Case II: Hartcourt Companies Inc.: A Micorcap Company Never Die
The predecessor of Hartcourt Companies Inc. was Hartcout Companies, a sole proprietorship operated and
owned by Alan Viet Phan of Los Alamitos, California. Records in the Federal Trade Commission indicate that Phan
engaged in a business of selling a non-tobacco product called Jazz cigarettes in 1992. Phan advertised that Jazz
cigarettes helped people quit smoking. He also claimed that Jazz cigarettes would not cause cancer because they did
not contain nicotine. The Federal Trade Commission filed charges against Phan that he made false and deceptive
claims about the health risks of smoking the product, and deceptive claims about its ability to help people quit
smoking. In March 1993, Phan entered a settlement with FTC that he would not making any future health or safety
claims about any smoking product unless they are true and substantiated by competent and reliable scientific
evidence. The FTC’s order was a death knell to Jazz cigarettes. Phan then switched his business to making and
selling pens.
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After the fiasco of Jazz cigarettes, Phan shifted his gear into the dark alley of Wall Street. In April 1993,
Phan incorporated Harcourt Investment USA with no cash or other assets but claimed to engage in the design,
manufacture and sale of writing instruments. In October 1993, he incorporated another shell corporation, Hartcourt
Pen, to engage in the sale of writing instruments. There is no evidence that Phan had ever engaged any business
activities in these two shell corporations.
In August 1994, Hartcourt Investment USA issued 250,000 shares, representing 80% of the common stock
of Hartcourt Investment USA outstanding shares immediately subsequent to the transaction, to acquire 60% interest of
Xinhui Harchy Modern Pens Ltd of China, a joint venture of Eastern Rochester’s Ltd. of China. Why would Eastern
Rochester so willingly be acquired by a company that did virtually nothing but printed a large number of stock
certificates? If one examined the financial statements of Eastern Rochester after the merger, one would discover
that Eastern Rochester was one of thousands of dying Chinese state-owned enterprises that could not compete against
more efficient and newly formed private enterprises. Merging with Hartcourt Investment USA would offer an
opportunity for this dying Chinese company to access the U.S. capital markets.
In November 3, 1994, General Stardust, a shell corporation with no assets or business operations but
quoted in OTCBB, acquired Hartcourt Investment USA for 6,110,337 shares. These double reverse mergers enabled
a financial-strapped Chinese pen company under the umbrella of Hartcourt Investment USA to become a publicly held
company in the US. Subsequent to the double reverse mergers, General Stardust changed its name to Hartcourt
Companies Inc (HRCT).
Nurtured by the fast growing Chinese economy and its vast market, many U.S. investors developed a strong
appetite for stocks with Chinese connection during the bull market of 1990s. To many naïve investors, China looked
like the Wild West where gold mines were abundant and opportunities abounded. Apparently, Phan and his Chinese
cronies were taking advantage of the Chinese fever and the often irrational exuberance that followed.
On December 1, 1994, HRCT paid 38,625 shares for Hartcourt Pen and 1000 preferred shares to Alan Phan.
The preferred stock created by Phan was very unusual. The sole preferred stock shareholder, Phan, could name 3/5th
of the board of directors while the common stock shareholders could only name 2/5th of the board of directors. This
inexplicable arrangement gave Phan the absolute majority to maneuver the board of directors.
In several filings to SEC, Alan Phan claimed that he had a Bachelor of Science degree in Environmental
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Engineering from Penn States University in 1967, a Ph.D. degree in Management from Sussex College of Technology
in London in 1973. According to the article, “Degrees without Tears for Status Seekers” from the Times newspaper
of London in June 1975, Sussex College of Technology was run by a former Royal Air Force corporal from his
country house in Sussex. There is no campus; students simply paid a few pounds for some dubious papers then were
granted the degree of their choice. Sussex could even backdate the degrees for their students. In some SEC filings,
he either mistakenly or falsely claimed that his Ph.D. was from Penn State University. Phan later claimed that he
needed a Ph.D. degree to impress his Chinese business partners.
