiods (10 years) raises suspicion of cash flow leakage.

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Hulic Co Ltd(3003 JP)Sector: RealEstateCountry:Japan

• High absolute score of 8 that exceeds the relative score of 7.5, suggests highaccounting risks

• Three auditor changes vs an average of 1.5 for the Japan focused universe, suggestspotential for accounting manipulation

• Deferred tax liabilities as % of equity is high at 12% vs median of <3% for our universe(ex Financials).

• Non-current investments as % of equity at 50% is high vs a median of 16% for ouruniverse (ex Financials).

• Long-term shareholding has declined by 22% points as indicated by change in freefloat over last 10 years, suggesting weakening of alignment of interest.

• Cumulatively over the last 10 years, the company has failed to generate positive cashflow in aggregate from operating and investing activities. While this could be becauseof re-investments into the business, negative cash flow generation over such longperiods (10 years) raises suspicion of cash flow leakage.

Note: Unless mentioned otherwise, the mention of "universe" in the above tableimplies "target universe ex Financials"

Summary Statistics from ourAnalysis

Notable Statistics from our Analysis: Based on the absolute accountingrisk scoring of the 572 companies in our target universe (ex Financials),please see below some summary statistics. Maximum accounting risk scoreexhibited by companies in our universe is 11 and minimum score obtained is0. Even for the bottom quintile, we obtained a score of 0 suggesting that atleast 10% of our target universe (ex Financials) comprises of companies thathave low risk from an accounting standpoint. Top quintile of our universeshowed a score of 7, suggesting that our end users looking for shortcandidates will find their time well spent focusing on companies withabsolute score of 7 and above.

Stats Value

Max 11.0

Top 5% 8.0

Top Quintile 7.0

Top Quartile 5.0

Median 3.0

Average 3.3

Bottom Quartile 2.0

Bottom Quintile 0.0

Min 0.0

Sector/Geography Heat Map: South Korea Industrials and China RealEstate show most susceptibility to accounting risks per aggregate absolutescoring obtained for our target universe (ex Financials). However, note thatas highlighted earlier, absolute score by itself is not sufficient to flag highrisk candidates. Relative scoring should also be taken into account atindividual company level before making any substantive conclusions.

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 16

Key Model Limitations and Risks

High Absolute and Relative score do not automatically suggestaccounting irregularities: Note that while we have tried to clean and refinedata where possible and have used various filters to enhance robustness andcomprehensiveness of our model, there still will remain significant noise inour model forecasts. One should not take for granted the high riskcandidates flagged by our model as outright financial shenanigans oraccounting frauds. The key purpose of the model is to highlight companiesand areas where accounting risks could potentially be high and extracaution/due-diligence is needed from an accounting standpoint.

Excludes Financials Sector: Our target universe excludes Financials sector.This is because many of the accounting parameters measured in ourframework are reported very differently from an accounting standpoint forFinancials sector companies. For investors still looking for some accountinginsights into Financials companies, we advise taking a deeper look into theindividual flags flagged by our model while ignoring some of them that maybe legitimate for the sector. For example, most Financials companies willscore high on loans and advances or contingent liabilities as % of equity dueto their nature of business, but such flags need to be assessed deeper asthese could be legitimate given the lending component involved in manysuch businesses. Also, users can focus on relative scoring to isolatecompanies with higher accounting risk than peers in the sector.

Data Limitations: There are certain areas such as related partytransactions, operating leases, auditing expenses, revaluation reserves,historical write-offs, R&D expenses, capitalized interest, capital work inprogress, frequency of key management and director resignations, etc.where data availability is limited in the Capital IQ system (largely a functionof lack of standardized reporting by companies). Related party transactionshistorically have played an important role in identifying high accounting riskcompanies. Ignoring such a key area handicaps our model to an extent. Untilsuch data becomes available, investors will have to rely on their ownresearch for these areas.

For certain accounting parameters, the data is not uniform across companiesor is imperfect. For example, the interest income field is not available on astandalone basis and includes dividend income. For some companies, theinterest expense is partially included in Cash Flow from Operations (OCF)while in many others it is included in Cash Flow from Financing, affecting

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Ankit Agrawal, CFA 17

our cumulative pre-tax OCF/EBITDA calculations. Note that to account forsuch noise in our data and lend some margin of safety to our model, we haveset stringent thresholds at the individual parameter level. For example, incase of pre-tax OCF/EBITDA, we have used a threshold of 70% vs expectedvalue of 100%. Similarly, for cash yield calculations that use interest incomedata, inclusion of dividend income further provides margin of safety to ouralready stringent threshold of 50% for cash yield/risk free rate parameter.Despite margin of safety from our end, we advise users of our model to takea deeper look into some of these parameters and adjust for any deviations atthe individual company level, before making any final conclusions.

Conclusion

Among the top 10 most risky candidates flagged by our model, two [ToshibaCorp (6502 JP), Olympus Corp (7733 JP)] of these have unfolded in the pastas prominent accounting scandals and are still grappling with some of therelated issues. Two others [Hlb Inc (028300 KS) , Hulic Co Ltd (3003 JP)] alsohave been flagged in the recent past by some short-sellers for their weakaccounting quality. We think our methodology to use both absolute andrelative scoring, use of stringent thresholds and filters to ensure enoughdata is available before making any substantive conclusions has lend ourmodel significant robustness. While our tool is not perfect as there is alwaysroom for improvement, we are positive that it will be a useful addition to ourclients' toolbox for forensic accounting analysis. We look forward toengaging with our users and making regular enhancements to our model toincorporate improvements and any feedback from our end users.

We also bring attention to some of the high risk accounting candidatesflagged by our model that are yet to receive attention from the broadershort-seller community. These names include Zoomlion Heavy Industry S A(000157 CH), Technopro Holdings (6028 JP), Mitsui Fudosan (8801 JP),Mineral Resources (MIN AU), Mitsubishi Materials (5711 JP) and Fila KoreaLtd (081660 KS).

Thank you for your time in reading this note. If you found it insightful,please take a moment to appreciate it using the "Like" button. To receivemy latest updates, please "Follow" me.For any feedback/questions, please feel free to comment below ormessage me.

Appendix

List of Companies in our Target Universe with Accounting Risk Score>= 8

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 18

Below we list companies in our target universe with absolute accounting riskscore of greater than or equal to 8. To refer to the full universe andassociated accounting risk score, please refer to Excel file named "ScoreAggregator". Companies with "Flag?" as "TRUE" are flagged by our model ascompanies with high accounting risk. Note that for companies where relativescore is not available, due to lack of enough peers (we need at least five peersthat have 5Y historical data for at least 15 accounting parameters), we flagthem as "FALSE".

Ticker Company Name Sector Country AbsoluteScore

RelativeScore

Flag?

SEHK:267 CITIC Limited Industrials HongKong

11 9.0 TRUE

KOSE:A006400 Samsung SDI Co., Ltd. InformationTechnology

SouthKorea

11 11.3 FALSE

TSE:6502 Toshiba Corporation Industrials Japan 10 6.0 TRUE

SZSE:000157 Zoomlion Heavy IndustryScience and Technology Co.,Ltd.

Industrials China 10 7.5 TRUE

ASX:TAH Tabcorp Holdings Limited ConsumerDiscretionary

Australia 10 FALSE

TSE:6028 TechnoPro Holdings, Inc. Industrials Japan 9 7.5 TRUE

TSE:8801 Mitsui Fudosan Co., Ltd. Real Estate Japan 9 8.6 TRUE

KOSDAQ:A028300 HLB Co., Ltd. ConsumerDiscretionary

SouthKorea

9 9.0 TRUE

ASX:MIN Mineral Resources Limited Materials Australia 9 9.0 TRUE

TSE:9504 The Chugoku Electric PowerCo., Inc.

Utilities Japan 9 10.9 FALSE

SEHK:3333 China Evergrande Group Real Estate China 9 11.6 FALSE

SEHK:813 Shimao Property HoldingsLimited

Real Estate HongKong

9 12.0 FALSE

SEHK:2777 Guangzhou R&F PropertiesCo., Ltd.

Real Estate China 9 12.0 FALSE

SEHK:1030 Seazen Group Limited Real Estate China 9 12.0 FALSE

SHSE:600547 Shandong Gold Mining Co.,Ltd.

Materials China 9 12.4 FALSE

KOSE:A010140 Samsung Heavy Industries Co.,Ltd.

Industrials SouthKorea

9 15.0 FALSE

TSE:1605 Inpex Corporation Energy Japan 9 FALSE

TSE:8963 Invincible InvestmentCorporation

Real Estate Japan 9 FALSE

TSE:7733 Olympus Corporation Health Care Japan 8 4.5 TRUE

TSE:9984 SoftBank Group Corp. CommunicationServices

Japan 8 6.0 TRUE

TSE:5711 Mitsubishi MaterialsCorporation

Materials Japan 8 6.8 TRUE

KOSE:A081660 FILA Holdings Corporation ConsumerDiscretionary

SouthKorea

8 6.8 TRUE

TSE:3003 Hulic Co., Ltd. Real Estate Japan 8 7.5 TRUE

TSE:6753 Sharp Corporation ConsumerDiscretionary

Japan 8 8.3 FALSE

SEHK:1233 Times China Holdings Limited Real Estate China 8 8.6 FALSE

NYSE:BABA Alibaba Group Holding Limited ConsumerDiscretionary

China 8 9.0 FALSE

TSE:6758 Sony Corporation ConsumerDiscretionary

Japan 8 10.5 FALSE

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Ankit Agrawal, CFA 19

SEHK:884 CIFI Holdings (Group) Co. Ltd. Real Estate China 8 10.5 FALSE

TSE:9508 Kyushu Electric PowerCompany, Incorporated

Utilities Japan 8 10.9 FALSE

TSE:9506 Tohoku Electric PowerCompany, Incorporated

Utilities Japan 8 10.9 FALSE

SEHK:1171 Yanzhou Coal MiningCompany Limited

Energy China 8 10.9 FALSE

SEHK:1918 Sunac China Holdings Limited Real Estate China 8 11.6 FALSE

ASX:CIM CIMIC Group Limited Industrials Australia 8 12.8 FALSE

KOSE:A028260 Samsung C&T Corporation Industrials SouthKorea

8 13.1 FALSE

SEHK:960 Longfor Group HoldingsLimited

Real Estate China 8 13.1 FALSE

SEHK:817 China Jinmao Holdings GroupLimited

Real Estate HongKong

8 13.1 FALSE

SEHK:1813 KWG Group Holdings Limited Real Estate China 8 13.1 FALSE

KOSE:A003550 LG Corp. Industrials SouthKorea

8 13.9 FALSE

KOSE:A009540 Korea Shipbuilding & OffshoreEngineering Co., Ltd.

Industrials SouthKorea

8 14.6 FALSE

TSE:3283 Nippon Prologis REIT, Inc. Real Estate Japan 8 FALSE

SEHK:6 Power Assets HoldingsLimited

Utilities HongKong

8 FALSE

Glossary

Below is a list of abbreviations used across our model and this insight.

Abbreviation Full Form

3M 3 Months

5Y 5 Years

10Y 10 Years

Adv Advances

Ann Mean Annualized Mean

Ann Std Dev Annualized Standard Deviation

BS Balance Sheet

CAGR Compounded Annual Growth Rate

Capex Capital Expenditure

CashST Cash and Short-Term Investments

Chg Change

COGS Cost of Goods Sold

CV Coefficient of Variation

CWIP Capital Work in Progress

D&A Depreciation & Amortization

DTA Deferred Tax Assets

DTL Deferred Tax Liabilities

EBITDA Earnings Before Interest Tax Depreciation and Amortization

Eff Effective

Emp Employee

Exp Expenses

FCF Free Cash Flow

ICF Investing Cash Flow

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

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Inv Investments

IS Income Statement

Liab Liability

LT Long-term

Net Worth Equity

Non-oper Non-operating

NWC Net Working Capital

OCF Operating Cash Flow

Oper Operating

PAT Profit After Tax

PP&E Property, Plant & Equipment

Ret Retirement

RFR Risk Free Rate

Snapshot of Capital IQ Screen Used for Filtering Universe

Note that the below screen yields 1029 companies. Of these we eliminateany ETFs and duplicate entries (multiple exchange listings) to get our targetuniverse of 658 companies.

Switch Formula Calculation Option in Excel

Click on the Office button highlighted in the Green box and then click on"Excel Options" button as highlighted in the Red box below.

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 21

Within "Excel Options", click on the "Formulas" tab in the left pane as belowand use the "Workbook Calculation" section to shift to "Manual" from"Automatic" and vice versa.

Refresh Worksheet Option in Capital IQ Plugin

As highlighted below in the Green box, use the "Refresh Worksheet" to fetchlatest data from Capital IQ.

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Ankit Agrawal, CFA 22

Disclosure & Certification

• I/We have no position(s) in the any of securities referenced in this insight

• Views expressed in this insight accurately reflects my/our personal opinion(s) about the referenced securities and issuers and/orother subject matter as appropriate.

• This insight does not contain and is not based on any non-public, material information.

• To the best of my/our knowledge, the views expressed in this insight comply with Singapore law as well as applicable law in thecountry from which it is posted

• I/We have not been commissioned to write this insight or hold any specific opinion on the securities referenced therein

• I/We have signed the Insight Provider Agreement and this insight does not violate any of the terms specified therein.

— Ankit Agrawal, CFA (21 Feb 2020)

A Forensic Analysis Tool for Detecting Accounting Red Flags: Focus on Developed Asia

Ankit Agrawal, CFA 23

Ankit Agrawal, CFA

Equity L/S Analyst

| Forensic Accounting | India

Luckin Coffee | ESG

Insider Diagnostics: A Repository of Short-Sell Target Asian Companies & Associated Key InsidersBy Ankit Agrawal, CFA | 31 May 2020

EXECUTIVE SUMM ARY

In this Original, we have created a repository of Asian companies andassociated key insiders targeted by prominent short-sellers, over the lastdecade, to help serve as a tool for insider diagnostics.

What's Original?We track 19 prominent short-sellers who in turn have targeted about115+ Asian companies over the past decade. Below we provide adetailed database of these companies along with the correspondingshort-sell thesis, price moves since the short-sell report and outcomeof the short-sell attack. We also track the current whereabouts of the500+ key insiders associated with these companies.How and to Whom would this be Useful?Insider Diagnostics (Quality of Management) and AccountingDiagnostics are two key pillars of any forensic analysis assessment.This Original, with a focus on insider diagnostics, further bolstersour prior Original focused on accounting diagnostics, A ForensicAnalysis Tool for Detecting Accounting Red Flags: Focus onDeveloped Asia. Together, these two Originals are intended to serveas a comprehensive toolkit for investors, analysts, corporates,auditors, regulators, exchanges, media, etc. looking to conductforensic analysis on Asian Companies.

Insight Flow:

• Prominent Short-Sellers (Targeting Asian Companies)

• Target Companies

• Key Insiders

• High Risk Insiders & Associated Companies

Insider Diagnostics: A Repository of Short-Sell Target Asian Companies & Associated Key Insiders

Ankit Agrawal, CFA 24

• Other Notable Insiders & Associated Companies

• Notable External Agencies

◦ Does Presence of Global Renowned Auditors/Investment Banksimply Strong Governance?

• Key Limitations

Please note that most of the repository content in this Original is inthree key tables in the "Target Companies" and "Key Insiders"section. These tables are labeled as - 1) List of Target Companies,2) Short-Seller Thesis on Individual Companies and 3) List of KeyInsiders: Role in the Target Company & Current Whereabouts. Notethat given the large amount of data and text in these tables, we haveprovided pagination and search functionality in these tables for ease ofuse and focused viewing. We have also provided these in the excelformat. Please refer to the attachments section of this insight todownload the excel files.

DE TAIL

Prominent Short-Sellers (TargetingAsian Companies)

To come up with the database of key insiders of Asian companies that havebeen short-sell targets, we looked at 19 prominent short-sellers namelyAnonymous Analytics, Aurelius Value, Blazing Research, Blue Orca (exGlaucus), Bonitas Research (ex Glaucus), Citron, Emerson Analytics,Glaucus, Gotham City, Grizzly Research, Hindenburg Research, IcebergResearch, J Capital, Muddy Waters, Prescience Point Capital, Spruce PointCapital, Triam, Viceroy Research, and Wolfpack Research (ex GeoInvesting).Note that we have not included some prominent short-seller research house likeGeoInvesting, etc. as well as short-oriented hedge fund managers (Kynikos, etc.)in our analysis as their activities and reports are not widely and freely availablein the public domain.

Among these short-sellers, most active in terms of the number of companiestargeted have been Glaucus, Muddy Waters and Citron. Bonitas, Blue Orca,Emerson Analytics and J Capital have also made a significant mark while therest have had limited activity (5 or less short-sell targets over the pastdecade).

