Morgan Stanley Central in Chinese Stock Dispute 

Such discrepancies highlight Morgan Stanley’s roles shepherding then promoting then defending Tianhe — which one of its investment funds partially owns — before and after the chemical company became a major international stock offering. If Morgan Stanley & Co. LLC and its fellow underwriters, Bank of America Merrill Lynch and UBS AG, failed adequately to vet Tianhe, the banks could be subject to reputational and legal concerns.

The controversy surrounding Tianhe (pronounced TYEN’-huh) carries special significance as China’s financial markets are opening to the world and increasingly becoming part of U.S. stock portfolios largely through pension and mutual funds. Investors unable to conduct their own, on-the-ground research of Chinese companies rely on investment banks like Morgan Stanley to act as gatekeepers, preventing problematic companies from listing.

Tianhe Chemicals Group Ltd. manufactures lubricants and sophisticated chemicals used to fight fires and toughen touchscreens. The AP began its review of the company after allegations arose about the firm from a shadowy investment research group tied to people betting against Tianhe’s stock. The group said the company had vastly overstated the size and profitability of its business.

Tianhe rejected the claims, and Morgan Stanley said it stands “resolutely behind Tiahne’s world-class management team, ” but Tianhe’s shares have fallen 39 percent since then.

Research in the U.S., Hong Kong, Shanghai and Tianhe’s hometown of Jinzhou over two months suggests investor concerns were warranted. Public records, commercial business data and site visits by the AP largely corroborated key claims by Anonymous Analytics, the group that targeted Tianhe, and uncovered additional information the group did not. The discrepancies involve basic matters such as Tianhe’s profitability, relationships with customers and even the company’s origins.

Among AP’s findings:

—Tianhe revenues cited in commercial business data from government and public sources were reported as a fraction of the revenues the company reported to foreign investors, $106 million in 2012, not $684 million. The AP purchased the financial data on Tianhe’s subsidiaries from vendors who also perform due-diligence work for the U.S. Commerce Department. Tianhe disputed the accuracy of this information, and allowed the AP to review local regulatory filings reflecting the higher revenue figures.

—Commercial business data and records from a state-owned financial institution identify a Tianhe predecessor as the property of Chinese government organizations, although the company’s founders said they own it. The difference matters because the older company transferred key assets to a current Tianhe subsidiary for “nil consideration” in 2009, and Chinese law requires government property to be sold at a “reasonably determined” price. A case manager for China Great Wall Asset Management Corp., a state-owned financial institution, confirmed that the government’s records show the predecessor was state-owned as recently as late 2013. Tianhe said the information was “very outdated” but declined to allow the AP to review regulatory files to settle the question.

—Tianhe’s financial filings indicate one principal customer, Shanghai Xidatong International Trading Co. Ltd., has bought as much as $100 million in chemicals each year. Business data purchased by AP said that company’s annual revenues in 2012 were less than $6 million, and the company’s net worth was minus $900, 000 at the end of 2012. Its chief executive, Zhang Silang, declined to answer questions from AP. Shanghai Xidatong’s registered office is an unoccupied room containing broken furniture and old mattresses in a dilapidated apartment building. It conducts its business out of two other offices, both prominently labeled with signs for other chemical companies.

Morgan Stanley, which declined to discuss the AP’s findings, twice conducted due-diligence investigations into the company — once before the investment made by the bank’s private equity fund and again before the company’s public offering. Tianhe told the AP the bank spent more than $2 million on its vetting investigations.

Tianhe Chief Financial Officer Joseph Lee, a former Morgan Stanley banker, said the private equity team had closely scrutinized Tianhe.

“They took a long time and also spent quite a bit of money, ” he said.

In response to AP’s inquiries, Tianhe executives provided AP limited access to confidential documents in Hong Kong and Jinzhou. In Hong Kong, the company twice allowed an AP reporter to inspect its Deloitte-audited financial statements and other records on the condition that she could not take notes or communicate with co-workers over an unmonitored phone line while viewing the files. It videotaped her the entire time. In Jinzhou, the company persuaded local government officials over their objections to allow AP to inspect and copy some of its own corporate records but not others.

After a two-year debate over penalties facing banks for allowing fraudulent companies to sell shares, Hong Kong’s Securities and Futures Commission said in August that it will not hesitate to rely on criminal statutes to prosecute banks.

One reason regulators adopted harsh standards for underwriters is that, in the event of fraud, obtaining recourse against mainland Chinese companies can be difficult or impossible, said Philippe Espinasse, a Hong Kong-based former investment banker and author of several books about IPOs. The listing system relies on banks to vet professionally a company’s promises, outlined in a document known as its prospectus, he said.

“The one document you should rely on is the prospectus, because that’s been vetted by a whole bunch of parties that supposedly know what they’re doing, ” he says.

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