HRCT has never been profitable. It lost $345,795 in 1994, $1,593,891 in 1995, $1,579,738 in 1996, $474,372 in
1997, $21,295,653 in 1998, $7,862,468 in 1999, $6,790,879 in 2000, $5,329,408 in 2001, and 2,550,002 in 2002.
The total accumulated deficits reported in the balance sheet on December 31, 2002 were an astonished figure of
$51,053,335. This is not a small change for a company of Hartcourt’s size. As the result, HRCT had received a
qualification on its ability to remain a going-concern from its auditor every year since its inception. Paradoxically,
the significant amount of loss and almost no cash did not preclude Hartcourt from acquisition frenzy. In March
1996, it acquired a complete line of cosmetics for 12,000 shares. In September 1996, it acquired Peony Gardens
Deposit, an apartment complex project in China, for 4,600,000 shares. In a separate transaction with two Chinese
companies, Hartcourt claimed that it had agreed to contingently acquire a 50% interest of mineral lease gold lode
claims in the Melozitna mining district near Tanana, Alaska for 1,298,700 shares of its own common stock. The pen
business was a flop. The cosmetic business went nowhere. The apartment building was never completed. The gold
mine has never been developed. It is inconceivable that the executives had no knowledge that these companies had
little viability. Apparently, those transactions either had no economic value or were just exaggerations. They were
tools to deceive the naïve investors.
By August 1998, Hatcourt terminated the business relationship to all its Chinese partners in pen
manufacturing, apartment development and the Alaskan gold mine. These were not painful divorces because all its
partners were more interested in access to cash from the U.S. capital markets rather than developing their own
businesses.
Obviously the company needed working capital to operate the business. No financial institutions would
loan the capital to a company that seemingly had no future and no viable business strategies. No reputable
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underwriters would be willing to take a company with tainted past for the secondary public offering. Therefore,
Hartcourt continuously raised additional capital through private placements from penny stock speculators at steep
discounts either under regulation S or under regulation D to circumvent the registration process. The speculators
then resold the stock to the other uninformed investors offshore or to the general public at OTCBB after the expiration
of restricted period. The speculators and the company then hired attorneys and promoters to promote the stock.
These actions revealed that Phan was more interested in making money from issuing stocks than developing any
businesses.
To avoid the appearance of a simple shell corporation, Hartcourt had to acquire real business entities and
consolidated their revenues into the financial statements of the shell. Without engaging such activities, the
perpetrators would not have been able to induce naïve investors buying Hartcourt stock. Of course, Hartcourt could
only acquire worthless companies that were on the verge of bankruptcy. After all, Hartcourt is just a shell. These
sick companies seldom stayed with Hartcourt for more than fourteen months. Their only goal was to pilfer the
money from naïve investors.
In July 1997, Hartcourt agreed to purchase a shopping center, Freeway Plaza, located in Perris, California
for $6.75 million, included a $25,000 cash down payment, bank financing of $3,725,000, and 34 of Hartcourt's 68
mineral lease gold lode claims, valued at $3,000,000. As described earlier, the Alaskan Gold Mine lease was very
nearly a scam. Of course, the purchase agreement for the shopping center was cancelled soon after. Apparently, it
was designed to pump up the stock price.
In October 1997, Hartcourt acquired Pego Systems Inc., a California distributor of air and gas handling
equipment for $500,000 and 450,000 restricted shares. Through Pego it acquired Pacific Pneumatics Inc., a
California manufacturer of industry dust collectors and filters for $200,000 and 9,796 shares. In addition Electronic
Component Systems (ECS) and Pruzin, Arizona manufacturers of printing circuit boards for $500,000, 250,000 shares
of common stock and 3,400 shares of convertible preferred stock. However, the marriage did not last for a long time.