In terms of success rate, these short-sellers have had a decent track recordwith a weighted average hit rate of 64%. Glaucus has had an impeccable hitrate of 86%, despite the highest level of activity among the 19 short-sellers.Notably, Blue Orca and Bonitas, both of which are ex-Glaucus outfits

Insider Diagnostics: A Repository of Short-Sell Target Asian Companies & Associated Key Insiders

Ankit Agrawal, CFA 25

(formed after Glaucus' two partners split), have had a below average trackrecord so far. Surprisingly, Muddy Waters despite being one of the pioneersand trend-setter in the space (especially in bringing to fore Chinese reversemerger or reverse takeover [RTO] frauds) has also had a below average trackrecord over the past decade.

Below table lists each short-seller and corresponding statistics - number ofcompanies targeted, hit rate, etc.

Short-Seller # of Targets Hit Rate (%) TBD (%) Fail (%)

Glaucus Research 21 86% 0% 14%

Muddy Waters 21 52% 5% 43%

Citron Research 15 67% 20% 13%

Bonitas Research 10 60% 20% 20%

Emerson Analytics 10 80% 20% 0%

Blue Orca Research 7 43% 14% 43%

J Capital Research 7 29% 43% 29%

Hindenburg Research 5 40% 60% 0%

Viceroy Research 5 80% 0% 20%

Aurelius Value 4 50% 50% 0%

Blazing Research 4 100% 0% 0%

Prescience Point 4 75% 0% 25%

Anonymous Analytics 3 100% 0% 0%

Grizzly Research 2 0% 50% 50%

Iceberg Research 2 100% 0% 0%

Wolfpack Research 2 0% 100% 0%

Gotham City Research 1 0% 100% 0%

Spruce Point 1 100% 0% 0%

Triam Research 1 100% 0% 0%

Weighted Average 64% 17% 19%

Source: Short-Seller Websites; Web Search

Note: # of Targets (count) above includes only Asian Companies; Hit Rate (%)- # of Successful Shorts/Total Companies Targeted; Fail (%) - # of Failed Shorts/Total Companies Targeted; TBD - To Be Determined (Outcome of the short-seller attack yet to be determined, in our opinion)

Target Companies

Below we list the short-sell target companies along with the short-sellername, short-sell report initiation date, outcome of the attack and pricemoves post the short-seller report.

Note that we have classified the outcomes in three buckets: 1) Success 2) Fail 3)TBD (To Be Determined). Success and fail outcomes have been determined basedon share price movement, delisting/suspension of trading, legal action,management/board changes, etc. For certain cases, we could not find much

Insider Diagnostics: A Repository of Short-Sell Target Asian Companies & Associated Key Insiders

Ankit Agrawal, CFA 26

action/evidence, beyond share price movements, to make a conclusive success/fail classification. We have classified these cases as TBD. Some of the TBD situations below have seen significant share price movement (as high as 30-50%either side), however, we have refrained from tagging these as success/fail given no other impact to the company other than share price movement.

List of Target Companies

Note that the Columns 1M, 3M, 1Y, 3Y, 5Y and ITD, in the below table, indicate price moves in % terms over 1 month, 3 Month, 1 Year, 3 Years, 5 Years and Inception to Date, respectively, since the short-seller report

Given the large amount of data, we have outlined our findings in the Excel file, named “List of Target Companies”.

Source: Short-Seller Reports

Note: For active listings, tickers correspond to Cap IQ convention; Price data is sourced from Cap IQ

Here we list brief synopsis of short-seller’s thesis on each of the companies targeted.

Short-Seller Thesis on Individual Companies

Note that given the large amount of data in the below table, we have paginated the table for ease of use and focused viewing. There is also a search functionality for ease of access.

Given the large amount of data, we have outlined our findings in the Excel file, named “Short-Seller Thesis on Individual Companies”

Source: Short-Seller Reports

Note: In most cases, we have taken the thesis verbatim from the short-seller report for the above synopsis; only in a few cases, have we made changes, mostly language related and in others, paraphrasing changes for summary purposes; Any reference of "our", "we", "us", refers to the respective short-seller; For active listings, tickers correspond to Cap IQ convention

Key Insiders

Analyzing 115+ short-sell target companies yielded us about 500+ keyinsiders. Below we track the career moves of these insiders post the short-seller report and enlist them along with their name and the currentwhereabouts.

Insider Diagnostics: A Repository of Short-Sell Target Asian Companies & Associated Key Insiders

Ankit Agrawal, CFA 27

In identifying key insiders, we looked across key executives, board members, insiders involved in related party transactions, key shareholders as well as external agencies like auditors, investment banks and brokers. In cases where there was significant shortfall in auditing aspects, we have particularly flagged insiders like CFO, Head of Audit Committee, Auditor, etc.

List of Key Insiders - Role in the Target Company and Current Whereabouts

Note that given the large amount of data in the below table, we have paginated the table for ease of use and focused viewing. There is also a search functionality for ease of access.

Given the large amount of data, we have outlined our findings in the Excel file, named “List of Key Insiders".

Source: Capital IQ, LinkedIn, Company Filings, Short-Seller Reports

Note:

• Role in Target Company* - At the time of the short-seller report

• Same value in columns - "Short-Sell Target Company" & "CurrentCompany & Role" - indicate that the key insider is in the same companyand in the same role currently as at the time of the short-seller report

• Abbreviations Used - i) NA - Not Available ii) ED - Executive Director iii)Chief Executive Officer iv) CFO - Chief Financial Officer v) CS - CompanySecretary vi) VP - Vice President vii) CMO - Chief Medical Officer viii) GM -General Manager

• Chinese Names above are a mix of "First Name Middle Name Last Name","Last Name First Name Middle Name", "First Name" and "Last Name"formats; Where possible and readily available, English names arementioned in the bracket

• Insiders include people involved as well as auditor and investment banking/broker companies

High Risk Insiders & Associated Companies

The above master data table in the "Key Insiders" section provide acomprehensive list of insiders, most of whom were allegedly (as per theshort-seller short) or connectedly (as per our own tracing) involved in somekind of direct/indirect participation in the alleged weak governance orfraudulent activity at the short-sell target companies.

Now to take a step further, below we highlight select key insider moves (fromthe above master data table) where the past track record and currentwhereabouts of these insiders suggest that the companies they are currentlyworking with could potentially have weak governance. Note that we havehighlighted such potentially risky companies in the bold font in the below table.

Insider Diagnostics: A Repository of Short-Sell Target Asian Companies & Associated Key Insiders

Ankit Agrawal, CFA 28

Insider Name |Short-SellTargetCompany |Role in TargetCompany*

Current Company& Role

Relevant Excerpts from Short-Seller Reports (in Italics font) & OtherComments (in Normal font) highlighting past track record of the KeyInsider

Yongjie Yao |Canaan (CAN) |Chairman & ED- Related Party

GrandshoresTechnology(SEHK:1647)- Chairman & ED ;Hangzhou TunlanInvestment -Chairman; HanTang International- Board Member;HamatonAutomotiveTechnology -SubstantialShareholder

Just one month before CAN’s NASDAQ IPO, a tiny Hong Kong stocknamed Grandshores (HK 1647) announced a purported “strategicpartnership” with CAN and agreed to purchase up to $150 Million USDworth of equipment in 2020, an amount that nearly equals CAN’s entiretrailing twelve month revenues of approximately $177 million USD. Wefind the transaction farcical on its face because Grandshore’s marketcap is a mere $50 Million USD and it reports having only $16 MillionUSD in cash on hand, nowhere near the financial wherewithal to buythis much equipment. Even Hong Kong analysts referenced in thisChinese media article expressed doubt the deal would ever beconsummated. Documents show that Grandshores is a clear relatedparty because its Chairman, Yao Yongjie, is an “Angel investor” of CANand owns 9.7% of CAN’s shares outstanding through entities hecontrols. Yet this transaction is not mentioned anywhere in CAN’s SECfilings.

Andres Romero| Canaan (CAN)| Employee(SalesRepresentative)

Northern Data AG- Head of Sales

While neither CAN’s Hong Kong listing application or its SEC filingsdisclose the names of its current top customers, we find it highlyirregular that CAN abruptly deleted 8 of the 11 unique distributors thatwere featured on its website shortly before the company’s NASDAQIPO (as archived by waybackmachine in May 2019). One of thesedeleted distributors, Nova Bit Mining Solutions, is apparently controlledby one of CAN’s sales representatives, Andres Romero. Romero’s ownLinkedIn profile lists himself as both “Global Sales” for CAN and theCEO of Nova Bit. In a 2018 Youtube Video, Romero identified himselfas a CAN VP of Marketing and invited viewers to an event in Dubai.CAN suddenly deleted Romero from its website sometime in the lastfew weeks (we archived it here) but used to feature him as a company“agent”. Nova Bit’s website continues to state it is “official distributors”of CAN although multiple calls to the phone number listed on NovaBit’s website went unanswered with a message “the Google Voicesubscriber is not available”.

Arnold Staloff |Deer ConsumerProducts(DEER) |Chairman -AuditCommittee

Centra Capital -Top Key Executive& InvestmentBanker; GigapixStudios - BoardMember

“Individuals with direct knowledge of the investigation say the SEC isfocusing on stock promoters, investment bankers, auditors and lawfirms that have been active in recruiting Chinese companies to U.S.stock exchanges and raising capital for those companies by sellingnew shares”. Unlike any other of the recent RTO implosions, DEERactually gives us a group of people who work together as an actual“network”. It is no secret that Benjamin Wey from New York GlobalGroup is the “mastermind” behind this whole operation. AuditorGoldman Kurland & Mohidin, LLP (GKM) and Audit CommitteeChairman Arnold Staloff serve several of the same New York Globalclients. GKM audits include Bodisen Biotech (BBCZ, -95% from itshigh), Agfeed Industries (FEED, -90%), Smartheat (HEAT, -78%) andmost recently Cleantech (CTEK.PK, already -52% from its high anddelisted from NASDAQ on March 1, 2011 for a serious disclosureviolation.

Benjamin Wey |Deer ConsumerProducts | CEO- New YorkGlobal Group(StockPromoter)

New York GlobalGroup - CEO

“Individuals with direct knowledge of the investigation say the SEC isfocusing on stock promoters, investment bankers, auditors and lawfirms that have been active in recruiting Chinese companies to U.S.stock exchanges and raising capital for those companies by sellingnew shares”. Unlike any other of the recent RTO implosions, DEERactually gives us a group of people who work together as an actual“network”. It is no secret that Benjamin Wey from New York GlobalGroup is the “mastermind” behind this whole operation. So it appearsto Citron that Wey stacked the deck by putting in his auditor and hisAudit Committee Chairman (Arnold Staloff as discussed above).

Yu Haifeng |Fanhua | Owner- Related Party

Puyi Inc.(NasdaqGM:PUYI)- Founder &Chairman

Yu Haifeng is chief representative or majority owner of several assetmanagement companies owned by Fanhua that generally go under thename Puyi. He also owns a company called Renshou Puyi CorporateManagement Center in Renshou, Sichuan, where Fanhua is relocatingits headquarters. This article says that Yu started Puyi on Fanhua'sbehalf. Three Fanhua employees confirmed to us that Yu is a Fanhuaexecutive. Yu is also owner of Shenzhen Chuangji InvestmentPartnership, to which Fanhua extended loans in 2017 withoutdisclosing them as loans to a related party.

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Hailiang Feng(Feng) |HailiangEducation |SubstantialShareholder

HailiangEducation; ZheJiang Hai LiangCo., Ltd(SZSE:002203) -SubstantialShareholder

As per the 20-F filings, Feng owned >83% of Hailing Education at thetime of the short-seller report; Per Citron's report, Hailiang Feng hasengaged in material related party transactions at Hailiang Educationthrough Hailiang Finance (a subsidiary of Hailiang Group) to enrichhimself.

Clayton Fong |L&L Energy Inc(LLEN) | ED

MedSpaceInnovations - VicePresident, MedicalOffice Real Estateand Development

Clayton Fong, LLEN’s Executive Vice President of US operations andLee’s right hand man, also has a history of troubled allegations. From1996 to 2009, Fong served as the CEO of National Asian Pacific CenteronAging (“NAPCA”), a Seattle-area non-profit organization. According toan investigative report by the Seattle Times, NAPCA dismissed Fong in2009 following an internal review, which, according to the NAPCAboard chairman, “uncovered a pattern of behavior and conduct of greatconcern to [the board]. In connection with Fong’s dismissal, theChairman stated that “we have a fiduciary duty here to look after theorganization’s and funders’ resources.” It does not take much to readbetween the lines: Fong appears to have been fired for misconductpotentially related to the misuse of a charitable organization’s funds.This was not the first time Fong came under scrutiny for his use of thecharity’s money. In 1999, Federal auditors working at the behest of theLabor Department issued a highly-critical report on the NAPCA whichquestioned $330,000 in expenditures and accused the NAPCA of“misusing taxpayer money to pay for golf balls, tobacco products, aChristmas party and a trip to LasVegas for its executive director[Clayton Fong].”

Khalifa BinButti | NMCHealth |Related Party

HakkasanLimited

NMC’s $107.4 million investment in redeveloping NMC Royal Women’sHospital contains numerous red flags. First, we calculate the cost ofthe investment at approximately $7,700 / m2. This cost seems greatlyout of line, as we would have expected $3,500 to $4,000 / m2. Thereare some indications that Khalifa Bin Butti’s company, KBBO Group,was involved in the development as well, which also was not disclosed.In early 2018, NMC acquired 70% of CosmeSurge from KBBO Group for$170 million, paying 12x EBIDA for it. Of course, KBBO’s Chairman isKhalifa Bin Butti. Even without the doubts about transactions involvingKBBO and other de facto related parties, the presence of a majorshareholder and board member of NMC in this transaction representsa conflict of interest that raises doubt about the valuation of atransaction price “based on valuation done by management”; Whensearching online, we found a $105 million three-year facility arrangedby FirstEnergy Bank. Khalifa Bin Butti became chairman of this bank inMay 2016. In a salacious coincidence, Mr. Bin Butti replaced Khademal-Qubaisi, who was arrested for his role in the “Billion Dollar Whale” /1MDB / Jho Low scandal. NMC made no disclosure or announcementof this facility, which we see as unusual based on its history. In March2018, NMC acquired 70% of Premier Care Home Medical and HealthCare LLC for cash consideration of $36.4 million.12,13 This is animplied valuation of $52.0 million. Sources with whom ourinvestigators spoke believe the acquisition, of which 91% wasintangibles, should have commanded only a fraction of this price.Notably, Guggenheim KBBO Partners Investment Banking (a jointventure with Khalifa Bin Butti’s KBBO Group) was the sole advisor onthe transaction. Insiders own 55% of NMC shares - 14.7% points of thisis owned by Khalifa Bin Butti and 7.3% belongs to joint Bin Butti vehicleInfinite Investments. Khalifa Bin Butti has pledged almost three-quarters of his directly owned shares.

BavaguthuRaghuramShetty (BRShetty) | NMCHealth |SubstantialShareholder

Alex NewMedical Center(CASE:AMES)[Subsidiary] -MajorityShareholder,Chairman & CEO;Finablr PLC(LSE:FIN) - KeyExecutive & Co-Chairman; UAEExchange Center,UnimoniFinancialServices Limited- Chairman &Former CEO

Insiders own 55% of NMC shares - BR Shetty owns 15.9%. In the pasttwo years, we estimate insiders have monetized £1 billion, net, viaselling, collaring, and pledging stock. We calculate that BR Shettyrealized an approximate £250 million from the collar transaction he puton his shares. NMC’s $107.4 million investment in redeveloping NMCRoyal Women’s Hospital contains numerous red flags. First, wecalculate the cost of the investment at approximately $7,700 / m2.This cost seems greatly out of line, as we would have expected $3,500to $4,000 / m2. The contractor that was responsible for the renovationwork on the hospital (the building already existed) appears to be defacto controlled by BRShetty, which was not disclosed.

Insider Diagnostics: A Repository of Short-Sell Target Asian Companies & Associated Key Insiders

Ankit Agrawal, CFA 30

Phillip Shamieh| Quintis (TFS) |FoundingPartner ofIncipientCapital

Greenvale Energy(ASX:GRV) -SubstantialShareholder &Prior KeyExecutive; wise-owl.com Pty Ltd -Top KeyExecutive; AlliedResourcesHoldings Ltd -CFO; IncipientHoldings Limited- FoundingDirector andshareholder in thepast

To support its unrealistic forecasts for the expected demand andfuture price of sandalwood, TFS’s marketing presentations rely on akey study by Incipient Capital. But TFS fails to disclose that IncipientCapital, far from being an independent research firm, is a small Dubai-based merchant bank which was the lead manager in raising $194million in financing for TFS from 2009 to 2012. TFS also fails todisclose that Incipient Capital’s founding partner, Phillip Shamieh, wassimultaneously the CEO of a JV which was 49% owned by TFS from2009-2014, when it was wholly acquired by the Company. Shamiehclaims on his LinkedIn page to have worked for TFS from 2009-2016.Not only do such conflicts of interest undermine the credibility of thedata, but we believe it is materially misleading for TFS to presentcritical forecasts to potential investors without disclosing that thesource is a related party that works and raises money for TFS.

