|ChinaCast (stock symbol: CAST):|
China Case Reveals Risks of Investing in a Foreign Company
By STEVEN M. DAVIDOFF
New York Times
January 12, 2012, 4:13 pm
The management of the ChinaCast Education Corporation appears to have a novel response to board elections: ignore them.
A remarkable series of events unfolded over the last few days involving this Chinese company, a secondary education provider. When I wrote about ChinaCast in December, the company had accused Ned Sherwood, one of its directors and owner of 7 percent of ChinaCast’s shares, of insider trading and other misdeeds. ChinaCast was trying to push Mr. Sherwood off the board by refusing to nominate him for election at the company’s annual meeting.
Mr. Sherwood denied the charges and started a proxy campaign to elect three dissident directors, including himself, to the ChinaCast board.
ChinaCast is based in mainland China and has all of its assets there, but it is listed on the Nasdaq and organized under the laws of Delaware. Mr. Sherwood thus also sued in Delaware to force a postponement of the shareholder meeting from Dec. 21 to allow him time to run an election campaign for his slate of directors.
A Delaware judge, Vice Chancellor Donald F. Parsons Jr., agreed to postpone the meeting to Jan. 10. The vice chancellor found that ChinaCast’s disclosure omitted material information about the allegations against Mr. Sherwood, including that the Securities and Exchange Commission had decided not to pursue the matter.
The annual meeting, held Monday in Beijing, was apparently bizarre.
According to a complaint filed by Mr. Sherwood in the Delaware court, ChinaCast’s directors convened the meeting at 9 a.m. Scott Winter, a managing director with the proxy adviser Innisfree, represented Mr. Sherwood at the meeting and tried to nominate Mr. Sherwood’s slate. Antonio Sena, ChinaCast’s chief financial officer and the ostensible chairman of the meeting, stated that Mr. Winter’s nominations were improper under the company’s bylaws.
The mystery deepened after that. According to Mr. Sherwood’s complaint, an “unidentified attendee” then took over the role of meeting chairman, reiterated that Mr. Sherwood’s nominees were disqualified and summarily adjourned the meeting to the next day, stating that it was necessary for the company to clarify an institutional investor’s voting intentions. The new meeting chairman called the adjournment a “recess,” meaning that the postponement did not require the shareholders in attendance to consent.
A lawyer for ChinaCast, Mitchell S. Nussbaum of the law firm Loeb & Loeb, declined to comment on the identity of the new meeting chairman because the matter was the subject of pending litigation.
The meeting reconvened near midnight that same day, according to a person close to Mr. Sherwood. But when Mr. Winter and his colleagues arrived at ChinaCast’s headquarters, the building was locked and the lights in the lobby were off. They managed to enter through the garage. The company reopened the meeting, asked if anyone wanted to vote, closed the polls and ended the meeting. It all took less than five minutes.
IVS Associates, which is based in the United States, was hired as the official inspector of the election, but was instructed to ignore Mr. Sherwood’s nominees in certifying the official election results, said the person close to Mr. Sherwood, who spoke on condition of anonymity. However, if Mr. Sherwood and his two nominees were counted, they would win three seats on the board, this person said.
Mr. Nussbaum denied that IVS had been instructed to ignore those votes.
Mr. Sherwood amended his lawsuit against ChinaCast on Tuesday, seeking to have his nominees seated on the ChinaCast board. He was not immediately available to be reached for comment.
We have yet to hear any real public response from ChinaCast, including an announcement of the election results. ChinaCast said in a statement on Tuesday night that it would release the final results once IVS had compiled an official tally. Mr. Nussabaum said that the results were delayed because IVS was processing these votes in China and not because of any actions by ChinaCast. Still, it is unclear why there should be such a delay as these types of reports are typically released almost immediately after shareholder meetings.
ChinaCast’s only other statement this week was issued on Monday, accusing Mr. Sherwood of being in league with Fir Tree Partners, an asset manager based in the United States and owner of 11.1 percent of ChinaCast’s shares. Fir Tree has a contractual right to appoint one director to the ChinaCast board. In its release, ChinaCast accused Mr. Sherwood and Fir Tree of acting in concert. It asserted that Mr. Sherwood was really an appointee of Fir Tree’s and that this effort was really a disguised attempt to take over the company. In a separate statement, Fir Tree denied the allegations.
The reason ChinaCast made those accusations is likely twofold. First, if Mr. Sherwood is not Fir Tree’s designated nominee, then Fir Tree can nominate another director, which would give the dissidents a chance at four of seven board seats. Second, if Mr. Sherwood and Fir Tree are acting in concert, their actions are likely to constitute a violation of United States proxy rules because Fir Tree failed to join Mr. Sherwood’s proxy statement that put forth his three nominees. While ChinaCast’s argument has resonance because Mr. Sherwood had previously been such a designee, it appears that Fir Tree has withdrawn this designation. These claims are unlikely to prevail unless more facts emerge, but it appears that ChinaCast is going to argue the point, setting the stage for more litigation.
We thus wait for the IVS results, ChinaCast’s further response and the Delaware judge mediating this dispute to act.
If ChinaCast again loses in the Delaware courts, the question is, what will it do afterward? The Chinese company could simply refuse to honor the court’s order. It has no assets in the United States, so it could easily ignore any monetary fine. However, it is listed in the United States and is subject to S.E.C. supervision; such an act is likely to crater its stock price. The likelihood of such a response is low, but it appears that ChinaCast’s current management is going to fight this coup to the bitter end. Expect more maneuvering by all parti0es involved.
There is a wider lesson here. It is hard to know the real facts in this case given the murky nature and distance of the events, but whatever the truth is, investing in companies based in a foreign country is risky not only because the rule of law is weaker, but also because of cultural differences.
Foreign companies are not as familiar with United States practices and laws governing domestic corporations. They are sometimes more willing to push the envelope, either out of cultural inexperience or simple ignorance. ChinaCast itself appears to have been a bit behind the ball in getting good advice. It hired Mackenzie Partners, a top American proxy adviser, to represent it only after it lost the first ruling in Delaware. The distance and language barriers only exacerbate these problems.
Mr. Sherwood is willing to expend substantial sums of money to hire advisers to represent him in court and in Beijing. But other investors may not be so willing or wealthy. Instead, these investors might be burned when they find that things are different when they invest in companies based outside the United States.
Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the world of mergers and acquisitions.