The original owners of Pego and ECS rescinded the merger agreement in early 1999. Phan organized a shell
corporation called Enova. Hartcourt exchange its ownership in Pego and ECS for 5,213.594 Enova shares.
Hartcourt then distrbuted Enova shares to Hartcourt shareholders. Although those Enova shares were worthless,
Phan boasted that Hartcourt had paid dividends to shareholders.
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A closer look at Hartcourt’s comparative financial statements of 1997 and 1998 in 10K of 1998, and
Hartcourt’s comparative financial statements of 1998 and 1999 in 10K of 1999, reveals that all the revenues of 1998
reported in the former comparative financial statements were in the section of continuing operations, but all the
revenues of 1998 reported in the latter comparative financial statements were in the section of discontinued operations.
This discrepancy clearly indicates that Hartcourt acquired Pego and ECS solely for the purpose of showing that it had
engaged in legitimate business activity and was not just a shell corporation. The parties who merged with Hartcourt
did not have any intention to stay with Hartcourt either. Once Hartcourt located another source of consolidated
revenues, it departed from the former partners. Mergers and acquisitions were just tools to attract uninformed
investors.
In 1998 and 1999, numerous companies that conducted business through Internet companies floated very
successful initial public offering. Investors rushed to gobble up companies that ended in dot-com. They were
willing to pay absurd prices for many dot-com companies that had no clear prospects or attainable strategies.
Unscrupulous penny stock operators took advantage of this irrational behavior rushed to attach their dreary companies
with dot.com. Apparently, Phan saw a golden opportunity to enrich him and his cronies. China has enjoyed the
highest economic growth rate in the world for the last fifteen years. It would not be difficult to attract naïve
investors investing in a company that conducted business in China. Again, reverse mergers provide easy ways of
bringing conceptual companies or unpromising companies into the capital market.
On June 20, 1999, Hartcourt entered into an agreement with UAC Stock Trading Online Co. Ltd. of
Beijing, China to form a joint venture called UAC Stock Exchange Online Co. Ltd. for 35% of ownership in the joint
venture. Under the terms of the agreement, Hartcourt agreed to invest $1,000,000 in UAC Stock Exchange, pay
$1,700,000 to the owners of UAC Stock Trading and transfer 800,000 common shares of Hartcourt to UAC Stock
Exchange and 200,000 common shares to UAC Stock Trading. On August 9, 1999, Hartcourt and UAC agreed to
covert the Hartcourt loan of $200,000 for an option to purchase additional 15% ownership in UAC Stock Exchange
from UAC Stock Trading. This intricacy relationship is designed solely for one purpose: consolidating UAC Stock
Exchange revenues into Hartcourt. Although Financial Accounting Standard Board (FASB) Statement 115 allows a
consolidation only if a company owns 50% or more outstanding shares of the investee, Alan Phan interpreted that an
option to purchase was the same as straight ownership. He did not care if the joint venture made money. He
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wanted to show the gullible investors that Hartcourt was not just a shell company. Suddenly he transformed a shell
corporation that had failed every business deal since the inception into a red-hot dot-com in China. Phan realized
that naïve American investors would not be able to verify the authenticity of mergers and acquisitions by microcap
companies in China.
In August 1999, Hartcourt entered into a stock purchase agreement with Financial Telecom Limited (FTL)
of Hong Kong, an online financial media corporation, to purchase 4,964,990 shares of common stock, representing
58.53% of the total common stock outstanding. Hartcourt paid $4,720 cash, $797,140 on account and 1,500.000
shares of common stock. Hartcourt stated that FTL was also acting as the marketing agent for Standard & Poor's
Comstock, a division of McGraw Hill, in Hong Kong. Actually, FTL paid the service to McGraw Hill for the
privilege of using its data bank.
In December 1999, Hartcourt entered into an agreement with GoCall Inc., a Delaware corporation for
Internet related development-stage businesses, to form a strategic alliance for the common interest of both companies
by exchanging shares among each other. As a result of these activities, Hartcourt became a hot stock on the OTCBB.