Yick PangPoon | RealNutriceutical |CFO

Li Bao Ge GroupLimited(SEHK:1869) -CFO & CS; ChinaFordoo Holdings(SEHK:2399) -Board Member

Real Nutri’s CFO, Mr. Poon Yick Pang, served as the director of financefor China Medical Technologies (“CMED”), a US-listed company whichGlaucus exposed as a massive fraud in 2011. After CMED collapsedfollowing our report, Real Nutri tried to conceal Mr. Poon’s connectionto the disgraced firm. Mr. Poon was CMED’s director of finance duringa period when CMED engaged in a fraudulent acquisition to secretlytransfer shareholder money to its Chairman. He was also CMED’sdirector of finance when CMED filed false financial statements whichdeliberately inflated the Company’s reported sales and profits. In ouropinion, Real Nutri is perpetuating a similar fraud on the market, andthe fact that it employs a disgraced CFO who would likely be behindbars in the United States only confirms our opinions.

Lik Ping Wong |ShougangFushan | Vice-Chairman

China Ever GrandFinancial LeasingGroup Co., Ltd.(SEHK:379) - TopKey Executive;China Ever GrandCapital GroupLimited -Chairman & TopKey Executive

Fushan’s long-time Chairman Wong Lik Ping (“Chairman Wong”) andhis cohort, Mr. Xing, each sold the vast majority of their respectivecompany shares within 18 months of the reverse merger. ChairmanWong grossed HK$ 4.5 billion and Mr.Xing grossed HK$ 4 billion asFushan’s stock soared on the strength of suspiciously high margins. Ifinvestors applied the valuation metric of comparable transactions(13.9x reserves) to the 3 Mines acquired by Fushan from its rich andpowerful benefactors in 2008, the total debt on the books of the 3Mines would have exceeded the value of the mines. In other words, itappears that Chairman Wong, Mr. Xing and their cohorts soldinvestors a net liability for over HK$ 10.5 billion. we believe Fushanfraudulently exaggerated its margins to pump up the price of its stock,which later allowed insiders Mr.Xing and Chairman Wong to dumpvirtually all of their shares.

Zhiqiang Lu |ChinaOceanwideHoldingsLimited |Founder &Owner

China OceanwideHoldings GroupCo., Ltd -Chairman & TopKey Executive;OceanwideHoldings Co., Ltd.(SZSE:000046) -Top KeyExecutive; ChinaTonghaiInternationalFinancial Limited(SEHK:952),China OceanwideHoldings Limited(SEHK:715) -SubstantialShareholder (viagroup entities)

We can surmise that at least $4.8 billion of “other receivables” is owedby related party entities. Much of these were upstreamedto ChairmanLu’s other entities. Instead, it looks like “other receivables” is simply amechanism to make unsecured loans to Chairman Lu’s other entities.Far be it for us to judge how a wealthy person spends their money, butChairman Lu has largely been spending borrowed cash. It is unclearhow many mansions (as per a WSJ article) and other creaturecomforts Mr. Lu has accumulated globally at this point. We wonder,why is the Chairman purchasing so many foreign mansions clusteredin the same California town? It begs the question of whether these aremerely attempts to shift assets overseas. At best it does not paint aportrait of a staid, judicious asset manager.As per the short-sellerreport, lot of shares across the group entities are also pledged byChairman Lu.

Robert Taub |Neuroderm Ltd| BoardMember &SubstantialShareholder

Nyxoah S.A.,Recoly N.V. -Chairman & TopKey Executive;Maya Gold andSilver Inc.(TSX:MYA) -Chairman;Magnisense SE,LifeBond Ltd.,FemPulse LLC -Board Member

As per 2017 annual report, Mr. Taub owned 12.3% of NeuroDerm andhis principal business office was same as that of NeuroDerm.

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Ankit Agrawal, CFA 31

Sheng Fu |Cheetah Mobile| CEO

Cheetah Mobile(NYSE:CMCM);Kingsoft NetworkTechnologyLimited -Chairman & CEO;Purple BullStartups - TopKey Executive;MARKABLE, Inc. -Board Member

CMCM initially caught our attention when we learned of its plans toinvest in a related party entity owned by its CEO Sheng Fu. On May 26,2017, CMCM announced its intent to invest $40m of shareholdercapital in OrionStar, an AI and robotic business, in exchange for a29.55% equity stake, effectively valuing OrionStar at $95.4m on a pre-money basis. Upon further analysis, we were troubled by thecircumstances surrounding the deal: 1) Only one year prior to theannouncement of the deal, in April 2016, Mr. Fu announced that CMCMintended to set up a subsidiary called Cheetah Robotics to pursue AI/robotics. Our research indicates the legal formation of this entity didtake place in May 2016. 2) Mr. Fu then appears to have hi-jacked theopportunity away from CMCM shareholders, forming his own AI androbotics company OrionStar in September 2016, only several monthsafter Cheetah Robotics’ formation. Cheetah Robotics now appears tobe a disregarded entity, as CMCM does not talk about it, it is notmentioned in CMCM SEC filings, and it is not accounted for in CMCM’scorporate structure as mapped out in the 2016 20-F (refer to theAppendix). 3) At the time the CMCM deal was announced, OrionStarhad existed for only 8 months, casting serious doubt on the legitimacyof its lofty ~$100m pre-money valuation.A total of 5 insiders have registered their shares for sale via Form 144filings over the past 5 months for an estimated total of $17.3m inproceeds, according to CapitalIQ. This includes an estimated $1.4m ofregistered stock sales by CEO Sheng Fu (via an entity he owns calledFax Vision Corporation)

Zhang Yang |TAL Education |Related Party (ShunshunLiuxue)

Shunshun Liuxue Shunshun hired a new chairman and CEO just prior to TAL’sinvestment: Yang Zhang. The 35-year old Mr. Zhang was a well-knownfigure in education in China, having written a bookwith his wife abouthis experience studying in the U.S. called “My Harvard Diary”. He joinedShunshun in June 2015. His tenure was ultimately short, though, as itappears he left after only approximately 12 to 18 months. Oddly forsuch a short tenure, he was granted 50% of the equity in the Shunshunentity. His shares appear to have fully vested, and he got liquidity formost of them after just one year. However, it was not TAL to whom hesold his shares. Surprise! The “buyer” was a newly established Fujiancompany controlled by wife, Beixi Wang. Beixi Wang establishedFuzhou Minqing Forest Park Business Center LimitedPartnership(Minqing) on May 26, 2016. Only two weeks later, on June7th, 36% of Shunshun was transferred to Minqing. The transferorswere her husband Yang Zhang and co-founders Du Zhang and YuxiaoLiu. It is unclear what consideration, if any, Minqing paid tothetransferors. It was from Minqing that TAL acquired its next stake inShunshun / DFRL with the transfer to TAL being official as of June23rd. TAL purports that it purchased this 36% block for a total of $32.7million, at a fair value of $103.7 million, which generated a valuationgain of $25.2 million in FY2017. Shockingly, Minqing did not build uponits apparent overnight business success. It was deregistered October10th. As of early 2017, though, Ms. Wang and her husband appeared tobe traveling the world. On January 2, 2017, Mr. Zhang’s personal blog,which had been dormant since June 2015, came back to life, providinga travelogue of his family’s excursions in the first half of 2017 throughSpain, the U.S., Canada, Japan, Thailand and China.

*At the Time of the Short-Seller Report; Any reference to We/Our/Us refersto the Short-Seller Report | Source: Short-Seller Reports, Cap IQ, LinkedIn,Web Search

Other Notable Insiders & Associated Companies

Below we highlight some other insider moves which while are not as high-risk as above, do possess medium-risk and are worth digging into further.

Name Short-Sell TargetCompany

Role in TargetCompany*

Current Company & Role

Xiangdong Qi 360 SecurityTechnology

Co-Founder(Former President &Director)

Qi An Xin - Substantial Shareholder; Beijing DigitalTelecom (SEHK:6188) - Board Member

PetersonAmy C

Beigene Former CMO CytomX Therapeutics - Senior Key Executive

Insider Diagnostics: A Repository of Short-Sell Target Asian Companies & Associated Key Insiders

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YairAverbuch

Caesarstone Former CFO Xjet Ltd - CFO

ChenggonFan

Cheetah Mobile CTO Memverge Inc - Founder & CEO

King KuenHung(Randy)

China Fiber Optic CFO China Shineway Pharmaceutical Group Limited -Head of IR

Wai Kei Lam(Jacky)

ChinaMediaExpress

CFO Bojun Education Company Limited (SEHK:1758) -Secretary

Kwok HoTam(Ronald)

Chong Sing CFO Huize Holding Limited (NasdaqGM:HUIZ) - Head ofIR

Ma Chun Kei Ct Environmental CFO Jianzhong Construction Development Limited(SEHK:589) - CFO

Hardy Zhang Deer ConsumerProducts

Chairman - AuditCommittee

Hero Faith International Enterprise Limited - CFO

Jiangong Dai(Richard)

Fang Holdings(Soufun)

CEO & BoardMember;Chairman's Nephew

Yiyi Holdings - Co-Founder & CEO

RayCatroppa

HW Holdings CFO and Secretary SABR Capital Management - ED & Board Member

MosheMizrahy

InMode Ltd Chairman & CEO InMode Ltd; Home Skinovations - Chairman & CEO;InsightLook Technologies - Top Key Executive;Escape Rescue Systems, Periness Ltd, PolymerLogistics - Chairman; Genoa Color Technologies -Board Member

DrewBernstein(MarcumLLPChairman)

IT TechPackaging

Chairman - Auditor Marcum LLP; Bernstein & Pinchuk LLP (Auditor) -Top Key Executive

Omar SharifKhan

Link Motion Co-CEO Enseo Inc - President (2017-2018); Magic Leap -Chief Product Officer

Sean Shao Luckin Coffee Head of AuditCommittee

China Photovoltaic Group - CFO

Oron Yacoby-Zeevi

Neuroderm Ltd Chief ScientificOfficer

NeuroSense Therapeutics - Chief Scientific Officer& Board Member; Kinarti - Co-Founder & ChiefScientific Officer

Lord PatrickMeade

NMC Health Chairman - AuditCommittee

Soma Oil & Gas Holding - Board Member; AngusEnergy (AIM:ANGS) - Shareholder

AbdulrahmanBasaddiq

NMC Health Board Member;Former Partner -Auditor (E&Y);Board Member -Related Party(Finablr)

UAE Exchange Center - Board Member

Wai MingWong

ProsperousFuture Holdings

Chairman - AuditCommittee

Baofeng Modern International - CFO

Jingbo Wang Qutoutiao Co-CFO Agora.io - CFO

HiranyaAshar

Rolta India CFO Axcelus Finserv Private Limited - Co-Founder & MD

RameshDungarmalTainwala

Samsonite CEO Tainwala Chemicals & Plastics (BSE:507785) -Minority Shareholder

Yung KwokTsui

ShenguanHolding

Chair - AuditCommittee

Shenguan Holding - Board Member; Ju TengInternational Holdings Limited (SEHK:3336) - CFO& Minority Shareholder

Carl Yueng Sky-Mobi CFO CFO - Qudian Inc; Director - Bumps to BabesLimited

Xiaoning Gao SpreadtrumCommunications

CFO VeriSilicon Holdings Co. Ltd. - Former CFO(2014-XXXX)

Li Kwong Yuk Superb SummitInternationalGroup

SubstantialShareholder

Dingyi Group Investment Limited (SEHK:508) -Chairman, Top Key Executive & MajorityShareholder

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Tak WahTam

Tech Pro Head - AuditCommittee

DigiTel Group Limited - CFO & Financial Controller;Future World Financial Holdings Limited(SEHK:572) - Board Member; Kingbo Strike Limited(SEHK:1421) - Board Member; Goldenway, Inc. -Board Member

Po Ling Low West ChinaCement

CFO Aquatic Foods Group plc - CFO & Board Member(2016-17)

Zishen Wu YongyeInternational

Chairman & CEO Yongye International; Inner Mongolia YongyeBiotechnology, Co., Ltd. - Top Key Executive

YonghuaWang

Zhou Hei YaInternational

SubstantialShareholder

Shenzhen Tiantu Capital Co - Founder & Chairman

Pan Pan Zhou Hei YaInternational

Board Member Shenzhen Tiantu Capital Co - Managing Partner

*At the Time of the Short-Seller Report | Source: Short-Seller Reports, CapIQ, LinkedIn, Web Search

Notable External Agencies

Below we list some external agencies which, in the past, have hadquestionable track record of overseeing governance and in some cases havebeen alleged to be complicit in purported mis-governance at the short-selltarget companies.

An insightful short-sell video by Muddy Waters on target companies - RinoInternational and Fushi Copperweld - refer to a media article which talksabout how a network of Law Firms, Accountants, Consultants andInvestments Banks help some Chinese companies to orchestrate fraud withthe network being collectively referred to as "Fraud School". Some notablenames mentioned in this video in context of the Fraud School and in relationto Rino International and Fushi Copperweld include a HK based investmentfirm, Chief Capital, and an auditor, Jimmy CH Cheung & Co. These alongwith other potential risky external agencies that we eked out from the short-seller reports are mentioned below. Association of these agencies with anycompany should automatically ring alarm bells and push one to pursuedeep-dive due diligence into governance.

Name Short-Sell Target Company Role in Target Company*

BDO Limited (HK) Gulf Resources, IT Tech Packaging,Shougang Fushan

Auditor Company

Chief Capital Fushi Copperweld, KingoldJewelery

Investment Bank

chineseinvestors.com Pingtan Marine Enterprise General InvestingWebsite (StockPromoter)

Elite Partners CPA Ltd China Household, Real Nutriceutical Auditor Company

Frazer Frost LLP (earlier Moore, StephensWurth Frazer and Torbet, LLP)

China Valves Technology Inc.,Harbin Electric

Auditor Company

Goldman Kurland & Mohidin LLP Deer Consumer Products Auditor Company

HLM CPA Ltd NOVA Group Holdings Auditor Company

Incipient Capital Quintis Dubai Merchant Banker

Jäderberg & Cie. GmbH Quintis German InstitutionalBank

Jaspers & Hall PC L&L Energy Inc Auditor

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Jimmy CH Cheunhg & Co Fushi Copperweld, KingoldJewelery

Auditor Company

MaloneBailey LLP China Customer Relations Center Auditor Company

Marcum LLP Hailiang Education, Hexindai, LinkMotion

Auditor Company

Network 1 Financials Hailiang Education Underwriter

New York Global Group Deer Consumer Products Stock Promoter &Advisor

Peak Vision Appraisals Ltd NOVA Group Holdings Independent Appraiser

Pender Newkirk & Company LLP Gulf Resources Auditor Company

Rodman & Renshaw LLC Hongli Clean Energy Technologies,Pingtan Marine Enterprise

Broker

Shenzhen Pengcheng CPA Co. Ltd Shenguan Holding Auditor Company

Ting Ho Kwan & Chan CPA Limited REXLot Holdings Auditor Company

ViewTrade Securities China Customer Relations Center Stock Promoter

*At the Time of the Short-Seller Report | Source: Short-Seller Reports, WebSearch

Does Presence of Global Renowned Auditors/Investment Banks implyStrong Governance? Based on the various short-seller reports, it seemspresence of a Big 4 auditor or other top global auditors like Grant Thorton,BDO, etc. and even investment banks like UBS, JP Morgan, etc. should notnecessarily be associated with high-quality governance. There have beencases of significant oversight, gross negligence and in some cases intentionalinvolvement in the wrongdoing allegedly due to hand-in-glove relationshipsof these firms' local/regional partners with the management teams of theshort-sell target companies. Below we present some quotes from the short-seller reports in this context.

