Puda had become an empty Chinese shell company after its chairman Ming Zhao secretly transferred the coal mine asset to himself.

Zhao, a wealthy Chinese businessman with connections to the government in Beijing, was also the co-founder and chairman of Shanxi Coal.

Despite waring signs, pressed ahead

Despite the glaring warning signs, New York-based Black and Fang pressed ahead with the equity raising.

The bankers finalised a prospectus, put together a management presentation to solicit investors via a "road show" and organised a press release. The marketing materials contained the blatantly false information.

Macquarie, the lead underwriter, then sold $US108 million of Puda shares via a share offering in December 2010, earning the bank $US4.17 million in underwriting fees. Both Fang and Black pocketed bonuses for their efforts.

Within 12 months, the 9 million Puda shares that investors paid $US12 each for were virtually worthless. The collapse was ultimately triggered by an investment blogger publicly blowing the whistle on the fraudulent Chinese company. Puda was soon delisted by the NYSE.

On Friday, Macquarie settled charges with the powerful US Securities and Exchange Commission, agreeing to pay $US15 million ($19.3 million) towards a fine and compensation fund for investors who lost money.


"Macquarie Capital proceeded with this offering despite a due diligence process that exposed a false claim by Puda Coal, and investors suffered massive losses when the truth publicly came to light," SEC director Andrew Calamari said.

Black agreed to pay $US212,711 to settle civil charges for failing to exercise appropriate care in due diligence. The fine mainly represents a large bonus he pocketed from the deal.

Black still with Macquarie

While Fang left Macquarie in July 2011 and is barred from the securities industry for five years, Black is still employed by Macquarie as a divisional director in equity capital markets in his home town of Sydney. Black, 40, is banned from supervisory roles in the US for five years.

Fang, a relatively junior banker now aged 31, agreed to pay $US35,000.

Macquarie and the two bankers settled the charges without admitting or denying the allegations.

The incident has also resulted in Macquarie launching legal action against major global law firm and one-time business partner on the soured transaction, Morrison & Foerster. Fang had sent the "no red flags" email containing the Kroll report to an associate lawyer at Morrison & Foerster.

How Australia's premier home-grown investment bank ignored palpable problems about an opaque Chinese coal miner that it was marketing to investors, is revealed in a detailed SEC complaint filed with the US Southern District Court of New York and other information obtained by The Australian Financial Review.


After Fang received the Kroll report and emailed it to colleagues, he did not discuss the contents with anyone or draw to their attention the problems identified, the SEC alleges.

Black, head of the Puda deal team for Macquarie's equity capital markets unit, read portions of the Kroll report, including the executive summary stating that Zhao Ming was Shanxi Coal's 50 per cent shareholder, the SEC says.

Contradictory information not shared, discussed

Black allegedly did not call to anyone's attention the contradictory information he read in the executive summary about Zhao's ownership of Shanxi Coal or discuss it with the deal team.

Despite knowing the Macquarie-drafted public documents stated that Puda owned 90 per cent of Shanxi Coal, Black merely skimmed sections of the rest of the Kroll report.

He did not go on to read that Chinese corporate records showed the true ownership of Shanxi Coal.

While seizing half of the company for himself, Zhao had also sold a 49 per cent of Shanxi Coal on July 22, 2010 to a trust managed by China's largest state-owned investment firm, CITIC Group. CITIC onsold the shares to Chinese investors.

The Kroll report indicated in three different places, including a table, that Zhao and CITIC owned virtually all of Shanxi Coal.


The oversight by Macquarie's New York team was perhaps surprising, given the reputation Chinese companies listing in the US had for fraudulent transactions.

Indeed, one unnamed Macquarie banker had sent Black and colleagues an email, warning that the transaction warranted a "deeper dive on due diligence", because Puda "went public in 2005 in a reverse-merger transaction that did not include the typical [due diligence] of a US-listed [initial public offering]."

Reverse merger, back-door listing

A reverse merger is a back-door way to list on equity markets, by avoiding the higher regulatory and market scrutiny applied to an IPO. A private company takes over a publicly held company with dormant operations. Dozens of Chinese firms such as Puda have used the strategy to list in the US, with several being exposed for accounting fraud.

Later, the unidentified Macquarie banker separately emailed members of the deal team, including Black and Fang, warning one of the "stickiest" due diligence issues will be around "potential conflicts of interest by Ming Zhao [and his brother]".

After the capital raising was conducted, Puda's share price climbed to a 52-week high of $US16.97.

But an online investment blog written by China-centric shortselling publisher, Jon Carnes of alfredlittle.com, exposed Puda's non-ownership of Shanxi Coal and the asset transfers between Zhao and CITIC Trust.

"Considering the 2009 and 2010 audited financials can no longer be relied upon, and more importantly the complete lack of internal control that allowed chairman Zhao to first steal the company, then sell half the company (pocketing the proceeds) and then pledge the other half of the company to a Chinese PE fund while piling on $US530.3 million of 14.5 per cent debt, I strongly believe $2.66 is the most this stock is worth today," Carnes wrote.


Investors immediately punished the Puda stock.

On April 8, 2011, the stock price crashed more than 30 per cent in a day to $US6. Puda issued a press release announcing its audit committee had hired lawyers to conduct an investigation into the internet report's claims. The NYSE halted trading in Puda shares.

Auditor cautioned reports not reliable

On July 7, 2011, auditor Moore Stephens resigned, saying in a filing with the SEC that "evidence supports the allegation that there were transfers by Zhao in subsidiary ownership that were inconsistent with disclosure made by the company in its public securities filings". The auditor cautioned that the financial reports for 2009 and 2010 were not reliable.

With its shares trading as low as US1¢, Puda was delisted by the NYSE on August 18.

The SEC alleges Macquarie displayed "broader organisational failure" in due diligence and in supervising Fang who had limited experience on China-based companies. "Macquarie did not have sufficient systems in place for ensuring the Kroll report was properly assessed," the SEC says in the court complaint.

A Macquarie spokesman in New York says it had noted the settlement between Macquarie and the SEC regarding Macquarie's underwriting of a follow-on stock offering by Puda Coal in the US in 2010.

"Macquarie takes its compliance and regulatory obligations very seriously and has worked closely with the SEC to provide relevant information," he says.


"Under the terms of the settlement, Macquarie has neither admitted nor denied the SEC's allegations."

'Egregious negligence'

Separately, Zhao and former Puda chief executive Liping Zhu were charged with fraud by the SEC in February 2012 and the case is before the courts.

Black did not respond to a Financial Review request for comment, while Fang could not be reached directly after a message was left with his New York lawyer.

Adding to the fallout, Macquarie last week launched a legal malpractice suit against Morrison & Foerster, alleging "egregious negligence" on the Puda due diligence.

Morrison & Foerster attorney James Bergin says the law firm was confident it met its professional obligations in performing the duties typically undertaken by US securities counsel in cross-border securities offerings.

"Morrison performed appropriate diligence, including obtaining an opinion from a local Chinese law firm regarding the ownership of Chinese subsidiary companies.

"With respect to the Kroll investigatory report, which is alleged to have identified the potential fraud, US securities counsel do not typically review or give legal advice regarding the work of private investigators."