An array of online publications, the paid pseudo-analysts or promoters, highly recommended the stock. The stock
took off. It went from the split-adjusted price of 12 pennies in early June 1999 to as high as $10.25 in December
1999.
Since Phan’s primary intention was to make money from selling stock, none of the business plans were
ever successfully developed. GoCall was very short-lived. It went bust in just a few months. UAC Stock
Exchanged ceased operation in 2001. Hartcourt received a note of $2,858,286 from UAC stock Trading, its joint
venture partner, and booked the gain on disposal for $1,060,371. The note was then resold to Edda Limited of
British Virgin Islands. One might be puzzled that why anyone would buy a seemly worthless note from a company
that had failed in every business transaction and incurred huge amount of operating loss. A closer look at Edda
reveals that Edda was a financing arm for Phan and his associates. Hartcourt sold restricted shares to Edda through
Regulation S private placements. Edda peddled the shares to naïve investors, using portion of the proceeds to pay
back Hartcourt. The mysterious owners of Edda probably owned Hartcourt shares too. They could dump their
shares into the open market. They could short their restricted shares through their offshore brokers because
enforcement from SEC was unlikely.
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Like GoCall and UAC Stock Exchange and FTL hardly produced enough revenue streams to cover the
overhead. Hartcourt acquired the remaining minority stakes of FTL in December 2002. Although, FTL’s web page
still exists, it is near inactive and poorly maintained.
Listed companies are very serious about the float of their shares. Common sense tells us that if a
company does not control the issuance of its shares, it will significantly dilute its earnings, causing a detrimental effect
on its share price. However, penny stock operators have no concern about the well being of their shareholders.
They tend to well take care of themselves and their related parties. Hartcourt was no exception. It had very
generously issued free shares to insiders and their consultants. The services provided by consultants, if any, are
often questionable. For example, Hartcourt issued 3,414,507 shares in 2000, 1,943,024 shares in 2001 and
7,214,847 in 2002 to its insiders and consultants. This is not a small change. The number of give-away shares
during the last three years was approximately 15% of the total outstanding shares. Ironically, Hartcourt also
generously gave free shares to its auditors. In 1998, Hartcourt gave free shares to the employees of its auditor of
1997, BOD International. In 2002, Hartcout offered free shares to a partner of its auditor of 2000 and 2001,
Weinberg & Co of New York.?? Although the employees of these CPA firms did receive the free shares after
Hartcourt contracted other CPA firms as its new auditors, it still cast a cloud to their integrities on the financial
statements these auditors audited in 1997, 2000 and 2001.
Hartcourt needed a boost to revive its Chinese Internet businesses. After the failure of UAC Stock
Exchange, GoCall Inc. and FTL Limited, Hartcourt had become a shell corporation again. In April 2001, Hartcourt
acquired a Chinese Internet financial services company, Sinobull.Com, which was incorporated in British Virgin
Islands in November 1999, for 805,802 shares. Sinobull.com had had a close tie with Hartcourt since its inception.
The acquisition was not a surprise. Hartcourt boasted that it would bring Sinobull.com to the Hong Kong Stock
Exchange and return handsomely to the shareholders after the website was fully developed. However, Sinobull was
nothing but a poorly designed web site. It has never contributed any revenue streams to Hartcourt. The web site
then became inactive in 2002.
Hartcourt continuously issued exaggerating press releases stating that the company engaged in a variety of
businesses in China including Internet financial service, wireless Internet service, financial cable TV channel, ecommerce
management, online education service that involved with many Chinese partners. It is inconceivable that
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a financially strapped company that constantly needed private placements for working capital was able to engage a
wide range of business deals. Of course, none of these businesses ever materialized. More likely, they were just
scams to attract gullible investors.
Hartcourt desperately needed to present revenues to its investors. In January 2002, it acquired 51%
ownership of a pre-paid phone cards company, Elephant Talk of Hong Kong for 4,756,058 shares of Hartcourt.