Insider Diagnostics: A Repository of Short-Sell Target Asian Companies & Associated Key Insiders

Ankit Agrawal, CFA 35

Some of the “independent” directors appear to us independent in name

only. Abdulrahman Basaddiq is a former Ernst & Young country partner

who is on the board of Shetty-controlled Finablr. Thus, we do not

believe he is truly independent. Jonathan Bomford, meanwhile, is also

a former Ernst & Young partner, and he also serves on the Finablr

board. These NMC directors remind us of the board of Sino Forest,

which we once called “the retirement plan for former Ernst & Young

partners”. (In our view, the cozy relationship between these former EY

partners and Sino-Forest’s then-auditor – EY – contributed to a lack of

rigor in the audit.) - Comment on E&Y in Muddy Waters Short-Sell

Report on NMC Health

LFT is audited by Deloitte Touche Tohmatsu, the mainland China arm

of Deloitte & Touche. Prior to this year, investors would have regarded

Deloitte as “the gold standard” for accounting in China. However, in the

wake of the CCME debacle, in which Deloitte’s recent resignation letter

identified no less than ten separate instances of the most egregious

corporate malfeasance, Citron has to wonder how it was that Deloitte

was all too happy to sign off on CCME’s books in 2009. Obviously the

halo over Deloitte’s head has been broken. There are a lot of bridges to

be crossed before Longtop’s current-year audit can be put to bed. -

Comment on Deloitte in Citron's Short-Sell Report on Longtop

Finanacial

The auditors of CHBT are BDO Limited…..who should not be confused

with BDO Seidman, as all they really share with that big-name firm are

3 letters in their name as explained in this article by China Company

Analyst. BDO seems to have become the auditor du jour for

questionable Chinese public companies. - Comment on BDO in

Citron's Short-Sell Report on China Biotics

For our curiosity, we would like to see PwC be included in ASIC’s first

call list to understand if either (a) PwC partners are inept and incapable

of catching fraud within a network of PwC audited companies, or (b)

the PwC partners involved in the audit are complicit and received

compensation from the fraudulent scheme (we suggest to start with a

review of RFM payments to suppliers) - Comment on PwC in Bonitas'

Short-Sell Report on Rural Funds Group (RFM)

In our opinion, this situation has arisen due to a complete failure of

Eros’s auditor, Grant Thornton, to apply even basic scrutiny to Eros’s

financials. - Comment on Grant Thorton in Hindenburg Research's

Short-Sell Report on Eros

Mary had a little lamb, Joyce Wei has an IPO. Wherever the daughter of

Tianhe Chemicals chairman Wei Qi goes, follows the potential US$1

billion IPO deal. First, it was JP Morgan Chase that was supposed to be

working on the initial public offering of the Liaoning-based company.

Joyce Wei was then working as an investment banking associate there.

Then in November last year, she resigned and joined UBS, and the US

bank stopped work on the offering. It would henceforth be handled by the

“Insider Diagnostics: A Repository of Short-Sell Target Asian Companies & Associated Key Insiders

Ankit Agrawal, CFA 36

Swiss bank she just joined as a Hong Kong-based junior-level employee in

its investment banking section.- Comment on UBS & JP Morgan in a

South China Morning Post Article on Tianhe Chemicals IPO

Key Limitations

Data Availability: In our analysis, we have relied significantly on Capital IQdata for tracking the career moves of key insiders. In certain cases, CapitalIQ does not have the latest whereabouts and in others the most recent datamay not necessarily reflect the current whereabouts accurately. Also, wenote that Capital IQ especially lacks data for situations where the key insiderhas moved to a non-public company given that the information pertainingto senior management of such companies is not as widely published.Accordingly, we were unable to locate the current whereabouts of a largenumber of key insiders. For such cases, while we engaged web search andalso referred to Linkedin data, we still failed to obtain information on asubstantial number of key insiders, especially those that are located inChina.

Short-Sell Target Universe: In our above analysis, while we have tried tocover as many as possible short-sellers and companies targeted by them(over the last decade), we may have missed some companies or short-sellersas we have relied mostly on personal knowledge, web search and short-seller's website to build our short-sell target companies universe.

Disclaimer: Note that the intention of the above insight is to synthesis dataand insights from various short-seller reports to identify insiders/companiesthat have been targeted by short-sellers in the past. In certain cases, we havetaken the lead from the short-seller reports to identify additional insidersbased on annual company filings and other company reported data.Inclusion of any insider/company name in the above insight is purely forresearch and analysis purposes. It should neither be construed as anallegation of any misdeed or mis-governance nor should it be taken as arecommendation to avoid the above-mentioned insiders/companies. Theflagging of some insiders, companies and agencies as high-risk is just tohighlight areas that need deeper research and due diligence.

Insider Diagnostics: A Repository of Short-Sell Target Asian Companies & Associated Key Insiders

Ankit Agrawal, CFA 37

Disclosure & Certification

• I/We have no position(s) in the any of securities referenced in this insight

• Views expressed in this insight accurately reflects my/our personal opinion(s) about the referenced securities and issuers and/orother subject matter as appropriate.

• This insight does not contain and is not based on any non-public, material information.

• To the best of my/our knowledge, the views expressed in this insight comply with Singapore law as well as applicable law in thecountry from which it is posted

• I/We have not been commissioned to write this insight or hold any specific opinion on the securities referenced therein

• I/We have signed the Insight Provider Agreement and this insight does not violate any of the terms specified therein.

— Ankit Agrawal, CFA (24 May 2020)

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Supun Walpola

Equity Analyst

Luckin Coffee | Forensic Accounting

Short-Sell Strategies –How to Get TeflonCoated?By Supun Walpola | 30 Jun 2020

EXECUTIVE SUMM ARY

This insight has been produced jointly by Shifara Samsudeen, ACMA,CGMA and Supun Walpola at LightStream Research

• In this Smartkarma Original, we provide a guide on short-sell strategiesemployed by short-sellers to identify, analyse, and subsequently targetcompanies. We also provide our recommendations to companies toprevent, detect, and combat short-sell attacks.

• We believe companies whose share prices have increased significantlywithin a short period of time and whose valuations are at significantpremiums to their peers become vulnerable for short-sell attacks. Theshare price of the short-sell targets in our sample increased by 89.2% onaverage from its 52-week low to the date of release of the short-sellreport. The EV/Revenue, EV/OP, P/E, and P/B multiples of the short-selltargets in our sample were at premiums of 241.2%, 37.6%, 42.5%, and118.7% on average over their peers, respectively.

• Short sellers also seem to target companies that significantlyoutperform their peers on operating matrices. Short-sellers imply thatsuch outperformance is due to fabricated results. The OP margin of theshort-sell targets in our sample were around 4.5x higher than theirpeers.

• It is conventional wisdom that insiders cash-out when they are nolonger confident about the prospects of the company. Short sellers tryto exploit this idea and are often on the lookout for instances whereinsiders are continuously cashing out, either by way of selling theirstake in the company, or through back door transactions like sharepledges, collar transactions, and high levels of compensation.

• Short-sellers show no mercy when it comes to questionable or complexcorporate structures like VIE arrangements either. Short-sellers are ofthe view that such dubious corporate structures enable companies toround trip revenue and assets to fabricate financial results. Short-

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sellers are also on the lookout for suspicious M&A transactions withrelated parties, particularly overvalued asset sales to and undervaluedasset purchases from insiders.

• When a company fakes revenue or profit at the income statement level,it leads to a fake cash problem, i.e. the company then has to forgesignificant cash balances to match its inflated profit. Short sellersbelieve that inflated capex or R&D expenses are helpful tools to burnfake cash as these expenses often do not raise any suspicion if they donot generate instant returns.

• Short-sellers also seem to target companies and insiders thathistorically have a bad reputation. We also came across severalinstances where short-sellers have questioned the track record ofauditors, underwriters, and appraisers that were employed by the targetcompanies. Short-sellers also consider frequent auditor changes andaudit fees that are either too-high or too-low as red-flags.

• Short-sellers regularly keep an eye out for companies with weakercorporate governance practices. However, some of the cases that wecame across in our research suggest that traditional corporategovernance matrices have limited relevance in exposing fraudsters inthis day and age. Short-sellers now seem to question the true“independence” of independent directors and are sceptical aboutcompanies with high board turnover.

• A short-seller can identify a plethora of red-flags for a company, but ashort-sell attack is seldom successful without any smoking-gunevidence. Therefore, short-sellers often thrive on finding that one keypiece of evidence that would make their thesis irrefutable. In most ofthe cases we looked at, this smoking gun evidence has come in the formof alternative filings, which include the likes of filings with the localregulators, credit reports, and tax filings. Short sellers have often usedthese alternative filings to reconcile reported financials and in somecases to trace the “true” ownership of assets.

• We believe recent short-sell reports on Luckin Coffee (LK US) and GSXTechedu (GSX US) raise the bar for modern-day short-sellers. Theanonymous short-sell report on Luckin was backed by 11,000+ hours ofstore traffic video and 25,000+ customer receipts while Grizzly’s short-sell report on GSX Techedu used a variety of alternative data sourcessuch as customer reviews, web traffic, keyword search results and apprankings as smoking-gun evidence.

• Short-seller attacks have become part of today’s investment world andcompanies should learn to co-exist with them and more importantly, todefend these attacks, companies should have a plan in place whilestrengthening their fundamentals and improving corporate disclosures.

• In order to prevent short-seller attacks we recommend companies to 1)be honest about any errors and make due restatements to reportedfinancials, 2) adopt conservative accounting practices, 3) avoidproviding aggressive earnings guidance, 4) provide detailed disclosureswhen deviating from accepted accounting standards, 5) avoidwithholding or delaying bad news such as product failures, litigation,

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profit warnings, layoffs, etc. from the market, 6) improve corporategovernance measures, 7) and improve company disclosures particularlyregarding company acquisitions, divestitures, and capital investments.

• If a company has always been committed to providing completedisclosures and its shareholders are kept informed about both good andbad news regarding a company, the best way to approach the shortsmay be to completely ignore them. However, a company should respondto a short sell attack if the allegations laid out by the shorts wereunreasonable or misleading or if it is impacting the company’svaluation.

DE TAIL

PART A: Short-Sell Strategies

“We are short-sellers. We are biased. Just because we are biased does

not mean that we are wrong” – Blue Orca

In this section of the report, we take a look at short-sell strategies employedby short-sellers to identify, analyse and subsequently target companies. Wehave taken a qualitative approach to our research, and after going through asample of thirty short-sell reports on Asian companies that were publishedin the past two years (the “sample”), we have highlighted below (in noparticular order), the biggest areas of vulnerabilities in the target companiesthat short-sellers have gone after.

Rapid Price Rallies and BloatedValuations

Our analysis suggests that short-sellers tend to target companies whoseshare prices have increased significantly within a short period of time. Onaverage, the share price of the companies in our sample increased by 89.2%from its 52-week low to the date of release of the short-sell report.

Ticker Company Name ReportDate

Change in the SharePrice

1-Year 52-week low

SEHK: 2020 ANTA Sports Products Limited 07/07/2019

38.8% 90.4%

SEHK: 1717 Ausnutria Dairy Corporation Ltd 14/08/2019

26.5% 79.6%

NAsdaqGS:BGNE

BeiGene, Ltd. 05/09/2019

-22.6% 24.6%

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SGX: CGN Best World International Limited 24/04/2019

0.6% 40.9%

SEHK: 3998 Bosideng International Holdings Limited 24/06/2019

92.2% 90.1%

NasdaqCM:CCRC

China Customer Relations Centers, Inc. 14/11/2018

-11.8% 56.8%

SEHK: 867 China Medical System Holdings Limited 06/02/2020

28.8% 66.1%

SEHK:715 China Oceanwide Holdings Limited 01/11/2018

-40.6% 11.8%

NasdaqGS:FANH

Fanhua Inc. 17/01/2019

-23.8% 3.7%

NYSE:GSX GSX Techedu Inc. 25/02/2020

N/A 416.9%

SEHK: 1044 Hengan International Group Company Limited 12/12/2018

-28.2% 3.4%

NASDAQ: HX Hexindai Inc. 15/01/2019

-73.9% 50.9%

NYSE: JKS JinkoSolar Holding Co., Ltd. 04/03/2020

23.1% 60.2%

SEHK: 496 Kasen International Holdings Limited 21/11/2019

-88.3% 4.6%

NASDAQ: LK Luckin Coffee Inc. 01/01/2020

N/A 187.1%

OTCPK:NMMC.F NMC Health Plc 17/12/2019

-7.9% 43.5%

SEHK: 1360 NOVA Group Holdings Limited 09/05/2019

51.3% 74.6%

NasdaqGS:OPRA

Opera Limited 16/01/2020

-0.1% 15.3%

NasdaqGM: HLG Hailiang Education Group Inc. 09/04/2018

706.8% 974.2%

TSE: 4587 PeptiDream Inc. 06/11/2019

30.6% 33.9%

NasdaqGS: PDD Pinduoduo Inc. 14/11/2018

N/A 15.8%

SEHK:1196 Realord Group Holdings Limited 21/08/2019

-10.2% 2.2%

ASX: RFF Rural Funds Group 06/08/2019

-30.1% 0.0%

SEHK: 1910 Samsonite International S.A. 24/05/2018

4.2% 5.9%

NasdaqCM:SKYS

Sky Solar Holdings, Ltd. 25/02/2019

-18.2% 62.2%

SEHK:1573 Southern Energy Holdings Group Limited 29/07/2019

-18.9% 3.5%

NYSE: TAL TAL Education Group 13/06/2018

105.0% 114.4%

NasdaqGS: UXIN Uxin Limited 15/04/2019

N/A 8.5%

ASX:WTC WiseTech Global Limited 16/10/2019

90.9% 124.4%

SEHK:1458 Zhou Hei Ya International Holdings CompanyLimited

01/03/2019

-56.6% 11.5%

Average 29.5% 89.2%

Source: LSR

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Valuations of the companies in our sample were also high compared to itspeers. EV/Revenue, EV/OP, P/E, and P/B multiples of the companies in oursample were at premiums of 241.2%, 37.6%, 42.5%, and 118.7% on averageover its peers, respectively.

Ticker CompanyName

Date Company Peer Average Premium

EV/Re

EV/OP

P/E P/BV

EV/Re

EV/OP

P/E P/BV

EV/Re EV/OP

P/E P/BV

SEHK: 2020 ANTASportsProductsLimited

07/07/2019

5.1 21.5 37.5 8.3 1.3 20.5 33.7 2.5 291% 5% 11% 230%

SEHK: 1717 AusnutriaDairyCorporationLtd

14/08/2019

2.9 17.9 27.2 5.0 5.6 27.3 47.1 9.2 -48% -34% -42% -45%

NAsdaqGS:BGNE

BeiGene,Ltd.

05/09/2019

15.4 N/A N/A 5.1 17.2 23.7 52.9 5.2 -10% N/A N/A -2%

SGX: CGN Best WorldInternationalLimited

24/04/2019

2.6 7.4 15.2 5.1 3.4 35.1 88.2 9.0 -24% -79% -83% -43%

SEHK: 3998 BosidengInternationalHoldingsLimited

24/06/2019

1.5 11.8 21.9 1.7 1.4 22.7 30.0 1.9 9% -48% -27% -10%

NasdaqCM:CCRC

ChinaCustomerRelationsCenters, Inc.

14/11/2018

1.8 11.9 21.5 4.6 1.0 39.3 49.8 1.4 78% -70% -57% 238%

SEHK: 867 ChinaMedicalSystemHoldingsLimited

06/02/2020

3.8 9.7 15.7 2.4 3.7 27.6 49.3 3.1 4% -65% -68% -22%

SEHK:715 ChinaOceanwideHoldingsLimited

01/11/2018

108.9 276.2 264.6 0.6 15.7 43.0 65.3 0.7 592% 543% 305% -12%

NasdaqGS:FANH

Fanhua Inc. 17/01/2019

2.0 11.2 17.3 3.2 1.3 19.1 54.4 1.7 61% -41% -68% 91%

NYSE:GSX GSXTecheduInc.

25/02/2020

34.0 N/A N/A 47.0 3.1 58.0 81.1 7.1 1001% N/A N/A 563%

SEHK: 1044 HenganInternationalGroupCompanyLimited

12/12/2018

2.8 12.4 19.0 3.5 2.0 23.0 33.3 3.0 39% -46% -43% 14%

NASDAQ: HX HexindaiInc.

15/01/2019

0.7 1.2 3.4 1.1 2.7 9.1 21.1 4.2 -75% -87% -84% -74%

NYSE: JKS JinkoSolarHolding Co.,Ltd.

04/03/2020

0.9 19.8 19.7 0.8 1.6 22.5 29.0 32.0 -45% -12% -32% -97%

SEHK: 496 KasenInternationalHoldingsLimited

21/11/2019

0.3 1.5 1.1 0.2 0.4 26.0 32.0 0.7 -33% -94% -96% -71%

NASDAQ: LK LuckinCoffee Inc.

01/01/2020

18.4 N/A N/A 10.5 3.9 46.3 43.4 4.4 372% N/A N/A 139%

OTCPK:NMMC.F NMC HealthPlc

17/12/2019

4.0 22.1 41.9 5.0 1.6 23.7 33.9 1.7 143% -7% 23% 199%

Short-Sell Strategies – How to Get Teflon Coated?

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SEHK: 1360 NOVAGroupHoldingsLimited

09/05/2019

9.3 27.0 42.9 15.2 1.8 7.6 12.8 2.0 417% 255% 236% 648%

NasdaqGS:OPRA

OperaLimited

16/01/2020

2.7 14.4 26.9 1.0 3.4 39.0 65.5 5.8 -21% -63% -59% -83%

NasdaqGM:HLG

HailiangEducationGroup Inc.

