The Untold Story of the Paul Weiss Internal Investigation that Didn’t Catch a Massive Stock Fraud

By Pam Martens and Russ Martens: May 13, 2019 ~

Scales of JusticeThe legal press has been having a field day with how the U.S. Department of Justice, funded by U.S. taxpayers to conduct its own serious and unbiased investigations, has been outsourcing its investigations to the criminal target and its outside counsel – specifically, the law firm Paul, Weiss, Rifkind, Wharton & Garrison.

The case making the headlines involves Deutsche Bank. But another Paul Weiss internal investigation that has escaped meaningful scrutiny by mainstream media involves China Medical Technologies. The U.S. Department of Justice now describes this company as a massive securities fraud that dates back to the time that Paul Weiss conducted one of its internal investigations and came up empty-handed – or, at least, that’s what China Medical Technologies told the Securities and Exchange Commission in an official filing document.

China Medical Technologies went public in the U.S. in 2005. The sole underwriter was the large global bank, UBS. A secondary share offering was underwritten by Credit Suisse and Morgan Stanley in 2008. The company was organized as a holding company under the laws of the Cayman Islands and depicted itself as “a leading China-based medical device company that develops, manufactures and markets advanced in-vitro diagnostic products.”

In a Securities and Exchange Commission (SEC) filing on July 30, 2009, China Medical informed its regulator that an anonymous letter had been received by its Audit Committee containing “allegations of irregularities and improper conduct” in connection with acquisitions made by the company, its disposal of a business, its revenues, and its relationships with stock analysts. The company then explained the ensuing internal investigation by Paul Weiss as follows:

“The audit committee, consisting of three independent directors, decided to initiate an independent internal investigation into the allegations contained in the anonymous letter. In connection with this independent internal investigation, the audit committee engaged an independent law firm, Paul, Weiss, Rifkind, Wharton & Garrison LLP, as well as independent forensic accountants, AlixPartners LLP, to assist the audit committee to carry out this independent internal investigation. The independent law firm and forensic accountants involved their experienced personnel from their U.S. offices to conduct this independent internal investigation and began their investigative work in April 2009 and the investigation lasted for more than three months.

“The investigation covered not only the entire senior management team but also employees from various key departments of all operating subsidiaries of the Company. The senior management and other relevant employees of the Company fully cooperated with the independent law firm and forensic accountants in the course of the investigation. During the process of the investigation, the independent law firm reported from time to time the scope, procedures and progress of the investigation to the audit committee. The independent law firm and forensic accountants have substantially completed their investigative work and have reported to the audit committee that the investigation has not identified evidence to support the allegations made in the anonymous letter.”

That was July 2009. On December 5, 2011 Glaucus Research Group issued a statement saying that it was initiating coverage of China Medical (which traded at the time under the Nasdaq stock symbol, CMED) with a “Strong Sell rating.” It added the following:

“CMED is a medical device company that manufactures and markets immune diagnostic and molecular diagnostic products for the detection of various cancers, diseases, and disorders, as well as companion diagnostic tests for targeted cancer drugs.

“A few weeks ago an anonymous short seller posted a blog entry on GeoInvesting’s website alleging that CMED committed fraud by, among other things, overpaying for acquisitions from undisclosed related parties. We here at Glaucus Research follow the U.S.-listed Chinese space closely, so we were naturally curious. We decided to investigate the allegations of fraud. Here is what we found.

“We believe that the evidence supports the anonymous blogger’s allegations that CMED committed fraud by overpaying for an acquisition from an entity that appears to be secretly related to CMED’s founder, CEO and chairman….”

In other words, it took Glaucus Research “a few weeks” to investigate and conclude that this company was engaged in fraud – something that the Paul Weiss investigative team had missed after a three-month investigation, according to the company’s SEC filing.

Less than a month after Glaucus Research made its finding of “fraud,” on January 6, 2012 Seeking Alpha reported that analysts at the following major Wall Street firms were still touting the stock of China Medical, writing as follows:

“Barclays Capital initiated coverage on China Medical Technologies (CMED) in a research note issued to investors on Tuesday January 3rd, 2012. They set an ‘overweight’ rating on the stock. Separately, analysts at Zacks upgraded shares of China Medical Technologies from a ‘neutral’ rating to an ‘outperform’ rating in a research note to investors on Friday, December 2nd. Deutsche Bank covers China Medical Technologies with a Buy rating and Morgan Stanley has maintained its Equal-weight rating with a price target of $5.50.”

Just six months later, on July 27, 2012, two joint official liquidators, Krys Global and Borrelli Walsh, were appointed by the Grand Court of the Cayman Islands to wind up the company since it had failed to make interest payments on hundreds of millions of dollars of its notes. The liquidators’ investigation found that China Medical’s Chairman and Chief Executive Officer, Xiaodong Wu, and its Chief Financial Officer, Samson Takyung Tsang, had “facilitated a scheme to misappropriate at least $521.8 million of CMED’s cash.” The liquidators also found that the medical technologies purportedly acquired by CMED had no significant value.

On November 9, 2012, the SEC finally got around to revoking the registration of the company’s shares, citing the company’s “failure to comply with reporting requirements of the Securities Exchange Act of 1934.”

The liquidators wanted to see all of the documents from the Paul Weiss investigation and asked the Bankruptcy Court for the Southern District of New York to issue a subpoena for the documents to Paul Weiss. The law firm turned over documents but withheld some based on attorney-client privilege and the work product doctrine. The Bankruptcy Court sided with Paul Weiss on this issue.

The liquidators were then forced to appeal that decision to the U.S. District Court for the Southern District of New York. Judge Ronnie Abrams ruled in favor of the liquidators this time around, writing that “The Court finds that Appellant, as CMED’s Liquidator, now owns and can thus waive the Audit Committee’s attorney-client privilege, regardless of the Committee’s prebankruptcy independence. The Bankruptcy Court’s ruling to the contrary is hereby reversed.”

Sounding like a small-scale version of the Madoff fraud, where Harry Markopolos wrote letters warning the SEC of a potentially massive fraud for years, it was eight years after the whistleblower wrote to the Audit Committee of China Medical Technologies and Paul Weiss conducted its unfruitful investigation that the U.S. Department of Justice filed an indictment against the company’s CEO and CFO for absconding with hundreds of millions of dollars of the company’s money.

The Justice Department’s indictment was filed in the U.S. District Court for the Eastern District of New York on March 20, 2017. A review of the docket in that matter yesterday shows that there has been no other entry since that date more than two years ago.

The docket sheet shows that the case has been assigned to Judge Kiyo A. Matsumoto. Representing the Justice Department is Lauren Howard Elbert of the U.S. Attorney’s Office for the Eastern District of New York and, curiously, the Justice Department is also being represented by an attorney for an outside law firm, Winston M. Paes of Debevoise & Plimpton, who has been designated, according to the docket sheet, as a “government attorney.” Debevoise & Plimpton is the home of the former SEC Chair, Mary Jo White. See The Whites Go to the SEC: Why Wall Street Still Owns Washington.

If the U.S. Department of Justice is being quietly privatized by Wall Street and its law firms, it’s time for journalists to conduct their own investigation and issue their findings.

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