Elephant Talk went through a reverse merger with Staruni Inc., an OTCBB shell corporation, at the same time.
Elephant Talk itself had suffered a huge loss every year. The reverse merger with Saruni and the acquisition by
Hartcourt enabled Elephant Talk access the US capital market. The insiders and the promoters could also cash their
wealth in the market.
The marriage lasted a very short period in time. In September 2002, Hartcourt and Elephant Talk
terminated the relationship. Hartcourt returned 2,500,000 shares of Elephant Talk to Elephant Talk. Elephant Talk
returned 4,756,058 shares of Hartcourt to Hartcourt. Hartcourt then issued a special dividend of 5,000,000 shares of
Elephant Talk to Hartcourt’s shareholders. The dividend shares were virtually meaningless. Elephant Talk was
thinly traded. There was no real demand for the stock because of its obscurity and its heavy losses. Hartcourt had
achieved its goal of borrowing revenues from Elephant Talk for the interim period of 2002. Apparently, Hartcourt
was tired of Internet and Telecom related businesses. It was ready to make a quantum leap.
Having divested Elephant Talk, Hartcourt was again virtually a shell corporation. The stock tumbled to
five pennies. Hartcourt needed to masquerade itself as a real business entity. In February 2003, Hartcourt acquired
45% of ownership of a Chinese PC part retailer, HuaQing Corporate Development Co. for 15,960,474 shares of its
common stock. Subsequently it acquired two other Computer retailers, 45% ownership of NewHuaSun Computer
for 13,769,156 shares of Hartcourt and 45% ownership of GuoWei Science and Technology Co. Ltd. for 10,863,792
shares of Hartcourt. Under FASB Statement 115, Hartcourt must use equity method to account for the investment.
To circumvent the Generally Accepted Accounting Principles (GAAP), Hartcourt obtained irreversible voting rights
proxy for 10% of the total equity interests of each company from a few shareholder of each company for five years.
Hartcourt claimed that it had 55% control interest of each company and was eligible for consolidating the operating
results and financial positions of each investee. The creative and abusive accounting procedures allowed Hartcourt
to present sales revenues of all three companies into Hartcourt’s financial statements. The computer retailers were
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barely surviving. Sales revenues were almost the same as cost of revenues. No gross profits were available to
absorb the selling and administrative expenses. Obviously, Hartcourt would record an operating loss. Naïve
investors did not understand this issue. The stock took off again. It jumped from a nickel to around $.60. All
those transactions were in China. They were difficult to be authenticated by a third party. The insiders of those
Chinese companies immediately file statement 144 to liquidate portions of their holdings.
Hartcourt had engaged in many intricate mergers and acquisitions, but it did not have a physical office.
The phone number and correspondent address in the 10K and 10Q were actually the address of its attorney. This
begs a simple question: if the company was so successful, why could it not afford an office. Moreover, Hartcourt
only has three employees that include chairman of the board, president and chief financial officer.
On May 27, 2003, SEC filed a complaint against the Hartcourt Companies, Alan Phan CEO of Hartcourt,
and Yongzhi Yang of Los Angeles. The complaint alleges that the defendants participated in a scheme to illegally
raise money for Hartcourt by using a Form S-8 registration statement. According to the complaint, from September
1999 to November 1999, Hartcourt raised over $800,000 by issuing one million shares of Hartcourt stock, pursuant to
a Form S-8 registration statement, to Yang's wife, purportedly to compensate her for services provided to Hartcourt.
S-8 registration statement is used for issuing free shares to the current shareholders. Holders of S-8 shares must hold
the stock at least one year. The SEC’s complaint alleged that the defendants engaged in securities trading with
inside information, selling unregistered securities and deceiving uninformed investors. The SEC is seeking
permanent injunctions and civil penalties against Hartcourt, Phan, and Yang and disgorgement and prejudgment
interest against Hartcourt and Yang2. SEC may take more actions against the operators of Hartcourt.
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