09/04/2018

11.7 61.0 101.8 10.7 8.7 30.9 48.6 5.0 35% 98% 109% 116%

TSE: 4587 PeptiDreamInc.

06/11/2019

91.2 183.7 289.9 38.1 10.7 38.0 61.3 4.3 754% 383% 373% 786%

NasdaqGS: PDD PinduoduoInc.

14/11/2018

24.8 N/A N/A N/A 2.6 27.9 29.3 2.5 857% N/A N/A N/A

SEHK:1196 RealordGroupHoldingsLimited

21/08/2019

15.7 N/A N/A 2.1 2.1 18.1 27.0 1.1 633% N/A N/A 82%

ASX: RFF Rural FundsGroup

06/08/2019

11.5 14.9 20.5 0.9 1.1 21.0 16.4 1.2 990% -29% 24% -29%

SEHK: 1910 SamsoniteInternationalS.A.

24/05/2018

2.0 15.9 26.9 3.0 3.5 21.9 34.9 4.1 -43% -27% -23% -28%

NasdaqCM:SKYS

Sky SolarHoldings,Ltd.

25/02/2019

4.2 9.1 N/A 0.4 23.7 66.5 35.1 1.8 -82% -86% N/A -80%

SEHK:1573 SouthernEnergyHoldingsGroupLimited

29/07/2019

9.6 20.6 34.5 5.2 1.5 6.7 11.9 1.0 533% 205% 190% 429%

NYSE: TAL TALEducationGroup

13/06/2018

11.3 96.1 166.3 14.1 1.6 35.7 37.5 2.2 596% 170% 344% 541%

NasdaqGS:UXIN

Uxin Limited 15/04/2019

2.1 N/A N/A 2.6 1.6 21.7 50.5 2.7 31% N/A N/A -6%

ASX:WTC WiseTechGlobalLimited

16/10/2019

29.6 121.6 205.7 13.8 9.0 59.5 98.9 11.7 231% 104% 108% 18%

SEHK:1458 Zhou Hei YaInternationalHoldingsCompanyLimited

01/03/2019

1.4 6.0 12.5 1.8 2.9 21.5 35.2 3.5 -51% -72% -64% -50%

Average 14.4 41.5 62.4 7.3 4.7 29.4 43.6 4.6 241% 38% 43% 119%

Median 4.2 15.9 26.9 4.0 2.7 26.0 37.5 3.0 61% -29% -25% 6%

High 108.9 276.2 289.9 47.0 23.7 66.5 98.9 32.0 1001% 543% 373% 786%

Low 0.3 1.2 1.1 0.2 0.4 6.7 11.9 0.7 -82% -94% -96% -97%

Source: LSR

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Superior Operating Performance

“Things that look too good to be true usually are.” – an old proverb (as

seen on Blue Orca’s short-sell report on China Medical System

Holdings)

Following are three extracts from short-sell reports on NMC Health PLC(NMC LN), GSX TechEdu, and Best World International (BEST SP) (BWI), byMuddy Waters (MW), Grizzly, and Bonitas, respectively. In all threeinstances, the target company had posted industry-leading profit margins,which short-sellers thought to be suspicious and worthy of furtherinvestigation.

An extract from MW’s short-sell report on NMC Health

Source: MW

An extract from Grizzly’s short-sell report on GSX TechEdu

Source: Grizzly

An extract from Bonitas’ short-sell report on BWI

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Short-Sell Strategies – How to Get Teflon Coated?

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Source: Bonitas

On average, the OP margin of the companies that are in our sample werearound 4.5x higher than its peers, and in some instances, theoutperformance was as high as 30x. This reaffirms the idea that companiesthat significantly outperform their peers are often targeted by short-sellers.

Ticker Company Name Date Company Peer Average Premium(x)

OPM NPM OPM NPM OPM NPM

SEHK: 2020 ANTA Sports ProductsLimited

07/07/

2019

25.6% 16.4% 8.3% 5.1% 3.1 3.2

SEHK: 1717 Ausnutria DairyCorporation Ltd

14/08/

2019

15.8% 9.5% 22.2% 16.0% 0.7 0.6

NAsdaqGS:BGNE

BeiGene, Ltd. 05/09/

2019

-159.3% -153.3% -90.3% -325.9% 1.8 0.5

SGX: CGN Best World InternationalLimited

24/04/

2019

34.6% 26.4% 4.3% 3.2% 8.1 8.4

SEHK: 3998 Bosideng InternationalHoldings Limited

24/06/

2019

13.8% 9.4% 5.3% 0.7% 2.6 14.5

NasdaqCM:CCRC

China Customer RelationsCenters, Inc.

14/11/

2018

7.0% 6.8% 6.2% -4.0% 1.1 -1.7

SEHK: 867 China Medical SystemHoldings Limited

06/02/

2020

37.9% 35.9% 23.1% 16.7% 1.6 2.2

SEHK:715 China Oceanwide HoldingsLimited

01/11/

2018

-87.3% -82.1% 41.5% 53.7% N/A -1.5

NasdaqGS:FANH

Fanhua Inc. 17/01/

2019

11.7% 15.7% 2.9% 2.1% 4.0 7.3

NYSE:GSX GSX Techedu Inc. 25/02/

2020

9.2% 8.2% -8.1% -10.8% N/A -0.8

SEHK: 1044 Hengan InternationalGroup Company Limited

12/12/

2018

22.8% 17.6% 8.3% 6.7% 2.7 2.6

Short-Sell Strategies – How to Get Teflon Coated?

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NASDAQ: HX Hexindai Inc. 15/01/

2019

-260.8% -214.5% 19.8% 13.0% N/A -16.5

NYSE: JKS JinkoSolar Holding Co., Ltd. 04/03/

2020

3.4% 1.7% 4.6% 3.0% 0.7 0.6

SEHK: 496 Kasen InternationalHoldings Limited

21/11/

2019

19.5% 12.7% 0.6% -2.1% 30.7 -5.9

NASDAQ: LK Luckin Coffee Inc. 01/01/

2020

-112.1% -114.0% 10.5% 10.0% N/A -11.4

OTCPK:NMMC.F NMC Health Plc 17/12/

2019

18.1% 11.4% 7.9% 2.7% 2.3 4.2

SEHK: 1360 NOVA Group HoldingsLimited

09/05/

2019

47.0% 18.7% 8.3% 6.1% 5.6 3.1

NasdaqGS:OPRA

Opera Limited 16/01/

2020

13.1% 14.1% 7.4% 5.0% 1.8 2.8

NasdaqGM:HLG

Hailiang Education GroupInc.

09/04/

2018

26.7% 19.6% 24.3% 21.9% 1.1 0.9

TSE: 4587 PeptiDream Inc. 06/11/

2019

49.6% 38.4% -214.9% -198.9% N/A -0.2

NasdaqGS: PDD Pinduoduo Inc. 14/11/

2018

-36.1% -30.7% 5.8% 6.0% N/A -5.1

SEHK:1196 Realord Group HoldingsLimited

21/08/

2019

5.8% 6.4% 5.5% 5.2% 1.1 1.2

ASX: RFF Rural Funds Group 06/08/

2019

71.3% 47.0% 3.0% 1.5% 23.6 31.6

SEHK: 1910 Samsonite InternationalS.A.

24/05/

2018

11.3% 5.9% 14.8% 12.1% 0.8 0.5

NasdaqCM:SKYS

Sky Solar Holdings, Ltd. 25/02/

2019

44.2% -76.7% 24.9% 27.5% 1.8 -2.8

SEHK:1573 Southern Energy HoldingsGroup Limited

29/07/

2019

45.9% 31.2% 19.2% 15.1% 2.4 2.1

NYSE: TAL TAL Education Group 13/06/

2018

11.9% 10.8% -11.9% -10.1% N/A -1.1

NasdaqGS:UXIN

Uxin Limited 15/04/

2019

-43.4% -42.5% 6.7% 4.2% N/A -10.2

ASX:WTC WiseTech Global Limited 16/10/

2019

24.4% 15.5% 22.8% 10.8% 1.1 1.4

SEHK:1458 Zhou Hei Ya InternationalHoldings Company Limited

01/03/

2019

14.5% 13.3% 9.7% 8.9% 1.5 1.5

Average -3.8% -10.7% -0.2% -9.8% 4.5 1.1

Median 13.8% 10.8% 7.4% 5.1% 1.8 0.9

High 71.3% 47.0% 41.5% 53.7% 30.7 31.6

Low -260.8% -214.5% -214.9% -325.9% 0.7 -16.5

Source: LSR

Short-Sell Strategies – How to Get Teflon Coated?

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Short-sellers often try to imply that such outperformance is due to fraud.Refer the following extract from MW’s short-sell report on Anta SportsProducts (2020 HK).

Source: MW

Insiders Cashing Out

"Don’t bet on science – bet on the management” - Michael Pearson,

former CEO of Valeant Pharmaceuticals.

It is conventional wisdom that insiders cash-out when they are no longerconfident about the prospects of the company. Short-sellers try to exploitthis idea. Most short-sellers also field the idea that insiders cashing-out is agood “motive” for fraud (for example, a company would be inclined to cookits books and manipulate the stock price, so that insiders can cash-outhandsome returns). Therefore, short-sellers seem to actively look forinstances where insiders have reduced their holdings in companies toidentify potential targets that are worthy of further investigation.

The Chinese biopharma company, BeiGene (BGNE US), which came under ashort-sell attack from J Capital is a good example of this. In BeiGene’s 4Q2018 earnings call, the company’s CEO and co-founder, John Oyler, had toldinvestors that:

"We believe that we're part of a once-in-a-lifetime opportunity that will

positively and fundamentally change how drugs are developed globally

and in the future. BeiGene was created with this opportunity in mind,

and it is indelibly imprinted in our DNA."

However, according to J Capital, BeiGene’s senior management had solddown a total of $322m in shares since its listing, with the company’s co-founder, John Oyler, alone selling around $189m in shares. The short-sellersuggested that it is counter-intuitive for the management to cash out sosoon if BeiGene is a “once-in-a-lifetime opportunity” as promised to theinvestors.

“

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Short-Sell Strategies – How to Get Teflon Coated?

Supun Walpola 48

Source: LSR and CapIQ

Insider transactions are generally disclosed, thereby, making it easier to spotwhen the management is cashing out from a company by way of selling theirstake. Therefore, over the years, fraudsters have employed many differentschemes, that are far less obvious and far less visible, to cash-out from theback door.

One such instance is through share pledges, where insiders secure loansfrom financial institutions by pledging their shares as collateral. Bonitas, inits short-sell report on Hosa International (2200 HK) (Hosa), suggested thataround 35% of Hosa’s shares were pledged as collateral by insiders, and onthe 29th of June 2018, Hosa’s stock plunged by around 87% as a result of thebanks selling just 2% of these pledged shares to secure margin financingrequirements.

Hosa’s share price fell by 87% on a single day after banks sold just 2%of pledged shares

Source: Bonitas/Bloomberg

Short-Sell Strategies – How to Get Teflon Coated?

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Shares pledged as securities was also one of the main weaknesses MWidentified in its recently successful short-sell attack on NMC Health. MWestimated that insiders have cashed out over £1bn from NMC Health in thepast two years, and incidentally, only £45m of this was through outright saleof shares, while £700m was through share pledges and further £250m wasthrough a collar transaction.

An extract from MW’s short-sell report on NMC Health

Source: Muddy Waters

Short-sellers have also flagged situations where insider compensations havegrown rapidly citing that the management may be cashing out at theexpense of the business. This was another point that MW highlighted in itsshort-sell report on NMC Health. According to MW, NMC’s managementcompensation had grown by nearly 6x over the past four years.

Another example of this is Bonitas’ short-sell report on BWI. Bonitasaccused that, BWI’s founders, Dora Hoan and Doreen Tan, haveexponentially accelerated their combined annual take-home pay by 20x infive years, from earning less than SGD 2m in 2013 to receiving SGD 40m+ incash in 2018, at the expense of the company’s liquidity (BWI’s payablesbalance was at an all-time high of SGD95m and its receivables were touchingall-time lows at SGD5m in 2018).

An extract from Bonitas’ short-sell report on BWI

Short-Sell Strategies – How to Get Teflon Coated?

Supun Walpola 50

Source: Bonitas

Dubious Corporate Structures

“If you own China stocks and do not know the basics of the VIE

structure and the related concerns, you have no business investing in

these stocks” – MW (in its short-sell report on TAL Education).

Round tripping is a common method that fraudsters use to cook their books.In short, round tripping refers to a situation where a company carries out aseries of fake transactions with undisclosed/disclosed related parties inorder to report fake sales and profits.

Our research suggests that, when short-sellers investigate a potential target,they almost always look to uncover evidence of any undisclosed relatedparties, which in most cases, are entities privately owned by either themanagement themselves or their relatives or proxies.

Bonitas, in its short-sell report on Bosideng Intl Hldgs (3998 HK), was able toidentify 45+ undisclosed related party entities for the company. Later, ananalysis of the credit reports of these related party entities revealed largebalances of undisclosed receivables and payables that were used to facilitatesham transaction volumes manifested as fabricated profits on Bosideng’sfinancial statements.

An extract from Bonitas’ short-sell report on Bosideng

“

Short-Sell Strategies – How to Get Teflon Coated?

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Source: Bonitas

This was also one of the central points of Blue Orca’s successful short thesison Samsonite (1910 HK). However, unlike J Capital, Blue Orca did not haveany smoking gun evidence that these transactions are fraudulent, andSamsonite had even disclosed these related party entities. However, the factthat these entities, with whom Samsonite frequently transacted, werecontrolled by the CEO was enough for Blue Orca to put together a plausiblethesis.

An extract from Blue Orca’s short-sell report on Samsonite

Source: Blue Orca

This suggests that short-sellers show no mercy when it comes toquestionable or complex corporate structures. China Customer RelationsCenters (CCRC US) (CCRC), which came under a short-sell attack by JCapital, for its VIE (Variable Interest Entity) structure, is one other example.

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A VIE structure allows Chinese companies in restricted sectors to raiseforeign capital. Under a typical VIE structure, foreign investors would ownan offshore entity (which is registered in a neutral location) which wouldhave contractual agreements with the domestic business that is controlledby the management. However, these VIE structures can be easilymanipulated by fraudsters for self-benefit, hence, short-sellers are oftenencouraged to go after companies with VIE structures.

Upon investigation, J Capital had found that CCRC’s relationship with theVIE has many red flags. In a typical VIE agreement, revenue and profits arepassed on to the ListCo by way of contractual agreements. However, as per JCapital, CCRC has not done this over the years, and are retaining theseearnings in the VIE’s books, and public shareholders of CCRC does nottechnically “own” any revenue or profits. J Capital highlighted this as one ofthe key red flags in its short thesis. J Capital also found out that the VIE hasbeen diverting cash to several undisclosed related parties.

An extract from J Capital’s short-sell report on CCRC

Source: J Capital

High Capex and R&D Spend

“Inflating capex facilitates fraudulent income reporting” – MW (in its

short-sell report on NMC Health)

Short-sellers believe that large capex or R&D expenses that aredisproportional to the scale of the business are signs of fraud. When acompany fakes revenue or profit at the income statement level, it leads to a

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fake cash problem i.e. the company then has to forge significant cashbalances to match its inflated profit. Inflated capex or R&D expenses arehelpful tools to burn fake cash as these expenses often do not raise anysuspicion if they do not generate instant returns.

Short-sellers are often on the lookout for red flags such as unnecessarycapital investments that are not justified by the company’s operatingcapacity and higher R&D spend per headcount. Refer the extracts belowfrom J Capital’s short-sell report on BeiGene.

Source: J Capital

Our analysis shows that capex as a percentage of revenue of the companiesin our sample is on average 1.2x higher than its peers. While this does notindicate a significant outperformance, in some cases, this was as high as5-6x. For example, Luckin Coffee’s capex as a percentage of revenue wasaround 4.9x higher than its peers, while its EBITDA/OCF ratio, which is anindicator of a potential “fake cash problem”, was around 1.3x higher than itspeers. Moreover, R&D expenses as a percentage of revenue of the companiesin our sample is on average 2.0x higher than its peers.

Ticker CompanyName

Date Company Peer Average Premium (x)

Capex/Rev

R&D/Rev

EBITDA/OCF

Capex/Rev

R&D/Rev

EBITDA/OCF

Capex/Rev

R&D/Rev

EBITDA/OCF

SEHK: 2020 ANTASportsProductsLimited

07/07/2019

3.4% 2.3% 1.2 3.1% 0.8% 1.0 1.1 2.8 1.2

SEHK: 1717 AusnutriaDairyCorporationLtd

14/08/2019

3.7% 2.0% 1.6 6.4% 0.8% 1.3 0.6 2.7 1.2

NAsdaqGS:BGNE

BeiGene,Ltd.

