Little did he know it would ignite a powder keg that sent ripples of shock through the investing landscape and sparked a newfound skepticism about companies that list their shares in Canada but operate in far-away emerging economies.
While Canadian companies eye lucrative Chinese markets to export everything from coal and potash to lumber, wheat and oil and gas — major Chinese players have sunk billions of dollars into Canadian resources in the last year.
Yet Block's research has tarnished the reputation of some Chinese firms and raised a red flag for Canadian investors.
"An investor reached out to us and said he was short," Block says — that is, short-selling the stock to profit on the assumption it was ripe to take a tumble.
A glimpse of the investor's research piqued Block's interest and prompted him to spend hours poring over documents chronicling the operations of the Toronto-area Chinese timberland company, its partners and suppliers.
"It was sorting through thousands and thousands of pages of documents to pull out the data," said Block, who found enough in the mountain of research to convince himself the time was right to also sell the stock short.
But Block didn't stop there.
When he was done, Muddy Waters Research published a report loudly accusing the company of a massive fraud. What resulted was one of the biggest scandals on the Toronto Stock Exchange in decades, although six month later none of the allegations against Sino-Forest have yet been proven.
Sino-Forest (TSX:TRE) was just the first Chinese company listed on the Toronto Stock Exchange to face allegations of fraud and misdeeds.
Silver miner Silvercorp (TSX:SVM) bristled in a vociferous defence after it was hit with anonymous allegations of fraud, while Chinese shoe manufacturer Zungui Haixi Corp. (TSXV:ZUN) would be brought into the spotlight after its auditors suspended their work and advised the company's audit committee that an independent investigation of financial results was warranted.
And while an investigation by KPMG Forensic Inc. confirmed Silvercorp's financial reporting and accounting as accurate, Zungui Haixi has done little to defend itself.
But Sino-Forest was the biggest to face troubles.
After the Muddy Waters report came out, shares in what was once the most valuable forestry company on the Toronto Stock Exchange plunged and investigations by the company, the Ontario Securities Commission and the RCMP were launched.
As the end of the year approached, $3.7 billion worth of Sino-Forest's stock market value had been wiped out. Trading in its shares remained halted and its future in doubt after it missed an interest payment on its debt and raised the possibility of a sale of the company.
While Sino-Forest has consistently denied it is a fraud, its own ongoing investigation has found its internal processes, infrastructure and breadth of management team had not kept pace with the growth of its operations.
Despite controversy, the appeal of the lucrative Chinese economy remains strong and headed into 2012, the Asian giant is expected to remain a dominant theme for investors. While Europe remains in turmoil and the U.S. economic recovery has remained sluggish at best, Asia and China in particular have continued to post growth.
The Toronto Stock Exchange opened an office in Beijing in November at an event attended by federal Finance Minister Jim Flaherty.
State-owned Chinese companies have been active in acquiring oil and gas, mineral and coal assets in Canada in recent years as it has moved to secure key resources around the world to supply the growing Chinese economy.
China National Offshore Oil signed a deal this year to acquire Oilsands operator Opti Canada Inc. in a deal valued at US$2.1 billion earlier this year, while Sinopec International Petroleum Exploration and Production Corp. bought Daylight Energy Ltd. for C$2.2 billion.
The largest investment to date has been Sinopec's US$4.65-billion stake in the Syncrude Canada Ltd. partnership, which operates the world's largest oilsands mine north of Fort McMurray, Alta. Sinopec also has a 50 per cent stake in Total E&P Canada's Northern Lights project.
China represents just a sliver of the Toronto market with 57 companies of the 3,824 listings on the Toronto Stock Exchange and TSX Venture Exchange based in Asia as of the end of November. Of the 494 new listings this year, just seven belong to Chinese or Asian companies.
But Ungad Chadda, senior vice-president of the Toronto Stock Exchange, said China is a key market.
"It just makes sense if you're looking for trying to attract more investment in Canadian listed stocks and Canadian companies and the Canadian economy that we should be there," Chadda said.
However, Chadda acknowledged there have been growing pains.
"I think everyone is learning here, including the Ontario Securities Commission and other commissions. I would say that it is early days in this in terms of understanding," he said.
Chadda said it's not the first time Bay Street has faced problems and the industry will learn from its mistakes.
The Ontario Securities Commission has launched a targeted review of companies listed on Canadian exchanges with significant operations in emerging markets. The regulator is examining the disclosure by companies as well as the role of the auditors and underwriters in this process.
OSC chairman Howard Wetston has said that reverse takeovers, like the kind used by Sino-Forest to gain a listing in Toronto, need to be re-examined. By using a reverse takeover to gain a listing, companies generally face less scrutiny than they would if they went through the traditional process of making an initial public offering.
Kai Li, a finance professor at the University of British Columbia with strong connections to China, said it has been a year of learning on both sides of the Pacific. She noted that UBC was approached by a Hong Kong investor to help teach Chinese companies about investor relations.
However, Li said plenty of red flags remain regarding the Chinese market, where even major companies have accounting irregularities and don't take ongoing compliance and disclosures to shareholders as seriously as they should.
"They just aim to be listed, raise money for one time, enrich themselves and their initial investors, that's all," she said of many companies.
"You only know what they disclose and it might not be factual."
Block suggested that fund managers were pushed into investing in China with little expertise in the sector and unaccustomed to the realities of investing in the Asian country.
"They lacked other compelling investment themes. Much of the global economy has been a mess," he said.
"China was still reporting blow out GDP growth numbers and that really made it stand out in a world of lacklustre economic and business performance."
Heading into 2012, Block warned there may be more to come as auditors sharpen their pencils and prepare for the upcoming audit season.
"I think that will present an overhang to the asset class," he said, noting that he expected pension funds and other large investors to start reducing their exposure to China.
"My outlook for the next six months for North American-listed Chinese stocks is somewhat negative on the whole."Suggest a correction