05/09/2019

21.5% 187.1% 1.2 25.8% 110.4% 1.0 0.8 1.7 1.2

SGX: CGN Best WorldInternationalLimited

24/04/2019

1.8% N/A 0.9 3.1% 1.1% N/A 0.6 0.0 N/A

SEHK: 3998 BosidengInternationalHoldingsLimited

24/06/2019

3.7% N/A 1.7 6.0% 2.4% 1.5 0.6 0.0 1.1

NasdaqCM:CCRC

ChinaCustomerRelationsCenters, Inc.

14/11/2018

3.0% 2.6% 1.3 0.9% 0.8% N/A 3.2 3.4 N/A

SEHK: 867 ChinaMedicalSystemHoldingsLimited

06/02/2020

0.8% N/A 1.1 10.1% 7.0% 1.1 0.1 0.0 1.0

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SEHK:715 ChinaOceanwideHoldingsLimited

01/11/2018

N/A N/A 0.1 1.8% 0.0% 1.3 N/A N/A 0.1

NasdaqGS:FANH

Fanhua Inc. 17/01/2019

0.6% N/A 1.0 1.0% 0.2% -0.2 0.6 0.0 -6.1

NYSE:GSX GSXTecheduInc.

25/02/2020

N/A 23.1% N/A 2.3% 1.3% N/A N/A 17.9 N/A

SEHK: 1044 HenganInternationalGroupCompanyLimited

12/12/2018

3.2% 1.9% 1.7 5.3% 1.0% N/A 0.6 2.0 N/A

NASDAQ: HX HexindaiInc.

15/01/2019

N/A 19.3% N/A 1.8% 1.6% N/A N/A 12.3 N/A

NYSE: JKS JinkoSolarHolding Co.,Ltd.

04/03/2020

N/A 1.2% N/A 13.5% 3.4% 1.1 N/A 0.3 N/A

SEHK: 496 KasenInternationalHoldingsLimited

21/11/2019

7.9% N/A 2.0 3.5% 0.4% 0.6 2.2 0.0 3.4

NASDAQ: LK LuckinCoffee Inc.

01/01/2020

48.0% N/A 1.0 9.8% 3.2% 0.8 4.9 0.0 1.3

OTCPK:NMMC.F NMC HealthPlc

17/12/2019

8.4% N/A 0.9 6.9% 0.0% 1.1 1.2 N/A 0.9

SEHK: 1360 NOVAGroupHoldingsLimited

09/05/2019

0.3% N/A -2.0 6.4% 1.7% N/A 0.1 0.0 N/A

NasdaqGS:OPRA

OperaLimited

16/01/2020

3.2% 17.3% 3.3 2.5% 9.8% 1.0 1.3 1.8 3.3

NasdaqGM:HLG

HailiangEducationGroup Inc.

09/04/2018

5.3% N/A 0.8 24.6% 0.0% 0.9 0.2 N/A 0.8

TSE: 4587 PeptiDreamInc.

06/11/2019

2.1% 15.8% 0.9 15.2% 192.6% N/A 0.1 0.1 N/A

NasdaqGS: PDD PinduoduoInc.

14/11/2018

0.1% 3.1% -0.7 2.9% 9.3% N/A 0.0 0.3 N/A

SEHK:1196 RealordGroupHoldingsLimited

21/08/2019

1.0% N/A 0.6 13.9% 0.0% -1.2 0.1 0.0 -0.5

ASX: RFF Rural FundsGroup

06/08/2019

23.2% N/A 1.3 3.5% 0.4% N/A 6.6 0.0 N/A

SEHK: 1910 SamsoniteInternationalS.A.

24/05/2018

2.3% 0.8% 1.2 4.8% 1.7% 1.4 0.5 0.5 0.8

NasdaqCM:SKYS

Sky SolarHoldings,Ltd.

25/02/2019

N/A N/A N/A 366.2% 0.0% 0.9 N/A N/A N/A

SEHK:1573 SouthernEnergyHoldingsGroupLimited

29/07/2019

0.1% N/A 1.3 11.9% 1.3% 1.1 0.0 0.0 1.2

NYSE: TAL TALEducationGroup

13/06/2018

N/A N/A N/A 3.1% 13.5% N/A N/A 0.0 N/A

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NasdaqGS:UXIN

Uxin Limited 15/04/2019

N/A 9.5% N/A 1.8% 2.2% N/A N/A 4.3 N/A

ASX:WTC WiseTechGlobalLimited

16/10/2019

1.9% 24.9% 0.9 3.1% 8.6% 1.2 0.6 2.9 0.7

SEHK:1458 Zhou Hei YaInternationalHoldingsCompanyLimited

01/03/2019

15.2% N/A 1.0 6.2% 1.0% N/A 2.5 0.0 N/A

Average 7.0% 22.2% 1.0 18.9% 12.5% 0.9 1.2 2.0 0.7

Median 3.2% 9.5% 1.0 5.3% 1.3% 1.0 0.6 0.3 1.0

High 48.0% 187.1% 3.3 366.2% 192.6% 1.5 6.6 17.9 3.4

Low 0.1% 0.8% -2.0 0.9% 0.0% -1.2 0.0 0.0 -6.1

Source: LSR

Bad Track Record

“Leopards do not change their spots” – an African proverb (as seen on

Blue Orca’s short-sell report on Ausnutria Dairy Corp)

Short-sellers tend to target companies that have historically had a badrapport.

Ausnutria Dairy Corp (1717 HK), which came under a failed short-sell attackfrom Blue Orca in 2019, had its shares previously suspended for over 2 yearsduring 2012-14 after whistleblower allegations by its auditor, which revealedthat the company was fabricating sales and that certain officers tried tocover it up by doctoring the company’s books and records.

Although Ausnutria Dairy Corp’s CEO resigned and took the fall, many ofthe executives at or near the epicenter of the fraud remained in key positionsat the company. Blue Orca suspected that the company could be committingthe same fraud again. Blue Orca did not find any smoking gun evidence thatthe company is cooking its books the second time around, however, the factthat some of Ausnutria Dairy Corp’s distributors were secretly controlled byboth current and former executives, including the former CFO, who waspreviously caught defrauding shareholders, was enough for the short-sellerto go after the company.

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Source: Blue Orca

Short-sellers also tend to target companies whose key insiders have a badtrack record. Opera Ltd (OPRA US), which was targeted by Hidenburg for ashort-sell attack is a good example of this. Opera was purchased by a China-based investor group prior to its IPO. Hidenburg found out that the group’slargest investor, and the Chairman/CEO of Opera, was involved in a Chineselending business that is listed in the US (Qudian) whose shares plunged bymore than 90% in just 2 years amid allegations of fraud and illegal lendingpractices. This, coupled with the fact that Opera was also moving into theonline lending business at that time, was one of the key points inHidenburg’s short thesis against Opera.

The recent anonymous short-seller report on Luckin Coffee also highlightedthe criminal history of the company’s co-founder. According to the report,Luckin’s co-founder and & Chief Marketing Officer, Fei Yang, was oncesentenced to 18 months imprisonment for illegal business operations whenhe was the co-founder and general manager of Beijing Koubei InteractiveMarketing & Planning Co.,Ltd. (iWOM).

An extract from the anonymous short-sell report on Luckin Coffee

Source: Anonymous

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Biased Auditors and Overseers

“Is today’s going rate for the E&Y branded pig lipstick only ~ S$

398,100?!?” – Bonitas (in its short-sell report on BWI)

Short-sellers are likely to go after companies with either too-high or too-lowaudit fees relative to its operating history.

MW, in its short-sell report on TAL Education (TAL US), highlighted thatTAL’s audit fees have not kept in pace with the expansion of the business.MW identifies starving the auditor as a sign of committing fraud as it doesnot give enough time or resources (in-terms of the man-power they couldemploy) for the auditor to audit the company’s books and records.

An extract from MW’s short-sell report on TAL Education

Source: MW

Bonitas, in its short-sell report on BWI, flagged the fact that the companyhad paid unusually high non-audit fees to its auditor in 2017. Bonitasaccused the company of “bribing” the auditor.

An extract from Bonitas’ short-sell report on BWI

Source: Bonitas

Short-sellers also consider frequent auditor changes as a sign of fraud. Agood example for this is the Realord Group Holdings (1196 HK), which cameunder a short-sell attack by Emerson Analytics.

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Realord Group was audited by BDO from 2011 through 2014. In 2015, BDOresigned as auditor and EY was appointed as the new auditor. In 2017, onlytwo years later, EY also resigned as auditor because "EY could not reach aconsensus on the audit fee". In its report, Emerson Analytics said thatauditors rarely resign as a result of fee disputes as there is sufficientcompetition among the Big Four and second-tier audit firms to ensure theydon't nickel and dime clients, and "fee disputes" are almost exclusively usedas a means for auditors to resign without being forced to alert regulators ofpossible financial irregularities.

We also found several instances where short-sellers have questioned thetrack record of auditors, underwriters, and appraisers that were employed bythe target companies. Short-sellers have made it a point to target companiesthat are clients of certain auditors, underwriters, and appraisers who havepreviously been attached to corporate scandals.

Citron, in its short-sell report on Hailiang Education (HLG US), accused thecompany of changing its auditor from KPMG to Marcum, after KPMGdisclosed several weaknesses. Marcum has been historically criticised byshort-sellers like MW for being biased, and its Chairman, Drew Bernstein,happened to have been a board member and the chair of the auditcommittee of Orient Paper, another company accused by MW of fraud.Citron also brought to concern the legitimacy of Haillang Education’sunderwriter, Network 1 Financial, who was also the underwriter for LongfinFinancial, whose trading was halted by the SEC.

Blue Orca, in its short-sell report on Mega Expo Holdings (1360 HK), accusedthe company of acquiring shell companies through a series of shamtransactions. According to Blue Orca, to facilitate this scheme, Mega Expoemployed the same appraisal firm that valued a sham acquisition for TechPro Technology (another company previously exposed by Blue Orca in 2016).Moreover, according to Blue Orca, Mega Expo’s auditor has only one othermajor client, China Ding Yi Feng, whose shares were recently suspended,and its assets were frozen by the SEC due to accusations of stockmanipulation and fraud.

Weak Corporate Governance

Short-sellers regularly keep an eye out for companies with weaker corporategovernance practices. However, some of the cases that we came across in ourresearch suggests that traditional corporate governance matrices havelimited relevance in exposing fraudsters in this day and age.

For example, having more independent directors on the board is consideredto be a sign of good corporate governance. However, we found severalinstances where short-sellers have questioned the true “independence” ofthese independent directors.

The anonymous short-sell report on Luckin Coffee highlighted that one ofthe company’s independent directors, Sean Shao, is/was on the board ofsome very questionable Chinese companies listed in the US. According to the

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report, four companies (out of a total of 18) that Sean Shao has served on theboard have been accused of being frauds and 5 were reverse mergers (whichwere infamous for generating droves of Chinese fraudulent companies backin 2011-2012).

MW, in its short-sell report on NMC Health, also highlighted that some ofthe company’s “independent” directors appear to be independent in nameonly. According to MW, two independent directors, namely AbdulrahmanBasaddiq and Jonathan Bomford, were on the board of Finablr, anotherentity owned by the founder and then-chairman of the board B. R. Shetty.Moreover, both of them were former Ernst & Young partners. Ernst & Youngwas also NMC Health’s auditor at that time, hence, MW also raised itsconcerns over their influence over the auditor.

MW also questioned the track record of the chair of NMC’s Audit Committee,Lord Meade, and his lack of apparent accounting experience. He was also theChairman of Eurasia Drilling, where he recommended a buyout by themajority oligarch shareholders while sitting on the board of another of thebuyers’ portfolio companies, Soma Oil & Gas. Soma Oil & Gas was itselfsubject to a Serious Fraud Office investigation into alleged bribery andcorruption in Somalia.

Short-sellers have also targeted companies that have appointed familymembers of key insiders in management positions. Bonitas’ in its short-sellreport on BWI, questions the reason for the company to appoint two familymembers of the CEO in charge of BWI’s management operations in China.Bonitas suspect these family members to be “facilitators of fraud”.

Another factor that is often highlighted by short-sellers is high boardmember turnover. Companies committing fraud often have high directorturnover as they struggle to convince directors to incur the liability ofsigning off on false financial statements.

Blue Orca’s short-sell report on Mega Expo suggests that the company hashad 4 chairmen and 4 CEOs since 2014. Moreover, each year, an average of3-4 directors resigned, which was considerable given that the company hasonly had 6-7 board seats at any given time.

Some of the other companies in our sample such as, Hailiang Education (3CFOs in the last 2 years), Realord Group (3 CFOs in the last 3 years), SkySolar (SKYS US) (3 CFOs in the last 6 months), Wisetech Global (WTC AU)(CFO was replaced immediately before an alleged fraud) have also had highsenior management turnover.

Suspicious M&A Activity

“The sale that wasn’t” – J Capital (in its short-sell report on Fanhua)“

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Short-sellers are generally interested in three types of M&A activity by acompany.

Undervalued asset sales to insiders

This refers to transactions where a company sells its assets to insiders orrelated parties at a valuation below the market price. This is a commonmethod used by fraudsters to strip a company of its profitable assets andacquire them at a cheaper price.

This was the central point of J Capital’s short thesis on Fanhua Inc (FANHUS). In 2017, the company said that it would sell its P&C insurance division(which had target 19 companies) for RMB 220m (or $32m) to Beijing ChecheTechnology (Cheche). Based on the financials of target companies and oncomparables, J Capital had calculated that this price is equivalent to just 1xP/E. This was the trigger point for J Capital, and upon further investigationof the SAIC filings of the target companies, the short-seller had found outthat out of the 19 companies, only 6 were sold to Cheche, and the rest, whichseems to be the more profitable units, were sold to a Fanhua executive (who,according to J Capital may be acting as a proxy for the founders).

Overpayment for assets from insiders

This refers to transactions where a company purchases assets/entities ownedby insiders or related parties at a higher valuation than the market value.This is a common method used by fraudsters to siphon out cash from thecompany.

Bonitas, in its short-sell report on Bosideng, accused the company’schairman, Mr. Gao Dekang (Chairman Gao), of siphoning out Bosideng’scash this way. According to Bonitas, Mr. Chow Mei Wo (Mr. Chow), aconspirator of chairman Gao, purchased three Chinese ladieswear brands oflittle to no value (Jessie, Buoubuou, and Joy Smile Group), and then flippedthem to Bosideng at marked up prices inflated up to 40x.

According to Bonitas, 1) in 2008, Mr. Chow bought and built Jessie for RMB16.5m only to sell the brand in 2011 to Bosideng for RMB 664m, generatingMr. Chow a 3,924% return in 3 years, 2) in 2013, Mr. Chow purchasedBuoubuou for RMB 17.5m only to sell the brand in 2016 to Bosideng for RMB71 m, generating Mr. Chow a 3,986% return in 3 years, and 3) in 2015, Mr.Chow purchased Joy Smile Group for RMB 530 million only to sell the brandin 2017 to Bosideng for RMB 660 million, a 25% return in 2 years.

Bosideng did not disclose Mr. Chow as a related party for Bonitas to identifyhim as the common counterparty in this case. Therefore, Bonitas’ triggerpoint, in this case, was the artificially high price of 15x-21x net tangibleassets paid by the company to acquire these assets. Thereafter, upon furtherinvestigation into the SAIC filings of these targets, Bonitas was able to linkthese acquisitions to Mr. Chow.

Extracts from Bonitas’ short-sell report on Bosideng

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Source: Bonitas

M&A activity used for asset parking

Asset parking is the practice of transferring an asset to a counterparty withthe intention of repurchasing the asset to inflate profitability.

This was one of the central points of MW’s short thesis on TAL Education.MW accused TAL of two fraudulent transactions that permitted the companyto inflate its pre-tax profit by $153m or 28.4% through asset parking.

According to MW, in the first transaction, TAL had sold an overseaseducation intermediary consulting subsidiary called Dongfangrenli (DFRL)to a company called Beijing Shunshun Bida Information Consulting Co. Ltd(Shunshun). TAL had later gone on to purchase Shunshun. In the secondtransaction, TAL had invested in one of its investees, Changing Edu, throughtransferring its national tutoring business called One on One (GZ 1-1) and15 months later TAL had bought back GZ 1-1 from Changing Edu. MWpresents very lengthy evidence that these transactions were carried out inbad faith, which we do not plan to discuss here in detail.

Nevertheless, similar to the aforementioned instances, MW also seems tohave investigated into SAIC filings of TAL’s subsidiaries/investees to uncoversmoking gun evidence about the two fraudulent transactions aftersuspecting TAL of asset parking.

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Alternative Filings

“In our opinion, a company has misrepresented its financial

performance when SAIC filings differ materially from financials

submitted to U.S. investors” – Blue Orca (in its short-sell report on

Pinduoduo)

A short-seller can identify a plethora of red-flags for a company, but a short-sell attack is seldom successful without any smoking gun evidence.Therefore, short-sellers often thrive on finding that one key piece ofevidence that would make their thesis irrefutable. In most of the cases in oursample, this smoking gun evidence came in the form of alternative filings,which include the likes of filings with the local regulators, credit reports, andtax filings.

We understand that a short-seller could use these alternative filings assmoking gun evidence in two main ways:

Tracing the ownership of an asset

As we have already mentioned in a previous section (refer the section onSuspicious M&A Activity), Bonitas, in its short-sell report on Bosideng,came across a serious of suspicious transactions where the company hadmade three acquisitions at inflated valuations. Bosideng did not disclose thecounterparty in these transactions, however, by referring SAIC filings ofthese assets, Bonitas was able to trace these transactions back to Mr. Chow,a proxy for the chairman. Likewise, short-sellers tend to use local filings totrace the ownership of undisclosed related parties.

An extract from Bonitas’ short-sell report on Bosideng

Source: Bonitas

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Reconciling consolidated filings

Our sample included a number of instances where a short-seller had usedalternative filings to reconcile the reported numbers by the company. One ofthe most common approaches used by short-sellers is to compare the localfilings (submitted for local authority for oversight) of a company’s revenuegenerating units against the consolidated financials reported by thecompany.

For example, Blue Orca, in its short-sell report on Pinduoduo (PDD US)(PDD), used the company’s reported filings to identify that there were onlytwo revenue generating VIEs for PDD. After which, Blue Orca had obtainedthe SAIC filings (SAIC filings are submitted by Chinese companies to adivision of the PRC government for the purposes of state oversight andregulation. These filings include financials, which are required by law to beaccurate) for the two revenue generating VIEs and had compared theirrevenue with the company’s reported revenue. Blue Orca claims that, afteradjusting for intercompany transactions, revenue generated by PDD’s twoVIEs was around 36% less than revenue reported by PDD in its SEC filings.

An extract from Blue Orca’s short-sell report on PDD

Source: Blue Orca

More Short-Sell Strategies

“Primary research is crucial and not as many people do it as you think”

- Jim Chanos (as seen on Blue Orca’s short-sell report on GDS

Holdings)

In this section, we look at several other investigative approaches used byshort-sellers that stood out in our research.

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An anonymous short-seller go to greatlengths to uncover fake coffee sales

The anonymous short-seller report on Luckin Coffee stands out in terms ofthe amount of leg work that has gone into the report. The report presentedevidence that the company’s sales at the store level is inflated supported by11,000+ hours of store traffic video. Around 92 full-time and 1,418 part timestaff were mobilised on the ground to run surveillance and record storetraffic for 981 store-days covering 100% of the operating hours. The reportalso presented evidence that the company is inflating its net selling price peritem supported by 25,000+ receipts collected from the customers. We believethis provides a good example of the lengths modern day short-sellers arewilling to go to uncover irrefutable evidence on their targets.

Extracts from the anonymous short-sell report on Luckin Coffee

Source: Anonymous

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Grizzly uses alternative data to identify fakeenrolments

Grizzly, in its recent short-sell report on GSX Techedu, used alternative datasources such as customer reviews, web traffic, keyword search results, apprankings, etc. as smoking gun evidence that the company is inflating itsresults.

Extracts from Grizzly’s short-sell report on GSX Techedu

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Source: Grizzly

Blue Orca uses reverse calculations toreconcile reported numbers

We also came across several instances where short-sellers have used certaindisclosed data points by the company to reverse calculate revenue/salesvolume. Blue Orca, in its short-sell report on PDD, used the transaction feeof 0.6% disclosed by PDD to reverse calculate its GMV, which according tothe short-seller, was around 40% lower than what the company hadreported.

Extracts from Blue Orca’s short-sell report on PDD.

Source: Blue Orca

Interviews and site visits still providecompelling evidence

Interviews and site visits are relatively old school investigative techniques.However, short-sellers continue to use them to understand ground-leveloperations better.

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MW’s short-sell report on Anta Sports Products (2020 HK) carried two legs.In the first section, MW uses SAIC filings of ANTA’s distributors to tracetheir ownership to the ListCo, and in the second section, MW uses a series ofinterviews with former ANTA executives and ANTA’s distributors to confirmthat ANTA is secretly controlling its distributors.

An extract from MW’s short-sell report on ANTA Sports

Source: MW

In another example, as per Bonitas’ short-sell report on BWI, the short-sellerhad visited 12 out of the 33 Best World Lifestyle Centers in China andgathered photographic evidence that some store locations were only fronts(based on the fact that they were not street-accessible and located in securedhigh-rise office centers) with some locations closed during posted openoperating hours. This, coupled with several conversations with storeemployees, provided smoking gun evidence for Bonitas to accuse thecompany of faking sales.

An extract from Bonita’s short-sell report on BWI

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Source: Bonitas

Additional Points to Consider

Do short-sellers target companies with a highdebt burden?

It is conventional wisdom that short-sellers tend to target companies thathave a high debt burden partly because the market already views thesecompanies as risky investments. However, we did not find this to be arecurring theme in the sample of the short-sell reports that we haveselected. Only once a short-seller had targeted a company in our sample dueto its high debt burden (Emerson Analytics in its short-sell report on RealordGroup). The average debt to equity ratio of the companies in our sample wasaround 65%, versus 93% of the peer companies.

Ticker Company Name Date Debt to Equity Ratio

Company(%)

Peer Avg.(%)

Premium(x)

SEHK: 2020 ANTA Sports Products Limited 07/07/2019

50.8 102.6 0.50

SEHK: 1717 Ausnutria Dairy Corporation Ltd 14/08/2019

34.7 44.9 0.77

NAsdaqGS:BGNE

BeiGene, Ltd. 05/09/2019

17.5 23.3 0.75

SGX: CGN Best World International Limited 24/04/2019

4.7 31.4 0.15

SEHK: 3998 Bosideng International Holdings Limited 24/06/2019

27.5 47.9 0.57

NasdaqCM:CCRC

China Customer Relations Centers, Inc. 14/11/2018

17.2 35.3 0.49

SEHK: 867 China Medical System Holdings Limited 06/02/2020

15.7 61.1 0.26

SEHK:715 China Oceanwide Holdings Limited 01/11/2018

110.2 22.9 4.82

NasdaqGS:FANH

Fanhua Inc. 17/01/2019

7.9 33.0 0.24

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NYSE:GSX GSX Techedu Inc. 25/02/2020

15.7 310.7 0.05

SEHK: 1044 Hengan International Group CompanyLimited

12/12/2018

139.6 31.2 4.47

NASDAQ: HX Hexindai Inc. 15/01/2019

19.3 72.0 0.27

NYSE: JKS JinkoSolar Holding Co., Ltd. 04/03/2020

215.9 1083.3 0.20

SEHK: 496 Kasen International Holdings Limited 21/11/2019

30.5 23.4 1.31

NASDAQ: LK Luckin Coffee Inc. 01/01/2020

6.3 25.7 0.24

OTCPK:NMMC.F NMC Health Plc 17/12/2019

165.9 121.8 1.36

SEHK: 1360 NOVA Group Holdings Limited 09/05/2019

63.9 8.8 7.27

NasdaqGS:OPRA

Opera Limited 16/01/2020

2.2 39.2 0.06

NasdaqGM:HLG

Hailiang Education Group Inc. 09/04/2018

5.9 32.5 0.18

TSE: 4587 PeptiDream Inc. 06/11/2019

0.0 71.6 0.00

NasdaqGS: PDD Pinduoduo Inc. 14/11/2018

1.3 33.4 0.04

SEHK:1196 Realord Group Holdings Limited 21/08/2019

341.6 74.7 4.57

ASX: RFF Rural Funds Group 06/08/2019

60.7 46.1 1.32

SEHK: 1910 Samsonite International S.A. 24/05/2018

136.0 16.5 8.24

NasdaqCM:SKYS

Sky Solar Holdings, Ltd. 25/02/2019

271.7 180.4 1.51

SEHK:1573 Southern Energy Holdings Group Limited 29/07/2019

12.3 32.2 0.38

NYSE: TAL TAL Education Group 13/06/2018

41.4 5.4 7.62

NasdaqGS:UXIN

Uxin Limited 15/04/2019

130.3 85.8 1.52

ASX:WTC WiseTech Global Limited 16/10/2019

0.2 46.0 0.00

SEHK:1458 Zhou Hei Ya International HoldingsCompany Limited

01/03/2019

9.7 35.4 0.27

Average 65.2 92.6 1.6

Median 27.5 39.2 0.5

High 341.6 1083.3 8.2

Low 0.0 5.4 0.0

Source: LSR

Do short-sellers target newly-IPOedcompanies?

The companies in our sample were equally split in terms of its tradinghistory. This goes against the conventional wisdom that the companies witha short trading history (or in other words, newly IPO-ed companies) are

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more vulnerable for short-sell attacks. Out of the companies in our sampleof 30, only 10 were subjected to short-sell attacks within the first three yearsof the IPO, and only 4 in the first year.

Ticker Company Name ReportDate

IPODate

Days from the IPOto the SS Attack

Years from the IPOto the SS Attack

SEHK: 2020 ANTA Sports ProductsLimited

07/07/

2019

10/07/

2007

4,380 12.0

SEHK: 1717 Ausnutria Dairy CorporationLtd

14/08/

2019

08/10/

2009

3,597 9.9

NAsdaqGS:BGNE

BeiGene, Ltd. 05/09/

2019

03/02/

2016

1,310 3.6

SGX: CGN Best World InternationalLimited

24/04/

2019

08/07/

2004

5,403 14.8

SEHK: 3998 Bosideng InternationalHoldings Limited

24/06/

2019

11/10/

2007

4,274 11.7

NasdaqCM:CCRC

China Customer RelationsCenters, Inc.

14/11/

2018

21/12/

2015

1,059 2.9

SEHK: 867 China Medical SystemHoldings Limited

06/02/

2020

28/09/

2010

3,418 9.4

SEHK:715 China Oceanwide HoldingsLimited

01/11/

2018

02/01/

1992

9,800 26.8

NasdaqGS:FANH

Fanhua Inc. 17/01/

2019

31/10/

2007

4,096 11.2

NYSE:GSX GSX Techedu Inc. 25/02/

2020

06/06/

2019

264 0.7

SEHK: 1044 Hengan International GroupCompany Limited

12/12/

2018

08/12/

1998

7,309 20.0

NASDAQ: HX Hexindai Inc. 15/01/

2019

03/11/

2017

438 1.2

NYSE: JKS JinkoSolar Holding Co., Ltd. 04/03/

2020

14/05/

2010

3,582 9.8

SEHK: 496 Kasen International HoldingsLimited

21/11/

2019

20/10/

2005

5,145 14.1

NASDAQ: LK Luckin Coffee Inc. 01/01/

2020

17/05/

2019

229 0.6

OTCPK:NMMC.F NMC Health Plc 17/12/

2019

22/05/

2018

574 1.6

SEHK: 1360 NOVA Group HoldingsLimited

09/05/

2019

06/11/

2013

2,010 5.5

NasdaqGS:OPRA

Opera Limited 16/01/

2020

27/07/

2018

538 1.5

NasdaqGM:HLG

Hailiang Education Group Inc. 09/04/

2018

07/07/

2015

1,007 2.8

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TSE: 4587 PeptiDream Inc. 06/11/

2019

11/06/

2013

2,339 6.4

NasdaqGS: PDD Pinduoduo Inc. 14/11/

2018

26/07/

2018

111 0.3

SEHK:1196 Realord Group HoldingsLimited

21/08/

2019

22/01/

1997

8,246 22.6

ASX: RFF Rural Funds Group 06/08/

2019

14/02/

2014

1,999 5.5

SEHK: 1910 Samsonite International S.A. 24/05/

2018

16/06/

2011

2,534 6.9

NasdaqCM:SKYS

Sky Solar Holdings, Ltd. 25/02/

2019

13/11/

2014

1,565 4.3

SEHK:1573 Southern Energy HoldingsGroup Limited

29/07/

2019

13/07/

2016

1,111 3.0

NYSE: TAL TAL Education Group 13/06/

2018

20/10/

2010

2,793 7.7

NasdaqGS:UXIN

Uxin Limited 15/04/

2019

27/06/

2018

292 0.8

ASX:WTC WiseTech Global Limited 16/10/

2019

11/04/

2016

1,283 3.5

SEHK:1458 Zhou Hei Ya InternationalHoldings Company Limited

01/03/

2019

11/11/

2016

840 2.3

Average 2,718 7.4

Median 2,010 5.5

High 9,800 26.8

Low 111 0.3

Source: LSR

Part B: How to Prevent, Detect andRespond to Short-Sell Attacks

The aim of short-sellers targeting a company is to create a market reaction,however, the shorts often engage in legitimate due diligence and extensiveresearch to uncover hidden facts about a company.

Passive short-sellers, investors who take short positions in stocks withoutissuing reports explaining the reasons for assuming short positions act aswatchdogs of the market while Active short sellers (explains the reason fortheir short position of a stock by releasing reports) often engage in activitiesto achieve their profit motives. As we discussed earlier, short-sellers oftenidentify the allegations laid out in a short-seller report by either comparingcompany accounting practices against accepted accounting standards (forChinese companies listed in the US, their SAIC filings are compared against

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SEC filings) or by physically verifying the existence of manufacturingfacilities, acquired entities, etc. At times, companies were subject to falseallegations or negative rumours which had cost them several thousanddollars in terms of litigations, damages to reputation and fall in the marketvalue of company shares. Over the years, a large number of companies havefiled legal actions against these short-seller firms, however, these lawsuitshad little consequences on the actions of those short-sellers.

Olam International (OLAM SP) in November 2012 was accused by MuddyWaters in a 113-page report that Olam will fail. Muddy Waters had likenedthe company to the failed US company Enron saying there were a number ofmaterial similarities in the way their businesses developed, and their action.

Olam runs a high risk of failure. Its “asset heavy” strategy appears to be

an off-the-rails CapEx and acquisition binge. Management talks about

the “gestation” of these projects, but our research makes clear that

they are marred by incompetence and perhaps significant misconduct.

We believe it is instructive to view Olam through the lens of failed USS

trader Enron Corp.

We value Olam on a liquidation basis because our opinion is that it is

likely to fail”

- Muddy Waters Research, Olam Report

Olam responded to the allegations with a detailed 45-page report andassured that it has sufficient liquidity to pursue its investment strategy.Olam’s report had a point-by-point rebuttal and focused on Muddy Waters’claims on solvency, accounting-related assertions, business model,acquisitions, and capital spending. In addition to issuing a detailed rebuttal,the company reached out to its stakeholders including its shareholders,banks, media and analysts through investor meetings, townhalls and mediainterviews.

Temasek, the government of Singapore owned investment fund who held16% of the shares of Olam (at the time of the short-seller attack) stepped into pull the company out of the mess by increasing its stake in the company.Following Temasek’s stake increase, several banks around the globe cameforward to lend to the company and it emerged stronger than before and hasnot been subject to similar attacks since then.

Regardless of whether the allegations put forward by Muddy Waters werecorrect or false, it had done an extensive damage to the company’sreputation as well as to the market capitalisation. Olam’s share pricedeclined 7.5% a day after the allegations were laid out (16th Nov 2012), eventhough the share price bounced back following the company’s rebuttal andstake sale to Temasek, Olam’s shares have not yet reached the company’sall-time high of SG$3.34 in November 2010 seen prior to the Muddy Waters’attack. These unconfirmed allegations did cost the company millions ofdollars.

“

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Source: Cap IQ

Short-seller attacks have become part of today’s investment world and thecompanies should learn to co-exist with them and more importantly, todefend these attacks, the companies should have a plan in place whilestrengthening their fundamentals and improving corporate disclosures. Wehave taken a qualitative approach to our research and have gone throughabout 50 short-seller reports published over the last 10 years to build ourrecommendation on how to prevent and respond to these attacks.

Under this section, we will be discussing the following:

• Prevention: the qualitative measures that the companies should adoptto reduce the likelihood of becoming a victim of unfair short-sellerattacks

• Detection and Response: how to detect if a company is becoming atarget for short sellers and how to respond if it falls victim to thoseattacks

How to Prevent Short-Sell Attacks?

Short-seller attacks have become part of today’s investment world and thecompanies should learn to co-exist with them and more importantly, todefend these attacks, the companies should have a plan in place whilestrengthening their fundamentals and improving corporate disclosures.While it is impossible for a company to completely protect itself from theseshort-sell attacks, some of the measures we have discussed below shouldhelp a company from attracting interest from shorts. At the same time, theprevention measures should help a company be ranked high in terms oftransparency and governance.

We have listed out a few of the qualitative measures that a company shouldadopt to reduce the likelihood of being attacked by short-sellers.

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Restatement of Financial Statements – Be Honest About Any Errors

Based on our research, we have found that the companies who restate financial statements due to accounting irregularities provide the basis for short sellers to commence activism against those companies. A large number of companies have come under short seller attack after restating their financial statements and most of these restatements were due to fraud or change in policies to overstate financial performance (such as changes to revenue recognition policy to overstate corporate top lines).

However, an accounting irregularity could arise due to a restatement required by either SEC or the company auditor. Restatements due to M&A activities, changes in segmental reporting and adoption of new accounting policies/practices are usually not negative and are part of a normal operation of a company.

On the other hand, a company could detect an error in the financial statements, and it needs to be corrected by restating these statements. At times, these unintentional errors could prompt short-seller attacks on a company. It is the management’s responsibility to be honest about the error and should provide clear explanation on these restatements.

Source: Muddy Waters, Olam Report

The company should attempt to answer questions (from investors) such asthe cause of the error, effect on past financial statements, any ongoingramifications and also provide the assurance that this might not reoccur andthe management’s commitment towards strengthening the internal controls.

Accounting Practices – Adopt ConservativePractices

A company adopting conservative accounting practices (anticipating andaccounting for future losses but not future gains) attracts less short sellerattention compared to a company adopting aggressive accounting practices.This helps companies to undervalue their investments and manage risks,thereby exceed investor expectations.

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Aggressive accounting, on the other hand, involves creative techniques thatoverstate a company’s performance in order to portray the company in thebest light for its investors. Over time, aggressive accounting is more likely toresult in future restatement of financial statements, attracting significantinvestor activism.

Source: Citron Research, QIHOO 360 Report

Aggressive Earnings Guidance – Don’tPromise What You Can’t Deliver

An overly aggressive earnings guidance by a company results in heightenedinvestor expectations which will be difficult to meet. Though one wouldthink issuing inflated earnings guidance could force short sellers to move outof their short positions, in real-world, it actually works otherwise. Anaggressive guidance will eventually make it difficult for the company toattain, causing volatility in share prices and attract short sellers. At the sametime, aggressive guidance leads to overvaluation of the stock, yet againattracting short sellers.

In 2017, Glaucus Research attacked the Australian company Quintis whoclaims to be the world’s largest manager of commercial Indian sandalwoodplantations. The company was accused of providing misleading financialforecasts, ponzi-like marketing materials, mysterious customer andunrealistic forecasts that could lead to dubious valuation for the stock.

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“Phantom Chinese Buyer? One of the festering uncertainties in TFS’s

business model is whether there will be a significant addressable

market for sandalwood once its plantations are ready for harvest. To

allay such fears, in September 2016, TFS announced that it completed

its first shipment under a “five-year agreement to supply 150 tonnes

per annum of processed heartwood to China.” Mysteriously, TFS did

not announce the identity of this Chinese buyer, even though it had

agreed to purchase the equivalent of USD 25 million in sandalwood

from TFS per year (50% of TFS’s projected harvests), making the

mysterious Chinese buyer TFS’s most valuable customer.

- Galucus Research, Quintis (formerly TFS Corporation) Report

Deviation from Accounting Standards –Provide Detailed Disclosures

The adoption of accounting standards and policies by a company isconsidered a proof that its financial statements provide a “true and fairview”. Therefore, the non-adoption or any deviation from these acceptedaccounting standards imply the otherwise.

Companies are required to disclose if their financial statement do notcomply with the relevant accounting standards or accepted practices. Thesedeviations are allowed if such deviations are necessary to present a “true andfair view” of the financial statements and in this instance, the companiesshould provide full and detailed disclosures regarding the nature of thesedeviations, their effect on the company financial statements and provide forappropriate justifications for the departure. In addition, these disclosuresshould be accompanied by a confirmation from the relevant external auditorof the company that they agree with the deviations.

Dealing with Bad News – Deliver it RightAway

Companies or their managers have a general tendency to withhold or delaybad news such as product failures, litigations, profit warnings, layoffs, etc.from the market. While bad news tends to result in an almost immediateshare price reaction (a downward movement), if it is not delivered properly,it could become detrimental to a company.

If a company is faced with bad news, it should respond quickly and come upwith a crisis communication plan. The company should issue a press releaseor a statement detailing the bad news and what possible actions thecompany could be taking to address those issues. Also, companies shouldprovide specific details about bad news even if it was due to a wrong choicemade by the management. The company should make sure that itcommunicates the bad news to all its stakeholders and also should takenecessary actions to address these issues during the company’s earnings call

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or any investor conference. This will also help corporations to obtaininvestor support if they are provided with the right information regarding aproblem.

Short sellers are well informed of any events affecting a company and theyoften bet on this negative news and could attack a company for notdisclosing the bad news to the market.

Marcus Aurelius Value attacked Inmode Ltd (INMD US) in March 2020claiming that the management has simply not been honest with investors orpatients about the safety of its products.

“broad pattern of undisclosed lawsuits, apparent out of court

settlements, and online reviews we obtained allege that patients have

suffered severe burns, permanent scarring, and even nerve damage

from treatments conducted with INMD products. Perhaps out of

concern for the IPO prospects, INMD’s executives have allegedly

concealed the existence of these adverse events by failing to report

them to the FDA as required by law.”

- Marcus Aurelius Value, InMode

Improvement to Corporate GovernanceMeasures

As we discussed earlier, short-sellers are likely to attack companies withweaker corporate governance practices. Investors have become suspiciousabout a majority of the recently listed companies (Chinese companies listedin the US in particular) where the board is made up of a long list of insiderswho look out for their own interests instead of the rest of the shareholders.

Short sellers have used different corporate governance measures such asboard composition, existence of committees to the board, board turnover,related party transactions and directors/executive’s involvement in othercompanies where they hold various board positions/management roles. Theadoption of strong corporate governance principles should support acompany from being a victim of malicious short seller attacks.

Related Party Disclosures

Most of the short seller reports over the past few years highlighted issueswith inadequate related party disclosures and companies failing to keeprelated entities at their arm’s length. GSX TechEdu was accused of notconsolidating subsidiaries which were not making profits.

We believe, companies should provide detailed disclosures (in accordancewith accounting standards) regarding related party transactions. Thesedisclosures should include who the related entities are, how they are relatedand the transactions and balances with each related party during a period.

“

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In addition, the company should provide detailed disclosures regardingmajor related parties which should help reduce any suspicions regardingthese transactions. At Lightstream Research, we use the following criteria toidentify the significance of a transaction.

• Sales to and Purchases from Related Parties: We consider atransaction significant if it is above 10% of the Net Income for theperiod.

• Balances due to and from Related Parties: We consider a relatedparty asset or liability significant if it is above 5% of the total assets forthe period.

A company could apply a criterion similar to that of the above to establishthe significance and should provide detailed disclosures about those keytransactions.

Frequent Board Turnover

According to Glaucus, companies who engage in accounting irregularities ormaking misleading financial statements experience high turnover amongdirectors and officers. Glaucus in its short-seller report on Quintis Ltd (QINAU) highlights that eight officers or directors have resigned since late 2011(until March 2017) and have done after a brief tenure of two years or less.

Having a moderate amount of board turnover is considered favourable by amajority of shareholders as it paves the way for new changes in thecompany. At the same time, it increases the transparency in boardnominations and appointments. However, if the company’s board is subjectto frequent changes, the companies should disclose these changes in atimely manner to the shareholders and the reason for the departure of theseofficers. At the same time, the company should pay serious attention andinvestigate on these departures. Also, in order to reduce any negativitysurrounding these departures, the company could establish a committeewith the representation of independent directors and external shareholdersto investigate the reasoning behind these departures.

In addition, companies should be careful enough to thoroughly conductbackground verifications of its board members/top executives as well as beaware of the representation of its board members at other companies. If theboard members, who are also members/executives of other companies, areinvolved in any misconduct or fraud, that could impact the company’sreputation as well.

Car Inc (699 HK)’s shares plummeted as a result of an internal investigationat Luckin Coffee found that the latter has fabricated its 2019 revenues. BothLuckin Coffee and Car Inc. are headed by the same chairman, Mr. CharlesZhengyao.

Auditor Changes

A company changing its external auditor frequently is undertaking large riskand therefore should give careful consideration to it before taking thosegiant steps. A large number of companies change their external auditors

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prior to their IPOs as companies seek to appoint reputed auditors as ameasure to reduce uncertainty and obtain a higher valuation of thecompany. However, corporations should pay attention on subsequentchanges to its external auditors.

Rotating external auditors every once in five years is a good practice as thenew auditor will bring fresh insights into the business. However, if thecompany decides to change the auditor for reasons such as audit fee, conflictof interest or change in control of the company (change in ownership, M&Adeals, etc.), it should provide detailed disclosures regarding (including aregulatory filing) the change and the rationale for replacing the auditor.

On the other hand, in some instances, changes to a company’s externalauditor signals problems with the management’s integrity and potentialcorporate governance related issues. Disagreements between a company andits auditor highlights issues such as management’s integrity, presence ofinternal controls and could portray the company as one willing to look for afresh auditor who could dance along the company’s lines.

In 2011, West China Cement (2233 HK) (WCC) was attacked by GlaucusResearch and one of the allegations brought upon the company wasabnormally high auditor and management turnover. Disagreement regardingaudit fee for FY2011 was cited as the reason for the resignation of PWC inMay 2011. However, Glaucus stated that if an auditor resigns over apurported fee dispute, there may be more than meets the eye.

Source: Glaucus Research, West China Cement Limited

In November 2018, Wageworks Inc (WAGE US) fired its auditor KPMG aftersignificant disagreement between the company and KPMG over massiverestatement of the company’s financial statements, internal investigationsand the departures of the CEO, CFO and the company’s General Counsel.KPMG notified the company that it could no longer rely on the

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representations by the company’s top executives. The company and KPMGcould not agree even after the resignations of the top executives and as aresult, the company decided to replace the auditor. WageWorks sharestumbled upon the release of the above news and the company was lateracquired by Healthequity Inc (HQY US).

If there is a disagreement between the company and the auditor, it shouldhandle the situation with more care as not to hurt the reputation of the firm.The company should act on behalf of the wellbeing of its shareholders andnot along the lines of its top management.

When a company chooses a new auditor, it should consider the audit firm’scapabilities, its independence and overall fit with the company’s auditcommittee. The company also should seek for shareholder ratification priorto the appointment of the new auditor.

In addition to the above, the company should also adhere to the combinedcode of governance when appointing members to the board and boardcommittees, establishing the independence of the board, conductingshareholder meetings, etc.

Continuous Improvement to AccountingDisclosures

Short sell targets have often been around companies who makemisstatements to the market. Therefore, corporate IRs should put a lot ofemphasis on improving company disclosures particularly regarding companyacquisitions, divestitures and capital investments.

Most of the companies tend to conceal or brush off losses related to aboveevents and short-sellers target companies after doing extensive research intoa company’s financials as well as after conducting thorough on the ground/physical checks.

Therefore, it is recommended that the companies should periodically updateits investors on any developments related to above events. As we discussedunder “issue bad news early as possible”, if the company thinks that anacquisition or a capital investment is not going to generate returns asexpected, it needs to be clearly communicated to the shareholders alongsidethe company’s plan to turn around the business before short-sellerscapitalise on those events. This will also help the company to obtainshareholder support in an event an activist investor or short-seller attacksthe company.

In addition, if the company decides to change its disclosures such as revenuereporting, segmental disclosures, revenue drivers or other matrices, it needsto be accompanied with proper reasoning.

We have summarised the Do’s and Don’ts for corporate IRs to preventthemselves from being attacked by short sellers below:

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Source: LSR

How to Detect and Respond to ShortSeller Attacks?

Short sellers generally do not give companies advance notice which makes itdifficult for companies to successfully defend those attacks. Prior toattacking a company, short-sellers take a large short position in a companyand therefore, firms can monitor any build-up in short positions of theirstock. If the company could sense that there is huge volume traded short ona daily basis, that could signal that the company may be under attack. Thetrading volume traded short for a company is often disclosed by the relevantexchange or is available from specialist data sources.

Short interest (the no. of shares that have been sold short) indicates themarket sentiment of a stock and a big change in short interest is a warningsign that investors are becoming more bullish or bearish on a stock. Thefigure below shows the short interest in iQiyi’s ADRs on Nasdaq. Days toCover is defined as the no. of days it would take on average for the number ofshares that are being shorted to trade. It is calculated by dividing the no. ofshares shorted by the average daily share volume. A higher no. of days tocover implies the amount of real short interest in a stock is higher.

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Source: Nasdaq.com

Monitoring of short position build-up in a stock could signal changes ininvestor sentiment. If a stock’s short interest has changed from one monthto the other that indicates the investor belief regarding a share priceincrease or decrease has changed. In addition, companies could keep track ofinternet chatroom discussions where some online short sellers usechatrooms to disseminate false information regarding a company.

While prevention is the best solution to keep short sellers off a company’sdoorstep, if a company is attacked by a short seller, it should respond to theallegations promptly and in a timely manner. In order to build ourrecommendation on how to respond to these attacks, we have read andanalysed how a number of companies dealt with these attacks and identifieda few actions which we believe should help them get through unfair ormalicious attacks. If a company has always been committed to providingcomplete disclosures and its shareholders are kept informed about bothgood and bad news regarding a company, the best way to approach theshorts may be to completely ignore them. If the company has maintainedopenness with its shareholders, the company will often have the trust of itsshareholders, and they will rally around the company to support it in anevent like the above.

However, a company should respond to a short sell attack if the allegationslaid out by the shorts were unreasonable or misleading or if it is impactingthe company’s valuation. But before responding, the IR department needs todecide on a proper communication plan (a press statement) beforeresponding and needs to be communicated to all shareholders and maintainthe company’s credibility. A majority of the companies respond to shortseller attacks by issuing a point-to-point rebuttal to allegations. Also, thecompanies could request for a trading halt if they believe that the marketwas misled by the shorts.

The company could seek help from legal advisers and also could considertaking legal action against the shorts for publishing false statements andmanipulating the market. These actions need to be in the best interest of theshareholders. Moreover, companies could also consider initiatives such asdividend announcement or share buy-back which could have a positiveimpact on the company’s share price.

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Rural Funds (RFF AU) (RFG), a real estate investment trust based inAustralia came under fire by Bonitas Research in 2019 where the companywas alleged to have overstated its reported financial performance. Bonitas’report also stated that it has a short interest in RFG’s stock and stands torealise significant gains in the event the company’s share price declines. Thecompany’s share price declined 42.1% to AU$1.36 on 06th August 2019 fromAU$2.35 per share at the close of the previous day’s trading following therelease of Bonitas’ report. The company was forced to request a trading halt.The company refuted all allegations in a nine-point rebuttal and engagedErnst and Young to independently investigate the matters.

“To reiterate, while entirely without foundation, RFG is seriously

addressing the allegations made by Bonitas and will vigorously defend

the business in the interests of all RFF unitholders.”

- Rural Funds Group

The company shares gained 41% following the release of the rebuttal andthe company also hosted an investor webinar to communicate its responseto all its shareholders. The company pursued legal action against Bonitasand in April 2020, the Supreme Court of NSW ordered Bonitas to pay RFGAU$899k in damages.

Source: Cap IQ

On the other hand, if a company comes under attack for not divulginginformation to the market on its deteriorating performance or for inflatingcompany financials, there is very little that the company could do to winback the trust of its investors. The company should briefly release the badnews to the market; however, it should provide reasonable assurance that ithas a plan in place to address the problem. The company should first attendto its business strategy before putting up a plan to discourage the shorts.

“

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As we discussed above, while short selling could help a company see itsown weaknesses, we strongly believe, identifying those weaknessesthrough a short seller can be very stressful, costly and time-consuming.As the old proverb says, “Prevention is Better than Cure”, a companyand its board/management should continuously look into ways in whichthey could increase transparency and improve communication withstakeholders. As there has been an increase in the number of short sellattacks over the past few years, companies should be prepared inadvance with a plan to deal with short attacks. As we mentioned earlier,the best defence for a company against shorts is to commit itself toopenness and transparency, else it will be too late once the shortsbecome active.

Disclosure & Certification

• I/We have no position(s) in the any of securities referenced in this insight

• Views expressed in this insight accurately reflects my/our personal opinion(s) about the referenced securities and issuers and/orother subject matter as appropriate.

• This insight does not contain and is not based on any non-public, material information.

• To the best of my/our knowledge, the views expressed in this insight comply with Singapore law as well as applicable law in thecountry from which it is posted

• I/We have not been commissioned to write this insight or hold any specific opinion on the securities referenced therein

• I/We have signed the Insight Provider Agreement and this insight does not violate any of the terms specified therein.

— Supun Walpola (29 Jun 2020)

Short-Sell Strategies – How to Get Teflon Coated?

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